Purchasing power parity: how to understand the real value of currencies

Main about PPS

• The PPS concept analyzes the cost of an identical set of goods in different countries, revealing the true strength of each currency.
• This indicator is critically important for an adequate assessment of GDP and understanding how effectively funds are spent in various economies.
• The connection of the PPS with the world of cryptocurrencies lies in the fact that it reveals the reasons why residents of countries with weakening currencies are more actively transitioning to digital assets and stablecoins.

Why PPS Matters in the Modern Economy

Think about it: the same shirt for $10 in one country can be significantly cheaper in another. This phenomenon is explained by the purchasing power parity (PPP) method — a tool used by analysts to assess the real strength of different currencies in the global market.

The essence is simple: PPP determines the volume of goods and services that can be purchased for a certain amount of money in different geographical locations. Whether it's a cup of coffee in Brazil, a car part in Mexico, or utilities in Eastern European countries — PPP creates a unified criterion for objectively comparing prices.

This concept is becoming increasingly relevant for those trying to understand the global economic hierarchy and to grasp why income in different countries has completely different real values.

The Mechanism of Purchasing Power Parity

The foundation of the PPP is the so-called law of one price. The theory suggests that with open borders, identical goods should cost the same everywhere ( adjusted for exchange rates ).

Imagine a scenario: a laptop costs $1200 in the United States and 1,320,000 rubles in Russia. Based on this equality, the exchange rate would be 1100 rubles per dollar — this is the theoretical parity.

However, in practice, the situation is much more complicated. Prices are influenced by tax rates, logistics, regional demand, customs duties, and many other factors. Comparing a single product is not enough to get an objective picture. Therefore, economists turn to basket of goods analysis, which includes food, textiles, housing and utility services, and energy resources. It is this comprehensive approach that allows for the determination of the relative competitiveness of currencies.

Where and how is PPS used

PPS is used far beyond academic circles. International financial organizations, such as the IMF and World Bank, rely on this indicator when analyzing the GDP of countries and comparing levels of prosperity.

When it comes to GDP per capita, raw figures can be misleading. India may appear significantly poorer by the standard rate, but when applying a PPP adjustment and considering the lower local prices for services and goods, the results become much fairer. Thanks to this adjustment, the income of the average Indian becomes more comparable to the income of a resident of a developed country, and the difference in living standards appears less dramatic.

Comparison of real wealth in different countries

PPP provides a real representation of how much a person can afford in each specific country. A salary of $50 000 annually can ensure a comfortable existence in some regions, but may be insufficient in others. This tool helps to fairly assess the standard of living.

Forecasting long-term trends in currency markets

Currency quotes constantly fluctuate due to political decisions, movements in stock markets, and economic news. However, the long-term trend shows that exchange rates gradually approach PPP indicators. This property allows analysts to make long-term forecasts regarding the behavior of various currencies.

Detection of artificial undervaluation or overvaluation of rates

Some countries deliberately manipulate official exchange rates to create the impression of greater strength of their currency. In these cases, PPP becomes a tool for identifying such manipulations and providing an honest assessment of the real value of the currency.

Practical examples from real life

One of the most well-known ways to visually demonstrate PPP is the Big Mac index, proposed by journalists from The Economist. The logic is elegant: the McDonald's burger is produced to the same standards in all countries, so the difference in its price reflects purchasing power parity. If it costs $5.15 in the USA and only 89 baht in Thailand, approximately $2.50 (, this clearly shows the difference in currency strength.

This principle was used to create other indexes: iPad Index, KFC Index, and others. They use universal consumer goods and provide an easy, intuitive way to understand PPP in the context of everyday life.

Limitations and Vulnerabilities of the PPS Method

Despite its usefulness, PPS is not without significant drawbacks. One of the main problems is related to differences in quality. Identical-looking products may have different quality in different countries, making their prices incomparable. Comparing solely based on cost is not entirely objective.

The second important factor is the presence of non-tradable services and goods. Real estate, hairdressing services, electricity, or medical procedures are sold exclusively in local markets. Their prices can vary enormously depending on regional factors and are not subject to global comparison.

Inflation volatility over time also complicates the analysis. PPP assumes price stability, but inflation can radically change the situation. Calculations made today may lose relevance in a few months.

Cryptocurrencies, Stablecoins, and PPS: An Unexpected Connection

Although purchasing power parity and cryptocurrency markets are not directly related )unlike classical forex(, PPP indicators highlight an important pattern: residents of countries with weak currencies show significantly greater interest in digital assets.

Bitcoin and other cryptocurrencies are supranational assets available anywhere on the planet. However, in countries where the PPP indicates the weakness of the local currency, cryptocurrencies acquire the status of an expensive tool for protection against devaluation. This is particularly relevant in regions that have experienced or are experiencing hyperinflation.

This is where stablecoins come into focus. In economies with weakened currencies and high inflation, these dollar-pegged tokens give people the ability to preserve the real purchasing power of their savings. For such regions, stablecoins have become a practical financial instrument that provides relative stability. Although they carry their risks, PPP helps people calculate whether converting local currency into stablecoins is beneficial for them.

Conclusion

Purchasing power parity is a powerful analytical tool for understanding global price structures, incomes, and economic development. Its shortcomings do not negate the fact that PPP provides an objective methodological approach to comparing economic indicators of different countries.

Competence in using exchange rates is useful for economists predicting currency trends, for business people developing pricing strategies in different countries, and even for travelers noticing why the same product costs differently abroad. This is not just an abstract theory, but a practical key to understanding the global economic reality.