Our company does a lot of business in the US and the exchange rate plays a significant role in our operations. Often friends and family ask me about the Canadian Dollar. Some want to head south and go shopping, others are going on vacation, some may want to buy currency based on speculation for a future holiday or event. I am not an economist or expert by any stretch but I thought I would share with you a theory.
A couple of years ago I taught an International Business course for Athabasca University. A portion of that course had to do with foreign exchange, money markets, and purchasing power parity (PPP). I had three hours to teach this ‘science’ the best that I could. We spent a lot of that time reviewing Burgernomics. So for those of you looking for advice here is a quick overview on Burgernomics and the value of our dollar.
Burgernomics is term used to describe the Big Mac Index. Essentially you want to predict exchange rate movement. The theory behind this is the rate between two currencies should naturally adjust so that a Big Mac should cost the same in both currencies. The Big Mac was chosen because it is available to a common specification in many countries around the world.
The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.
For example (numbers as of January 31st, 2007), the price of a Big Mac is $3.63 in Canada and $3.22 in the United States; thus, the PPP rate is 3.63/3.22 = 1.13 The actual exchange rate was 1.18 the meaning our dollar was undervalued by 4%. From this data you might speculate that our dollar will gain value against the US dollar, obviously we have gained much more than 4% in the last 5 months.
If you want to see how our dollar stacks up today, go to your local McDonalds check out the price of the Big Mac, call a McDonalds in the US and ask for their price of the Big Mac, use the formula above to determine the PPP. For those of you going to the UK the same principle and formula works as well.
It is a quick overview and I know it can be difficult to ‘digest’. Don’t come back to me with an ‘beefs’ about the formula if it doesn’t work for you. Sorry, I couldn’t resist.
