As recent Wine Economist columns have reported, it’s very clear now that the world economy has fallen into a recession, with some countries and regions affected more than others. The depth of recession is hard to gauge. A few weeks ago I thought that things would be very bad here in the United States, with as many as 5 million unemployed. But by late last week almost 10 million had applied for unemployment benefits in just two weeks and the shoes are still falling. Incredible. What will things look like two weeks from now?
Silver lining predictions based on the current wine sales surge aside, it is pretty clear that the wine industry will be negatively impacted by the slowdown in spending. How much depends in part on what “shape” the recession takes, which is to say what factors dominate the decline and how long it takes to recover.
Recessions are like stomachs — they come in lots of different shapes (see the classic 1960s Alka-Seltzer tv commercial above for humorous examples). Will it be a V-shaped recession? Or will we be dealing with a W, U, or maybe an L? The shape matters for the global economy and for the wine economy, too. Herewith a brief survey of the economic landscape.
Best Case Scenario: The Deep V
Initial projections (and many current ones, too) forecast a deep V-shaped recession. The economy will shrink rapidly for two quarters and then rebound just as quickly, so that by this time next year we will be safely back to square one. The logic behind this is simple — everyone goes home to hide out from the coronavirus and, when the danger is passed, the Reset button is pressed everyone goes back to their old jobs and habits.
This scenario makes sense if you think of the coronavirus crisis as just an exaggerated version of the annual seasonal flu season with minimal permanent impacts. But not many hold that view any more from a medical standpoint and there are big doubts about it in terms of the economy. Not all the businesses that shut down as we entered the crisis will be coming back, even with historic levels of economic stimulus.
Consumers will find it hard to recover, too. A 2019 Federal Reserve survey found that about 40% of American households did not have the ready cash or credit to weather an unexpected $400 economic emergency. Those 10 million (and growing) unemployed workers are facing a lot more than $400 worth of problems. The crisis will badly undermine the foundations of their economic security.
But a deep V is not out of the question if the massive bazooka blasts of government aid and helicopter drops of interest-free money are effective. If they work and work fast, then the Reset button will engage a speedy recover. I hope that’s what happens.
I’m worried that the problems are deeper and that you can hit the Reset button until you are blue in the face, but the economy won’t spring back so quickly. If I am right, it is bad news for the wine trade, which might have hoped that consumers would stock up on wine now, drink it all up while sheltering in place, and come back for more in the fall.
Double Dip W
A second fairly optimistic theory currently making the rounds is that the economy rebounds as described above, but then a second coronavirus pandemic wave appears in the fall or early next year. The necessarily closures and quarantines would trigger a second recession, but it would be smaller and shorter because the world would be better prepared.
I don’t have a strong opinion about the double dip recession scenario except to note that (1) there is no reason to think that the current pandemic will be the last we will see and (2) I sure hope we learn from our mistakes this time around.
The double dip W complicates things for wine because it makes it even harder to predict when a sustained economic recover would power higher wine sales. Instability and uncertainty — is this the new normal?
The Classic U-Shaped Recession
The U-shaped scenario is a third possibility. The U-shape recession is longer in duration but less deep than the V or the W. Full recover might take 3 to 5 years, not a few months. This is the classic recession shape and it sometimes works this way. Demand falls for any number of reasons, so that inventory builds up and production slows down and unemployment rises (which further depresses demand). Excess inventories are eventually drawn down and new orders placed, which stimulates production creates incomes and jobs, and encourages a rebound in demand.
The U shape would be a problem for wine because several years of depressed demand would exacerbate the structural wine surpluses that plague the industry both in the U.S. and in many other wine-producing countries. Supply-side vineyard adjustments, which are already recommended in order to reduce capacity, would be critical.
There is reason to doubt the U-shape scenario, however. First, the coronavirus recession is more than just falling demand, so a demand-based theory doesn’t seem to fit all that well. And, second, it would seem like the bazookas and helicopters would shorten the cycle if this scenario holds, so the U would become a V. That’s a bit of good news, which I supply at this point because things are about to get very dark.
L is for Liquidity Trap
The worst case scenario, from a strictly economic standpoint would be an L-shaped recovery. The global economy plunges and then … does not recover for a very long time. An extended recession is of course very bad for the wine industry as it would undercut the economic foundations of wine buyers of all generations.
There are a couple of realistic scenarios that could lead to such an outcome.
The first is a financial crisis. The coronavirus recession may have started with health issues, but there is a high probability that a financial crisis will follow. Not necessarily a banking crisis this time, because banks are better capitalized than a decade ago, although banks and non-bank lenders are still vulnerable The worry focuses on weakness in and liquidity of corporate junk bond debt and emerging market debt and the contagion that collapses in these markets can cause. You might add state and local debt problems to the mix if the crisis persists for more than a year.
We have already seen several instances of financial markets freezing up, or nearly so, in a panic for liquidity. This could create the conditions for a liquidity trap, which is a situation where financial actors are so concerned about liquidity that they soak up any new funds that are injected into the financial system, not spending, investing, or lending. Monetary policy, even maybe helicopter money, is impotent because the new funds just disappear into reserves with no real economy impact.
You can call the second scenario the Zombie Economy and it goes like this. Many firms collapse during the coronavirus crisis, but are kept alive — just barely — by aggressive government support. They don’t die, but they aren’t really alive enough to actually recover either. They continue on for years soaking up trillions of dollars of (debt-financed) resources and preventing an economic shake-out that would free up resources for self-sustained growth.
Is the Zombie L-curve possible? It seems hard to believe … until you call it by its other name: post-bubble Japan.
What’s going to happen? What will the recession look like? I really don’t know, but I hope that the coronavirus health crisis and the economic dislocation it causes are both milder than seems likely at this point and that we return to health quickly. Fingers crossed that the massive economic stimulus that is being unleashed around the world is effective.
In Sydney our stock of wine should see us through the social distancing. Thinking about the economic outlook is a great diversion, so thanks for bravely putting your views!
It seems most richer countries will release huge fiscal relief for incomes and consumption but will not boost output as much. Then attention may turn to the sharp rise in public debts, putting a brake on what may be a tepid recovery. After that would come the real dilemma for governments: tighten taxpayers belts or opt for rising inflation as the way out of trouble. So a mix of Vs, Ws and Ls.
The situation in developing countries seems likely to be dire.
Excellent summary. Thanks.
Interestingly, I am getting offers from of my favorite producers for 35 percent off, greater than the 30 percent off I received as an industry participant. I wonder if this is driving the wine demand? Could such deep discounting now help lead to a, gulp, L recovery?
Happy Birthday, Karl! I am getting those offers, too. One highly allocated producer said clearly that they needed to replace restaurant sales with additional DtC sales. So selling to consumers at wholesale prices does that. Big worry for producers: when restaurants start to dump their existing stocks of wine at low prices.
I find it curious that you refer to the various scenarios as “recessions” and avoid the most descriptive word about what’s happening, which is “depression.” Historically speaking I think none of the letter-shaped theories apply to this one at all. The rules of economics that applied before not only don’t apply anymore, they’ve been shattered. 10 million unemployed in a few weeks? Nothing even remotely like that has ever happened since our industrial economy has been developed. Our systems aren’t built for this, and they will change fundamentally.
As a tiny producer, we are seeing a slight uptick in online sales, as a result of additional email and social media campaigns. We’re doing virtual tastings, “bringing the tasting room to you” webinars that create sales. We kept our costs low for the recent past, have adequate inventories, and now can manage sales and deliveries from our home vineyard. We’ve led with some minor discounts but haven’t seen our customers asking for bargain basement prices. Of course on-premise distribution wholesale is down to zero, though talking to restaurants, they mostly envision a roaring-back clientele, good for all of us. These times feel more like adapting to a new condition of our economy and that recovery may be an improvement on old practices.
“Big worry for producers: when restaurants start to dump their existing stocks of wine at low prices.”
Most restaurants are “just-in-time delivery system” purchasers: acquiring what is currently in the distributors’ portfolios . . . principally current releases likewise available in retail stores.
Restaurants historically had no need to carry more than one case of any wine at a time. (That minimized the “carrying cost” of their inventory. An important consideration for a low profit margin business.)
After gauging depletions over the weekend, a restaurant could place a replenishment order on Tuesday with its local distributor, and be assured of receiving more wine before the next weekend.
A fine dining restaurant prices its wines using a formula of 2.5 or 3 times wholesale unit cost.
By contrast, a fine wine store prices its wines using a formula of 1.5 times wholesale unit cost.
Let’s say that wine is a Napa Valley Cabernet Sauvignon.
In a retail store, a $65 wholesale unit cost wine sells for about $100.
By contrast, a $65 wholesale unit cost wine sells about $163 (2.5 times) or $195 (3 times).
A restaurant can’t compete on price with a wine store, should they need to “deaccession” their inventory by establishing a “take-out” business to complement its meal delivery service.
The restaurant would have to discount its wines by 40% (2.5 times) or 50% (3 times) to be price competitive with a wine store.
The “just-in-time delivery” restaurant minimizing its “carrying cost” of inventory might have only a single case — or a fractional case — of any specific wine on premises. With no incentive to reorder that wine for its newly established “take-out” business.
By contrast, a wine store might have multiple cases of the matching wine on premises. With every intention of reordering more cases it as it depletes.
Finally, how many wine enthusiasts “staying at home” during a lockdown are going to drive across town — or across multiple towns — to their favorite restaurant, order take-out food and wine, and then drive home? Their food would be cold by the end of that round trip, and the wine would be overpriced vis-à-vis a comparable wine store purchase.
I have queried many restaurateur friends in the greater Los Angeles area, and almost no one is selling wine on take-out (despite the new easing of restrictions by California’s Alcohol Beverage Control agency).
My friends’ restaurants are closed. Their sommelier / beverage program staff is furloughed. With no projection on when — or “IF” — they reopen.
Take-out food and wine is no panacea for restaurants these daze.
~~ Bob Henry