July 24, 2010


Source: www.economist.com

The latest exchange-rate scorecard, the so-called "Big Mac index" came out this week.  Published by the Economist twice a year, "it is based on the theory of purchasing-power parity (PPP), which argues that in the long run exchange rates should move to equalise the price of an identical basket of goods between two countries."

The most recent reading of this index suggests that several European currencies along with the Brazilian Real, Canadian Dollar and Australian Dollar are still overvalued in comparison to the US Dollar.  By contrast, some emerging market currencies including the Chinese Yuan are said to be undervalued.  

This Index, while somewhat of a rough indicator, has many flaws and should be taken with more than just a grain of salt.  While the concept of purchasing power parity makes sense when comparing a basket of goods that gives a broad range of comparable products among the list of surveyed countries, limiting the concept of PPP to just one product does not make much sense. As the Economist puts it:

”The index is a lighthearted attempt to gauge how far currencies are from their fair value.”

In view of the ongoing debate as to how much the Chinese Yuan is undervalued, perhaps someone should suggest to certain elected officials  that the Big Mac Index is only a “lighthearted attempt”, not a realistic assessment of a country’s fair currency value.   In case some of these officials from the West were visiting China they should enjoy the immense variety of the local cuisine rather than “chowing” down a burger and wonder about the price difference with regard to the US Dollar.

As far as I am concerned, the last thing I would want to do in China is eat a Big Mac whatever the price may be - when in Rome...



No comments: