The Big Mac index
The dollar has slipped over the past six months, but still looks dear
Jul 13th 2017
THIRTY-ONE years ago, The Economist created the Big Mac index as a way of gauging how different currencies stacked up against the dollar. The index is based on the theory of purchasing-power parity, the idea that in the long run, exchange rates should adjust so that the price of an identical basket of tradable goods is the same. Our basket contains one item, a Big Mac.
The latest version of the index shows, for example, that a Big Mac costs $5.30 in America, but just ¥380 ($3.36) in Japan. The Japanese yen is thus, by our meaty logic, 37% undervalued against the dollar.
In that, the yen is not alone. The greenback has strengthened considerably in recent years: of the 34 currencies we track in the full index, 31 are currently undervalued against the dollar. Only the Swiss franc, Norwegian krone and Swedish krona are overvalued. That said, plenty of currencies have clawed back some ground against the dollar in the past six months.
Take, for example, the Egyptian pound, which burgernomics holds to be the most undervalued currency. In November, the Egyptian government decided to allow its currency to float freely. By December the pound had fallen to its current value of around 18 per dollar. Inflation has soared as a consequence, averaging 30% over the past six months. Big Mac prices have increased accordingly, from 27.5 pounds ($1.53) to 31.4. The net result, according to our index, is that the Egyptian pound has gone from 71% undervalued against the dollar in January to 67% today.
The euro has also gained ground in the same period. The single currency buys $1.14 today, up from $1.05 at the start of the year; the euro has gone from being 20% undervalued against the dollar in our index, to 16% undercooked. That reflects a mixture of politics and economics. Eurosceptic parties were beaten back at the polls in both the Netherlands and France, muting fears that populists would find success. The euro zone grew substantially faster than the American economy in the first quarter, and the European Central Bank has started to signal that its policy of extraordinary monetary stimulus will not last for ever. If Europe’s recovery continues to strengthen, American tourists to the continent may end up getting less burger for their buck.
One of the best-performing currencies over the past six months has been the Mexican peso. In January, the peso had fallen to a record low of 22 to the dollar, thanks in no small part to fears of a possible trade war with Mexico’s northern neighbour. But markets have become increasingly sceptical that Donald Trump will follow through on his most blood-curdling trade threats. The peso has recovered ground and hovers at around 18 per dollar. The Mexican currency is now only 48% undervalued against the greenback, compared with 56% in January.
Markets are also losing faith in Mr Trump’s ability to pass domestic economic reforms. On the campaign trail, the president-to-be promised expansionary fiscal policies, including tax cuts and increased infrastructure spending. Traders believed that the Federal Reserve would be forced to increase interest rates in response. The dollar surged, reaching a 15-year high in January. Since then, the dollar has slipped by 5% on a trade-weighted basis. That not only vindicates those sceptical of Mr Trump’s legislative prowess. It’s also a partial vindication for believers in burgernomics. If our index has any fact content, the dollar may have further to fall.
A new approach to financial regulation
A significant Trump nominee for the Fed
Jul 13th 2017| NEW YORK
DONALD TRUMP promised to unshackle America’s financial firms from mounds of stultifying regulation and the grip of bureaucrats with little practical experience of capitalism. One way to put that pledge into practice is to appoint officials with business backgrounds and deregulatory agendas. This element of the Trump strategy was on show this week, with a presidential nomination for a critical job at the Federal Reserve and the first public address by the new head of the Securities and Exchange Commission (SEC), another financial regulator.
Buried in the voluminous pages of the Dodd-Frank act, an Obama-era law passed in response to the financial crisis, was the creation of a new supervisory job at the Fed. Thus far, this powerful post has been informally delegated to an existing Fed board member, first Daniel Tarullo and, since his departure, Jerome Powell. That is set to change. Randal Quarles was formally nominated for the job—technically a vice-chairmanship with a brief covering financial supervision—on July 11th.
Mr Quarles has held a number of jobs—as a lawyer for financial institutions at Davis Polk, a leading law firm; as a senior official in the Treasury; working on bank investments at Carlyle, a private-equity firm; and most recently, as head of Cynosure, a firm investing on behalf of wealthy families. If approved by the Senate, Mr Quarles will have his new office in a building named after Marriner Eccles, chairman of the Fed from 1934 to 1948, and a relative of his wife, Hope.
Mr Quarles is described by former associates as being in favour of policies administered through transparent and direct rules. If so, this would mark a shift from the Obama administration’s approach to finance. It oversaw a profusion of complex, and sometimes conflicting, directives; supervisors kept banks on a tight leash through stress tests that lacked clear criteria. That created vast uncertainty for financial institutions. It also gave regulators great discretionary power (to say nothing of lucrative job opportunities helping financial institutions to navigate their way through the murk).
In what may be another sign of a changing approach, Jay Clayton, appointed chairman of the SEC in May, gave his first public speech on July 12th, to the Economic Club of New York. He heads a deeply troubled agency. A third of the new rules the agency is required to write by the Dodd-Frank act have yet to be completed. Three out of the five commission slots need to be filled; Mr Obama’s last two nominations failed to win approval because of deep ideological divisions in Congress. The SEC’s three missions—of investor protection; fair, orderly and efficient markets; and the facilitation of capital formation—are often seen to be at odds with one another or insufficiently understood.
Mr Clayton’s speech expanded on a theme first voiced in his confirmation hearing, that a sharp decline in publicly listed companies in America over the past two decades reflects deep problems in the structure of financial markets. In turn, this causes average Americans harm by denying them the opportunity to invest in dynamic companies.
Among the causes of the decline, he said, was the cumulative impact of disclosure requirements that had gone far beyond the core concept of what is material to an investor. Some of these requirements were aimed at providing indirect benefits to “specific shareholders or other constituencies”, he said, a passage seen by many as an attack on activists who use disclosure standards to push companies on social rather than business issues. Additional compliance mandates had piled on costs for listed companies that they could avoid by staying private.
The first change of the Clayton era is telling. On July 10th a new rule went into effect that raised the size threshold for companies that are allowed to file private registration statements to raise capital with the SEC, thereby delaying the exposure of sensitive information that might be of use to competitors. Companies, says one lawyer, consider the disclosure process akin to undressing in public, and thus a reason to stay private. The SEC’s rule change is a small one but may be indicative of a broader change in regulatory philosophy. If the market does not work for companies, it will not work for the public.
Climate change and inequality
The rich pollute, the poor suffer
Jul 13th 2017
ON JULY 12, the Larsen C ice shelf in Antarctica disgorged a chunk of ice the size of Delaware, a small state on America’s east coast. America’s government seems unfazed by the possibility that such shifts might one day threaten Delaware itself. Its climate defiance grows not only from the power of its fossil-fuel industry and the scepticism of the Republican party, but also from a sense of insulation from the costs of global warming. This confidence is misplaced. New research indicates not only that climate change will impose heavy costs on the American economy, but also that it will exacerbate inequality.
Calculating the economic effects of climate change is no simple matter. It means working out how a given increase in global temperature affects local weather conditions; how local weather affects things like mortality and crop yields; how those changes add to or subtract from regional GDP; and how thousands of local-level changes in GDP add up nationally or globally. No sweat.
The sheer number of moving parts means that the “damage function” used in many papers, which links changes in global temperature to economic costs, is not well characterised. The authors of a new study published in Science aim to firm things up. Solomon Hsiang of the University of California, Berkeley, Robert Kopp of Rutgers University and their co-authors run their climate models repeatedly, for three different temperature scenarios, to see how 15 different economic variables behave in 29,000 possible future states of the world, for each of 3,143 American counties.
Using that information, they assemble probability distributions showing the costs America is likely to sustain by the end of the century. Their findings are stark. Even a modest rise in temperature impairs American economic performance. An increase in global temperature of 1.5°C is very likely to reduce annual output by the end of the century by between zero and 1.7%; a rise of 4°C would probably generate losses between 1.5% and 5.6% of GDP. These figures mask considerable variation across America. In some counties the models forecast a rise in local GDP of 10%; others face a staggering expected decline in annual output of 20%.
It is not surprising that the nationwide costs of climate change should conceal losses in some places and gains in others; that is how averages work. But the distribution of losses matters. The study shows that the pain of climate change will fall more heavily on America’s poorest bits than on its richest areas. Falling crop yields and labour productivity, and rising mortality and crime, are expected to be especially pronounced in America’s hot southern counties, where incomes are below the national average. In richer New England and the Pacific north-west, in contrast, winters will be milder and less deadly, and agricultural yields may rise. The aggregate economic cost of climate change is reduced because the burden disproportionately falls on those with low incomes, hardly the ideal way to slash the cost of warming.
Climate change is costly in part because its effects are uncertain, impairing investments and other actions which might mitigate its harms. Thus people would be willing to pay some money to know with greater certainty what higher temperatures will mean in future. Uncertainty around economic projections is highest in the poorest counties. For some of these places the worst outcomes could mean GDP losses of 40% or more. The authors reckon that after adjusting for the uncertainty of climate change, and for its unequal effects, the economic damage caused by a global temperature rise of 3°C could be 1.5-3 times bigger than the unadjusted aggregate figures suggest.
Though focused on America, the analysis also describes the world’s climate problem. The costs of global climate change will again be unevenly (and uncertainly) distributed, but harm will often be smaller for richer, temperate countries. As a result the estimated economic loss from warming is almost certainly understated, because the nastiest effects are concentrated in places where incomes are lowest: and, correspondingly, where tumbling incomes have the smallest effect on global GDP.
Yet just because a county in Mississippi faces a harsher future as a result of climate change than a county in Washington does not mean Mississippians must fare worse than Washingtonians. The authors hold the distribution of America’s population constant in conducting their analysis, but point out that harm could be reduced by large-scale migration. Is that a realistic possibility?
People do move as it grows hotter—but not in a uniform way. Research by Cristina Cattaneo and Giovanni Peri, for instance, shows that migration is an important element of the response to warming in middle-income countries, but that in poorer places the cost of moving locks people in place, amplifying the regressive impact of climate change. What is more, climate change might well require broad migrations from the middle latitudes to countries farther north or south, yet rich-country borders are far less porous (with respect to migrants from poorer countries, at least) than those in the developing world. Even within the large domestic territory of a country like America, mobility cannot be taken for granted; it has been falling in recent decades, even as economic fortunes have diverged and an opioid epidemic has ravaged some parts of the country while sparing others.
Ice in their veins
The rich are disproportionate contributors to the carbon emissions that power climate change. It is cruel and perverse, therefore, that the costs of warming should be disproportionately borne by the poor. And it is both insult and injury that the wealthy are more mobile in the face of climate-induced hardship, and more effective at limiting the mobility of others. The strains this injustice places on the social fabric might well lead to woes more damaging than rising temperatures themselves.
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