Global currencies can be strange and confusing. For example, should you pop online for a game of pokies, but want to play in another country, how would the betting amounts be decided? Currency values fluctuate dramatically the moment you pass over a border, which can a recipe for disaster. More to the point; how do you determine the true value of a country’s buying power, given that there is no easily understood standardised currency?
Easy. Economists came up with a slick solution, the Big Mac Index. Published since 1986 in The Economist, the Big Mac Index has now become the standard way in which to understand global buying power. Though, the creators are quick to point out, it is by no means an exact science, and should be taken with a pinch of salt. Or at least be taken as more than a perfect indication, given that multiple factors play into the value of any country’s currency. If anything, the Big Mac Index is a great way to see which countries are being undervalued.
How Does It Work?
Since McDonalds is present in almost every country on Earth, and the Big Mac burger on every McDonald’s menu, the cost of the burger is a fairly accurate way to understand global currency. McDonalds works on a standardised system, meaning that every burger is the same size, made with the same ingredients, and sold in the same way. Hence any discrepancies in prices are due to factors other than the quality of the food. Or, to take a different angle, the varying cost of the burger can be attributed to the buying power of that country rather than the condition of the product.
In order to create the index economists simply research the cost of the burger in each country, and then convert that cost to the United States dollar. The overall result should align with PPP, or purchasing power parity. The theory says that, given enough time, the exchange rates of two countries should gradually align, and the burger should cost the same. This, however, is a theory based in a perfect world.
What 2019 Revealed
The 2019 Big Mac Index was, as always, a controversial reveal. Most startling was the enormous undervalue of many currencies. The Russian rouble appears to be currently undervalued by as much as 64.5%. It is the most undervalued currency in the report, although, even more alarming, it is performing better than six months ago when it was undervalued at 70.4%. To be more specific, the report suggest that the exchange rate should be 22.65 roubles to $1. In reality the exchange rate is 63 roubles.
But a closer look at the chart reveals that virtually every country on earth is undervalued to some extent, and it is just the level that differs. A better way to look at it is that the United States dollar is drastically overvalued. But how does such a situation arise in the global economy? The list showed that:
- Switzerland is the only country slightly overvalued at 14.0
- Sweden was undervalued at a modest -6.2
- Canada was presently undervalued at -10.2, but remained generally very stable
- Norway, although often overvalued, is currently undervalued at -15.4
- Israel which is also generally very stable, was currently undervalued at -17.0
At the other end of the spectrum we see the most undervalued currencies.
- The Russian Rouble is -64.5 undervalued
- The Malaysian Ringgit is -62.8 undervalued
- The South African Rand is -61.9 undervalued
- The Romanian Leu is -61.6 undervalued
- And the Ukraine Hryvnia -61.2 undervalued
The Big Mac Index has come under fire on many occasions, with arguments that that the cost of creating a burger is cheaper overall in poorer countries. In order to counteract these criticisms, The Economist added a new factor. An adjusted price was added in an update, which took into account the GDP per capita, which gave more accurate results. But even with this factored in; the South African Rand is still undervalued by a massive 26.9%. Why?
There are many factors that result in a currency being undervalued. In fact, so many that it can be difficult to keep track. Economics is not a simple science by any stretch of the imagination. Demand for a currency is an important factor, as well as the risks investors are willing to take. In the case of South Africa, the economy is currently stagnating. Add to this on going political turmoil and the result is a currency that isn’t currently considered a safe bet.
However, should the political situation in the country stabilise, and once the economy has again shifted into growth, the currency should reach its ‘proper’ exchange rate of R10 to $1, as opposed to the average R14 where it currently stands.