Bilal Hafeez, Research Analyst at Nomura, suggests that there is no one accepted way to value currencies and the most basic method is to compare prices of similar goods across countries and see whether after translating for the currency the prices are the same.
Key Quotes
“If not, then one could argue the currency is either over or under-valued. The Big Mac Index is perhaps the most popular version of this concept. At the moment, it suggests that Big Macs in Switzerland are the most expensive in the world at $6.43, while Big Macs in South Africa are the cheapest at $1.64. On this basis, one would say that the Swiss franc is overvalued and the South African rand is undervalued.
One cannot help feeling that the Big Mac index belongs to the analogue era, so perhaps it is better to look at the defining product of the digital era: the iPhone. Moreover, people are much more likely to travel to find a cheaper iPhone than they would a Big Mac, so the arbitrage principle that underlies comparative prices or purchasing power parity forms of currency valuation are more likely to be activated.
So after accounting for the latest currency rates, where are the most expensive and most cheap iPhones in the world? Brazil and the US are the respective answers. In Brazil, an iPhone 6S 4.7 inch 16GB model costs a whopping $1,188 compared with the US’s $649. That makes the Brazilian real the most overvalued currency (by 60%). The Big Mac index in contrast puts it at 30% undervalued. Turkey, Russia, Sweden and New Zealand would be other countries with heavily overvalued currencies. At the other end, the US, Canada, the UK, Hong Kong and Mexico have currencies that are on the cheap side, though all are moderately overvalued compared with the dollar. The fair value for the pound would be 1.20, for example.
The glaring gaps between iPhone and Big Mac valuations in emerging markets reflect the difference in labour costs. The cost of Big Macs would include a large local labour cost component, which would generally make emerging markets look cheap (as wages are lower).The cost of IPhones, meanwhile, would reflect more the local infrastructure for high-end technology and luxury products. The problem with both measures is that they would also reflect local taxes of various kinds, which cannot obviously be arbitraged. In the end, an argument could be made for using either, but according to both measures, the currencies of Sweden and Norway look expensive, while Mexico and Hong Kong look cheap.”
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