Can a burger tell us something about the future performance of the main world currencies? If the burger in question is a sort of emblem of global fast food and its anticipatory capacity is calculated by the Economist, then the discussion is worth investigating. According to the results of research conducted by The Economist, the Big Mac Index can give us some information on the possible trend of the main world currencies, at least in the medium term.
What are we talking about? The famous Big Mac Index, an indicator of the trend of the real exchange rate of the main international currencies. The reasoning behind the index is quite simple. The emblematic hamburger of one of the best-known fast food chains is always made with the same ingredients anywhere in the world, so in theory – precisely due to the law of one price – it should always cost the same price. If, converted into dollars, the price of the Big Mac outside the US is different from the price paid in the US, it means that the local currency is overvalued or undervalued against the dollar.
But in addition to having a picture of the purchasing power of the main world currencies, can the Big Mac Index be a tool capable of saying something about the future trend of exchange rates? The Economist tried to verify if this possibility exists, and they did so by comparing the performance of the index they developed with the real exchange rate of the main international currencies (i.e. the nominal value of a currency compared to a basket of other seven currencies adjusted for inflation).
The analysis showed a negative correlation between the performance of the Big Mac Index and that of exchange rates over a five-year period. In numbers, the study shows that a currency that is 20% overvalued against the dollar experiences a 4% drop in the real exchange rate over the next five years. Mirror speech in the event that the currency is initially undervalued against the dollar.
If the argument holds, looking at the latest data from the Big Mac Index, a condition of undervaluation against the dollar emerges for the pound and the yen, while the Euro is in a strong position against the US currency. Applying the correlation described above, the Economist concludes, a revaluation for the pound and yen and a “devaluation” for the Euro could be expected over the next five years.
Obviously, these are numbers to be taken with a grain of salt, the variables involved are too many and perhaps the foundations on which the correlation is based are too few. Still, the research provided us with some information, demonstrating how much the dynamics of inflation, monetary policy, and economic performance weigh on the trend of currencies.
Featured image retrieved from: https://fbs.eu/es/blog/what-is-the-big-mac-index-466
Well written. Insightful perspective.