Tourists and Big Macs

Diana and I stepped out of a victorious pub quiz night and into the first rain in nearly six months. A heavy, cleansing rain. I woke up and walked up the hill to Alamo Square Park to enjoy the fresh air and city views in sharp contrast under a blue sky only possible a few hours after a storm front. Dozens of people were walking the usually vacant paths around the slopes of the four square blocks at the top of the hill. Their cameras and pocket sized video recorders marked them as tourists who had ventured beyond the slope facing the painted ladies, the Victorian row of Full House fame framed by the city skyline. They were all Europeans. The first couple I passed spoke a hushed German, the next two groups spoke unabashed French, and I didn’t need to hear the last group sitting on the benches in the redwood circle, their passionate gesticulations were unmistakably Italian. Like mushrooms after the rain, the European tourists are popping up everywhere.

With a Euro now buying $1.40, this is an ideal time for Old Worlders to travel in the United States. I am surprised there weren’t a few topless o’s mixed into the babel on our landmark hill now that the loonie, the Canadian dollar, has overtaken its southern equivalent for the first time in 30 years.

All the new lows for our currency have set off a spate of articles about the dollar’s demise, some in unsuspecting places. One of the local alternative papers, SF Weekly, picked up mostly for its music and film listings, ran a doomsday feature article on the dollar’s demise. All the dead horses were beaten about: our enormous public debt and mounting deficits, the sub-prime lending fiasco, and recounts of past currency meltdowns in Latin America and Asia. Everyone agrees that while the dollar is historically weak, all indicators suggest that conditions will only worsen for the benchmark currency.

This consensus reminds of me of the anecdote about Rockefeller getting a stock tip from his shoeshine boy circa 1929—he knew then and there it was time to sell.

I've got a similar feeling that now is the time to be bullish on the dollar. Yes, our federal budget is a mess, thank you Mr. Bush, and our public debt is enormous, but it is easy to lose perspective on the numbers involved because we are participants in the largest national economy the world has ever known. Our (by some estimates) $5.6 trillion dollar debt seems horrific until it is pointed out that it ranks 35th in the world as a percentage of GDP, and not out of line with many other rich world nations. And unlike Europe, where below replacement level fertility rates threatens population decline and onerous ratios of future workers to retirees on pension, the United States is actually witnessing a rise in its fertility rates (making us the only nation on the planet to go through the demographic transition and then see fertility rates rebound past the replacement level).

The historical charts for the dollar’s exchange rate read look like a mountain range of peaks and valleys; it is rare to see the dollar standing still. These trends suggest that the dollar and currencies in general are continually over and undershooting their values. Other measurements tend to bare this phenomenon out.


By some measures economists have long advocated that the best gauge of a currency is not its exchange rate, but the relative purchasing power of that currency in proportion to other currencies. Purchasing Power Parity (PPP) is the assumption that a set amount of a given currency should buy the same basket of goods abroad that it does at home once converted into the foreign currency. The bi-annual Big Mac Index is a slick version of PPP published by The Economist. In this index the Big Mac hamburger represents the basket of goods, convenient because you can one in nearly every country on earth. The index determines the dollars needed to purchase a Big Mac in various countries, and then this price can be compared to the dollar’s official exchange rate..

As of July, a Big Mac cost $3.41 and $4.17 in the Euro zone, an implied exchange rate of $1.12 to the Euro. The actual exchange at the time of the survey was $1.35 to the Euro, which suggests it was 22% overvalued against the dollar. This makes sense. There are real world underpinnings to the strength of the EU economy, one big factor being the successful incorporation of the relatively low wage, high productivity countries of Central Europe into the EU's economic frontier. But at a ten percent clip for five years running?

On the other hand, the index implies most Asian currencies are significantly undervalued against the dollar, led by the Chinese Yuan which has a PPP of 58% more than the exchange rate. Asian central banks have been purchasing hoards of US treasuries for years to keep the dollar strong in relationship to their currencies. The BMI suggests that the dollar could yet weakened substantially versus the Yuan and other Asian currencies.

The Big Mac Index is not a perfect measure of PPP. The BMI makes the imperfect assumption of a world of low transportation costs where a given basket of goods could be distributed and sold anywhere. The Big Mac is not such a mobile product, as it is made up of much more than two all beef patties special sauce lettuce cheese pickles onions on a sesame seed bun. The rent on paid on the building and the wages paid to the burger flippers are non-tradable components (in the sense that it is not possible to offshore fast food workers) that factor into the price of a Big Mac. Local taxes and demand variance are also not necessarily representative of an economy as a whole. Still, the BMI provides a quick and easy comparison of the world’s currencies, and it suggests that while the dollar has weakened against the Euro and the Pound, it is now trading at a discount to the market. The opposite maybe true for its relationship to the Yuan and the Yen.


At the end of the day a currency has value because people believe it has value. When this confidence snaps, nasty results can ensue, and in the electronic age this can happen with lightning speed--witness the 1997 financial implosion in Asia. There is no inherent reason that the dollar is immune to a currency collapse. There may come a point when the world is sated with US Treasuries, and keep in mind that the Euro now provides the first feasible alternative to the dollar as an international store of value post Bretton Woods.

In mid April 2002, the dollar was ten percent stronger than the euro. In my two-dollars-to-place betting fashion, I remember going to the currency exchange in Ljubljana and converting a couple hundred dollars into Euro's that month. Small stakes, though it turned out be a fair instinct. Now that I’ve contemplated the forecasts of the shoeshine boys/music critics and I'll go and place my (conservative) bets that apocalypse is not nigh. The dead presidents will rise again, at least over the bridges of Europe.