8. Understanding the Pound

18 10 2016

Brexit Blog 8:  Understanding the Pound

Why is the Pound Important?

For many talk of ‘the Pound’ is confusing so here is an ultra-simple approach to ‘understanding ‘the pound’:

Imagine these exchange rates – we’ll use big figures for ease (but they are never this big):

  Pounds Sterling US dollars Euros
Week 1 1 4 6
Week 2 1 3 4
Week 3 1 2 3

What this imaginary table means is that

In week 1 you could exchange your pound for 4 dollars or 6 euros

In week 2 your pound will now get 3 dollars or 4 euros

In week 3 your pound will now get 2 dollars or 3 euros

In the language you see in the press,

In week 1 the pound is strong

In week 3 the pound is weak

A stronger pound is shown by a lower figure for pence per euro/dollar, as it takes less sterling to buy a euro or dollar

A ‘weaker pound’ is shown as a higher figure for the other currency, as it takes more sterling to buy that currency.

(The exchange rates go up and down according to international trade in currencies, rates of inflation and various other international economic factors)

See below, the cost of buying 1 dollar or 1 euro according to the above example table:

   1 US dollar 1 Euro  
Week 1 25p 16.6p Stronger pound
Week 2 33.3p 25p  
Week 3 50p 33.3p Weaker pound

Good news or bad news?

Let’s consider different people:

1. Holiday maker

In week 1, going to France you could have got 6 euros for your pound – lots to spend for few pounds used

Week 3, you only get 3 euros per pound, i.e. you either need to spend twice as many pounds to get the same number of euros or accept you will only take half the number of euros.

2. French Business man

He sells his item at home for 6 euros.

Over here his price tag will be £1 in week 1 but £2 in week 3

i.e. it will be less attractive (more expensive) here in week 3.

Consequences:  with a ‘weak pound’ imports are more expensive and will either not sell so well (luxury goods) or will push up cost of living (essential goods)

 3. British Business man

He sells his item at home for say £1

Over in France his price tag will be 6e in week 1 but 3e in week 3

i.e. it will be more attractive (cheaper) there in week 3

Consequences: with a ‘weak pound’ exports are less expensive and thus more attractive abroad. Good for British manufacturer who may expand his business, take on more staff, helps employment, puts more money into pockets for spending in UK.

(In reality the price ticket changes would not happen so quickly as there are usually a number of buffers [in money or goods held] that means prices take a little while to react.)

And what did the Press say?

Pound hits 31 year low as hard Brexit fears grow  (Oct 4th)

(Sounds bad news)

Sterling fell to a 31-year low against the dollar today amid fears over a so-called hard Brexit. Philip Hammond, the new chancellor, has warned the economy faces a “rollercoaster” ride.

(and then later….)

a 31-year low of 1.2643 against the dollar last night   Oct 7th

(but….)

Sterling stuck in Brexit-inspired spiral (Oct 11 2016, The Times)

(a bad sounding headline followed by….)

The pound fell by half a cent against the dollar to $1.2382 yesterday as traders continued to worry about a possible “hard Brexit”.

(But near the end of the article….)

Lord King of Lothbury, the former Bank of England governor, told Sky News yesterday that fears over the behaviour of the pound since the referendum were overblown.

He said: “The economy was slowing somewhat before the [Brexit] vote and we are in a position where the rest of the world is not offering us much help. I don’t think we should fear [Brexit]. It’s not a bed of roses, but nor is it the end of the world.”

Indeed, a former International Monetary Fund executive has claimed that the slump in sterling is a blessing in disguise after years of overvaluation and helps to break the stranglehold of the financial elites over the British economy.

“The idea that Britain is in crisis or is on its knees before the exchange rate vigilantes is ludicrous,” Ashoka Mody, a former IMF deputy director for Europe now at Princeton University in the United States, told The Daily Telegraph.

The UK economy is rebalancing amazingly well. It is a stunning achievement that a once-in-fifty-year event should have gone so smoothly.”

(and also interestingly, reporting the same….)

Pound needs to fall further’  (The Telegraph – 11 October 2016)

The slump in sterling is a blessing in disguise after years of overvaluation and helps to break the corrosive stranglehold of the financial elites over the British economy, according to a former bail-out chief for the International Monetary Fund.  “It is desirable from every point of view. The idea that Britain is in crisis or is on its knees before the exchange rate vigilantes is ludicrous,” said Ashoka Mody, the IMF’s former deputy-director for Europe and now at Princeton University.

Conclusions?

Don’t Panic – think!

 

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