The Puzzle of Carruades de Lafite

Ten years ago I wrote that, whenever China buys, the price will go up and, whenever China sells, the price will go down. I recently modified the second half of that to, whenever China sells, the price will go up too, because I expect China's factory wages to quadruple over the next decade.

The slogan is a play on China's size. In economics, most observations are based on small perturbations to a complex system. For example, when a small country joins the international trading system, economists estimate the impact on the country's economy based on price convergence with international prices. When a large country like China joins the global trading system, the impact is felt both ways. In some areas, like natural resources, for example, China's impact dominates, hence, the change of relative prices for everybody.

One area that I believe China will have a great impact on in the future is the luxury market. The strong preference for "famous Pands," much like in Hong Kong and Taiwan, has now begun to exert a surprising strength as the size of wealthy consumers grow in China. When one treks through luxury shops selling watches and bags in Europe, almost all have Mandarin-speaking salespersons.

There are clearly different degrees of preferences for luxuries among different nationalities, even when one controls for all economic variables like income, age or family size. One important factor is what economists call the discount rate. It measures how much one wants to be paid for deferring consumption. Long-term interest rates are supposed to measure this factor. But, with a global capital market, money flows around the world to arbitrage interest rate differences. In addition to this, central banks inflate the supply of money to stimulate the economy. Interest rates no longer reflect the differences in consumption patience.

The discount rate can partly explain the global imbalance. President Obama has been putting pressure on China to appreciate its currency, in an aim to decrease the U.S.'s trade deficit with China. But I seriously doubt that this will be effective. You need only to glance at the differences in spending behavior between Americans and Chinese in Paris. Apart from Europeans, these two nationalities probably dominate the tourism market in Paris. Americans cut their travel in 2008 and '09. But now they are back in Paris with a vengeance. Some have said Americans rushed over to benefit from the euro devaluation, rushing to Paris for a bargain.

The problem is that Americans are deep in debt. Why should they bother if visiting France has become a bit cheaper? They should be saving money to pay off their debt. But, Americans are in Paris for a good time again. They stay at nice hotels, drink good wine, and eat expensive French food.

On the other hand, Chinese tourists go in groups, stay in cheap hotels, eat instant noodles and then spend ten thousand euros on an LV bag. I disagree with the choice. LV bags are sold almost exclusively to the Chinese and Japanese, believing it is a prestigious luxury Pand. In fact, the product has been designed to profit from Asia's misunderstanding of western luxury.

My view on LV bags is beside the point. The main point is that Chinese leave with something that will last, while Americans put everything in the stomach. This fundamental difference in behavior won't change with a yuan revaluation. If the yuan goes up, it will benefit LV sales, not American exports.