CHICAGO May 3 U.S. grain farmers have enjoyed a
rare combination of soaring prices and land values since 2009
but if incomes dip as expected they should be careful not to
fall into the trap of borrowing against inflated land values,
the Kansas City Federal Reserve said in a report on Friday.
"In 2013, historically high farm incomes are projected to
keep U.S. farm debt and leverage low. Yet longer-term
projections suggest that farm incomes could fall dramatically in
2014," the study, entitled "The Wealth Effect in U.S.
Agriculture," stated. "If agriculture's historical wealth effect
holds true, farm enterprises might use existing wealth to
finance and smooth investment spending, sowing the seeds for
another round of debt accumulation."
The authors, Kansas City Fed Vice President Jason Henderson
and Kansas City Fed economist Nathan Kauffman, cautioned that
"the stage is set for another wealth effect and leveraging cycle
in U.S. agriculture."
On the one hand, they said, expanding global population and
rising incomes in developing nations are boosting demand for
agricultural commodities. Farmers in top exporters like the
United States - the largest grain exporter - have been
increasing production through capital investments in equipment,
irrigation and storage.
"As a result, projections of farm profits indicate that the
combination of rising supplies and higher production costs could
cut farm profits by 2014," the study said.
Looking at past farm booms and busts, such as the 1910-1920
and 1970-1980 periods, U.S. farmers built debt even as incomes
fell and interest rates rose. By contrast, with the record grain
prices of recent years, fueled not just by hungry overseas
buyers but the domestic biofuels boom, grain farmers have reaped
not just record profits but retired debt - and seen asset values
soar as land prices set new records. But that overall wealth
effect is a warning sign, the authors say: farmers tend to
accumulate more debt when wealth levels are high.
"High wealth levels increase the amount of collateral
available to underpin farm borrowings," the Fed study notes.
"Today, an increase in farm debt may signal the beginning of
another turning point in farm debt and leverage. After rising
less than 1 percent annually since 2008, farm debt outstanding
at commercial banks rose roughly 5 percent in the fourth quarter
of 2012 for both real estate and non-real-estate debt.
Similarly, Farm Credit System lending for real estate mortgages
and production and intermediate-term loans rose 5.7 percent
That bodes ill for farm solvencies, the authors say, given
prospects of lower farm incomes and higher interest rates.
After posting record highs the past two years, U.S.
government projections suggest farm profits will erode over the
next decade, the study notes. With a return to more normal
weather, a rebound in U.S. and world grain production is
expected to build supplies - and pressure prices. Combined with
other types of farm production, the USDA projects U.S. net farm
incomes to fall 20 to 25 percent below 2013 highs during 2014
and remain near these levels over the next decade, the authors
At the same time, the Federal Reserve has said that interest
rates could begin to rise during this period of lower incomes.
Currently, most of the Federal Open Market Committee (FOMC)
members of the Federal Reserve indicate that keeping the fed
funds rate below 1 percent is appropriate policy through 2014,
the study notes. "However, there is less consensus on future
interest rate policy, as some FOMC members indicate that the fed
funds rate should rise above 3 percent by 2015," it says.
"History has shown that a combination of falling profits and
rising interest rates drive farmland prices lower," the study
states. "History also has shown that when land values and farm
wealth fall, solvency issues and farm bankruptcies rise."
The authors caution against the certainty of such long-term
projections. They note that current farm debt ratios remain near
historical lows. Yet projections of lower farm incomes, high
wealth and low interest rates "are the recipe for another wealth
effect in U.S. agriculture."
The lesson for farmers, the authors say, is to preserve
capital and not go overboard on debt to guard against a sudden
fall in asset values like land.
"Working capital is the first line of defense farmers can
use to manage through periods of weak profitability," the study