How will the rising dollar affect the U.S. wine market? The answer, predictably, is that it’s complicated. Read on for analysis organized around three questions. Why has the dollar appreciated? What are the textbook effects of a rising dollar? How and why is the impact on U.S. wine likely to be different?
Why has the dollar appreciated?
The U.S. dollar has appreciated dramatically on foreign exchange markets, powered by several factors. Expectations of higher interest rates in the U.S. is a big part of the story as the reality of the end of the Federal Reserve’s asset purchase program sinks in. Add to this the fact that the Europoean Central Bank is finally close to beginning its own quantitative easing program, which will keep rates down on that side of the pond. This combination is a recipe for the sort of change you see in the graph above.
The relative strength of the U.S. economy, weakness of the E.U.with its potential “triple dip” recession and uncertainty regarding China and oil prices all contribute to the economic environment that has helped fuel the dollar’s recent rise. Where is money going to go in a risky world? Can you say USA? A lot of us have been impatiently waiting for the dollar to move higher for a couple of years. Now that it has happened, what should we expect?
What are the textbook effects of a rising dollar?
The classic textbook effect of a rising currency is that imports increase because they are relatively cheaper and exports decline because they are costlier to those holding foreign currencies. Imports up, exports down. That’s where the Econ 101 story often stops, but the situation is a little more complicated.
Prices adjust faster than quantities in most cases. Price effects (rising export costs, falling import prices) tend to happen quickly, but quantities take longer to change because of inventory lags, recognition lags, and contract lags. Basically, it takes time before the new exchange rate translates into real actions because existing inventories must be depleted before new orders are made, because it takes some time before economic actors feel certain that the change is sustained and not just a market blip, and because existing contracts often preclude immediate adjustments.
These lags create what economists call the “J curve” effect, with opposite short-term and long-term payments impacts. The Econ 101 results take longer to show up in significant amounts than you might think and even then will only appear if other intervening economic factors don’t offset them. So predicting the short term impact of an exchange rate change isn’t as simple as you might think even if you earned an “A” in Econ 101.
But price is a powerful force, and the fact that a rising dollar makes our exports more expensive to foreign purchasers (and imports cheaper for U.S. buyers) should not be ignored even if immediate run impacts are not obvious. Don’t expect everything to change at once.
One more complication is that although we like to talk about the dollar rising or falling, the overall trend conceals the fact that the dollar might be higher relative to one currency and still falling compared to another. During one recent period when the dollar was quite weak by some standards, for example, it still rose compared to some other currencies that were even weaker.
How and why is the impact on the U.S. wine markets likely to be different?
Given all this, it is instructive to read a 2012 report by Kym Anderson and Glyn Wittwer titled “Studying the impact of exchange rate movements on the world’s wine markets, 2007-2011” (a University of Adelaide Wine Economics Research Centre working paper — the link takes you to a pdf of the paper). The Anderson-Wittwer study examined the impact of exchange rates on wine trade during a period when the dollar was falling instead of rising and finds that the impact of exchange rates was different in different import markets and in different wine market segments. (I told you it was complicated!)
In the U.K. market, for example, the exchange rate impacts were pretty much what theory suggested both in terms of import effects and distribution among different wine exporting countries. A good textbook case.
But the U.S. was a different story, as you might expect given that we have a substantial domestic wine production base and that we both export and import wine with the two trade flows connected to a certain degree by the “wine drawback program” (Click here to read a 2012 UC/Davis report on the drawback program.)
The wine drawback program allows a refund of 99% of import duties and excise taxes on wine for which the importer has matching exports of commercially “interchangeable” wine. Because per-unit import duty and excise tax rates are substantial compared to the price of bulk wine, use of the program is high for bulk wine imports, which compete with wine from low-price Central Valley grapes. Bulk wine exports dominated imports until 2009 and the program stimulated import growth. Now, with imports and exports roughly in balance, the program stimulates both exports and imports—leaving net trade in bulk wine roughly in balance.
– Summary of the U.C. Davis Report
The Anderson-Wittwer study found that the falling dollar had different effects on U.S. consumption of Old World and New World wine imports during 2007-2011. Old World imports increased despite the dollar’s fall and New World imports fell. Obviously the price effects were more strongly felt for New World wines than for Old World products (see Table 6 of the report) and although Australia accounted for much of the import decline and may be a special case in some ways, Argentina, Chile and South Africa were also negatively affected.
The study found differences by price category, too. Non-premium and commercial premium New World wines were the most affected by the exchange rate changes while super-premium wines showed less impact. This makes sense because the lower priced products are often part of the bulk wine trade, which has become highly efficient, facilitating ease of substitution from one country’s products to another. A small change in cost can have a big impact on the size and direction of trade. Textbook effects rule here.
More expensive products benefit from greater product differentiation. The power of an established brand acts as a shock absorber when costs increase, although there are obvious limits to this.
So if Old World imports increased and New World imports fell during the period when the dollar was slumping, can we expect just the reverse now that the dollar is soaring? It would be great if we could just take the Anderson-Wittwer numbers and change the signs from plus to minus and so forth, but life is more complicated than that. Anyone who has tried to sell wine can tell you that it is easier to lower a price than to increase it! It’s a kind of hysteresis in the sense that where you can go now depends on where you have been. You can’t just back out to where you started.
That said I think there are important insights to take away here, key among them is the idea that the impacts are likely to be different for bulk wine and packaged good trade and for Old and New World products.
Textbooks and research give us good guides to understanding the impacts, but there aren’t any simple answers. And the exchange rate isn’t the only thing that’s changing this time around. I know a number of New World producers who made big bets on the Russian market, for example. Seemed like a good idea at the time, but my how things have changed! They’ll be desperately looking for markets for the wine they can’t sell to Moscow. And imports from Argentina may be more affected by that country’s domestic policies (and the upcoming elections) than exchange rates.
It occurs to me that this column is a classic example of what Paul Krugman once called “up and down economics.” This goes up, that goes down, and so on. Made me think of the Winslow Homer painting “Right and Left” that you can see in the National Gallery in Washington D.C.