Dec 03 2008

How the weak British Pound made my Himalayan ski fantasy a reality!

BBC NEWS | Business | Sterling rebounds from sharp fall

Americans, are you planning a vacation anytime soon? If so, why not visit LOVELY Great Britain! Why, you ask, would ANYONE want to visit the UK in during this wet, cold season? Well, here’s why I’m buying British this year:

I recently booked a Himalayan ski tour in Indian Kashmir organized by a British company. The price? 1400 GBP, which only three months ago was the equivalent of $2800 US! Today, with the newly weak British Pound, my ski trip to India will only cost me $2100*. In the span of just a few months, the dollar price of this amazing Himalayan ski adventure has fallen by $700! Naturally, Americans like myself now have an incentive to buy British!

POUND STERLING v UNITED STATES DOLLAR: December 2007 – December 2008

Chart

What has caused the slide of the Pound in recent months? Here’s the complicated answer:

“The environment of very weak sentiment regarding the domestic economic picture and potential rate cuts alongside equity volatility is keeping sterling very much on the defensive,” said Jeremy Stretch, strategist at Rabobank.

Strategists get paid lots of money to say stuff that 99% of people don’t understand the first time they read it. I get paid very little money to help those people better understand it, specifically, my students. Here’s what Mr. Stretch is trying to say:

A weak economy in Great Britain leads foreign investors to believe that the Bank of England may lower interest rates in the near future. Why would Britain’s central bank lower interest rates? Because lower interest rates create an incentive for consumers and businesses to take out loans from banks and spend money in the economy, which should create new jobs and help prevent a recession in the UK.

If the bank does lower interest rates, this puts “the sterling on the defensive”, in other words, leads to a weakening of the British Pound, as foreign investors looking to put their money where they can earn a decent return on it will be less likely to save in the UK when interest rates fall. “Equity volatility” is a fancy way of saying British stocks have been performing poorly, decreasing their attraction to foreign investors. When saving in British banks becomes less attractive due to expected interest rate cuts, and buying British stocks becomes risky due to their volatility, investors turn to the safest investment in the world, which is… can you guess? United States government bonds!

So how’s this all relate to exchange rates, you ask? Let’s leave this question for readers to answer and discuss in the comments:

Discussion Questions:

  1. How does the expected drop in British interest rates affect the demand for British pounds on foreign exchange markets? What does this do to the value of the pound?
  2. Why does the stability and safety of US government bonds lead to a strengthening of the dollar in times of global economic slowdowns?
  3. How has the recession in the United States further contributed to the weakening of the British pound?


*In fact, I’m too poor to take a ski trip to India this year, I will have to settle for the puny peaks here in the Swiss Alps!


About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

20 responses so far

20 Responses to “How the weak British Pound made my Himalayan ski fantasy a reality!”

  1. Colleenon 03 Dec 2008 at 6:04 am

    Thanks, Jason. I am sending this on to my folks. Maybe they will visit there someday soon. As for me, I have to stick with the measly slopes of the Sierras. Oh well.

  2. Nicholas s.on 04 Dec 2008 at 3:38 am

    The expected drop in British interest rates will most defiantly cause the pound sterling to perform poorly on the foreign exchange market. The reason for this is that people are speculating that the bank of England will seek to boost the British economy by decreasing interest rates (expansionary monetary policy), which is attained through increasing the money supply. The low interest rates are a turn off for investors who would prefer to invest where they would receive higher returns. This decrease in investment into pound sterling will most likely cause it to perform poorly in foreign exchange markets. To be sure as to whether or not the pound has actually depreciated we must look at its relative interest rates compared to another country.

    The weak pound is ‘bad’ for British consumers as they are unable to buy as many exports with their depreciated ponds compared to before, however the weak pound does benefit british producers, Mr. Welkers Himalayan ski tour in Indian is a perfect example of how the depreciation of the pound compared to the USD has now made it possible for him to afford the ski tour bringing with it both revenue for the Himalayan ski company and supplying Mr. Welker with large amounts of utility.

  3. Robin Thekemuriyilon 07 Dec 2008 at 6:53 am

    I think Nic has answered the first question well, and I agree with him saying that the pound will depreciate to the dollar. As he already mentioned, lower interest rates means less return for investors, so they are less likely to invest in the UK at the moment. Now I will try to answer the second question, the article states that the safest investments in the world are in US government bonds. I said that people are less likely to invest in the UK now, due to the low return, now these people have an option to invest in US bonds. In times of instability, US government bonds are safe, and people will want to invest in this due to the security. Investors want to invest in places where they get decent returns and with the least risk involved. This will increase the demand for US dollars because more people will now want to invest in US bonds. US bonds have less risk than investing in a country that might be falling into recession. This increase in demand will cause the dollar to appreciate. This is the reason to why the stability and safety of US government bonds lead to a strengthening of the dollar in times of global economic slowdowns.

  4. Eithanon 08 Dec 2008 at 5:46 am

    There are three factors causing the depreciation of the GBP. First, lower interests will mean less foreign investment, less demand for GBP, and hence a depreciation of the pound. Second, as investors speculate that the pound will depreciate, investment in the pound as an asset will fall. This will cause a decrease in demand for GBP and thus a depreciation of the pound. Third, as a result of the economic recession in the US, American consumers are saving more and buying less. This also means that they will demand fewer British products. As demand for the pound falls, the pound will depreciate. Interestingly, a depreciation of the pound will serve as an incentive for American consumers to purchase more British goods, which now appear cheaper. This is an example of how floating exchange rates balance trade. Finally, I don't agree with Nick's statement that "To be sure as to whether or not the pound has actually depreciated we must look at its relative interest rates compared to another country." In order to check if the pound has depreciated, its value must be compared with another currency's value, not another country's interest rates.

  5. Magdalenaon 09 Dec 2008 at 1:58 am

    Because of that the British pound will depreciate against the US dollar, American consumers will demand more pounds since the currency is now cheaper.

    Investors are going to think that it is risky so have stocks in Britain which will lead to that they will sell their stocks in Britain, and buy other foreign ones, and people are going to want to invest in America because it will be considered as more safe.

    British people are going to demand US bonds because they are safer, which would lead to an increase of the demand of dollars, which would lead to that they would have to supply more, so an increase in supply aswell,which would cause the dollar to appreciate agaisnt the pound.

  6. Moritzon 09 Dec 2008 at 3:02 am

    I think everybody above has answered the question properly, as Britain's interest rates drops foreign investors will have less incentive to buy Pounds because the return is less than it was before and other countries probably have higher interest rates.

    As other currencies fluctuate, and investors speculate that the currency will depreciate they can invest into US government bonds because they tend to be more "safe". As more people demand US Dollars to by government bond the Dollar will appreciate and is therefore safe to invest in.

    The recession in the United States has decreased consumer spendings from Americans. This means that they are less likely to import British goods such as Walkers Crisps. The decrease in demand for British goods and therefore British Pounds means that the Pound will depreciate compared to the US Dollar.

  7. Elisabeth Spielbichlon 12 Dec 2008 at 12:58 am

    I have another example that relates to the weak British pound and the strong US Dollars.

    I know somebody who recently went to New York for their Christmas shopping because apparently they believed that it was cheaper to buy in New York rather than in London. However, if they looked at the exchange rate, they would have seen that the British pound depreciated and that the American dollars appreciated.

    Consumers would have to pay more for Christmas goods in America compared to in England where they are cheaper. In theory, Christmas shopping should be done in London rather then in New York because the goods have become cheaper.

  8. Mankaon 12 Dec 2008 at 6:36 pm

    well, everone has answered the question pretty well! i would like to further dicuss Elisabeth's comment….Elis, you said that someone you know went to New York instead of London. It could be possibly because the airfares might be cheaper if you travel to New york than in London. Also, it might be their decision to visit places in New York, and they didn't want to go to London!

    basically, the underlying message is that, exchange rates do affect the demand and supply of goods in a country to a certain degree, but a lot of different factors such as tastes and preferences, are involved which affect demand and supply!

  9. Miguelon 14 Dec 2008 at 8:47 am

    A drop in interest rates will depreciate the British pound, the reason for this is that because interest rates are lower people will have less of an incentive to put their savings in British banks. Making the demand for the British pound decrease.

    The reason why the stability and safety of US government bonds will lead to the appreciation of the dollar because people will demand more bonds many investments in this economic slowdown seem insecure, such as the housing market and stocks. Bonds seem very alternative as an investment as they are secure, and buyers will definitely get a return.

    The recession in the United states has lead to a depreciation of the British pound because as consumer confidence decreases people are likely to consume less (British) imports, decreasing the demand for pounds and making the pound depreciate.

  10. Joelon 14 Dec 2008 at 7:04 pm

    To answer the first question, the expected drop in interest rates causes a depreciation in the pound through speculation. When countries' domestic central banks lower their interest rates, they disincentivise foreigners as well as the domestic population from saving their money in domestic banks, as they will get less return for their financial investment. This plays into the factor of relative interest rates. The pound will depreciate due to lower demand for it on foreign exchange markets. Who wants to buy pounds when you can't make money on them?

    Also, in a situation with a volatile market, such as a recession, investors will look to stable forms of investment. Government bonds offer this kind of stability. As long as the country that issues them is politically stable, bonds usually guarantee stable higher-than-market-rate returns on loans by individuals to the government. It's a safe investment, and as the US borrows more and more for its fiscal stimulus in this time of recession, it will seek to borrow more finance domestically, issuing more bonds. This will naturally cause an appreciation of the dollar, as the demand for these bonds is inelastic. Thus, people will need to buy dollars to be able to acquire these bonds.

    The recession in the US has further contributed to the weakening of the pound through the foreign demand for its government bonds, and the effects of the recession which started in the US on British government economic policy i.e. reducing the interest rates. Britain has only lowered the cost of borrowing because of the recession, and this can be firmly blamed on the US.

  11. Merion 14 Dec 2008 at 10:10 pm

    I think all the points have been discussed above and I don't really have anything to add but I personally find this article very interesting and I think it explains very well what we have done in class. It is interesting how people should buy British good because of the weak pound but on the other hand they should invest in the US because Britain has low interest rates, I actually thought this was confusing in the beginning but I think I understand it well now.

  12. Calvinon 17 Dec 2008 at 4:43 am

    How has the recession in the United States further contributed to the weakening of the British pound?

    A recession in the United States of America has contributed to the weakening of the British pound by Americans demanding less British imports. Most other nations who also import into the United States will also see this trend in their currency. American consumers are scared of this recession and might therefore be more catious on what they spend their money on. In other words the consumer confidence and spending in america has gone down. This affects the British pound in the way that as Americans demand less British goods they demand less pounds on the foreign exchange market. This will lead to a depreciation of the pound as more pounds are available on the market. The dollar may acutally appreciate in this time of recession as the supply of dollars is reduced due to the decrease in the demand of imports.

  13. Deirdre Stensonon 17 Dec 2008 at 4:54 am

    When I first read this article I was very confused; however, I was interested by the idea that depreciating currency in one nation can result in positive effects for neighboring states.

    As interest rates fall in the UK, the British pound will begin to depreciate. Thus resulting in consumers having less incentive to invest their money in British banks, as the returns are not as high as in other nations. Because of the lack of financial return, foreign investment and demand for the British pound will drastically decrease.

    On the other hand, during a volatile economic period, such as a recession, investors will look for areas within the economy that will provide steady returns. This is best seen in the form of United State bonds. Bonds, are a form of alternative investment which can provide stable returns for investors. Furthermore, as more investors look to buy United States bonds, the US Dollar will appreciate.

    within the United States, real incomes for consumers will also fall as a recession grows. This will lead to American consumers being less likely to buy imports or British goods, and switch to domestically produced items. This in turn will again fuel the US economy.

    Due to both the interest rates in the UK, the economics threats of volatility and fall in real incomes, as the dollar appreciates the British pound in turn depreciates.

  14. Horia Stanescuon 17 Dec 2008 at 5:03 am

    Why does the stability and safety of US government bonds lead to a strengthening of the dollar in times of global economic slowdowns?

    In times of global economic slowdowns, people are less likely to go and spend this money on commodities such as cars, concert tickets, video games, etc. Instead people are going to want to save their money. However, the economic crisis means that it is difficult for banks to secure the money which people would invest in them. As such, people opt to buy government bonds, a form of IOUs from the government. This is because governments, unless they collapse (which is very unlikely) will always be able to guarantee that they will eventually pay your money back with interest. Decreasing the supply of dollars by taking them out of the circulation through the selling of these bonds, the government is thus able to increase the value of its currency, which means it would revalue.

  15. Catherineon 17 Dec 2008 at 5:52 am

    The expected drop in British interest rates affect the demand for British pounds on foreign exchange markets. This is because less people will want to place thier money into the banks since they will get less in return from the bank, as a result of the intrest rates being decreased. Not only people from outside of the country will have a decreased incentive to place thier money into the banks, but also people from the country itself. There will be an appreciation of the dollar because more and more people will be demanding government bonds in the recession of the country. Also, as Horia already mentioned, the reduction of the supply of dollars by taking them out of the "circulation through the selling of these bonds, the government is thus able to increase the value of its currency, which means it would revalue".

  16. Jenny Zimmermannon 19 Dec 2008 at 4:36 pm

    An expected drop in British interest rates affects the demand for British pounds on foreign exchange markets because, as the interest rates drop, it will mean that foreign investors will have less incentive (as their possible returns will not be as high) to invest in the UK. This means that fewer pounds will be demanded on foreign exchange markets, causing the pound to depreciate in relation to other currencies.

    The stability of US government bonds leads to a strengthening of the dollar in times of economic slowdown because, in times of economic slowdown, people will be less willing to take risks with their money, therefore they will prefer to invest in more stable things, such as US government bonds. This will mean that more dollars will be demanded and the dollar will therefore appreciate, aka strengthen.

  17. JLon 30 Dec 2008 at 10:37 pm

    Well, I disagree with nost of the people above. I am not an expert in economics but I know for sure that Egland has no industry and the 2 sections moving the money around are the real estate and the insurance business. I live in Greece and if I needed 300,000 Euros to buy a house in London one year ago, now I will need much less (do the maths). Also all the big companies will go for sure to Egland to have their new insurance contracts as GBP is so weak against Euro/USD/JY. I do not think that the govermant has another option than to push the pound up, as products will have to get 20% more expensive compared to 3 months ago.

    Maybe I am wrong but today I bought 10K in GBP, hoping that in the next 2 months I will make some good profit.

    Please advice

    Yannis

  18. Doreenon 06 Aug 2009 at 9:22 am

    Dr. Lopez Jean Marc recently said: “People expecting the sterling to become strong have to be extraordinary optimists on the long term but I think that sterling is undervalued against the euro and the dollar at this time…I have started investing in it ; But we have to be careful. It’s not easy money.” Dr. Lopez Jean Marc expects the British currency to appreciate during July and August 2009 .

    He says currency swings have especially helped his performance.

    A dynamic and energetic businessman, Dr. Lopez Jean Marc has extensive experience in the areas of asset management (private equity and portfolio management), business consulting, government and higher education. Presently, Dr. Lopez Jean Marc is the President of A-Venture Capital LLC., an asset management firm situated in Wall Street Manhattan.

    In the past, he has advised foreign governments and various businesses, providing both practical advice and analyses in the area of currency risk management and global development. He presently is an advisor to several companies.

    Dr. Lopez Jean Marc is a quantitative monetary economist (to include international economics & finance) and is a currency expert.

  19. Rocio Perezon 18 Nov 2009 at 4:35 am

    Demand for Britain pounds falls whenever there is a drop in interest rates due to the low returns from saving or investments in their economy. And wherever there is a decrease in demand for the pound, there is a fall in exchange rates relative to other currencies. Naturally people turn to save investments such as US government bonds, thus a higher demand for the dollar which strengthens the currency. The recession in the US has resulted in a lower demand for British exports affecting the country's GDP. The Bank of England responds by lowering interest rates which brings me back to the beginning where lower interest rates create less of an incentive to save in Britain.

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