Shocks, Interest Rates and Implications for Farmers
August 15, 2011
Debt crisis in Europe. Debt downgrade in America. Tsunami in Japan.
And this just scratches the surface. Add political upheaval in the Middle East. Floods along the Mississippi and Missouri rivers. Drought in Texas.
And still the list is incomplete. I won't go on, because the point is clear: We've had more earth-shaking, market-moving shocks in 2011 than we've had in some past decades. Is it any wonder financial markets, including ag-commodity markets, have been in turmoil?
If there's a silver lining for farmers and ranchers, it's the prospect of continued low interest rates. Only a few months ago the smart money was on rates rising later this year or early next. Economists were predicting a pickup in economic growth that would force the Federal Reserve to begin pushing short-term interest rates up.
Hardly anyone thinks that now. Buffeted by the year's shocks, the economy is barely growing and leading indicators are pointing to slow expansion at best for the rest of the year. Consumer and small-business confidence languishes. Housing languishes.
Inflation is a tad higher than the Fed would like, but with unemployment still above 9%, workers have no bargaining power. There's little risk of that scary scenario in which price increases beget wage increases which beget further price increases as inflation spirals out of control.
Interviewed in late July, Ross Anderson of AgriBank thought short-term rates would stay low until 2013. His opinion matters because he's the chief credit officer for one of the Farm Credit System's largest district banks, with a territory stretching from Ohio to Wyoming and from Arkansas to North Dakota. AgriBank has skin in the game.
My colleague Marcia Taylor and I talked with
Anderson before U.S. government debt was downgraded, and with it the bonds of the Farm Credit System. But it isn't likely those events will undermine Anderson's forecast. The immediate, counterintuitive reaction was a decline in yields on 10-year U.S. Treasuries.
There could still be a bit of an uptick, especially if other ratings agencies follow Standard & Poor's. But after the downgrade, Anderson's view got a boost from a body whose opinion matters even more -- the Federal Reserve Board. At its latest meeting, the Fed made an unusual long-term forecast of low short-term rates "at least through 2013."
Whatever else can be said about it, that's good news for farmers and ranchers. More good news: Anderson told us he sees high grain prices, tempered by high volatility, continuing for another two to three years. Add it all up and "It's very hard for me to see a problem in the grains sector for at least two years if not three."
But that doesn't mean AgriBank is letting down its guard. As Marcia has written in some detail and with great authority in her blog (http://bit.ly/…), Anderson has directed local credit officers to dig into the ability of 5,000-acre to 15,000-acre farmers to repay loans.
Because many of these farmers are renting 80% of the land they work and paying landlords $300 an acre and up, he worries they could swing from big profits to big losses should grain prices head south. Crop insurance only protects them for a year, he noted, while leases are often for three years.
This is not a rehash of "farmland bubble" phobia. Anderson isn't worried about land prices as much as he is about rents. He distinguishes between "financial risk," which is what felled farmers in the 1980s who had borrowed too heavily to buy land, and "operating risk," which is what he worries could fell today's big-acre renters. The renter is in some ways of greater concern to a farm lender, as there's often less-tangible collateral behind his loan.
Whether low interest rates continue beyond 2013 hangs on the state of the economy. In the wake of the 2008 financial crisis, consumers are still trying to pay down debt. They're spending less so the economy isn't growing as fast. Economists warn that this "deleveraging" can take seven years or more. This isn't a recession, says Harvard economist Kenneth Rogoff. It's the "second great contraction" (http://bit.ly/…). The first occurred in the 1930s.
If Rogoff's right, the Fed will be under pressure to open the monetary spigots further. With Uncle Sam, like consumers, needing to pay down debt, there's less scope in the years ahead for fresh fiscal stimulus, and while the Fed, too, has fired most of its bullets, it has at least one left. It can do more "quantitative easing," a bond-buying exercise that boils down to printing money.
You can imagine the rationale. It will stimulate a weak economy, some will say. It will weaken the dollar, boosting exports. It will ease the burden on debtors, including the government itself. Sure, it will come at the expense of inflation, but a little inflation won't hurt, will it?
The Fed's inflation target is 2% or less. Some economists, including Rogoff, are already saying we need 4% to 6% inflation to get the economy moving. They haven't carried the day yet, and they may not.
If they do, though, the question will soon become whether we can have higher inflation and low interest rates at the same time. Because inflation erodes the value of bonds, it tempts investors to sell them. If enough do, interest rates will rise whether the Fed wants them to or not.
In other words, if 2014 brings a great inflation shock, an interest-rate shock may not be far behind.
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As always I welcome your feedback on this letter and your suggestions for how DTN might serve you better.
Urban C. Lehner
Vice President, Editorial
DTN/The Progressive Farmer
office: 402 399 6440; cell 402 301 6143
Follow me on Twitter: www.Twitter.com\urbanize
Source: Urban C. Lehner
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