Chinese currency, RMB or Yuan, has had some big move in the last few days, rising from 6.78 to 6.74 per US dollar.  Link this to coming US election and Chinese policy makers are playing a precarious game.

Andy Xie, former Morgan Stanley Asia economist, wonders about the question. This is quite an interesting phenomenon.

By ANDY XIE

China's impact on the luxury French wine market has been enormous. The French fine wine index (Liv-100 index) is up by roughly 37% from a year ago, 24% year-to-date, and its upward momentum remains strong.

Not many asset classes have hit new highs above their mid-2008 levels. In addition to fine French wine, gold and China's residential property sector reached new highs in 2009. But I can't recall any others. And among the three, French fine wines seem to have performed best.

There is little doubt that Chinese buyers, not Wall Street traders, are the force behind this positive trajectory for French fine wine. Bordeaux wine producers are all talking about China and Chinese buyers seem to dominate the en premieur for the 2009 vintage available from next year. In fact Chinese mainland buyers are increasingly pricing out buyers from Japan, Taiwan and Hong Kong in the quest for 'first growth' wines.

French wine is, of course, different from a Louis Vuitton bag. When you drink a bottle of wine, it is gone. You can store it as an investment, but the process is complicated and costly.

For most Chinese, investment is actually a secondary consideration. Drinking it now is more important. Yet this seems inconsistent with the dominant Chinese preference for accumulation. So the question is, why so much demand from China?

Like Japan in the 1980s, an important factor seems to be the need to lubricate business relationships. This phenomenon plays out across the world during rapid economic development. Successful economic development may require a little intoxication – when one sinks a lot of money into an under-developed economy, it needs courage.

The business drinking culture has been changing in China. Like elsewhere, liquor consumption (like baijiu) has been declining out of health concerns. So the need for alcohol in business entertainment has produced a unique Chinese phenomenon: massive demand for Chateau Lafite wine. Lafite is one of the five first growth wines from Bordeaux. France classified Bordeaux wines into first to fifth growth in 1855 for its World Expo. At that time four chateaux – Lafite, Latour, Haut Brion, and Margaux – were classified as first growth. In 1975 Mouton also qualified. The chateaux in some of the Bordeaux areas like Pomerol and St. Emilion do not participate in this classification system and have started their own, with some of their wines even 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 on a life of its own, rising much quicker than the fine wine market as a whole, and other first growth wines in particular. For example, 2000 vintage Lafite 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, and the price of its same vintage has risen roughly in line with the overall market. The price differentials between Lafite and other vintages of first growth wines are not as dramatic as for the 2000 vintage, but they are still large. Something special has happened to Lafite these past few years. That something is China.

Essentially, Lafite has become the unofficial Chinese wine for business entertainment. There are theories as to why, the most popular being that the Chinese translation is easy to say and sounds nice. I am not sure this is the best explanation. Drinking at business events in China is not really sophisticated; it is more about getting tipsy quickly. Guests are expected to be impressed by the price of expensive wine, and not the taste.

Is the Lafite phenomenon a bubble? As Greenspan has said, one can never be sure if a bubble exists until it bursts. It is possible that Chinese drinkers appreciate something in Lafite that other drinkers never did. Hence, as Chinese become richer and spend more on wines, Lafite benefits from this source of demand more than others. So the Lafite phenomenon may actually be a price revaluation, rather than a bubble.

An alternative scenario could be that other first growth wines will get the Lafite treatment over time. Chinese demand for Lafite is due to lack of knowledge about alternatives, so when Chinese drinkers become more sophisticated, the demand for other first growth wines will probably increase. This could be a rising tide that will gradually lift other fine wines.

The second scenario is possible, and it has to do with the French system for wine production and the laws that make it impossible for the great wine chateaux in Bordeaux to increase production. Bordeaux wine producers have to go for quality and high price rather than quantity. Hence, when a new source of demand comes, the price always goes up.

Indeed, the Lafite price is now so high that it has led to a large counterfeit industry. Some analysts estimate that 70% of the Lafite consumed in China is fake. I have personally experienced this on a few occasions, although the people who served me fake Lafite were unaware of its questionable provenance because they paid the same high price fetched by the genuine article. I could tell that the fake was good wine too, probably a good second growth poured into a Lafite bottle. Forgers have targeted the legendary 1982 vintage in particular. Many wealthy Chinese have bought large stocks of 1982 Lafite and the odds are most of it is fake. There are so few bottles of the real vintage left that it is highly unlikely to find several cases of the real thing.

When the Chinese economy matures in ten or 15 years and business entertainment declines in importance, Lafite prices may come under pressure. At this point demand will be mostly for self enjoyment and hence, more price sensitive. Japan has already gone through such a cycle.

A market is efficient when informed consumers make rational choices. An efficient market motivates producers to improve quality and control costs and this cycle leads to great brands that last.

The French wine market was like that, but I am afraid that Chinese demand is decreasing the market efficiency and may bring down great brands over time. When winemakers see prices resulting from propaganda, not quality, they will focus on marketing and decrease their investment in 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.

One of the hottest topics now in China is the fast rising wage of migrant workers. The recent news came that wage in China’s manufacturing sector nearly on par with Mexico.

I have dealt with the same issue a few times in the past, such as post here, and here.  In my view, the rising wage is not to be afraid of – most people are worrying about China losing its competitive edge to other developing countries.  However, the development experience of most East Asian countries proves that the rising wage is a great force to incentivize firms to upgrade their technology and pushes the country out of its current low-value-added industries, into the industries with more technological component.  This is good news for both Chinese workers and China's long term growth.

Fan Gang, professor of economics at Beijing University holds the similar view. He even doubts the supply of cheap labor has been drained out. There were many factors in the past few years that have had impacts on the supply of Chinese migrant workers.  Here I list a few, 1) agricultural subsidies; 2) sharply increasing investment in western provinces; 3) the effect of one-child policy started to play; 4) a positive income shock from selling land to governments and real estate developers and coincides with Chinese housing bubble.

Economist Magazine also runs a similar analysis. Here I include a couple of interesting charts.

Chad Bown of Brandeis' economics department goes to White House and serves as sr. economist on President's Council of Economic Advisers (or CEA).  Chad is a no non-sense trade economist.   I am happy for his appointment.

The new CEA will be headed by Austan Goolsbee. And here is the video interview of Brandeis’ Cathy Mann on this change of President’s economics team.

Recent research by Vernon Smith et al. shows "all the postwar recessions and the Great Depression leads to the following empirical proposition: If there is no recovery in housing expenditures, confirmed by a recovery in consumer durable goods expenditures, then there is no economic recovery."

In the Great Depression and in every recession since, recovery of residential construction has preceded recovery in every other sector, and its recovery has been far larger in percentage terms than the recovery in any other major sector.

Applied to the Great Recession, it appears that those who see signs of a recovery may be grasping at straws. What one should hope is that this time it is different from every one of the past 14 U.S. downturns, but those who believe this have the weight of past experience against them.

We looked at all the major expenditure components of Gross Domestic Product in percentage deviations from their levels in the fourth quarter of 2007, officially declared as the start of the Great Recession by the National Bureau of Economic Research.

The onset of and decline during this recession were like previous recessions, though its course has been deeper and longer. By quarter four of 2007, sales of new homes had fallen without interruption for nine straight quarters and expenditures on new residential construction had fallen for seven quarters—strong lead time signals of the looming distress. New home sales recovered briefly in 2009 but have now declined for three quarters. Residential construction expenditures have essentially been flat for five quarters. Consumer durables spending at best has stabilized, up slightly from its low in the fourth quarter of 2008.

The average increase in new residential construction in the first year following the previous 10 postwar recessions has been 26.3%. The largest increase in residential construction followed the 1981-82 recession, when it increased 75.5% as monetary policy was relaxed. In the past year, residential construction has increased 6.3%. This is the slowest rebound in residential construction in any sustained recovery from a postwar recession.

No currently debated policy will likely change this situation, as the market is saturated with foreclosed houses and homeowners suffer from $771 billion in negative equity. This fact needs to be confronted: We are almost surely in for a long slog.

Link to the full text of the research paper