What can a world-famous fast-food burger tell us about the future of the Australian Dollar? More than you might think.
Substantial amounts of time, money and research are invested each year in an effort to work out what will happen to the value of currencies. Will the Australian Dollar rise or fall against the mighty US Dollar? Will Greece’s economic woes continue to affect the performance of the Euro? Economists, fund managers and forex traders all search for the crystal ball that can accurately predict the future.
Despite the many complex economic models in place to chart the fluctuations in currency value, there may be an even simpler way to determine the true worth of a currency. It’s known as the Big Mac Index and it offers a unique and interesting way to look at exchange rates.
What is the Big Mac Index?
When the experts at The Economist were looking for a way to explain exchange rate theory to the general public in 1986, they settled on a burger known around the world to help them do it. The Big Mac Index compares the price of a McDonald’s Big Mac in the US with the price of the same burger in a range of other countries around the world.
The Big Mac Index is based on the theory of purchasing-power parity (PPP). The basic premise of this theory is that, over time, exchange rates should move towards the rate that equalises the cost of an identical basket of goods and services in any two countries. So in this case, the price of the near-ubiquitous Big Mac in two countries should eventually reach the same level.
Although the index was never intended to offer a precise way to determine the true value of a currency, it has become a popular and widespread method useful for explaining exchange rates to everyday citizens. Often referred to as a global standard for measuring the relative value of a currency, the Big Mac Index has even made its way into many respected economics textbooks. The term "Burgernomics" was coined to refer to this unique way of looking at exchange rates.
The 2016 Big Mac Index
The latest data on worldwide burger prices was released in January 2016. Based on the raw data calculations, where the price of a Big Mac was USD$3.74 in Australia compared to USD$4.93 in the United States, the Australian Dollar was undervalued by 24%.
The same data revealed that the Russian Ruble was undervalued by 69% and the Venezuelan Bolivar by a massive 86.5%, while the Swiss Franc was almost 31% overvalued. Sweden and Norway were the only two other countries with currencies classed as being overvalued, at 6.1% and 5.8% respectively.
Interestingly, in July 2014, the Big Mac Index suggested that the Australian Dollar was almost exactly at the point where it should be. Market exchange rates had the price of a Big Mac in Australia at USD$4.81, compared to USD$4.80 for the same burger in the United States.
The price of the Australian Dollar relative to the US Dollar has steadily declined since then, however, reaching a low of 68 cents in January 2016 before climbing back above the US 75 cent mark in March.
If the Aussie Dollar is to regain parity with the US Dollar, the Australian economy might need a little bit of "special sauce" to help it get there.