What does a latte tell us about currencies? Very little, actually

Purchasing power parity is not the same as the Big Mac Index.

The Wall Street Journal sees what the Economist is having, and it likes it. The latter's Big Mac Index is famous for demonstrating the variation in prices for the same good around the world. Despite Big Macs being basically identical no matter where you are, the dollar price varies wildly, from $6.81 in Switzerland down to just $1.82 in India. It's so influential that it's widely thought that Argentina is exerting pressure on its branches of McDonalds to keep the price down so as to not provide evidence of the nation's tinkering with reported inflation.

So now the WSJ wants a piece of the action, and has created its Starbucks Latte Index. I mean, it doesn't call it that, but that's what they're thinking:

Click to embiggen.

But like the Economist, the WSJ draws the wrong inferences from the variation. They both have a habit of using the data to illustrate purchasing power parity, the idea that some currencies are under- or over-valued because a comparable basket of goods varies in price. So the WSJ's Ira Iosebashvili writes:

One way to determine how currencies stack up is purchasing-power parity, or PPP, which compares the amount of currency needed to buy the same item in different countries. A grande latte at Starbucks, for example, costs $4.30 in New York, but the equivalent of $9.83 using Norwegian krone in Oslo, and just $3.92 in Turkish lira in Istanbul.

Starbucks Lattes and Big Macs both have another unique feature, though, which renders them less useful for comparing the strength of a currency overall: they are both made up of highly fungible goods, produced in two of the most integrated supply chains in the world. McDonalds, for instance, doesn't need to buy artisanal wheat from an individual farm; it can just trade in "wheat" as a mass-produced, internationally-traded com oddity. The company has even invented a product to sell to take advantage of variations in the cost of pork, the McRib.

In fact, for Starbucks, that's even more true than it is for MacDonalds. While Maccy D's has made a big deal out of its promise to only use British beef in its British burgers, most of the countries Starbucks operates in in don't grow their own coffee. That has to be imported from South America or North Africa, and so a Starbucks in London will almost certainly be paying the same for its coffee as a branch in Oslo, despite the difference in retail price being over $6.

What the Starbucks and Big Mac indices actually show is the price of unskilled labour and retail space. Those are the parts of the companies' businesses which, no matter how hard they try, they can't erase national differences from. Operating in Oslo, land of high taxes, is always going to be expensive, no matter how strong or weak the krone is.

The Starbucks index even makes this clear, thanks to the fact that the WSJ has included three American cities. A latte in New York City costs more than one in Detroit, a difference that self-evidently can't be due to the currency variation.

But the really important news is that London is actually one of the cheapest cities in the world for a Starbucks latte. Still overpriced for what it is, though.