The Big Mac Index and Russian Tailwinds

An interesting informal metric to pay attention to for international investing is the Big Mac Index.

The Economist magazine initially started this basically as a joke, but it has been updated regularly since 1986 and it’s now a widely-cited indicator of global purchasing power.

A Big Mac combo consists of several ingredients in a partially standardized (but not perfectly standardized) way across the world, and yet a Big Mac combo costs very different amounts of money in various countries.

For example, if a Big Mac combo costs on average 116 Thai baht in Thailand, and the current exchange rate is one U.S. dollar for about 31 Thai baht, then the equivalent USD price of a Big Mac in Thailand is 116/31 = $3.74. This is much cheaper than the $5.58 USD it costs on average in the United States.

This is generally in line with what I found when visiting Thailand a little over a year ago. While I didn’t eat at McDonald’s, a simple meal would generally cost 100-150 baht which was rather inexpensive when converted to USD.

Looking at the Current Numbers

Statistica has a good updated list of Big Mac Index prices here. 

The top five most expensive countries to buy a Big Mac are:

• Switzerland: $5.62
• Norway: $5.86
• Sweden: $5.84
• United States: $5.58
• Canada: $5.08

Likewise, the top five cheapest countries to buy a Big Mac are:

• Russia: $1.65
• Ukraine: $1.94
• Turkey: $2.00
• Argentina: $2.00
• Malaysia: $2.20

Most of the list is not particularly surprising. Wealthy places like Switzerland and Norway are of course expensive places to buy a burger. In contrast, it’s currently cheap to buy a burger in places that recently had currency crises, like Argentina and Turkey.

The USD has been very strong over the past several years:

U.S. Dollar Index (DXY)

Chart Source: MarketWatch

Having positive real interest rates compared to other developed regions in Europe and Japan is a big reason why the U.S. dollar is doing so well. But there are also long-term negative currency fundamentals in the U.S. like a consistently negative balance of trade and negative current account, and a larger budget deficit than most other developed nations. Overall, the status of USD as the dominant foreign-exchange reserve currency gives the dollar lot of consistent demand.

In theory, countries where the Big Mac is super cheap have arbitrage opportunities that could eventually re-balance the currency towards a more neutral exchange rate. A business could buy things in cheap areas and sell them in expensive areas, for example. Or they could set up shop and produce a product or service in a cheap area and sell those things to an expensive area (like Mexico selling car parts to the United States, or a Swiss company offshoring some IT tasks to an Indian firm).

In practice, this sort of index only has modest predictive power, because currency differentials can take very long times to rebalance. Still, it’s nice to know if there’s a fundamental tailwind or headwind against the currency of the market you’re interested in investing in based on purchasing power disparity.

The most interesting country on the list in my eyes is Russia, which has the most undervalued currency based on this metric. Strictly based on fundamentals, Russia’s currency should be stronger. Their foreign-exchange reserves are massive relative to their GDP and money supply. They have a government budget surplus, a consistently positive balance of trade and current account, and strongly positive real interest rates. But of course, their pariah status in the world ever since the event in Crimea has resulted in various sanctions and partial isolation, and both stock valuations and currency valuations have been at extremely low levels for years in Russia.

Russia is like a coiled spring. It has a lot of issues but even partial improvement of them could be a huge tailwind for years as both stock valuations and currency valuations move upward. For example, just a 20% valuation improvement and a 20% currency improvement over a few years would provide about a 40%+ tailwind to Russian equity performance in dollar-terms, on top of whatever earnings growth Russian businesses may have. The caveat, of course, is the assumption that Russia won’t do something that would result in further sanctions and economic isolation.

The good news for Russia is that it’s a “damned if you do, damned if you don’t” situation for their currency. As long as Russian currency remains very cheap, it gives them a major competitive advantage in exports, which is positive for the economy.

As one example, in the past few years Russia has surpassed the U.S. to become the world’s largest wheat exporter as quality has improved while costs have remained low. This has not been good for global wheat prices, and not good for U.S. farmers or European farmers, but Russian farmers can more easily make a living wage because their cost of living is lower in terms of purchasing power parity.

As the Wall Street Journal reported in a recent article about this topic:

“Russian farmers come out ahead when export earnings are converted into rubles. Since the Russian currency has depreciated, a dollar now converts to twice as many rubles as it did in 2014. Russia has a similar advantage against the euro and other currencies. Russian farmers can cover their costs at home to keep planting, and also undercut Western competitors on price.”