What the Big Mac says about Russia
One of the stupidest commentaries we’ve seen regarding Russia is the Economist magazine’s “Big Mac Index.” Even while admitting it is “light-hearted” and totally without any real meaning the magazine goes right on publishing it.
This year’s index says that Big Mac sandwich costs $3.57 on average in four large American cities while it costs $2.04 in Russia (based on an unspecified number of cities surveyed). The world’s cheapest Big Mac is in Hong Kong (where it costs $1.72) and the most expensive is in Norway (where it will set you back $6.15). So Russia has a claim to fame! It offers one of the cheapest American hamburgers on the planet (more than enough reason to book a plane ticket, right?). Good job, Russians!
Based on this revelation, namely that the Big Mac is $1.53 or 43% cheaper in Russia than in the USA, the Economist concludes that the Russian currency is 43% undervalued and that the exchange rate should not be 32.8 rubles to the dollar, which it currently is, but rather 18.8 rubles to the dollar, which would make the price of the sandwich the same in both countries.
The implication of this is that Russians are foolishly willing to pay more than fair market value for a dollar, Americans foolishly unwilling to pay more for a ruble. For various reasons, it’s surely one of the stupidest economic suggestions ever made.
First of all, in insane fashion the Economist scribes are assuming that the price of the Big Mac in the United States (based on just four cities) is “correct.” There’s no basis for that assumption.
Second, the Economist is assuming that the cost of producing the same product is the same everywhere. That’s idiotic, and the Economist itself knows that. It warns: “Care is needed when drawing quick conclusions from fast-food prices; the cost of a burger depends heavily on local inputs, such as rent and wages, which are not easily arbitraged across borders and tend to be lower in poorer countries.” That’s putting it mildly. Russians work for slave wages in middle class living conditions that would amount to poverty in the United States. Russian workers and consumers have none of the legal rights they enjoy in the U.S., and McDonald’s faces none of the attendant costs. Even if it did, McDonald’s simply can’t afford to charge the same price for a cheeseburger in a country where the average wage is $3/hour as it does in one where the wage is $20/hour. That’s to say nothing of the frightening costs of crime and corruption which Mickey D faces in Russia and doesn’t in the U.S. The Economist makes no attempt to suggest that McDonalds makes the same profit on a burger sold in Russia as it does on one sold in the U.S. For all the magazine knows, McDonalds is losing money and hoping the market will recover eventually.
Third, the Big Mac cost 59 rubles last year, so it has seen a whopping inflation of 13% in the past year. But the sandwich cost exactly the same in the United States in both 2008 and 2009, down to the penny. The American inflation rate has been 0%, something the Economist doesn’t care to consider. During this period, the ruble has according to the Economist actually become more undervalued, since it was only 29% undervalued a year ago and is 43% undervalued now. Sheer unadulterated gibberish.
The Russian economy is now grinding metal against metal. In the third quarter of this year, it will deplete its Soveriegn Reserve Fundfrom 3 trillion rubles to 1.6, in other words by half, in order to cover a massive budget deficit as tax revenues plunge because of the national recession. By the end of next year, at the latest, this fund will be totally exhausted. That means Russia will be forced into the position of borrowing from foreign lenders (Russia itself has no capital resource capable of providing such funds) and that as Russia’s self-made domestic subprime crisis rolls in Russia will have no cushion to fall back upon. Should the Western financial crisis prove durable and demand for crude oil remain low, Russia will soon be facing bankruptcy.
So, if anything, the world is overvaluing the Russian ruble, right along with everything else connected with the Russian economy. It is forgetting that no matter how much book value the Russian economy might have, two factors will always make it a bonehead play to invest, as IKEA recently learned: incompetence and corruption. The Russian economy is permanently riddled with inefficiency and graft, problems that start at the rotten head in the Kremlin and poison the entire body. Put your money in Russia and the Kremlin may steal it outright. Even if you avoid that fate, you will see the failed system collapse and your investment right along with it.