(And How I’m Using it
to Finance My Vacation)
By Evaldo Albuquerque, Editor, Exotic FX Alert
How can you tell if something is overvalued?
If you want to buy a car, a house, a computer and pretty much anything else, it’s pretty simple. You just need to look at what similar products are selling for, and compare prices.
For currencies, there’s also an easy way to see if a currency costs too much.
You just have to glance at the Big Mac Index. With this index, I was able to identify the most overvalued currency in the world.
I’m using this overbought currency to pay for most of my vacation expenses. Let me explain….
Big Macs Cost a Whole Lot More Here
The theory of purchasing power parity says that a dollar should buy the same amount of the same good everywhere.
So at least in theory, a Big Mac should cost the same price in every country. But it doesn’t always work out that way.
At the moment, a Big Mac in the U.S. costs around $4.07. But here in Brazil, where I’m spending some time with my family, Big Macs are more expensive.
After converting your dollars into the Brazilian real, a Big Mac should cost R$6.71 Brazilian reais. (You multiply $4.07 by the current exchange rate of 1.65 to get that.)
But a Big Mac here in Brazil actually costs close to R$10. That’s much more expensive than it should be.
So according to the Big Mac index, the Brazilian real is more than 40% overvalued. That makes the Brazilian real the most overvalued currency in the world.
That’s great news for me – because I’m using it to finance my vacation.
Don’t Buy Shirts or Phones Here
Every time I visit my hometown in Brazil I have to pay for my expenses in Brazilian reais. So I have to convert my income in dollars to the local currency.
I could just buy Brazilian reais at the ongoing exchange rate. Today, that would mean I could get R$1.65 for each dollar.
But thanks to the overvalued Brazilian real, I can do much better than that.
Knowing that the real is extremely overvalued, I decided not to simply exchange my dollars for reais.
Instead, I bought some shirts that cost me $45 in the U.S. each, with the sole intention to sell them here. Based on the ongoing exchange rate of 1.65, that shirt should cost only about R$75 here.
But I’ve been selling those shirts for R$150 to my friends here. Because those same shirts cost R$260 at any local store.
If you used my shirts to value the Brazilian real instead of the Big Mac Index, you would see the real is more than 240% overvalued right now. That’s just ridiculous!
I did the same thing with my cell phone. And that’s how I’m paying for my vacation.
Waiting for the Right Time to Buy the Real
The Big Mac index is a long-term indicator. In other words, currencies can remain overvalued for years.
But my trip is showing me the real is extremely overvalued. So I wouldn’t buy it now. I would consider buying it only after a significant correction.
That’s especially the case now that the Brazilian Central Bank has just started to cut interest rates. This should weaken the currency in the short-term.
Another thing I’ve noticed while I’m here is that Brazil still has a bright future. Like any other nation, it will from time to time face some short-term challenges. But I see signs of great economic strength everywhere I travel.
So I still believe in the Brazilian currency for the long-term. But the price you pay is one of the most important things in any investments, including currencies.
Right now, the real is just too expensive. If you’re interested in buying this currency for the long-term, wait for a correction of at least 20% to buy some.
Editor, Exotic FX Alert
Source: The Sovereign Investor