Wine, Stagflation, and the Strong Dollar Syndrome

The U.S. dollar has surged in value on foreign exchange markets in the last year and especially the last few weeks, as this graph of the dollar versus the euro makes clear. It once took about $1.30 to purchase a euro, but some analysts believe that USD-EUR parity — a dollar per euro — is on the cards for later this year.

The story differs country-by-country, but the overall trend is clear. Just as in the 1980s, when the Federal Reserve tightened monetary policy to fight inflation, the dollar has soared on foreign exchange markets. Exchange rate movements are not generally either good or bad, they create winners and losers like any other change in price. But a sustained spike in the U.S. dollar can be a global problem. The strong dollar of the early 1980s created a global crisis that came to an end through the Plaza Accord, an international agreement to re-align exchange rates.

I don’t think the strong dollar syndrome will go away soon because, as I explain below, it is very useful to U.S. policymakers just now. It is too soon to know how this strong dollar episode will end, but not too soon to think about the implications in light of the 1980s experience, with special emphasis on the wine industry. Herewith three factors to consider.

Trade, the Dollar, and Wine

The conventional wisdom is that a strong currency encourages a country to import and discourages exports because each dollar (in this case) buys more foreign currency, and it takes more euro (for example) to buy a dollar. So it would seem like the super-strong dollar, by encouraging imports and discouraging exports,  would be counter-productive if you are interested in jump-starting growth. But there are other factors to consider (see next point below) and these are unusual circumstances.

International trade is all fouled up with logistics costs and bottlenecks, for one thing, and the pattern of trade in many commodities is distorted by covid closures in China and commodity trading shifts due to the Russia-Ukraine war. In other words, a strong dollar may have less impact on trade today than in other situations.

This is true in the wine trade as well. The strong dollar may push wine import prices down, but logistics issues and the impact of some protectionism policies pushes in the other direct. The exchange rate still matters a lot in the international wine trade, but other factors are more important right now. The dollar’s impact will be felt, however, if the strong dollar can be sustained (as it was in the 1980s).

Inflation, the Dollar, and Wine

The reason why the strong dollar is suddenly a stealth national economic policy is inflation. By making imports cheaper, a strong dollar puts a limit on the ability of domestic firms to raise prices. It is harder to raise the price for generic California wine if the price of imports is stable or declining. This is one factor (not the only one) that has kept U.S. wine prices from rising along with the overall inflation rate.

The strong dollar also makes imported production inputs cheaper for U.S. firms, a significant advantage in the global product chain.

For the Federal Reserve, a strong dollar means that they can be less aggressive in their domestic contractionary policies designed to squeeze inflation out of the economy. The dollar, by putting a limit on price increases through foreign competition, will do some of the dirty work for them.

Unintended Consequences

But not everyone will be happy with this situation. Our trading partners will be justified in their belief that the U.S. is exporting some of its inflation to them though higher prices for imports from the U.S. and other commodities that are priced in dollars rather than local currency. Their domestic firms will find it easier rather than harder to raise prices with the cost of imports rising, too.

There are also international debt issues to consider since many countries borrow (and must repay) in dollars. An increase in the dollar’s value can have more impact on debt servicing costs than a rise in interest rates, for example.

As a result of these unintended consequences there is now talk of a sort of inverted currency war. Usually currencies wars take the form of competitive devaluations, as everyone tries to have the cheapest currency to encourage exports.

Now, however, several factors but especially inflation is causing policy-makers to re-think this strategy and consider a sort of arms race to increase currency values. The instability that results from such a situation can be serious and lead to conflict, which is what produced the Plaza Accord in 1985.

And in the Long Run …

So the direct effects of the strong dollar syndrome are worth your consideration, but the indirect effects — the inflation lid, the international currency war, a potential debt crisis, etc. — are perhaps even more important.

In the long run, however, the impact on the U.S. wine industry is likely to be more severe both through the direct effects on input and domestic labor cost factors and through the classic Econ 101 impacts once the logistics issues have time to settle out.

But there is one more long term factor to take into account. As the Plaza Accord demonstrated, a very strong dollar is not sustainable from a global financial standpoint. When the market turns it is likely to be sudden. A soft landing can change abruptly. Buckle up.

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