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Perspective: OK, It's Officially "If"

08:28AM Nov 26, 2014

Try to think of the last time you heard an ag economist or banker say the words, “It’s not if interest rates go up, it’s when.” That shouldn’t be too hard. Near as I can tell, those professions are incapable of not saying it during any conversation or speech.

Those confident statements make the old joke look wise. There are two kinds of economists—those who can’t predict interest rates and those who don’t know they can’t predict interest rates.

Consider this awkward fact. The prime rate has not gone up since July 2006. It is celebrating its sixth anniversary at 3.25%. Piling on, the earliest that bond investors see at least a 50-50 chance of a bump upward is the end of 2015.

Relentless predictions of rising rates violate the Phipps Rule of Economic Predictions—if it hasn’t come true in two years, it’s just wrong.

Let’s dispense the idea that interest rates are controlled by the Federal Reserve. The Fed does influence short-term interest rates, but bond buyers bid yields up or down to determine medium- and long-term rates.

Many disagree, but this is mostly scapegoating to grapple with a phenomenon that has us stumped.

The unwavering conviction that interest rates are about to skyrocket is rooted in a belief the future will look like the past. The next time is never different; we just have to force the facts to fit patterns we know. Yet, enough time has passed without significant inflation (less than 2% for more than 20 years) to at least question the idea rates must rise.

Another fallacy is “the only direction they can go is up.” Actually, there is another path. Rates can simply not change. The longer flatlining continues, the more we should question some core beliefs about free markets. Why aren’t interest rates rising as our economy grows, albeit slowly?

One reason is median wages are declining as GDP rises. Virtually all income gains accrue to a small percentage of top earners; there hasn’t been a healthy expansion of demand for goods and services. Meanwhile, demand has grown for assets to invest in, exacerbating the interest rate doldrums. 

Interest Rate Lull Poses Challenges. Now inject the growing suspicion among economists that long-term stagnation might be more likely than originally imagined. The globalization of labor, shifting consumption patterns and plain old discouragement are prompting consumers’ caution. The decline of mid-wage manufacturing jobs—often thanks to automation—and the shift to a low-wage service economy adds more demand shortfall.

I see a fragile, lopsided global economy with increasingly fewer mechanisms to get money into the hands of people who spend rather than invest. There is little political will to arrest this trend. 

It might be prudent for farmers to consider what it means if rates stay historically low for decades, as has happened in Japan. If money only earns 2% in a 10-year bond, other assets could earn lower yields. In fact, why should farmland owners expect a 4% to 5% return? That rule of thumb is largely driven by competition with other assets’ returns. In a world of secular stagnation, $10,000-per-acre land could rent for $200 per acre. 

Rents are determined residually from gross profit left over after extracting essential production costs. With the strong pricing power of inputs such as seed and fertilizer, rents could shrink. This could pull land values down, as most expect, or drop to a new “normal” level of return-on-assets on land, as I predict. Call it the Two Percent Solution.

Of course, there are two kinds of farmers, too, those who can’t predict land prices and…