Is Australian dollar is substantially overvalued? No. As we know, the IBM is based upon the price of a Big Mac in one country relative to another country, and comparing that with their exchange rate. However, is the IBM a reliable method? It has a major flaw; that of which it does not account for non- traceable goods. The index assumption that the costs of the goods are the same and purchasing power parity would hold, but that is not always the case. The IBM fails to account for non-traceable goods, such as tax, transaction costs, wages and rent.
Even f the prices of traceable goods are said to be equalized via arbitrage, they are still subject to regulations, subsidies and trade barriers that might warp the costs. This biases can distort the perceived valuation. Another point that we shall look at would be in the following graph of the exchange rate within the last 10 years. As we can see, there has been an upward trend barring the financial crisis. This might point to the fact that the adjusted IBM that is using past data is might be biased towards a lower relative APP, and does not account for the sustained growth trend that we have experienced.
A new valuation of relative APP should be considered, considering that Australia’s core commodities market is still going relative strong, despite China’s growth slowdown