If a farm equipment dealer were to ask Mike Boehlje if he’s seeing anything that could signal a slowdown in the overall agricultural economy is in the offing, without hesitation he says, “Yes, we do see some things. We are increasingly concerned about what’s happening in the markets.”
He acknowledges that the tone of his comments may be construed as a pessimistic view of what’s ahead for farming. But Boehlje insists he’s not an alarmist nor does he hold a negative view about agriculture and its future. In fact, he says, “I’m quite positive about the longer term future of agriculture. What I am nervous about are the bumps in the road on our way to the long run.”
The distinguished professor in the Dept. of Agricultural Economics and the Center for Food and Agricultural Business at Purdue Univ. has observed and analyzed the ag industry at its peaks and valleys during the past 4 decades or more.
He’s worked primarily in the finance area “during a time when we were encountering financial stress in agriculture,” he says. “I did a lot of my work during the farm crisis in the 1980s with both farm finance and the banking and lending sector.”
Since 1991, he’s focused his efforts on strategy and risk management issues both for farms and agribusinesses.
“Today, I continue to work in the risk management and finance issues. The recent run-up in land values and what’s happening with the farm income side have kind of returned me to my roots,” he says.
What’s making Boehlje nervous about the industry’s short term prospects?
“We don’t know what the future holds, but we do have some concerns about some of the industry’s fundamental drivers and the direction they’re driving,” he says.
“We have evidence of increased volatility, but most of the volatility we’ve had in the last 5 years has been on the upside and there’s reasons to believe there’s now some volatility on the downside that we really ought to be positioning for.
“What I tell farmers, and I would say the same thing to machinery dealers, is I’m very positive about the long term future of agriculture,” Boehlje says. “What I don’t want you to be is road kill on the way to that long run future. You’ve got to be positioned to handle the downside.”
Ag’s Cycles in Context
“U.S. agriculture is notorious for its boom and bust cycles” is the opening line to a paper entitled, “Agriculture’s Boom-Bust Cycles: Is This Time Different?” Boehlje co-authored with Jason Henderson of the Federal Reserve Bank of Kansas City and Brent Gloy, director of the Center for Commercial Agriculture at Purdue.
To fully understand what’s happening today and the factors that may be setting the stage for ag’s next phase, he says, it’s particularly important for dealers to put the history of agriculture’s boom-bust cycles into context.
When comparing the 1970s and ‘80s environment and what happened to agriculture during the last major down cycle — the one that most veteran dealers remember best — Boehlje says dealers were the part of the industry that felt the most intense pain.
“It is true that we had some significant financial stress in the production sector of the agricultural industry during the 1980s,” he says.
“But what I don’t think many people fully appreciate is that we actually had far more stress in the machinery and equipment part of the industry during that time period. The fact is, we did not lose as many farmers in the 1980s as as people think. There was a lot of debt written down on the part of banks, a lot of financial stress and downsizing of farms, and some farms exited because of bankruptcies, but we didn’t lose that many farms.”
The major long-term impact on the production side of the business was that entry into farming declined, according to Boehlje. “A lot of farm kids decided not to go into farming.”
It was in the equipment sector where the farm crisis took its real toll. Boehlje estimates that 25% of all farm equipment dealerships closed up during that period. “One out of four machinery dealers went out of business or were merged out of business during the 1980s. Dealers didn’t have the safety net that farmers had and that situation hasn’t changed. This is very problematic if we think about what could happen going forward.”
8 Critical Factors to Watch
Boehlje says that he watches 8 critical issues that heavily influence the general health of agriculture. He advises dealers to do the same.
1. World Income Growth. “To be honest with you,” says Boehlje, “worldwide income growth is slowing down.” But, he adds, this is only part of the bigger picture.
The first, and most significant, he says, is the recession in the European Union and slowing growth in China. These are connected and, when taken together, pose a significant threat to North American agriculture. With 25% of Chinese exports going into the European Union, if the current recession in the EU is longer and deeper than anticipated, China’s growth will be impacted in a big way.
“Chinese economic growth has been a major driver of the growth in our export markets for agriculture,” says Boehlje. “History shows that U.S. farm income is heavily dependent upon exports. If exports from the U.S. weaken, farm incomes fall and machinery sales decline. If exports are strong, farm incomes are strong and machinery sales increase.”
The fact of the matter is the volume of U.S. agricultural exports — both livestock products and grain — has been declining during the past 3-5 years. It has been the value of ag exports that increased during this period, largely because of the high prices of the commodities, especially grains.
“We have concerns about some of the industry’s fundamental drivers and the direction they’re driving...”
— Michael Boehlje
We need to watch world economic growth carefully, Boehlje says, and clarifies this factor further. While most have heard the news about the world population growth to 9 billion people by 2050, this is not the main driver of future growth in agriculture.
“It’s economic and income growth that will drive long-run demand,” says Boehlje. “While a rapidly expanding worldwide population gives a reason to feel positive about farming’s future, 9 billion people with no income is not effective demand; it’s a social and poverty problem. So we need to have economic growth, not population growth, to have expanding demand for our products. It’s important that we make this distinction,” Boehlje adds.
2. Expansion of Biofuels. There’s little doubt that rising commodity prices of the last decade have been significantly impacted by expansion in the use of corn and other agricultural raw materials for biofuels. Boehlje says that demand for biofuels has been policy driven through tax incentives, import restrictions and mandated requirements with the Renewable Fuels Standard. “That mandate, in terms of corn-based biofuels, is maturing out, and the biofuels industry is hitting what’s called the ‘blend wall,’” says Boehlje. “There is not very much optimism for continued growth in the biofuels demand, and cellulosic is highly unlikely to come to market.
“We’ve been predicting increased use of cellulosic materials for biofuels for the last 30-plus years. It just isn’t there and probably will not be there for a long time,” he adds.
As the biofuels market matures, demand is expected to flatten out with little growth expected in the next few years, at least. This is another reason to be concerned about the short to intermediate run in terms of the demand side. “So the two main growing sources of demand — export demand because of growing incomes and biofuels demand because of government policy — are both maturing out,” says Boehlje.
3. Value of the U.S. Dollar. A weak dollar has been a significant contributor to high agricultural exports for several years. With a weak dollar, products imported into the U.S. are more expensive and those exported from the U.S. are less expensive.
“In the last year, we’ve seen the falling value of the dollar flattening out and right now it’s rising,” say Boehlje. “So our currency values relative to other exporting countries, like Brazil, are strengthening, putting U.S. products at a disadvantage in those export markets. This is further compounding the first issue we discussed, the slowdown in worldwide economic growth.”
4. Weather-Induced Crop Shortages. According to Boehlje, over the past 4 or more years, worldwide crop yields have not been very good generally. This, together with the 2012 drought in the U.S., left world crop supplies abnormally low. “In spite of the short supplies, and given the delay in planting we experienced in the U.S. this spring, we’re seeing significant discounts for the 2013 corn and bean crop compared to the 2012 crop,” he says.
“What this tells us is the market is betting that there won’t be another abnormally short crop in the next year. If production comes in closer to normal in 2013 and 2014, this, combined with the slowdown in worldwide economic growth, in all likelihood, will result in a build-up of inventories of feed and food grains to more normal levels. This will inevitably lead to lower prices for those crops.
“We need to understand that we can’t predict the weather,” says Boehlje, “but to count on weather-induced short supplies as a permanent phenomena is probably not a realistic expectation.”
5. Rising Input Costs. Input costs have been going up rapidly over the last 5 years, according to Boehlje. “We’ve seen an increase in the costs and breakeven prices for corn of 54% and soybeans of 33% on a per-bushel basis from 2006 to 2012. Our best estimate of breakeven price in 2013 is $4.90 for corn and $10.67 for soybeans. This is for total cost of production, including the operator’s labor and depreciation allowances, not the cash cost of production.”
He adds this is not unusual as commodity prices rise. “Everybody in the value chain — fertilizer, seed, chemical, machinery, dealers, landowners, everybody except bankers — want a chunk of that higher pricing and income, and they’ve been able to obtain it.”
The bigger worry, according to the Purdue professor, is that as commodity prices drop, input costs don’t drop at the same rate, thus creating significant margin compression for farmers. This, he says, is already showing up in futures market prices. “I’m not saying the futures market is exact in predicting prices, but I hate to bet against it.”
Confronted with margin compression, farmers typically respond by reducing capital expenditures. “That’s the first thing they adjust,” says Boehlje.
With the high levels of new equipment purchases during the past 5 or 6 years, this should be a significant concern, he says, as growers accelerated their upgrade cycles.
“Dealers must be careful about extending a lot of credit to farmers buying machinery. They don’t want to become the farmer’s banker..."
“We’ve got an extremely modern equipment inventory out there and some people say farmers could go quite a while before they would need to buy anything new. By that I mean, instead of buying every other year, they could probably hold off for 4 years.”
6. Rising Interest Rates. Eventually interest rates will go up, says Boehlje. “We don’t know when, we don’t know how much, but we’ve been in a consistently declining interest rate environment for the last 20 years, which has made it favorable for farmers to make capital expenditures.
“They’re at abnormally low levels today, and even the Federal Reserve and interest rates futures market are suggesting that we’ll see a rise in interest rates in 2014 and 2015, maybe as much as 200 to 300 basis points in real interest rates above where they are today by 2016-17.”
Will they rise up into the high single or low double-digit numbers? Boehlje doesn’t think so. But if they don’t increase, this would suggest that we’re continuing to see a global slowdown and more economic stress, “which means they’re staying down for the wrong reasons,” he adds, “and this is not good for the demand side of agricultural products.”
When interest rates go up they’ll increase costs and also decrease the value of capital assets, which means assets like farmland, which have been bid up to record levels.
“We would expect to see less enthusiasm for buying farmland and there are some who believe we could even see some decline in farmland values. So rising interest rates has a cost impact as well as it has a wealth impact. And a wealth impact is really a big issue right now in agriculture. It’s a damned if you do or damned if you don’t scenario,” Boehlje says.
7. Growing Worldwide Competition. If North American dealers aren’t paying attention to the rising international competition that will impact their customers, they’re making a big mistake.
For example, the Purdue professor takes to task what he calls one of the great myths of agriculture and farmland, which is “they ain’t making any more of it.”
“This is just absolutely not true,” he says. “At a very rapid pace, we are converting land that has not been tilled to tillable land in the rest of the world.”
According to Boehlje, 123 million additional acres of land has been moved from non-tillable to tillable land in the world in the last 6 years; 30 million acres last year alone.
To put this into perspective, he says, “The U.S. planted about 95 million acres of corn last year and we’ll probably plant something around that this year. So we have brought into production new land in the world that’s about 1.5 times the amount of total land that we produce corn on in the U.S.”
Much of the land that’s being brought into production isn’t as productive as U.S. land, but over a period of perhaps 6 or 7 years, it becomes more productive. But the main point of all this, says Boehlje, is that “Higher commodity prices incent expansion in world production. Once land comes into production, it stays in production.”
He also notes that producers in Brazil, for example, have rapidly caught up to and in many ways surpassed U.S. soybean producers. “Today, Brazil has a higher quality bean in terms of its protein content than the U.S. It has become the number-one soybean producer in the world with higher yields than in U.S. On top of it, they have a vast expansion of acreage with which to expand.”
8. Government Policies. Historically, U.S. government policy has provided a buffer for U.S. farmers in times of financial stress and other natural disasters.
“We’ve had a farm safety net for a very long period of time for U.S. farmers. If you consider the deficiency payment program and ACRE programs, as well as others that were put in place for price and income supports, this safety net built into the farm program is substantially lower than it has been.”
On the other hand, the crop insurance program proved its worth during the 2012 drought. But farm program payments have a “big red bull’s eye” on them in the current budget debate.
“No question about it, we’re going to have reduced program payments, including no more deficiency payments. The biggest concern is what they’ll do with the current crop insurance program, which could make the government’s safety net either less effective and/or more costly for farmers going forward.
“In other words, farm policy may not provide as much buffering of the downside risk as we might have had in previous boom-bust cycles,” says Professor Boehlje.
Concerned, Not Pessimistic
“Absolutely not,” is Boehlje’s response when asked if he is pessimistic about agriculture in the long run. “We are very optimistic about it. Are we concerned about what could happen in 2014 and 2015? Yes.
“We believe 2013 probably will not be too bad a year. We’ll probably get somewhere close to a normal crop, we’ll see somewhat lower prices than we saw in previous years. We certainly will not see a collapse in prices. We’ll still have a fairly effective crop insurance program, so we don’t see any major problems in 2013.”
Even looking beyond the current crop year, he doesn’t expect to see the type of collapse the industry experienced in previous boom-bust cycles.
If the industry’s current level of production and profitability does slip, Boehlje expects a “soft landing” but not a major “bust.”
Everything considered, what’s the best advice Boehlje would offer to equipment dealers?
“Dealers must position themselves for the prospects of a sales decline. They need to be very careful about not accumulating a lot of used equipment or machinery. Those dealers in the 1980s that were most severely impacted were those that had accumulated a lot of used equipment that they weren’t able to move.”
They also must be careful about extending a lot of credit to farmers buying machinery so they don’t become the farmer’s banker. “Dealers don’t want to be a banker for their customers.”
Finally, he says, dealers need to re-emphasize their service and parts business. “If what I’m suggesting occurs, farmers will have more need to repair their equipment rather than buying new. And dealers will need to have a financial reserve so that they have more absorptive capacity when sales volume declines.”