Why do currency rates help or hurt tourists?

Question

Using Britain and the US as examples, I often hear tourists say one of two things:

1. British tourist: Shopping is so cheap in the US, since the pound is ~1.3 against the dollar!

2. American tourist: Shopping is so expensive in Britain, since the dollar doesn't go very far against the pound!

This has always confused me. Surely, a $5 item in the US costs 5 / 1.3 = £3.84 ? And surely a £5 item in Britain costs 5 / 0.81 = $6.17 ?

Shouldn't the item's price and value be the same in relative terms? Why would the currency difference have any effect on what you have to spend?

Unless the item is actually cheaper or more expensive in absolute terms in the other country, in which case the currency has nothing to do with it. Am I wrong?

Answer 1

Suppose the exchange rate is 1.5 USD = 1 GBP. Suppose in New York there is a hamburger you can buy for $3 and in London there is a hamburger you can buy for 2 GBP. At this time the prices of the two hamburgers are effectively equal since 3 USD = 2 GBP. So you can say the price of either hamburger is 3 USD, or you can say it is 2 GBP; they are the same. If you were sitting in New York with $15 in your hand, you could buy five hamburgers, or you could go to London, exchange the $15 for 10 GBP (15/1.5 = 10), and still buy five hamburgers. Likewise if you were sitting in London with 10 GBP, you could buy five hamburgers or go to New York, trade your pounds for $15 (10*1.5 = 15), and still buy five hamburgers.

Now suppose that due to some event (such as the Brexit vote) the exchange rate shifts. Now 1.25 USD = 1 GBP. It is unlikely that hamburger vendors in both cities will immediately update their prices to reflect the change. Thus the hamburger in New York still costs 3 USD and the hamburger in London still costs 2 GBP. But because of the change in exchange rates, if you measure the prices in the other currency, you find that hamburger in New York now costs 2.40 GBP (3/1.25), while the hamburger in London now costs only $2.50 (2*1.25).

The prices of the hamburgers have now diverged. If you were sitting in New York with $15, you could buy five hamburgers -- or you could exchange your 15 USD for 12 GBP (15/1.25 = 12), and when you went to London, you would now be able to buy six hamburgers, because each one costs only 2 GBP. Likewise if you were in London with 10 GBP, you could buy five hamburgers, but if you exchanged your 10 GBP for $12.50 (10*1.25 = 12.5), when you got to New York you would no longer be able to afford five hamburgers, because they cost $3 each.

This is what is meant by saying that a given exchange rate makes things cheaper or more expensive in one country versus another. It means if you were to exchange your money for the other currency, it would buy more (or less) of the same goods in the other country. In the longer term, the fluctuation of exchange rates may be intertwined with other economic changes that could cause prices to shift for other reasons, so the "hamburger arbitrage" opportunity might not last. But from the perspective of a traveler going from one country to the other, it just means there are at least some goods available at prices that are not commensurate when converted to a common currency.

Answer 2

Yes you are wrong in most cases, because exchange rates between 2 currencies are always changing as they are traded on the FX market.

If the GBP goes up 20% against the USD then it will be cheaper for English tourists in the US and more expensive for US tourists in the UK. If the GBP goes down 20% against the USD then it will be more expensive for English tourists in the US and cheaper for US tourists in the UK.

In fact, lately it has become more expensive for UK tourists to go to the US and cheaper for US tourists to go to the UK, as the GBP has fallen 28% since mid-2014.

Another example of this is with the AUD/USD. In mid-2011 the AUD reached $1.10 against the USD and everyone who could was taking the opportunity to take a trip to the US because it was so cheap for us compared to previous years. Now that the AUD has fallen back to $0.75 against the USD, it has become a lot more expensive again for us to go for a trip to the US and spend our money there.

Answer 3

It depends on the items, and for example, the relative labor cost for services such as waiters in a restaurant. There is a concept of "Purchasing Power Parity" to attempt to normalize the cost of goods and services. The mosy accessible example is The Economist magazine's long-running Big Mac Index which compares the local cost of a McDonald's Big Mac to infer information on the relative strength of currencies using an identical product. If you look at that link, in USD terms, the price of a Big Mac ranges from $1.99 to $6.59 across the world.

At a more micro level of $5 and £5 transactions (meals, pints of beer, etc) there is a trend to choose psychological pricing. 4.99 is simply going to be more common on menus or in retail stores than 3.84 or 6.14; and will stay at 4.99 for some time due to price stickiness even if the local currency suddenly plunges or strengthens against the dollar.

Furthermore, within a country like the US, a draft pint of the same kind of beer can run $3 to $7. Dinner entrees range from $10 to $30. From my experience in the UK, the price point of beer and entrees also lies within this range in the quanta of pounds, but I don't have a strong sense for where the median might lie nationally (or to what extent it depends on the region). So in a local sense for a single person considering a single transaction, the quanta of the price of an item or meal might be interpreted in their "home currency" and then they interpret the cost differential as an exchange rate difference, even if it's really a price spread due to the location of the service provider. Often (but not always) tourist areas are overpriced compared to other options within a country.

Answer 4

The advantage for a tourist with a favorable exchange rate is that their currency goes further when converted to the local currency where they're visiting. If, for instance, you receive $1.30 U.S. for every British Pound, you can purchase 30% more for each pound than if the exchange rate was even -- $1.00 U.S. to each British Pound.

So, for instance, using a sample exchange rate of $1.30 to the Pound (don't want people taking this seriously as an actual rate, mind you!), I would receive $130.00 U.S. for 100 British Pounds. The exchange rate has no effect on local prices -- it's not as if anyone you're buying from during your holiday is going to raise their prices to account for the exchange rate. So you benefit by paying what the local rates are, even though you receive more of the local currency because of the favorable exchange rate.

On the reverse, a U.S. tourist traveling to Britain would fare less well, because it would take $1.30 U.S. for each British Pound he wants to convert, so everything costs him more in relative terms -- since his home currency is the U.S. Dollar. His $100.00 would only net him 81 British pounds. He has to put up more dollars for the same amount of goods priced in Pounds, so everything does cost him more compared to locals.