$2 a pound

The commentary below is by Scott Grannis, Chief Economist at Western Asset Management.
-- David M Gordon / The Deipnosophist
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The currency markets today registered a milestone of sorts, as the British £ traded above $2.00 for the first time since 1981. The strength of the pound against the dollar has been remarkable, given that U.K. inflation has exceeded U.S. inflation by 25% in the intervening years and the pound was already plenty strong against the dollar in the early-1980s. By my calculations, as shown in the following chart, the dollar is more undervalued relative to the pound today (i.e., the pound is more overvalued vs. the dollar) than at any time in the past 30+ years. My guess at "parity" (the exchange rate which would make U.K. prices about the same as U.S. prices) is $1.32. So today an American tourist in London finds that on average things there are about 50% more than they are here in the U.S. Our London colleague, Andres, has been experiencing the flip side of that equation, as he discovered that Apple laptops sell here for about 25% less than they do in London. A U.K. tourist anxious to see Hollywood and carry home a shiny new MacBook Pro 17" could pay for an economy ticket with the money he or she saves on the laptop. That's an attractive arbitrage opportunity.

[click on chart to enlarge]

Those of us who have been around for awhile remember when the exact opposite occurred. It was in late 1984/early 1985 that Americans by the droves flew to London for weekend shopping sprees. Back then the dollar was about 50% overvalued relative to the pound -- about as strong then as the pound is strong today.

Currency markets are notorious for their ability to follow a trend for too long, overshooting on the upside and then the downside. It looks to me the current valuation of the British £ pushes the limits of how strong it can get.