Jul 28th 2011, 14:35 by The Economist online
A beefed-up version of the Big Mac index suggests that the Chinese yuan
is now close to its fair value against the dollar
THE Economist’s Big Mac index is a fun guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of a basket of goods and services around the world. At market exchange rates, a burger is 44% cheaper in China than in America. In other words, the raw Big Mac index suggests that the yuan is 44% undervalued against the dollar. But we have long warned that cheap burgers in China do not prove that the yuan is massively undervalued. Average prices should be lower in poor countries than in rich ones because labour costs are lower. The chart above shows a strong positive relationship between the dollar price of a Big Mac and GDP per person.
PPP signals where exchange rates should move in the long run. To estimate the current fair value of a currency we use the “line of best fit” between Big Mac prices and GDP per person. The difference between the price predicted for each country, given its average income, and its actual price offers a better guide to currency under- and overvaluation than the “raw” index. The beefed-up index suggests that the Brazilian real is the most overvalued currency in the world; the euro is also significantly overvalued. But the yuan now appears to be close to its fair value against the dollar—something for American politicians to chew over.
Click on the tabs in the table below for a ranking of currencies on both the raw and the adjusted index:
• For more on the Big Mac index, see this week's leader and economics focus
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Food for thought...
Big commodity exporters are overvalued now -- Brazil, Argentina, Canada. I have to wonder why Australia isn't higher. It could just be cheap local beef, but there are a lot of cows in Argentina and Canada too.
In the years to come, as the chinese yuan continues to climb in value relative to the dollar, getting rid of the Treasury bonds in the Chinese reserve is going to be an even more painful process. They should start now and do it slowly. It's hard to believe that the dollar won't keep falling long term. That more than any debt ceiling theatrics should be weighing on the minds of foreign creditors.
Latin America heading toward another currency crisis
I would consider these results to reflect the productivity of labor and fairness of division of income.
In Chine the Big Mac Price is in line with the labor costs, which are low because China lends all her money to US (Why?).
In Brazil the workers listen samba while serving the Macs under the supervision of the greedy franchiser.
Finally!
I look at this measurement on Bloomberg via PPP. It does seem to be accurate, viz. the franc is indeed 2x or even 2.5x overvalued compared to the dollar. But Argentina? Unless their inflation has dramatically changed prices since 1.5 years ago, it should be significantly cheaper there than in America, whereas the chart shows 20% overvaluation. Maybe it's only this one product that is more expense.
What's the deal with Hong Kong and Brazil, especially the GDP adjusted number for Brazil?
China exchanges products for bonds with America, like Germany did with Greece/Italy. What structure is unraveling and will cause destruction to both sides. America needs to go back to Austrian economics: accumulation of capital, and all government policies geared towards this as the priority.
Oh good. The RMB is at fair value. Can somebody tell the BOC? They can stop buying USD (and any other currency they can get their hands on) now. I can't wait to see how this works out for everyone. Interesting times.
Please provide the r-squared value for the trend line on the Big Mac Price vs. GDP Per Person chart.
Big Macs are a Weapon of Mass (Destruction).
Obesity is epidemic.
Look up from your computer at the your neighbors. It is the disease in plain sight that everyone chooses to ignore.
It is the World's Number One Health Problem. It is a major contributor to hypertension, heart disease, cancer, arthritis and diabetes.
It kills more people than terrorism, global warming and catastrophes combined.
It makes the 1918 Spanish Flu Epidemic look like the sniffles.
The end of the world scenario of flesh eating zombies should be replaced by a world of Big Mac eating Morbidly Obese.
Your best option is to move to a place where Big Macs are exceedingly expensive and inaccessible.
Your July 2010 index showed the US cost was $3.73
That's an inflation rate of 9.1% in one year!
Regards