Big Mac Index
The Big Mac Index could be a useful macro tool for gauging inflation, cost of living in different economies, and the exchange value of currencies.
Technical and fundamental indicators take the guesswork out of forecasting and improve the likelihood of you making bang on the money calls.
Looking through the optics to gauge reality is challenging, particularly in the current age of storytelling.
Some of the mainstream economic indicators, the macro data is so heavily massaged and frequently contradicts other data that it blurs the image.
So in a quest for truth-seeking, for investors this means the difference between making nose bleeding losses or profits, bizarre economic indicators are mushrooming up everywhere.
For the Freudian believers in search of the truth and an appetite for sleaze, there is even the Latvian Hooker Index. In short, in times of economic boom households have more disposable income to make discretionary spending. So, when the economy is booming demand for adult entertainment increases and there are more extramarital affairs. Think about it. If we lie to ourselves how can we expect the state to tell us the truth?
But let’s keep this on the family-friendly moral upright Big Mac Index.
The Big Mac Index measures purchasing power
The world-famous burger, The Big Mac was created by Jim Delligati in Pennsylvania. Today, the Big Mac is sold in 70 countries. But the price you pay depends on where you are.
The Big Mac Index was created by economists in 1986 as a lighthearted way of illustrating purchasing power parity
So given that McDonald’s is one of the biggest companies in the world and the Big Mac is widely available globally, it means that the famous burger is used as a basic goods comparison between most countries.
In other words, the Big Mac index can help foreign exchange traders gauge whether a currency is out of equilibrium and its exchange value, or parity value, is either over or undervalued
For example, a Big Mac costs ¥24.40 in China and $5.81 in the United States.
If we then compare the implied exchange rate to the actual exchange rate, we can see whether the Yuan is over or undervalued.
Here is how to calculate the Big Mac Index using China and the price for a Big Mac in the US
- Establish the cost of Big Mac in China which is ¥24.40
- Establish the cost of Big Mac in the USA $5.81
- Divide the two figures, so 24.40/5.81, which equals 4.20
- Determine the actual exchange rate; so one USD equals 6.34 Chinese Yuan, according to February, 17 data.
- Take the Big Mac exchange rate, which is 4.20 and subtract it from the actual rate of 5.81, then divide this figure by the exchange rate, which is 6.34
- So, (4.20-5.81) /6.34 which equals minus 25%
So by using the Big Mac Index, we can deduce that the Yuan is 25% undervalued
Beyond currency misalignments, the Big Mac Index also shows inflation in burger prices over time.
A Big Mac cost $2.90 in May 2004 and in January 2022 $6.98, which is a 100% increase.