Many people have tried a famous Big Mac at McDonald’s fast food restaurants at least once in their lives (even though it’s not quite healthy food).
This hamburger is probably the most famous in the product line of the American fast food industry. However, few people know that it gave rise to the so-called Big Mac Index, which is used to compare the value of currencies of different countries.
What is the Big Mac Index?
The Big Mac Index is the price of the burger in various countries that are converted to one currency (such as the US dollar) and used to measure purchasing power parity.
It all started in 1986 when The Economist magazine decided to estimate the currencies’ value by countries based on the prices of Big Mac at McDonald’s fast-food restaurants.
Thus, The Economist introduced a simple indicator of the fundamental value of currencies globally.
Why exactly was the Big Mac taken as an indicator?
The reason is very simple. Big Mac is the most well-known product in McDonalds’ fast-food chain. Besides, the same ingredients are used for Big Mac in any country: meat, bread, cheese, lettuce, onions, etc. Therefore, The Economist experts use Big Mac alone instead of determining the cost of a consumer basket (more complex method) for each country.
Big Mac Index Table for 2019
The most relevant Big Mac Index so far (as of July 2019) is presented in the table below.
Let's analyze these data a bit.
The Russian ruble exchange rate expressed in terms of the Big Mac Index in 2019 is 22.65 rubles per dollar.
Considering that the current market rate of the Russian currency is about 63.84 rubles, rather than 22.65 per US dollar, the Russian ruble is undervalued by approximately 64.5%.
Thus, the Russian ruble is the world’s most undervalued (cheapest) currency according to the Big Mac Index.
In 2018, the Ukrainian hryvnia was the most undervalued (by 69%) currency worldwide.
Now, Big Mac costs 57 hryvnias in Ukraine. While the price of the burger in the United States is $5.74, the Ukrainian currency exchange rate is 9.93 hryvnias per dollar in terms of the Big Mac Index.
However, the hryvnia is much cheaper in Forex – about 25.65 hryvnias per US dollar. Therefore, we can conclude that the Ukrainian currency is undervalued by the market by almost 61.3%.
In the list of world’s most undervalued currencies, Russian ruble and the Ukrainian hryvnia are accompanied by the Malaysian ringgit (undervalued by 62.8%), the South African rand (by 61.9%), and the Romanian leu (by 61.6%). Notably, the currencies of India, Pakistan, Philippines, and other low-income countries are not in the top five most undervalued currencies in 2019.
As for the most highly valued currencies, the statistics by countries shows that the world’s most overvalued (expensive) currency is the Swiss franc.
Considering that Big Mac costs 6.54 francs in Switzerland, the USD/CHF rate expressed in the Big Mac Index terms should be 1.1 francs per dollar. However, the value of this pair is currently quoted around 0.99 in Forex, which makes the Swiss currency overvalued by the market by 14%.
Besides the Swiss franc, The Economist’s experts identified two other overvalued currencies in their previous rating – Norwegian and Swedish krona. However, today, things are not the same for these currencies as well – they have also become undervalued, although not as much as the Russian ruble.
According to the Big Mac Index authors, Euro is also undervalued by the market. The average price of Big Mac in the Eurozone is 4.57 euros, meaning the currency is undervalued by 20.3%.
Notably, according to the Big Mac Index, all major currency pairs, except the Swiss franc, are undervalued against the US dollar.
Can We Use This Knowledge in Trading?
We can hardly do it in the short and medium terms, but the Big Mac Index can serve as a useful assistant while long-term trading.
For example, it can be used as a filter when opening positions in the Forex market. After all, if the Japanese yen is significantly oversold against the US dollar, traders are better to refrain from opening long positions on USD/JPY.
Similar conclusions can be drawn for other Forex currency pairs.
The key thing to remember is that the Big Mac Index is a true indicator of the fundamental value of currencies, and it can be used by traders in trading.