By The Economist, Special for USDR
The latest Big Mac index from The Economist indicates that 31 of the 34 currencies tracked are undervalued against the US dollar. Only the Swiss franc, Norwegian krone and Swedish krona are overvalued.
Now in its 31st year, the Big Mac index is based on the theory of purchasing-power parity, the idea that in the long run, currency exchange rates should adjust so that the price of an identical basket of tradable goods is the same. The Economist’s basket contains one item: a Big Mac.
A Big Mac currently costs $5.30 in America, but just ¥380 ($3.36) in Japan. The Japanese yen is thus, by this meaty logic, 37% undervalued against the dollar. A Big Mac costs £3.19 in Britain and €3.91 in the euro zone, implying the two respective currencies are undervalued by 22% and 16%.
- One of the best-performing currencies over the past six months has been the Mexican peso. In January, the peso had fallen to a record low of 22 to the dollar, thanks in no small part to fears of a possible trade war with Mexico’snorthern neighbour. But markets have become increasingly sceptical that Donald Trump will follow through on his most blood-curdling trade threats. The peso has recovered ground and hovers at around 18 per dollar. The Mexican currency is now only 48% undervalued against the greenback, compared with 56% in January.
- The euro has also gained ground in the same period. The single currency buys $1.14 today, up from $1.04 at the start of the year; the euro has gone from being 20% undervalued against the dollar in our index, to 16% undercooked. The euro zone grew twice as fast in the first quarter as the American economy, and the European Central Bank has started to signal that its policy of extraordinary monetary stimulus will not last for ever. If Europe’s recovery continues to strengthen, American tourists to the continent may end up getting less burger for their buck.
The dollar surged, reaching a 15-year high in January. Since then, the dollar has slipped by 5% on a trade-weighted basis as markets lose faith in Mr Trump’s ability to pass domestic economic reforms. That vindicates not only those sceptical of Mr Trump’s legislative prowess. It’s also a partial vindication for believers in burgernomics, which indicates that the dollar may have further to fall.
The full report is available http://www.economist.com/content/big-mac-index
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SOURCE The Economist