The puzzle of Carruades de Lafite(2)
An important factor seems to be the need to lubricate business relationships. Like Japan in the 1980s, drinking is an all-important component in developing business relationships. For some reason, this phenomenon is replicated during the economic development phase in places across the world. A little intoxication may be necessary for successful economic development. When one sinks a lot of money into an underdeveloped economy, it needs courage. When many do the same, it then becomes a self-fulfilling prophecy.
Lubricating relationships with government officials may play a more important role in China's fine wine demand. In the East Asian investment and export-led development model, the government usually plays an important role. In China, this role is even more influential because of government ownership of most assets and deal-making that is often dependent on individual approval. When befriending government officials, private businessmen obviously pay for the best.
The business drinking culture has been changing in China. Like elsewhere, liquor consumption has been declining out of health concerns. Obviously, liquor is more effective at loosening people up and advancing business relationships. But, its deleterious effects on health have dampened consumption. When wine is not effective, the liquor is still needed. That is why China's liquor consumption is declining but still at a high level.
The role of alcohol consumption in entertaining for business has produced a unique Chinese phenomenon -- the massive demand for Chateau Lafite wine. Lafite is one of the five first-growth wines in Bordeaux. France classified Bordeaux wines as first-growth and unclassified them in 1855 for its World Expo. At the time, four chateaux: Lafite, Latour, Haut Brion and Margaux were classified as first-growth. In 1975, Mouton also qualified. Chateaux in some of Bordeaux's areas like Pomerol and St. Emilion didn't participate in the classification. They have started their own classification system. Some of their wines are more expensive than the five first-growth wines. Nevertheless, the first-growth label travels well, especially to a new market like China.
Among the first-growth wines, Lafite has taken a life of its own, rising much more quickly than the fine wine market as a whole and other first-growth wines in particular. For example, Lafite of 2000 vintage has appreciated by about 550% in pound sterling since 2005, compared to 180% for the market as a whole. The most comparable wine to Lafite is Latour. The latter's price of the same vintage has risen roughly in line with the overall market. The price differentials between Lafite and other first-growth wines from other vintages are not as dramatic as for the 2000 one but are still large.
Something special has happened to Lafite in the past few years. That something is China.
China has been experiencing a Lafite phenomenon in the past five years. It has become almost the official Chinese wine for business entertainment. There have been many attempts to explain this. The most popular one is that the Chinese translation is easy to say and sounds nice. I am not sure this is the best explanation. Drinking for business entertainment in China isn't the most sophisticated pastime. Providing expensive wine is really for its own sake, because it is simply the high price, and not the taste, that is meant to impress. When a wine becomes expensive, it can take on momentum of its own. The fact that Lafite sounds nice in Chinese gives it a negligible advantage.
Is the Lafite Phenomenon a bubble? As former Federal Reserve chairman Alan Greenspan says, one can never be sure until it bursts. It is possible that Chinese drinkers appreciate something in Lafite that other drinkers never did. Hence, as the Chinese become richer and spend more on wines, Lafite benefits from this source of demand more than others. So the Lafite phenomenon is a price revaluation, not a bubble.
An alternative scenario could be that other first-growth wines would get the Lafite treatment over time. The Chinese demand for Lafite is due to lack of wine knowledge. As Chinese drinkers become more sophisticated, the demand for other first-growth wines will increase. This could be a rising tide that will gradually carry over to other fine wines.
The second scenario is possible. The Lafite sensation has something to do with the French system for wine production. The laws prevent the great wine chateaux in Bordeaux from increasing production. The most important restriction is that they cannot irrigate. The chateaux have to cut out half of the grape buds to improve the quality of the other half. Wine producers in Australia and the U.S. use irrigation, and can produce four times as much wine from the same acreage of land. Bordeaux wine producers have to go for quality and high prices rather than quantity. Thus, when a new source of demand comes, the prices go up.
Indeed, the Lafite price is so high that it has led to a large fake industry. Some analysts estimate that 70% of China's Lafite consumption is counterfeit. I personally experienced this on a few occasions. The people who served me fake Lafite didn't know it, because at the very least, the prices seemed genuine. And the fakes were probably decent wines, possibly some good second-growth poured into a Lafite bottle. They just weren't the real thing.
The forgers have targeted the legendary 1982 vintage in particular. Many rich Chinese have bought large stocks of 1982 Lafite. The odds are that these are all fakes. There are very few bottles of the vintage left. It is highly unlikely that one can get several cases of the real thing.
When the Chinese economy matures in 10 or 15 years, prices for Lafite may come under pressure, as entertaining for business changes. The final demand would come from personal enjoyment, making the wines more price sensitive. Japan has already gone through such a cycle.
While I am not sure that the Lafite phenomenon is a bubble, I am quite sure that Chateau Lafite's second label, Carruades de Lafite or "little Lafite" in Chinese, is a bubble. The production of fine wine requires the vine age to average 30-40 years. Vines older than 80 years must be replaced. Hence, a chateau is always taking out old vines and planting young vines. But grapes from young vines cannot produce high quality wine. Great chateaux like Lafite and Latour use the grapes from young vines to produce second-label wine to recover some costs. These second labels are usually quite cheap. They are usually much cheaper than second-growth wines.
For example, Lafite's second label, Carruades de Lafite, sold for about 200 British pounds per case until five years ago. Since 2005, the price of Carruades de Lafite has increased roughly 10 times. Its price sometimes rivals the prices of non-Lafite first-growth wines and is usually higher than great second-growth wines. Little Lafite is not a bad table wine. But it is definitely not a grand wine. Its meteoric rise is really due to mistaken identity.
As Lafite's price becomes a small fortune, the search for a substitute is a natural market response. In China, the substitute is little Lafite. The choice is way off the mark. If one shifts from Lafite to Latour, Haut Brion, or Margaux, it would be rational. Their qualities are similar. When Lafite's price is so much higher than that of others, they should become the next choices. But, in Chinese, little Lafite has the connotation of Lafite's junior brother, probably similar but a bit less good. Hence, it becomes the substitute for Lafite. Moreover, as its price has risen, it seems to confirm its worth. At least the choice doesn't look cheap to the host.
The magnitude of price distortion in the Carruades de Lafite is probably similar to that of Internet stocks in 2000. Of course, over time, the bubble bursts. So why should we be upset about it? The problem is that it has become an insult to other great winemakers. I'm really ashamed of the enormous Chinese demand that has created this phenomenon. I personally witnessed Chinese tourists unloading cases of little Lafite at enormous prices in Bordeaux to ship back to China.
French wine chateaux maintain traditional methods for making wine. It is arduous, costly and often unrewarding. The top chateaux can afford a lot of labor and fine equipment to maintain quality and sustain high prices. Most chateaux in Bordeaux are not so lucky. They suffer through low prices and low quantities. I visited one unclassified chateau about two kilometers from Chateau Petrus, the maker of the most expensive wine in Bordeaux. Its wine is quite good. For some good vintages, it is comparable to the second labels of the first-growth chateaux. But it sells for 1/50th of what Carruades de Lafite does.
A market is efficient when consumers are informed and make rational choices. An efficient market motivates producers to improve quality and control cost. The virtuous cycle leads to great brands that last.
The French wine market is like that. I am afraid that Chinese demand is decreasing the market efficiency and may bring down great brands over time. When winemakers see the price a result of propaganda, not quality, they will focus on marketing and decreasing investment for improving quality. It would be a tragedy if Chinese demand, by bringing easy money, brings down a French legacy that has lasted for five centuries. See this commentary on Caixin Online.
