What Does Big Mac Index 2003 Say?
From The Economist print edition
The Economist's Big Mac index of currencies offers food for thought.
The Big Mac index seeks to make exchange-rate theory more digestible.
It is arguably the world's most accurate financial indicator to be based
on a fast-food item.
IT IS time for our annual bite at burgernomics. The Economist 's
Big Mac index was first launched in 1986 as a gastronome's guide to whether
currencies were at their correct exchange rate. It is not intended to
be a precise predictor of currency movements, but simply a way to make
exchange-rate theory a bit more digestible.
Burgernomics is based upon one of the oldest concepts in international
economics: the theory of purchasing-power parity (PPP). This argues
that the exchange rate between two currencies should in the long run
move towards the rate that equalizes the prices of identical bundles
of traded goods and services in each country. In other words, a dollar
should buy the same amount everywhere.
Our “bundle” is a McDonald's Big Mac, which is produced to more or
less the same recipe in about 120 countries. The Big Mac PPP is the
exchange rate that would leave hamburgers costing the same in each
country. Comparing a currency's actual exchange rate with its PPP is
one test of whether the currency is undervalued or overvalued.
The greatest triumph of the Big Mac index has been in tracking the
euro. When Europe 's new currency was launched in January 1999, virtually
everybody predicted that it would rise against the dollar. Everybody,
that is, except the Big Mac index, which suggested that the euro started
off significantly overvalued. One of the best-known hedge funds, Soros
Fund Management, admitted that it chewed over the sell signal given
by the Big Mac index when the euro was launched, but then decided to
ignore it. The euro tumbled; Soros was cheesed off.
Overall, the dollar has never looked so overvalued during 15 years
of burgernomics. In the mid 1990s the dollar was cheap against most
currencies; now it looks dear against all but three. The most undervalued
of the rich-world currencies are the Australian and New Zealand dollars,
which are both 40-45% below McParity. They need to ketchup.
All the emerging-market currencies are undervalued against the dollar
on a Big Mac PPP basis. That, in turn, means that a currency such as
Argentina 's peso, which is undervalued only a tad against the dollar,
is massively overvalued compared with other currencies, such as the
Brazilian real and virtually all of the East Asian currencies.
Some of our readers find the Big Mac index hard to swallow. Not only
does the theory of purchasing-power parity hold only for the very long
run, but hamburgers are a flawed measure of PPP. Local prices may be
distorted by trade barriers on beef, sales taxes, or big differences
in the cost of property rents. Nevertheless, some academic studies
of the Big Mac index have concluded that betting on the most undervalued
of the main currencies each year is a profitable strategy.
Source: http://www.economist.com/markets/bigmac/displayStory.cfm?story_id=581914
http://www.economist.com/markets/bigmac/displayStory.cfm?story_id=1537385 |
