Will the ag 'boom' bust soon?
Farming's a business of booms and busts. Each period of prosperity is followed by a downturn, some sharper than others.
The last few years has been pretty good for a lot of U.S. farmers -- crop prices are solid, grain demand is strong, interest rates are low and overall farm incomes are healthy. But, what goes up must come down, right? If the last century or so of history holds true, that would mean the current "golden era" will inevitably fade.
Will that happen this time around? There are a few reasons to believe the "bust" may not accompany the boom underway, at least not immediately, says Federal Reserve Bank of Kansas City Omaha Branch Executive vice president Jason Henderson.
"In many respects, today’s farm boom is quite similar to past eras of farm prosperity. Global demand for agricultural products is strong. Agricultural supplies are tight. Low
interest rates are supporting the capitalization of rising incomes into farmland values," Henderson says. "Still, farmers have yet to use debt to pay for investments in land, equipment, and machinery on the scale of past farm booms."
There's been a lot of volatility in farm profits in the last decade; Henderson says in 4 of the last 10 years, net farm income has jumped by more than 25% and in 3 others, income's been 20% lower in the Fed's Kansas City district. Despite that, farm profits have surged based largely on crop and livestock demand, especially from exports.
"Spurred by rising incomes in developing countries, such as China, U.S. agricultural exports could reach a record high in 2011, topping $130 billion, double 2005 levels. Heading into the fourth quarter of 2011, crop and livestock exports jumped more than 35% and 25% above previous year levels, respectively," Henderson says. "Projections of additional gains in both population and income in developing nations underpin bullish expectations for agricultural commodities into the future."
As a farm profit driver, look for this factor to continue as both population growth and grain stocks tightening continues.
"Combined with robust demand, world grain supplies have fallen to historical lows with U.S. corn supplies at less than 10% of its annual use. In the livestock sector, global meat production has struggled to keep up with world demand, and prices for cattle, hogs, and milk have soared to record highs," Henderson says. "For U.S. producers, the prices received from crop and livestock products have risen more than 35% and 17%, respectively, over the past year."
Interest rates and land values
Coupled with this strong grain demand, low interest rates are translating directly to high farm land values. That alone would normally be a reason to fear the bursting of the farm profit bubble. But, one thing that's different during this boom cycle is the amount of debt accumulated to make the increasingly expensive capital purchases on the farm, Henderson says.
"Despite the similarities in broader market and financial conditions, farm capital investments are a striking difference between current and past farm booms. In contrast to past farm booms, non-real-estate investments in agriculture have not soared to the highs of previous farm booms. In addition, farmers have not used debt to fuel their capital investments," Henderson says. "Unlike the 1970s, farmers today
have been more restrained in their capital investments. To be sure, capital expenditures have risen sharply, but they have increased at roughly the same rate as farm profits. The ratios of farm capital expenditures to net income remained stable over the past 2 years, as it has, over the past decade."
This, to Agriculture.com Farm Business Talk veteran contributor kraft-t, is the biggest difference between past boom-bust cycles and today, and will continue to be if farmers take today's profit levels in perspective.
"Those with a lot of debt can service it at present rates. The last time we had onerous interest rates and declining asset values," he says. "Operating capital declined for many operations which diminished asset values as more land and equipment came to the auction block.
"I suspect the high prices for land and rent will be self destructive for some farmers and it could happen sooner rather than later."
More debt ahead?
If the boom's going to turn bust in the near future, it will be debt that does it. So little debt and strong farm profits right now could add up to an increase in debt load in the future as more farmers start to capitalize further on their strong financial footing.
"A lingering concern, however, is whether farmers will limit their capital expenditures and debt in future years. Agricultural advocates often tout that rising populations and a burgeoning middle class in developing nations will drive additional demand and profits for agriculture into the indefinite future," Henderson says. "These expectations combined with historically low interest rates could ultimately entice farmers to expand their capital investments to seize emerging opportunities."
Generally, though he's not counting out a slowdown in the ag economy in the next year or 2, Henderson says the current debt situation will likely keep the current "golden era" intact longer than those preceding it.
"Many farmers have not used excessively high levels of debt to finance capital investments. History has shown that golden eras fade and that farm corrections devolve into farm busts in highly leveraged environments."While current conditions appear to be following the rhythms of the past, there is at least one distinct difference—capital investments," he says. "With rising incomes and low interest rates, farmers are making significant capital expenditures on equipment, machinery, structures and land improvements."
Adds kraft-t: "Hopefully most operations are not over-borrowed, as banks and borrowers should have learned from the last go-round."