Can Everyday Commodities/Products Predict Foreign Exchange Rates?

It seems that everyday products can provide a good indicator regarding foreign exchange rates. Forex analysts use standard global products or services to determine the ‘fair value’ of an exchange rate.

In addition, standardized products, such as coffee, can be used for developing interesting Indexes. Some of these indexes include the MacDonald’s Big Mac Index and the Starbucks Latte Index. There is also the “Domino’s Medium Pepperoni Pizza Index” and the “Nobu Black Cod with Miso Index”.

Creating Indexes by Using Standard Products

 

The Wall Street Journal “Latte Index”

In 2013, the Wall Street Journal created the "Latte Index" which tracks the price of a Starbucks Grande Latte in major cities. The price of a Grande Latte is compared in 29 different countries:

(i) All prices are converted to US Dollars, and

(ii) they are compared to the Starbucks Latte price in New York City, which works as a benchmark price. The price of Starbucks Latte in New York is US$3.45.

 

 

How Does The Starbucks Latte Index Work?

The “Latte Index”, uses PPP (Purchasing-Power Parity) to compare the cost of the same commodity (Latte Coffee) in different countries –in order to determine overvalued and undervalued currencies. The Index can measure how many coffee cups can purchase a minimum-wage earner with its hourly pay. In countries with a strong currency, it would take more dollars to buy a Starbucks latte than in countries with a currency that has less buying power.

The report of WSJ included twenty-nine (29) cities, and the benchmark was New York, where the Starbucks latte cost $3.45. Actually, New York ranked in the middle of the list (14th place).

The WSJ wrote: “Though the latte prices are likely also affected by factors such as country taxes, The Wall Street Journal’s Latte Index broadly mirrors the results of other valuation methods.”

Example

For example, the USD price of a latte in Zurich, Switzerland is $5.76, while the USD USD price of a latte in Mexico City, Mexico is $2.19. According to the “Latte Index”, the Swiss Franc is 66% overvalued against the US Dollar while the Mexican Peso is 36% undervalued against the US Dollar. If we consider, that the Swiss Franc is a ‘hard currency’ focused on monetary-stability, and the Mexican Peso is a ‘flexible currency’ focused towards easy-exports, then the findings may reflect somehow the truth.

 

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