Ag's Boom Cycle Facing Rough Waters

This Business of Farming

Demand destruction, other economic factors may bring end to glory days

Published on: June 21, 2013

Look back at the past five years or so and savor the memories. Unprecedented prosperity for agriculture may be coming to an end, at least for a while.

The latest sign that this is the end of a golden era happened this week when the U.S. House failed (again) to pass a farm bill, leaving agriculture facing more uncertainty, at least in the policy arena.  And by that I mean risk management tools.

While it's easy to look at proposed cuts in food stamps as the main reason why support for the house bill fell through, let's not also forget the growing number of fiscal hawks who see crop insurance subsidies as unnecessary in these days of agriculture prosperity.

"For me, the boom ends when interest rates rise," says economist Jason Henderson.
"For me, the boom ends when interest rates rise," says economist Jason Henderson.

Ironically – and isn't everything coming out of Washington these days ironic? - we could see cuts in that key risk management tool just as farmers begin to need that safety net most.

Okay, that's just one piece of the puzzle. Consider the demand destruction taking place due to the 2012 drought. End users are finding other ways to meet their needs, leaving a potential reduction in corn demand just as drought eases (at least in Eastern Corn Belt) and a good crop appears to be in the offing. Higher prices cooled export demand. The heat caused cattle herds to be liquidated, and that takes time to rebuild.

Of course it's early, but a good crop this fall coupled with curtailed demand will lead to a margin squeeze we haven't seen in years. Typically costs lag revenue when farm economy gets bearish. Landowners rarely ratchet back rents - period. There will be a lot of negotiations going on this fall and some farmers will be forced to give back land that no longer pencils out.

Next, watch land values. Could land values continue growing at a 15% clip? As land values soften, assets shrink and lenders get nervous. Financing may come under greater scrutiny.

As senior editor Bryce Knorr points out, in times of economic weakness stock prices retreat; inflation is tame, giving the Federal Reserve room to lower interest rates. As the economy strengthens interest rates will rise as the fed tries to manage the rebound and help the economy achieve a 'soft landing.'

For farmers, the turn to higher interest rates means it's crucial to fix interest rates and make sure all debt is properly structured to match the life of the asset to the term of the loan.

In fact, a combination of weaker land prices and higher interest rates could signal the end of the golden era says Jason Henderson, Purdue extension director and former vice president at the Kansas City Federal Reserve. "At today's prices you can justify $10,000 per acre farmland. But what if prices drop to $4.60? It's worth closer to $7,000 land," he says. "With higher interest rates at some point in time, you're looking at farmland values falling dramatically.

"For me, this boom ends when interest rates rise, which tend to push up the value of the dollar, slow exports, and trim capitalization of higher incomes and farmland values," he says.

Other fundamentals

Fundamentally, the major forces of super cycles are demand, supply and leverage. Demand destruction is one factor to consider. Think also about growing world supply. As Henderson points out, higher grain prices bring more farmers and acreage into play. How much more is a factor of water, resources and production costs.  

Another stall point: ethanol. The biofuel industry will probably not go away, but how much more growth is there beyond 15 billion gallons annual usage, especially when ethanol is up against a blend wall at 10%? Fuel usage in the U.S. is declining thanks to better vehicles and the slower economy.

"Farm booms always end, and how they end is the concern," says Henderson. "Are you looking at a 1980s scenario or 1940s?"

Most important: what are you doing to manage the risk?