The lowest interest rates in history, coupled with growing worldwide demand for commodities, have been a boon to American farmers at a time when much of the rest of the U.S. economy has been in the cellar.
But what happens when those near-zero interest rates start rising? How much a factor will inflation be as massive amounts of liquidity flow into the economy?
“One of the unique things about today’s situation, says Brian Briggeman, “is that at the same time the Fed has dropped interest rates to zero, they’ve also pushed historical amounts of liquidity into the marketplace.
“During normal times, before the financial crisis and recession in 2007, the Fed’s balance sheet normally had about $800 billion of assets. Today, it’s at $3 trillion, and continuing upward. It has nearly quadrupled — a massive amount of liquidity, such as we’ve never seen before.
“At some point,” says Briggeman, associate professor and director of the Arthur Capper Cooperative Center at Kansas State University and former economist with the Federal Reserve Bank of Kansas City, “all that liquidity is going to have to come out, and we’ll have to return to a more stable environment.
“What matters is the sheer size of the liquidity,” he said at the Mississippi Farm Bureau Federation’s joint soybean, corn, wheat, and feed grains advisory committee meeting at Grenada, Miss. U.S. banks normally would have about $50 billion excess reserves sitting in the Fed’s coffers, he says. Today, they have about $1.5 trillion on the Fed’s books.
“Banks make money by making loans — that’s their bread and butter. At some point, that ton of money that’s just sitting on the sidelines is going to flow out. That is relevant to us in agriculture because of the potential for inflation and rising prices, and the way the Fed flights inflation.
“A rapid rise in inflation occurs when too much money is chasing too few goods. What drives inflation is the quantity of money, the velocity of that money, and the quantity of goods. When we have tons of liquidity, as we do now, it starts economists asking if we might have hyper-inflation. We’ve worked off a lot of goods inventory, we’re coming off one of the worst recessions we’ve ever had, and we’re in a slow growth period
“In the 1970s, when we saw prices shoot up, inflation tended to be good for agriculture in the short term, but a challenge in the long term. The challenge is in the way the Fed fights inflation. In the mid-1970s, interest rates got insanely high — 18 percent, and some home loans were 22 percent. Think about how that could hamper our ability and competitiveness in the global marketplace and how it could depress our farm incomes.”
Very low inflation environment
The stage is set for this to become a topic of discussion, Briggeman says. “No matter what measure you use to calculate inflation — whether you include energy and food, or whether you strip them out — today we’re in a very low inflation environment. In fact, some might argue we’re continuing to battle deflation, the falling prices of goods and services. That’s what’s motivated the Fed to pump a lot of liquidity into the marketplace — to avoid deflation, which is terrible and can really wreck an economy.”
The Federal Reserve Bank of Cleveland has analyzed many components of the economic outlook, he says, and has developed inflation expectations for 10 years out. “They project inflation as exceptionally low, and the market is telling us inflation is not going to be an issue going forward. Of course, the market has been wrong — it told us sub-prime loans were OK.
“So, the question is if this will indeed be slow and steady inflation that’s kept under control? That’s largely what [Federal Reserve Chairman] Ben Bernanke says when he speaks for the Fed.
“When we look at all that money sitting on the Fed’s books and couple it with U.S. businesses with $2 trillion in cash sitting on their balance sheets, there’s a lot of liquidity that at some point is going to flow into the marketplace.
“The question is, can the Fed unwind their balance sheet in a way that does not (1) push us back into a recession, (2) create uncertainty, and (3) send global markets spinning out of control? Or can we actually realize the slow and steady pace the market is expecting? The market is saying the Fed will be able to do this in a straightforward manner that won’t adversely affect financial markets.”
Assuming the Fed can unwind all those assets in an orderly way, that will mean higher interest rates, Briggeman says. “If you’re going to incentivize people to purchase assets off the Fed’s balance sheets, interest rates have to rise.
“For those in farming, two key questions become: How are you going to position your business under that kind of environment? And how do you need to set yourself up to operate and be successful in such an environment?
“Supply and demand drives a lot of what we do in production agriculture. The ultra-low investment rate environment has helped boost farmers’ net income and stimulated interest in investing in agriculture. But, what happens when that begins to unwind, we maybe have inflation, and interest rates start to rise? The Fed’s exit strategy, pulling out of this market, will be tremendous and will have broad ramifications, not just for agriculture but other industries as well.”
Driven by strong crop profits in 2012, inflation-adjusted net farm incomes remained near historically high levels — the highest since 1974, Briggeman notes. “Net farm income in 2011 and 2012 was exceptionally high, and 2013 is expected to be even better.
Two types of agriculture
“But, dissecting 2011-12, it was a tale of two types of agriculture: crops and livestock — and the income picture depends on which sector you were in. High grain prices benefited crop producers, but livestock producers were hurt by high feed costs that slashed profits.
“In 2013, USDA is projecting another banner year for net farm incomes, higher than 2012; they’re expecting plantings fence-row to fence-row, with good yields. This would benefit everyone, especially livestock, with stronger grain supplies helping to bring down feed costs.
Corn prices tell much of the story of what has happened for crop and livestock producers, Briggeman says.
“We’re nowhere near the real dollar highs we experienced in the 1970s, when we found out Russia was going to be coming into our marketplace — that had a profound effect on commodity prices, with corn reaching $12-13 per bushel on a real dollar basis.
“We’ve had productivity gains since then, which have helped to limit price, and we haven’t seen the exceptionally high prices of the 1970s. During the 1970s, we also had a lot of inflation, with rising prices for goods and services. Might we see some 1970s-type forces that would bring a surge in commodity prices today?
“When we look at where we are today, on the corn side, we can look at it as an opportunity or a headache. The high prices offer opportunities to lock in profits, but the headache of up-and-down market oscillations makes it difficult to decide when to lock in profits.”
The demand environment we’re in today is helping to bolster markets and provide solid commodity prices, Briggeman says. “Coupled with a growing global economy — not just from a population standpoint, but also from an income standpoint — there is a lot of opportunity out there that’s helping to make production agriculture a pretty appealing place to make profits.
‘But when we look at the livestock side, the picture changes quite a bit. Even in the near-term, it looks pretty tough.” Today, he notes, returns are significantly negative for Kansas City finished steers, “but high feed costs have limited profits across all livestock sectors.” Demand has also been significantly dampened.
“We haven’t seen U.S. consumers coming back to the meat counters.They continue to purchase lower cuts of meat, not buying the higher cuts of ribeyes, filets, etc., that drive a lot of the profits for livestock producers.
“As we project forward, we expect net returns to not be as negative, and to begin to return to positive territory over the next few months. But there are still a lot of questions: Will we actually see a bumper corn crop that will push feed prices down and ease the expense side for livestock producers? Will consumers come back to the meat counters and pull up the revenue side? We still aren’t seeing that happen, primarily because with the elevated unemployment rate and flat real wages, consumers just haven’t been buying.
“The livestock industry is strongly tied to the U.S. economy and its growth, but the health of the economy affects all of agriculture one way or another.”