This week saw the latest Big Mac Index (BMI) from The Economist. The survey, launched in 1986, is described as ‘a way to make exchange-rate theory a bit more digestible ‘and is based on the theory of purchasing-power parity (PPP), in simple terms the idea that a dollar is a dollar wherever you happen to be. The Economist use the Big Mac as their traded good benchmark, a product that is produced to roughly the same specifications in 120 countries across the globe so comparing exchange rates with PPPs should be a good indication as to whether a currency is under or over-valued.
This year’s index indicated via a series of calculations (dividing the Yen price of the Big Mac by the Dollar price gives the Big Mac PPP which is then compared to the current trading price of Yen) the Japanese Yen is currently undervalued to the tune of 6%. The cheapest Big Macs, indicating the most undervalued currencies, are found in China, Malaysia, The Philippines and South Africa whilst the most expensive – and hence the most overvalued currencies – are eaten in Switzerland, Britain and Denmark. The pound, it would seem, is losing it’s strength in the world market – last year the BMI considered sterling to be overvalued by 20%, this year that figure had fallen to 12%.
Whilst these results are hardly surprising, the Big Mac index has proved most useful for tracking the value of the euro since its launch in January 1999. Whilst most analysts predicted the rise of the euro against the dollar, the BMI rightly predicted that the euro was overvalued at launch and currently indicates that Sterling is currently 26% overvalued against the euro. Whether or not the BMI factors in the PMs ‘when the economic climate is right’ policy is yet to be seen but if it does it is a fairly safe bet that Britain won’t be adopting the euro any time soon.
