The Big Mac Index
We’ve written about the issue of purchasing power parity (PPP) before, but often with regard to big ticket items. Here’s another approach. Economist:
The Big Mac Index is based on the theory of purchasing-power parity (PPP), which says that exchange rates should move to make the price of a basket of goods the same in each country. Our basket contains just a single item, a Big Mac hamburger, but one that is sold around the world. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value yardstick.
Only a handful of currencies are close to their Big Mac PPP. Of the seven currencies that make up the Federal Reserve’s major-currency index, only one (the Australian dollar) is within 10% of its fair value. Most of the rest look expensive. The euro is overvalued by a massive 50%. The British pound, Swedish krona, Swiss franc and Canadian dollar are also trading well above their burger benchmark. All are more overvalued against the dollar than a year ago. Only the Japanese yen, undervalued by 27%, could be considered a snip.
The dollar still buys a lot of burger in the rest of Asia too. The Singapore dollar is undervalued by 18% and the South Korean won by 12%. The currencies of less well-off Asian countries, such as Indonesia, Malaysia and Thailand, look even cheaper. China’s currency is among the most undervalued, though a bit less so than a year ago…
sophisticated analyses come to broadly similar conclusions to our own. John Lipsky, number two at the IMF, said this week that the euro is above the fund’s medium-term valuation benchmark. China’s currency is “substantially undervalued” in the IMF’s view. The dollar is sandwiched in between. The big drop in the greenback’s value since 2002 has left it “close to its medium-term equilibrium level,” said Mr Lipsky.
This is a rather similar point to the one that IBD made at the end of last year. Question: if commodity prices hadn’t gone parabolic, would we generally have the impression that the dollar had lost so much purchasing power?