Why the British Pound Is Stronger Than the U.S. Dollar

From 2012 through 2016, the British pound (GBR) has been worth $1.35 to $1.75 in U.S. dollars (USD). Some confusion exists as to why the British pound is consistently stronger than the U.S. dollar, despite the United States having a stronger and more powerful economy than that of Great Britain or the United Kingdom. The simplest explanation is that the nominal value of a country’s currency and its economic strength have little to nothing to do with one another. For example, Japan features the world’s third-largest economy as measured by gross domestic product (GDP), over 50% larger than that of the United Kingdom, yet as of June 2016, it takes over 102 Japanese yen (JPY) to equal one U.S. dollar and 140 yen to exchange for one British pound.

Nominal Value vs. Relative Value

The nominal value of a currency is relatively arbitrary. What matters is how the value of that currency changes over time relative to other currencies. For all of recent history, one U.S. dollar has been worth less than one British pound. However, as of June 2016, the pound is sitting at historic lows relative to the dollar at $1.37 to one pound, down from $1.71 to one pound in July 2014. This trend is indicative of deteriorating economic conditions in Great Britain combined with an improving U.S. economy.

It’s also worth considering that many more dollars are in circulation than pounds. As of year-end 2015, nearly 1.4 trillion U.S. dollars were in circulation. By contrast, the total pounds in circulation came to a mere 68 billion. To draw an analogy, the 2016 market capitalization of Berkshire Hathaway Inc. (NYSE: BRK.B) is much lower than that of Microsoft Corp. (NASDAQ: MSFT), despite Berkshire Hathaway’s share price being much higher. This is because there are many more outstanding Microsoft shares than Berkshire Hathaway shares.

Consequences of Brexit

On June 23, 2016, British citizens went to the polls and voted in favor of a referendum to leave the European Union (EU), of which the country had been a member since 1973. The “Brexit,” or British exit, came about as a result of a populist movement that had grown wary of ceding control of laws and regulations to outside forces in Brussels and feared the effects of what it viewed as unchecked immigration into Britain. Economists, most of whom were confident that Britain would vote to remain in the EU, warned of economic consequences that would result from Brexit.

The vote in favor of Brexit, which shocked oddsmakers and roiled world markets, had an immediate and pronounced effect on the British pound, which declined in value by over 8% in the 24 hours following the vote. This is another example of relative value trumping nominal value. While the pound remained stronger than the dollar in nominal terms, investors still abandoned the currency, citing its precipitous decline in relative value.

Contributing Writer: Greg DePersio

Reference: Investopedia

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