Monday, November 9, 2009

Big Mac Index Yet Again

Someone else responded to Mr Gunasegaram's article and thinks a "strong" currency is not a good idea:

"First of all, I believe this is a crazy and short-sighted idea. It likely leads to a recession. When our currency is strong, everything we import seems to be at a discount and this encourages people to spend more on foreign goods and services through imports.

Strong currency also discourages our usual foreign trade partners to buy goods from us, thus export value will drop.

It also causes a country to lose its competitive advantage in attracting foreign investments.

At a time when inflow of money is significantly less than outflow, a serious current account deficit occurs in a broader sense. Malaysia will then be in deep trouble, after a short period of delusive wealth."


"If the ringgit were to be strengthen to a level of one for one US dollar, I would say good luck to everyone in Malaysia, welcome to the “burgernomics club”.

We will be staring with mouths watering at the Big Mac burger with an attractive price of RM3.54 in Malaysia just to find that our wallet is empty. And conveniently, if you want some money, IMF out there is willingly to lend you plenty.

There is no free lunch. Permanent and sustainable wealth does not come from currency rate delusion."

He's a bit less polite than I was though.


  1. hello... hapi blogging... have a nice day! just visiting here....

  2. A weak or strong currency is neither good nor bad. That is because a currency is always weak relative to another currency, which is stregthening.

    What is important is the causes for the currency movements. The US$ is a structurally weak currency because of rising budget deficits and monetisation of debt.

    The logic of not buying foreign goods with a strong Ringgit is basically flawed. If our currency is strong due to internal economic fundamentals (e.g. low inflation, fiscal health, etc) then a strong currency enables consumers to buy good quality foreign goods and rpovides local competitors to be more quality or price competitive.

    I am surprised that u feature such simple economic fallacies as above. The currency rate is a barometer of your health lah. Stop trying to look at the weighing machine and start exercising.

  3. Another point to note is that a rising currency may not reflect robust economic fundamentals. For instance, a country like Australia was once hiking up their interest rates from 2006-2008 and attracted carry trades from Japanese savers. Eventually the currency fell 16% in 2008, wiping out the gains in previous years.

    Is this the type of currency mirage which could encourage naive Australians to make big long-term purchases of foreign goods? I can say for sure without the data.

    But it shows that strong/weak currency tells us nothing about the wisdom of policies or healtyh of economies.

  4. Nehemiah, I'm not sure of the point you are trying to make. I featured this particular article mainly because it was in opposition to the Gunasegaram article, less because I believe the hyperbole. Perhsp I should have made that clear, in which case I aplogise for being disingenous.

    In any case, my stance is here (with further links you might want to go through). My main beef with the Gunasegaram article is the assumption that the Ringgit is being deliberately depressed, and that a policy of strengthening would be a panacea for some of our structural problems - as you rightly point out, a "strong" currency does not necessarily result in that outcome.

    "The currency rate is a barometer of your health lah. "

    I absolutely do not agree. There are beneficial economic policies that will result in a depreciation of the exchange rate, for instance reduction in trade barriers and liberalisation of the capital account. As you point out earlier, the exchange rate is a relative price, not an absolute one. But that characteristic is inconsistent with the view that the currency is any kind of barometer.

  5. Ok. But the debate abt currencies should always be focused on which pair u are talking about. The US dollar is in structural decline against most major currencies. Hence, producing some appreciation in the Ringgit in recent months. Does this reflect anything about Msia's economy? If RM strengthens to 2.50/US$, is that what Gunasegaram is calling for and u are against? To avoid this illusion of strength, we should measure rates on a trade weighted basis.

    My barometer analogy can be applied in both the relative sense and the absolute sense.

    For instance a person of certain height should weigh within a range of 65-70kg. Beyond or below that range is considered overweight or underweight. In the relative sense, the fact that I am 66 and you are 69 doesn't really matter but just indicates you are a bit heavier than me.

    Frankly all the fundamental models to predict the fair value of currencies don't work in the short term, including PPP. However, I believe currencies will track economic health in the long term. This is why the US dollar index can bounce up last year, come down this year and possibly rebound in 1H2010 before returning to its secular downtrend.

  6. Nehemiah,

    Actually if you check my exchange rate posts, I'm almost always talking about MYR appreciation/depreciation with respect to its trade weighted value, and I've displayed both the IMF trade-weighted series and my own. But when commenting on news reports, the point of reference is the USD rate since that's what most people refer to.

    Yes, I oppose a deliberate policy move towards MYRUSD 2.50 at the present moment, because it is not supported by economic fundamentals - I'd oppose any move off the equilibrium rate.

    There's a flaw in your barometer reasoning - it only works if you assume every other currency is at its equilbrium point. Otherwise there is no basis for intertemporal comparison even of the trade weighted value, much less currency crossrates.

    To use your analogy, you cannot assume people's heights are constant - economic policies and fundamentals change over time, and thus so will the bilateral and multilateral equilibrium exchange rates. Just as important, some welfare-positive policies depress the equilibrium exchange rate (e.g. reduction in trade barriers), while some welfare-negative policies boost the equilibrium exchange rate (e.g. closed capital account). In other words, you could have an increase in incomes and wealth while at the same time experiencing a depreciating exchange rate, and vice versa.

  7. Dr Marc Faber: "I suppose that even someone without any common sense might understand that a “strong currency” over longer periods of time reflects a high degree of prosperity and economic success, whereas a chronically weak currency is symptomatic of economic imbalances, such as a lack of competitiveness or overconsumption, arising usually from excessive supply of money and credit."

  8. Anon,

    While I respect Dr Faber's views on the long term prospects of gold and other metals, he is precisely wrong on the cause. It's more a supply problem relative to demand in my view - check the production statistics. And I won't lay odds against a "chase for yield" driving metal prices up either, in short you may be looking at a gold bubble.

    There is no risk of inflation, much less hyperinflation, affecting the US economy under the current circumstances - that presumption depends on the monetary transmission mechanism being intact. It is not, and won't be fixed for some time (read: years). As such the US dollar is at no risk of "crashing" due to quantitative easing.

    Comparing the USD rate against the Peso over time is laughable - it presumes that Mexico's economic fundamentals have not improved over the years, which it has, substantially.

    And to use his prescription of the relative strength or weakness of a currency as a reflection of economic soundness means for instance that the Euro area and Japan are the healthiest economies at present - which they most assuredly are not.