Purchasing Power: The Value of the USD

I have noticed a negative correlation between the US dollar and the S&P 500/Nasdaq 100 reflecting the earnings of the largest publicly held US companies. In other words, when the market indices go up, the dollar value was going down. And as the dollar value dropped, the markets went up. This got me interested in researching the concept of purchasing power.

Purchasing power is the value of a currency expressed in the amount of goods or services it can buy. Purchasing power decreases as prices rise faster than income increases, also known as inflation. Inflation erodes your purchasing power; it takes more money to buy the same groceries for example. Purchasing power increases when wages grow faster than the costs of goods and services increases. Here, you can buy more potatoes and avocados with the same amount of money than previously.

To give some context, one US dollar in 1973 could buy goods and services equal to that of $6.86 worth of the same purchases in 2023. In other words, one potato, one loaf of bread, and one apple cost $1 in the grocer store in 1973. In 2023, the buy the potato, bread and apple, it would cost you $6.86.  If your wages went up 686% over that time, you would not feel the inflation. If, however, your wages did not go up at the same level, you would not be able to buy the same groceries; you would have to buy less.  This concept gets to purchasing power parity, or the ability to buy the same amount of goods and services, as compared to either another currency or at a different time.

One of my favorite editions of the publication The Economist is when it publishes their Big Mac Index. The Big Mac Index reflects the globally available sandwich from McDonalds, the Big Mac, and the impact currency has on the ability for a consumer in each countries’ currency to purchase the same thing, a Big Mac sandwich from McDonalds.  This informal way to measure the purchasing power parity (PPP) between two currencies; in other words, is your currency taking a bite out of your wallet and your ability to buy a sandwich, pun intended.  

In ideal settings, PPP is measured for a specific basket of goods, like the example above with one potato, one loaf of bread, and one apple.  However, in practical reality, sourcing an identical basket of goods in every country provides a complex challenge as it does not account for other factors such as local geographic benefits (e.g., temperature is ideal for growing a specific crop or raising cattle), or deficiencies such as lack of any crude oil domestically that therefore necessitates the import of oil which increases its costs.  Tariffs, government subsidies, and other government interventions also influence the prices of the basket of goods across countries, not just the currency exchange rate.  Despite it’s imperfections and in recognition of is intended humor, the Big Mac Index has taken on a cult following as it illustrates exchange rates in a way that everyone can understand.

Below is an image from November 2022 illustrating the Big Mac Index. In this illustration, A Big Mac will set us back $5.35 in the US, while in Switzerland, our mouths will be left open with a price tag go $7.75, reflecting an exchange rate that favored Switzerland at that time.

In this illustration from the Visual Capitalist, albeit for a different time period, the differences are depicted relative to US dollar. In this illustration the US is the baseline at $5.69 for the sandwich, and in Switzerland $8.17.  This is then depicted as the red line farthest left, indicating +44% price in Switzerland (CHE) compared to the US.  Taiwan, in this example, is 58% less expensive for the Big Mac than were it to be purchased in the US. I wonder, based on this chart, if leisure travel from Taiwan to Switzerland would be extremely low given the extreme between the two currencies relative to the USD?