The Big Mac Index

Being that my wife and I are traveling to France this fall, I am watching the euro, hoping against hope that it will deflate relative to the dollar before we have to pay the bills then.  One of the more interesting ways of comparing monetary exchange rates is by using the Big Mac index created by The Economist magazine.  I won't go into the details of this calculation here but those of you who are curious please visit The Economist for its very interesting algorithm.  The bottom line is that the euro seems to be overvalued by about 35% ... which means that the euro should currently trade at about $1.10 per euro ... not the current $1.45 per euro.  Wouldn't it be nice if this adjustment were to occur before our trip?

Another salient part of this investigation involves what might happen to the economy in the European Economic Community before and during our trip.  Any shocks here might well affect the exchange rates to which we would be subjected  To pursue this analysis I have found an interesting website that shows the cost of credit default swaps (CDSs) in many countries (see: Credit Default Swap Costs).  Think of this credit default swap data as the cost to buy insurance against a particular country defaulting on $10 million of its 5-year sovereign debt.  Obviously, the higher the cost ... the greater the risk of default ... and the greater the chance of this country's currency deflation. 

Today, it costs $47.35 for such insurance against the U.S.'s sovereign debt versus $164.84 against France's (and $2,218.27 to insure Greece's).  Now the euro is used in many of the countries represented in this table so to be very accurate, one would have to use a GDP-weighted average of these CDS figures.  So, forgetting about how our Federal Reserve Bank and the European Central Bank intervene to manipulate these exchange rates, surely the cost of the euro would/should move close to the Big-Mac-index parity figure by the time of our trip.  If it doesn't, I think then my wife and I will be buying lots of Big Macs in France this fall.