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The Big Mac attack

Paul Sullivan

 

The stock market is crazy enough…why would you want to get into something that seems the exclusive province of financial wizards like George Soros? I'm talking about the currency market, and despite appearances to the contrary, it doesn't require a grasp of voodoo to get it in the game; in fact, it's as easy as ordering a Big Mac!

More on that in a minute, but first a brief primer on why you too can trade currencies like a Big George.

When you think about it, there are 10,000 stocks from which to pick the wrong one on the big board, whereas there are about nine or 10 currencies, backed up by the treasuries of the world's strongest economies, so the odds are better in your favour.

Consider also that currency trading boils down to a couple of simple principles:

  1. Interest rate differential. According to DR Barton Jr. of the Oxford Club's Investment U, interest rate differential is easy to understand: If the same amount of money receives a higher interest rate in one country than another, money will naturally flow there. Now the Big Mac attack:
  2. Purchasing Power Parity: An item, such as a Big Mac burger, should cost the same from country to country, and Barton Jr. argues that if it costs more in one country relative to another, chance are the more expensive currency will lose value over time. In China, at the time of the survey, a Big Mac went for $1.33 US, by far the cheapest, while the same burger sold for $5.21 in Switzerland and a whopping (sorry for the pun) $6.37 in Iceland. By charting the price of a Big Mac in Switzerland, China, Canada, Japan, and Iceland, Barton Jr. was able to discover that the Japanese Yen and the Chinese Yuan were undervalued compared to the US greenback and the Icelandic Kronur and the Swiss franc were pricey, while the Canadian dollar and the US dollar were trending toward parity.

I love a simple, if not necessarily a simple-minded guideline and the Big Mac analysis turns out to be pretty good, if high in saturated fats. Barton takes simplicity one step further by following these two principles and operating on currency guru Chris Weber's Max Yield Strategy:

Every year, on January 1, Weber invests his currency dollars into the developed country with the highest interest rate by starting a savings account in that nation's currency! That way, he avoids Big Mac deflation by reinvesting in the strongest currency annually, get the benefit of the higher interest rate and gain on the currency appreciation that goes with the country that is treating money most favorably at the time.

Weber, by the way, is a legend in do-it-yourself investor circles. At 16, he parlayed an initial stake of $650 US into $10 million net worth, and although he's been at it for 35 years, he's never had a losing year. Ironically, he and I were in Dublin during the last week in July. Here's what he saw:

“Right now I'm looking out of my hotel window onto Grafton Street in Dublin (the main shopping area) and the shops are extremely crowded. You wouldn't suspect that a snake lies in the grass ready to strike.”

He's talking about interest rates, and in Ireland, where the economic boom is being driven by new housing construction, the economy is particularly sensitive to rising interest rates, because most borrowing is not fixed, but floating: “I don't care who you are... if you have contracted debt at 2% and the rate then rises to 4%, or 5% (as it may by the end of the year) - then you've got costs you probably hadn't counted on or prepared for.”

Why this is important, in particular, why is this important in an article about trading currencies? Well, “For me, a place like this is another canary in a coalmine of a new trend of rising global interest rates.” This is not, clearly, a good time to invest in a volatile stock market, or even the bond market, as interest rates are on the rise and the era of easy money appears about to end.

You can look at this as the glass half-empty, if you're carrying a large debt load, or the glass half full, if you're sizing up currencies for investment on January 1. With interest rates going up, we're about to have a number of attractive options to choose from - if we haven't spent all our disposable income covering our debts.

Just remember that this is a particularly precarious time to invest in anything, and perhaps Chinese Yuans aren't the ticket, whatever the Big Macs are saying.

Here's Weber's latest advice, and it's worth noting from a man who argues that he never takes a risk: “The best cash could well be in the U.S. dollar: The very currency that the average person is now panicked about. But panicked action never made for wealth. Instead, patient preparation and the ordering of your affairs to take advantage of any opportunity that presents itself - while at the same time compounding interest - that's the ticket to wealth.”

Paul Sullivan is a longtime Vancouver journalist and president of Sullivan Media. He also writes for The Globe and Mail.

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