Yup, the Big Mac is more than just a burger; it’s also a reliable currency index tracking a basket of 17 foreign currencies over the U.S. dollar. The “Big Mac Index,” published by the newspaper The Economist, has proven to be surprisingly accurate at judging the relative price of different currencies to the U.S. dollar since its inception over thirty-one years ago. This can be a useful tool for exporters to judge currency volatility and price or select the currency of their contracts with buyers.
The “Big Mac Index” is based on the idea that a Bic Mac in Japan should cost the same as a Big Mac in America if both currencies are fairly valued. Simply put, if a Bic Mac in America costs more than a Big Mac in Japan it is fair to assume that the Japanese yen is undervalued against the U.S. dollar.
Why does this matter to the U.S. small business exporting on dollar terms?
Currency Risks to the Buyer Can Impact Payment
Any transaction where a foreign buyer is facing a large swing in their local currency relative to the U.S. dollar represents a currency risk to them which is good to know beforehand. If the buyer’s local currency is heavily over-valued against the U.S. dollar an exchange rate adjustment after purchase could be prohibitive. This could impact the buyer’s ability or willingness to pay. They may not be able to pass this cost along as it would immediately impact heir short term cash-flow. If very steep, it may convince them to not accept shipment entirely and alternately source their purchase. The currency risk is even more pronounced on transactions with extended payment terms, which is the global norm these days.
Maintaining Price Competitiveness
It’s hard enough to export when the U.S. dollar is strong as it has been for the last decade but a weakening dollar shouldn’t cause you to drop your guard and ignore the relative price of other currencies. True, recent political and global economic developments have seen the dollar fall to a 33 month low in mid-September 2017, according to an article by The Financial Times, however this boon could be short lived. The dollar has bucked, no pun intended, many trends that should have kept it down before, especially in times of heightening geopolitical tension. Over the next twelve months increasing U.S. interest rates and slower economic growth in the E.U. and Asia could also play a part.
Choice of Invoice Currency
Keeping your eye on the Bic Mac might also pay off in figuring out how to keep your product or service competitively priced. Short of engaging in foreign exchange hedging, currency swaps, and options, which you could price into the total cost, knowing the relative market position of various currencies could help you choose an alternate currency for invoice repayment with your buyer.
- Sellers Currency: Of course, invoicing in dollars is the hassle free way to eliminate currency risk as this places the risk on solely on the buyer. Yet the key to making a sale might be sharing the potential risk if you anticipate a rise in the dollar.
- Third Country Currency: Pricing the contract in a third countries currency is another option to stay competitive. Typically this is done for a hard currency that is freely convertible, actively traded, and ideally, has little price volatility expected relative to the U.S. dollar over the term of your transaction.
- Buyer’s Currency: If the buyer’s currency is a hard currency that meets the above mentioned conditions this could be an option but what if the buyer’s currency is not a hard currency?
Accepting the buyer’s currency places the exporter at risk for currency fluctuations. This is why the Big Mac Index can be useful for a quick check of currency movements over time in most tradeable currencies. While this option places the exporter at risk, they needn’t be exposed to all political and commercial risks.
Learn how EXIM Bank’s short-term Export Credit Insurance can help minimize the risk of commercial and political in over 180 countries around the world. To find out more about EXIM finance products before calling, download this free guide, Export Expertise: 10 Finance Tools to Grow Export Business. When you are ready to speak with one of our Trade Finance Specialists, click on the Consultation Request Link.