Hamburgers should be an essential part of every economist’s diet” AND “Global capital rules, okay
Write two short summaries of the two article below(“Hamburgers should be an essential part of every economist’s diet” AND “Global capital rules, okay?”). each summary should be 100-200 words.
Hamburgers should be an essential part of every economist’s diet
THE past year has been one to relish for fans of burgernomics. Last April The Economist’s Big Mac index flashed a strong sell sign for the dollar: it was more overvalued than at any time in the index’s history (see article). The dollar has since flipped, falling by 12% in trade-weighted terms.
Invented in 1986 as a light-hearted guide to whether currencies are at their “correct” level, burgernomics is based on the theory of purchasing-power parity (PPP). This says that, in the long run, exchange rates should move toward rates that would equalise the prices of an identical basket of goods and services in any two countries. To put it simply: a dollar should buy the same everywhere. Our basket is a McDonald’s Big Mac, produced locally to roughly the same recipe in 118 countries. The Big Mac PPP is the exchange rate that would leave burgers costing the same as in America. Comparing the PPP with the actual rate is one test of whether a currency is undervalued or overvalued.
The first column of the table shows local-currency prices of a Big Mac. The second converts them into dollars. The average price of a Big Mac in four American cities is $2.71. The cheapest burgers are in China ($1.20); the dearest are in Switzerland ($4.52). In other words, the yuan is the most undervalued currency, the Swiss franc the most overvalued. The third column calculates Big Mac PPPs. Dividing the local Chinese price by the American price gives a dollar PPP of 3.65 yuan. The actual exchange rate is 8.28 yuan, implying that the Chinese currency is undervalued by 56% against the dollar. The average price of a Big Mac in the euro area is now exactly the same as in America. This implies that the euro’s PPP is exactly $1, so at its current rate of $1.10 the euro is 10% overvalued. The British, Swedish and Danish currencies are still significantly overvalued against the euro.
Among rich economies, the most undervalued currency is the Australian dollar. The Aussie dollar is still 31% below PPP against its American counterpart: its rise over the past year has been largely offset by a fall in the relative price of burgers in Australia. Many emerging-market currencies are undervalued against the dollar by 30-50%. One exception is the South Korean won, which is exactly at its PPP, implying that it is overvalued against other emerging-market currencies.
Many readers complain that burgernomics is hard to swallow. We admit it is flawed: Big Macs are not traded across borders as the PPP theory demands, and prices are distorted by taxes, tariffs, different profit margins and differences in the cost of non-tradables, such as rents. It was never intended as a precise predictor of currency movements, but as a tool to make exchange-rate theory more digestible. Yet in the early 1990s, just before the crisis in Europe’s exchange-rate mechanism, it signalled that several currencies, including sterling, were markedly overvalued against the D-mark. It also predicted the fall in the euro after its launch in 1999.
Academic economists are taking burgernomics more seriously, chewing over the Big Mac index in almost a dozen studies. Now a whole book has been written about the index* by Li Lian Ong, of the International Monetary Fund. She says it has been surprisingly accurate in tracking exchange rates in the long term. But there are some persistent deviations from PPP. In particular, emerging-market currencies are consistently undervalued.
Differences in productivity are one explanation of this. Rich countries have higher productivity than poor countries, but their advantage tends to be smaller in non-tradable goods and services than in tradables. Because wages are the same in both sectors, non-tradables are cheaper in poorer countries. Therefore, if currencies are determined by the relative prices of tradables, but PPP is calculated from a basket that includes non-tradables, such as the Big Mac, the currencies of poor countries will always look undervalued. Ms Ong finds that currency deviations from PPP are indeed related to productivity differences relative to America. After adjusting for this, she finds that the Big Mac index performs better in tracking exchange rates.
The Big Mac index suggests that the dollar is no longer overvalued against the euro. But having overshot PPP, the dollar may well now undershoot, because America’s huge current-account deficit is becoming harder to finance. Without stronger domestic demand in Japan and Europe to help trim the deficit, the dollar will have to take more of the strain. What are this year’s other hot tips? The Australian dollar is likely to see the biggest gain. The pound will fall further against the euro. And China will come under increasing pressure to revalue the yuan.
2. Global capital rules, okay?
It is time to modernise the regulation of cross-border finance
GLOBALISATION is supposed to have made politicians impotent, and nothing is more global, you might think, than capital. Yet the reality falls short of the hype. Capital is not the untamed worldwide ocean of money it is often portrayed as. Most countries have rules that restrict where it can go rules that, for all the ingenious attempts to find ways around them, often have a big effect.
Some oddball regimes, such as Malaysias, claim that their economies prosper best behind a wall of capital controls. Most governments, though, have come to think that barriers to capital are against the national interests. Reforming financial regulation to make it more accommodating to cross-border flows is high on the political agenda. In Europe, a committee of wise men chaired by Baron Alexandre Lamfalussy, a Belgian banker, has recently published ambitious proposals to bring closer the long-promised single capital market within the European Union (see article). In America, Phil Gramm, chairman of the Senate Banking Committee and the Bush administrations leading adviser on the financial world, has long worried that Uncle Sams antiquated regulatory structure may threaten the global supremacy of its equity markets. Now may be his best chance to do something about it.
Rules for regulators
As the regulators modernise, there are some simple lessons to draw on. First, though an unregulated market may sometimes be more efficient than a badly regulated one, a well-regulated one is superior to both. No doubt, you may say but what is good regulation? At a minimum, which may be all you need, nothing more than enforcing contracts and customary rules of conduct. This is especially likely to suffice in markets that consist of professionals dealing with professionals, be they investors with capital or business people raising it. A good example was the eurodollar market, which thrived without government regulation after America drove it offshore in the 1960s by imposing an interest-equalisation tax.
Lesson two: markets involving non-professional investors need to be regulated differently. Amateurs may lack information or basic financial skills, making them vulnerable to hucksters. Regulation is needed to protect them and self-regulation, which would inevitably be run by professionals, is not the answer. How much protection is appropriate can be debated, though any regime not based on caveat emptor is likely to lead to problems. It is striking that America has much higher capital-market participation by individual investors than Europe, and its regulations lay great emphasis on striving to create a level playing field between amateurs and professionals. In particular, the disclosure of information to investors of all sorts is far greater in America than elsewhere.
The third lesson is perhaps the most pertinent to todays reformers: competition among regulators, at least across borders, is a good thing. Fears that competition of this sort starts a race to the bottom that is, to lax regulation are misplaced. Well-regulated markets are more efficient; that means they grow. So competition among regulators favours those who do a good job. A monopoly regulator can err on the side of heavy-handedness or neglect and expect to get away with it. A single capital-market regulator for the world, even supposing it were feasible, would therefore not be desirable.
The virtues of regulatory competition were clearly demonstrated by the European Unions single passport policy an approach to securities markets based on mutual recognition and home-country supervision. The idea was that any firm or exchange with approval in one EU country could operate throughout the union, subject mainly to the rules of its home country. This approach has been no more than half-heartedly implemented. Even so, it has generated fierce competition between regulatory regimes. Some national stock exchanges have merged as a result, and innovative new trading systems have entered the business. The upshot has been a great increase in the efficiency of Europes securities markets.
As the EU modernises its regulations, it should take care not to crush this healthy process under too much homogeneity, still less under the weight of one pan-European regulator. It would be better to extend the existing model across the Atlantic. Regulators have been reluctant to allow European exchanges to ply their trade in America, by putting their trading screens there. The official reason is the desire to protect non-professional American investors. The real reason is the desire to protect Americas domestic exchanges. If Messrs Gramm and Lamfalussy really want to advance the cause of well-regulated global capital markets, allowing American and European exchanges to compete for each others customers while continuing to be supervised by their own competing regulators would be a capital idea. May the best rules win.
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