Infographics: The Big Mac Index

This is a neat infographics on the Big Mac index from onlinemba.com

(hat tip Scott Lincicome)

click on this link: onlinemba.com to see the original image

Big Mac Index: Swiss Priciest, India Most Affordable

The Economist gives us an update on their Big Mac Index.

They write,

THE ECONOMIST's Big Mac index is based on the theory of purchasing-power parity: in the long run, exchange rates should adjust to equal the price of a basket of goods and services in different countries. This particular basket holds a McDonald's Big Mac, whose price around the world we compared with its American average of $4.20. According to burgernomics the Swiss franc is a meaty 62% overvalued. The exchange rate that would equalise the price of a Swiss Big Mac with an American one is SFr1.55 to the dollar; the actual exchange rate is only 0.96. The cheapest burger is found in India, costing just $1.62. Though because Big Macs are not sold in India, we take the price of a Maharaja Mac, which is made with chicken instead of beef. Nonetheless, our index suggests the rupee is 60% undercooked. The euro, which recently fell to a 16-month low against the dollar, is now trading at less than €1.30 to the greenback. The last time we served up our index in July 2011, the euro was 21% overvalued against the dollar, but it is now just 6% overvalued. Other European currencies have also weakened against the dollar since our previous index, notably the Hungarian forint and Czech koruna, which have fallen by 23% and 16% respectively. Six months ago both currencies were close to fair value, but they are now undervalued by 37% and 18%.

Except for the Philippines, neighboring ASEAN economies as Thailand, Indonesia and Malaysia’s currencies are now in China’s levels whom represent the cheapest in the world, outside India, Ukraine and Hong Kong.

The Philippine Peso from last year’s USD $2.78 seem to have narrowed the gap with a US based Big Mac to $ 2.68 (due to perhaps real appreciation, although in 2011 the Peso was unchanged nominally speaking).

Big Mac Index: Brazil’s Real Priciest, India’s Rupee Most Affordable

The Economist has an annual update of their Big Mac Index

The Economist writes, (bold emphasis mine)

THE Economist’s Big Mac index is a fun guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of a basket of goods and services around the world. At market exchange rates, a burger is 44% cheaper in China than in America. In other words, the raw Big Mac index suggests that the yuan is 44% undervalued against the dollar. But we have long warned that cheap burgers in China do not prove that the yuan is massively undervalued. Average prices should be lower in poor countries than in rich ones because labour costs are lower. The chart above shows a strong positive relationship between the dollar price of a Big Mac and GDP per person.

PPP signals where exchange rates should move in the long run. To estimate the current fair value of a currency we use the “line of best fit” between Big Mac prices and GDP per person. The difference between the price predicted for each country, given its average income, and its actual price offers a better guide to currency under- and overvaluation than the “raw” index. The beefed-up index suggests that the Brazilian real is the most overvalued currency in the world; the euro is also significantly overvalued. But the yuan now appears to be close to its fair value against the dollar—something for American politicians to chew over.

My two cents:

As per the Economist, the mercantilist’s imputation of the massive overvaluation of the Chinese yuan would be a mistake. I have been saying these here here and here. A China bubble bust would deflate and expose on these protectionists’ canard.

ASEAN, China and India remains as most undervalued in terms of local currency prices of Big Macs (original index).

The surprise is that the augmented GDP based Big Mac index reveals that Brazil’s real has topped the Eurozone as the world’s most overvalued currency

This reminds me of the great Ludwig von Mises who once wrote

the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.

Below is an interactive graph from the Economist

Big Mac Index , Mercantilist Fallacies and ASEAN Currencies

An updated graph of the Big Mac Index is shown by The Economist.

THE Big Mac index, says the Economist, is based on the theory of purchasing-power parity (PPP), according to which exchange rates should adjust to equalise the price of a basket of goods and services around the world.

Again, the above shows that ASEAN and other Asian countries as having the most affordable ‘Big Mac’, while the euro area remains the most expensive.

If we go by the mercantilist perspective where cheap currencies=strong exports then we must deduce that outside China, South East Asia should be today the world’s biggest exporters.

Well unfortunately, again with the exception of China, this isn’t true. The priciest currency, the Euro, according to the table from the CIA, lodges the largest exporting region of the world.

Why is this so?

Because currency values do not solely determine exports or wealth for that matter. There are many factors involved and chief among them are the nation’s capital, production and the market structure, and importantly the desire to compete...

And as part of capital structure, this includes the perception of stability, which as example, the Economist cites the Swiss Franc,

``Investors looking for a safe place to put their money have sought refuge in the Swiss franc. Despite attempts by the Swiss central bank to stem the appreciation, the Swiss franc is overvalued by 68%”

This means that if the intent or priority is to seek a safehaven, then pricing risk from a ‘stable’ currency becomes less sensitive relative to other forms of risks.

Nevertheless, the affordability of ASEAN’s Big Mac in itself doesn’t intuitively posit that her currencies would close or equalize the gap with that of the Euro.

Instead ASEAN’s intent to expand trade with the world (globalization) and undergo more economic integration with the region (regionalization) should be the primary reason why the ASEAN’s currencies should be a buy.

The other way to say it is that the convergence won’t come from currency values, in as much as from lower costs (wages etc.), but from increasing wealth from free trade which would then be reflected on the respective currency.

Of course, the only way to devalue a currency is to print more of it, which essentially gives justification to expand government at the expense of the market or a euphemism for socialism.

Big Mac Index And The Furor Over China's Yuan

Here is an update of the Economist's Big Mac Index which shows how McDonald's Big Mac are priced around the world.

In other words, the relative purchasing power of a currency measured in terms of Big Mac prices.
According to the Economist, (bold highlights mine)

``RECENT renewed American calls for China to revalue its currency have so far fallen on deaf ears. China has rejected accusations that America's huge trade deficit with it is caused largely by an artificially weak yuan, which has been pegged to the dollar since July 2008. Economists point out that a depreciation of the yen did little to help reduce America's trade deficit with Japan in the 1980s. But the yuan is unquestionably undervalued. Our Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should equalise the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar. "

While it may be true that the Chinese yuan may be "artificially weak", it is inaccurate to entirely blame the yuan for the America's deficits.

Chart from Google

As you can see, US trade deficit is largely a world phenomenon, except that China takes up most of the load (see below)

From US Census Bureau

In addition, outside of the oil exporters and China, the US has substantial deficits with Canada, Ireland and Japan even when the currencies of the 'developing economy' group are mostly "dearer" [or 'at par' with the US as with Japan].

Several additional observations:

-It is a fallacy to assume that weak currencies automatically extrapolate to strong exports or increased jobs.

As the Economist rightly points out, the strength of the Japanese Yen over the past decades didn't automatically transform Japan into a "consuming" class. To this day Japan is known as an "exporter".

-All furor over the Yuan, ignores the role played by the US dollar as the world's de facto currency reserve.

In short, the US has to produce dollars, required not only at home, but to fund global transactions and thus contributing to deficits. [see the Triffin Dilemma as previously discussed in The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency]

-If the Chinese have indeed been subsidizing their export sector, it does so to keep Americans buying their product.

In a subsidy one group is favored over another, which means redistribution of resources from other sectors to the favored sector.

chart from Google

China's exports account for 35% of the GDP, alternatively this means the rest of her economy is shouldering the burden of the subsidies.

In addition, if China is subsidizing her exports then it also means that by keeping the yuan "artificially cheap", her subsidies extend to the American consumers. So how bad can it be for Americans?

And such dynamic is seemingly being reflected on the growing clout of US discount behemoth Walmart to influence the production methods of her Chinese suppliers,

This from the Washington Post,

``Wal-Mart has more than 10,000 suppliers in China. In addition, about a million farmers supply produce to the company's 281 stores in China. If Wal-Mart were a sovereign nation, it would be China's fifth- or sixth-largest export market. So the company hopes that small measures taken by all suppliers start to add up. Its 200 biggest suppliers in China have already trimmed 5 percent of their energy use.

``In the past, environmental concerns have taken a back seat to growth in China and to costs for Wal-Mart. And China and Wal-Mart have come under sharp criticism for conditions in factories. Yet pollution now threatens China's growth; as a result, awareness of climate change and energy security has spread in China. Likewise, as consumers grow more environmentally aware, Wal-Mart's executives have responded. On Thursday, the company pledged to reduce its greenhouse gas emissions by 2015."

In short, politicos when caviling over currencies are looking only looking at superficial and not on structural issues.

-The problem of US joblessness isn't an issue of China stealing jobs but instead of domestic bubble policies as earlier explained in Why Americans Are Jobless

-Lastly, it is simply foolish and highly pretentious to believe that foreign policies based on antagonism or belligerency will alleviate US economic woes.

Even if we assume that China yields to Americans, as shown above, this won't solve their problems. So failure to do so would only prompt blood lusting politicians to ask for more interventionism that may lead not only to a trade war but to a risks of military confrontation.

Importantly, it would seem that egotism has overwhelmed rationality such that by threats to slap protectionism aggravates and not helps the US predicament. Remember the Smoot-Hawley Tariff Act?

It is such hypocrisy for these dunces to proclaim that they are working for the common good when they are, in fact, agitating for a great depression.

As the UNCTAD recently wrote, (all bold highlights mine)

``Amidst continued financial crisis, the question of the global trade imbalances is back high on the international agenda. A procession of prominent economists, editorialists and politicians have taken it upon themselves to “remind” the surplus countries, and in particular the country with the biggest surplus, China, of their responsibility for a sound and balanced global recovery. The generally shared view is that this means permitting the value of the renminbi to be set freely by the “markets”, so that the country will export less and import and consume more, hence allowing the rest of the world to do the opposite. But is it reasonable to put the burden of rebalancing the global economy on a single country and its currency? This policy brief contends that the decision to leave currencies to the vagaries of the market will not help rebalance the global economy....

``It is time to break with a sterile polemic that ignores the increasing evidence from a range of experiences showing that both absolutely fixed/pegged and fully flexible/floating exchange rate systems are suboptimal. These so-called “corner solutions” have added to volatility and uncertainty and aggravated the global imbalances . With this as a starting point, the debate can move forward to explore new common formulas for exchange rate management that increase consistency between trade and financial flows in a globalized economy.

``In order to address global imbalances coherently, governments need to act in the same spirit of multilateralism that characterized the international fiscal response to the crisis at its most critical moments in 2008. A coherent approach to restoring balanced trade calls for policies that address and prevent currency speculation at the global level. Even those who criticize governments for stabilizing exchange rates and intervening in financial markets generally recognize that a viable long-term solution to the problem of massive trade distortions and global imbalances cannot be expected from individual central banks trying to find a unilateral solution to a multilateral problem like the exchange rate."

Big Mac Index: The Fallacy of Blessed And Burdened Currencies

The Economist recently published its updated Big Mac Index aimed at demonstrating whether a currency is cheap or expensive relative to the US dollar, as benchmarked to the price of the a McDonald's Big Mac Burger in the US.


According to the Economist, (bold highlights mine)

``THE Big Mac index is based on the theory of purchasing-power parity (PPP)—exchange rates should equalise the price of a basket of goods in different countries. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value benchmark. So our light-hearted index shows which countries the foreign-exchange market has blessed with a cheap currency, and which has it burdened with a dear one. The most overvalued currency against the dollar is the Norwegian kroner, which is 96% above its PPP rate. In Oslo you can expect to pay around $7 for a Big Mac. At the other end of the scale is the Chinese yuan, which is undervalued by 49%. The euro comes in at 35% over its PPP rate, a little higher than half a year ago.

Looking at the chart above, 'expensive' nations hail mostly from the Euro zone except for Australia, Canada and Turkey.

On the other hand, emerging markets, especially our ASEAN neighbors Indonesia, Thailand and Malaysia have been classified along with China as "cheap".

So by virtue of association we assume that the Philippine Peso is likely to be in the 'cheap' category.

Yet reading through the article we observe that 'cheap' currencies have been reckoned as "blessed" whereas 'dear' currencies have been deemed as "burdened".

This is just an example of the perverted mainstream view [as recently discussed in Dueling Keynesians Translates To Protectionism?] which gives prominence to mercantilist ideology that the advocates "inflationism" and varied form of regulatory protectionism.

The oversimplistic idea is that 'cheapness' equals export strength and competitiveness which translates to economic growth.

Yet such preposterous prejudice is unfounded.


Based on the list of world's export giants from wikipedia.org estimates (left window), 8 nations from Europe plus Canada comprise the top 15 biggest international exporters belong to the "expensive" category. In short, a majority.

Meanwhile, only 3 of the ultra blessed 'cheapest' currency nations (Mexico, Russia and China) and marginally cheaper (South Korea and Japan) are part of the roster of elite exporters.

Moreover, in terms of competitiveness, except for Singapore, Japan and the US, 7 out of the 10 most competitive nations, according to the World Economic Forum, come from the 'burdened' expensive currency group.

In other words, the rationalization of 'cheap' as blessed and 'dear' as burdened greatly misleads because, as evidence reveals, cheapness doesn't guarantee competitiveness or export strength.

Why the mainstream's predisposition on such a view? Because of the fixation to parse on economic disequibrium predicated current account asymmetries.

Zachary Karabell writes in the Wall Street Journal that global imbalance is a myth because in no time in history has there been a global economic equilibrium.

From Mr. Karabell (bold highlights mine), ``The blunt fact is that at no point in the past century has there been anything resembling a global economic equilibrium.

``Consider the heyday of the "American century" after World War II, when Western European nations were ravaged by war, and the Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S. accounted for more than 40% of global GDP and the preponderance of global manufacturing. The country was so dominant it was able to spend the equivalent of hundreds of billions of dollars to regenerate the economies of Western Europe via the Marshall Plan, and also of Japan during a seven year military occupation. By the late 1950s, 43 of the world's 50 largest companies were American.

``The 1970s were hardly balanced—not with the end of the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation and stagflation, which spread from the U.S. through Latin America and into Europe.

``The 1990s were equally unbalanced. The U.S. consumed and absorbed much of the available global capital in its red-hot equity market. And with the collapse of the Soviet Union and the economic doldrums of Germany and Japan, the American consumer assumed an ever-more central position in the world. The innovations of the New Economy also gave rise to a stock-market mania and overshadowed the debt crises of South America and the currency implosion of South Asia—all of which were aggravated by the concentration of capital in the U.S. and the paucity of it in the developing world. When the tech bubble burst in 2000, it had little to do with these global dynamics and everything to do with a glut of telecommunication equipment in the U.S., and stock-market exuberance gone wild."

In looking at the US current account chart from globalpolicy.org one would note that deficits began to explode during the 80s.

This probably implies that, aside from the above assertion by Mr. Karabell, as the China and emerging markets got into the globalization game, the US deficits soared. This bolsters the Triffin Dilemma theory as vastly contributing to such phenomenon.

Moreover, mainstream experts seem mixed up on the participating identities of those involved in current account and trade deficits with that of budget deficits.

With budget or fiscal balancing it is the government that accrues the surpluses or deficits. In contrast with trade balances, individuals through enterprises and not nations engage in commerce.

Professor Mark Perry makes a lucid explanation, (all bold underscore mine)

``It might be a subtle point, but it's important to realize that countries don't trade with each other as countries - rather it's individual consumers and individual companies that are doing the buying and selling. The confusion gets reinforced when we constantly hear about the "U.S. trade deficit with Japan" or China, which might again imply that the "unit of analysis" for international trade is the country, when in fact the unit of analysis is the individual U.S. company that engages in trade with other individual companies on the other side of an imaginary line called a national border.

``It's possible that some of the confusion about international trade can be traced to confusion about the "trade deficit" and the "budget deficit." The relevant unit of analysis for the budget deficit is indeed the country, since it's the entire country via elected officials that is responsible for the "budget deficit." By conflating these two distinctly different deficits, it's then easy to assume that the relevant unit of analysis for both is the "country" when in fact that only applies to the "budget deficit" and not the "trade deficit."

``Once one understands that it's individual companies, not countries, that are doing the trading, then it's not so easy to get fooled by statements or headlines like "Punitive tariffs are being imposed on China," or "Obama to hit China with tough tariff on tires." Since China doesn't actually trade with the United States at the national level, tariffs cannot be imposed on the country of China - it's not like the United States government sends a tax bill to the Chinese government.

``Rather, since it is companies that are trading, it's companies that have to pay the taxes (tariffs) TO their OWN government. In the case of U.S. tariffs on Chinese tires or steel, the tariffs (taxes) are being imposed not on the Chinese government or even the Chinese steel-producers, but on American companies who now are taxed for buying tires or steel from China, and then those taxes are ultimately passed along to the individual Americans who purchase the tires and purchase the consumer products like automobiles that contain Chinese steel."

In addition, it would seem similarly incoherent and ironic to think that manipulating currencies to subsidize "exporters" would generally benefit the country engaged in such policies.

That's because as a general rule for every subsidy someone has to pay for the "subsidized" cost. In short, subsidies redistribute rather than generate wealth.

Professor Donald Boudreaux debunks the favorite fixation of the mainstream: the US-China imbalances,

``The real costs of the resources and outputs exported by the Chinese people are not lowered simply because Beijing keeps the price of the yuan artificially low. And the resources spent to supply the extra American demand that results from an artificially low price of yuan—even though they are unseen by the untrained eye—represent a huge cost that harms the Chinese economy."(emphasis added)

So not only have mercantilists been barking up at the wrong tree, they have been brazenly promoting policies that focuses on short term fixes, which favors a select political group, and importantly, raise the risks of provoking a mutuality destructive trade war.

In closing this apt quote from John Chamberlain, ``when nations begin worrying about the "balance of trade," they are saying, in effect, that the price of a currency expressed in an exchange rate is more important than bananas, or automobiles, or whatever. This is a perversion that sacrifices the consumer to an abstraction; better let the currency seek its own level in the world's money markets."

Big Mac Index: Work Time Needed To Earn A Big Mac

This is an interesting change of perspective in looking at the Purchasing Power Parity based on the Economist's Big Mac index.

See previous post Big Mac Index Update: Asia Cheapest, Europe Priciest

It shows the work time required to earn a Big Mac.

According to the Economist,

``THE size of your pay packet may be important, but so is its purchasing power. Helpfully, a UBS report published this week offers a handy guide to how long it takes a worker on the average net wage to earn the price of a Big Mac in 73 cities. Fast-food junkies are best off in Chicago, Toronto and Tokyo, where it takes a mere 12 minutes at work to afford a Big Mac. By contrast, employees must toil for over two hours to earn enough for a burger fix in Mexico City, Jakarta and Nairobi"

Interesting.

Big Mac Index Update: Asia Cheapest, Europe Priciest

The Economist has recently released its Big Mac Index as a guide to valuing currencies based on purchasing power parity.

Basically, the idea is, leveraging from McDonald's global presence and its best selling product Big Mac and its worldwide reach to consumers, the Economist uses the Big Mac as a benchmark to estimate on the worth of national currencies compared to the US dollar-since the US dollar has functioned as the world's international currency standard.

According to the Economist, ``WHICH countries has the foreign-exchange market blessed with a cheap exchange rate, and which has it burdened with an expensive one? The Economist's Big Mac index, a lighthearted guide to valuing currencies, provides some clues. The index is based on the idea of purchasing-power parity (PPP), which says currencies should trade at the rate that makes the price of goods the same in each country. So if the price of a Big Mac translated into dollars is above $3.57, its cost in America, the currency is dear; if it is below that benchmark, it is cheap. A Big Mac in China is half the cost of one in America, and other Asian currencies look similarly undervalued. At the other end of the scale, many European currencies look uncompetitive. But the British pound, which was more than 25% overvalued a year ago, is now near fair value." (emphasis mine)

Why Purchasing power parity (PPP) as the selected gauge?

Perhaps using the wikipedia.org explanation, `` Using a PPP basis is arguably more useful when comparing differences in living standards on the whole between nations because PPP takes into account the relative cost of living and the inflation rates of different countries, rather than just a nominal gross domestic product (GDP) comparison." (bold highlight mine)

Of course, PPP is simply a statistical construct that doesn't take into the account the capital structure or the operating framework of the political economies of every nation, which is impossible to qualify and or quantify.

Left to its own devices, theoretically, the currency markets should have closed such discrepancies. But again, national idiosyncrasies and much government intervention to maintain certain levels in the marketplace, as policy regimes embraced by many countries with a managed float or fixed/pegged structure, hasn't allowed markets to work in such direction.

Nonetheless, present trends indicate of a growing chasm in the currency values (based on PPP) where continental Europe has been getting pricier while Asia has been getting cheaper.

As per July 13th based on the currencies monitored by the Economist, Hong Kong is the cheapest currency against the US dollar (-52%) , followed by China, Sri Lanka, Ukraine (-49%), Malaysia, Thailand (-47%), Russia, Indonesia (-43%) and the Philippines (-42%) using the % variance against the US dollar from where the abovementioned currencies are 40%+ below.

Based on the Big Mac Index alone, it would appear that Asia's currencies have much room to appreciate against the most expensive Euro or against the US dollar.

Burgernomics: 2008 Financial Crisis Cheapens Asia's Big Macs

According to the Economist, ``THE dollar's recent revival has made fewer currencies look dear against the Big Mac index, our lighthearted guide to exchange rates. The index is based on the idea of purchasing-power parity, which says currencies should trade at the rate that makes the price of goods the same in each country. So if the price of a Big Mac translated into dollars is above $3.54, its cost in America, the currency is dear; if it is below that benchmark, it is cheap. There are three noteworthy shifts since the summer. The yen, which had looked very cheap, is now close to fair value. So is the pound, which had looked dear the last time we compared burger prices in July. The euro is still overvalued on the burger gauge, but far less so than last summer."

True. Applied to Asian currencies, after a nearly broad market rout during the last semester (see below from ADB Bond Monitor), except for the Japanese Yen and China's remimbi, most of the region's purchasing power parity computed Big Mac Index became more affordable relative to the US dollar. Thus, the region's currencies are likely to have more potential exchange rate value appreciation over the long run.

Tale of The Tape: The Philippine Peso Versus The US Dollar

``It requires very unusual mind to make an analysis of the obvious."-Alfred North Whitehead

It has also been our exposition that the recent rally of the US dollar relative to the Philippine Peso, which has been popularly imputed to rampant “inflation”, had been based on a false premise, see Figure 2.

Figure 2: ADB Bond Monitor: Fiscal balance as % of GDP (left), Net food and petroleum exports in 2007 in $ billions (right)

In my view, the markets simply looked for an excuse (available bias) to sell down the Peso and Philippine asset classes, when it had been mostly a combination of the phenomenon of a natural countertrend cycle, the lowering of world economic growth expectations and forced liquidations from capital raising financial institutions abroad.

Although the so called food and energy driven “Inflation” (defined by mainstream as rising prices-which is not the true definition) had been somewhat a contributor, as a market driver, it signified a minor role relative to the above, but had immense political coverage or impact. Thus, in terms of easy to sell explanations for a consuming public that buys on the appeal of oversimplified information, the mainstream news accounted for what is popular backed by experts who fed on such fallacious biases (confirmation bias).

Since currency valuation comes in “pairs” or is a zero sum pricing dynamic (one advances, the other declines), the proper approach should be to cover similar variables of the nations being compared with, in assessing currency or asset pricing. You cannot deal with one factor without assessing the other because pricing comes in “pairs”.

Recently the easy and popular explanation had been- fiscal prudence relative to national balance sheets are likely to be sacrificed in order to mitigate social and political pressures arising from high food and energy costs. Thus, the fiscal costs amounts to balance sheet expansions which means rising interest rates at the expense of economic growth and the corresponding deterioration of asset valuations.

The ADB July Bond Monitor shows of the Asia’s net food and petroleum trade (right) and importantly the fiscal balance in % of GDP on the account of today’s “inflation” (see left).

The chart shows of the deterioration of fiscal balance even with the recent government actions of targeted subsidies for the Philippines as only 1% of the GDP even in the environment where the country would have to import more petroleum and food at the expense of its trade account.

But the US budget deficit projections calculated on February alone had been $410 billion for 2008 or 2.7% of GDP due to increased federal spending (yahoo).

Notwithstanding, the recent deterioration in tax revenues or collections has been putting a strain on financing the present government expenditures which has also been exacerbating the pressures of additional budget deficits especially under today’s recessionary environment. As discussed in our previous article Has The Underperformance of Philippine Markets Been Due To Policy Credibility?, the Nelson Rockefeller Institute has identified 36 states undergoing recession, which has been contributing to state budget deficits.

In addition, the present structure of US government debts have been mostly in short term instruments. Rising yields are likely to increase the costs of financing of its domestic spending requirements. Thus, the cost of financing is likewise a potential added burden for US taxpayers.

Moreover, the fiscal and monetary costs of nationalization of financial institutions, e.g. IndyMac- where the estimated costs of the Federal Deposit Insurance Corp (FDIC) takeover is $4-$8 billion (latimes) while 2 more banks were recently added to that casualty list (more of bank takeovers risks depleting the $53 billion insurance fund of the FDIC), the recent $168 billion national stimulus (with prospects of possibly more stimulus-William Gross of PIMCO is asking for $500 billion more!) and the provision of bridge financing to key financial institutions (recently including Fannie Mae and Freddie Mac) suffering from both an illiquid environment and potential insolvency.

Figure 3: Heritage Foundry: A Nation of Entitlements

It doesn’t end here. The US also bears the costs of its exploding unfunded entitlement programs which seem to likewise jeopardize the balance sheets of the Federal Government, see Figure 3.

According to the Heritage Foundry (highlight mine), ``The U.S. spends a total $1.2 trillion on the Big Three entitlement programs ($581.4 billion on Social Security, $370.8 billion on Medicare, $291.2 billion on Medicaid).”

So it isn’t as simple as inflation here should weigh on the Peso and financial assets-blah blah, because all the abovementioned costs have been a huge onus to the US economy relative to the problems in the Philippine setting.

Even in the spectrum of purchasing power, the Economist’s Big Mac Index (discussed on my recent post) shows that Asian currencies are terribly undervalued relative to the US dollar, which means that the prospects for the Peso to advance alongside its neighbors is quite compelling.

Burgernomics: Where is the world’s most Expensive and Cheapest Big Mac? Peso one of the world’s cheapest.

The Economist magazine has used its premier product the Big Mac, which is served in McDonald’s 31,000 outlets in 119 countries, to gauge on a domestic currency’s purchasing power against the US dollar. These are applied to nations where McDonald's has existing branches.

So where is the cheapest and most expensive Big Mac?

Courtesy of the Economist

The most Expensive are found mainly in European countries, while the cheapest are in Asia.

According to the Economist, ``Many of the currencies in the Fed's major-currency index, including the euro, the British pound, Swiss franc and Canadian dollar, are overvalued and trading higher than last year's burger benchmark. Only the Japanese yen could be considered a snip. The dollar still buys a lot of burger in the rest of Asia too. China's currency is among the most undervalued, but a little bit less so than a year ago.”

For a little technicality on how they arrived at this comparative, we will further excerpt the Economist (highlight mine),

``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…

``PPP measures show where currencies should end up in the long run. Prices vary with local costs, such as rents and wages, which are lower in poor countries, as well as with the price of ingredients that trade across borders. For this reason, PPP is a more reliable comparison for the currencies of economies with similar levels of income…

``If that judgment is right, the squalls stirred up by the credit crises have moved at least one currency—the world’s reserve money—closer to fair value. Curiously the crunch has not shaken faith in two currencies favoured by yield-hungry investors: the Brazilian real and Turkish lira. These two stand out as emerging-market currencies that trade well above their Big Mac PPPs. Both countries have high interest rates. Turkey’s central bank recently raised its benchmark rate to 16.75%; Brazil’s pushed its key rate up to 13% on July 23rd. These rates offer juicy returns for those willing to bear the risks. Those searching for a value meal should look elsewhere.”

Courtesy of the Economist

So where does the Philippines stand?

At 44.5 per US dollar, the Philippine Peso, as measured from the Big Mac Index above, shows of a notable discount of FORTY FIVE percent against the US dollar.

The Peso is one of the cheapest after Malaysia (-52%), Hong Kong (-52%), China (-49%), Thailand (-48%), Sri Lanka (-47%) and at par with Pakistan (-45%).

This means if we take heed of the Economist advice of “PPP measures show where currencies should end up in the long run”, the Peso and most of the currencies mentioned above are likely to appreciate significantly over the longer term (all things being equal).

Another aspect worth to consider in the Economist article is that currencies of high interest rates countries such as Brazil’s Real and Turkey’s Lira appear to remain unaffected by the credit crunch.

Translation: Global liquidity appears to remain abundant enough to lure global investors towards selective high yielding "high risk" currencies.

Yes, the risk aversion has increased, but apparently the chase for yields has NOT entirely vanished.