By Nicholas A. Vardy, CFA
The last six months have been a tumultuous time in the $5 trillion dollar a day world of global currency trading. The moves in both developed-market and emerging-market currencies have been sharper than any time since 2009.
A stronger economy and falling oil prices has pushed the U.S. Dollar Index 15% higher in the past six months. The euro went the other way, tumbling 17% in anticipation of the European Central Bank's recent entry into the quantitative-easing game. The steep 14% fall in the value of the Japanese yen offered continued evidence of Japan's commitment to Abenomics and its easy money policy.
Then there was the dramatic jump of 13% in one day in the Swiss franc when, on Jan. 15, the Swiss National Bank abandoned its currency's peg to the euro.
Not to be outdone, Vladimir Putin's shenanigans and tumbling oil prices gave the Russian ruble a shellacking, beating the Russian currency down by roughly 50% since mid-summer.
Enter the Big Mac Index
One way to get your head around currencies is to look at what the same goods cost in different cities across the world.
Since 1986, Britain's Economist magazine has done exactly that with its now-famous Big Mac Index — a tongue-in-cheek but surprisingly useful way of measuring purchasing power parity (PPP) — that is, the relative over- and undervaluation of the world's currencies compared to the U.S. dollar.
By comparing the cost of Big Macs — an identical item sold in about 120 countries — the Big Mac Index calculates the exchange rate (the Big Mac PPP) that would result in hamburgers costing the same in the United States as they do abroad.
Compare the Big Mac PPP to the market exchange rates, and voilà, you get an instant insight into which currencies are under- or overvalued.
The current state of play
I have been writing about the Big Mac index for close to a decade. Yet, I've seen the most dramatic movements only in the past year.
Take the example of the European currency. Seven years ago, the euro was overvalued by a massive 50% compared to the U.S. dollar. Last year, the European currency had fallen to being 7.8% overvalued. Today, the euro is 11% undervalued.
So if you're looking to splurge on that trip to Paris to see the Mona Lisa in person, this is the best time to go in the past 10 years.
Back in 2007, the United Kingdom was one of the most expensive places on the planet as the British currency hit a high of $2.10 U.S. dollars to the Great British Pound (GBP). After the Great Recession in 2008, the GBP tumbled to about $1.35. Today, it's back to $1.50.
In the current Economist survey, a Big Mac actually costs 8.8% less in the United Kingdom — $4.37 — than it does in the United States, where a Big Mac sells for $4.62.
By the way, the cost of a Big Mac in the United States rose 3.7% in 2014 on top of a 5.72% rise over the previous year. Both of these increases are substantially higher than the headline U.S. CPI numbers.