Last Updated on Saturday, 16 October 2010 01:54 Written by admin Friday, 15 October 2010 01:46

Why China Needs More Expensive Burgers

A WEAK currency, despite its appeal to exporters and politicians, is no free lunch. But it can provide a cheap one. In China a McDonald’s Big Mac costs just 14.5 yuan on average in Beijing and Shenzhen, the equivalent of $2.18 at market exchange rates. In America the same burger averages $3.71. That makes China’s yuan one of the most undervalued currencies in our Big Mac index, which is based on the idea of purchasing-power parity. This says that a currency’s price should reflect the amount of goods and services …

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Last Updated on Sunday, 17 October 2010 09:29 Written by admin Thursday, 14 October 2010 01:21

Why China Needs More Expensive Burgers

A WEAK currency, despite its appeal to exporters and politicians, is no free lunch. But it can provide a cheap one. In China, for example, a McDonald’s Big Mac costs just 14.5 yuan on average in Beijing and Shenzhen, the equivalent of $2.18 at market exchange rates. In America, in contrast, the same burger averages $3.71.

That makes China’s yuan one of the most undervalued currencies in the Big Mac index, our gratifyingly simple guide to currency misalignments, updated this week (see chart). The index is based on the idea of purchasing-power parity, which says that a currency’s price should reflect the amount of goods and services it can buy. Since 14.5 yuan can buy as much burger as $3.71, a yuan should be worth $0.26 on the foreign-exchange market. In fact, it costs just $0.15, suggesting that it is undervalued by about 40%.

The tensions caused by such misalignments prompted Brazil’s finance minister, Guido Mantega, to complain last month that his country was a potential casualty of a “currency war”. Perhaps it was something he ate. In Brazil a Big Mac costs the equivalent of $5.26, implying that the real is now overvalued by 42%. The index also suggests that the euro is overvalued by about 29%. And the Swiss, who avoid most wars, are in the thick of this one. Their franc is the most expensive currency on our list. The Japanese are so far the only rich country to intervene directly in the markets to weaken their currency. But according to burgernomics, the yen is only 5% overvalued, not much of a casus belli.

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Last Updated on Monday, 22 February 2010 06:39 Written by admin Monday, 22 February 2010 06:15

The Big Mac Index is based on the concept of Purchasing Power Parity (PPP). That said, PPP holds better in situations where the costs of transporting the good are small or non-existent. This opens up the opportunity for arbitrage which is basically buying a good in a place where it’s cheap and selling it in a place where it’s expensive. This is easy for things like currency but much harder for things like Big Macs. Arbitrage doesn’t exactly work with perishable items.

That said, PPP should still hold to some extent because even if the Big Mac as a finished project isn’t likely to be bought and sold. Laurie Peterson argues in the the article “Real or Rediculous: The Big Mac Index” that in fact PPP doesn’t hold as well as expected in the Big Mac Index because the components on the Big Mac are “non-tradables“. As a matter of clarity, “non-tradables” are things that are unlikely to be imported or exported like services or real-estate.

The Big Mac Index is useful for travelers, giving a good idea about which countries are “expensive,” and which are not, says economics professor Robert Barsky from the University of Michigan. For example, if you’re traveling to Australia this year, plan on paying $4 for the double beef patty sandwich.

“It is less clear, however, that a pop index is a good predictor of changes in the exchange rate over time,” Barsky adds, because “the Big Mac is in large measure, a measure of the non-tradable component of the Consumer Price Index. There is no strong reason that the prices of non-tradables should be equalized across countries.”

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The fact that Big Macs are standardized across countries is what makes it a relatively effective measure of PPP. The non-tradable nature of the Big Mac however takes away slightly from its predictive nature in regards to the exchange rate.