The Snob Effect

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The following story came to my attention via the good folks at r/wine, and I find it somewhat unbelievable. According to Reuters’ wine writer Leslie Gevirtz, wealthy Americans have taken to pawning their collectible wines in order to raise fast cash.1 The pawn shops I know are usually gated, dilapidated businesses, generally located in low income neighborhoods where the cashier works behind bulletproof glass. Not exactly the type of place that sells first growth Bordeaux’s.

Nevertheless, Gevirtz’s story mentions five different “high end” pawn businesses that are securing loans with wine as collateral. One of the five is Beverly Loan Company, which was also profiled by the Wall Street Journal in its 2011 story Pawn Shops for the (Formerly) Rich.2 The Journal describes Beverly Loan Co as “the granddaddy of all the plutocrat pawnshops,” and “the pawnshop to the stars.” Clientele includes “hedge-fund managers, bankers, lawyers, doctors and even Oscar winners.”1 Really?

Well maybe…

The “usual [interest] rate at Beverly Loan is 4% per month.”3 That’s 48% annualized without compounding, a true sucker’s interest rate. What sort of plutocrats go for that deal? None! They certainly wouldn’t be plutocrats if they did. On the other hand, broke celebrities and indebted professionals with a spending vice might go for nosebleed interest rates in order to maintain their aura of richness; at least until the next paycheck arrives. And although this course of action does not appear to be sane, irrational behavior is par for the course when dealing with the snob effect.

Economist Harvey Libenstien defined the “snob effect” as the extent to which the demand for a consumers’ good is decreased owing to the fact that others are also consuming the same commodity (or that others are increasing their consumption of that commodity). This represents the desire of people to be exclusive; to be different; to dissociate themselves from the common herd.“4 Maybe Libenstein had wine snobs in mind when he came up with the snob effect. After all, buying first growth Bordeaux’s might be the ultimate act of exclusivity when it comes to purchasing wine. This is clearly reflected in the retail wine futures market. Here are The Chicago Wine Company’s current bottle prices for the yet to be released 2010 first growth Bordeaux’s:

They don’t have Latour but here is Petrus for good measure:

These prices will vary by retailer, but nonetheless are a good barometer of the lack of affordability and exclusivity of Premier Cru Bordeaux’s.

For those that don’t know, wine futures are a paper contract allowing wine merchants and professional wine buyers to purchase “still-in-barrel wines,” but they differ from a regular commodity future contracts in that the “buyer always takes delivery.”6 Wine futures are traded through Bordeaux market makers and wine exchanges such as Liv-ex, which claims its membership accounts for over 75% of “global fine wine turnover.”7 Forty percent of Liv-ex’s volume comes from trades involving first growth Bordeaux’s.6 The Liv-ex Fine Wine 50 index is composed of the ten most recently released vintages of the first growths. Wine futures are traded at Live-ex with their Standard En Primeur contracts (minimum quantity 1 case).8 Liv-ex says the following about En primeur:

When working as it should, en primeur enables consumers to obtain the new vintage at an advantageous price and in hard-to-find formats. In return, the chateaux gets access to capital to finance the vintage two years prior to delivery. It also keeps Bordeaux in the headlines for 2-3 months each year and has no doubt contributed to maintaining Bordeaux’s position as the pre-eminent wine region in the world.9

Advantageous for consumers? I don’t think so. En primeur trading has existed in Bordeaux for centuries, but the internet has facilitated explosive growth in speculative fine wine trading.10,11 This has led to massive price inflation in present and future vintages, especially amongst the top tier Bordeaux’s. Here are the ex-negociant (initial release) prices per bottle of the first growths in 2000 and 2010:

      •                                        2000 Vintage          2010 Vintage
      • Haut-Brion                         €120.00                 €600.00
      • Lafite Rothschild                €120.00                 €600.00
      • Latour                                €120.00                 €780.00
      • Margaux                            €120.00                 €600.00
      • Mouton Rothschild            €120.00                 €600.00 12,13

Once the wines hit the inter-dealer market the prices jump even more as noted above. Much of the price increases are chalked up to massively increased demand from Asia. Some even call the Bordeaux wine market a bubble.11 That might be the case, but why did the trend start in the first place? My contention is that irrational demand resulting from the snob effect has compounded on itself via internet facilitation, creating a positive feedback loop of higher prices and higher exclusivity for first growth Bordeaux’s in particular. The demand at these prices is truly irrational given the current availability of thousands upon thousands of excellent and affordable wines produced around the world.

It’s the same irrationality that lets people “trick themselves into believing [expensive] wines provide a more pleasurable experience than less expensive wines.”1 It’s the irrationality that compels wealthy (or formerly wealthy) individuals to pawn their wines for a 48% interest rate rather than simply selling them to a merchant. Nobody who is a member of this club wants their membership revoked. In order to stay in the game they have to spend more and more on the next vintage despite the fact that it is truly unknown how these wines will hold up 20 years from now. That doesn’t even matter because these wines really aren’t for drinking; they are for measuring social status. I suppose it’s a reflection of the 1% vs the 99% theme that is so prevalent today.

Having said that, I’d really like to try these wines at some point down the road. But I’m not going to spend a thousand bucks. That’s for sure.

References:

  1. http://in.reuters.com/article/2012/02/22/us-wine-loans-idINTRE81L1UA20120222?feedType=RSS&feedName=everything&virtualBrandChannel=11709
  2. http://blogs.wsj.com/wealth/2011/09/27/pawn-shops-for-the-formerly-rich/
  3. http://www.beverlyloan.com/beverly-loan-press/down-and-out-beverly-hills-pawnshops-booming
  4. Leibenstein, H. Bandwagon, Snob, and Veblen Effects in the Theory of Consumers’ Demand. The Quarterly Journal of Economics. Vol. 64, No. 2. (May, 1950), pp. 183-207.
  5. http://www.tcwc.com/s.nl/sc.17/category.189753/.f
  6. http://www.forbes.com/2009/07/13/livex-wines-futures-markets-equity-entrepreneur.html
  7. http://www.liv-ex.com/pages/static_page.jsp?pageId=40
  8. http://www.liv-ex.com/pages/static_page.jsp?pageId=208
  9. http://liv-ex.typepad.com/livex_fine_wine_market_bl/2009/05/reforming-en-primeur.html
  10. http://en.wikipedia.org/wiki/En_primeur
  11. http://www.bloomberg.com/news/2011-08-02/billionaires-wine-thirst-quelled-by-record-bordeaux-futures-sale-prices.html
  12. http://www.winespectator.com/webfeature/show/id/Prices-for-2000-Bordeaux-Continue-to-Set-New-Records_20067
  13. http://www.newbordeaux.com/documents/release_prices.html

Footnote: There are many questions regarding the sustainability of En primeur wine trading which I have not addressed in this essay that I hope to address at a later time.

Some Poems

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“wine is bottled poetry”

Give me women, wine and snuff
Until I cry out “hold, enough!”
You may do so sans objection
Till the day of resurrection;
For bless my beard they aye shall be
My beloved Trinity.

                          – John Keats

To wash and rinse our souls of their age-old sorrows,
We drained a hundred jugs of wine.
A splendid night it was . . .
In the clear moonlight we were loath to go to bed,
But at last drunkenness overtook us;
And we laid ourselves down on the empty mountain,
The earth for pillow, and the great heaven for coverlet

                                           – Li Po

Whenever I would rest I grasp a cup of wine,
Oblivious of all else in this great capital.
So vast are heaven and earth that I remain unknown,
An old man wandering by himself among mankind.

                                  – The Master Yün-fang

Is 7,116 wineries too many?

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We’ve all seen the wealth management advertisements that greatly exaggerate vineyard and winery ownership as the ultimate retirement dream. Clearly the Madison Avenue ad wizards that come up with these have never worked the harvest. But their cheesy methods are perhaps more effective than meets the eye, as the total number of US wineries has nearly doubled since 2005.1 The latest issue of Wine Business Monthly (WBM) provides their annual statistical breakdown of wineries across the United States. As of 2011, there are 7,116 wineries in the US, with nearly half of those located in California. Washington state landed in second, followed by Oregon, New York, and Virginia rounding out the top 5. The total number of US wineries increased by 278 in 2011, a new winery growth rate of 5 percent. My question is this: does 7,116 wineries indicate the US market is oversaturated? On the surface, twenty straight years of increased US wine consumption indicates the answer is no, but diving deeper into the available statistics and information shows the answer is not so clear cut.8

Interestingly, the largest new winery growth rates in 2011 were seen across the Midwest in places such as Minnesota, Kansas, Texas, and Kentucky.1 Slower expansion in the well established top five wine states should not come as a surprise though; the industry is far more competitive and the coastal regions generally have higher construction costs and higher cropland values, making the barrier to entry more difficult.2,3 Further, many of the West coast areas with desirable grape growing micro-climates are already heavily planted, in addition to being heavily regulated with regards to new plantings.4  In February’s WBM, David Kent, CEO of America’s second largest wine operation, The Wine Group, stated “When I joined the industry 21 years ago, California wine had an 80 percent share of the domestic market… this year, we as an industry will sell every available grape and barely supply 60 percent of the consumer demand in America.”

Perhaps not so coincidentally, 21 years ago marked the implementation of California’s first major vineyard erosion control regulation, the Napa Hillside Ordinance. This was followed by similar regulations in Sonoma, Mendocino, Marin, and elsewhere, all of which severely limit new vineyard planting. There are also strict water usage rules in California that make it difficult to establish a new vineyard, especially in the San Joaquin Valley where grapes are “the number two agricultural commodity… after milk.”5 The barriers to increased California production are well established, and California may very well have reached its “peak vineyard acreage.” Data from the USDA supports this notion, showing that total California grape acreage has been in a slow downtrend for ten years now.7 As a result, other states attempt to pick up the slack, but they face a number of steep obstacles in the process.

In colder, wetter regions such as Northern Oregon and Washington, it can take as long as 7 years to properly establish a grapevine’s root system before it becomes a viable cash crop. In Southern states the lifespan of Vitis vinifera, the major species of wine grape, is severely shortened by Pierce’s disease. Across the Midwest, severe weather conditions make effective vineyard management nearly impossible. In fact, much of the wine produced in the Midwest is bulk wine trucked in from California, which is then blended into the final product. East coast grape growing is also severely encumbered by inclement weather with the exception of a few small regions such as the Finger Lakes. So where has the extra grape tonnage come from to support the rapid expansion of wineries across the US?

According to the Wine Institute’s latest statistics, it has never materialized. From 2006 to 2009, US vineyard acreage increased from 937,179 to 943,750.6 A paltry gain when considering the number of bonded wineries increased by 21% over the same time frame.1 Combining the statistics from the USDA and Wine Institute, we find that California is still home to 89.5% of all the vineyard acreage in America. And it’s important to note that California’s total crush weight has remained consistent around 3.8 million tons since 2002.9

From these statistics and a little common sense, it’s easy to deduce that the vast majority of recent start-up wineries are small or even micro sized. They are not responsible for California’s loss of domestic market share; that can be attributed to increased wine consumption, stagnant grape production, and foreign competition. Anybody can see this when they walk the wine aisle of their local grocery store. However, the sustainability of all the new US wineries remains a question in my mind.

I personally subscribe to the philosophy that 95% of a wine’s quality is derived from the vineyard, so in my opinion, estate grown vines are almost essential for brand distinction and long-term competitiveness. But what ultimately decides the viability of a winery is the quality, price point, and ability to market and distribute the finished product. A new winery of small size has vastly higher overhead per bottle than market behemoths like Gallo, The Wine Group, and Constellation Wines. The start-up is forced to price their product higher in order to remain solvent. But if their product is originating from the same vineyards as California mid tier, large, and giant wineries, how can they expect to compete over the long run?  It is clearly very difficult, however, I do believe there are market niches to be filled by start-up wineries.

In my estimation, the niche for start-up wineries is an emphasis on localism. Effective, creative marketing to the local community combined with regional tourism can make start-up wineries a thriving success. But an emphasis of this sort effectively places a ceiling on the size of the winery, as well as the number of wineries in a given region. The number of wineries local communities can support depends on many factors such as population, local GDP/capita, local unemployment, and a variety of other factors. The likelihood of local wine communities develop into big time wine destinations seems slim but not impossible. However, I think it is safe to say that the number of wine Mecca’s such as Bordeaux, Burgundy, or Napa will always be limited.  Now I’ll try to bring this exposé full circle and answer my original question: is 7,116 wineries too many?

I think that over the long term, even if US wine consumption continues to increase, we will find the answer is yes. The competition is so stiff, and the geographically favorable grape growing regions so limited, that devoting resources to winery development in many places throughout the US may prove to be a misallocation. However, while there is little money to be made in genetic modification of grapevines given that they are perennials, it is possible that through rootstock breeding, many regions will one day be far more conducive to growing wine grapes. And at that point in time, 7,116 wineries might seem like a drop in the bucket.

References:

1) http://www.winebusiness.com/wbm/?go=getDigitalIssue&issueId=5241

2) http://www.nass.usda.gov/Charts_and_Maps/Land_Values_and_Cash_Rents/crop_value_map.asp

3) http://www.dcd.com/pdf_files/1107analysis.pdf

4) http://www.sheppardmullin.com/publications-articles-71.html

5) http://ucanr.org/sites/CE_San_Joaquin/Agriculture419/

6) http://www.wineinstitute.org/files/WorldVineyardAcreagebyCountry.pdf

7) http://www.nass.usda.gov/Statistics_by_State/California/Publications/Grape_Acreage/201004gabnarr.pdf

8) http://www.wineinstitute.org/resources/statistics/article86

9) http://www.nass.usda.gov/Statistics_by_State/California/Publications/Grape_Crush/

Footnote: I also wanted to mention that exchange rates play a large role in the import/export dynamic of the wine industry, but will write about that at a later date.

Nazi Gold

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April 12, 1945 was a solemn day in American history. It marked the passing of four term President, Franklin Delano Roosevelt. He was 63. Just two months earlier, FDR had attended the historic Yalta conference, in which he, Winston Churchill, and Joseph Stalin discussed the future of post war Europe. At this meeting, the so called “Big Three” agreed that upon Germany’s unconditional surrender, the nation would be divided into four quadrants, and occupied until Nazism was “extirpated.”1 America, Great Britain, France, and the Soviet Union would each be responsible for occupying one zone until the mission was accomplished. The Yalta plan was not to be revealed until the war in Europe had ended, but upon hearing the details of the arrangement on April 11, 1945, General George S. Patton, commander of the United States Third Army, realized his immediate task was one of an urgent nature.2

Just one week earlier, while marching through the zone of future Soviet occupation, members of Patton’s 357th Infantry Regiment bypassed what was perhaps Nazism’s last bastion of hope, the Merkers salt mine.2,3,4 What the soldiers mistook for a normal mine operation, had in fact been converted into the central depository for the Nazi Reichsbank’s Precious Metals Department. The mistake was only realized when two Germans attempted to flee an American vehicle convoy well beyond the mine site. The two men were Reichsbank employees; Albert Thoms, head of the precious metals department, and Director Frommknicht, the key holder to the vault at Merkers. Frommknicht escaped into the woods, but Albert Thoms was detained and the secret of Merkers was revealed shortly thereafter.2

When Patton learned of the treasure buried inside the mine, he insisted on verifying the contents prior to going public with the information. On April 12th, the day of FDR’s passing, Patton was joined by General Dwight D. Eisenhower, General Omar Bradley, Lieutenant General Manton Eddy, Brigadier General Otto Weyland, and Colonel Bernard Bernstein to inspect the findings. As they descended in the mines single cable elevator, Patton remarked, “promotions in the United States Army would be considerably stimulated” if the cable were to snap.2 When the grouping of American military elite passed through the blasted vault entrance, what they saw was a sight to behold: an approximately 11,000 square foot room, packed to the brim with gold and other valuables. The treasure “included, among other things, 3,682 bags and cartons of Germany currency, 80 bags of foreign currency, 4,173 bags containing 8,307 gold bars, 55 boxes of gold bullion, 3,326 bags of gold coins, 63 bags of silver, 1 bag of platinum bars, 8 bags of gold rings, and 207 bags and containers of SS loot.” The treasure was estimated to be valued at “over $520 million,” and it included “a large quantity” of possessions taken from Holocaust victims by Himmler’s SS.2 After inspection, Patton ordered the contents at Merkers, which also included hundreds of pieces of priceless artwork, to be moved to Frankfurt posthaste, where it would remain safely under US custody until further notice.

The war in Europe ended on May 8th, 1945, just one month after the discovery of the German gold at Merkers. It is amazing to think that had Albert Thoms not fled the American convoy, then perhaps the deposits at Merkers would have been lost to the Soviet Union forever. Another possibility is that remaining Nazi fugitives could have “used [the] foreign exchange assets… as a means of perpetuating the Nazism and Nazi influence both in Germany and abroad.”2 The thought of Nazism lingering on compelled Colonel Bernstein to conduct a massive search across Germany for other hidden sources of Nazi funding. But an estimated “98.6%” of known Nazi gold was in fact located at Merkers.2 It was the mother load and the loss was a crippling blow to any hope of the Nazi’s financing an insurgency. The story of the Nazi gold did not end with the war however; in fact, it carried on for another 60 years…

To be continued at a later date.

References:

1)http://millercenter.org/president/speeches/detail/3819

2)http://www.archives.gov/publications/prologue/1999/spring/nazi-gold-merkers-mine-treasure.html

3)http://en.wikipedia.org/wiki/Allied-occupied_Germany

4)http://en.wikipedia.org/wiki/Merkers-Kieselbach