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Are Black Swans on the Horizon?

September 6, 2012
By: Ed Clark, Top Producer Business and Issues Editor
p12 Are Black Swans on the Horizon
  
 
 

History suggests agriculture is destined to cycles

Since 2008, corn and soybean producers, for the most part, have enjoyed a Cinderella run. After three years of record corn prices, this year was supposed to be a correction year, with prices near $4 per bushel. Then one of the worst droughts since the Dust Bowl occurred and there’s talk of $9 corn before it’s all over.

The fairy tale can’t last forever, right? Will black swans emerge on the horizon that suggest this boom cycle, the fourth in the past century, is about to bust?

"History has told us that the golden eras of agriculture often turn into fool’s gold," says Jason Henderson, economist for the Federal Reserve Bank of Kansas City. To examine the instigators behind the ag boom and try to determine if this round is different, the Kansas City Fed recently held a symposium for a sell-out crowd of bankers and industry leaders.

The good news is, not a single speaker predicted a bust in the ag economy, although most have income and debt concerns moving forward. The same factors continue to drive the boom times: Chinese demand, exploding ethanol use and low interest rates. The bad news, and what makes this cycle different, is that every factor is driven by politics: Chinese import decisions, the ethanol mandate, interest rates and the strength of the dollar. Policy, like the weather, is hard to predict.

Chinese Imports. Enter the first potential black swan. Europe could fall into a dark recession, which would throttle imports of Chinese goods and impact imports of U.S. ag products, noted Mike Boehlje, ag economist at Purdue University.

If Europe stumbles and investments flow into the safe haven of the U.S., a stronger dollar could result, increasing the cost of grain to global buyers.

Chinese economic growth is projected to moderate to 5% to 6% by 2025, according to one estimate.

"In China, 5% growth is equivalent to a recession," Boehlje said at the symposium. That’s not good news for the farm sector.

Others disagree. "A slump in China’s growth would mean that the Chinese Communist Party would be more willing than ever to pay whatever it takes to keep ag imports coming in to avoid public unrest," said William Hudson, principal, the ProExporter Network.


Golden Eras in Agriculture: U.S. Corn Prices and Farm Real Estate Values

p18 Are Black Swans on the Horizon Chart



Low Interest Rates. Black swan No. 2., Boehlje said, is that while present low interest rates go a long way to separate the current agricultural boom with past ones, they won’t last forever. Once the U.S. economy improves, the Fed will likely tighten its monetary policy to make sure inflation does not raise its ugly head.

"We have the potential for farm debt problems if there is a rapid reduction in incomes and if over the next two to three years, we see rising interest rates," Boehlje said. "Put the two together and we might get something not dissimilar to the 1980s. I’m not worried about next year, I’m worried about 2013/14."

The Same but Different. What’s different from the 1970s and early 1980s is that farmers are in much better financial condition, so they’re better able to withstand a correction, said Clayton Yeutter, former U.S. Trade Representative and Secretary of Agriculture. Today, the U.S. is an export kingpin, further separating this boom from earlier ones. As late as 1968, U.S. agriculture was exporting only $10 billion worth of products and commodities. This past year, the figure was $140 billion.

What worries Yeutter is the level of euphoria among crop producers. "When there is euphoria, things can get out of line with reality," he said. Case in point, the 1970s. "A correction is in order," Yeutter added.

While many farmers think lower debt this time around will spare the industry from a disaster, that’s not the necessarily case. According to Allen Featherstone, an economist at Kansas State University, in 1979 his state’s debt-to-asset ratio was 24.6%, but was higher in 2010 at 26.8%.
"We have higher leverage now than in 1979," Featherstone said.

"The financial situation is better than eight years ago, but not so much better that we have removed all of the risk."

Despite all the talk about low interest rates, Featherstone said, the real cost of money now—factoring in inflation—is actually 4.67% compared with 2.4% in the 1970s. "Money isn’t quite as cheap when you adjust for inflation," he added.

Profit Perspective. Hudson is bullish on crop prices and income. His long-term projections call for corn prices to moderate but remain at profitable levels to 2021, near $5 per bushel most years. He believes demand from ethanol and China will hang tough. Most costs will increase appreciably, however.

Hudson forecasts net return over total costs for crop producers to go from $33.3 billion in 2011/12 to $14.4 billion in 2014/15 and to $6.4 billion by 2020/21—still black ink every year, though.

What do farmers think about the future? Brent Gloy, an economist at Purdue, asked a group of Indiana farmers if they think agriculture is in a bubble. Of those who actively operate a farm, more than 50% said they believe that farmland prices are in a bubble.

His research also found no relationship between farmer expectations for corn prices and farmland values. Respon-dents estimated the average corn price for the next five years to be $5.41, although the distribution was all over the board. In other words, farmers are more optimistic about corn prices than most economists and USDA.

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FEATURED IN: Top Producer - September 2012

 
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