Stein’s Law, named for famed economist Herbert Stein, holds that if something cannot go on forever it will stop. Unsustainable trends ultimately yield to the inevitable in one way or another.
Stein’s Law seems to be simply stating the obvious, but you would be surprised how many people find a way to ignore the obvious when it is in their interest to do so. As Upton Sinclair wrote, “It is difficult to get a man to understand something if his salary depends on his not understanding it.”
Argentina’s Inflation Problem
And so we consider the case of the Argentinean wine industry. It’s not just the wine sector, of course, it’s the whole Argentinean economy, but wine is especially affected. Something’s going to happen according to Stein’s Law, because it can’t go on forever as it has up to now, but it is hard to know exactly what.
The problem begins with Argentina’s high inflation rate. The official statistic puts the annual increase in consumer prices at around 10%, but this number is viewed with disbelief by the international economic community. The Economist magazine quit publishing the official figure in 2012, saying “Don’t lie to me, Argentina” to the officials there. The most commonly cited estimate of the actual inflation rate is 25% per year.
Inflation is a sensitive political issue in Argentina as it is in every country that has ever experienced a hyperinflation crisis (think Germany, for example). Some in Argentina go to great lengths to deny the obvious reality of inflation.
The story (which may be true) is told about a McDonalds restaurant in Buenos Aires that displayed all the usual products on its big backlit menu board except the signature Big Mac. Where’s the Big Mac? Oh, we have that price hidden around the corner so that no one will see it — especially the people from The Economist magazine who use it to estimate the purchasing power of the peso in their Burgernomics index!
As a recent article on The Drinks Business website suggests, high inflation is putting the squeeze on Argentina’s wine producers. (The squeeze is made worse, I understand, by government policies that restrict imports of products used in wine production as part of a general policy to control foreign exchange reserves). Production costs (grapes, labor, etc.) may have doubled over the past four years, putting a squeeze on margins.
It is difficult to pass these peso costs along to consumers in the U.S., Canada, the U.K. and Brazil, the main export markets. Consumers are price sensitive and while the average export price of varietal Cabernet and Merlot wines have risen by 7.2% and 24.8% respectively in the past year, this provides only limited relief from rising costs since Malbec takes the lion’s share of the export market and its dollar export price has risen by just 1% in the last year and by an average of only 2.8% per year since 2009.
Purchasing Power Inaction
The textbook remedy to this situation is for the foreign exchange value of the peso to fall to achieve what economists call Purchasing Power Parity. In a system of market determined exchange rates, according to the PPP theory, a 25% fall in the domestic purchasing power of the peso due to inflation should result in a 25% decrease in its foreign exchange value.
And indeed the peso has depreciated, but not by nearly enough to overcome the inflation difference between Argentina and the four main export markets. The peso has fallen in value by about 20% in the last two years, if we look at the official exchange rate, so each dollar of export earnings brings in more pesos, but inflation-driven peso costs have increased by much more. That puts a real squeeze on margins. This can’t go on forever — something has to give.
[I’m told that the black market exchange rate is 8 pesos per U.S. dollar, far below the official rate of about 5 per dollar. Such a big differential is often an indicator of crisis to come.]
Something’s Gotta Give
What happens when a country gets itself caught in a squeeze like this? Well, the conventional wisdom is there needs to be a sharp currency devaluation followed by monetary tightening to control inflation. This is a painful process and Argentina has been through it before. What if the government ignores the conventional wisdom? Internal adjustment must eventually take place to restore competitiveness if external adjustment through the exchange rate is ruled out.
A recent Wall Street Journal article about real estate prices in Buenos Aires shows one pattern of adjustment. The dollar prices of luxury apartments have tumbled as owners seek to cash out of their real estate investments and buy into the more credible U.S. currency. The WSJ reports that
In May last year, Argentine President Christina Kirchner strictly limited access to U.S. dollars and other foreign currencies in a bid to stem capital flight. With the Argentine peso facing about 25% annual inflation (government figures, widely discredited, set the rate much lower), and an unofficial exchange rate that has effectively devalued the peso sharply, demand is high for dollars.
These days, the main feature that foreign buyers say they look for in a Buenos Aires property has nothing to do with closet space or a wide terrace. It is a seller with a bank account outside Argentina to which they can legally wire funds. This is a way to get around having to convert any dollars wired into Argentina into pesos at the official rate, after which it is nearly impossible to convert back into dollars at the official rate.
Something will have to give in the wine industry, too, if the exchange rate doesn’t adjust and the currency controls continue. In the meantime, I think every effort is being made to control costs and to keep margins out of the red. But, as Herb Stein might say, this can’t go on forever so somehow it will stop.
Herbert Stein may be best known today as father of Ben Stein, the actor, law professor, and columnist, but he was ever so much more famous in his day as a chairman of the president’s council of economic advisers
Little known fact: the Pabst beer company held an economics competition in 1944 (the year of the Bretton Woods conference) for the best plan to sustain high employment in the post-war era. Herb Stein’s plan was named the winner from among the more than 36,000 entries. He was 28 years old and the prize was $25,000 — the equivalent of $330,000 today.