ECONOMIST: Big Mac cost attack
The Economist magazine’s Big Mac index was recently released, providing insights into the cost of the classic McDonald’s burger in countries around the world. The index was started in 1986 to provide a quick look at how currencies are trending against one another. The economic concept of purchasing power parity (PPP) indicates that exchange rates change over time to equalize the global price of an identical basket of goods and services. A single burger was chosen because it is highly standardized irrespective of location (and is ubiquitous and simple to grasp).
The most recent data indicates that the vast majority of world currencies are undervalued compared to the dollar based on the price of a Big Mac and prevailing exchange rates. Even when adjusted for the relative wealth of countries, the dollar remains stronger than most. Although clearly the Big Mac index is merely an illustration, the dollar has been trending at a fairly strong level for a while. The index also suggests that US inflation is now lower than that of most (but not all) major countries.
The Federal Reserve maintains a more comprehensive index of how the dollar is performing against the currencies of the 26 most important US trading partners by volume of bilateral trade. The base year is 2006, and the index generally stayed below that level for years except for a period of time during the Great Recession. Starting in 2011, however, the relative value of the dollar began to rise. The pattern was uneven at times, with notable spikes during times of uncertainty such as the pandemic. A peak of about 128 was reached last fall, and the index is currently around 121.
In addition to the dollar’s role as a safe haven, demand is boosted by high US interest rates and resulting demand from foreign investors for dollar-denominated options. In addition, a large share of global business is conducted in dollars and the US dollar is the world’s dominant reserve currency. (While there have been headlines about this situation changing, I don’t see that happening.)
A strong dollar is both good and bad. An overly weak currency would be a symptom of big problems such as persistent low economic growth and high inflation. It also makes imported goods more expensive. However, a strong dollar causes US exports to be more costly in world markets. In addition, for US firms doing business overseas, it reduces revenue as international sales are converted.
Looking ahead, the dollar should remain relatively stable for the time being. The economy is resilient, and the Fed is dealing with inflation. There is also no stronger or more stable financial system anywhere, and uncertain times call for safe havens. Stay safe!
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www. perrymangroup.com), which has served the needs of over 3,000 clients over the past four decades.
