Tuesday, June 28, 2016

How depreciation of the Pound Sterling affects the Commoner.

Throughout the past year, the British Pound Sterling has been trading against the US dollar at roughly $1.46 (this is just an eyeball guess--I probably erred a bit on the low side, truth be told).

This means the holder of 1 Pound could exchange it and receive $1.46US.

Today (June 28, 2016) 1 Pound exchanges for $1.32.  Now 1 Pound "buys" $.14 (cents) LESS than it did a week ago.  The Pound Sterling has DEPRECIATED relative to the US Dollar.  It is worth less (not worthless!) than it was before the depreciation

How does can this affect a British citizen at home?

Assume a British importer imports $1,000 worth of Apples from the US.  Before the depreciation the importer had to give up 684.9 Pounds to order to buy the apples ($1,000 divided by the exchange rate for 1 Pound---$1.46US).

After the depreciation, the importer has to give up 757.6 Pounds in order to buy the apples ($1,000/ divided by the exchange rate for 1 Pound---$1.32US).

That is a difference of 72.7 Pounds or a 10.6% increase in the price the importer pays.  How do they make up for this?  Either they cut expenses elsewhere, take the loss in profits or increase the price of apples.

This is a quite unsettling sudden shock development for importers and/or domestic consumers of foreign goods and services.

However, it does not only affect importers of finished goods like apples that go directly to consumers for consumption.  The same analysis above applies to British businesses that purchase foreign INPUTS for the production of a domestic good and/or service.

If a British baker buys US apples to use in the production of apple pies, they face the same situation---an increase in the cost of production.  What to do--cut expenses, take the loss in profits or increase the price of apple pies?  Sound familiar?

Bottom line: Depreciation of a currency can (ceterus paribus) lead to broad increases in prices---Inflation.  There are LOTS of caveats with this so take it with a grain of salt.

Hopefully salt not purchased with a depreciating currency.

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