Wednesday, June 29, 2005

The Big Mac Index and the PPP

My kids are taking Macroeconomics this fall, and being an involved Dad I decided to see if I remembered any of it. I’m no great fan of theory, but there is a great debate going on about Purchasing Power Parity (PPP) and laissez-faire markets.

I’m a big fan of Adam Smith (I even visited his grave in Edinborough) and I believe in the basic concept behind laissez-faire is “let it be”, and allow market pressure to bring international trade into equilibrium. Under the “law of one price”, international commodities (tomatoes, computer consultants, &c) will equalize as a function of the exchange rate, and that at the end-of-the-day, prices for identical goods will equalize and the only differentiator will be quality.

This “quality” factor has important connotations for my international consulting business, where computer professionals are treated as commodities. In a huge turnaround, I’m seeing foreign countries who are suppliers of “cheaper” computer programmers coming to me even though I charge 10x more than many foreign “Outsourcing” firms.

In a free international market (I require payment in U.S. dollars), overseas consumers purchase dollars at the exchange rate and apply PPP to determine the “absolute purchasing power parity”, essentially the “apples-to-apples” comparative costs, plus perceived quality.

Now, do overseas consumers really ”run” these complex numbers? You bet. In several of my overseas clients I replaced “offshoring” competitors. The differentiator was productivity and price and while the competition was 10x cheaper per hour, my experienced developers were 15x more productive.

But what does this have to do with Big Macs? When we evaluate disparity in PPP it’s always a function of market manipulation (tariffs, trade barriers) we always look for some “equal good” to compare the “real” purchasing power of different currencies. The Big Mac, by virtue of having exactly the same ingredients (remember the jingle “Two all beef patties, lettuce, pickles, onions, cheese, special sauce on a sesame seed bun?) and the ubiquitous nature of McDonalds across the globe, make the “Big Mac index” of a highly reliable index of PPP and artificial trade barriers.

History of the Big Mac

By the way, the Big Mac sandwich was named after Gen. Douglas Macarthur, an amazing medal grabber and legend in his own mind (Ike said that "I studied drama under Macarthur"). I was watching Jeopardy the other day and the final question was “the last name of the only father and son to receive the Congressional Medal of Honor”. All of the contestants got it wrong, but I knew the story of Big Mac. It’s an interesting tale.

Douglas’ Dad, Arthur Macarthur was a brave teenaged officer in the Civil War, back when the U.S.A gave out the “medal of Honor” like candy. Arthur got his at 18, and was a Lt. Col by 19 years old.

Now "Big Mac" was fearless in WWI and he easily made general by 1918, and developed a marketing “persona”, just like Patton did with his combat helmet and pearl-handled pistol:

Macarthur’s ”thing” was a custom hat completely covered in scrambled eggs and a trademark corncob pipe. Back in the 1930’s he thought it was dashing to carry a cane, but after a child wrote and asked “Are you feeble?”, Mac tossed the cane forever!

My Dad served under Mac in Luzon, right before he abandoned 70,000 soldiers to the Bataan death march, and I’m told that Mac was arrogant, aloof and prone to screaming temper tantrums. When Mac made is famous saying “I shall return”, his men mocked him with quips like “I’m going to the latrine. I shall return”.

We all know how Truman fired him for insubordination in the 1950’s, but I’ve always been deeply offended by his politicaly-finagled medals for valor (sound familiar?)

- Congressional Medal of Honor
- Distinguished Flying Cross
- Silver Star with 1 silver oak leaf cluster (six times awarded)
- Bronze Star with "V" device
- Air Medal

In all fairness, he was fearless in battle (no doubt because of his desire to live-up to his Dad, Arthur), and he got a few of these medals for real heroism, but I ask you, how the hell do you get awarded The Silver Star six times? The Distinguished Flying Cross for "extraordinary achievement in aeral combat"? C’mon. . . .

Even Audie Murphy (the most decorated U.S. soldier in history) only got the Silver Star twice. Murphy was the real-deal hero, and he played himself in the 1955 smash hit move “To Hell and Back”, a really, really great movie, especially when you know that Murph is playing himself!

Now, Big Mac wanted to stay in Luzon and get captured with his men, but he was ordered to leave his men, for the Bataan Death March.

It’s never been clear how he finagled the Medal of Honor, but to be awarded the MOH for his failed “defense of the Philippines” is a disgrace to the G.I.’s who died there and those who really earned their medals.

The Big Mac Index

The “Big Mac index” is a measure of the price of a Big Mac adjusted by the exchange rate to locate the real cost of living, a market anomaly that would not exist without trade barriers, and the Big Max Index has been spectacular in tracking the Euro.

Can you see the problem with the Euro? It’s a clearly indicated that the Euro has discounted the U.S. dollar value by 17% in the past 18 months (ostensibly because the dollar was “overvalued” in a free market)!

Of course, this makes U.S. good relatively cheaper (my clients must buy cheaper U.S. dollars to pay us), and greatly helps my international business, and hurts foreign outsourcing firms.

Anyway, it’s all good new, and I’ll cry about the weak dollar all the way to the bank. . . .