What would have to happen in the USA economy for the US Dollar to gain in value compared to the British Pound?

Question

This might seem like a simple question to many of you economics students, but I never took an economics course; therefore, I am a novice about this subject.

The dollar always seemed to be worth about $1.50 to $1.75 a British Pound for years, but within the last year or so it sank to where High Street banks are only valuing it to about $2.05 to a Pound.

Why is this, and how did it happen?

What would the Americans need to do if they wanted their dollar to be more at par with the British Pound? Or, what would have to happen in the UK for the British Pound to sink lower in value to be nearer to the USA Dollar level?

Thanks! As I said, I am not an economist, so please have patience with my simplistic questions.

Answer 1

As with the value of anything, the value of currency is based on supply and demand. Value is inversely proportional to supply: if supply goes up value goes down. On the other hand, value is directly proportional to demand: if demand goes up so does value. Both sides of the law of supply and demand are working against the value of the dollar.

1) Supply: In order to finance the war in Iraq, the government is printing more money. They borrow the money by issuing Treasury bills etc. But they need to print cash to actually spend it. (This is a very simplified description, there is much more to it than just this).

2) Demand: Because of the declining international opinion of the US, less foreign investment in the US is occurring. Foreign investors do not want to invest in a "bad" country because of the perceived additional risk. Since there is less foreign investment, there is less growth in the US economy. Think of the economy (at any scale) as being a big swimming pool of cash. The cash flows around and around, but unless there is more cash added (foreign investment) the level of the pool stays the same. Without foreign investment, there is little demand for dollars.

In the end, higher supply and lower demand has caused the dollar to weaken against not only the Pound, but also the Yen and the Euro.

In order for the dollar to strengthen against the Pound (or any other currency), demand would have to increase and/or supply would have to decrease.

One example: A strong stock market would attract foreign investors, thus driving up demand for dollars. A strong stock market could result from a change in interest rates. Lower rates result in more money to expand businesses.

Hope this helps

Answer 2

This is a very good question. I am not an economist either, but here are a couple of things that the U S might do to increase the value of the dollar (keep in mind that the U S actually wants the dollar to keep falling). A rise in interest rates would streigthen the dollar. A drop in the trade deficit would strighthen the dollar. A drop in the budget deficit would streighten the dollar. The latter two are not likely to happen any time soon. U S wins the war in Iraq. Again somewhat unlikely in the near future. Price of oil drops to $35.00 a barrel. Not too likely either.

On the U K side, the U K announcing they would increase forces in Iraq would likely drop the pound. U K cuts interest rates. A major terrorist attack on the U K. A collapse of the chunnel.

Answer 3

The US is borrowing a ton of money to pay the the wars they are currently in. When borrowing so much money, we owe more money. It makes our dollar weaker.

Basically we have to stop borrowing money to make our dollar stronger.

Money is traded on the FOREX market its a free market. Countries and others feel that because of the debt the US dollar has its better to invest in the British Pound. It makes the value of the dollar less. Other people would rather have their assets in other currency then dollars and it weakens the dollar. Hell at this point Im thinking the Federal Reserve wishes they could have their money in something other then the dollar.

Thats the simple answer.

Answer 4

http://www.wisegeek.com/what-is-currency-valuation.htm

Here's a rather simplified answer but it's a pretty darn good one.
Essentially, for the dollar to increase in value, the US would have to import less than it does currently, export more (reduce the trade deficit) and reduce outstanding debt (reduce the spending deficit). All much easier said than done.

Answer 5

At it's most basic the USA needs to export more.