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.
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 24.4 percent (a whopper). By contrast, the Mini Mac shows the dollar overvalued 3.4 percent on average (small fries).
Since February, the dollar’s Mini Mac valuation has soared 6.1 percentage points, bringing its year-on-year rise to ten points. Fed rate hikes have driven much of the surge. Over the last five months, the Fed has lifted its deposit rate from zero to 2.5 percent. In other developed countries, sluggish growth has kept central banks from tightening as quickly, pushing investors into dollar-denominated assets.
Developed nations with lower rates have, correspondingly, seen their valuations drop. The Bank of England, for example, has hiked rates just one percent this year, and the pound is now 4.3 percent undervalued—down from 8.1 percent overvalued in February. The European Central Bank, similarly, has hiked only 0.5 percent, and the euro has dropped from 5.7 percent overvalued to 5.4 percent undervalued.
Valuations have also plummeted for emerging markets. As Pakistan teeters on the edge of default, its rupee has plunged from 3.2 percent overvalued in February to 20.7 percent undervalued. Sri Lanka, which defaulted in May after abandoning its currency peg, has seen its currency fall from 1.2 to 13.8 percent undervalued. And as China has stuck resolutely to its costly “zero COVID” policies, its renminbi has slipped from 3.2 percent overvalued to three percent undervalued.
As of July, The Economist stopped estimating valuations for Russia, where Big Macs are no longer for sale, and Ukraine. But looking at minis instead of Big Macs, both nations’ currencies are roughly fairly valued against the dollar. Falling mini prices have caused Ukraine’s hryvnia, in particular, to rebound sharply from its 16.5 percent undervaluation on the eve of Russia’s invasion. Ukraine is therefore more clear evidence that the law of one price holds—through peace and war alike.