from Geo-Graphics

CFR Mini Mac Index Shows Dollar Strength as Inflation Climbs

   

 

 

The “law of one price” holds that identical goods should trade for the same price in an efficient market. But how well does it actually hold internationally? The Economist magazine’s Big Mac Index uses the price of McDonald’s Big Macs around the world, expressed in a common currency (U.S. dollars), to measure the extent to which various currencies are over- or under-valued. The Big Mac is a global product, identical across borders, which makes it an interesting one for this purpose.

But the law of one price assumes there are no restrictions on, or costs involved in, the movement of goods, and Big Macs travel badly. So in 2013 we created our own Mini Mac Index, which compares the price of iPad minis across countries. Minis are a global product that, unlike Big Macs, can move quickly and cheaply around the world. As explained in the video here, this fact helps equalize prices.

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As shown in the graphic at the top, the Mini Mac Index suggests that the law of one price holds far better than does the Big Mac Index. The Big Mac shows the dollar overvalued against most currencies, by an average of 31 percent (a whopper). By contrast, the Mini Mac shows the dollar slightly undervalued—4.3 percent on average (small fries).

Since February, the dollar’s valuation, as measured in minis, has ticked up 2.4 percentage points. This rise reflects investors’ expectations that the Fed may soon scale back its unprecedented monetary easing. Back in April, core PCE inflation soared from just below the Fed’s two-percent target to 3.1 percent; it has since climbed to 3.5 percent. Fed officials have signaled, as a result, that they may begin winding down quantitative-easing asset purchases as early as October.

As measured in minis, emerging-market currencies have, in contrast to the dollar, taken a beating. Since February, Turkey’s lira has slipped from a fifteen percent overvaluation to a ten percent one today. Argentina’s peso has fallen from a six percent overvaluation to a three percent undervaluation. These drops reflect souring growth expectations for the developing world, driven by the rapid global spread of the Covid-19 delta variant.

China’s slowing economy has, too, taken a toll, hitting others which rely on exports to the regional giant. The Thai baht has fallen from a nine percent overvaluation to a two percent undervaluation. The Philippine peso has plunged from a seven percent overvaluation to an eleven percent undervaluation. And the Malaysian ringgit has dipped from an eight percent overvaluation to a four percent one.

As for China’s RMB, it has held steady at a two percent undervaluation, thanks to the PBoC’s interventions aimed at maintaining a constant exchange rate.

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Economics

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