By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
This Great Graphic show the highlights of the latest reiteration of the Economists Big Mac Index. Since 1986, it has been illustrating the concept of Purchasing Power Parity by looking at the price of McDonald’s ubiquitous Big Mac in various countries. The spot currency price is as of January 22.
Norway and Switzerland continue to stand out as the most over-valued of the major currencies. The Bank of Canada Governor recently said the Canadian dollar remains strong, suggesting it was a headwind and on the Big Mac basis, remains the move over-valued of the G7 currencies at about 8%. The euro is seen about 7% over-valued according to this metric and sterling is fairly valued.
The Governor of the RBA called for an $0.85 cent Australian dollar and recently another official at the RBA argued for $0.80. According to the Big Mac metric, it is about 3% under-valued already. With Big Macs about 37% cheaper in Japan than in the US, the Japanese yen is the most under-valued of the major currencies.
With most emerging market currencies selling off sharply in recent days, it is interesting to observe that according to the Big Mac Index, the Indian rupee, South African rand and Indonesian rupiah (three of the so-called vulnerable five) are already deeply under-valued. The Turkish lira is about 9% under-valued compared with almost 20% over-valuation in last year’s index. The leaves the Brazilian real as only one of the “vulnerable five” over-valued.
There are many criticisms of Purchasing Power Parity. One is that tradeable goods prices would naturally be lower in poor countries because labor costs are lower. The Economists proposes to address this in an adjusted index, which uses the best line fit between Big Mac prices and GDP per capita.
By this measure, the Brazilian real is the most over-valued currency (of the 48 countries and euro area included in its study) at about 73%. Colombia is next at about 55% over-valued. The Israeli shekel and the Turkish lira are both about 28% over-valued. Rounding out the vulnerable five, the rupiah is about 12.5% under-valued; the rand is about 23.5% under-valued, and the rupee is 40% under-valued.
The adjusted index estimates the euro is about 16.5% over-valued and sterling about 10%. China is fairly valued at current exchange rates, while the original index puts it at nearly 40% under-valued. The yen is about 34% under-valued, not far from the original index estimate.