According to the Murray County assessor, our 211 acres of farmland is worth $225,100 more than it was a year ago. Not only is that a lot of money, at least for a couple of ink-stained scribblers like my wife and me, but it raises questions that go to the heart of current economic problems.
For example, does the tripling of farmland values since 2007 in many parts of the Midwest stem from improved fundamental prospects for agriculture? Or, should we thank — or blame — Ben Bernanke and colleagues at the Federal Reserve?
Is the 43 percent increase since last year evidence of an unsustainable asset bubble or merely the workings of an efficient market? Should I maintain my plans, driven in part by tax consideration, to leave this asset to my heirs? Or should my wife and I increase our level of consumption to reflect the half-million dollars that fate dropped into our laps in less than eight years?
Let’s start with the simplest question. Yes: the Fed has a lot to do with booming land prices. In its efforts to stave off deflation and spur economic activity, it has pushed interest rates for all maturities to very low levels.
Writing 192 years ago, British economist David Ricardo explained that the value of a perpetual asset, like land, is determined by the annual income it produces, such as interest or rent, divided by the prevailing long-term interest rate. Halve the interest rate and you double the price of such assets, at least if potential buyers trust that both annual income generated and the interest rate will continue over the longer run.
Ricardo assumed rational thought. The calculation just described outlines what a rational buyer would be justified in paying. But people are not entirely rational, a fact that economists are finally admitting. That complicates the affair.
Unsupported optimism based on recent positive news is one way people frequently violate Ricardo’s assumption of perfect rationality. Bubbles in asset markets, whether for stocks in Japan in the late 1980s, Internet stocks in the U.S. in the late 1990s, housing from 1999 to 2005, or farmland in the late 1970s, all create self-perpetuating feedback loops. People read in some pundit’s column that land prices have increased by 16 percent a year for a decade and decide that might be a good investment for themselves. As more and more people jump into the market, prices continue to rise until skepticism eventually overcomes unjustified optimism. Then prices collapse.
Blame the Fed for the low denominator in Ricardo’s equation, but what about the numerator, the income it produces?
Yes, crop subsidies and the federal ethanol mandate contribute to per-acre profitability that is higher than would otherwise be the case. But these programs were already in effect before land prices really started to boom about eight years ago. Ditto for demand from China. These are part of the explanation, but far from all of it.
So is this an unsustainable bubble? For dyed-in-the-wool believers in rationality and “efficient markets,” bubbles are impossible.
Indeed, Eugene Fama, the father of efficient market theory, famously said in an interview in late 2007, as the housing market bubble collapsed around him, “the word ‘bubble’ drives me nuts.”
But every agricultural economist I have talked to thinks that current land prices are unsustainable. So does Robert Shiller, the Yale economist who, a decade ago, predicted the collapse of housing prices and has now turned his attention to farm prices. And so do I. Time will tell who is right, and we will probably know in a couple of years.
If it is true that land prices are doomed to fall substantially, why don’t I sell now? If I were purely rational and furthermore cared only about money and the things it can buy, I would. But I am not entirely rational, and there are sources of satisfaction that are not priced.
I still get what some economists call “psychic income” from going down and puttering around upgrading fences, drainage tile and waterlines or mowing thistles. I still get satisfaction from simply owning the land where I grew up, where my two oldest children were born and where I worked so many hours. The plan was to leave it to my heirs who would then sell it. That course also meant that no federal income tax would ever be paid on as much as $1 million in capital gains.
But every man does have his price, and few people are completely irrational. If the sort of price drops we saw 30 years ago are a guide, in a few years, the market price of our farm might be a half-million dollars less than now. Although admittedly the run-up was “paper” assets, not cash, that’s a lot to pay for the ability to putter around and walk one’s own freehold. And there are fun things we could do with the money now. A nice trip back to Florence or Rio could ease the psychic pain of no longer being “a farmer.”
There is another element of irrationality. Rationally, it should not make any difference how we came to own a valuable asset. But I am not alone in having different feelings about money stashed in a 403(b) retirement account, for which I toiled, compared with an unrealized capital gain on a family asset held for 37 years.
If I thought there was a chance I would lose half the value of my retirement accounts, I would be alarmed indeed. But I don’t feel the same urgency about riding a farm price bubble down as well as up.
“Easy come, easy go” sounds sinful to Calvinists like me, but it is a pretty accurate expression of economic human nature.
Across Minnesota, there are many thousands of urbanities who still own a hunk of a family’s farm. All of us are in the same boat, agonizing over whether to take the money and run or pay a high price for pleasant intangibles. It will be interesting to see what most of us actually do.