A Big Mac costs 48 kroner ($7.77) in Norway but only $4.80 in the United States. That makes the kroner overvalued by 61.8% and makes it the most overvalued currency in the index. In contrast, the Big Mac costs just $1.62 in Ukraine, making its currency the weakest looked at by the Economist. Ukraine beat out long-time cheapest “Big Mac” champion India — though because Hindus don’t eat beef, Big Macs in India are made of chicken.
One Way to Think About Currencies
Another good intellectual shorthand is to think of a currency as the “stock” of a country.
Much like stocks, overvalued currencies become overvalued for reasons that have little to do with their fundamentals.
These include a country’s future prospects, its perceived “safe haven” status or, as in the case of Brazil, just plain investment fashion.
About four years ago, the Brazilian real was 52% overvalued based on the Big Mac Index. That was because Brazil was perceived to be (yet again) the “country of the future.” But as Brazil’s economic growth has tumbled as the government introduced populist policies, the reputation of Brazil’s currency has suffered a big fall.
Today, the real is “only” 22.1% overvalued compared to the U.S. dollar. But on the Economist’s scale adjusted for gross domestic product (GDP), the real today is still overvalued by an eye-popping 86.8%.
Over the past few years, savvy Brazilians have been quick to convert their overvalued Brazilian reals into Miami condominiums. Based on the current “Big Mac” Index, they would be wise to continue to do so.
Puzzling also is the continued “safe haven” status of the Swiss franc, as well as the still-remaining Scandinavian currencies, the Norwegian Krona and Swedish crown. These currencies have been consistently the most overvalued currencies in the world over the past decade. Today, according to the Big Mac index, each is overvalued by 42.4%, 61.8% and 24.2%, respectively.
Here is one possible explanation.
Deep-pocketed investors don’t think of these currencies like they do others.
Much like central London property, they hold these currencies simply as a way to store value.
When you have too much money, your “existential choice” is about keeping what you have safe.
And these currencies offer the opportunity to do just that.
The ‘Exorbitant Privilege’ of the U.S. Dollar
Just last week, French Finance Minister Michel Sapin launched into a rant about the U.S. dollar’s unfairly dominant position in the international financial system.
He’s not the first Frenchman to do so.
Almost 50 years since Valéry Giscard d’Estaing did the same complaining about the U.S. dollar’s “exorbitant privilege.”
Much to the consternation of the “doom and gloom” crowd, the U.S. dollar has maintained its exorbitant privilege as the world’s safe-haven currency.
And looking at the “Big Mac Index,” the editors of the Economist conclude that the U.S. dollar is faring quite well, thank you.
Despite predictions of the “death of the dollar,” the U.S. dollar has gained ground on its emerging markets rivals since the global financial crisis.
The average valuation of the emerging-market currencies in the Economist’s GDP-weighted index has moved from roughly neutral in 2009 to about 15% undervalued against the dollar this year.
It turns out that the recovering U.S. economy and the Federal Reserve’s gradual reduction of quantitative easing is making the U.S. dollar ever more attractive.
So there you have it…
Currencies add an extra, complex dimension to the investment process.
But understanding how to think about currencies can give you just the extra edge you need to make better and more profitable global investments in the future.
In case you missed it, I encourage you to read my e-letter column from last week about why investing in Russia may not be a crazy idea.
Nicholas Vardy is currently editor of the monthly investment newsletter, The Alpha Investor Letter, which provides longer-term global investments. He also writes two weekly trading services, Triple Digit Trader and Bull Market Alert, which focus on making short-term profits in the hottest markets in the world.
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