Invented in 1986 as a light-hearted guide to whether currencies are at their “correct” level, The Economist magazine’s Big Mac index is used to gauge purchasing power between countries as the Big Mac is exactly the same in the more than 25 000 McDonald’s stores in almost 120 countries.
The theory of purchasing power parity (PPP) says that in the long run exchange rates should move towards rates that would equalise the prices of an identical basket of goods and services in any two countries.
The Big Mac PPP rate is the exchange rate that would leave a Big Mac burger in any country costing the same as in the United States.
A Big Mac burger costs $2,90 in the US and R12,40 in South Africa, implying that the Big Mac PPP rate is R4,28 a dollar.
The cheapest Big Mac in US dollar terms is in the Philippines at $1,23, while the most expensive is in Switzerland at $4,90. In December 2001, when the rand touched a record worst level of R13,86 per dollar, a South African Big Mac cost less than a dollar.
In other words, in May 2004, the Philippine peso was the world’s most undervalued currency, while the Swiss franc was the most overvalued.
The most interesting finding is that all emerging-market currencies are undervalued against the dollar. The Chinese yuan, for instance, is 57% undervalued.
The Economist magazine said the Big Mac index was never intended as a precise forecasting tool. Burgers are not traded across borders as the PPP theory demands; prices are distorted by differences in the cost of non-tradable goods and services, such as rents.
The prices of traded goods will tend to be similar to those in developed economies as traded goods trade in a global market place with transport costs the differentiator.
The prices of non-tradable products, such as housing and labour-intensive services, are generally much lower in emerging market due to a lower cost structure. A haircut or a house is, for instance, much cheaper in Johannesburg than in New York.
Measured at market exchange rates, emerging economies account for less than a quarter of global output. But measured using PPP they account for almost half.
Small wonder, then, that global economic rankings are dramatically transformed when they are done on a PPP basis rather than market-exchange rates.
The US remains number one, but China leaps from seventh place to second, accounting for 13% of world output. India jumps into fourth place ahead of Germany, and both Brazil and Russia are bigger than Canada.
The way in which economies are measured also has a huge impact on which country has contributed most to global growth in recent years.
Using gross domestic product (GDP) converted at market rates, China has accounted for only 7% of the total increase in the dollar value of global GDP over the past three years, compared with the US’s 25%. But on PPP figures, China has accounted for almost one-third of global real GDP growth and the US only 13%.
This exchange-rate distortion is also evident in South Africa where the nominal GDP grew by only 7,9% to R1,209-trillion in 2003 in 2002, whereas in US dollar terms it grew by a massive 50% to $160-billion.
This is one of the reasons why South Africans feel wealthier and more optimistic about the future even though the official data shows that real rand GDP growth has been below population growth for the past four quarters.
This helps to explain why commodity prices in general and oil prices in particular have been surging, even though growth has been relatively subdued in the rich world since 2000.
Emerging economies are not only growing much faster than rich economies and are more intensive in their use of raw materials and energy, but they also account for a bigger chunk of global output if measured correctly. Even if a Chinese Big Mac costs less than half one made in the US, it uses the same amount of flour, beef, lettuce and such.
That is why South Africa’s export commodities such as platinum and iron ore are much more geared towards Chinese demand than developed country demand. — I-Net Bridge