The Big Mac Index

“The Economist” has developed the Big Mac Index as a way to determine if currencies are overvalued or undervalued. The thought is that a McDonald’s Big Mac being pretty much the same everywhere around the world, one should expect the cost to be the same as well.

Of course, this is never true and the Economist publishes its Big Mac index to show those difference as overvaluation and undervaluation of individual currencies. The most overvalued currency right now is the Norwegian Krona, with the Big Mac 121% more expensive in Oslo than in the US. Hong Kong and Malaysia have the most undervalued currencies, a Big Mac costing 52% less there than in the US. (see chart to the right).

What one should immediately notice is that every major developed currency is overvalued including the Euro, Sterling, the Canadian Dollar, the Swiss Franc, the Swedish Krona, and the New Zealand Dollar. The sole exception here is the Australian Dollar. On the other hand, all the major Asian manufacturing countries and oil producing nations have undervalued currencies. This includes China, the UAE, Saudi Arabia, Singapore, South Korea, and Taiwan.

Most of the overvalued currencies are free-floating currencies, while most of the undervalued currencies are pegged to the dollar.

So what does this mean for the U.S. Dollar going forward? The U.S. currency depreciation against major free-floating developed economy currencies is over. The Euro is 50% overvalued, Sterling is 28%. There is not a lot of upside to that trade from here. On the other hand, the Asian and Middle East currency pegs are at some risk of busting wide open. The Asians and Middle Est have held their currencies way too low for way too long. Inflation is rife in these countries as a result. It is only a matter of time before new pegs are found or a currency basket is used to replace the dollar peg. For China, the timing will be critical as their currency is significantly undervalued and protectionist sentiment in the U.S. is sure to mount as the slowdown takes hold.

On the whole, the U.S. Dollar should continue to be weak. But, weakness should come at the expense of Asia and the Middle East more than Europe.

In the meantime, if you want a Big Mac, going to the Olympics in Beijing this summer might not be a bad idea. I hear the Big Macs there are cheap.