Work Down Debt Now

October 30, 2009 09:02 AM


As harvesttime comes to an end and our thoughts shift to next year, one particular lesson, actually from summer 2008, stands out in my mind: When producers had the opportunity to sell corn two years into the future for historically high prices, they didn't because they didn't know what their costs would be.
As a result, the first way producers can improve their long-term marketing plan is to control input costs. The key is realizing that prices are cyclical and using the highs and lows to prepare for the future. Right now, two major areas of long-term exposure are near historically low costs. The first is interest rates and the second is natural gas, used to produce anhydrous ammonia or nitrogen.
Let's focus on interest rates. The big question is, How much longer will the Federal Reserve continue to support historically low interest? For perspective, let's look at what's behind their decision making. First, they have implemented policy to keep interest rates low in order to reliquefy the banking sector. By keeping the discount window cheap, banks can borrow money from the government and then loan it to the public to replenish their margins—but it's going to take some time.
The second reason interest rates will stay low is because of the government's massive spending. Essentially, the government has been forced to aggressively spend money to replace the major reduction in consumer spending and stabilize the economy. Since the government spending is based on short-term, rather than long-term, rates, its bias is to keep rates low. Granted, the Fed is supposed to be independent of political pressure, but it still exists.
The situation. The government continues to pour money into the economy to offset the lack of consumer spending. In the meantime, consumers continue to contract their spending and save more to reduce debt because of the continued uncertainty about employment. When jobs are lost, reduced tax revenue is available to the government, which forces it to borrow more money. This is a dangerous pattern that any person with common sense realizes cannot go on indefinitely.
The question that's now starting to develop is, What's the endgame? How does the Fed ease up on the gas pedal? If it lets interest rates rise too quick, it could possibly kill the economic recovery at the same time it's starting to get traction. On the other hand, if the Fed waits too long, it could cause an overstimulated economy that would require a drastic increase in interest rate in order to cool off. Anybody remember the early 1980s?
Which way will they go? I have no idea what the Barack Obama administration will do, but my gut tells me it's all about politics. Right now everybody is more worried about deflation than inflation. We must keep housing and commercial loan values firm on the banks' books or everything goes up in smoke.
An important political lesson was relearned in 2008: If you're the party in power and you allow fuel prices and food prices to explode before a primary election, you are going to pay for it in the end!
So what is my point? The potential of a major economic meltdown has been avoided, but we are now hooked on the cure. The longer we take to wean ourselves off the drug, the worse the withdrawal symptoms will be. It is human nature to avoid pain; we all want jobs right now regardless of the future inflation pain we'll suffer.
Recommendations for producers: I believe you have two to three years to work down your debt load before interest rates start to creep back up and are a real risk. Now is the time to pay off loans. Convert existing debt from variable to fixed. Lock in long-term rates by being short 10-year notes or 30-year bonds.

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