Big Macs are becoming a real bargain everywhere in the world… except for the United States. This is because most emerging market currencies have taken a big hit since the election of Donald Trump, whereas, the dollar is as strong as it has been in almost 20 years. Not only has Trump raised expectations of an increased strength of the dollar, but many foreign countries have had problems of their own as well, leaving emerging markets lagging behind. The Turkish Lira, for example, is one of the worst performing currencies so far this year due to terrorist bombings, economic slowdowns, and a central bank reluctant to raise interest rates to defend the currency (The Economist, Big Mac Index of Global Currencies). Emerging market struggles paired with a surging US dollar has led the Lira to be undervalued by 45.7% according to the Big Max Index.
You may be asking yourself “what on Earth is the ‘Big Mac Index?’” At least that’s what I asked myself the first time I heard it. You may be surprised to hear the Big Mac index is exactly what it sounds like: the cost comparison of a McDonalds Big Mac burger from one country to another. It is a fun, educational, and interesting way to learn how the world is valuing cost of goods on a country by country basis. The Big Mac index is built on the idea of purchase-power parity, meaning in the long run currencies will converge and rates should move towards equalization of an identical basket of goods & services.
In the United States a Big Mac costs $5.06 versus 10.75 Lira, or $2.75, in Turkey. The Mexican peso is even more undervalued at 55.9% versus the US dollar, meaning, a Big Mac only costs $2.23 in Mexico as of January 15th, 2017. The Big Mac index allows us to take complicated subjects, such as international commerce, and make it relatable and understandable.
One drawback of the Big Mac index is it does not take account of labor costs. Of course, a Big Mac will cost less in a country like Mexico because workers earn lower wages than workers in the US. So, in a slightly more sophisticated version of the Big Mac index, labor is included. This typically devalues the US Dollar (USD) compared to other countries around the world because our income is higher. For example, in the traditional Big Mac index, the Chinese yuan is 44% undervalued to the greenback, but after labor adjustments, it is only 7% undervalued. When this adjustment of labor cost is made, it makes it nearly impossible for the USD to trade at a premium against the Euro. This is because Europeans have a higher cost of living and lower incomes than Americans (The Economist, Big Mac Index of Global Currencies). Typically, the Euro trades around a 25% premium against the USD according to the Big Mac index. However, since the election of Donald Trump, even with the labor cost adjustment, the Big Mac index currently finds the Euro UNDERVALUED to the dollar. The US dollar is so strong, it is currently trading at a 14 year high in trade-weighted terms.
A strong dollar may sound great, but it has many disadvantages. In the United States specifically, a strengthening USD can lead to a widening trade deficit with decreased exports and increased imports. This has a negative result on domestic businesses that operate in foreign countries as well as anyone servicing debts tied to the US dollar. President Trump has publically stated he feels international commerce is rigged against the United States. Whether he is right or wrong, as the trade deficit grows, so does the likelihood of him imposing tariffs on imports from China and Mexico in hopes of bringing balance to trade. If we put a tax on imports, it will lead to something called “protectionism,” or the practice of shielding the United States’ domestic industries from foreign competition. Some feel this is a strong policy because it will keep businesses in the United States and, according to Trump, will prevent us from being taken advantage of. However, it is fairly accepted in macroeconomics that protectionism is a poor/outdated policy because corporate globalization has led to international supply networks that promote convergence and integration throughout the world. Simply put, the countries that are the best at developing goods, develop them, and other countries benefit from the best products at the lowest prices. When something like protectionism takes place, it disintegrates these networks and adversely affects trade-dependent states and the domestic country itself (in this case the United States). The import tax will ultimately drive up prices for domestic consumers who would otherwise benefit from world prices that are significantly lower. This will lead to an increase in trade of intermediate goods and inward investing into value chain niches.
The reason the Big Mac index is so interesting is because it can explain a complex subject like macroeconomics with something as simple as the cost of a hamburger. By knowing the price of a Big Mac on a country by country basis, we are able to understand a significant amount about the world economy and the repercussions the US will face based on the actions we take moving forward.
The Big Mac index is telling us one thing for certain: the US dollar is abnormally strong, which makes the near future uncertain. It is important to have a well-diversified portfolio with an appropriate asset allocation and a competent, experienced fiduciary like DWM to help guide you through times like this.