July 02, 2019
We are taking a break from our normal schedule this week due to the Independence Day holiday and shifting to a seasonal topic. We are still examining foreign exchange and international economics, but with the arrival of summer and a four-day weekend ahead for many, we wanted to revisit the “Big Mac Index” and what your dollar will buy during vacation this summer.
The Big Mac Index was created by The Economist Magazine in 1986 and is one of a handful of indexes used to compare purchasing power parity (PPP). PPP is a measure of relative prices among countries. The Big Mac Index examines a generic consumable (Big Macs taste pretty darn similar across the globe) based on how much it costs in various countries, expressed in U.S. dollars.
The current price domestically, a compilation of prices from various U.S. locales, is $5.58. The most expensive country to order a Big Mac is in Switzerland at $6.57 and the cheapest, somewhat surprisingly, is in Japan at $3.59.
Looking at the cost of this one item, in line with other goods in that country, can also indicate whether that currency is over- or undervalued to the U.S. dollar. Looking at the current comparison of major currencies, only the Swiss franc is significantly overvalued. The Swedish and Norwegian currencies are almost fairly valued. Many currencies seem to be significantly undervalued. The Canadian dollar is not that far off, but once you get to currencies like the British pound, this index calculates sterling as being 23 percent undervalued.
Granted, most of us choose vacation destinations with a lot of factors in mind – relative cost being a big one, but just one of many. If you want to use only this index, you would vacation in South Africa based on a 57 percent undervaluation of its currency, the South African rand (ZAR). Of course, for Americans a lot of that currency advantage would get eaten up in travel costs. Want something closer to home? The Mexican peso is 51 percent undervalued, according to this analysis. Bon voyage!
In theory, currency under-valuations or overvaluations get evened out over time by market forces. Currencies that are undervalued attract investors and businesses looking to buy cheap goods, which increases demand for that currency and forces it to rise in value. But these are bizarre times, with factors like negative interest rates skewing what would otherwise be a normal functioning market.
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