The Economist is out with their Big Mac Index of currency valuations. The Big Mac index looks at foreign-exchange rates based on the theory of purchasing-power parity (PPP), the notion prices/exchange rates should adjust over the long run, so tradable goods cost the same across countries. Here’s their conclusion based on the latest data,
The Big Mac index suggests that currencies are particularly overvalued in Norway, Switzerland and Brazil (see chart). The continuing strength of the real is a big source of irritation to Brazil’s finance minister, Guido Mantega, who first trumpeted the phrase “currency wars” in 2010. Brazil battled back by introducing capital controls in the form of taxes on foreign purchases of Brazilian securities, but the currency remains overvalued. In December Brazil notched a record current-account deficit as its exports tumbled, contributing to a slide in the economy’s growth prospects. Switzerland handled its overcooked currency by pegging its franc to the euro in 2011. That halted the Swiss franc’s appreciation against the then-beleaguered single currency, although not against the dollar.
Currencies in much of the emerging world, including Russia, China, and India, are too cheap relative to the dollar on our gauge. Critics of burgernomics say that you would expect average prices to be cheaper in poor countries than in rich ones because labour costs are lower: PPP signals where exchange rates should head over the long run, as a country like China gets richer, not where prices should be right now. Even so, the perennially undervalued yuan has scarcely moved towards the Big Mac measure of fair value. That, many reckon, is down to meddling by the chefs at the People’s Bank of China, who are relying on export growth for sustenance: China posted a larger-than-expected $36.1 billion trade surplus in December, thanks to 14% growth in exports year-on-year.
Japan is the country that caused the most recent talk of currency battles. The new government’s plan to reflate the economy with fiscal and monetary stimulus has helped drive the value of the yen down in recent months. The Big Mac index put the yen close to fair value against the dollar in July; it is more than 19% undervalued now. That’s a tasty development for Japanese exporters but indigestible news for rivals.
This helps ‘splain why Brazilian equities trade so poorly.
(click here is chart is not observable)