The pound was not overvalued before it tanked against the dollar and euro. Pundits ranging from the IMF to the Guardian’s Larry Elliott say that sterling’s price was too high on foreign exchanges and needed to fall.
But the Economist magazine’s Big Mac Index tells a different tale. This simple tool, based on the theory of purchasing-power parity, compares the price of a Big Mac across the world. If a burger is selling for less than the $5.04 average price in the States, then it follows that the currency is undervalued.
In July 2016 the index reported that the Big Mac price in Britain of £2.99 ($3.94) represented an exchange rate of 0.59. The actual exchange rate of 0.79 showed that the pound was undervalued by 21.8%.
True, that’s just the raw index. But a more sophisticated index that adjusts for GDP per person shows the same pattern and a 13.3% undervaluation.
The dollar-pound exchange rate is now 0.82. Good or bad? That depends on whether you trust the IMF or burgernomics.