USD Still Undervalued On a Purchasing Power Parity Basis

December 09, 2013
By Knowledge Leaders Team in Uncategorized

The purchasing power parity (PPP) theory basically states that the exchange rate between two countries should adjust so that a basket of goods in Country X costs the same as it does in Country Y when priced in the same currency. It is a useful theory in understanding the relative strength of a currency, especially for a reserve currency such as the USD. It is important to keep in mind that over/under valuation based on PPP can remain in place for years and that this is not at all a timing tool.

The USD is currently undervalued against 15 of the 18 countries that we track it against on a PPP basis. We show this visually by building a diffusion index (every time the USD is undervalued it registers a +1, if it is overvalued it registers a -1).

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Below are some individual PPP charts of the USD vs other major currencies. While the USD may still be undervalued, it has generally strengthened on a PPP basis over the past two years.

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