Rafael Pampillón. Director. Economic Area. Instituto de Empresa
1 December 2004
How the modest meat-based sandwich can serve as a guide to understanding complex monetary matters.
Since 1986, the U.K. magazine The Economist has regularly published the Big Mac Index, an indicator based on the price of a hamburger eaten in McDonald’s establishments in various countries around the world. The Big Mac Index shows whether currency exchange rates are valued correctly or if they are being over- or undervalued. In other words, the index acts as a guide to whether or not a currency is at its “correct” parity.
This year, those of us who are burgereconomy enthusiasts have had our fair share of enjoyment. In January the index revealed a significant appreciation of the euro in comparison with the dollar (24 percent), which meant that the euro was more overvalued than at any other time in the index’s history. Since then, the trend has changed and it has depreciated.
The latest hamburger data (The Economist, 27 May) for this year showed that the average figure for countries in the Eurozone stood at an exchange rate of overvaluation of only 13 percent in comparison with the dollar. At the current exchange rate, therefore, hamburgers are 13 percent more expensive in the Eurozone than in the United States.
In other words, despite the downward trend of today’s exchange rate, hamburgers are still more expensive in the Eurozone than in the U.S. The Big Mac Index reveals that the euro is still being overvalued (13 percent) - albeit not as much as in January - and that in the mid term this situation should tend towards self-correction, with further depreciation in comparison with the dollar.
However, overvaluation of the Swiss franc (which still plays the role of refuge currency) is much greater (69 percent). The same story can be told of Danish and Swedish crowns (appreciation of 54 percent and 36 percent, respectively). The cheapest hamburger in the world is eaten in China ($1.20), which means that the yuan is being undervalued by 57 percent, which explains why the international community is asking for it to be floated for its consequent appreciation.
This is why pressure exerted on China to revalue its yuan is growing heavier. In Latin America, Argentine and Venezuelan hamburgers, at $1.48, show that the Argentine peso and the bolivar are undervalued by 50 percent, which makes countries in the southern hemisphere and the Caribbean very attractive for tourism.
A useful tool
The theoretical focus of the Big Mac Index comes from the theory of purchasing power parity, which holds that similar products in different countries should have the same price. The Big Mac sold at McDonald’s establishments is a basketful of representative assets, since it has the same characteristics at the international level.
The fact that it is sold in 3,000 outlets in 120 countries using the same ingredients makes it possible to compare the countries’ prices on a world scale. The base price is always that of the U.S. and is obtained as an average of the prices in four American cities (Atlanta, Chicago, New York and San Francisco).
The index is far from a perfect measuring rod. But it is an amusing guide to whether or not currencies stand at their correct level of parity with regard to other foreign monies. It also hints at how exchange rates might be expected to evolve. There are those who think this index is nothing more than a frivolous whim. It remains true however, that besides the fact that numerous books and doctoral theses have been written about it, it has predicted exchange rates more successfully than many econometric models. For example, on 1 Jan. 1999, the Big Mac Index indicated that the Argentine peso was being overvalued in comparison with the dollar and that it would depreciate; and indeed it did.
Halfway through 2002, and after heavy devaluation, according to the Big Mac Index, the peso was undervalued by 70 percent. Since then, the exchange rate of the peso in comparison with the dollar has appreciated as forecast. (It is comforting to see that we economists sometimes get it right.) In The Economist for 27 May the index once again insists that the Argentine peso is still undervalued and that, in the mid term, it will continue to appreciate against the dollar.