Big Macs Show Dollar Hugely Overvalued, But “Mini Macs” Beg to Differ.

The “law of one price” holds that identical goods should trade for the same price in an efficient market. But how well does it actually hold internationally? The Economist magazine’s Big Mac Index uses the price of McDonald’s Big Macs around the world, expressed in a common currency (U.S. dollars), to measure the extent to which various currencies are over- or under-valued. The Big Mac is a global product, identical across borders, which makes it an interesting one for this purpose. 

But the law of one price assumes there are no restrictions on, or costs involved in, the movement of goods, and Big Macs travel badly. So in 2013 we created our own Mini Mac Index, which compares the price of iPad minis across countries. Minis are a global product that, unlike Big Macs, can move quickly and cheaply around the world. As explained in the video here, this fact helps equalize prices.

As shown in the graphic at the top, the Mini Mac Index suggests that the law of one price holds far better than does the Big Mac Index. The Big Mac shows the dollar overvalued against most currencies, by an average of 22 percent (a whopper). By contrast, the Mini Mac shows the dollar slightly undervalued—4 percent on average (small fries). This is up slightly from a 6.6 percent undervaluation in January.

With the notable exception of Japan, all the world’s major reserve-currency central banks appear to be moving into an extended easing phase. All eyes are now on the U.S. Federal Reserve, which markets expect to cut its policy rate by 50 basis points on or before September 18. Recent elevated currency volatility, driven largely by unwinding of the yen “carry trade”—in which investors borrow in “cheap” yen to invest in higher-yielding currencies, such as the Mexican peso—may persist into the fall as investors parse U.S. labor-market and inflation data for signs of shifting sentiment among Fed officials. Tune in with us again in January to find out what Big Macs and Mini Macs make of the resulting currency shakeout.