Nicholas Vardy

It is that time of the year again, and Britain's Economist magazine has just published its annual "Big Mac Index."

Since 1986, the "Big Mac Index" has provided a tongue-in-cheek but surprisingly useful way of measuring purchasing power parity (PPP) -- that is, the relative over and undervaluation of the world's currencies compared to the U.S. dollar.

According to the theory of purchasing power parity, a dollar should buy the same amount of the same good across all countries.

The "Big Mac" Index compares the cost of Big Macs -- an identical item sold in about 120 countries -- and calculates the exchange rate (the Big Mac PPP) that would result in hamburgers costing the same in the United States as they do abroad.

Compare the Big Mac PPP to the market exchange rates, and you instantly see which currencies are under or overvalued.

Not that the Big Mac index is perfect. In Argentina, ground zero of this week's emerging markets sell-off, McDonald's doesn't really sell the Big Mac anymore because the government decided it didn't want to be included in the Economist surveys and regulated the hamburger's price. And the inclusion of price of a "Big Mac" in India -- the cheapest in the world at $1.54 -- is problematic because in India Big Macs are made of chicken. Hindus don't eat beef.

Finally, with several emerging markets' currencies plummeting in the past few days -- most notably Turkey -- the Economist's data is already out of date.

Global Currencies: The Current State of Play

Over the past few years, each time I looked at the Big Mac Index, I was struck by how many currencies got back in line with what PPP would suggest.

Let's take the example of Europe. Five years ago, the euro was overvalued by a massive 50%, compared to the U.S. dollar. Today, the European currency has settled at being a mere 7.8% overvalued.

The Big Mac Index once had the United Kingdom pegged as one of the most expensive places on the planet for much of the past decade. Back in 2007, the British pound hit 2.10 GBP to the U.S. dollar. After the Great Recession, the GBP tumbled to about $1.35. In the current survey, a Big Mac actually costs the same in the United Kingdom -- $4.63 -- as it does in the United States, where a Big Mac sells for $4.62. (By the way, the cost of a Big Mac in the United States has risen 5.72% over the past year -- higher than the headline inflation numbers would suggest.)

This past year, currencies have jostled around more than usual, thanks mostly to two factors.

Nicholas Vardy

Nicholas Vardy is currently editor of the monthly investment newsletter, The Alpha Investor Letter, which provides longer-term global investments. He also writes two weekly trading services, Triple Digit Trader and Bull Market Alert, which focus on making short-term profits in the hottest markets in the world.