What Is Burgernomics? The Big Mac Index

Where is the Australian dollar heading? It’s a question that employs the minds of many economists, fund managers and currency analysts around the world. A more lighthearted answer, though, may lie in a humble burger.

What is Burgernomics?

The “Big Mac Index” was invented by The Economist back in 1986, as a way to simplify exchange rates theory for the general public. Also known as Burgernomics, the Big Mac Index judges the value of a country’s currency against how much a Big Mac costs to buy in that country compared to other countries – i.e. the exchange rate.

No doubt the analysts who invented Burgernomics were simply hungry at the time they named their tongue-in-cheek theory – but it’s certainly a useful tool for watching the value of different countries’ currencies. While not intended as a precise tool for currency predictions, it has become a popular global benchmark or standard.

Why the Big Mac? This ubiquitous burger was chosen as the symbol of worldwide equality to power the index, probably because there are very few countries in the world now where you actually cannot buy a Big Mac.

The theory behind the Big Mac Index is purchasing power parity (PPP). This is the assumption that over the long-term, exchange rates should adjust so that an identical basket of goods and services (a Big Mac) will cost the same in real terms between any two countries. If the Big Mac doesn’t cost the same in two different countries, then it is likely that one country’s currency is under/over-valued.

Big Mac burger

Your currency should be able to buy you at a reasonable price…

Burgers gourmet sliders

…not mini-sliders at an inflated price.

“For example, the average price of a Big Mac in America in July 2016 was $5.04; in China it was only $2.79 at market exchange rates.

So the “raw” Big Mac index says that the yuan was under-valued by 45% at that time.”

Source: www.economist.com

What does under-valued or over-valued currency mean?

It means that either you require a large amount of a currency in order to make small transactions (under-valued currency), or that you can use small amounts of the currency to make very large transactions (over-valued currency).

For example, do you remember the Zimbabwean dollar? Probably not, because rampant inflation of 500 billion percent and the collapse of the Zimbabwean economy made their dollar so highly under-valued that they had denominations up to a $100 trillion dollar banknote. It meant people had to carry wheelbarrows full of money into the village to buy a loaf of bread – or a Big Mac…

In 2009, attempts to revive the currency were abandoned, and today Zimbabwe has several official currencies that it uses instead: South African Rand (ZAR), Botswana Pula (BWP), GBP (Great Britain Pound Stirling), Indian Rupees (INR), Euros (EUR), Japanese Yen (JPY), Chinese Yuan (CNY), US dollars (USD), and even Australian Dollars (AUD)!

And watch this space, because in mid-2016 Zimbabwe announced its central bank had been printing and distributing bond notes that could be cashed – which critics have scorned as a return to the dreaded Zimbabwean dollar. While local Zimbabwean retailers must purchase goods using legitimate currencies, their customers will now be able to pay them in “zombie money” with no fixed price or value and no government guarantee.

How is the Australian dollar going on the Big Mac Index?

Based on The Economist’s raw data calculations for the 2016 Big Mac Index, the Australian Big Mac at $4.30 AUD, which compared to $5.75 USD is under-valued by approximately 14.6%. Don’t panic – we were over-valued against the USD by 12.2% in January 2013. This means an actual exchange rate of 1.34 and an implied exchange rate of 1.14.

When adjusted for the relationship between prices and GDP per person, though, the Big Mac index indicates that the AUD has been under-valued since 2013 and that the AUD is now rising again, towards our correct long-term exchange rate of almost exactly parity.

As you can see, these estimations are rather accurate, given how the Australian dollar fell from 2013 to early 2016, before rising again slightly in late 2016.

So is our exchange rate likely to head North again anytime soon? It’s perhaps something to discuss over a hearty lunch.

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