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What the Big Mac Can Tell You about Currencies

Currencies have experienced a massive wave of volatility in the past three years. Driving some of that volatility are the early stages of a sovereign debt and currency crisis. As I laid out in my June 26 Money and Markets column, history suggests many of the sovereign debt problems in the world will likely be responded to with competitive currency devaluations. So it’s reasonable to expect large moves in currencies. How large should we expect? For our guide, let’s take a look at the market’s estimate of the current “fair value” of currencies. We’ll use an economic theory known as purchasing price parity (PPP), which adjusts the exchange…
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