Despite the recent weakness, the dollar still looks strong. Remember that Big Mac Index, our carefree measure for currency valuation. Of the currencies of the 20 trading partners examined by the US Treasury Department, our measurement suggests that all have appreciated against the greenback since July, but that all but the Swiss franc are still cheap. That gives a lot to chew on the new Biden administration, which has promised to take “aggressive trade enforcement measures” against currency manipulators.
Our burger-based index is based on the idea that prices should adjust over the long term so that the same basket of tradable goods costs the same everywhere. By converting prices to dollars at the prevailing exchange rates, you can judge whether a currency is too cheap or too expensive. To avoid the problem of people buying different things in different places, let’s compare the price of only one good: the McDonald’s Big Mac. The burgers aren’t exactly the same across countries – India’s Maharaja Mac, for example, doesn’t contain beef – but they’re consistent enough. A burger in Thailand costs 25% less than in America when its price is converted to dollars at prevailing exchange rates, suggesting, for example, that the Thai baht is undervalued.
Since wages tend to be lower in poor countries, Big Macs may be cheaper there. That is why we also calculate an index that takes into account GDP per person. On this basis, the Thai baht is no longer cheap compared to the dollar. The number of trading partners with undervalued currencies drops to 11.
Is the Big Mac Index in line with recent American policy on currency manipulators? The two don’t rate the same things. Our index records the results. In contrast, policymakers seek to punish countries that deliberately depress their currencies. The US Department of Commerce says currencies are only unfriendly when they are cheap due to government measures. The Treasury Department also deals with manipulation, not undervaluation. It looks for evidence of intervention as well as persistent trade imbalances.
However, given the currency fluctuations over the past year, the Big Mac index could serve as an antithesis to American politics. When covid-19 first spread, investors fled to the dollar only to reverse the trend after the Federal Reserve flooded the markets with liquidity. The fluctuations in the Mexican peso, according to our index, caused it to be undervalued from 53% against the dollar to 61% in the first half of 2020 before the move was closed. In contrast, the Vietnamese dong shifted less than half a percentage point against the dollar in the first half of last year.
Consistent with this, Mexico has escaped penalties from the Treasury and Commerce Departments. Vietnam doesn’t have. On December 16, the Treasury Department labeled him a currency manipulator, citing his enormous surplus of goods with America and his intervention in the foreign exchange markets. The Ministry of Commerce imposed tariffs on tire imports from Vietnam on the basis that a depressed dong acted as a subsidy for producers.
However, on other fronts, America’s recent actions are at odds with our index. The Ministry of Finance has also branded Switzerland as a manipulator, partly due to its currency intervention of around USD 100 billion (14% of GDP) in the year up to June. However, both versions of our index suggest that the Swiss franc is overvalued against the dollar.
The Commerce Department also used currency manipulation to justify tariffs on cable ties imported from China that were used to seal plastic bags. Incoming officials may want to point out that after adjusting for GDP, our index suggests that the yuan is actually 2.5% overvalued against the dollar. Food for thought.