Last week I wrote about the strong U.S. dollar and its impact on U.S. wine imports. My conclusion was that there was an exchange rate effect, but it was less than you might otherwise expect because of specific factors that are at work in the sparkling, bulk, and bottle wine import markets today.
This week we turn to U.S. wine exports. Econ 101 tells us that a strong currency discourages exports by increasing their cost to foreign buyers and this is an important factor. Thus, for example, we would expect U.S. wine exports to Canada to have fallen over the last year.
The U.S. dollar has appreciated dramatically against Canadian dollar (or “Loonie,” as they call it) over the past two years. After coming close to parity in 2014 the Canadian dollar nose-dived and it now takes in the neighborhood of C$1.45 to purchase one U.S. dollar.
After weathering the global financial crisis better than most countries, Canada has fallen victim to its dependence on natural resource exports, especially oil exports. As the price of oil has fallen the foreign exchange value of the Canadian dollar has plunged, which raises the cost of imports for Canadian buyers. They are feeling the pain.
How bad is it? The New York Times reported that the combination of drought in California, which raised agricultural goods prices, and the falling Loonie has resulted in soaring imported fruit and vegetable prices. How high? Eight dollars for a head of cauliflower! Yikes!
Canada is largest single market for U.S. bottled wine exports so you would expect this situation to depress wine sales to Canada and to have a similar but perhaps smaller effect in other countries where the exchange rate shift has not been as extreme. Has it happened? Let’s look at the data.
Here are wine export data for the first three quarters of 2015 as as provided by Wine by Numbers, a publication of the Unioni Italiani Vini (click on the chart to enlarge). These data show that U.S. wine exports actually increased in the time period covered here rather than decreasing as theory predicts. The story varies from country to country (as it did with imports), but the overall trend is to higher exports — exactly opposite of the textbook prediction. What gives?
A first answer is that perhaps it takes more time than has passed so far for the higher exchange rate value to pass through to higher import prices, higher wholesale prices, higher retail prices and then for the quantity effects (lower depletions, lower reorders etc) to funnel back. International finance theory has a whole chapter on how these lags can create distortions. There is something to this lag theory, but I think there is more going on.
A second factor, especially on higher value bottled wines, is branding strategy. Rather than raise price and lose market share, it is possible that some big players are absorbing lower margins to keep on the shelves and in the game abroad. How long can they do this? Some Argentinean wineries have been doing it for three or four years so far here in the U.S. It’s expensive, but could be worthwhile if things turnaround before too long.
A third factor, which applies especially to the bulk wine market, is that U.S. tanks are full of these wines with no indication that domestic consumer demand for them will pick up soon. Better to sell them off abroad as bulk exports than dump them out when they are too old and tired to find buyers.
A final piece of the puzzle is the duty drawback program, which I wrote about last year. This is a very peculiar U.S. government program that under some circumstances will refund import duties for a winery if it exports a similar U.S. wine abroad. Sometimes this makes it seem like exports subsidize imports and, as now, it might be true that imports provide rebated duty funds that can subsidize exports. To be honest, I am not really sure of the net effect except to say that there is an incentive for large integrated wine companies to balance imports and exports.
As we saw last week, while bulk wine imports have not surged due to the exchange rate effects, they have remained significant. This fact means that, for certain companies (especially larger wineries) importing and exporting the right wines to and from the right places, duty drawbacks can be significant.
Looking back over these two columns, the first conclusion is that so far in this cycle the pure foreign exchange effects have largely been offset by specific forces in different sectors of the wine business and in different countries. Exchange rates matter, but they are just one of many forces at work. Since those forces are likely to be different in the future, it is important to be cautious in projecting these trends ahead too far.
I used to warn my students against trying to forecast foreign exchange rates. Too many variables. Too many unknowns. Exchange rates are the most difficult thing in economics to predict, I would tell them. But now I know that I was wrong. Wine trade may be more difficult because it is affected by all the forces that hit the exchange rate and a whole lot more.
I encourage readers to drill down in the data provided here because there are a lot of individual country stories to be examined along with the big picture analysis I have provided here.