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The US dollar has soared in value as the British pound weakens following extended periods of political turmoil, low or negative economic growth, and tensions around the future of the UK markets following Brexit and the impacts of the Coronavirus pandemic.
Although a strong dollar might be a positive in terms of confidence in the American economy, the knock-on effect can damage global trade for industries that rely on USD as a primary exchange currency.
Further issues have emerged in the last few weeks with the appointment and resignation of Prime Minister Liz Truss, with a poor market response to a tax plan heavily weighted towards higher earners.
However, USD and GBP are different currencies from dissimilar economies, and their importance within international trade and forex markets is not comparable.
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An Overview of Global Foreign Exchange Market
The Foreign Exchange Market, often called Forex, is an international, decentralized financial market where currencies are traded. It’s the largest financial market in the world, with a daily volume exceeding $6.6 trillion.
The forex market operates 24 hours a day, five days a week, with the major trading centres being London, New York, Tokyo, and Sydney. Its participants include banks, businesses, governments, and individual traders.
The primary purpose of the Forex market is to facilitate international trade and investment by allowing businesses to convert one currency to another.
Traders also participate in this market to speculate on currency value changes, attempting to profit from these changes.
For instance, a British exporter to the U.S. might want to sell their USD for GBP when they believe the pound will increase in value and the USD will drop.
Pound V Dollar: The Basics
Historically, GBP has always been worth more than USD in direct trading. Still, the price of one currency against the other does not reflect essential considerations such as strength, purchasing power or wealth.
Even though the pound is worth more than the dollar by around 13 cents, a more meaningful metric is to look at how a currency has increased or decreased in value over time – indicating that the dollar is significantly stronger than sterling.
For example:
- The Japanese yen, JPY, is considered one of the strongest currencies, yet one yen will buy you about one cent in US dollars.
- One British pound can purchase more than one dollar – current exchange rates are around 1.13. But, the UK economy is considerably smaller and has a fraction of the purchasing power.
The USD dollar is important because it is the most traded and reserved currency globally. Hence, a continual decline in sterling is not as internationally significant as if the same were to happen to the dollar.
When we look at comparable power and how a currency changes in value to other denominations, we get a different picture from relying solely on the nominal exchange rate at any given point.
Highs and lows of GBP v USD
The pound reached a record-high rate of $2.649 against the US dollar on March 6, 1972, the strongest exchange rate achieved since floating in 1971.
Before that, the British government set the GBP to USD rate and maintained around £1:$5 for most of the 1800s and 1900s.
The UK government decided to reduce the declared value of the pound to £1:$4 in 1840 and implemented two additional devaluations during the 1960s before the currency became free-floating.
From here, the US dollar began to grow in strength and mitigate the perceived power of the pound, resulting in a record low of $1.054 on February 25, 1985 – which we were close to on September 26, 2002, with a rate of 1.0697.
In the 1980s, oil prices doubled, and the Federal Reserve in the US boosted interest rates beyond 20 per cent, which prompted large inflows of capital investment and a subsequent climb in the dollar value.
How USD May Be Worth More Than GBP In Real Terms
The role of central banks and their influence on interest rates is another crucial aspect to consider when evaluating the strength of a currency. Central banks, such as the US Federal Reserve and the UK Bank of England, manipulate interest rates to manage inflation, control economic growth, and stabilise their respective country’s financial systems.
Raising interest rates typically strengthens the country’s currency because higher interest rates provide higher rates to lenders, thus attracting more foreign capital, which causes a rise in exchange rates. Conversely, when a central bank decreases interest rates, it typically weakens the currency as lower interest rates provide lower returns for lenders, which may reduce foreign capital flowing into the country.
Purchasing Power Comparison
Apart from these, the real-world purchasing power of the currency in its home country can offer another perspective on its relative strength. This can be evaluated by comparing the cost of the same basket of goods in two different countries, often measured through a metric known as the Big Mac Index popularised by The Economist.
Purchasing power comparison is an important factor to consider while assessing currency strength.
The question of relative strength in a currency depends on your perceptions and how you calculate the weighted value of one currency over another.
Typical currency quotations show that the pound is more valuable than the dollar, but most other measurement bases will reflect the opposite.
Purchasing Power Parity (PPP) calculates how much a currency is worth based on a basket of goods, similar to the Consumer Price Index (CPI), which measures inflation. So, for example, if we have a GBP/USD rate of 1.2500, our basket of goods worth £100 in the UK would cost $125 for a US consumer.
PPP is a theoretical concept that provides an anchor to measure exchange rate movements. In addition, analysts will assess the variance between the PPP and the market currency exchange rate to evaluate other influences, such as investor speculation.
When a currency is in high demand, it grows in value – but that is a natural outcome of forex market trends and confidence and does not necessarily mean that real-time purchasing power has changed.
Currencies are strong when their value climbs to other currencies and weak when the opposite happens, indicating that although £1 will buy more than $1, sterling is not necessarily the stronger denomination.
The strongest currencies globally are those considered safe-havens, such as:
- US dollars (USD)
- Swiss francs (CHF)
- Japanese yen (JPY)
These currencies are less likely to fluctuate wildly during economic turbulence, with the USD being the most popular investment option with high liquidity levels, in use as a global reserve currency, and backed by the Federal Reserve and US Treasury reliability.
Why GBP has declined in purchasing power
The British Empire of 1900 meant that sterling was one of the most widely used currencies, with a pound worth around five times more than a dollar. However, the two World Wars, the breakdown of the British Empire and the growth of the USD caused a sharp decline, with dollars becoming the primary exchange currency.
Today, nearly every major commodity, such as grains, metals and oil, is priced in USD. USD also accounts for around 60 per cent of currency reserves held by less affluent countries to shore up their economies.
USD is considered a safe currency when the markets are unstable due to falls in stock markets, economic volatility or concerns over the impacts of geopolitics on global economics.
The US overtook the UK in the 1890s as the largest worldwide economy, and the dollar was established as the preferred reserve currency in the 1920s.
GBP has consistently declined against the USD for most of the 20th century, making the pound a weaker currency, regardless of exchange rates.
The Issue With GBP/USD Exchange Rate Quotes
One of the crucial issues for traders is to recognise that GBP/USD exchange rates quoted online do not reflect the real-time trading value you would achieve if you purchase one currency for the other.
Forex brokers set exchange rates based on the interbank rate, their commissions, or a spread between the ask and bid prices for any currency pair. Even where a site such as FX Street or Daily FX quotes a live exchange rate, this is not a customer rate.
International financial systems use interbank rates. The exchange rates banks use for their internal transactions.
Many online exchange rate websites also publish attractive headline rates that do not indicate the realistic rates a trader or customer might expect to pay.
The best way to receive an actual exchange rate for a prospective transaction, trade or investment position is to request a verified quote from a currency broker.
Pound V Dollar – An Unequal Pairing FAQ
Generally, one pound is worth more than one dollar, so on the face of it, sterling is a stronger currency than the US dollar. However, the exchange rate is not necessarily the only indicator of the power of a currency or how much influence is held over international trading markets.
Regarding relative movements, the pound has halved in its value compared to the US dollar over fifty years, indicating a weakening currency regarding purchasing power.
Exchange rates quoted online are often interbank rates, not those you would get as an individual consumer or trader. This is because the interbank rate shows the exchange rate between banks rather than the value you could buy, sell or exchange the two currencies.
Over the last two years, sterling has dropped due to various factors, including the Coronavirus pandemic, when GBP fell 12 per cent within two weeks during the early days of the lockdown.
Investors have also sold sterling more recently due to economic and political uncertainty, choosing to invest in US dollars as a safer, less turbulent alternative.
The pound sterling has been worth more than one US dollar for over 20 years, which was why the switch to vice versa caused a market shock and disruption in forex trading. In September 2022, USD was at about 1.1000 to GBP, meaning the pound is close to parity with the dollar for the first time.
When the outcome of the UK referendum was announced, and it became clear that Britain would leave the EU, the pound fell by 13 per cent against the US dollar within 14 days.
Leaving the EU caused several concerns, including sweeping changes to immigration laws, international law and the legal system, where many statutes had been based on European regulations.
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Ripping off the public as usual the fat cat at the trough again.