Is The Euro Overvalued?
The euro recently celebrated its tenth birthday and many analysts decided they are obliged to raise once again an old dispute about the correctness of the euro exchange rate against other major world currencies. Even high-ranking officials from the International Monetary Fund insisted that the euro is overvalued, while the finance ministers of the 16 states in the Eurozone stated that they believe the euro exchange rate is too high. Debates about the value of a particular currency are characteristic part of a global game related to the exchange rate levels and sometimes the statements regarding the euro exchange rate should be taken with a pinch of salt. Many university professors earned their degrees defending a thesis that the euro or the U.S. dollar are overvalued but not many of them managed to influence the world financial markets as financiers like George Soros or Warren Buffet did. On the other hand, statements like this should not be taken lightly. If the chairperson of the Eurogroup Jean-Claude Juncker insists that the euro is overvalued, maybe there is something wrong with the present exchange rate. For his part, Juncker could be trying to influence the euro exchange rate for he and his colleagues consider it unfavourable for the European exports, for instance. Forex dealers know that the Chinese yuan is tied to the U.S. dollar and if the euro exchange rate against the dollar and the yuan, respectively, is too high it is not very advantageous for the European trade balance. This could be the hidden driving force behind the statement of Juncker, for example. On the other hand, this is the exchange rate determined by the market so read between the lines when someone is trying to convince you that a certain currency is overvalued or undervalued. The Economist regularly publishes their Big Mac Index, which is a funny reading presenting the price of the popular fast food at different places around the globe. The index is based on the idea that a particular good should have the same price, say, one dollar, regardless of the country where it is sold. According to this index the price of the Big Mac in Europe is about 16% overvalued compared to the cost of a Big Mac in the U.S. How correct is this data? You should take into account multiple factors when calculating the value of a currency and determining whether it is overvalued. Apart from all fundamentals, there are also psychological factors like the level of trust in a currency and susceptibility to outside influences among the market makers, which can hardly be measured. Moreover, the cost of a Big Mac in Frankfurt, London or New York depends not only on simple calculations of a currency exchange rate but includes also factors like purchasing power and inflation, to name a few. The debate whether the euro is overvalued will continue in the years to come and many pundits will argue for or against the proposition that the euro exchange rate is overvalued. In a truly liberal economy, the market is the only arbitrator whether a currency is worth the price asked for it.