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.
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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 24 percent (a whopper). By contrast, the Mini Mac shows the dollar slightly undervalued—3 percent on average (small fries). This is up slightly, driven by dashed hopes for Fed rate cuts, from our last update in August—which had the dollar undervalued by 4 percent. The Aussie dollar, a liquid proxy for Chinese RMB owing to high Australian exposure to China, has, in contrast, fallen from 1.6 percent undervalued to 5.2 percent undervalued.
Looking forward, the big question for FX markets is whether the dollar will be driven further upwards by President Trump’s aggressive tariffing moves. To the extent that tariffs reduce demand for imports from tariffed countries, they reduce U.S. demand for their currencies and push up the dollar.
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