In The News
The Starbucks Index
A new application of purchasing-power parity IS percolation through foreign in market.
Burgers or Beans?
Should move: towards levels that equalize the prices of a basket of goods and services in different countries= dollar should buy the same everywhere. By coincidence, the average price of a Starbucks tall latte in America is the same as the average price of a Big Mac, $2.80. By dividing the local currency price in each country by the dollar price we can calculate dollar paring these with actual exchange rates is one test of whether a currency is undervalued or overvalued.
Index tells broadly the same story as the Big Mac index for most main currencies (see table). Economic trouble is surely brewing in Europe: the euro (based on the average price of €2.93-$3.70–in member countries where Starbucks operates) is about 30% overvalued against the dollar. Sterling is 17% too strong. By both measures, the Swiss franc is the world’s most overvalued currency. The Canadian, Australian and New Zealand dollars are still undervalued against the dollar despite their recent climb.
There the two measures differ is in Asia. The burger index says the yen is 12% undervalued against the dollar; on the coffee standard, however, it is 13% overvalued. More startling is the Chinese yuan: it is 56% undervalued according to the Big Mac, but spot on its dollar PPP according to our Starbucks index. If so, American manufacturers have no grounds to complain about the yuan. The pricing differences probably reflect different competition in the markets for the two products.
Many readers will find burgernomics and Reaganomics hard to swallow. Both are flawed as measures of PPP, because they are distorted by differences in the cost of non tradeables such. Yet they are surely a more fun ~y to understand exchange rates than textbooks. Author’s Note: Except, of course, this one.) Many readers ask of y don’t we use the price of The Economist around the globe. Unlike the Big Mac or a tall latte, The Economist is produced locally in lots or countries, so distribution accounts for a large chunk of its cost. Burgers and coffee re therefore like to give some clues about currencies.