The U.S. Department of Agriculture predicts farmers will produce a record corn crop in 2016. I predict that 2016 will go down in farm history for another reason. This is the year in which a “farm financial crisis” will become national news rather than something discussed among insiders.
Don’t be alarmed. People over 50 in farm states will recognize the term “farm financial crisis” from the 1980s, when a land boom begun a decade earlier finally popped. High numbers of farmers went bankrupt, in absolute terms and as proportions of all farmers and of all acres farmed. Millions of acres of land were foreclosed upon. Hundreds of banks failed.
2016 and ensuing years won’t repeat that history. The structure of farm society has changed, as have institutions and practices in agricultural lending. Nothing this year from the farm sector will shake national financial institutions on the scale of the 2008 recession, let alone the 1980s. The national economy will not be noticeably affected. Most importantly, farm production will not slacken, food will remain cheap and agricultural exports will continue uninterrupted.
But many farmers will go broke, with failure much more common among top 10 percent of farmers with the largest sales than among smaller operators. Many ag lenders will take large losses. Some will fail. Sales of farm machinery and construction of grain handling and livestock infrastructure will shrink for some time. Farmers in no danger of failing will nevertheless find it difficult to obtain operating credit as stressed lenders become gun shy.
Let me be clear that this prediction is my own and is based on anecdotal evidence — something scorned by most respected economists. These problems are not yet showing up in published statistics, although direct conversations with lenders indicate that they will start to show up in the financial statements of many.
My insights on what will unfold here come from the works of general economists on similar issues, including Charles Kindleberger’s classic “Manias, Crashes and Panics,” Carmen Reinhart and Kenneth Rogoff’s “This Time It is different,” and Hyman Minsky’s “Stabilizing an Unstable Economy.”
The reasons for this contained crisis are two-fold: overinvestment in “physical capital” and the bidding-up of farmland prices to record levels. By “physical capital,” economists mean machinery, such as tractors and combines, or infrastructure, such as grain bins and livestock structures.
Outlays and prices for farmland and capital reached unsustainable levels over the long run. The reasons for this is several years of high crop prices. These stemmed in part from a cheap U.S. dollar, which makes our exports low-priced for foreign buyers.
Over a longer term, prices were rising for virtually all commodities produced anywhere. Meanwhile, in the shorter-term, the cheap dollar gave a special edge to U.S. sales and hence to farm and mine-level prices here in Minnesota.
But what some call a multi-year global “commodities supercycle” is a larger factor and one that affects all commodity-producing nations.
Now global prices are falling and the stronger dollar works to producers’ detriment.
Since the turn of the century, virtually all commodities, including farm products, minerals, metals, timber, petroleum and even coal, faced strong demand. China’s mushrooming economy was the principal cause, with growth in India and several other developing nations also supporting demand. Eventually, however, booms take on a life of their own. High prices over years generate highly unrealistic expectations that such prices and high profitability will continue unabated. The fact that political and military factors in the Mideast bolstered crude oil prices for a decade also contributed to widespread irrationally optimistic expectations.
This bust will be different socially from the 1980s because the structure of agriculture has shifted in response to that shakeout and to evolving production technology and marketing channels.
Farm production is even more skewed than back then, with a relatively small number of very large producers generating an even higher proportion of total output. This is greater than land-ownership data would suggest, because most large operators rent substantial acreage in addition to land they themselves own. These large operations, highly mechanized and highly efficient in technical terms, are the ones most at financial risk right now.
There still are many moderate-size producers, some part-time. Some of these also are in trouble, particularly if they bought land in recent years. But a higher fraction of land purchases by smaller operators were internally financed within families. And more of their equipment purchases were of used machines — hand-me-downs from the big guys who didn’t blanch at laying out a quarter-million for shiny new metal. Coming years of lower prices will be hard on all crop producers but will punish the more capital-intensive and highly leveraged big operators most harshly. The upshot is that a smaller fraction of family farms will face liquidation than 30 years ago.
Ag lending is not what it was in the 1980s, either. In the wake of widespread failures and consolidations of independent rural banks 30 years ago, and in response to the changes in the makeup of the owners of production, new lenders moved in to cream off the largest, most capital-hungry farms. Some were input suppliers who long had financed purchases of their own implements or other supplies. These branched out to make general operating loans. Other specialized nonbank lenders sprang up, large enough to raise money directly in capital markets and skilled at using the economies of scale of a focus on big loans. Some of these may be at highest risk. We have little historical experience of how this sector will fare because it is so new.
Traditional rural banks are not out of the picture, and many will be increasingly forced to write off loans. Some will fail. But most have diversified and have not allowed the levels of leverage on farm borrowers that was common 35 years ago.
These are reasons I and other observers long downplayed the likelihood of another ag crisis. When queried whether booming land prices presaged another bust, our standard answer was “farmers are not as highly leveraged as they were in the 1980s, lenders are much more cautious in valuing farmland on balance sheets and few land sales are seller-financed the way they were in the 1970s.” That was true eight years ago and even four. But it no longer is.
The irrational optimism Kindleberger and Minsky describe in their books inevitably seeps into producer and lender thinking. The unsustainable run-up in land prices and overinvestment in new physical capital no longer can be unwound neatly. “There will be blood,” at least metaphorically.
If this particular farm bust will affect fewer families than those of the 1930s or the 1980s, and if will not harm the national economy or financial system, why should the average person care? Perhaps we shouldn’t. But just as the bust 35 years ago made front-page headlines over an extended time, the coming shakeout will be a visible issue in farm states, especially in the corn, soy and wheat-growing regions of the Great Plains and Midwest. There will be appeals for greater federal income re-distribution to farmers than the modest $10 billion or so running now.
More broadly, while the bankruptcy of many large farm operations, losses to many farm lenders and lean years for farm machinery suppliers should not, in themselves, harm the national economy, the straw-on-camel’s-back problem does not have a probability of zero. There are many more negative uncertainties in the global economy right now. The collapse of the supercycle affects other commodity-producing countries and sectors that include much of South America, Canada and Australia — not to mention Minnesota’s Iron Range. When the overall global economy is so dicey, any more bad news is unhelpful.
So while this prediction is based more on an educated gut instinct than data, let’s hope I am wrong.