Believe it or not, there is something called the Big Mac Index, that confuses issues of global foreign exchange even more.
The Global Big Mac Burger as a Currency equalizer
When I learned that the Economist publishes the Global Big Mac Index annually, a mystery was unveiled…at least for me. I have been wondering why Washington pushes Beijing to raise the Yuan…Now I know…the Global Big Mac Index!
As I live by the rule that where two are fighting, two share the guilt, I have to admit that both the US and China have their flaws, be it in fiscal or social policy, yet on a relative basis I think the U.S. is little more to blame when it comes to currency war-fare. While the US clearly has been exploiting the global economic turmoil to its advantage by exporting inflation global, it has destabilized a lot of trading partner currencies by intentionally making the dollar weaker- more dollars coming off the presses simply means that supply and demand becomes unbalanced
The best way to understand why we are even having a currency war, is to understand the concept of Purchasing Power Parity or the “law of one price”, which states that the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. Or simply, a Big Mac in U.S. dollars should be priced equally the same, worldwide.
The Big Mac Index
The Big Mac Index, published annually by The Economist, is an index that uses the US dollar as a benchmark and analyses whether other currencies are over/ undervalued relative to the U.S. dollar. Studying the table below, in China a McDonald’s Big Mac costs just 14.5 Yuan on average, the equivalent of $2.18 at market exchange rates. In America the same burger averages $3.71. That makes China’s Yuan one of the most undervalued currencies in the Big Mac index. Since 14.5 Yuan can buy the same burger that is sold for $3.71, a Yuan should be worth $0.26 on the foreign-exchange market. At just $0.15, it is undervalued by about 40%.
Now I understand why Washington thinks it should confront the issue of the Yuan being undervalued. Most people think that an apple should be an apple , but rarely is. Washington obviously is of that opinion – no complication, just simply comparing the Sales Price of a Big Mac there and one here.
No consideration for the fact that labor cost in China is a fraction of labor cost in the US, ergo people make a lot less money. No consideration either for the fact that the Big Mac is built out of oversized buns, lettuce, tomatoes, onions, cheese, two beef patties and mustard or mayo, all ingredients that carry different price tags. Accepting the raw percentages that the sales price of a Big Mac is roughly 40% overhead (don’t forget the marketing and franchise cost, 30% personnel cost and 30% food cost, in China $0.65 goes to food cost, while in the US that amounts to $1.12. That is the only factor that counts and if I deduct 40% from $1.12 I end up with $0.67. Pretty darn close to the Food cost part in China, isn’t it?
No, I think those old crackers in China understand economics much better than our guys in Washington.
