Recently I noticed that the 1 USD was worth 0.8 GBP and now it’s worth 0.78 GBP. Not much deal to an average consumer. What does that mean for the economy for both countries and what does it tell about the relative strength of both currencies?
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It’s all about supply and demand, both within an economy and on a global scale.
China has a strong economy, but $1 US is still worth a little over 7 Yuan. The economies are very different from one another, so the values are different when compared. The wages reflect this as well, since the median Chinese income is around 26,000 Yuan.
They’re different, but that doesn’t mean one is better than the other.
A currency’s value can also rise or fall on the global market without any significant impact on the domestic market. It’s unusual, since imports and exports decide a lot of the global value, but it’s possible.
As far as “what it means for the economy of both countries,” the exchange rate plays a big role in determining the level of trade between countries. A “strong” currency sounds good, and in some situations it is – for example, if you’re traveling in a country with a “weaker” currency, your money will probably go farther. But at a national level, having a strong currency makes it harder to export goods, because it is more expensive for other countries to buy them.
Using the China example, when China imports goods from the US, they have to pay in dollars. Meaning that they have to buy dollars, which at the current exchange rate is a bit costly. On the flip side, if the US wants to import from China, it can buy 7 yuan with each dollar and use those to pay for goods.
The exchange rate is hardly the only thing that determines trade flows; it’s not even the biggest thing. At the end of the day, the US buys from China because China can make stuff very very cheaply compared to most other countries. But sometimes when two countries are offering similar products at similar prices, the exchange rate might determine which is more attractive.
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When the value of currency goes down, it makes the exports more competitive and decreases imports as people can’t afford them as well. That usually makes the money flow into the country, making currency more valuable, etc. The other way around the money flows out the country, decreasing its value, etc. So it’s that sort of balancing act. The absolute value of currency means nothing, only what the trend is at any point in time.
The relative strength of both currencies is determined by things such as demand for those currencies on the global market and differences in interest policies. (On of the) most important, if not the most important factor is the simple economic law of supply and demand. Keep in mind however that the USD is often used as the currency against which other currencies are valued, it is known as the “world reserve currency”. This means that the USD is often used by countries even when neither of them uses the USD themselves, for example when trading oil or natural gas on the world market. Prior to WW2 the British Pound was often used.
So, especially when only comparing a currency to the USD it may seem that the non-USD currency gets stronger (increases in value) of weaker (decreases in value), whereas in fact it is the USD which gets weaker or stronger when more currencies are compared. The world bank uses a weighted average of the values of different currencies (amongst which are the US Dollar, British Pound, Euro, Japanese Yen and Chinese Renminbi) as the base currency against which to trade others.
In general, you can say that a weaker currency will stimulate a country’s export (as their products become cheaper because you get more of their currency for your dollar), while it may make their imports more expensive (as they need more of their currency to purchase dollars on the world market). Though this will obviously help their export, it has downsides too as the price for goods like oil, raw materials and food rises. This will result in higher prices for consumers, causing shortages and inflation (which is just a fancy way of saying your currency is losing value or purchasing power).
Having a stronger currency tends to create more stable markets and reliable development of prices which has long-term economic benefits. Historically it seems that a stable currency benefits a country more than continuing devaluations in attempts to stimulate exports.
Minor changes, like those in your example, are mostly caused by demand and supply, and much like the value of stocks on the stock market it may not always be easy to explain exactly why they went up or down.
Having said all this, keep in mind that the global economy is a very, very difficult subject and what I said are just broad generalizations.
This means that the pound became stronger. The reason is that there is a net import into the UK meaning that there are less people that wish to buy USD in order to pay for non-UK goods they wish to import into the UK them there are people that wish to buy GBP in order to pay for UK goods for export.
The result from an UK point of view is, that buying stuff priced in USD becomes more effordable as you need to exchange less GBP to obtain the same amount of USD. This means that imported goods will become more expensive. Same goes for going on a holiday in a USD country. In contrast, buying UK products as an outsider becomes more expensive.
This might result in an increase in UK imports and an decrease in exports resulting in a balance. If the UK production is however still more competitive despite this changes, the trend will continue, making life in the UK more effordable for its inhabitants and their savings more valuable on an international scale.
Minor fluctuation in the currency are quite frequent, but long term trends could indicate a general trade inbalance between different countries.
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