GBP Currency Crisis - Forex supply and demand affecting exchange rates

Question

Reading this article on Why China Buys US Treasury Bonds I understand the notion of supply and demand affecting a currency value against the other and how they need to buy up the excess dollars they are paid in. I understand this on the basis if there is a lot of USD in factories bank accounts and no local currency (that the owners might want to invest in things within the country, property etc) then this will push up demand for local currency among the local market (as not as many of those owners would want to be investing in the USA). Or at least as I understand it.

It goes on to talk about GBP currency crisis after World War 2, with Pound Sterling being the worlds reserve currency even though counties did not intend to spend their reserves or invest in the UK and eventually sold off, leading to deteriorating economy and high interest rates.

My questions are:

1. This selling off, as i understand from a supply and demand perspective - would develue the currency. Interest rates were increased by the Bank of England by removing GBP from supply (how do the do this are notes destroyed?)

2. If the UK was exporting more than it imports, then a falling currency would be beneficial as it would allow demand to increase due to buying power of other countries. Was this the case, or are there other issues at play?

3. What books would you recommend for learning more about these mechanics - exchange rates and pegging etc have always been a mystery, but learning more about the nuances of supply and demand would be useful.

Thanks in advance for the time and helping in my journey of understanding econimics in more detail!

Answer 1

Interest rates were increased by the Bank of England by removing GBP from supply (how do the do this are notes destroyed?

Actually, the relationship is endogenous here equilibrium interest rate and quantity of money are simultaneously determined by each other.

Higher interest rate makes people save more and borrow less money or let's say repay flexible interest mortgages earlier or government will issue less bonds than it otherwise would. Lending expands money supply as it allows more money to be created than the amount originally existed as high powered money, and repaying loans destroys those non-high powered money.

If the UK was exporting more than it imports, then a falling currency would be beneficial as it would allow demand to increase due to buying power of other countries. Was this the case, or are there other issues at play?

This is actually more complex. First, it does not matter whether UK was exporting more than importing. Depending on macroeconomic situation it might be better for a country to export more than it currently does.

By the numbers UK is currently net importer (net exports are negative), but again you can't just blanketly say that means strong currency is beneficial for UK. Whether country is net exporter or importer depends also on value of the currency. If GBP devalues enough it will likely turn UK into net exporter, ceteris paribus.

What books would you recommend for learning more about these mechanics - exchange rates and pegging etc have always been a mystery, but learning more about the nuances of supply and demand would be useful.

Good textbook that covers this is: Copeland Exchange Rates and International Finance.