Will This Time Be Different?
May 22, 2013
The Kansas City Federal Reserve just released a workpaper entitled "Farm Investment and Leverage Cycle: Will This Time Be Different?".
The article describes the four major farm cycles that have occurred since 1900. The first cycle begin in 1910 and ended in 1940. The First World War caused farm prices to rise dramatically which led to an increase in farmland prices. Once the great depression started, this increase in farm land prices was mostly wiped out and many farms went bankrupt.
The second cycle began in 1940 with the start of World War II and continued to until 1960. Real farm income tripled from 1940 to 1943 causing a resulting increase in land prices. However, unlike any other farm boom cycles of the last 100+ years, this cycle did not end in any type of bust.
The third cycle started in the early 1970s and ended in the late 1980s. With the rapid increase in crop prices due primarily to the US-Russia grain pact, farmland prices started to rise dramatically. There were other inflation pressures during this period that also help cause the increase. As prices rose, farmers continued to expand with more debt than was proved prudent. This led to the crash of the 1980s that really took at least 15 years or more to recover from.
This brings us to the latest cycle that started in 2005. Many factors led to increased crop prices (ethanol, China, etc.) and this cycle is still in process. The authors indicate that things still look good, but if there is a dramatic drop in land prices and if the debt to asset ratio crosses over 20% again (like the 1980's), then we will have a bust to end the cycle. However, if this ratio stays at 17% or lower, then we will not have a bust (similar to the 1940-60 cycle). The ratio (using their definition) is currently at 10% which is the lowest it has been since the mid 1950s.
The authors are not predicting a bust but are letting us know the parameters that may cause one. It will be important to watch these signals and be ready to respond accordingly.