1. Global Economy, Recovery, and Linkage to Agriculture Kevin Bernhardt UW-Extension and Center for Dairy Profitability October 2009

2. World Situation to Farm Income 2 World Income World Currency Exchange Rates Flow of Agricultural Imports & Exports Energy Demand and Prices Biofuel Demand and Prices Demand for biofuel raw material (corn) Agricultural Commodity Prices & Production Demand for U.S. Products (Exports) Farm Income How much Who gets the business

3. Farm & Risk Management Team © 2009 A Little Theory 3 Q P1P1 P0P0 S D0D0 D1D1 All else staying the same, as income increase demand and price increase

4. Farm & Risk Management Team © 2009 World Real GDP Growth Rate versus World Feedgrain Exports 4 As World Growth Rates Go – So Goes World Exports

5. Farm & Risk Management Team © 2009 World Real GDP Growth Rate versus U.S. Exports 5 As World Growth Rates Go – So Goes U.S. Corn Exports

6. Farm & Risk Management Team © 2009 Canada’s Real GDP Growth Rate versus U.S. Exports 6

7. Farm & Risk Management Team © 2009 China’s Real GDP Growth Rate versus U.S. Exports 7

8. Farm & Risk Management Team © 2009 Mexico’s Real GDP Growth Rate versus U.S. Exports 8

9. Farm & Risk Management Team © 2009 Japan’s Real GDP Growth Rate versus U.S. Exports 9

10. Farm & Risk Management Team © 2009 Remember 10 Q P1P1 P0P0 S D0D0 D1D1 As demand for U.S. exports increase then all else being the same price increases

11. Farm & Risk Management Team © 2009 U.S. Corn Exports versus Nominal U.S. Corn Prices 11 As U.S. Corn Exports Go – So Goes U.S. Nominal Prices

12. Farm & Risk Management Team © 2009 U.S. Corn Exports versus Real U.S. Corn Prices 12

13. Farm & Risk Management Team © 2009 What’s the Point? As the world’s income (GDP) rises U.S. Exports increase And as U.S. exports increase so does U.S. prices 13 A Global Impact that affects U.S. Ag Prices is real GDP Growth

14. Farm & Risk Management Team © 2009 A Little Theory 14 Demand also can increase if your currency becomes comparatively stronger. That is, your currency buys more of your trading partners stuff!

15. Farm & Risk Management Team © 2009 Real U.S. Exchange Rate Index versus U.S. Corn Exports 15 As Value of U.S. Dollar Falls – U.S. Corn Exports Increase The exchange rate going down means the value of the dollar compared to other currencies is less.

16. Farm & Risk Management Team © 2009 And as we have already seen increasing U.S. Corn Exports Increase Prices 16 As U.S. Corn Exports Go – So Goes U.S. Nominal Prices

17. Farm & Risk Management Team © 2009 What’s the Point? If the value of the U.S. dollar is comparatively low then that gives our trading partners more money to buy U.S. stuff – Leads to increased demand for U.S. exports – As U.S. exports increase so does U.S. prices 17 A Global Impact that affects U.S. Ag Prices is the exchange value of the U.S. Dollar

18. Farm & Risk Management Team © 2009 Two Global Impacts Ag Prices 18 Exchange value of the U.S. Dollar Income, GDP, Growth of our trading partners

19. 19 The Global Recession Before and After

20. Farm & Risk Management Team © 2009 Real Gross Domestic Product Growth Rate (through 2007) Source: IMF:

21. Farm & Risk Management Team © 2009 Real Gross Domestic Product Growth Rate (through 2009) Source: IMF:

22. Farm & Risk Management Team © 2009 Monthly Real Exchange Rate, per U.S. $ Jan 1980-Dec 2007 (2005 base) The lower the number the more attractive U.S. products.

23. Farm & Risk Management Team © 2009 Real Exchange Rate, per U.S. $ (2005 base) The lower the number the more attractive U.S. products.

24. Farm & Risk Management Team © 2009 Real Exchange Rate, per U.S. $ (1980-2009, 2005 base) The lower the number the more attractive U.S. products.

25. Farm & Risk Management Team © 2009 Real Exchange Rate, per U.S. $ (1980-2009, 2005 base) The lower the number the more attractive U.S. products.

26. Farm & Risk Management Team © 2009 Interest Rates, 1992-2009 26 Copyright © 2009 Mortgage-X.com Source: www.mortgage-x.com Reprinted with permissionwww.mortgage-x.com If i-rates come back to a more “normal” state then that slows the engine a bit.

27. Farm & Risk Management Team © 2009 Unemployment, 1990-2009 27 If unemployment returns to a more “normal” range then that increases income & consumption.

28. Farm & Risk Management Team © 2009 Consumer Confidence 28

29. Farm & Risk Management Team © 2009 Dow Jones Industrial Averages, 2000-2009 29

30. Farm & Risk Management Team © 2009 World Feedgrains and Wheat Ending Stocks (Source: FAS PSD Online) Feedgrains: corn, barley, oats, and sorghum

31. Farm & Risk Management Team © 2009 How Did We Get Here? Imbalance of trade, investment, and savings between trade surplus countries (China) and trade-deficit countries (U.S.). – U.S. has been at the party too long  Spending instead of saving and investing  Running up debts on low interest rates  Irrational Exuberance (aka: stupidity) – Morning/Hangover came in 2 nd half of 2008  Likely continue until the end of 2009 first half of 2010. 31

32. Farm & Risk Management Team © 2009 Short Term Impact of Crisis Hit 1: Crisis was worldwide causing a fall in incomes and thus a fall in demand Hit 2: The U.S. while hit hard still had a stronger position than much of the rest of the world and thus the dollar actually strengthened – Causing U.S. products to be more expensive  Ag Exports fell  Ag Prices fell 32

33. Farm & Risk Management Team © 2009 33 U.S. $ Index, July 2007-Oct 2009 Copyright 2009 INO.com, Inc. All Rights Reserved. July 2008

34. Farm & Risk Management Team © 2009 Long Run ???????? All Depends on the adjustments and re- alignments of savings, investment and trade. – Do we re-ignite the party  High U.S. spending  High foreign investment in the U.S.  Low U.S. savings  That is: continued and further imbalances – Result for U.S.: Fun in the short run, but a new hangover to follow 34

35. Farm & Risk Management Team © 2009 OR ???????? Do we rebalance exchange rates, savings, investment, and trade re-alignment that puts the world on a more sustainable economic growth path. – Good for the U.S. in the long run – A step back for the trade surplus countries (China) that have been supplying the party. 35

36. World Situation to Farm Income 36 World Income World Currency Exchange Rates Flow of Agricultural Imports & Exports Energy Demand and Prices Biofuel Demand and Prices Demand for biofuel raw material (corn) Agricultural Commodity Prices & Production Demand for U.S. Products (Exports) Farm Income

37. What the 2008/2009 World Economic Crisis Means for Global Agricultural Trade August 2009 Report by the Economic Research Service WRS-09-05 May Peters, Mathew Shane, & David Torgerson 37

38. Farm & Risk Management Team © 2009 The Study Simulation model developed to reflect the onset of the Economic crisis from December 2008 forward Reference scenario plus two alternatives: 38

39. Farm & Risk Management Team © 2009 Reference Scenario Based on: – World economic recovery beginning in late 2009 – Slow appreciation of the U.S. dollar – Modest Economic (GDP) growth in the world and in the U.S.  Initial contraction  Builds back to a long-term just over 2% per year. 39

40. Farm & Risk Management Team © 2009 Ref. Scenario: Real U.S Trade- Weighted Exchange Rate (the lower the better for exports) 40 Source: ERS, 2005 base Value of the dollar is going up, but that is from a near 30 year low. Back to average.

41. Farm & Risk Management Team © 2009 Reference Scenario, Real GDP 41 Return to a pre crisis state with slight edge in favor of the U.S. vs ROW, thus the $ increase

42. Farm & Risk Management Team © 2009 Ref Scenario: Real U.S. GDP Growth Comparisons (the lower the better for exports) 42 Source: ERS, 2005 base GDP recovers back to a long term average

43. Farm & Risk Management Team © 2009 Reference Scenario Ag Commodity Prices Initially – Value of dollar rises – GDP Falls  Consumption growth rate falls (demand falls)  U.S. Exports fall  Commodity prices fall Dramatically in the beginning (we’ve seen that) 43

44. Farm & Risk Management Team © 2009 Reference Scenario: Ag Commodity Prices Long-Term – Dollar continues to grow which dampens any big increases in commodity prices – GDP levels off in a way that slightly benefits U.S. compared to ROW – Stabilize around 2012 to an equilibrium price 44 What will the equilibrium price be?

45. Farm & Risk Management Team © 2009 Must be a New Era (Nominal Corn Prices, 1866-2008 45 5.24 4.13 3.14

46. Farm & Risk Management Team © 2009 Nominal Corn Prices Ranges based on all data recent and all periods and no outliers all periods and recent 2.25 4.86 4.42 6.32 6.70 4.60 3.00 4.63 5.26 3.31 4.21 4.01 5.24 4.13 3.14

47. Farm & Risk Management Team © 2009 Class III Prices – 1988-Present

48. Farm & Risk Management Team © 2009 Alternative Scenario 1: High Dollar Value Continuation of trade and savings imbalances – Developing countries (China)  continue large trade deficits with developed countries (U.S.)  continue larger savings rates and investment in developed countries (U.S.). 48

49. Farm & Risk Management Team © 2009 Alternative Scenario 1: High Dollar Value For the U.S. this means – Investment and economic growth, maybe too strong! – Strong economic growth makes our dollar strong which dampens the attractiveness of U.S. commodity exports  U.S. Dollar value is 40% higher in this scenario versus reference scenario. 49

50. Farm & Risk Management Team © 2009 Real U.S Trade-Weighted Exchange Rate (the lower the better for exports) 50 Source: ERS, 2005 base

51. Farm & Risk Management Team © 2009 High Dollar Scenario vs Reference: Percent Change in Real GDP 51 After an initial recovery, U.S. may be partying too hard (again)

52. Farm & Risk Management Team © 2009 High Dollar Scenario Results Higher dollar, less exports, lower Ag Commodity Prices 52

53. Farm & Risk Management Team © 2009 Alternative Scenario 2: Low Dollar Value In one word – Balance – Significant reduction and realignment of world trade and savings imbalances. – Re-balancing of capital flows – Economic growth is resumed, but at a more sustainable long-term level. Results in long-term, less volatile, and sustainable growth and a lower valued dollar 53

54. Farm & Risk Management Team © 2009 Real U.S Trade-Weighted Exchange Rate (the lower the better for exports) 54 Source: ERS, 2005 base Historically quite low, is that sustainable?

55. Farm & Risk Management Team © 2009 Low Dollar Scenario: Real GDP Growth Compared to Reference Scenario – U.S. versus ROW 55 U.S. re-aligns in a way that results in longer term sustainable growth.

56. Farm & Risk Management Team © 2009 Low Dollar Scenario Results Lower supply of capital from other countries Increased savings in the U.S. Higher interest rates More sustainable growth compared to rest of world Lower dollar U.S. Exports more attractive 56

57. Farm & Risk Management Team © 2009 Low Dollar Scenario Results 57 Higher Ag Commodity Prices BUT

58. Farm & Risk Management Team © 2009 BUT Lower dollar value bucks a LT history Will President(s) and Congress be satisfied with a GDP that “falls” to a sustainable level? Impact of health care Afghanistan Will developing and emerging markets accept policies that “correct” imbalances that currently favor them? 58

59. Farm & Risk Management Team © 2009 So, What’s the Future? A Guess: Economic recovery in 2010 Comparatively more by U.S. – U.S. Dollar increases – Dampens prospects for any big increases in U.S. Ag Commodity prices – Ag Economy slowly recovers to a steady state in 2011-2012  Potential 80’s style re-structuring (especially in the Dairy Industry) 59

60. 60 Longer Term Historical Perspective

61. Farm & Risk Management Team © 2009 Gross Domestic Product Growth Rate (through 2008) Source: World Bank Group:

62. Farm & Risk Management Team © 2009 Goss Domestic Product Growth Rate (through 2008) Source: World Bank Group:

63. Farm & Risk Management Team © 2009 Gross Domestic Product Growth Rate (through 2008) Source: World Bank Group:

64. Farm & Risk Management Team © 2009 Gross Domestic Product Growth Rate (through 2008) Source: World Bank Group:

65. Farm & Risk Management Team © 2009 Where is Population Growth Source: World Bank Group:

66. Farm & Risk Management Team © 2009 Where’s the Population Pop. (bil)% of WorldRank World6.667 China1.33019.91 India1.14817.22 Indonesia.2383.66 Bangladesh.1542.39 Nigeria.1382.111 EU.4917.44 U.S..3034.55 45.1 Source: U.S. Bureau of Census

67. Farm & Risk Management Team © 2009 Must be a New Era (Nominal Corn Prices, 1866-2008 67 5.24 4.13 3.14

68. Farm & Risk Management Team © 2009 Real Corn Price (2009 base) 68

69. Farm & Risk Management Team © 2009 Class III Prices – 1962-Present

70. Farm & Risk Management Team © 2009 Real Class III Milk Price (2009 base) 70

71. Farm & Risk Management Team © 2009 It’s cliché, but it is a different world Not worse, not better, just different – Emerging markets – Information economy – Energy – Climate Change 71 Food For Thought

72. Farm & Risk Management Team © 2009 72 Food For Thought We have been here before: 1914 1945 1975

73. Swings between high, low, and zero profit margins will be – Greater – More often – More dependent on timing Need for greater cash management Margin Management Changing cost structure 73

74. Increased lender requirements, documentation, and verification Information management Heterogeneity Opportunities!!! Marketing Psychiatrist 74

75. Milk Price 19,00021,00023,00025,000 10(143,977)(123,977)(103,977)(83,977) 11(124,977)(102,977)(80,977)(58,977) 12(105,977)(81,977)(57,977)(33,977) 13(86,977)(60,977)(34,977)(8,977) 14(67,977)(39,977)(11,977)16,023 15(48,977)(18,977)11,02341,023 16(29,977)2,02334,02366,023 17(10,977)23,02357,02391,023 188,02344,02380,023116,023 75 Production Matters Price Matters $137 hay, $4.00 corn, $300 SBM Return to Management and Labor

76. -15%-10%-5% 23,000 Avg5%10%15% 10 (85,938)(93,206)(101,166)(109,923)(119,117)(128,311)(137,505) 11 (62,938)(70,206)(78,166)(86,923)(96,117)(105,311)(114,505) 12 (39,938)(47,206)(55,166)(63,923)(73,117)(82,311)(91,505) 13 (16,938)(24,206)(32,166)(40,923)(50,117)(59,311)(68,505) 14 6,062(1,206)(9,166)(17,923)(27,117)(36,311)(45,505) 15 29,06221,79413,8345,077(4,117)(13,311)(22,505) 16 52,06244,79436,83428,07718,8839,689495 17 75,06267,79459,83451,07741,88332,68923,495 18 98,06290,79482,83474,07764,88355,68946,495 76 Input Costs Matter Increase in Feed Costs Decrease in Feed Costs

77. Management Matters 110 MN and WI farms, 500-1,500 acres Average of 2006 and 2007 77 Bottom 20% 20-40%40-60%60-80%Top 20% Net Ret. 7,73722,23252,42739,856110,988 Acres 340308407237416 Yield 164165178174183 Direct Exp. 385387392376372

78. Farm & Risk Management Team © 2009 Dairy Enterprise ($/cow) 1996-2007 (101-200 cows, no org. or RG, MN&WI) Source: Center For Farm Financial Mgt.

80. Farm & Risk Management Team © 2009 80 Futures Prices in Context (Comparison of Feb 7 to Sept. 14, 2007) 1996-2006 data

81. 81

82. Look Backwards - Meticulous Attention to Financials – Have a farm records system – Use the farm records system!  Know your costs of production, Know your margin – Know “at risk” versus “secured” costs – Sensitivity analysis – Prepare accurate financial statements AND Use them to evaluate your profit blueprint. 82

83. Look Forwards: Cash Flow/Enterprise Budgets – Plan your production, plan your cash flow, communicate your plan, work your plan – Evaluate sensitivity TOTAL Communications – lender, broker, and other advisors. Know what makes you money – Partial budgeting: production practices and inputs 83

84. Farm & Risk Management Team © 2009 Partial Budgeting Additional CostsAdditional Revenues Reduced or Lost Revenues Reduced or Eliminated Costs Dollars Lost =________Dollars Gained = _____ 84

85. Know and use marketing tools and strategies  Remember, It’s the Margin That Counts Farm Programs Insurance Instruments – LGM-Dairy, Crop insurance – Levels of coverage 85

86. Strategies for Down Times – Flexible Lease Arrangements – Defer Capital Expenditures – Defer Income Taxes – Refinance long-term obligations – Borrowing against Equity capital, but with planned repayment – Compare financing rates  Careful: one needs committed friends in down times 86 Source: Edwards, William. “Managing through a recession: options for farm operators. Ag Decision Maker, Iowa State Extension

87. Aligned/Cooperative Business Structures Value-Added, Branded Products – Not less risk, just different Change Your Marketing Mindset Know where your risk is 87

88. Farm & Risk Management Team © 2009 Sources: Websites The Oil Drum: http://www.theoildrum.com/story/2006/10/5/215316/408http://www.theoildrum.com/story/2006/10/5/215316/408 Association for the Study of Peak Oil: http://aspo-usa.com/http://aspo-usa.com/ Oil Market Report: http://omrpublic.iea.org/http://omrpublic.iea.org/ Now and Future: http://www.nowandfutures.com/index.htmlhttp://www.nowandfutures.com/index.html WTRG Economics: http://www.wtrg.com/http://www.wtrg.com/ World Bank Group: http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembershttp://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers Farm Foundation: http://www.farmfoundation.org/http://www.farmfoundation.org/ USDA Economic Research Service: http://www.ers.usda.gov/http://www.ers.usda.gov/ Trading Charts, Inc: http://futures.tradingcharts.com/http://futures.tradingcharts.com/ CHOICES: http://www.choicesmagazine.org/magazine/issue.phphttp://www.choicesmagazine.org/magazine/issue.php Foreign Agricultural Service: http://www.fas.usda.gov/default.asphttp://www.fas.usda.gov/default.asp University of Illinois Farmdoc website: http://www.farmdoc.uiuc.edu//http://www.farmdoc.uiuc.edu// Iowa State University Ag Decision Maker: http://www.extension.iastate.edu/agdm/http://www.extension.iastate.edu/agdm/ University of Wisconsin, Center for Dairy Profitability: http://cdp.wisc.edu/http://cdp.wisc.edu/ University of Minnesota Center for Farm Financial Management: http://www.finbin.umn.edu/http://www.finbin.umn.edu/ International Monetary Fund, World Economic Outlook database: http://www.imf.org/external/pubs/ft/weo/2009/02/weodata/index.aspx http://www.imf.org/external/pubs/ft/weo/2009/02/weodata/index.aspx

89. Farm & Risk Management Team © 2009 Sources: Written Articles Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices. USDA/ERS, July 2008. http://www.ers.usda.gov/Publications/WRS0801 /http://www.ers.usda.gov/Publications/WRS0801 / Bahn, Henry. “Commodity Prices Rock World Markets: Structural Shift or Short Term Adjustments?” Choices, AAEA, 2 nd qrt 2008 23(2). http://www.choicesmagazine.org/magazine/issue.php http://www.choicesmagazine.org/magazine/issue.php Westhoff, Pat. “Farm Commodity Prices: Why the Boom and What Happens Now?” Choices, AAEA, 2 nd qrt 2008 23(2). Lawrence, John D., James Mintert, John D. Anderson, and David P. Anderson. “Feed Grains and Livestock: Impacts on Meat Supplies and Prices.” Choices, AAEA, 2 nd qrt 2008 23(2). Irwin, Scott H., Philip Garcia, Darrel L. Good and Eugene L. Kunda. “Recent Convergence Performance of CBOT Corn, Soybean, and Wheat Futures Contracts.” Choices, AAEA, 2 nd qrt 2008 23(2). Mark, Darrell R., B. Wade Brorsen, Kim B. Anderson, and Rebecca M. Small. “Price Risk Management Alternatives for Farmers in the Absence of Forward Contracts with Grain Merchants.” Choices, AAEA, 2 nd qrt 2008 23(2). Abbott, Philip C., Christopher Hurt, and Wallace E. Tyner. “What’s Driving Food Prices?” Issue Report from the Farm Foundation, July 2008. http://www.farmfoundation.org/news/templates/template.aspx?articleid=404&zoneid=26 http://www.farmfoundation.org/news/templates/template.aspx?articleid=404&zoneid=26 Fortenbery, T. Randall and Hwanil Park. “The Effect of Ethanol Production on the U.S. National Corn Price.” Univ. of WI-Madison Dept. of Ag and Applied Econ: Staff Paper no. 523, April 2008.

90. Farm & Risk Management Team © 2009 Sources: Written Articles Irwin, Scott. “Crop value and volatility in a new era” 2008 Illinois Farm Economics Summit, http://www.farmdoc.uiuc.edu//presentations/index.asp. http://www.farmdoc.uiuc.edu//presentations/index.asp Schnitkey, Gary. “Prospects for Crop Production Costs” 2008 Illinois Farm Economics Summit, http://www.farmdoc.uiuc.edu//presentations/index.asp. http://www.farmdoc.uiuc.edu//presentations/index.asp Schnitkey, Gary. “Farm Economics Facts & Opinions”, Department of Agricultural and Consumer Economics, College of Agricultural, Consumer, and Environmental Sciencds, university of Illinois at Urbana-Shampaign, FEFO 08-13, July 11, 2008. Duffy, Michael, and Darnell Smith. “Estimated Costs of Crop Production in Iowa- 2009,” Ag Decision Maker, Iowa State University, University Extension, FM-1712 Revised, December 2008. Duffy, Mike. “Estimating costs of crop production for 2009,” Ag Decision Maker Newsletter, Iowa State University, University Extension, January 2009