Big MacCurrencies

The Economist ^ | 04/25/2002 | Staff

[lds23]

In the history of the Big Mac index, the dollar has never been more overvalued

CURRENCY forecasters have had it hard in recent years. Most expected the euro to rise after its launch in 1999, yet it fell. When America went into recession last year, the dollar was tipped to decline; it rose. So to help forecasters really get their teeth into exchange rates, The Economist has updated its Big Mac index.

Devised 16 years ago as a light-hearted guide to whether currencies are at their “correct” level, the index is based on the theory of purchasing-power parity (PPP). In the long run, countries' exchange rates should move towards rates that would equalise the prices of an identical basket of goods and services. Our basket is a McDonald's Big Mac, produced in 120 countries. The Big Mac PPP is the exchange rate that would leave hamburgers costing the same in America as elsewhere. Comparing these with actual rates signals if a currency is under- or overvalued.

The first column of the table shows the local-currency prices of a Big Mac. The second converts these into dollars. The average American price has fallen slightly over the past year, to $2.49. The cheapest Big Mac is in Argentina (78 cents), after its massive devaluation; the most expensive ($3.81) is in Switzerland. By this measure, the Argentine peso is the most undervalued currency and the Swiss franc the most overvalued

The third column calculates Big Mac PPPs. Dividing the Japanese price by the American price, for instance, gives a dollar PPP of ¥105, against an actual exchange rate of ¥130. This implies that the yen is 19% undervalued. The euro is only 5% undervalued relative to its Big Mac PPP, far less than many economists claim. The euro area may have a single currency, but the price of a Big Mac varies widely, from euro2.15 in Greece to euro2.95 in France. However, that range has narrowed from a year ago. And prices vary just as much within America, which is why we use the average price in four cities.

The Australian dollar is the most undervalued rich-world currency, 35% below McParity. No wonder the Australian economy was so strong last year. Sterling, by contrast, is one of the few currencies that is overvalued against the dollar, by 16%; it is 21% too strong against the euro.

Overall, the dollar now looks more overvalued against the average of the other big currencies than at any time in the life of the Big Mac index. Most emerging-market currencies also look cheap against the dollar. Over half the emerging-market currencies are more than 30% undervalued. That implies that any currency close to McParity (eg, the Argentine peso last year, or the Mexican peso today) will be overvalued against other emerging-market rivals.

Adjustment back towards PPP does not always come through a shift in exchange rates. It can also come about partly through price changes. In 1995 the yen was 100% overvalued. It has since fallen by 35%; but the price of a Japanese burger has also dropped by one-third.

Every time we update our Big Mac index, readers complain that burgernomics does not cut the mustard. The Big Mac is an imperfect basket. Hamburgers cannot be traded across borders; prices may be distorted by taxes, different profit margins or differences in the cost of non-tradable goods and services, such as rents. Yet it seems to pay to follow burgernomics.

In 1999, for instance, the Big Mac index suggested that the euro was already overvalued at its launch, when nearly every economist predicted it would rise. Several studies confirm that, over the long run, purchasing-power parity—including the Big Mac PPP—is a fairly good guide to exchange-rate movements.

Still, currencies can deviate from PPP for long periods. In the early 1990s the Big Mac index repeatedly signalled that the dollar was undervalued, yet it continued to slide for several years until it flipped around. Our latest figures suggest that, sooner or later, the mighty dollar will tumble: relish for fans of burgernomics.

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[lds23]

I'm a White Castle man, myself.

[tcostell]

The white castle hamburger is the Indonesian Rupiah of the burger world.

[AzJP]

I have good friends in Belfast, university lecturers.

One commented that the Big Mac comparison lacked credibility due to artitrage, commodity and tax costs, yatta yatta yatta. He lectures Economics, of course.

His daughter, wise beyond her years, cut him off in mid-sentence with "Father, no one wants to buy your paper, you can't eat economic theory, I want to buy a ******* burger!"

What are friends for? :)

[AdA$tra]

So much like gold. An ounce of gold in Roman times could buy you a decent suit and a pair of shoes. An ounce of gold now can buy you a decent suit and a pair of shoes.

[JRandomFreeper]

The price of bread hasn't changed much in the last 3000 years either, if you look at it's price in silver.

Black pepper, however, used to be ounce for ounce with gold. It's much less expensive now.

/john

[GGpaX4DumpedTea]

Twenty two years ago when I lived in Northern Ireland (Portadown) you could not buy a Big Mac in Belfast - you could in Dublin though. In Belfast you could get a burger at Wimpy's, their local idea of a fast food equivalent. By any stretch of an American burger standard, the Wimpy's burger was sub "slider", and not a desirable repeatable experience.

The value of the British Pound has been overstated for many years. When I lived in the UK (1978 to 1981) the exchange rate floated around $2.00 to the Pound. The value of the Pound in the UK was about equivalent to the value of the Dollar in the US in buying power, a 2 to 1 disparity.

[lds23]

My kids think I'm crazy when I come back from the mailbox all excited because the new issue is in. I mean, it's not like I'm wearing black socks and sandals while mowing the lawn.

Is it?

[TLI]

The `Merican Economic Standard.

 

WHATABURGER

SIMPLY THE BEST

[supercat]

Are all of these prices tax-inclusive? In some countries sales and VAT taxes are generally included in posted prices, while in other countries they are not.

In Britain, many restaurants have different prices for eat-in and take-away food, in significant measure because 17.75% VAT is charged on the former but not the latter. I forget what the prices were for Big Macs when I was there.

Also, while Burgernomics are somewhat 'cute', I don't think it's accurate in assessing certain currencies as being 'undervalued'. McDonalds, after all, probably sets prices lower in developing countries with the intention that establishing market share is more important than immediate profit, especially since pricing their products in line with official currency valuations would probably put them out of reach of potential customers.

[supercat]

The value of the British Pound has been overstated for many years. When I lived in the UK (1978 to 1981) the exchange rate floated around $2.00 to the Pound. The value of the Pound in the UK was about equivalent to the value of the Dollar in the US in buying power, a 2 to 1 disparity.

Even at $1.43/£1, a lot of stuff still seemed pricey in Britain. Of course, a 17.75% VAT doesn't help matters.

[Texas_Jarhead]

I second that motion.

[Friedrich Hayek]

The Economist should be required reading for anyone interested in world news. The best magazine out there, all news, no fluff, I devour it each week!

Strangely enough, there was an article about you posted on FR the other day!

Personally, I cancelled my subscription when the Economist endorsed Bill Clinton for President in 1992. It's such a wishy-washy wet Tory magazine.

[Eagle74]

You can't judge the value of a currency by one product. You need the basket of commodities, as well as the inflation rate, exchangablity(liquidity), and utility(can you use it internationally, to buy oil for example) of the currency. Other factors influencing a currency's value, include the issuing nation's political stability, as well as it's finacial stablility and credit rating, also it's size and prevalence in world markets. Finally, a freely traded currency is worth exactly what the market says it's worth, at any particular time, which means "there is no such thing as over or under valued in a free market".