Changing China

Giant on the move

Starbucks and the overvalued yuan

September 25, 2009

 

 

 

 

 

 

 

 

 

 

Is latte at Starbucks in China overpriced or is the local currency, the yuan, unexpectedly overvalued? The former is certainly more plausible, but it might be equally true that the yuan, if not overvalued, is at least not as undervalued as other measures suggest.

This conclusion would come from my proposed Grande Latte index, the caffeinated equivalent of The Economist’s Big Mac index. The Grande Latte index, like its burger brother, is a light-hearted attempt to find a basket of goods that can be compared across countries to assess purchasing power parity (PPP) and, by extension, fair currency value. There are serious flaws, but I will save these for, ahem, the bottom of this blog.

The cross-country cost comparison of grande (i.e. medium in Starbucks-speak) lattes shows that the Seattle-based coffee chain’s brew is rather dear in China. A grande latte costs $3.75 in the United States but $4.10 in China in dollar terms. It is even more expensive in Japan. The conclusion, that the yen is currently overvalued by 23 percent, accords well with the views of many analysts. But the idea that the yuan might be overvalued by 9 percent flies in the face of pretty much all conventional wisdom. It is also a drastically different perspective than that of the Big Mac index, which in its latest edition showed the yuan to be 49 percent undervalued.

The Grande Latte index is certainly not the gospel truth, though nor is burgernomics. The truth, as ever, probably lies somewhere in between the two extremes — i.e. the yuan is undervalued, but not to the tune of 49 percent. One thing is clear. Arguing that the yuan is undervalued is easy enough, but the actual degree of undervaluation is a matter for serious debate. With Beijing not about to let the exchange rate float freely, the market may have to wait a few years more before getting a chance to deliver its own verdict.

As for questions about the price of Starbucks, there is no shortage of coffee shops in China, from international chains to local cafes, and their prices are all about the same. Here, in any event, is what a Starbucks spokeswoman in Shanghai said:
“Setting the price for coffee is quite complicated. We have to consider the costs. We import the coffee from the U.S. and there are customs taxes. There is the labour cost, the store rental cost and the drink cost, so there are many factors to consider. Different markets have different conditions, so you cannot do a direct comparison with the United States. As far as we understand, our customers do have some price sensitivity. But this is not their only deciding factor. They think the service we provide and the values that Starbucks represents are more important.”

 
Grande Latte index

Local currency / Dollars / Implied PPP / Actual dollar  / Valuation / Big Mac %
                                         of dollar      exch. rate        vs dlr %     

USA       3.75       3.75

Britain    2.35       3.76            1.60             1.60                  ~             +3

Canada   3.75       3.45            1.00            1.08                -7.5             -6

Japan      420        4.63            112               91              +23.1            -3   

China        28        4.10            7.47            6.83               +9.4           -49

 
The most glaring flaws in the Grande Latte index are that: (1) a key input, coffee, is not locally produced in most countries, and (2) in places like China, coffee is a niche product that is consumed by a subsection of well-heeled urbanites.

But, in defence of the index, coffee beans are a relatively small input in every latte, with water, milk, labour, rent, advertising and packaging making up the bulk — all are reflections of local costs, hence fair measures of purchasing power parity. As for catering to well-heeled urbanites, this is true, but these are the very people with international experience, who should know the fair price of a latte, and hence should insist on proper application of the law of one price in China.

Comments

Love this blog: judging an exchange rate on the basis of burger and beverage prices. Now THERE’S accessible economics information.
However, at least in the USA, where I live, a latte would still be considered a luxury item. Is its price, then, a fair standard for exchange rate comparisons?
S in NY

Posted by susan Doubilet | Report as abusive
 

The price of the coffee can also be part of the branding, image, and marketing of the latte. Consider this quote, which was written about college tuition prices a few weeks back at the NYT:

“This is because such costs “serve as markers of institutional quality and prestige,” the authors write.”

Here: http://economix.blogs.nytimes.com/2009/0 9/01/us-news-college-rankings-yes-they-m atter/?src=twt&twt=nytimeseconomix

Posted by Mark Beauchamp | Report as abusive
 

This is a very well written article good analysis. These kind of questions would make many think about on what basis are these prices decided. http://bit.ly/psf9999

 

The Economist does a ‘tall latte’ index

http://www.economist.com/finance/display story.cfm?story_id=E1_NPGTDSN

Posted by Matthew | Report as abusive
 

As the writer of this blog, I can honestly say that I had no knowledge of the Tall Latte index, though perhaps it was buried somewhere deep in my subconsciousness. It seems to have been run only once by The Economist, in 2004 (see Matthew’s link), and then abandoned. Guess it was time for a revisit.

Posted by Simon Rabinovitch | Report as abusive
 

Nice article. As for coffee being a niche product catering to well-heeled urbanites in China, the Big Mac is actually also a niche product in China. A Big Mac in China is VERY expensive when you consider how little a proper (non-burger) meal for the average person in China costs

Posted by Johnny | Report as abusive
 

Purchasing Power Parity is supposed to be for products that would appear in the basket of goods that an average person buys. In China, a country of 1.3 billion, maybe .5% of the people buy these products. Maybe, but probably much less.

Posted by Chris W. | Report as abusive
 

Great blog.

It’s also worth pointing out that the size of a Starbucks cup in China is much smaller, (a grande in the US = a venti in China), since the cool niche concept here, and in many other countries outside the US is not based on the Big Gulp. I remember the last time I came home to Seattle on vacation. I had really forgotten just how us American’s love to scarf down those barrels of fat and sugar.

Posted by Daniel | Report as abusive
 

Heading should be:
Overvalued Starbucks and the yuan

 

Very funny and thought provoking. Is this a cheese burger or a cheesed-off burger ? Maybe the new $1 Big Mac breakfeast should replace the cholesterol bomb as universal parity comparator ? I prefer to call it the $1 Parity Breakfast.

I maintain that there is an unfounded fear of the Yuan. My collective subconscious tells me that this is the reason why China is stalling. A major sell-off of Treasury Bills and Bonds, come on. I read lately that the Euro and Yen would suffer most in such a scenario, something to do with cross-rates ?

Posted by Casper | Report as abusive
 

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