Liam Dann 's Opinion

Business editor of the NZ Herald

Liam Dann: Our dollar is undervalued, says Big Mac

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The Big Mac Index is compiled by comparing the price of a Big Mac in various countries around the world. Photo / Thinkstock
The Big Mac Index is compiled by comparing the price of a Big Mac in various countries around the world. Photo / Thinkstock

Is the New Zealand dollar overvalued? Not according to the latest result of the Economist's long running Big Mac index series.

Benchmarking the local price of a Big Mac against the US version indicates that the New Zealand dollar is currently undervalued by about 7 per cent. To which exporters will want to say: "burger that!"

How can this index justify a kiwi dollar near US80c in an economy that has been tracking sideways for three years, with interest rates at historic lows, when we still have horrible euro style levels of private debt and now falling prices for our major export commodities?

The Big Mac Index measures currency value based on the price for a basket of just one globally ubiquitous consumer item.

So in the US the July price of a Big Mac is US$4.33. In New Zealand the price is $5.20.

The US price is divided by the NZ price and the difference is compared to the actual exchange rate.

The kiwi was at about US78c on July 1 but using the Big Mac Index calculation we should have been worth US83.3c. Bingo, we are almost 7 per cent undervalued!

The Economist does describe the Big Mac index as a "light hearted" look at currency values. There are plenty of variables which could distort the results. Just for starters there's the "two whole beef patties, special sauce, lettuce, cheese, pickled onions on a sesame seed bun" (if you are a child of the 80s you can probably sing that pretty fast).

That's a lot of ingredients which will be subject to regional variations in inflation.

But across a lengthy time period the inflation doesn't seem to mess with the New Zealand Big Mac too much.

In 2002 it cost NZ$3.95 in New Zealand a decade later it is NZ$5.20 - so a rise of about 30 per cent.

That puts it roughly in line with the average inflation rate.

In the US the price has risen a lot more according to the Economist which records it as US$2.49 in 2002 against the latest US$4.33 (a 70 per cent rise).

Surely that downward pressure on the New Zealand price must bias the results towards undervaluing the kiwi.

Then there is the fact that Big Macs vary in size from country to country and of course a big part of the cost may reflect the rent that restaurants have to pay.

So does that all add up to a meaningless piece of data? Don't bet on it.

Cost variations don't seem to be enough to stop the index being unnervingly accurate for the kiwi.

The Economist has been doing this every six months for 25 years but has only included New Zealand in the mix for the past decade - at least in published results.

A sweep through online archives is a bit hit and miss but a sample of seven index results across the past decade provides enough data to see a trend.

The kiwi dollar regularly rates as undervalued on the index but that rating is consistently justified by future movements.

Here's two examples:

In April 2002 the Index picked that the currency was 29 per cent undervalued.

At the time the kiwi was trading at US44c. History shows it rose steadily from there achieving a 29 per cent rise in less than 12 months. In May 2004 the kiwi was deemed to be 8 per cent undervalued at US63c.

At that time exporters were already complaining about the high value of the dollar and would have been horrified to know it was going to hit US70c let alone US80c.

The only time, in these samples at least, that it was estimated to be overvalued was July 2007 - right before the global financial crisis started to unfold.

After the crisis the New Zealand dollar crashed and by February 2009 had fallen to US54c.

At that time the Big Mac Index picked the kiwi to be 30 per cent undervalued - a call that would surely have flabbergasted most pundits analysing New Zealand's gloomy outlook.

But come back it did - it took just six months for the kiwi to recover that 30 per cent - hitting US70c in January 2010.

On January 30 this year we were at US80c and the index called us 5 per cent undervalued. We hit US84c by the end of that month.

In the end the the Big Mac Index is just a bit of fun. No one is claiming it is scientific.

But it provides a timely reminder of something we should probably know by now.

Sensible domestic assessments of currency value, based on economic fundamentals like commodity prices, debt levels and interest rates, are consistently ignored by market traders who live only in the present moment and make their calls based only on relative considerations.

If we think our economic outlook is grim and undeserving of a high dollar then we are probably failing to factor in just how bad the rest of the world looks.

twitter.com: @liamdann

- NZ Herald

Liam Dann

Business editor of the NZ Herald

Liam Dann is the Business editor of the New Zealand Herald, overseeing all our business content in print and online. He has been a journalist for 20 years, covering business for the last 14 of them. He has also worked in the banking sector in London and travelled extensively. His passion is for Markets and Economics, because they are the engine of the New Zealand economy.

Read more by Liam Dann

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