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

A Brief History of the UK pound (GBP) vs. the US dollar (USD)

Before WWII, the British pound was the primary medium of foreign exchange,

The British pound (aka Sterling) has been nominally stronger than the USD for most of the past few decades, making a high just over 2.0000 USD per GBP around the time of the Great Financial Crisis (GFC) of 2008/2009. The GFC saw investors flee to the USD and out of the pound, among other major currencies. Once the GFC dust had settled, GBP had dropped to the 1.4000/4500 level. The GBP weakness was more a case of panic buying of the USD rather than any GBP-negative issue, as other major currencies weakened sharply against the USD as well (see long-term chart below).

In subsequent years, GBP/USD fluctuated between roughly 1.40-1.70, but then came Brexit in June of 2016, where the UK surprisingly voted to leave the European Union. The pound was knocked from the 1.40/45 area lower down into the 1.20/1.25 area virtually overnight, where it remained until recent events and market dislocations. The culprit this time was a combination of factors, chief among those is USD strength due to widening interest rate differentials in the USD’s favor. Along with higher relative interest rates, the US economic outlook is reasonably positive, while market watchers are soon to declare the UK is in or near recession.

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. Historically, for over 20 years one U.S. dollar has been worth less than one British pound. As of July 31, 2020, the dollar is sitting around 1.32 to one pound. This is down from 1.68 in May 2014 and 1.40 in March 2018. This trend is indicative of deteriorating economic conditions in the United Kingdom, mainly from Brexit, combined with an improving U.S. economy.

It’s also worth considering that many more dollars are in circulation than pounds. As of July 2020, nearly 1.93 trillion U.S. dollars were in circulation. By contrast, the total pounds in circulation came to a mere 70.16 billion. To draw an analogy, the 2020 market capitalization of Berkshire Hathaway Inc. (BRK.A, BRK.B) was much lower than that of Microsoft Corp. (MSFT) despite the fact that Berkshire Hathaway’s share price is 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 weary of ceding control of laws and regulations to outside forces in Brussels and feared the effects of what it viewed as unchecked immigration. 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 shocked oddsmakers and roiled world markets. It also 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.

The pound has been turbulent and volatile since the 2016 Brexit announcement. Near the end of 2016 the GBP/USD reached lows around 1.20. In 2018 there was a slight rebound, peaking at around 1.40 in April 2018. In March 2020, the currency pair reported some new lows around 1.16.