The Economist
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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 a really brilliant idea by Pam who is a 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 the underlying economics here. What's what's going on? Why 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 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 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 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
