The Swiss National Bank (SNB) revaluation of the Swiss franc caused me to look at The Economist magazine’s ‘Burgernomics’ website (which can be found here).
While it may not be popular with high minded economists, the Burgernomics site attempts to put a fundamental value on currencies from around the world by looking at the cost of buying a Big Mac in each country.
In theory, a Big Mac ought to cost the same thing no matter where you buy it, but that isn’t the case in the real world. For example, if I traveled to Stockholm, Sweden, a Big Mac would cost me 40.70 Swedish krone, which works out to be $5.95 at today’s exchange rate.
I’m much better off buying a Big Mac at home and bringing it with me since they only cost $4.80 in the U.S. If Big Macs should cost the same, you would say that Swedish krone is roughly 24 percent overvalued compared to the U.S. dollar.
The data on the site goes through July, so it’s interesting to see that, based on this metric, the Swiss franc was overvalued by 42 percent during the summer, when the exchange rate was 0.9 francs per dollar, which works out to $6.83 for a burger.
This simple model would imply that the franc would have to trade up to 1.2 francs per dollar before reaching what economists call, purchasing power parity (PPP).
After the revaluation last month, assuming that the Big Mac still costs 6.16 Swiss francs, the currency is now even more overvalued than it was before at 0.86 francs per dollar, or $7.16 per burger.
(That means that the world leaders visiting Davos right now are paying through the nose just to get a cheap old burger – I read that a vodka tonic at the main downtown hotel currently sells for $41 U.S. dollars).
Since my last visit to the Burgernomics website, The Economist has made a significant upgrade and now shows you the data two ways. The first way, as I have described above, shows the ‘raw’ valuation numbers.
The new, ‘adjusted’ method adds in a twist by adding in a proxy for labor costs.
It makes sense that the raw materials in a burger should cost the same thing the world over, but just looking at the cost of two all-beef patties, special sauce, lettuce, cheese, pickles, onions – on a sesame seed bun would be the same, but that ignores the labor costs.
The minimum wage in Switzerland is quite a bit higher than it is in Egypt (the home of a very cheap Big Mac).
With this adjustment, the Swiss franc does not seem as overvalued – only 15 percent instead of 42 percent, which makes a little more intuitive sense.
As the European Central Bank (ECB) starts their quantitative easing program, it would be normal to expect the value of the euro to drop against the U.S. dollar, just as the Japanese yen did when their program started over there a few years ago.
Interestingly, the median census forecast of 93 banks is that the euro trades right around 1.16 through the end of the year. The range calls for a high of 1.33 euros per dollar and the low forecast is 1.06. The market forecast based on forward prices (a form of derivative) suggests a year-end price of 1.17.
It seems inevitable that 2015 will be another year of surprises.