Inflation and agriculture: what does it mean for your farm?

From their farm in western Illinois, Krista Swanson and her husband, Brett, look like many young farmers their age. They managed carefully, bought farmland and borrowed money to do it. But one thing she insists on?

Fixed interest rates.

“I feel pretty comfortable borrowing money if it’s against farmland,” she says. “But I am very demanding on a fixed interest rate. It costs a little more than a variable rate, but if they are low they can only go up. It is obvious.

That’s where Swanson’s experience comes in. She’s an agricultural economist, working as a research associate for the University of Illinois (look for her byline on Farmdoc articles), and before that she analyzed loan portfolios for Farm Credit. From her colleagues there, she learned to be careful with valuation and interest rate risk – hard-earned lessons many of them learned from the 1980s.

“Many of Farm Credit’s management team at the time had been junior loan officers in the 1980s, and they were all very cautious,” Swanson recalls, adding that variable interest loans made to times were increasing the debt every day.

These generational approaches still play out today, when you can mention inflation and interest rates — and debt — and likely get a different response from different generations. Before writing their recent interest rate article, economists from Farmdoc AG spoke about the difference in how young people view debt compared to those over 40.

“This 40-plus generation is more debt-free at this point, and maybe a little more nervous, where younger people haven’t experienced the 1980s,” Swanson says. “Young people tend to be more comfortable with more leverage. They got used to it because of the cost of getting into commercial farming for their generation.

And what if interest rates rise and debt becomes more expensive? What happens in the wake of inflation, driven by labor and government policy and global pandemics? And how should a farmer react, whatever his generation?

U.S. agriculture has entered a time of high disruption and risk, says Carl Zulauf, professor emeritus of agricultural economics at Ohio State University, who also contributes to the Farmdoc team.

“In this age of disruption, risk will come in directions we don’t normally anticipate,” says Zulauf. “There are times when the world, or a country, goes through a period of increasing risk. A lot of things are happening that you would normally say have a low probability, but they are coming together. We are in one of those times now.

How we got here

Zulauf says that despite the long-term rise in federal debt, the risk comes from the flow of interest, not the debt itself. There was a long-term decline in interest rates and a low period of inflation (see chart). The real interest rate on 10-year U.S. Treasuries has been negative for two years, and as Zulauf points out, the only other two-year period of negative real interest rates occurred in the 1970s.

“So we have two generations that have no experience with either rising interest rates or inflation,” he describes, adding that higher interest rates affect farmers in three ways:

  1. operating credits
  2. non-fixed interest agricultural loans
  3. federal farm programs – the government has less money for farm programs if it spends more for its own benefit

“If you don’t manage inflation and interest rates properly, you create longer-term problems with negative consequences,” he says.

There are different ways to track inflation, but agricultural economics professor Carl Zulauf recommends this one, where annual inflation is measured by the change in the implicit index of the GDP price deflator. Interest rates are tracked by the constant maturity interest rate on 10-year US Treasury bills, as reported by the Federal Reserve Bank of St. Louis.

Zulauf says inflation is tied to supply chain issues, which lead to labor supply. It is not the only factor, but it is an important factor. Economists wonder whether the increase in inflation is temporary or permanent; Zulauf believes the answer is in the job.

“Worker-induced inflation tends to be more permanent than transitory, because you increase workers’ incomes,” he says. The labor supply is weak partly due to low population growth, the absence of immigration policy and the retirement of the baby boomer generation. Zulauf’s point: Watch labor trends to see where inflation will go.

What this means for agriculture

If interest rates rise in response to inflation, it will affect cash outlays, especially for those using operating loans. And, adds Zulauf, persistently higher interest rates will have a negative effect on farmland prices.

But farmers can take steps to properly prepare and respond. Here is an overview:

Be aware of the risk. It’s easy to say — and really important, in this case, says Zulauf. “We are in a different period than we have known for 40 years, and you have to change your management plan,” he adds. “It won’t happen overnight.”

Exercise caution in lending. Swanson says today lenders generally don’t lend more than 60% of appraised value because they’re buffering the unpredictable decline in land values ​​- and that’s a change from the 1970s and 1980s. “On the lending side, a lot of the decision-makers went through that period, and they’re holding the reins a little tighter today,” she says. “They also don’t want the 1980s to happen again.”

Keep the job happy. Zulauf predicts that managing work will be an even bigger challenge over the next five years, as it will be even more disruptive to lose a good employee. You have a few weeks to plant and a few weeks to harvest, and if you don’t have labor, that’s a huge cost. “There is a skill set that is unique to agriculture. You may have to pay more and worry more about the satisfaction of your employees,” he says, adding that he knows farmers who have already raised their wages to keep people from leaving.

Monitor profitability per acre. Inflation forces us to look at input costs, Swanson says, but it should also help drive up commodity prices. Look at your farm budget and ask: What is the negative influence on costs versus the positive influence on prices? Inflation may not mean an entirely negative impact on profitability. Monitor your cost to revenue ratio.

Review budgets now. Winter is the perfect time to review your financial statements from last year. Use last year’s income and expense statement and mark it up to make a cash flow statement for this year: “Here’s what I spent in 2021; here’s what it will look like in 2022. Calculate your working capital by subtracting current liabilities from current assets. Divide that by square footage to get working capital per acre. Swanson recommends FAST tools on the Farmdoc site for monthly cash flow planning, quick cash flow projections and more. You can even enter expected costs and revenues and do a stress analysis: if that number goes south, what happens?

Borrow with caution. Zulauf says today’s scenario should make you wary of long-term debt that you can’t lock in interest rates on. “That’s what happened in the 70s,” he says. “It was a watershed event in my economic education. Think about how you want to handle that if, indeed, it changes.

Want more information on interest rates and inflation? Check out these recent articles from Farmdoc:

So far so good for farmland

If there is a singular watermark of 1980s agriculture that farmers often point to, it is the collapse of land values ​​by almost 50%. Today, despite high inflation and the possibility of rising interest rates, farmland managers say they don’t expect that to happen again.

Eric Sarff, president of Murray Wise Associates and a farm boy who grew up in the 1980s, acknowledges that land markets are cyclical, but says buyers are still interested in farmland, as indicated by an increase of almost 20% of Illinois land value in 2021. .

“I think we’ll continue to see land values ​​go up this year, but not at such a crazy rate as last year,” Sarff says. Part of the reason they jumped so dramatically in 21 was due to historically low sales volume in 20. Pent-up demand combined with weak supply, coupled with inflationary fears, caused land to explode – potentially artificially, because land that sold for $12,000 an acre a year ago now costs $17,000 to $19,000.

“I don’t foresee such a big jump in the next 12 to 18 months. I think we could see maybe 5% to 7% this year,” Sarff says.

As for the cycle, he expects a small correction at some point, but the question is when.

“At some point the market will calm down, but no one knows when that will happen,” he says. “Historically, farmland has seen declines, but overall it has continued to rise as an asset class.”

With land values, cash rents, and Sarff says it might be a good time to negotiate 2023 leases. If you’re currently on cash rent, it might be reasonable to ask for a flexible lease with a discount from 10% to 15% of the base payment. Then, if commodity prices stay high, the landowner receives a bonus payment — like an extra $25 per acre if December contracts at the Chamber of Commerce hit $7, for example.

This gives the farmer a bit more leeway on fixed costs, but both sides win if prices are high. Sarff says flexible leases vary widely, and farmers can even enter into a three-year lease, which would provide some longevity protection.

About Andrew Estofan

Check Also

Ratings remain stable | The star

PETALING JAYA: While government debt levels are expected to rise in the near term, this …