Invented by The Economist in 1986, the Big Mac Index is a supposed efficient tool of calculation of global currency valuations. The Economist has been claiming for more than 20 years now to have developed a system which successfully shows overvalued or undervalued currencies. Though the libertarian news magazine laughs at its own tool it also takes it seriously as so it is by some scholars, the press, business and financial leaders as well as economics students all around the world.
Looking at their brand new Interactive currency-comparison tool one can find many flaws in the index. First of all, there shouldn’t be a pined currency to determine overvaluation or undervaluation, currency value is an objective one that can be determined through Purchasing Power Parity (PPP)-(on a range of products and not just Big Macs) and fundamental currency equilibrium.
Secondly, these valuations are approximate at best and do not necessarily represent the truth of current currency valuation problems. Indeed, while China seems to have a roughly well-valued Yuan it actually has it strictly undervalued by around 40%, on par with Japan’s Yen. Though Japan’s case is shown on the index China’s isn’t. On the overvalued side, though Brazil’s Real is said to be overestimated by 20% (Source: Goldman Sachs Asset Management), the Index puts it at nearly 100%! Again, Norway hardly has an overvalued currency but just very different living standards and is penalized by The Economist to the point of being stared as a currency manipulator.
Thirdly, the Big Mac Index doesn’t take into account the massive changes that occurred in McDonald’s supply chain less than 10 years ago. The company has gone local on both the offer (India and its Chicken Maharaja Mac) and the supply (especially in Europe where the demand is more health and environmentally conscious). This drastic change is making an old index more and more obsolete though it remains the public domain’s reference point for currency evaluation.
I am not trying to say that The Economist does bad work, but simply that some people shouldn’t take it so seriously.