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.
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.
