The Big Mac Index: A guide for currency valuation?

  • What is the Big Mac Index?

In short the Big Mac Index (BMI) provides a general sense of, all things being equal, where the exchange rate should be. It compares the average price of a McDonald’s Big Mac in one country to another after converting the exchange rate. In theory, the Big Mac should have the same value and price anywhere in the world and the exchange rate should be adjusted accordingly. For example, “the average price of a Big Mac in America in January 2017 was $5.06; in China it was only $2.83 at market exchange rates. So the "raw" BMI says that the Yuan was undervalued by 44% at that time.” (Excerpt from The Economist page). There is also the adjusted BMI which adjusts the price by GDP per capita.

The Economist provides an interesting tool which shows relative overvaluation and undervaluation of currency using BMI. The current chart looks as follows:

 

  • How should you use it?

I wouldn’t take the index too seriously but you can use the index as a general guideline to decide when to buy a currency. For example, you can see that Canadian dollar is fairly valued when USDCAD is about 1.31 or so. In other words, we could say that we should buy USD when USDCAD is below 1.31 and sell USD otherwise.

You can use the chart for speculative bets as well. You could buy New Taiwan Dollar seeing that the currency might be undervalued by 40% relative to USD according to the chart. In fact, the Taiwanese government is allegedly manipulating the market to depreciate its currency (source: Bloomberg Markets).  If the US government makes an official statement declaring Taiwan as a currency manipulator, New Taiwan Dollar might start appreciating in value.