WILL BANNING TRANSFATS LEAD TO A STRONGER DOLLAR?

McCurrencies: Hamburgers should be an essential part of every economist's diet (The Economist, 4/24/03).

THE past year has been one to relish for fans of burgernomics. Last April The Economist's Big Mac index flashed a strong sell sign for the dollar: it was more overvalued than at any time in the index's history. The dollar has since flipped, falling by 12% in trade-weighted terms.

Invented in 1986 as a light-hearted guide to whether currencies are at their “correct” level, burgernomics is based on the theory of purchasing-power parity (PPP). This says that, in the long run, exchange rates should move toward rates that would equalise the prices of an identical basket of goods and services in any two countries. To put it simply: a dollar should buy the same everywhere. Our basket is a McDonald's Big Mac, produced locally to roughly the same recipe in 118 countries. The Big Mac PPP is the exchange rate that would leave burgers costing the same as in America. Comparing the PPP with the actual rate is one test of whether a currency is undervalued or overvalued. . . .

Many readers complain that burgernomics is hard to swallow. We admit it is flawed: Big Macs are not traded across borders as the PPP theory demands, and prices are distorted by taxes, tariffs, different profit margins and differences in the cost of non-tradables, such as rents. It was never intended as a precise predictor of currency movements, but as a tool to make exchange-rate theory more digestible. Yet in the early 1990s, just before the crisis in Europe's exchange-rate mechanism, it signalled that several currencies, including sterling, were markedly overvalued against the D-mark. It also predicted the fall in the euro after its launch in 1999.

Academic economists are taking burgernomics more seriously, chewing over the Big Mac index in almost a dozen studies. Now a whole book has been written about the index . . . .

In a comment below, I wrongly stated that the Economist had stopped following the Big Mac index. As this article shows, not only do they still keep track of it, but it continues to be predictive. Given the generally poor quality of most economic statistics, the corruption endemic to most third world govermental statistics and the lag in announcing more precise statistics, the Big Mac index might actually be the world's most useful predictive economic indicator. Posted by David Cohen at July 29, 2003 10:22 AM