Purchasing power parity and the law of one price

It is owned and totally controlled by the company “Condé Nast”. “Vogue” is published all over the world and each country where this magazine is published is producing it on its territory. So this product is not imported, the product is absolutely identical in all countries and prices should be equal everywhere according to the “Vogue” policy. All said above brings us to the conclusion, that “Vogue” can be used to estimate the “correct” level of currencies as well as Big Mac. That is why we will try to apply the Law of One Price on the Vogue Magazine.

Using the prices on “Vogue” in 10 different countries with 10 different currencies. Here you can see the shortcut of the spreadsheet.

Source for Vogue prices httpV/www.ccrdenSiom and

The last column presents the percentage of under or over evaluation of the currency against the US Dollar, which is used as the base currency as in the original Big Mac index. Now we will try to explain this under or over evaluation and we will start in alphabetical order.

The growing importance of the Brazilian real severely affected exports. In the past year, Britain sent $ 3.5 billion (€ 2.28bn) of goods and services for the largest economy in the southern part of America - 3.8% over the past 12 months -that exports from Brazil to the UK fell by 13% (Inman, 2013). This export problems cause great overvaluation of real and consequently the economic crisis in the whole country.

British pound is also over valuated. In the center of the case of pound sterling overestimation is the observation that there is a significant degree of misinterpretation by unemployment threshold Bank of England due to unemployment threshold: is neither the purpose nor the trigger to increase the interest rate. It is a point of consideration (Unknown, 2013).

The reason of over rating of the Canadian Dollar is their large underlying trade deficit, says Porter (Beltrame, 2013).

Many companies in the euro area have complained about the strength of the single currency. They believe that they need to have a weaker euro to expand оn pоtential ecоnоmic grоwth (Ahmed, 2014). That is how European analytics see the reason of euro over valuation.

Indians see the core factor of Indian rupee greatest under valuation in politics. The US Federal Reserve supports their currency. The unstable political situation in the country and recent elections worry the US government enough to stop supporting Indian rupee (Unknown, The Economic Times. Markets, 2013). But most Indian analytics are optimistic about the future (distant future, I should admit) of their home currency.

Japan's ability to keep borrowing costs are the second lowest in the developed world. It is partly dependent on its position as a net holder of external assets. Strong yen cutting into corporate profits and exports could push the current account deficit, pushing bond yields and make it more expensive for countries to borrow (Warnock, 2012). Here some analytics see the core problem of Japanese yen. They also see some similarities with the European case.

Russian stock market experts find a certain pattern in BRICS and developing countries’ currencies being undervalued (Russia is a BRICS country as well). These currencies are always undervalued towards PPP. However the more developed national currency is (means the development of currency market of the country) the closer these indices become (Grinkevich, 2013). We should never forget about the dreadful level of corruption in Russia, which also affect the creditability of the country.

In the case with Turkish lira we have to come back to politics. Former political turbulence and corruption caused increase in tax and prices. The cost of Turkey's debt is also rising alarmingly quickly (Boyle, 2014). All these factors reflect in high under estimation of the domestic Turkish currency.

And finally we will regard the Venezuelan case. The reason that the Venezuelan bolivar is over rated is that get very few bolivars for petrodollar. Their economy is mostly based on oil and consequently highly attached to petrodollars. The Central Bank of Venezuela will start to report the Sicad exchange rate, thus turning it into a benchmark official forex rate. Analysts believe that in order to get more bolivars for petrodollars and reduce the gap between revenue and expenditure, the government will use Sicad to sell US dollars to companies that were formerly sold US dollars via Cadivi (Salmeron, 2013).

Having said all that we see that the Law of One Price is not working perfect. As any law it has some limitations. Basically, it is the Purchasing Power Parity who has the drawbacks. In particular, if the law of one price holds for all goods, the PPP is fulfilled automatically only if the set of goods in the consumer basket in different countries remains. In addition, in different countries, the alignment of the prices is complicated by the fact that not all the goods and services involved in international trade. Foreign trade barriers, restrictions of the convertibility of the national currency, capital controls, may discourage adjustment of prices and availability. Worth noting also that the goods that are subject to international trade are not always fully interchangeable for different consumer groups. In assessing the differences between the actual exchange rate and the long-term equilibrium exchange rate PPP method, there are two major problems associated with the choice:

• 1)    Most available indicators of prices or costs;

• 2)    The base period, starting from which it will be possible to evaluate the changes in relative prices or costs (Owen A. Lamont, 2003).

2.Beltrame, J. (15 October 2013 r.). CTV News. Retrieved 27 January 2014, from CTV News:
3. Warnock, E. (18 January 2012 r.). Bloomberg News. Retrieved 1 February 2014, from Bloomberg News:  

Sources:

1.Ahmed, K. (25 January 2014 r.). The Telegraph Finance. Retrieved 31 January 2014,                 from                 The                 Telegraph: