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Report Summary October 2008
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The Troubled Dollar
Will the world's "anchor" currency be replaced?
By Peter Behr

Since World War II, the powerful U.S. dollar has symbolized American economic might and fueled an expanding global economy. Foreign central banks stash dollars in their vaults as secure reserves, and most. . . .

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The Issues
  • Does the United States need a stronger dollar?
  • Will the euro surpass the dollar as the world's anchor currency?
  • Could the dollar's value plunge?


Pro/Con
Could the euro replace the dollar as the globe's anchor currency?

Pro Pro
Jeffrey A. Frankel
Professor of Capital Formation and Growth, Harvard Kennedy School. Written for CQ Global Researcher, September, 2008
Adam S. Posen
Deputy Director, Peterson Institute for International Economics. Written for CQ Global Researcher, September, 2008


Spotlight
Undervalued currency makes the burger cheap in Beijing.

If you're going to have a Big Mac attack, have it in China. Last July a Big Mac that would have cost $3.57 in the United States cost only $1.83 in China — largely because the Chinese currency is undervalued by 49 percent, according to a currency benchmark developed by The Economist magazine.

The index was designed to answer questions such as: Is the euro overvalued? Is the dollar priced too low? What about Brazil's real or Norway's krona?

An undervalued currency can make a country's exports unrealistically cheap, giving that country an unfair advantage in international trade. With profits, jobs and global political standings at stake, questions about currency values cry for clear answers. But instead, the academic research on currency values is debated by experts, in part because of the difficulties in comparing the costs of living in wealthy and poor nations. Ideological differences about the advantages of strong and weak dollars also color the debate.

The currency exchange rate between two countries reflects many factors, such as interest rates and inflation pressures, investor and speculator hunches about where an economy and its currency rates are headed and sometimes government actions to try to change the rate by buying or selling their own currencies.

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In trying to determine what currencies are really worth, The Economist created the "Big Mac Index" — a whimsical but seriously regarded benchmark for determining the purchasing power of various countries' national currencies. It compares the price — in each country's currency and in the dollar — for a hamburger in McDonald's franchises around the globe.

"The Big Mac Index is based on the theory of purchasing-power parity (PPP), which says exchange rates should move to make the price of a basket of goods the same in each country. Our basket contains just a single item, a Big Mac hamburger, but one that is sold around the world. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value yardstick," The Economist said in its latest index update in July 2008. Footnote 1

In July a Big Mac cost $3.57 at a U.S. franchise participating in the survey. At the same time, an American tourist in Reykjavik, Iceland, paid 469 kronur for a Big Mac. Under the actual exchange rate for the two countries at the time, $1 was worth only 78.57 kronur, so the tourist had to pay $5.97 to buy enough kronur to buy the burger (469 kronur divided by 78.57 kronur per dollar equals the $5.97).

Thus, according to the index, the kronur is "overvalued," because the burger cost $2.40 more in Iceland than it does in the United States — or 67 percent more. So the "fair value" exchange rate for the kronur should be 67 percent higher, or 131 per dollar.

Conversely, China's currency appears "undervalued" in the Big Mac Index. The $3.57 burger in the United States costs 12.5 yuan in China. At the current exchange rate of 6.83 yuan per dollar, that comes to $1.83. Thus, the yuan is undervalued by the difference between $3.57 and $1.83, or 49 percent, according to the Big Mac Index.

The Economist found that, compared to the dollar, currencies from Britain, Europe, Norway, Brazil and Turkey are overvalued. Undervalued currencies included Saudi Arabia's riyal, the Japanese yen, Thailand's baht and Pakistan's rupee.

The results buttress the argument that China and other Asian exporters need to raise their currencies' values to create a fairer trading arena with the rest of the world.

[1] "The Big Mac Index: Sandwiched," The Economist, July 24, 2008, www.economist.com/finance/displaystory.cfm?story_id=11793125.

Footnote:
1. "The Big Mac Index: Sandwiched," The Economist, July 24, 2008, www.economist.com/finance/displaystory.cfm?story_id=11793125.


Document Citation
Behr, P. (2008, October 1). The troubled dollar. CQ Global Researcher, 2, 271-294. Retrieved from http://library.cqpress.com/globalresearcher/
Document ID: cqrglobal2008100000
Document URL: http://library.cqpress.com/globalresearcher/cqrglobal2008100000


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