August 3, 2020
Fast food for thought.
In 1986, The Economist developed a tasty way to assess whether currencies are trading as they should be: The Big Mac Index.
In theory, countries’ exchange rates should allow a person to buy the same product – in this case, a burger – for the same amount of money in any currency. In reality, currencies are often undervalued or overvalued. When an analyst says a country’s currency is undervalued relative to the U.S. dollar, it means a burger costs less in that country than it does in the United States.
For example, in June 2020, a fancy burger cost about $5.71 in the United States. In Britain, it cost £3.39, which is about $4.46 using last week’s exchange rate. That makes a British burger a lot less expensive than a U.S. burger. If the currencies were aligned properly, the burger should have cost £4.34. So, the British pound is undervalued relative to the U.S. dollar.
In June, visitors to Switzerland paid more for burgers than they would have in the United States. A Swiss burger cost SFr6.50 or about $7.15 in June 2020. If the currencies were aligned, the burger would have cost about SFr5.19.
The cheapest burger in the world was found in South Africa, where it sold for 31.00 rand or $1.83 in June. If the currencies had been in parity, then a South African burger would have cost 96.97 rand. You also can buy a burger for less in China. The Economist explained, “A [burger] costs 21.70 yuan in China and $5.71 in the United States…[This] suggests the Chinese yuan is 45.7 percent undervalued.”
The Big Mac Index should be taken with a grain of salt. It’s an imprecise tool some economists find hard to swallow because the price of a burger should be lower in countries with lower labor costs, and higher in countries with higher labor costs. When index prices are adjusted for labor, the Thai baht and Brazilian real are the world’s most overvalued currencies relative to the U.S. dollar, while the Hong Kong dollar and the Russian ruble are the most undervalued.
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https://www.washingtonpost.com/business/economy/white-house-officials-democratic-leaders-convene-rare-weekend-talks-as-unemployment-benefits-expire-for-millions/2020/08/01/9637d21a-d3f8-11ea-8c55-61e7fa5e82ab_story.html (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/08-03-20_TheWashingtonPost-Both_Sides_Say_Progress_Made_in_Talks_on_Pandemic_Relief-Footnote_3.pdf)
https://www.barrons.com/articles/dow-jones-industrial-average-drops-42-points-as-investors-stay-wary-51596245732 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/08-03-20_Barrons-Why_this_Rally_Still_has_Room_to_Run-Footnote_4.pdf)