Macroeconomic Outlook: Implications for Agriculture

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Macroeconomic Outlook Implications for
Agriculture

• John B. Penson, Jr.
• Texas AM University
• November 18, 2008

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Change, Change, Change
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When I spoke to you back in 2004

• Real GDP growth was approximately 4.
• Inflation was approximately 2.
• Manufacturing capacity utilization was rising.
• Consumer confidence was rising.
• Consumption expenditures was expanding.
• The civilian unemployment rate was 5.4.
• The price for crude oil was 44 a barrel.
• The price of corn was 2.06 a bushel.

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How much have things changed?

• With the current market turmoil, what is the
  easiest way to make a small fortune?

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How much have things changed?

• With the current market turmoil, what is the
  easiest way to make a small fortune?
• Start off with a large one.

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How much have things changed?

• I went to an ATM this morning and it said
  insufficient funds

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How much have things changed?

• I went to an ATM this morning and it said
  insufficient funds
• I wondered if it was them or me!

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How much have things changed?

• What is the difference between Lehman Bros. and
  a large pizza?

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How much have things changed?

• What is the difference between Lehman Bros. and
  a large pizza?
• A large pizza can still feed a family of four.

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So Much for Jokes.There is nothing funny about
todays economy!
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It has been 26 years since we have experienced a
significant recession
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What is a recession?
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Defining a Recession
The National Bureau of Economic Research or NBER
officially declares a recession has occurred
based upon
significant decline in economic activity spread
across the economy, lasting more than a few
months, normally visible in real GDP, real
income, employment, industrial production, and
wholesale-retail sales. A recession begins just
after the economy reaches a peak of activity and
ends as the economy reaches its trough.
(www.nber.org)
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Illustration of a Recession
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Illustration of a Recession
The key question today is how long and
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Illustration of a Recession
The key question today is how long and how deep
the recession will be
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Recessions in the 20th Century
Dates of Recession Months
Recent significant recessions
Source National Bureau of Economic Research
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Recessions in the 20th Century
Dates of Recession Months
Great Depression
Recent significant recessions
Source National Bureau of Economic Research
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The Great Depression

• Over-indebtedness caused by easy money in the
  1920s fueled speculation and asset bubbles.
• Large scale lack of confidence by consumers.
• Firms expanded output into 1930s but consumers
  did not buy hoarding of money.
• Smoot-Hawley Act doubled duties on exports, which
  fell sharply hard on agriculture.
• Fiscal policy increased marginal tax rates.
• Monetary policy money supply shrunk by 33
  during 1929-33. Fed failed to add liquidity.
• Businesses could not get new loans, some old
  loans not renewed, investment ground to a halt
  and asset values declined.

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The US economy today
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Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
22
Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
23
Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
24
Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
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Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
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Manufacturing Sector Today
Source Institute of Supply Management. Number
of months moving in current direction. PMI
refers to Purchasing Managers Index.
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Lets compare the current condition with recent
recessions
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Annual Change in Real GDP
Great depression
1973-75 recession
1981-82 recession
1990-91 recession
2001 recession
An annual graph does not show shown term
recessions lasting less than one year. The ratio
of debt-to-GDP highest since 1954.
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Quarterly Change in Real GDP
3rd qtr 2008
1973-75 recession
1981-82 recession
1990-91 recession
2001 recession
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Manufacturing and Recessions
10/2008
1981-82 recession
1973-75 recession
Note The difference between a expanding
manufacturing sector and one that is contracting
is0 an index value of 50 (see red line above).
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Fed Funds Rates and Recessions
1981-82 recession
1973-75 recession
10/2008
Note announced benchmark rate currently stands
at 1.0 percent.
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Unemployment and Recessions
1981-82 recession
1973-75 recession
10/2008
Note Increased from 6.1 to 6.5 this month.
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Price of Oil and Recessions
10/2008
1981-82 recession
1973-75 recession
Note The price of crude oil closed at 55.08 a
barrel yesterday. Some argue this price serves
as a global economic indicator in the present
market.
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Exchange Rate and Recessions
1981-82 recession
1973-75 recession
10/2008
The US dollar was actually worth less than the
Canadian dollar earlier this year. The Euro fell
against the US dollar shortly after I left Europe
this summer.
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Inflation and Recessions
1973-75 recession
1981-82 recession
10/2008
Note concern may turn from disinflation to
deflation. The rate based on the CPI was 4.94 in
September. The core rate was 2.5, food prices
grew 7.5 and energy grew at 16.6. The decline
in energy prices in the last 45 days will result
in disinflation.
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Consumer Credit and Recessions
10/2008
1981-82 recession
1973-75 recession
The question is whether the ability to repay this
short term indebtedness has grown as well.
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Consumer Credit and Recessions
10/2008
1981-82 recession
1973-75 recession
Consumer loans (excluding real estate) today
represents 30 cents per dollar of disposable
income as compared to 10 cents during last major
recession.
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Net Loan Losses and Recessions
1990-91 recession
10/2008
The availability of this data does not allow us
to look back at the last two major recessions.
Higher charge offs require higher loan loss
reserves, and lower bank profits.
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Recession Drivers

• 11/73-3/75 quadrupling of oil prices with high
  government spending due to Vietnam war.
• 7/81-11/82 Iranian revolution increased oil
  prices. Tight monetary policy to combat inflation
  carried over from 1970s.
• 7/90-3/91 Unsound lending practices led to SL
  crisis and government bailout (160 B).
• 3/01-11/02 Collapse of the dot.com bubble, the
  9/11 attacks and accounting scandals.
• Today Sub prime loans, collapse of the housing
  bubble, cost of war on terror, high oil prices,
  lack of capital market oversight and government
  bailout (??? B or T).

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Any Common Threads?

• Oil price effects (73-75, 80-82, 90-91,today)
• Bursting of bubbles (01-02, today)
• Unsound lending practices and regulation, Fannie
  Mae quarantees (90-91, today)
• Military actions (73-75, 90-91, today)
• Fraud and abuse (who knows?) The Enron scandal,
  for example, contributed to the 01-02 recession.
• Government financial bailouts (90-91, today)

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Today Vs. Recent Recessions

• Fed funds rate much lower today than in recent
  major recessions.
• Unemployment rate much lower today but
  increasing.
• Oil prices much higher today but softening at
  present.
• Inflation much lower today.
• The value of the dollar is lower today but
  increasing in recent weeks.
• Drop in manufacturing smaller today but
  increasing.
• Consumer credit much higher today relative to
  their disposable income.
• Net loan losses at commercial banks smaller today
  but increasing.

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Things are bad globally

• Major countries entering a recession this year
  include
• United States
• Most if not all EU countries
• Japan
• Emerging economies
• Major countries avoiding a recession this year
  include
• China
• India

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Where does the US economy go from here?
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2009-10 Street Forecasts

• Length of recession the 1981-82 recession
  lasted 16 months.
• Depth of recession the 1973-75 recession, while
  also lasting 16 months, was not as deep as the
  1981-82 recession.
• Goldman Sachs this week forecast the deepest
  recession since 1981-82.
• They see the economy shrinking 3.5 in the 4th
  quarter and 2 in the 1st quarter of 2009. The
  4th quarter drop worst since WWII.
• They also see the unemployment rate climbing to
  8.5 by the end of 2009.

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Goldman Sachs Forecast
1973-75 recession
1981-82 recession
GSs six month forecast well below 1981-82
recession
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1. Policy Options

• The reasons for these recessions and the problems
  today reflect some similarities, but also some
  significant differences that affect available
  policy tools.
• A major difference is that the Federal Reserve
  today has little room to lower interest rates
  much further. The Fed will likely lower its
  benchmark Federal funds target another 50 basis
  points. Then what?
• Recent cuts have bought little increase in bank
  lending. Lowering reserve requirements may also
  have little effect in the current real economy.
  The money supply, which was likely too low in
  2006-07, is up markedly today!

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2. Policy Options

• This leaves the Fed in the position of acting as
  a commercial bank (buying commercial paper) and
  printing money (Treasury announces tax rebate,
  issues bonds to finance it, gives them to the Fed
  in exchange for deposits, and draws on this
  account to clear checks mailed to taxpayers).
• The major governmental stimulus to address the
  length and severity of todays recession
  therefore has to come from Congress and the
  administration.

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3. Policy Options

• The use of the 700 billion bailout has been
  hotly debated, and modified greatly since the
  original proposal. Few sectors have not asked for
  access to these funds in recent days.
• Yesterday the Senate began debate on loaning 25
  billion to US automakers.
• Little or no direct attention has been given thus
  far to the housing market, where the credit
  crunch problem manifested itself. Redo loans
  under more favorable terms that lowers
  foreclosure pressures? Whatever, we need
  policies that reduces further foreclosures.

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4. Policy Options

• Tax cuts, or at least a clear statement that the
  Bush tax cuts will not be rolled back by the
  incoming administration, would also provide
  incentive (reduce uncertainty) to business
  investment.
• Finally, some are calling the 50 decline in gas
  prices a tax cut. Lets not lock this lower
  price of a cartel controlled natural resource
  at the current level. Sure demand is off
  globally, but OPEC is hardly dead. Its recently
  announced cutback is obviously being violated by
  some member countries.

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My two cents
I expect the recession to last into early 2010
given what we know today and the fact that this
is a global recession with weakening exports.
What can be done?

• Address the housing market directly.
• Fiscal stimulus that increases jobs, which will
  enhance consumer confidence, (now at lowest level
  since 1957) and backs consumer loans (a bank
  asset), which will increase consumer lending.
• Postpone discussion of tax increases by the
  incoming administration until healing occurs
  (more later)!
• Avoid deflation. Inflation may actually be a good
  thing in the near term if it prevents
  deflationary pressures, increases asset prices
  and improves public finance.

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Implications for Agriculture
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The 5 Rs Key Macro Linkages to Agriculture

• Rate of interest
• Rate of growth in real GDP
• Rate of inflation
• Rate of unemployment
• Rate of foreign currency exchange

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Consequences for Agriculture

• Interest rates impacts interest expenses, net
  farm income, and farmland values.
• 2. Unemployment rate impacts availability of
  non-farm employment for farm operator families.
• 3. Inflation impacts input costs and eventually
  interest rates as the Federal Reserve responds to
  inflationary expectations.
• 4. GDP marginal impact on demand for food,
  greater impact on other product and input
  markets.
• 5. Value of dollar impacts demand for our
  agricultural products in client nations (remember
  the Asian financial crisis and the price of
  wheat?).

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Recent Macro Conditions

• Weak dollar (good for Ag!)
• Expensive fuel (bad for Ag!)
• Low inflation (good for Ag!)
• Low interest rates (good for Ag!)
• Low unemployment (good for Ag!)
• Low income tax rates (good for Ag!)

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Troubling Look at 2009-10
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Potential Macro Scenario

• Expensive fuel (bad for Ag!)
• Rising inflation (bad for Ag!)
• Higher interest rates (bad for Ag!)
• Stronger dollar (bad for Ag!)
• High unemployment (bad for Ag!)
• Higher income taxation? (bad for Ag!)

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Lessons from History

• Agriculture has historically been adversely
  affected by rising inflation, interest rates and
  a strong dollar.
• Deflation, on the other hand, would be hard on
  real estate values, which represents 85 of most
  farm balance sheets. Remember the 1980s.
• External credit rationing (price and quantity) by
  banks and Farm Credit System entities may be a
  problem in 2009.
• Fortunately much of agriculture has benefited
  from historically high prices and is in a good
  cash position. Stress for highly leveraged firms.

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Looking Forward
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Commodity Prices

• Prices for many program commodities hit record
  highs the past two years.
• Lower oil prices and slowing client economies
  will keep prices well below the highs seen this
  year.
• High input prices for fertilizer, seed, etc will
  squeeze profits/create losses.
• Land values will not increase at double digit
  rates seen the last 3-4 years, and may well
  decline in 2009.

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Structural Change in US Corn Market
Source Agricultural Prices, NASS, USDA.
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Variability of Corn Futures Contracts
Source Chicago Board of Trade.
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Land Prices Sensitive to Macroeconomic Events
Growth in global food demand. Russian wheat deal
in 1972. Export expansion, low stocks.
Tight world stocks, supply. Asian financial
crisis in 97/98.
Source Iowa State University Extension Service.
Global recession. Fighting inflation. Strong
dollar.
Rising crop prices. Growth in emerging
countries. Growth in renewable fuels.
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Land Rents Sensitive to Macroeconomic Events
Catch up time?
Rents fell during financial crisis in the 1980s.
Asian financial crisis
Source Chicago Federal Reserve District (IL, IA,
MI, IN, WI) Chicago Federal Reserve District
Bank.
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2009 Central Illinois Corn Budget
Yield 191 bushels Assumed sales price 4.20 per
bu. Other revenue 24 payment Gross
revenue 826 per acre Fertilizer 215 per
acre Seed 110 per acre Other costs 99 per
acre Total direct costs 424 per acre Power
costs 88 per acre Overhead 56 per acre Total
non-land costs 568 per acre Spread 258 per
acre
The spread of 258 must cover term debt service,
cash rent or equivalent, and family living
expenses. Those who have already locked in 300
cash rents would need 4.42 corn just to break
even. This leaves nothing for family living and
scheduled term loan payments.
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Debt on Balance Sheets

• Balance sheets in agriculture are in a much
  better condition than the 1981-82 recession.
• USDA points to great solvency status.
• Solvency ratios however reflect high land values
  which may fall in 2009-10.
• Furthermore, two-thirds of farmers have no term
  debt. Thus, one-third of farmers owe all term
  debt outstanding!

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Liquidity and Debt Strategies

• Producers will need to be well prepared when
  visiting their lenders for 2009 financing.
• Those who used previous profits to purchase fixed
  assets may face cash flow constraints.
• Dont expect previous LOCs to be renewed at
  previous levels, especially if previously unused.
• Pay down debt best investment you can make in
  the current environment.
• Look for ways to increase efficiency.
• Retain sufficient liquidity Dave Kohl
  recommends net working capital be 33 percent of
  total expenses. Varies by enterprise.

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Politics?

• A new administration brings questions about where
  we go from here
• Market regulation?
• Income taxation?
• Focus of government spending?
• Energy policy?
• Strategies adopted to revive the domestic
  economy?
• Global macroeconomic policies and impacts on
  agricultural trade?
• Global unrest?

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For example.

• Joseph Stiglitz, a Nobel Prize-winning economist,
  said in a Washington Post article on November 9th
  that it will take the Obama Administration 18
  months to turn around the economy even if
  everything goes perfectly.
• Stiglitz urges the new administration to role
  back the 2001 and 2003 tax cuts.
• He also urges that capital gains be taxed as
  ordinary income.
• Says it would reduce the deficit, have few
  short-term adverse effects on an already reeling
  economic, and make the tax code more fair.

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In Summary

• Economic signs going forward are confusing.
• 2009-10 however will present increased economic
  stress.
• High input costs for fertilizer, seed, land
  rental rates a concern in agriculture.
• Inflationary monetary and fiscal stimulus may
  lead to higher interest rates and stronger dollar
  over time.
• Changes to current energy policy, taxation, etc?

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Some Signs are Hard to Read

• The 50-50-90 rule anytime you have a 50-50
  chance of being right, there is a 90 chance you
  will be wrong.
• Profits will be under stress.
• Maintain sufficient liquidity in current
  environment. Liquidity is king for now.
• Paying down debt a safe investment.
• Examining the sensitivity of investment decisions
  in fixed assets to a changing economy will lead
  to better informed decisions.

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Thank You for Your Attention