The Canadian dollar took a beating in 2013 and the new year has so far brought an acceleration of the decline. On a one-year basis, our currency has lost 9.3% of its value to the U.S. dollar, with 3.7% of this decline coming since the turn of the calendar year.
On a fundamental basis, over long periods of time, a currency’s value tends to be pulled towards the gravitational center of Purchasing Power Parity (PPP). PPP states that long-run exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services. The most recent data from the Organisation for Economic Co-operation and Development (OECD) places fair value for the Canadian dollar at about $0.81. Today, our dollar trades at $0.91 which suggests that, from a PPP perspective, the Canadian dollar remains overvalued.
A lighthearted way of gleaning a further understanding of PPP is The Big Mac Index. Since 1986, the Economist has been reporting a simplified measure of PPP by tracking the currency-adjusted value of a McDonald’s Big Mac across many countries. There are two versions of the index, dubbed “raw” and “gourmet.” The raw index presupposes that a Big Mac should, after adjusting for exchange rates, cost the same regardless of where it is purchased. If there is a discrepancy, then there must be a currency over/undervaluation. The gourmet index is probably the more relevant as it makes some further adjustments to account for differences in GDP per person. And, according to the Big Mac Index, the Canadian dollar remains overvalued by 6.2%.
To learn more about the Big Mac Index, visit The Economist’s website: www.economist.com/content/big-mac-index
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