Purchasing Power Parity: how PPP works and why it is important for cryptocurrencies

Brief Overview

Purchasing Power Parity (PPP) is a key economic indicator that allows for comparison of the real value of money across different countries by analyzing prices of identical goods. Through the prism of PPP, it becomes clear which currency has greater purchasing power and how this affects people's interest in alternative assets, including cryptocurrencies and stablecoins, especially in regions with unstable national currencies.

Fundamental Concept: Law of One Price

The theory of PPP is based on a simple yet powerful principle – the law of one price. Suppose a phone costs $500 in the USA and 55,000 yen in Japan. According to this law, in the absence of trade barriers, the price of the same good should be equivalent when converted at the exchange rate. Based on the example above, the ratio would be 110 yen to one dollar.

However, the reality is much more complex. Taxes, transportation costs, local demand, and many other factors distort the simple scheme. That is why economists do not limit themselves to a single good, but use a basket of goods — a set of everyday items (such as food, clothing, housing, utilities), which reflect the real differences in the standard of living between countries.

PPS in Practical Application: Measuring Real Income and Living Standards

When it comes to the gross domestic product (GDP) of a country, nominal figures can be misleading. Take India: if you look only at the exchange rate, the GDP per capita appears alarmingly low. But once you apply the PPP adjustment, considering the significantly lower prices of goods and services, the picture changes dramatically. The real purchasing power of citizens turns out to be much higher than what the nominal figures suggested.

This explains why international organizations — International Monetary Fund (IMF), World Bank, and others — use the PPP-adjusted GDP specifically for analyzing the global distribution of wealth and economic opportunities in regions.

Three main applications of PPS

Comparison of wealth between countries

$50 000 a year can provide a fairly comfortable life in one country, but in another, it barely suffices for survival. PPP allows for these differences to be taken into account and provides an objective view of the real standard of living, leveling out currency differences.

Long-term currency exchange rate forecasting

Exchange rates fluctuate under the influence of politics, the state of the stock markets, and speculative factors. However, in the long term, they tend to align with PPP. Economists use this property to forecast the direction of currency pairs.

Detection of currency manipulation

Some countries artificially maintain an inflated official exchange rate, creating the illusion of a strong national currency. PPP serves as a tool for exposing such manipulations, providing an objective assessment of the real value of money.

Big Mac Index and Other Practical Examples

The publication The Economist proposed a clear and amusing way to demonstrate PPP — the Big Mac index. Since McDonald's hamburgers are virtually identical worldwide, their price serves as a simple marker of purchasing power. If a Big Mac costs $5 in the USA and $3 in India, it clearly shows the difference in the cost of living between the countries.

Over time, similar indexes (iPad, KFC, and others) appeared, using familiar consumer products to visually explain the concept of PPP in everyday life.

Limitations and Criticism of PPS

Despite its usefulness, PPS has significant drawbacks:

Quality issue. A product that is more expensive in one country may simply be of higher quality, even if they appear identical externally. Thus, direct price comparisons lose objectivity.

Non-tradable goods. Services such as hairdressing, haircuts, electricity, or real estate are not traded on international markets. Their prices depend solely on local conditions and can vary drastically without any apparent reason.

Time factor and inflation. PPP assumes relative price stability, but inflation can completely change the picture in a matter of months. A comparison that is relevant today may become outdated tomorrow.

Why PPS Matters for the Cryptocurrency World

Although the PPI and cryptocurrency markets are not directly related, this indicator reveals deep economic reasons why people in different countries have different attitudes towards digital assets.

Bitcoin and other cryptocurrencies are truly global assets. But in countries with weak currencies (according to PPP) and high inflation, cryptocurrencies become not just a speculative tool, but a means of protecting savings. People in such regions are looking for ways to preserve the purchasing power of their money in the face of local currency devaluation.

Stablecoins play a particularly important role in countries with unstable economies. Instead of holding money in a depreciating national currency, people can convert it into a stablecoin pegged to the dollar or another stable currency. This allows them to maintain purchasing power without being exposed to the risk of hyperinflation or sharp devaluation. PPP helps determine in which regions such a transition is most feasible and beneficial.

In countries that have experienced or are experiencing economic crises, stablecoins are transforming from an exotic financial instrument into a practical solution that allows ordinary people to protect their capital.

Conclusion

Purchasing power parity is a universal key to understanding the real economy behind nominal figures. From forecasting exchange rates to explaining why cryptocurrencies are gaining popularity in certain regions, PPP shows the relationship between macroeconomics and people's financial behavior.

Understanding PPP is useful not only for economists and financiers developing investment strategies but also for anyone who wants to understand why the same cup of coffee costs differently in different corners of the world, and how these differences affect the choice of financial instruments, including cryptocurrencies.