Wednesday, 8 May 2013

J. Wellington Wimpy, Economist

"I will l gladly pay you Tuesday for a hamburger today."

The famous pitch, now eight decades old, from perennial mooch Wimpy of Popeye fame. (Side Note: Wimpy apparently was based upon an admixture of two men - one called Wellington J. Reyonolds, an instructor of the cartoonist E C Segar at the Chicago Art Institute, and the other "Windy Bill" Schuchert, the manager of an opera house where Segar had worked).

Now, recalling the character of Wimpy - not too fond of work, with a voracious appetite, and an uncanny ability to hit up others for the money to obtain his favourite food - I was amused to read on this Finance site of a creation of the Economist magazine: the "Big Mac Index."

The basic idea is that the price of a Big Mac, a fairly common good that is subject to the various laws of economics - supply and demand, inferior/superior goods, income substitution theory, revealed preferences and the like, can be indexed and used for various microeconomic analyses.

In the article, the author argues that the government are using some sleight of hand in manipulating the consumer price index (CPI) as part of a grander scheme to puff up the economy despite the appearance to all those NOT employed by the US Treasury that our economy is recovering.

Peter Schiff, an economist at a firm called Euro Pacific Capital and the author of the recent book The Real Crash, is to say the least, a sceptic of claims from Washington:
According to government measures, inflation in the U.S. is all but non-existent. The officially endorsed Consumer Price Index (CPI) claims a mere 1.5% rise in prices over the 12 months ending last March. Food and energy, which are excluded from core inflation, rose 1.5% and fell 1.6% in the same release.  
Citing The Economist's Big Mac index, Schiff says real inflation has been understated since the government started adjusting the way inflation was measured in the early 2000s. Since 2002 the Big Mac has risen in price at nearly three times the rate of overall inflation.
According to Mr Schiff, this represents "more anecdotal evidence that what we get from the government when it comes to inflation is not information but propaganda."

Anyone paying even the least attention to the news by now is aware of the mania around "the sequester" and the "grand bargain" being played at by the US congress and the president.  The main baton mis dans les roues is the indexing of entitlements (e.g., Social Security) to the CPI.  The president and the Democrats are of course strongly opposed to any revisions in the way that these benefits are calculated.  It represents something of a conundrum in my view for the president.  On the one hand, we're told that running ever larger deficits is OK because inflation is currently under control - and the CPI is used for this calculation.  On the other, constraining benefits to the so-called "chained CPI" would result in a slower rate of growth of said benefits, which would in effect represent a significant cut in purchasing power for retirees and other beneficiaries as inflation erodes the value of the dollar.

Mr Schiff points out that the price of a Big Mac (in the US) closely paralleled the CPI from 1986 until 2002, and then diverged.  Since 1986, the CPI has increased about 110%, whilst the BMI has grown significantly faster (173%), with virtually all of the increase since 2002.  This is right around the time of the greatest inflection in the housing "bubble," with a brief period in the 2008-2010 implosion.  Following the election of Mr Obama, the BMI really took off.

The Historical Big Mac Index
Of course, these data don't really prove anything, but it is an interesting window into empirical impacts of fiscal policy.  We're told that the flooding of our economy with easy money has not resulted in significant inflation, and in fact, much of the current, common wisdom of Keynesian economists like Paul Krugman is that - far from being concerned about deficits - we should be continuing to print money and stimulate.

The evidence is far from dispositive, but needless to say, if we were to switch to a barter economy with Big Macs as a means of exchange, inflation would be obvious to all, including Professor Krugman.

The Economist, largely a not-at-all-silly source of news, concocted the Big Mac Index in 1986 in a somewhat tongue-in-cheek measure, somewhat like the old Pax McDonica - the artefact that no two countries who each have a McDonald's restaurant have ever gone to war - of economics.

At their site, there is a fascinating, interactive set of graphs by which people can use the price of a Big Mac for various analyses.  My favourite is its use as a measure of fiscal and currency manipulation.  For example China is currently the bĂȘte noire of the currency world.

In this simple analysis, the current price of a Big Mac in various countries is compared to the price of same in the US - its index price.  This is adjusted for purchase price parity - a measure of how much a comparable basked of products costs, adjusted for per capita GDP.

This is used as the means of empirical currency evaluation.  In essence, if a Big Mac costs $1 in the US, and RMB8 in China, then the exchange rate should be roughly 8:1.  This presumes purchase price parity, which of course is inexact; restaurant spending is somewhat positional- part of the cost includes the societal "value" one gains by being seen doing something.  The positional value of a Chevy Impala is pretty low; the relational value of an Audi, comparably higher.  Believe it or not, in China, eating in a McDonald's was seen in the past as a symbol of affluence - the consumer could afford a "modern, western" lifestyle of a sort.

The official exchange rate is then compared, and the currency either 'overvalued' or 'undervalued.'

Below is the most recent display of currency manipulation as adjudicated by the Big Mac Index.

Current State of Currency Policies
Countries who are coloured in RED are those where the currency is undervalued (i.e., is empirically worth more than the official exchange rate yields), whilst those in BLUE are overvalued.  The US, as the index, is green.

China, unsurprisingly, is one of the top places where the currency is undervalued.  A Big Mac currently goes for RMB16.00.  Using the official, current exchange rate of $1=RMB6.14, the PPP-adjusted price of a Big Mac in China is equal to $2.61 in the US.  The actual current index price of a Big Mac in the US is $4.30.  Hence, the RMB, using this rate, is undervalued by 40% ( {$4.30 - $2.61} / $4.30}).

What this means is, in a nut-shell, that if the exchange rate of the RMB to the US dollar were indexed to the cost of a Big Mac, one dollar would buy 3.22 RMB, as opposed to the 6.13 it actually does.  There is, thus, some empirical evidence that China is undervaluing its currency, at least according to the eminent economist Ronald McDonald.

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