Two years ago in another column, I discussed China’s impact on the luxury economy.

Here I want to discuss China’s impact on luxury French wines. Not many asset clas
ses have made new highs above mid-2008 levels. Gold is one. French fine wine is
another. The residential property in China made a new high in October 2009. I ca
n’t recall anything else. Among the three, French fine wines seem to have performe
d best. The French fine wine index (Liv-100 index) is roughly up by 37 percent f
rom one year ago and 24 percent this year to date. Its upward momentum remains s
trong.
There is little doubt that the force behind the current upward momentum is Chine
se buyers, not Wall Street traders. Bordeaux wine producers are all talking abou
t China. Chinese buyers seem to dominate the en premieur (酒花) for 2009 vintage that
will be available in another year. In the first growth wines, Mainland Chinese b
uyers are increasingly pricing out the Japanese, Taiwanese and Hong Kong people.
French wine is different from an LV bag. When the cork is popped, it’s gone. Of co
urse, you can store it as investment. But the process is complicated and costly.
In terms of Chinese demand, investment is still a secondary consideration. Drin
king is now a bigger factor.
Drinking expensive wine is probably the ultimate consumption. One could swallow
a lot of money – and quickly. It seems inconsistent with the dominant Chinese pref
erence for accumulation. Why is there so much demand from China?
An important factor seems to be the need to lubricate business relationships. Li
ke Japan in the 1980s, drinking is an all-important component in developing busi
ness relationships. For some reason, this phenomenon is replicated during the ec
onomic development phase in places across the world. A little intoxication may b
e necessary for successful economic development. When one sinks a lot of money i
nto 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 ro
le in China’s fine wine demand. In the East Asian investment and export-led develo
pment model, the government usually plays an important role. In China, this role
is even more influential because of government ownership of most assets and dea
l-making that is often dependent on individual approval. When befriending govern
ment 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 mor
e effective at loosening people up and advancing business relationships. But, it
s deleterious effects on health have dampened consumption. When wine is not effe
ctive, the liquor is still needed. That is why China’s liquor consumption is decli
ning but still at a high level.
The role of alcohol consumption in entertaining for business has produced a uniq
ue 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
chateaus: Lafite, Latour, Haut BRion and Margaux were classified as first growt
h. In 1975 Mouton also qualified. Chateaus in some of Bordeaux’s areas like Pomero
l and St. Emilion didn’t participate in the classification. They have started thei
r own classification system. Some of their wines are more expensive than the fiv
e first growth wines. Nevertheless, the first growth label travels well, especia
lly to a new market like China.
Among the first growth wines, Lafite has taken a life of its own, rising much qu
icker than the fine wine market as a whole and other first growth wines in parti
cular. For example, Lafite of 2000 vintage has appreciated by about 550 percent
in pound sterling since 2005, compared to 180 percent for the market as a whole.
The most comparable wine to Lafite is Latour. The latter’s price of the same vint
age has risen roughly in line with the overall market. The price differentials b
etween Lafite and other first growth wines from other vintages are not as dramat
ic as for the 2000 one but are still large. Something special has happened to La
fite in the past few years. That something is China.
China has been experiencing a Lafite phenomenon in the past five years. It has b
ecome almost the official Chinese wine for business entertainment. There have be
en many attempts to explain this. The most popular one is that the Chinese trans
lation is easy to say and sounds nice. I am not sure this is the best explanatio
n. Drinking for business entertainment in China isn’t the most sophisticated pasti
me. Providing expensive wine is really for its own sake, because it is simply th
e high price, and not the taste, that is meant to impress. When a wine becomes e
xpensive, it can take on momentum of its own. The fact that Lafite sounds nice i
n Chinese gives it a negligible advantage.
Is the Lafite Phenomenon a bubble? As Greenspan says, one can never be sure unti
l 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 mo
re on wines, Lafite benefits from this source of demand more than others. So the
Lafite phenomenon is price revaluation, not bubble.
An alternative scenario could be that other first growth wines would get the Laf
ite treatment overtime. The Chinese demand for Lafite is due to lack of wine kno
wledge. As Chinese drinkers become more sophisticated, the demand for other firs
t growth wines will increase. This could be a rising tide that will gradually ca
rry over to other fine wines.
The second scenario is possible. The Lafite sensation has something to do with t
he French system for wine production. The laws prevent the great wine chateaus i
n Bordeaux from increasing production. The most important restriction is that th
ey cannot irrigate. The chateaus have to cut out half of the grape buds to impro
ve the quality of the other half. Wine producers in Australia and the US use irr
igation, 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 quant
ity. 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. So
me analysts estimate that 70 percent 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 in
to a Lafite bottle. They just weren’t the real thing. The forgers have targeted th
e legendary 1982 vintage in particular. Many rich Chinese have bought large stoc
ks of 1982 Lafite. The odds are that these are all fakes. There are very few bot
tles of the vintage left. It is highly unlikely that one can get several cases o
f the real thing.
When the Chinese economy matures in ten or fifteen years, prices for Lafite may
come under pressure, as entertaining for business changes. The final demand woul
d 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, i
s a bubble. The production of fine wine requires the vine age to average 30-40 y
ears. Vines older than 80 years must be replaced. Hence, a chateau is always tak
ing out old vines and planting young vines. But grapes from young vines cannot p
roduce high quality wine. Great chateaus like Lafite and Latour use the grapes f
rom 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 growt
h wines.
For example, Lafite’s second label, Carruades de Lafite, sold for about 200 BRitis
h pounds per case until five years ago. Since 2005, the price of Carruades de La
fite has increased roughly ten times. Its price sometimes rival the prices of no
n-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 natura
l 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 wo
uld be rational. Their qualities are similar. When Lafite’s price is so much highe
r than that of others, they should become the next choices. But, in Chinese, lit
tle 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 pri
ce has risen, it seems to confirm its worth. At least the choice doesn’t look chea
p 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 ha
s created this phenomenon. I personally witnessed Chinese tourists unloading cas
es of little Lafite at enormous prices in Bordeaux to ship back to China.
French wine chateaus maintain traditional methods for making wine. It is arduous
, costly and often unrewarding. The top chateaus can afford a lot of labor and f
ine equipment to maintain quality and sustain high prices. Most chateaus in Bord
eaux are not so lucky. They suffer through low prices and low quantities. I visi
ted 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 v
intages, it is comparable to the second labels of the first growth chateaus. But
it sells for one fiftieth 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 vi
rtuous cycle leads to great brands that last. The French wine market is like tha
t. I am afraid that Chinese demand is decreasing the market efficiency and may b
ring down great brands over time. When winemakers see the price a result of prop
aganda, not quality, they will focus on marketing and decreasing investment for
improving quality. It would be a tragedy if Chinese demand, by bringing easy mon
ey, brings down a French legacy that has lasted for five centuries.