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I've eaten probably the world's most expensive Big Mac in Switzerland. I've also eaten one of the world's cheapest Big Macs in Taiwan. And I was very curious to discover whether they taste the same. And I'm happy to report that they do. And that's the reason why we adopted the Big Mac as our universal standard of purchasing power. This is not my idea. I've been writing about the Big Mac for just 20 years, a mere half of its life. The idea came from um someone mentioning to Pam Woodall, our then economics correspondent, quite how expensive burgers were in certain parts of
Europe. And that gave her the inspiration. She describes it as this bathtub moment, this Eureka moment that perhaps the price of a burger, a standardized burger could tell us something interesting about currencies. And indeed it does. The reason why these prices diverge so much is because some currencies are overvalued, others are undervalued. And this index has taken on a life of its own. There's there used to be an exhibit on it in the money museum in Frankfurt, the Gel Museum. Um, one of our colleagues, Henry Trix, on a rare visit to North Korea presented
the Big Mac Index to government functionaries there. And although there is no McDonald's in North Korea, they were quite keen to learn what it said about the Chinese yuan. China obviously being North Korea's key trading partner. And it's even excited the interest of currency traders, fund managers. I'm told that uh Soros Fund Management admitted that when the euro was introduced, it looked at the Big Mac index which suggested the euro was overvalued and therefore might be ripe for a fall. and it wondered whether it should trade on this signal. Ultimately, it ignored
the Big Mac index. It went with the consensus view that the euro would strengthen and it lost out as a result. Um, as Pam mentioned, Soros is probably very cheesed off about this. Well, it was a really brilliant idea by Pam who is a dear colleague and she had lots and lots of good ideas, but this was one that really stuck. Henry, tell me a little bit about the underlying economics here. What's what's going on? Why does this work? Well, the idea is uh purchasing power par. The idea that uh currencies should exchange should exchange at the rate implied by their purchasing
power locally. And it works very well because as Simon said, the Big Mac is the same everywhere, but also uh because the Big Mac is actually quite representative of local economies. It contains some things that are globally traded, some things that are uh only locally available. it reflects the cost of labor and rent uh locally and so on. So it's a very effective uh proxy for that. But of course the problem is that currencies do not in fact only represent the uh purchasing power they have locally. They also reflect confidence in the economy's institutions, the outlook for economic
growth and very importantly and one reason the Big Mac often goes wrong very importantly interest rates. And so when the Big Mac index and uh the currencal exchange rate gets out of whack, very often it's because central banks are doing something which is causing all this speculation that has nothing whatsoever uh to do with burgers. Look, it is it's as Henry describes, it's a very simple idea. That was its brilliance. Um but it is a it's an imperfect but nonetheless simple way of capturing exchange rate misalignments, purchasing power par. Um and as such it is used
and Josh will tell us I'm sure how it's used by traders but because it is so easy and now so widespread and we collect it every month from and McDonald's helps us um uh for huge numbers of countries it's a kind of back of the envelope way of trying to you know assess a mismeasurement and so it's great for scholars have used it I don't know Simon can tell us exactly how many papers have been written about it but huge numbers of academic papers it's also something that for policy makers is a flash Because if you have an undervalued currency and the big mac index pointed
out then you're going to become very bristly about that particularly. Well, we have an we actually have an example of that from the Taiwanese central bank normally very mildmannered people. They say using purchasing power parity concepts including the big mac index to gauge the equilibrium exchange rate is inappropriate. Then they go on to say that international institutions, they quote, say that PPP is not an equilibrium exchange rate and should not be used to measure currency under or overvaluation, let alone relying on a single commodity to assess a nation's exchange rate
valuation. This is really interesting because this was a response to a very good and hard-hitting piece um about the Taiwanese economy and why the Taiw and the and Taiwan scores, you know, at the bottom of the Big Mac index. And the Taiwanese central bank has had a policy of systematically ensuring the undervaluation of its currency. So of course it's going to bristle at this. So Josh, the billiond dollar question is do traders actually use this? Well, yes, it's a meaty question, isn't it? Um the Oh no, we can't we have to stop. We have to call trees on puns at this point right from the beginning. So I think in one way,
no, it does not predict short-term movements of currencies. You know, imagine if a well-known signal that is quite easy to construct like this did tell you how currency markets were going to move in the short term and you could trade profitably on it. Well, obviously professionals would construct it themselves. They'd use it immediately. They'd already harvest the gains and the signal would go away. Over the longer term, it has sometimes been a sort of weak kind of 6 to 10 year uh signal of where currency markets are going. So a feature of currency markets even more than others like stocks and bonds is that their returns are wildly
unpredictable and this doesn't really help you in another sense. However, if say I'm an investor thinking of investing in a Korean clothing chain or a casual dining group, then a concept like purchasing power par is very useful to me because I need to know how wealthy do Korean households feel over and above what's implied by exchange rates. So I definitely need signals like this.
