Category Archives: Economic impact

Wine and the Falling Dollar

August 29, 2023 By in Economic impact, exchange rates, globalization, wine, wine markets Leave a comment

There are good reasons why it has been a while since I last wrote about wine and the dollar’s foreign exchange value. A lot of things have shaken up the pattern of wine sales here in the U.S. market, especially the channel-shifting that occurred during the covid pandemic and uneven return to what we laughingly call “normal.”

Many factors shaped the pattern of international wine imports and exports, too, especially supply chain bottlenecks that saw the cost of container shipments zoom up by a factor of ten (when you could find a container) and have now settled back down to roughly pre-pandemic levels.

Falling Dollar, Bouncing Dollar

The exchange rate has been a factor in the wine market through all of this, but it wasn’t really the important factor in most cases. The dust has settled enough now, however, that we need to think about the dollar’s value once again.

Although the situation can vary from currency to currency, the overall trend for the U.S. dollar in the last year has been down (see the graph above of the USD versus the EUR). The dollar fell sharply through the end of January and has bounced up and down a bit but has been in a downward trend since then.

A cheaper dollar makes imports more expensive since each greenback buys fewer units of foreign exchange. U.S. exports benefit because a cheaper USD means a lower cost to foreign buyers. It takes a while for the impact of an exchange rate change to be felt, but if the change is sustained, the impacts eventually come around.

Falling Dollar in Perspective

What should we make of the recent dollar decline? One good source of analysis is the Economist magazine’s “Big Mac Index” of currency values. The clever folks at the Economist have found that comparing the local currency costs of Big Mac sandwiches in different countries can provide insights into exchange rate conditions. Some currencies are “overvalued,” which means that they buy more Big Macs (and other stuff) abroad than they do at home. Market forces should push these currencies down in relative value over time.

That, more or less, is the story of the dollar in the last year. The dollar’s relatively high value encouraged some Americans to travel abroad and those who stayed home to buy lots of imports because the dollar’s strength made foreign things seem cheap. Inevitably, as they sold dollars and bought foreign currencies, the dollar fell in value relative to those currencies.

The dollar’s fall is a bit surprising because U.S. interest rates have been rising steadily this year and that usually creates an incentive for foreign investors to buy up dollars, offsetting the trade effects. But many other countries have boosted their interest rates, too, so the investment impact is less than you might expect. Perhaps the combination of the downward overall trend plus the periodic interest rate increases account for some of the trampoline bounce shown in the graph at the top of the page.

Where does the dollar stand today? As of August 3, when the Economist report went to press, the dollar was about four percent undervalued compared to the Euro, so it is not unreasonable to expect a bit of a bounce. It was seven percent undervalued relative to the Argentina peso, but I suppose that is using the semi-fictional official exchange rate. There is a special cheaper ARS rate for wine designed to encourage exports and of course, the black market rate is even lower.

Incredibly, the official ARS-USD exchange rate, which was approaching 300 pesos per dollar when the Economist report went to press, is now hovering around 350 peros per dollar after a sharp devaluation in response to destabilizing election results. (The exchange rate on the street is nearly twice as many pesos per dollar as the official number.) The graph below shows how quickly conditions have deteriorated for Argentina’s currency.

Over and Under

If the exchange rate isn’t a big factor in U.S. wine trade with Europe (but probably is a factor encouraging imports from Argentina because of the special exchange rate), then what about the rest of the world? The Economist study suggests that Southern Hemisphere wine producers have an exchange rate advantage when exporting to the U.S. market because their currencies are undervalued.

The New Zealand dollar, for example, is undervalued compared to the USD by 9.7 percent. This makes their popular wines even more competitive in the Sauvignon Blanc category, which is one of the few parts of the wine market that has experienced growth recently. The Australian dollar is undervalued by ten percent.

Undervaluation is the flip side of overvaluation. The currency is relatively cheap on the foreign exhange market, so foreign buyers get a good deal, but imported goods and services are more expensive. Both sides of the coin involve trade-offs. You get cheaper imkports if your currency is overvalued, but better export performance if it is undervalued.

Chile’s currency is undervalued by 16.7 percent in the Economist study, with the number for the South African rand an incredible 49.7 percent. Such large currency distortions are potentially very important in parts of the wine market where cost differences are critical.

Export Market Impacts

The analysis above has focused on how the exchange rate affects U.S. imports of wine, but it is important to note that American wine producers also compete with foreign producers (who also compete with each other) for exports to other countries, especially the Eurozone and Great Britain. The value of major southern hemisphere currencies is so low, if the Economist analysis is correct, that the dollar needs to fall a good deal more to make American wines competitive abroad. That’s not likely to happen.

What does the future hold? In the long run, over-valued currencies should fall in value and under-valued ones rise. But lots can happen long before the long run arrives, so don’t hold your breath. I will check in again on this topic when the next Economist report is released.

Too Much of a Good Thing: Washington’s Wine Woes in Perspective

August 22, 2023 By in Economic impact, Washington wine, wine, wine markets 12 Comments

It has been a little more than a month since executives from Ste Michelle Wine Estates (SMWE) told their Washington winegrowers the bad news. Having already trimmed grape purchases over the past several years, they now planned to cut grape contracts by 40 percent over the next three years, starting with this fall’s harvest. SMWE is by far the largest wine producer in Washington and many of the vineyards that have come into production in the past ten years were planted with sales to “the Chateau” clearly in mind.

The announcement was big news. The wine press here in the U.S. and around the world has covered this situation very well. I am not a SMWE insider, so I don’t have breaking news to report here, but as someone who studies the U.S. and global wine markets (and as a personal consumer of Washington wine products), I want to contribute some perspective to the situation, which I hope Wine Economist readers will find useful.

Washington’s Problem By the Numbers

Washington has about 60,000 acres of producing vineyards today, a number that has grown rapidly in the last decade. SMWE is such a dominant producer in the state that their 40 percent cut in grape purchases will make about 10,000 vineyard acres redundant. Growers are advised to look at the situation strategically and to identify diseased and unproductive vineyards for vine removal. Demand and supply are out of balance. Thoughtfully reducing supply is a necessary short-term action.

This is not only sensible advice, it is also the advice that I hear nearly everywhere in the wine world these days.  Jeff Bitter, the President of Allied Grape Growers in California, has been telling our State of the Industry audience at the Unified Wine & Grape Symposium this very thing for several years. It isn’t just that Washington has too many grapes, it is a California and global problem, too. I know of a few regions around the world where grapes are in short supply, but the list isn’t very long.

So the Washington situation isn’t unique, but its impact gets attention because of SMWE’s size relative to the Washington industry. Where other regions have suffered from grape cuts by dozens or even hundreds of smaller producers, the spotlight is focused clearly on Washington’s big producer. The big cut makes the news more clearly than many smaller cuts even if the net effect may be much the same.

That said, the proportion of vineyards that will be directly affected by cuts in Washington is higher than in California. This is partly the case because Washington was planting new vineyards while many growers in California were pulling them out. That explains a lot of the problem but not all of it.

The Curse of the Signature Wine

The success of Sauvignon Blanc from New Zealand and Malbec from Argentina has made many people believers in the “Signature Wine” phenomenon. You need to have one signature wine to define a wine-growing region, the story goes. I have always seen Signature Wine as both a blessing and a curse. It is a blessing because it makes a region easier to understand and to sell. But it is a curse because, in my experience, the monolithic identity makes it harder to sell other wines from the region.  I have had some great Syrah and Riesling from New Zealand, for example, but these wines don’t get much love because everyone is thinking Sauvignon, Sauvignon, Sauvignon.

Ditto for Argentina, where the Syrah, Cabernet Franc, and Pinot Noir can be wonderful and the Semillion will surprise you. But the market chant is Malbec, Malbec, Malbec. Listen. You can hear it now! And that’s despite the fact that some winemakers think their Cabernet Sauvignon is a better wine.

Students of economics may recognize this as a sort of cockeyed variation on the foreign exchange theory of the “Dutch Disease,” where great success in one industry can backfire in terms of its negative impact on other industries.

I saw the Signature Wine blessing in person when we visited New York City a few years ago. A tour of notable wine shops found lots and lots of wines from Oregon and very few from Washington. Why? Customers who came looking for Oregon wines wanted one thing: Pinot Noir. So the shops made sure to have a large selection. But Washington wine isn’t dominated by one grape variety. There are lots of great wines, but no defining grape variety theme. And so no clear guidelines as to what consumers might expect.

Washington’s Signature Price Point

Actually, that last statement is not quite correct, and maybe this is the important point. Whereas Oregon is Pinot Noir (and Napa is Cabernet Sauvignon), Washington’s Signature Wine isn’t defined by a grape variety so much as a price point. I don’t think it was intentional. Washington has always made lots of different wines from lots of different grape varieties at lots of different price points. But SMWE, the state’s dominant producer, and some other volume producers, too, eventually discovered success by producing large quantities of wines in the $9 to $11 price range at a time when that was the sweet spot of the market. Bulls-eye!

SMWE has many wine brands from Washington state, how did it (and the state) end up being stereotyped to one spot on the wine wall? It is too big a question to be analyzed here. I admit that as a consumer, I sometimes struggled to figure out the relationship between big-volume brands like Chateau Ste. Michelle, Columbia Crest, and 14 Hands. It seems like the power of market growth in that critical price range was like the firm pull of gravity. Hard to resist. But I am sure there was more to it than that.

As premiumization has driven the market sweet spot higher, SMWE’s advantage has melted away enough to create a crisis. That signature price point is still important, but it can’t absorb all the grapes that were planted in anticipation of its continued growth.

Realignment is necessary, but it won’t be as simple as raising price or creating new brands (or designing new labels as I have seen on store shelves). That signature thing will be harder to reset because it is easy to change how you represent your brand, but hard to control how others will perceive it (a variation on a Machiavelli lesson).

Washington is now in a new era, where identity will come from the bottom up through the work of the many successful small- and medium-sized wine producers. It is a big challenge, but the quality is there and so is the determination.

A California Thought Experiment

Here is a little thought experiment that might put the Washington situation in context. What would it mean if California’s largest wine business, Gallo, were to cut grape purchases by 40 percent the way the SMWE did in Washington? I put this question to Natalie Collins, President of the California Association of Wine Grape Growers, and Jeff Bitter, President of Allied Grape Growers. Here is my analysis (all errors are mine, not theirs) based on our conversations.

Gallo buys about one-quarter of California’s wine grapes (a much smaller proportion than SMWE in Washington, although that could be where things end up). That would amount to about 1 million tons of wine grapes in a fairly typical 4 million ton year. A 40 percent cut would mean 400,000 fewer tons of grapes and so, figuring maybe 12 tons per acre, that’s more or less 35 thousand acres of surplus vineyards. If all those vineyards stayed in production, that would be a huge surplus of grapes that would drag down grape prices in some market segments.

The hypothetical Gallo cuts wouldn’t impact all parts of the wine grape market equally, of course. Given recent market trends you might expect vineyards in the interior to be disproportionately affected, although high-quality grapes might find a home in some California blends, replacing more expensive grapes from other regions as the cost squeeze continues to bite.

Bottom line for this thought experiment: a 40 percent cut by the state’s biggest wine grape buyer would have a greater absolute impact in California, as you would expect, but SMWE’s cuts are a larger relative problem in Washington

Something to Think About

Do I expect Gallo to cut grape purchases by 40 percent? No. This is just a hypothetical exercise to stimulate thought.

But Gallo’s huge portfolio is subject to the same general market forces as other producers, so some quantity adjustments are necessary. And Gallo might even become a seller of wine grapes in some market segments if they can’t find a use for all the grapes on the 20,000 acres of vineyards that they control.

Gallo selling grapes? Now that’s really something to think about.

Wine and the Curse of the Inverted Yield Curve

August 8, 2023 By in economic crisis, Economic impact, wine, wine markets 3 Comments

These are uncertain times for the global and U.S. economies and for the wine industry’s economy, too. The International Monetary Fund recently released its World Economic Outlook mid-year update and the story it tells can be as optimistic or pessimistic as you want it to be.

Landings: Soft, Hard, Trampoline

The “glass half full” story is that, for the world economy as a whole, inflation seems to be slowing and global growth is slowing, too. But nothing is crashing … yet. That makes the possibility of a “soft landing” scenario seem more likely than it did just a few months ago. Maybe the slowing economies will moderate rising prices without the need for a sharp, job-destroying recession. And perhaps key central banks will be able to halt interest rate increases before they go too far.

A “soft landing” is far from certain, but it might be possible. That’s good news for a dismal scientist like me because one alternative is the “hard landing” scenario, where jobless numbers zoom to bring inflation down (or the “trampoline landing” possibility, where anti-inflation nerves fail and prices jump pop back up again).

Down the Up Yield Curve

These same issues apply here in the United States, where economic growth seems to be holding up better than in some other regions. But concern is especially heightened by a phenomenon called the “inverted yield curve.” A yield curve plots government bond yields from short-term (30 days) to long-term (30 years). The curve normally slopes upwards as in the chart above from 2021, which makes sense since long-term investors should receive higher returns for taking on the risk associated with longer-maturity assets. You can better guess what economic conditions will be like in 30 days than in 30 years, so the 30-year return should be higher.

A lot of attention is paid to the yield curve among investors. The New York Times and the Wall Street Journal publish yield curve charts daily. And Japan’s central bank actually makes yield curve management one of its policy targets.

In this context, an inverted yield curve, where bond yields are lower for longer-term assets as in the recent chart above, is a puzzle and an alarm. It is a puzzle because it is not clear why investors would be willing to lend longer-term for less. Do they think that inflation, which is relatively high today, is likely to be much lower in the future and so the inflation premium necessary to compensate for price hikes would be lower than today?

What? Me Worry?

Or is it because they expect today’s high-interest rates to push the economy into a recession? Falling incomes tend to drive interest rates down because loan demand is less. And a deepening recession would likely force the Federal Reserve to push interest rates back down. Down to the level, the yield curve seems to predict? That’s something to worry about.

And investors are worried because the inverted yield curve has a very strong record of predicting recessions. The economy doesn’t tank immediately, but eventually. Growth turns negative a year or so after the curve inverts and recession alarms go off.

This Time is Different?

So it has been about a year since the yield curve turned topsy-turvy and it is no wonder that investors are getting nervous. Will the curse of the inverted yield curve take hold later this year or perhaps in the first quarter of 2024? Some so believe in the yield curve’s track record that they are positive that bad news is in the offing.

It is dangerous to argue “this time is different” in the face of a theory that has both logic and history on its side, but maybe this time is really different, and that soft landing will happen. After all, how many times in the past have the conditions that led up to the yield curve flip included a global pandemic, supply chain breakdown, massive fiscal stimulus, and a very hot shooting war involving major powers?

So maybe the curse of the inverted yield curve won’t strike the U.S. economy in the near future. A recession is bound to happen eventually and some people will look back at today’s yield curve situation and see cause and effect, but there are just enough wild card shocks to the system in the past few years to make it plausible that the U.S. economy might “stick” its soft landing after all.

This Wine is Different?

That said, it makes sense to consider how a recession might impact the wine sector. After all, even if the U.S. economy avoids a recession, many of the other major global economic engines including Great Britain, the E.U., Japan, and China look vulnerable today.

If we exclude the short, sharp shock of the covid pandemic period, the last sustained recession was about 15 years ago during the global financial crisis. The weak economy affected the wine industry in many ways, but trading down (to lower prices) and trading over (to more casual wine brands) were part of the story. Would that happen again if a recession showed up now?

Yes, I suppose so, at least to a certain extent. But the wine market has changed in many ways since the last big slump. For example, U.S. wine sales growth was still pretty strong going into that crisis, whereas the market is already slack today and a recession could be more damaging.

Luxury Market Woes?

The trend towards premiumization has strengthened, too, which could affect trading down and trading over. The heart of the market has moved to higher price points that may well display different characteristics than before. And of course, wine sales seem even more dependent on a relatively small segment of the total market, so their particular reactions are very important.

The fact that growth in wine sales has become increasingly concentrated in the luxury part of the spectrum is troubling right now. Sales of luxury goods in general surged during the covid pandemic. Cash from government stimullus payments plus the money that wasn’t being spent on services financed a luxury spending spree. Recent financial reports suggest that tighter consumer budgets have brought a lot of this spending to a halt except at the very high end (think Birkin bags). Even Champagne is feeling the squeeze, I’m told.

The wine economy is experiencing lots of stress and uncertainty these days. It would be great if the inverted yield curve turned out to be a false alarm this time. Fingers crossed!

Unsustainable? Anatomy of California Vineyard Economics

April 18, 2023 By in economic crisis, Economic impact, wine, wine markets 9 Comments

The April 2023 “Vineyard Issue” of Wine Business Monthly features articles that address many different important winegrower issues. I find W. Blake Gray’s analysis of “Prices Don’t Pencil Out for Growers Who Saw Production Costs Double” particularly interesting because it deals with a problem that I wrote about earlier this year in a Wine Economist column titled “Margins? What Margins? The Big Squeeze in Winegrowing 2023.”

Red Ink Harvest

The Wine Economist column was provoked by a conversation with some California growers at this year’s Unified Wine & Grape Symposium and connected the dots linking their observations with Vinpro data presented a few weeks earlier for South Africa. Only 9 percent of South African winegrowers earn a sustainable return on their vineyard investment.  A little more than half break even or earn small nominal profits, but not enough to sustain continuing investment. And almost 40 percent reported losses. And the margin gap is getting wider.

My California grower friends said their situation was not much different from the South Africans and, indeed, this is a problem I have seen around the world, although not typically backed by the sort of data that Vinpro collects for the South African industry.

The two simple strategies to claw back margins are to reduce yields to try to raise quality and therefore price or to reduce unit cost by increasing yields. South African growers have found it difficult to raise prices enough to make the first strategy work, so many are focusing on higher yields. But it is not as simple as that, the California growers told me, because sometimes buyers won’t allow higher yields and, in any case, some older vineyards just aren’t set up to make high yields possible.

Losing in Lodi

W. Blake Gray’s article digs deeper into the California situation, specifically for District 11, the San Joaquin Valley North, which includes Lodi. He quotes Aaron Lange of Lange Twins Family Winery and Vineyards in Lodi, for example, who explains that average grape prices are lower now than they were 25 years ago (despite higher costs throughout the production chain). Lodi Cabernet Sauvignon, for example, sold for an average of $695 per ton in 2022 according to the UDSA grape crush report. It sold for an average of $794 in 1997. The figures for Chardonnay grapes are $627 in 2022 versus $774 in 1997. That, my friends, is a big squeeze.

Is it possible to increase yields enough to break out of the big squeeze? Gray provides data from a 2021 UC/Davis study of the District 11 situation that suggests that higher yields can sometimes, but not always, solve the problem. At a price of $650 per ton (which is close to the average current Chardonnay and Cabernet prices), for example, the Davis study calculates a $156 per acre profit at 12 tons per ace and a $780 per acre product at a yield of 13 tons, but losses at lower per-acre yields.

The situation is only a little different at a price of $750 per ton. Profits ($633 per acre) appear at a yield of 11 tons per acre, rising to $2080 at a yield of 13 tons. But yields below 11 tons per acre still generate red ink even with the higher price.

Lower prices make things much worse. At a price of $550 per ton, no level of yield between 7 tons and 13 tons generates a profit. It’s red ink all the way down.

Unsustainable Yields

These data and reports make me wonder if winegrape growing is economically sustainable for many producers in District 11 and similar regions and these doubts are heightened by Gray’s interview with Jeff Bitter, the President of Allied Grape Growers (and a grower himself). Bitter notes that the economics of winegrape growing have made it difficult or impossible to focus solely on grape production.

Why continue to farm grapes? Some farm winegrapes because it is what they want to do (a “lifestyle” choice), Bitter suggests at one point, or because the alternatives are unattractive. There are a lot of factors that define the situation, including market conditions in different regions (Central Valley, Central Coast, North Coast) and farm size. There is money to be made in winegrapes under the right circumstances, but there are plenty of losses, too, and it is easy to understand why generational transitiions among growers are often in doubt.

When we talk about sustainable winegrowing, we usually focus on the environmental impacts, but Gray’s article suggests that we need to take the issue of economic sustainably more seriously, too.

Thanks to Wine Business Monthly for all the great articles in this issue and to W. Blake Gray for his focused report on the vineyard margin problem and the economic issues facing growers generally.

Wine and the No-Recession Recession

August 9, 2022 By in economic crisis, Economic impact, wine, wine markets 2 Comments

Are we headed for a recession here in the United States? Or are we already there? What about the future — the second half of 2022 and 2023?

If you follow economic news reports you have encountered all sorts of answers to these questions. And you can be forgiven for being a little confused and maybe quite a lot frustrated that the answers to these important questions are not clearer.  Herewith a brief guide for the perplexed with implications for the wine sector.

The Recession Question

The “rule-of-thumb” definition of a recession is when there are two consecutive quarters of falling gross domestic product (GDP). The U.S. economy is in a recession now by this definition because GDP fell in both the first and second quarters of 2022 (second quarter data subject to revision). By this measure, many of the world’s most important economies are either in recession, too, or teetering on the brink.

The two-quarter rule is very useful, but it is not the final world. The National Bureau on Economic Research (NBER) more formally defines a recession in a way that stresses depth, diffusion, and duration:  a recession is a significant decline in economic activity that is spread across the economy and lasts more than a few months.

The NBER’s more nuanced definition is better than the two-quarter rule, but it has some downsides. How significant is significant, for example? And how widely spread need the decline be? There is also the problem, unavoidable with lagged economic indicators, that a recession can only be declared well after it has started and will probably be over before the conclusion is called.

So we might be in a recession now — one that started months ago in fact — or we might not. We will only know for sure later on — perhaps when the recession (if there is one) is already over. Argggh!

Up, Down, Twist

If you follow business and finance news you will find evidence to back up any hypothesis you may have about a recession. Prices in some sectors are rising quickly (have you bought a airline ticket recently?) and plunging steeply in other areas.

There are plenty of stories of firms with squeezed profits, declining sales, and employee lay-offs. But there are also stories about rising sales and profits and, of course, the labor market puzzle, where the number of unfilled positions is about twice the number of people who say they are looking for work (but apparently cannot find it).

Last week’s job report was unexpectedly strong — the unemployment rate is only 3.5% and total employment is back to the pre-pandemic level — suggesting that the U.S. is not currently in recession, despite what the GDP figures say. Ironically, some analysts speculate that this good jobs news actually increases the odds of bad news in the near future. The reasoning is that the Federal Reserve will be forced to raise interest rates even higher now in order to slow control demand-driven inflationary pressures.

What’s the story? Is the economy up or down? The correct answer (which applies to wine, too) is … yes. If you are looking for a generalized answer to the recession question you won’t find it. Maybe it is best to say that the economy is twisting. The devil is in the details here and the answer you get depends upon where you look and how.

The Price is Right?

There are several reasons for this complicated picture. One of them is that the economy — like the wine market — is never all one way or another. Like the climate, it is always running hotter in some areas and colder elsewhere.

But another, particular to this moment, is the fact of rapid inflation because an inflationary economy works by different rules. In an economic system with stable prices, consumers cut back purchases when employment falls or when there is fear of unemployment. In an inflationary economy, the pressure to cut back spending affects a much broader set of consumers who find their budget squeezed by rising prices of necessities. Higher energy and housing prices (although moderating somewhat in recent weeks) have put the squeeze on millions of households regardless of job market status.

And so that’s what we are seeing now. So maybe the recession question isn’t the right one to be asking.

The Squeeze: A Tale of Two Worlds?

The conventional wisdom is that wine is recession-proof. Maybe. But an inflationary squeeze and the twist it creates is different and I don’t see how wine sales can escape unscathed.

Under these circumstances it is more important than ever to know your customers and the product chain that connects them with your business. Based on recent quarterly reports, for example, it looks like selling wine into mass market Walmart World’s part of the retail spectrum, where both the retailer and its clients seem to be really feeling the squeeze — is much different from selling wine into high income Costco World, where the squeeze is still on but the impact seems more moderate. So far.

The Big Squeeze: Stagflation and Shrinking Wine Margins

June 21, 2022 By in Economic impact, wine, wine markets 2 Comments

Sue and I are in Santa Rosa this week where I will be speaking to a meeting of Allied Grape Growers, a 500-member grape grower marketing association that sells more than $100 million worth of grapes each year. I am looking forward to learning as much as I can from the growers about what they are seeing in the grape markets today and how they plan to react.

Optimists and Pessimists

There are two schools of thought about what is happening to the economy, both here in the US and around the world. One school holds that we will soon face the most serious case of stagflation — inflation with slow or no growth– that we’ve seen in 40 years. These are the optimists!

The opposing school — call them pessimists or realists — holds that stagflation is already here (have you seen some corporate earnings reports?) but maybe we just don’t fully appreciate it yet. And it will get worse before it gets better.

Either way the near future promises to present challenges to everyone in the wine product chain with costs rising, consumer budgets getting squeezed, and a strong dollar disrupting international trade flows.

Waiting for Wine Prices to Rise

So far wine prices have not risen as fast as consumer prices generally, which have been up more than 8% on an annual basis in recent months. Wine prices (and beer prices, too) have risen less than half that, which means they have fallen in real (inflation adjusted) terms.

A recent Wine Economist column tried to think through what might happen (and why) if wine prices do eventually start to increase. But I am having real doubts that this will happen generally. Some wineries and retailers are likely to be able to raise price, but I am not so sure about the broader market.

The “Stag” in Stagflation

Why? Well, because this isn’t inflation that we are looking at, it is stagflation and distressed consumers (and the retailers who market to them) are likely to push back against price increases even more firmly than in the past. Yes, I know that premiumization has been one of the big trends on recently years, but premiumization is about buyers moving up to higher priced products, not paying more for the stuff they already buy. Rising wine prices? They still hate that.

Big box retailers like Walmart and Target are already feeling the squeeze as costs rise but prices don’t or don’t as much. Some reports suggest they are trying to protect margins by shifting even more to private label brands, for example. In any case the push back seems to be as strong as the cost push itself in many cases.

Retailers are feeling the squeeze. Will wine margins experience a big squeeze, too? That’s what I suggested in a presentation to the Wine Industry Leadership Conference. earlier this year and, with the ability to raise price in even more in question today, it seems to be a likely scenario.

>>><<<

Here is a link to my presentation on “The Big Squeeze” on wine margins at the Wine Industry Leadership Conference in February 2022. My presentation begins at about minute 38 in the video.

 

Wine, Stagflation, and the Strong Dollar Syndrome

May 24, 2022 By in Economic impact, exchange rates, wine, wine markets Leave a comment

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.

Wine and Inflation: Will the Rising Tide Lift Wine’s Boat?

May 10, 2022 By in economic crisis, Economic impact, wine, wine markets, wine price 1 Comment

The U.S. is experiencing the highest inflation rates since the 1980s and cost-of-living increases are on everyone’s mind here and around the world. The Federal Reserve has signaled that it will speed up monetary tightening to try to reverse rising inflationary expectations — too little and too late, according to   the Economist newspaper (The Federal Reserve Has Made a Historic Mistake on Inflation).

I am very concerned about how higher inflation will impact the wine industry, especially when combined with a stagnant overall economy (GDP actually fell in the US in Q1/2022).

The Big Squeeze

Costs are increasing, some dramatically, throughout the wine and grape commodity chains and rising interest rate expenses will add to cost woes. The list of cost factors is long and includes energy, fertilizer, transportation, glass and other inputs, and especially labor, which remains in short supply.

Will growers and wineries be able to hold on to their margins by passing higher costs along to consumers in the form of higher prices? A lot of people I talk to think so. Surveys suggest that many wineries plan to raise prices in 2022 and there is an attitude that consumers might not push back too much, given that the price of everything else is rising, too.

So I am a little bit surprised that some of the data suggests that wine prices have not risen along with the prices of other goods — at least not yet.  Wine Business Monthly, for example, cites NielsenIQ data on average bottle prices. The May 2022 issue reported an average price of $8.52 for the most recent 4 week survey period, up from $8.18 reported in the May 2021 issue — an increase of 4.1  percent. Average domestic bottle price rose  from $8.12 to $8.46 and average import bottle prices rose from $8.35 to $8.69.

The Booze Bust

Prices are rising, according to these figures, but at about half the current rate of overall inflation. NielsenIQ doesn’t measure all sales channels, of course, and there is a lag in the data, so maybe prices are really rising faster than these numbers suggest and wine industry margins will hold.

But the IRI data shown above, taken from a recent Rabobank report about inflation and the beer market suggest that wine in particular and beverage alcohol in general is struggling to increase prices in line with rising costs. Take a close look at the top half of this table, which shows that some non-alcohol beverage categories have been able to boost price much faster than the roughly 8% general inflation rate for the U.S. economy — topped by sports drinks with an incredible 17%+ annual rate price increase. Wow!

Beer, wine, and spirits have all increased average prices, but much less than, say, coffee, and substantially below the overall inflation rates. In other words, the real price of wine, on average, has actually fallen in the last year and the relative price of wine with respect to some other beverage categories has fallen, too. Averages hide a lot, of course, and some strong brands have successfully pushed prices higher while others have not. But beverage alcohol generally, according to the Rabobank figures, has fallen behind in terms of price.

Why haven’t wine prices increases faster.? Here are a few of the many possible explanations.

  1. Radar’s Rule. Wine prices will increase — “wait for it,” as Radar used to say on M.A.S.H. — it just takes time for price changes to work their way through the system.  It is hard to refute this because it is impossible to know the future. Maybe there is something about wine’s annual production cycle that causes price changes to come more slowly. But then why do beer and spirits, which are in continuous production, also lag behind the inflation rankings?
  2. The Wall. Consumer pushback is too strong in the wine category for large price increases to take hold. Yes, I agree that wine buyers are very price sensitive, but prices do rise when they are driven by short supply. And of course there is the whole premiumization phenomenon, where consumers pay more for what they see as better products while resisting price rises on products they already buy.
  3. The Hidden Price Increase Trick. Candy bar makers sometimes try to disguise price increases by simply shrinking the size of the product. Wine makers can do something a bit like that by shifting grape sources from coastal to inland vineyards and in some cases by blending in wines from earlier vintages. Consumers may not notice (just as they might not immediately realize their candy snack has shrunk a little).  Wineries can also increase their average revenue by reducing production of lower-tier wines, shifting the grapes up the ladder.
  4. Three-tier Blues. It’s the three-tier system, where producers sell to distributors who sell to retailers who sell to consumers. On one hand this system means that there are three margins at stake and to each tier has an interest in raising the price at which it sells wine. But each tier also has an incentive to resist increases in its cost of goods. So distributors push back on producers who want to raise price, retailers push back on distributors, and consumers push back on retailers.  The three-tier effect may explain why the lowest average price increases in the Rabobank table above are for beer, wine, and spirits.

More Questions Than Answers

There are other theories and explanations about inflation and the wine category, but perhaps the most important thing to say is that, with the most recently experience of significant U.S. inflation so far back int he rearview mirror, we are left with more questions than answers.

All the basics — the who, what, when, where, how, and why of the wine market have changed very dramatically since the 1970s and 1980s.

Will wine prices rise in line with inflation? If so, when? And how will consumers react? Come back next week for more analysis.

>>><<<

Thanks to Steve Fredricks at Turrentine Brokerage for stimulating my thinking on this topic.

Here Be Dragons: Wine and the Economy Enter Uncharted Waters

April 19, 2022 By in economic crisis, Economic impact, wine, wine markets 6 Comments

The International Monetary Fund is expected to announce today revised global economic forecasts –– slower growth, higher inflation, and increased uncertainty due to war in Ukraine plus (although I don’t know if it will feature in the IMF report) massive  covid lockdowns in China. Here be Dragons, indeed!

As much as we all would like to think that economic conditions and the global wine market will soon return to what we used to call “normal,” I think it is important to realize that we have actually entered what are in some ways uncharted waters. Old maps and rules of thumb do not necessarily apply and the ability to pivot quickly as conditions change is even more important than in the past.

Flashback to the 1980s

Sometimes I get to thinking that I’ve passed this point in life one time before. (That’s actually a line from a John Hartford song.) Way back in 1981 I wrote a college economics textbook because I couldn’t find a text that could help my university students understand what was happening to the economy.

The uncharted territory back them was stagflation — high inflation and high unemployment at the same time. The standard textbook analysis used Keynesian analysis to understand unemployment and the Phillips Curve to plot the trade-off between unemployment and inflation. Higher unemployment meant lower inflation. But we had both high inflation and high unemployment — how did that happen? And what could be done about it?

The problem (in very simple terms) was that inflation was caused by cost-push not demand-pull factors and had unleashed sustained self-fulfilling inflationary expectations.  The Volker solution was highly restrictive monetary policy that pushed unemployment even higher until the expectations broke. Harsh medicine for a vicious disease.

Zoom Ahead to 2022

Zoom ahead to 2002. After years of relatively stable or even falling price levels, inflation is here again at rates that haven’t been seen in the U.S. since the 1980s. The problem this time is a combination of cost-push and demand-pull factors. Higher energy, food, and transportation costs plus persistent shortages of key commodities push prices higher while the huge fiscal and monetary stimuli of the pandemic and post-financial crisis era have pulled inflation higher, too.

This is not a repeat of the 1980s, by any means, but also not like anything we’ve seen at this level in a very long time. I can’t remember seeing such a combination of broad forces aligned to boost demand and constrain supply.

The war in Ukraine adds to the inflationary pressure, especially with respect to energy and food prices, and it is hard to see these forces disappearing any time soon. Even if a truce were declared today, the energy and food price effects would continue for some time. The Chinese covid lockdowns are squeezing production of many manufactured goods at the same time.

Disruptions in global trade and finance are another factor to take into account. For a long time the “China Price Syndrome” kept a lid on prices of manufactured goods. If a company was tempted to raise price, the ready availability of cheaper alternatives from Asia and especially China acted as a constraint. The “China Price” served as a price anchor then, but much less so now because of unraveling trade relations.

Getting from QE to QT

Taken together this is a situation we haven’t really seen before, but the thing that really makes people like me nervous is monetary policy, The Federal Reserve will be responsible for squeezing inflation out of the economic system (just as it was in the 1980s), but financial conditions are different now. We have had very low interest rates for a long time now and wave after wave of quantitative easing (QE — Fed purchases of Treasury and mortgage-backed securities that pump liquidity into the markets). The markets have kind of become addicted to the constant monetary boost.

Raising interests from this very low level can be expected to disrupt financial markets if only because of the mathematical impact on present value calculations. Exchange rates will shift, too, with disproportionate impact of development market currencies.

But the real “uncharted waters” factor is the transition from QE to QT, quantitative tightening. This will initially take place as the Fed’s bond holdings mature and are not rolled over, which takes liquidity out of the market. It will start slow (which still means billions of dollars a month) and could pick up speed if necessary.

The question is how financial markets will deal with this change after having a liquidity drip line month after month for this long? There is nervous talk of another sharp liquidity crisis, but maybe bigger than the last one, which the Fed addressed quickly and well. If key credit markets freeze up and contagion takes place, the Fed will have little choice but to reverse course, opening the door to even higher inflation.

The alternative is a very hard landing as the impact of the financial crisis spreads through the economy. How hard a hard landing? It depends on what it would take to shift inflationary expectations. So you can see the concern — we may be perched on a narrow ledge with higher inflation on one side and financial crisis on the other.

What About Wine?

The wine economy operates by its own rules, but it can’t fully escape the forces shaping the economy in general. To repurpose something that is said about the pandemic economic, we aren’t all in the same boat, but we are in the same storm.

Wine has also experienced a combination of cost-push and demand-pull factors, but not uniformly for various categories. Demand-pull, for example, seems focused on more expensive wines. Cost-push is everywhere, however, which means that the crunch is felt particularly in the middle- and lower-price tiers.

Honestly, I cannot remember a time when cost pressures have been so broad and deep. To what extent will price-sensitive consumers push back on price increases? Or will the consumer inflation expectations in general soften attitudes towards rising wine prices? Given that these are uncharted waters, the map holds more questions than answers.

Gearing Up for the 2022 Unified Wine & Grape Symposium

December 7, 2021 By in economic crisis, Economic impact, Unified Wine & Grape Symposium, wine, wine markets Leave a comment

The Unified Wine & Grape Symposium is North America’s largest wine industry gathering — a vast trade show and ambitious collection of seminars and presentations with something new and useful for every wine professional.

The 2020 Unified was the last in-person wine conference that Sue and I attended before the pandemic closures and protocols hit. So we are looking forward with more than the usual amount of excitement to the 2022 Unified, which is scheduled for January 25-27 in Sacramento.

Trade Show by the Numbers

Last year’s Unified was a virtual event and a very good one, but wine is a people business and nothing can fully replace the in-person experience. The two-day trade show will take place in the newly renovated SAFE Credit Union Convention Center on January 26 and 27. Covid protocols will be followed, of course.

You will find 760 booths and 40 large vineyard and winery machinery areas filled with just about everything anyone might need to grow grapes and make and sell wine. If you want to know what’s new, this is the place to find out.

If you haven’t been to the Unified before, you might enjoy reading New York Times wine expert Eric Asimov’s report on his visit to the trade show in 2017. It is interesting to see the event through Asimov’s critical eyes.

Problems and Opportunities

The 2022 conference program features an expanded three full days of meetings January 25-27. The typically ambitious agenda is organized around wine industry problems and opportunities as the Daily Schedule makes clear. There is a strong emphasis on positive take-aways — practical approaches to dealing with wine industry issues and information to help us all make sense of our changing world.

The wine world has changed dramatically in just a short period of time and the themes of this year’s program take this into account, with sessions on environmental shifts, smoke taint problems, new marketing directions, and attracting and retaining essential talent. Two sessions are in Spanish.

State of the Wine Industry

Once again this year I will be fronting the Wednesday morning “State of the Industry” session. I’ll set the stage by analyzing the changing wine market from a global perspective then the all-star line-up takes over: Danny Brager (changing consumer trends), Steve Fredricks (the supply side of the wine market), Mario Zepponi (investment trends, M&A activity), and Jeff Bitter (grower trends and issues).

Danny Brager returns to the podium at the session’s end to recognize wineries that were particularly successful navigating the wine dark seas in 2021. Lots of information and analysis packed into a 2-1/2 hour session.

I don’t have to tell you that 2021 has not been the easiest year for those of us in the wine industry, so look forward to honest, straightforward analysis with a focus on practical strategies as we move ahead into the uncertain future.

The Unified is back. See you there!