The "Big Mac" Indicated
the Colón is Undervalued
The daily Spanish
newspaper La Nación in
today's report says that
the true value of the
Colón, the Costa Rican
national currency,
against the U.S. dollar
should be ˘467 and not
the ˘520 maintained by
the Banco Central de
Costa Rica (Central
Bank).
The source of finding
the true value of the
Colón against the US
dollar is the Big Mac,
of course.
The Big Mac, the leading
product of the
McDonald's restaurant
chain, costs ˘1.540
(us$2.96) in Costa Rica,
while costing ˘1.770
(us$3.41) in the U.S.
˘752 (us$1.45) in China
and ˘15.88 (us$3.06) in
Europe.
The Big Mac hamburger
reflects, although in a
very simplified way, the
cost of living in the
different countries.
With that methodology,
if one were to use the
U.S. dollar to define
value of other
currencies, then it can
be concluded that China
and Costa Rica is
under-evaluated.
Of course the "Big Mac"
index was not created by
La Nación.
"The Economist" created
the index some 20 years
ago, using the Big Mac
as a standardized
product and comparing
prices of the product
around the world.
The Economist's Big Mac
index seeks to make
exchange-rate theory
more digestible. It is
arguably the world's
most accurate financial
indicator to be based on
a fast-food item.
The Economist's Big Mac
index is based on the
theory of
purchasing-power parity
(PPP), according to
which exchange rates
should adjust to
equalize the price of a
basket of goods and
services around the
world. Our basket is a
burger: a McDonald’s Big
Mac.
The index is supposed to
give a guide to the
direction in which
currencies should, in
theory, head in the long
run. It is only a rough
guide, because its price
reflects non-tradable
elements—such as rent
and labour. For that
reason, it is probably
least rough when
comparing countries at
roughly the same stage
of development.
If the Banco Central
would not participate in
foreign exchange markets
buying and selling
currencies and leaving
the Colón free, it would
appreciate more,
affirmed the manager of
the bank, Roy González.
An excess of dollars in
the economy, due to
income from investments,
growth in real estate,
increases in exports and
the arrival of
speculative capital,
have pressured a low
exchange rate, according
to the Banco Central's
former president,
Eduardo Lizano.
Lizano added that if the
Banco Central drops the
lower band on the
exchange rate, it will
leave speculators with a
shortfall and would put
at risk other sectors of
the economy, like
exports.
"Our priority at this
time is to administer
and consolidate the
exchange system and
search for a way for a
gradual adjustment",
said González.
Since the introduction
of the "cambiario de
bandas" (floating
exchange rate) on
October 17, 2006, the
Central Bank has not
ceased in its
intervention of
purchasing dollars.
However, in the last
weeks, the bank's
participation had been
reduced significantly,
according to González.
The table below shows by
how much, in Big Mac PPP
terms, selected
currencies were over- or
undervalued at the end
of January.
|
