How could the British pound, or any other currency, be worth more than the U.S. dollar? Isn't America the most powerful country in the world? It turns out that long-term movements in currency prices are more important than exchange rates.

Key Takeaways

  • Historically, one British pound has usually been worth more than one U.S. dollar, even though the U.K. has a much smaller economy.
  • The price of one currency compared to another is not necessarily an indication of wealth, power, or strength.
  • A currency that increases in value against another over many years is generally considered to be a stronger currency.
  • Currency values are sometimes arbitrarily reset by governments, especially after periods of high inflation.

Relative Strength

When one country's currency is worth more than that of another, it does not necessarily indicate a stronger economy. For example, the Japanese yen is regarded as one of the world's strongest currencies. Yet, a Japanese yen is worth only about one U.S. cent. Historically, one British pound has usually been worth more than one U.S. dollar, even though the U.K. has a much smaller economy.

The fact is that looking at a currency's worth relative to that of another currency at a static point in time is meaningless. The best way to judge a currency's strength is by observing its value in relation to other currencies over many years. Supply, demand, inflation, and other economic factors will cause changes to a currency's relative price. It is these changes that ultimately determine the strength of a currency.

Never mistake a high exchange rate for a strong currency.

The Decline of the British Pound

Although one British pound was worth a little more than a U.S. dollar in 2020, it used to be worth a lot more. Britain had a global empire in 1900, and the British pound was worth almost five times as much as the U.S. dollar. World War I, World War II, and the break up of the British Empire took a heavy toll on the pound. During much of the 20th century, the British pound depreciated against the U.S. dollar. This decline made the pound a weak currency, even though it was worth more than a dollar. By the 1980s, the value of the British pound hit bottom. Between the 1980s and 2020, the pound stabilized against the dollar and usually traded for between one and two U.S. dollars.

The Rise of the Japanese Yen

U.S. currency is worth more than Japan's yen mostly because of World War II, but gains by the yen since that time made it a strong currency. In the early 1970s, the U.S. dollar was worth more than 300 yen. The value of the dollar dropped below 100 yen by 1995, in part because of persistent U.S. trade deficits with Japan. Even though the U.S. dollar was still worth more than the yen, the yen was a stronger currency because it was rising in value.

Resetting Currency Prices and the Mexican Peso

In fact, currency prices can be reset at different values. For example, a national government could decide that there has been too much inflation and create a new currency. It might be 10, 100, or even 1,000,000 times the value of the old currency. For example, the Mexican government introduced a new peso in 1993 that was worth 1,000 of the old pesos.

An Example

For instance, let's say that at the beginning of the year, the U.S. dollar was worth 1.75 XYZ dollars (a fictitious currency). Six months later, the U.S. dollar rises to 2.00 XYZ dollars. In this case, the U.S. dollar increased in value over the XYZ dollar by around 14%. This change could be due to XYZ having higher inflation or to lower demand for the XYZ dollar in the United States.