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.

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.