The Big Mac Index
The Big Mac Index: How To Profit From the World's Most Expensive Burger
by D.R. Barton, Jr., Contributing Editor
Thursday, June 1, 2006: Issue # 190
I ate my last Big Mac sometime back in the early 1980s.
Don't read into this any implication that I'm a health food nut - I still enjoy a good burger (hence the aversion to Big Macs). I just don't eat the fast food variety.
But the rest of the world continues to gobble up plenty of McDonalds' flagship burgers. The availability of Big Macs, made the same way and using the same ingredients in 120 countries, has allowed The Economist magazine to create the Big Mac Index. This is a surprisingly useful measure of the relative value of currencies around the world.
The Big Mac Index has established such a following that the venerable magazine is celebrating the 20th anniversary of the index in this week's issue.
Despite the objection of some economic purists, the Big Mac Index is one of the most simple and useful examples of Purchase Price Parity that you can find. Most objections raised by the traditionalists are technical in nature, and are trumped by the fact that the index has proven itself to be a very good guide to currency valuation over the years.
Quite simply, if a Big Mac costs a lot more in one country relative to another, chances are that the expensive currency will lose value over time.
So, what does this economics lesson have to do with trading and investing? Plenty - if you want to understand currency prices and their most likely direction in coming months. Let's see what the Big Mac Index is telling us now, and what you can do about it in your account.
Using the Big Mac Index for Currency Valuation
Before we go any further, let me give you a few countries/currencies to ponder (in the list below):
Switzerland (Swiss franc)
Canada (C. dollar)
The average cost for a Big Mac in four major U.S. Cities is $3.10. If you bought a Big Mac in the other countries listed, where would you have to pay more than $3.10, and where could you pay less? Just for fun, take a guess before we move on…
The answers certainly surprised me.
I've always "known" that Tokyo was one of the most expensive cities to visit. So, I naturally put Japan at the top of my list for most expensive. I figured that China's Yuan has been kept artificially low, so they would be near the bottom of the list (this is the only one I got right). Canada has always had a weaker currency (for the last decade or so anyway), so I figured they were down as well.
Here are the real answers, according to The Economist:
Big Mac in Local Currency
Big Mac in U.S. Dollars
% of Price Paid in U.S.
|Switzerland||S. Franc: 6.30||$5.21||+68%|
|Canada||Can. $: 3.52||$3.14||+1%|
I was amazed that Iceland had the second-highest priced burger on the list! (Only Norway was higher.) All of the Scandinavian countries comprised the highest group. But why little Iceland? They are offering very high interest rates on their government-backed bonds, so money is flowing there (as my good friend Dr. Steve Sjuggerud says, money goes where it is treated best).
Switzerland and the general Eurozone is the next highest group, followed by North America.
I must admit that I was amazed to find the burgers now cost more in Canada (if only by a little bit) than they do in the U.S. The Canadian dollar has had a huge bull run against its U.S. counterpart, and many pundits think that the Canadian dollar will only get stronger.
It was not very surprising to find that South American currencies were significantly discounted relative to the U.S. dollar.
My next surprise was in Japan. Based on purchasing-power parity, the yen is 28% undervalued versus the U.S. dollar. That was another big surprise. Other Asian currencies were moderately to very weak versus the weakest of them all: China's yuan.
No surprise here. But the Chinese government's ability to keep the yuan artificially low is clearly seen in the price of Big Macs, with the burgers selling at an astonishing 58% discount to their American counterpart. However, you shouldn't rush out and load up the yuan just yet…
So, What Can You Do About Relative Currency Values?
There are several things that the average trader or investor can do to balance his portfolio and make it less dollar dependent:
- Buy Certificates of Deposit (CDs) denominated in other currencies. EverBank has a broad line of products that were created to help people hedge against currency moves. You can buy CDs in other currencies through them. (Note: The publisher of Investment U has a marketing relationship with EverBank. So, while we value their products, it's necessary to disclose this to you.)
- Buy foreign company stocks on U.S. Exchanges. Stocks like Japan's Sony (NYSE: SNE), and Germany's software giant, SAP (NYSE: SAP), can be bought on U.S. stock exchanges in the form of American Depository Receipts (ADRs). They trade like any other stocks.
- Play the "Max Yield" Strategy. In the book that I co-authored (Safe Strategies for Financial Freedom), Steve Sjuggerud outlined a great strategy for finding the strongest currency each year and investing in it. I'll give more details on this in next week's article, or you can pick up a copy of the book (see details in today's "Tips and Tricks" ).
Earlier in the year, I wrote an article for the Oxford Club's Communiqué that described how the euro looked quite weak relative to the U.S. dollar, and that it should strengthen. The euro has had an impressive rally since then, and for now, there doesn't appear to be a compelling case for a re-valuation either way in that currency pair.
Tune in next week when we'll look at an amazingly simple and extraordinarily effective way to benefit from year-to-year currency fluctuations.
Today's Investment U Cribsheet
- Safe Strategies for Financial Freedom, The New York Times best-seller that I co-authored with Van Tharp and Steve Sjuggerud, has some really useful information on currencies, inflation and other macroeconomic issues affecting traders and investors, as well as a full description of the Max Yield strategy mentioned above.
- Frank Trotter, president of EverBank, recently wrote a guest essay for Investment U readers. If you'd like to see Frank's take on the currency climate, read Investment U E-Letter # 523: The Decline of the Dollar: Four Torpedoes Are Headed Straight For the Dollar… Take Cover And Profit. And to learn more about EverBank's World Currency Certificates of Deposit, call 800.926.4922 , or visit EverBank online, and be sure to reference your membership to Investment U. (Again, please note that while I think EverBank's products are first-rate, it's important for me to let you know that the publisher of Investment U has a marketing relationship with EverBank.)
The Chart of the Week
The U.S. dollar has suffered a massive sell-off in the last six months, relative to the Yen. But it has just broken a trendline, and some key fundamental central banking changes in Japan point to more upside potential for the dollar.