The Big Mac Index Post-Brexit
By Andrew Dassori
The Economist created the Big Mac Index in 1986 to measure purchasing power in different currencies based roughly on the price of a burger. The idea behind this index dates back to the 16th century¹ and effectively states that identical products should cost the same amount regardless of where they are sold. While this does not consider tariffs and transport costs, it remains relevant based on the assumption that people will buy a product in one location and sell it in another when a mispricing exists.
It takes time to import and export goods, so measures like the Big Mac Index are representative of pressure built over the long-term. Short-term changes, however, can either correct or exacerbate differences in valuation, so examining these after an event like Britain’s vote to leave the European Union can tell an interesting story.
Figure 1: Adjusted Big Mac Index Valuations for the British Pound
Source: McDonald’s; Thomson Reuters; IMF; The Economist
In January, the Pound was relatively well-balanced in terms of its valuation using the index. When considering major trading partners, Britain’s currency was undervalued relative to the US Dollar, overvalued relative to the Japanese Yen and Chinese Yuan, and fairly valued relative to the Euro. Since the results of the Britain’s vote to leave, or Brexit, this balance has shifted, leaving the Pound undervalued versus the Dollar, Euro and Yuan. Only the Yen remains on the positive side of the ledger.
How does this impact markets and the economy?
As seen in the changing levels of the Big Mac Index, imbalances can persist and expand over time. When it comes to purchasing power over the long-term, however, something eventually has to give. That something can be seen directly in the currency’s value, or indirectly in factors that impact this, such as economic growth and inflation.
The impact of currency devaluation can stimulate growth through more competitive exports. In the UK, however, where imports outweigh exports, higher prices at home can also be troublesome. Commodities priced in dollars now cost more in pounds, creating higher production costs for businesses. As these hit the consumer and the goods they purchase, price adjustments result in inflation. Other factors at play, such as new trade agreements and regulation, are likely to complicate things further. The one clear result affecting markets and the economy is the important headwind of increased uncertainty.
In this context, a portfolio balanced to economic outcomes helps lessen the impact of new and potentially painful risks. It also provides investors with the potential to benefit from the opportunities these risks create as currencies and economic variables adjust.
* * *
¹Froot, K. A., Kim, M., & Rogoff, K. (2001). The Law of One Price over 700 Years. IMF Working Paper.
Longwave Advisor, LLC (“Longwave”) is an SEC-registered¹ investment adviser located in New York. Longwave may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. Longwave’s website is limited to the dissemination of general information regarding its investment advisory services to United States residents residing in states where providing such information is not prohibited by applicable law.
Accordingly, the publication of Longwave’s website on the Internet should not be construed as Longwave’s solicitation to effect, or attempt to effect, transactions in securities or the rendering of personalized investment advice for compensation over the Internet.
Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in this report is derived from sources that Longwave believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
For information pertaining to the registration status of Longwave, please view the United States Securities and Exchange Commission’s website at www.adviserinfo.sec.gov. A copy of Longwave’s current written disclosure statement discussing Longwave’s business operations, services and fees is available from Longwave upon written request. Longwave does not make any representations as to the accuracy, timeliness, suitability, completeness or relevance of any information prepared by any unaffiliated third party, whether linked to Longwave’s website or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
¹ SEC registration does not indicate a certain level of skill or training.