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
The art of economics consists in looking not merely at the immediate hut at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups—Henry Hazlitt
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
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).
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
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.
``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."
``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)
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
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.
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
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
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.
Courtesy of the Economist
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
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
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.