HISTORY never repeats itself, but it sure does rhyme. With apologies to Mark Twain, that was the key message about the U.S. economy that Purdue University economist Jason Henderson shared with agricultural bankers last week at their annual conference in Minneapolis, Minn.
"What goes up in agriculture generally has to come back down again," he explained, referring to a recent string of consecutive years with record net farm income. "Based on what the U.S. Department of Agriculture is projecting, net farm incomes are expected to retreat back down to historic average levels."
If that is truly the case and farm profitability is the basis for current land values, then land values must also start to come back down. A similar cycle occurred in the late 1970s and 1980s. That boom/bust cycle drove many farmers out of business and, according to Henderson, kept an entire generation from choosing careers in farming and agriculture.
It also makes farmers keep one eye to the past, comparing current conditions to those that predicated the economic horrors of the '80s bust.
"Right now, it is a great time for agriculture, and it is a good time for rural communities, but what happens as incomes decline? You have to consider the spillover effect to main street businesses in these communities," Henderson warned.
Henderson, associate dean of Purdue's College of Agriculture and previously with the Federal Reserve Bank in Kansas City, Mo., has spent several years studying the economic trends that led to the '80s farm crash and how those trends might play out today. He and colleague Brent Gloy told lenders that the end of the current boom cycle is, in reality, inevitable.
However, it isn't the end of the boom that should be troubling; rather, the industry should be concerned with how the boom ends.
"There have been four major farm booms in the past 100 years, and two didn't end so well," Gloy explained. "The Great Depression and the '80s were disastrous, but the post-World War II boom turned out pretty well."
The fourth boom, of course, is the current period of agricultural prosperity. Gloy said in real terms, farmland values have never increased as much on a decade-by-decade basis as they have in the past 10 years.
Land values increased by roughly 400% in the 1970s, but inflation was a major factor in those value increases and a major reason the ensuing bust was such a challenging period. Values are up roughly 300% now, but those gains are mostly in real terms because inflation has not been much of an issue at all.
Henderson's former Federal Reserve colleague Nathan Kauffman, an agricultural economist at the Fed's Omaha, Neb., branch, highlighted seven major risks to agriculture:
1. Farm incomes;
2. Farmland values;
3. Agricultural exports;
4. Global competition;
5. Energy policy;
6. Farm debt, and
7. Interest rates.
"If you had to tie profitability to only demand-side factors, you'd have to point to exports and ethanol," Kauffman explained in a presentation to reporters last week in Kansas City. "What happens in energy policy in the next few years has huge potential implications."
With the Environmental Protection Agency and Congress each considering possible changes to the renewable fuel standard's ethanol mandate, the demand structure for corn could change and, with it, the prospects for corn farmers' continued profitability. Similarly, global competition and the U.S. farmer's ability to maintain export market share will be a major key to the sector's future net income.
All three economists agreed that interest rates and farm leverage will be critical in determining the success of the industry moving forward. With farm incomes expected to drop 20% next year, by Kauffman's calculations, incomes will still be relatively high, but the drop could have significant implications for highly leveraged producers.
Generally speaking, the debt structure of U.S. agriculture is much different today than it was at the end of the 1970s farm boom. Producers, as a whole, are not nearly as leveraged as they were previously, but Henderson and Gloy cautioned that if interest rates rise too rapidly — as was the case in the inflation-plagued 1980s — those producers who are leveraged could be in trouble.
At the same time, while the average debt structure is much more favorable, the fact that farmers have not taken on huge amounts of debt to finance shockingly high farmland prices means they have likely spent significant volumes of profits or reserve capital, meaning that if trouble strikes, cash-poor producers might be in trouble.
"I worry about the poor financial structure of today's farms," Gloy said. "Some estimates suggest that as much as 87% of farmers' assets are tied up in land. Farmers have overpaid for real estate in many cases, and they've used reserve cash to do so."
He cautioned that banks need to carefully watch for signs of stress in their portfolios and be more judicious in controlling the amount of credit in the market. With many similarities between the current boom and the 1970s, keeping a careful eye on the amount of credit available to finance bad decisions could be the difference between a smooth end to the boom cycle and another debacle like the 1980s.
Henderson summed it up simply, noting that the Fed's Federal Open Markets Committee has signaled that it will begin its exit strategy sometime in 2015 and that interest rates will begin to rise. "When interest rates are going up, being land rich and cash poor is a bad place to be," he concluded.