The Big Mac Factor... And What It Means to You

When "experts" say the dollar is "overvalued and about to crash," what exactly is it that they're talking about? How do they know?

It turns out, they don't know what they're talking about... as the U.S. dollar is not undervalued or overvalued versus the major currencies of the world, based on how much a dollar buys, versus how much a euro or a yen buys (this is based on a rather complicated calculation of "purchasing power parity," or PPP).

Fortunately, The Economist magazine invented a novel way to show PPP that everyone can understand. According to the May 29, 2004 issue of the magazine, the editors invented the Big Mac Index "in 1986 as a light-hearted guide to whether currencies are at their 'correct' level."

The magazine simply asks McDonald's for the U.S. dollar price of a Big Mac all over the world (McDonald's serves burgers in 120 countries). As of May 29, a Big Mac was 13% more expensive in Europe than in the States. However, in Japan, a Big Mac was 20% cheaper.

My take on this is that the U.S. dollar likely won't crash or soar against these major currencies, based on this indicator. The brutal truth is that the dollar isn't much overvalued or undervalued.

The currency world sure is a much more boring world today than many commentators would have you believe. It was a different story back in 1995...

A Big Mac in Japan was 100% more expensive than a Big Mac in the States. Not surprisingly, over the next few years, the Japanese yen crashed. In 1995, at the yen's peak, it only took 80 yen to buy one U.S. dollar. By mid-1998, it took nearly twice as many yen to buy one U.S. dollar.

If you had been smart enough to recognize the huge overvaluation of the yen in 1995 - and the Big Mac Index was one very simple way you could have done that - then you could have profited enormously as the yen weakened.

Currency Trading: Much Ado About Nothing, at the Moment

I don't expect you to turn into a currency trader. And the great thing is, right now, you don't need to be an expert on currencies - you don't need to transfer your money back and forth from yen to euros to dollars... why? Because the world's paper currencies are fairly in line with each other - a Big Mac costs the same in the countries of the world's major currencies.

The next time a Big Mac hits $6 a burger in Tokyo, I'll let you know.

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