Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. December 4, 2014 Jason Henderson Director of Purdue Extension Associate Dean College of Agriculture Is There a Wealth Effect In Agriculture?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. The Wealth Effect People have 2 ways to pay for spending. Incomes and wealth often move together. Income/Cash FlowsWealth/Savings

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. What are the side effects of the wealth effect? PercentBillions of dollars Calculations based on Federal Reserve System and Bureau of Economic Analysis data U.S. Household Debt

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Indiana Farm Real Estate Values 0 - $499 $500 - $999 $ $1999 $ $2999 $3000 and up $Dollars per Acre Constant 2011 dollars Source: USDA Farm profits and land values surge after 1972 Russian grain deal Farmers leverage the farm during the farm boom Federal Reserve raises interest rates in 1982 to fight inflation

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. A Farm Boom starting in $499 $500 - $999 $ $1999 $ $2999 $3000 and up $Dollars per Acre Constant 2011 dollars Indiana Farm Real Estate Values 1900 Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. WWI and the “Golden Era for Agriculture” boost farmland values. 0 - $499 $500 - $999 $ $1999 $ $2999 $3000 and up $Dollars per Acre Constant 2011 dollars Indiana Farm Real Estate Values 1920 Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Farmland values decline during the “Roaring 20s”. 0 - $499 $500 - $999 $ $1999 $ $2999 $3000 and up $Dollars per Acre Constant 2011 dollars Indiana Farm Real Estate Values 1930 Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. The Great Depression pushed down farmland values further. 0 - $499 $500 - $999 $ $1999 $ $2999 $3000 and up $Dollars per Acre Constant 2011 dollars Indiana Farm Real Estate Values 1940 Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Why Didn’t Land Values Rise with Corn Prices in the 1940s and 1950s? Dollars per acre (Constant 2011 dollars) U.S. Corn Prices and Farm Real Estate Values Dollars per bushel Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. What is the role of leveraging/deleveraging cycles in agriculture? Billion dollars (2005 constant dollars) Calculations based on U.S. Census Bureau and U.S. Department of Agriculture data deflated with consumer price index from the Federal Reserve Bank of Minneapolis. U.S. Farm Debt Farm Debt Soars 1910s: farm real estate debt. 1970s: farm real estate & non-real-estate debt Farm Debt Collapses 1940s: Deleveraging continues 1980s: Farm financial crisis

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. U.S. Agriculture is in Great Financial Health, but… Non-real-estate debt is on the rise. Percent change from previous year Source: FDIC, Call Report data Farm Debt Outstanding at Commercial Banks

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. How big will losses be in 2015?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Past Cycles Suggest a 5-Year Slump Since 1975, U.S. crop sector has experienced two downturns. – – A Five-Year Slump for Corn Profits Similar Path for other Crops U.S. Net Returns to Corn Production (Excluding Government Payments) Dollars per acre Calculations based on USDA Projected Prices and Yields and Costs of Production from Cost and Returns Data

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. The Outlook: A Liquidity Challenge for Agriculture, especially Crops. The Concern: When do Liquidity Problems turn into Solvency Problems?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. As Farm Incomes Fall, What Will Farmers Do? What is the storyline? – Insatiable demand Global population of 10 billion after 2050 Rising incomes in developing nations (China) – Limited supply Not growing anymore land How will farm investments shift? How will farmers finance investments?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. The Stages of Farm Investment Land Investments Equipment Investments Lifestyle Investments

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Farmland Value Gains Slow Chicago Federal Reserve Bank – Seventh District Dec. 2012: 16% year-over-year gain Dec. 2013: 5% year-over-year gain Oct. 2014: 0% year-over-year gain But, farmland fell 2% between July and October – Indiana Oct. 2014: 4% year-over-year gain

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Farm equipment sales begin to fall, but remain historically high Through August 2014, combine and tractor sales are 14.4% and 17.3% below 2013 levels U.S. Tractor and Combine Sales Unit Sales Source: Association of Equipment Manufacturers * Estimated based on sales through June 2014

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Family Living Expenses Have Increased Substantially Source: Compiled from Kansas Farm Management Association Executive Summaries

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Farmers have added proportionately more real estate debt in recent years Source: USDA

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Is This Farm Boom Different? Demand Shocks: Persistent demand shocks lead to high land values and capital investment Supply Shocks: Persistent supply shocks that lead to production expansions reduce prices Interest Rate Shocks: – Lower interest rates associated with higher incomes – Lower interest rates yield lower capitalization rates

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Is This Farm Boom Different? Demand Shocks: Persistent demand shocks lead to high land values and capital investment Supply Shocks: Persistent supply shocks that lead to production expansions reduce prices Interest Rate Shocks: – Lower interest rates associated with higher incomes – Lower interest rates yield lower capitalization rates Exports and Ethanol - Flat Big Supplies lead to Low Prices Will Interest Rates Rise?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Federal Reserve Monetary Policy Projections The Federal Open Market Committee suggests that the appropriate timing of policy firming is 2015/2016 How soon is the longer run?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Key Point to Remember What does it take to get higher interest rates? To get inflation, the global economy needs to strengthen to spur demand. How do farmers finance investments amid stronger demand? INFLATION

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Agriculture Faces Interest Rate Risk, but Farmland is an Inflationary Hedge… How does the demand for real assets and farmland values respond to inflation? When do interest rates respond to inflationary pressures? How does this affect the movements of farmland values? Inflation Rises Higher Interest Rates Weigh on Farmland Values Rising Demand for Real Assets Lifts Farmland Values

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Inflation How Fast? How High? Watch the Federal Reserve Balance Sheet and Bank Excess Reserves Source: St. Louis Federal Reserve Billions of dollars Federal Reserve Assets and Excess Reserves of Depository Institutions

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Will Demographics Drive Demand-Pull Inflation? Annual percent change Calculations based on Census data Boomers Millennial Boomers Millennial

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. What Should Agriculture Watch For? 1.Sticky costs of production 2.Poor financial structure - Highly leveraged farms - Long-term cash leases - Off-balance sheet financing 3.Gigantic deferred tax liabilities 4.Young/aggressive farmers whose experience with risk is the last 7 years 5.Few risk management options for multi-year risks

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. Conclusion Low interest rates typically benefit debtors, not creditor. Inflation tends to benefit debtors, not creditors. What are farmers? Asset rich, cash poor. But … Rising inflation will ultimately trigger higher interest rates and a new stage in agricultural cycles. Is agriculture prepared for this stage of the ag cycle?

Purdue University Cooperative Extension Service is an equal access/equal opportunity institution. How Will the Farm Boom End? 1940s and 1950s Cycle 1970s and 1980s Cycle or It depends on how farmers finance the farm as cash flows (liquidity) tightens?