June 5, 2015

DrKohl_color The Ag Globe Trotter

Dr. Dave M. Kohl

Welcome to the weekly edition of The Ag Globe Trotter by Dr. Dave Kohl.

How does the current economic cycle compare and contrast to those of the past? Is the current economic cycle similar to the 1980s or, worse yet, the Great Depression era? People also want to know whether or not history repeats itself. These are common questions asked of me as I travel and speak with agriculture groups across North America.

K-Wave and Economic Cycles

First, economic and market cycles will continue to be a major part of business decision making now and into the future because 80 percent of decisions are based on emotions and behavioral economics rather than good old-fashioned logic. One only has to examine the general economy’s cycles to find that on average economic expansions have durations of 58 months and recessions generally last 11 months. Post-1960s the expansion cycles increased to 84 months and recessions lasted an average of seven months due to the Federal Reserve’s intervention and stimulus packages which attempt to minimize the impacts of cycles. Going to higher level global economics, Nikolai Kondratiev, a Russian economist, conducted analysis which found that every 45 to 60 years a major recession or depression occurs worldwide. Similar to the four seasons of the year, his hypothesis was that the economy goes through a spring, summer, fall, and winter. His winter season is characterized by recession or depression as a means of renewal for the start of a new cycle. Over a number of centuries, his hypothesis has been quite accurate.

Commodity Super Cycles

Examining the history of the agricultural industry, boom and bust cycles have occurred as well. Post-Civil War boom times in agriculture and rail were followed by a major recession, and some call it a depression, of the 1880s. This was followed by the first commodity super cycle which occurred from 1910 to 1920, followed by the Great Depression of the 1930s. The second and third commodity super cycles were post- World War II and into the 1970s followed by the 1980s farm crisis. Recently the fourth commodity super cycle, often called the great commodity super cycle due to both its extent and duration, lasted from 2002 to 2012. Now agriculture and rural areas are showing signs of economic entrenchment in the 45 to 60 year rotation.

How do the cycles of the past compare to the current cycle? If one examines the expansion cycles of the past, inflation was a common denominator in prices, costs, and asset values. Some of it was market induced, that is, linked to cotton in the Civil War; food for global markets in World War I; planting “fence row to fence row” for increased population in the 1970s; and upgrades in diet and demand for fiber and fuel in expanding global emerging economies recently.

In the cycle of the 1970s, inflation was the culprit. A policy of a quick rise in interest rates to kill the dragon of inflation was devastating to the agricultural and rural regions and to a lesser extent in the U.S. coastal economies. Interest rate increases first impacted operating margins where large amounts of financial leverage or credit was utilized as an inflation hedge. The rising rates choked off farm profit margins, creating short run liquidity issues and problems securing capital to maintain operations. Subsequently, farms were liquidated at discounted values, which destroyed paper wealth on the 1980s farm balance sheets.

A New Century

Fast-forwarding to the 21st Century finds inflation in prices, expenses, and asset values occurred during the great commodity super cycle. The difference now is that disinflation or deflation is occurring first in commodity prices and now spilling over into farm assets, starting first with machinery and now occurring in land values, both owned and rented, in some areas of the country. Deflation is occurring despite record levels of monetary stimulus by the central banks in the U.S. and abroad to jumpstart their economies. This is a result of slow velocity of money, which is the number of times currency changes hands in a year; aging populations that are more conservative in spending and investing; uncertainty as a result of the great recession of 2009 to 2010; and technology and automation which are making products much cheaper.

In the credit bubble of the 1970s, producers used debt to secure more assets. In contrast, producers are utilizing profits and more cash and equity pledges in purchases of assets in the current asset bubble. This means the current cycle’s devaluation will be more methodical and longer in duration than in the 1970s. The point is that businesses are not required to sell assets to meet obligations and debt servicing requirements, which was the case in the 1980s.

Concentration of Debt

This economic cycle is much different than previous cycles in another way. Farm debt was dispersed over a wide range of producers from all sizes of farms, ranches, and enterprises in the previous cycle. Today, of the 2.1 million farms and ranches, approximately 263,000 carry 63 percent of the total farm debt. The debt is not only concentrated amongst larger producers, but interconnected with other producers and agribusinesses as complexity of businesses has increased tenfold in agriculture in recent years.

Steady prices with little volatility and generous government agricultural support were the modes of operation working through the prior cycles. Today and in the future, cycles will have more price and cost volatility. However, what will happen this time as public and political support for agriculture wanes?  Managing through this volatility will be on the backs of agricultural managers.

Land Cycles: Bubbles and Crashes

Historically, the largest asset on farm and ranch balance sheets has been farmland. If one examines a century of farmland value cycles, it is interesting to draw comparisons. World War I and technological advancement from horse power to mechanical power created the first land value bubble 30 years from the 1880s crash. This was followed by the 1920 to 1930’s crash, which was a result of an exodus of people from rural areas to cities; rapid stock market appreciation which provided alternative investments; and the Smoot-Hawley Tariff Act which deterred exports in general, including agricultural exports resulting in farm sector asset correction.

Land values were bullish in the 1970s, 30 to 50 years post-crash. In this period stock market returns showed a mere 1 percent appreciation from 1962 to 1980, encouraging investment in land. Economic policy and global population growth were the catalysts for the boom which increased land values from an average of $219 per acre in 1972 to $823 per acre in 1982.

In the 1980s, Federal Reserve chairman Paul Volcker increased interest rates to counter inflation. Global demand for food production was slowing. These factors along with the 1980s stock market bull run contributed to a 27 percent nominal land value decrease, and 38 percent inflation-adjusted decrease in land values. Farm land values in 1987 tumbled to a level comparable to 1972 values. Ouch!

The 2000 to 2013 farm land bubble was again 30 years from the previous crash. As in the past, global markets, government policy, and bioenergy were factors that impacted the bubble. Also, accommodative Federal Reserve policy, including low interest rates and low value of the dollar encouraging exports resulted in record farm profits and a subsequent increase in land values and cash rents.

Now the question will be whether a strong dollar, slowing emerging markets, the maturation of bioenergy, and trade issues will result in a softening of land values. Only time will tell!

Survivors’ Strategies

What are some successful strategies of survivors of previous cycles who have capitalized on opportunities?

  • Businesses in a strong cash position purchased others’ assets at discounted values.
  • Survivors have worked with strong relationship lenders who understand agriculture cycles and the agricultural industry.
  • Producers have recognized the importance of moderation in growing the business and modesty in living withdrawals.
  • Survivors realize that cash and liquid assets are always “king.” Going back through the history of cycles, one can see how fortunes have been made and lost by those who had the cash.

Are we headed into the winter season of the 45 to 60 year cycle? If history is able to project the future, perhaps the economic winter season is beginning. Those who weather the season well will be in a good position to hit the ground running when the spring and summer economic seasons arrive.