Trading and Investing Forum

Go Back   Trading Forum and Blogs > Trading Strategies and Systems

Thread Tools Display Modes
Old 06-27-2009, 07:53 AM
Bryan Rich's Avatar
Bryan Rich Bryan Rich is offline
Money and Markets
Join Date: Mar 2009
Posts: 12
Bryan Rich is on a distinguished road
Default The Big Mac ... Purchasing Price Parity ... and the Euro

If you were to travel outside of your home country and encountered a McDonald's, would you pay more or less for a Big Mac?

Well that depends ...

You would likely notice a difference though. A major cause of this difference is the value of the local currency relative to your home country's currency.

For example, a Big Mac in the U.S. will run you about $3.50. If you're traveling around Germany, you'll pay in the neighborhood of 3.42 euros for that sandwich. So at current exchange rates, the same sandwich in Germany will cost you $4.82 or 37 percent more than you'd pay in America.

What does this analysis tell you about the value of the euro?

It could tell you that the euro is overvalued. But there are also other factors to consider when comparing the Big Mac across countries: Labor costs, real estate costs, taxes, transportation costs, trade-related costs, the quality perception of the product and other variables that impact doing business in different countries.

The bottom line: Running a McDonald's in Omaha is quite different than running a McDonald's in, say, Moscow. Nonetheless, it's a useful quick analysis ...

The more academically accepted version of purchasing price parity (PPP) is the measure against a basket of goods and services. These statistics are compiled by the Organization for Economic Co-Operation and Development (OECD).

Both the Big Mac Index and the OECD's work are broadly accepted tools for assessing the relative under or over valuation of currencies. However, PPP analysis in general is a longer-term tool. It does not incorporate many of the short-term influences that can drive currency values.

Yet it does provide a benchmark equilibrium exchange rate as a reference point, which combined with a healthy dose of assumptions, can be used to normalize the cost of a product across countries.

So What Does PPP Tells Us Right Now About The Most Overvalued Currencies In the World?

In my chart below, you can see some of the most overvalued currencies according to the Big Mac Index and the OECD's PPP. The axis on the left shows how overvalued these currencies are relative to the equilibrium exchange rate based on purchasing price parity.

Both measures agree that the Swiss franc is overvalued. The strength of the franc is why the Swiss National Bank stepped in this week, for the second time since March, to halt the rise of its currency against both the euro and the U.S. dollar. Hampered by a strengthening currency, Switzerland's exports to the rest of Europe, which accounts for more than a quarter of GDP, have been suffering big-time.

At the same time, the Swiss economy is experiencing deflation, and its core banking industry is getting hit by bad loans to eastern and central Europe. What's more ... a global initiative to curtail tax evaders is threatening its bank secrecy model.

Adding to the problems, the Swiss franc has found its traditional appeal lately as a safe haven currency in times of crisis. This has helped send the Swiss franc surging 10 percent against the euro and roughly the same against the dollar since the global financial crisis started to unravel.

And while the euro is undervalued against the Swiss franc, it's overvalued against almost everything else!

Since reaching all-time lows against the dollar in 2002, the euro nearly doubled in value at its highest point last year. And now it still stands 70 percent higher against the dollar from those 2002 lows. Meanwhile, the fundamentals don't support the strength. The Eurozone economy is expected to contract by 4.8 percent this year, downgraded from earlier estimates of 4.1 percent.

At the same time, the U.S. economy is expected to have among the smallest contraction of G-7 countries at 2.8 percent. And this week, the OECD upgraded expectations for a global recovery based on expectations that improvement in the U.S. economy would lead a world recovery.
But the OECD's outlook for Europe was grim ...

Europe has been slower and less responsive to the crisis than its counterparts and continues to hold its benchmark interest rate above that of the U.S., the UK, Japan, Switzerland and Canada. In fact, officials at the European Central Bank have had strong debates about establishing a 1 percent floor on rates. Alternatively, after assessing the Eurozone economy for itself, the OECD made a direct recommendation that the ECB "exhaust" the room left for rate cuts — and sooner rather than later.
Perhaps the ECB is showing signs of stepping up the fight against its troubling outlook: This week, it made a huge move, injecting more than $600 billion into the European banking system to get credit flowing more liberally.

As For the Undervalued Currencies ...

The major Asian export-centric economies dominate those currencies deemed the most undervalued according to purchasing price parity. Among them are the Malaysian ringgit, the Thai baht, the South Korean won, and not surprisingly, the Chinese yuan.

Even after moving from a pegged currency regime to a managed float four years ago — where the Chinese central bank manages the value of the yuan to a basket of currencies — the yuan still remains grossly undervalued.

As I mentioned earlier, the Big Mac Index and the OECD's PPP aren't great trading tools. But they do give some additional perspective when combined with fundamental, technical and sentiment analysis.
And considering the challenges facing the Eurozone, these valuations give further reason to believe that the euro will likely come under pressure again before the broadest global recession on record passes.



P.S. Registration for Tuesday’s special briefing CLOSES in just 48 HOURS!

Registration is FREE and takes only a few seconds. Just click this link to reserve your place at this landmark briefing and be on-hand as we reveal ...

The startling forecasts our analysts are now making for the rest of 2009 and through 2012 ...

The three massive economic cycles that are now converging to create "The Perfect Storm" and how they will impact your stocks ... gold ... silver ... the dollar ... and more over the next three years ...

Seven specific investment recommendations designed to help you harness the money-making power of long-term and shorter-term cyclical convulsions in these markets and ...

How you can USE this paradigm shift in investment timing with specific "buy" and "sell" signals to sharpen your investment timing both over the long term AND ALSO to help you profit from shorter-term fluctuations along the way.

Please remember: There is no cost for attending. Your registration for Solving the Timing Mystery is absolutely free. Just click here to reserve your place while you still can!

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit

Last edited by Bryan Rich; 06-27-2009 at 07:59 AM.
Reply With Quote


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
Thread Tools
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off

Forum Jump

All times are GMT -6. The time now is 04:31 PM.

Powered by vBulletin® Version 3.8.6
Copyright ©2000 - 2018, Jelsoft Enterprises Ltd.