Monday, October 18, 2010

The Parody of Parity

Australia is currently alight with conversation relating to reaching 'parity' with the USA dollar. While I am certainly happy about about the 1:1 parity being achieved, I do not think it deserves all the hype.

1:1 parity is an accounting benchmark. While it looks great on paper, the fact that our respective dollars happen to have passed each other in the night doesn't change anything.

The real benchmark is purchasing power parity (PPP), the exchange rate at which products in each country cost the same relative to the exchange rate. For example, a chocolate bar that sells for AUD$1.50 in an Australian city should cost US$1.00 in a U.S. city when the exchange rate between Australia and the U.S. is 1.50 USD/AUD. (Both chocolate bars cost US$1.00).

The benchmark for tongue-in-cheek PPP is The Economist's Big Mac Index. The Economist has been running the BMI for as long as I can remember and, despite its simplicity, it provides an interesting and tangible expression of over- and under-valued currencies around the world. This site has a 'live' version of the BMI which is updated daily in accordance with changes in the exchange rates.

Interestingly, the BMI suggests that Australia is really at parity with the USA at an exchange rate of around 0.85USD, but this is somewhat higher than the exchange rate that matters to me.

To me, 1:1 parity and PPP are far less important than my arbitrage parity - that is, the point at which it is cheaper for me to import my consumer goods (technology, clothes, shoes etc.), than to purchase them here in Australia. In essence, this is the same as PPP, but also takes into account transport costs, exchange rate costs (bank fees etc.) and a risk premium (which I apply to all internet purchases).

I were looking to purchase a Big Mac, my arbitrage parity would be at some point above 0.85USD, but it seems like most of the goods I like to purchase I can source considerably cheaper in the USA. As such, my arbitrage parity is typically at an exchange rate of approximately 0.65USD. Anything on top of that is cream on the cake - or savings in the bank as the case may be.

When purchasing running shoes for instance, I can source shoes from the USA for $125USD (including postage) that would cost upwards of $250AUD. This reflects an arbitrage parity of 0.5USD. In addition to this (and the original reason for importing shoes), I am able to import the shoes that best suit my feet.

Technology often provides a lower discount in the USA and, therefore, my arbitrage parity is higher. A Macbook for instance costs $1,000USD and $1,250AUD. By the time I find someone willing to sell it to me (Apple USA won't ship to Australia), and pay for postage, my arbitrage parity would be closer to the BMI parity of 0.85USD.

The most considerable benefit to me of the 1:1 parity is that it widens the scope of goods that I can reasonably import - that is, as the exchange rate improves, a greater range of goods will become viable to import.

I wonder what I should import next?

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