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“Mini Mac” Shows China’s Currency Shifting Into Undervaluation

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.

August 6, 2019

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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.

More on:

United States

International Economic Policy

International Finance

Russia

China

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 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 35 percent (a whopper). By contrast, the Mini Mac shows the dollar slightly undervalued—two percent on average (small fries).

The Mini Mac therefore offers no support for President Donald Trump’s view that the Fed or Treasury needs to push down the dollar broadly. But it does suggest that he’s right to be concerned about China’s currency. To relieve pressure on its exporters from Trump’s tariffs, China has allowed its currency to slide since trade negotiations broke down this spring. According to the Mini Mac, the RMB has plunged from a four-percent overvaluation in January to an eight-percent undervaluation.

The largest discrepancy between the two indexes remains Russia’s currency. With oil prices having ticked up since January, the Mini Mac shows the ruble rising from a five-percent undervaluation to a ten percent overvaluation. Despite higher oil prices, however, the Big Mac still has it undervalued by 65 percent. That just shows why their index won’t cut the mustard.

More on:

United States

International Economic Policy

International Finance

Russia

China

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