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DAVID KRUSE

Remembering inflation

February 23, 2018
Farm News

Do you remember inflation? I do and my recollections of it are not very fond. I started farming in 1973 heading right into an inflationary cycle. If you had assets, they went up in value, but if you were trying to acquire them, they went up in cost and you were constantly chasing them. Costs seemed to run ahead of revenues. It was a tough time to start farming. That would be true of most anytime, as right now farmers are living off their equity and they had to be farming a while before they accumulated some to be able to do that. That is very hard on young farmers.

The big correction going on in the stock market was being attributed to a change in monetary policy and interest rates, a transition from easy money, being reacted to by the bond market. As noted, up to this point, for several years now, the only place to get a return was in stocks (or farmland). Tightening labor markets, restricted immigration and trade protectionism is all inflationary. Rising wages sounds good to a lot of people but they are rising costs to business. It is called wage and price inflation because the two are directly connected.

The Fed will moderate the upturn in inflation by raising interest rates which increases costs too. While stock and bond markets recognized the change in the capital flow that will come with higher inflation I do not expect that we will see the kind of inflation that typified the 1980's for a while, likely many years. Looking back at recent interest rate history, interest rates are coming up off of an extreme bottom. I would expect to see them stabilize at a modestly higher level for an extended period of time before they would become onerous again as they did in the 1980's.

Back then farm asset appreciation was the offset to inflation. There was a time when leverage added to your balance sheet performance, because assets inflated more than the cost of borrowed money. There was a period in time in the late 1970's when tractors appreciated rather than depreciated because of inflation. The Deere dealership would take advance orders for tractors so farmers could lock in a price even if the farmer was not sure that he wanted the tractor, because if he waited a few months, the prices would have gone up...a lot. Farmers leveraged up in order to load up on assets which appreciated until they stopped when interest rates rose so much that they exceeded returns from inflation and the debt became onerous. Thank s a lot to then-Fed Chairman Paul Volker.

That forced the ag sector into a painful de-leveraging. Lenders had over-accommodated the leverage which when the economy busted, took a slew of banks and the Farm Credit System down with them. At one point they were lending 90 percent on farm values with a generous appraisal that made it closer to 100 percent. When farm income collapsed, there was no equity to support the debt and that meant that farm assets flooded back on the market, voluntarily or through foreclosures. That turned a downturn of the farm economy into a collapse.

It was like dominos as when prices fell, more land loans went under water putting more land on the market which intensified the pressure. It didn't end until Washington stepped in with farm subsidies to stabilize income. Today, farm revenue has not covered farm expenses, so lending is going up to cover the difference. Farm loans are rising to bridge the gap between expenses and revenue. The difference is that this ag downturn did not start from a point of extreme leverage but from a point of financial strength.

There is a lot of farm equity. Lenders did not allow more than 55 percent leverage on farmland and a lot of farmland was bought with cash. As such while the Ag economy is struggling it is not in crisis. Liquidating assets are not flooding the market. I am sure that some farmers think it feels like it is, but long-established farmers have not run out of equity yet.

I heard the farm economy described as fragile by Ag Secretary Sonny Purdue. I concur. While it is still struggling but stable, it will take some additional major negative event, such as a trade war, in order to trigger another farm crisis. The irony is, that is what the Trump administration is advocating. You can't get where Donald wants to take trade policy without breaking some eggs along the way. With the economy at full employment and an Ag sector job market extremely tight, a significant slowing of immigration, legal and otherwise, is likely to trigger some labor shortages. Wages go up, then prices go up. Tyson Foods said this week that their transportation costs would rise $200 mln for the company in 2018 and their labor costs would increase too. Their CEO said, "We expect that we will recover the majority of those costs through pricing."

We are just starting a man-made inflation cycle and markets know it. When they put tariffs on Chinese solar panels, in this case the US solar industry claims that it will lose jobs and the cost of solar to US consumers goes up. China is reciprocating with tariffs on sorghum imports from the US. Tit for tat. Each one grabs the others throat and squeezes.

The new 2-year budget adds over $300 bln more federal debt so the total annual deficit is $1 trillion again. Anyone delusional enough to think that China will help finance it? If Trump goes after Japan on trade they won't buy Treasuries either. All Trump's immigration and trade policies will do is take us closer to 1932.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

 
 

 

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