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Dr. David M. KohlBy: Dr. David M. Kohl

This year is certainly slipping by as the holidays and beginning of the New Year rapidly approach. Many are into yearend buying and investment decisions for tax management purposes and to position their businesses for 2014 and beyond. The state of the economy is top of mind as businesses are in the planning mode. What is in store for 2014 and beyond?

The emerging nations’ economies i.e. the BRICS and KIMT nations of Brazil, Russia, India, China, and South Africa, along with South Korea, Indonesia, Mexico, and Turkey, have been the fuel motoring the agriculture industry and rural economies. Since 1998, GDP growth in these emerging nations has averaged 9.8 percent, elevating the standard of living in many of those regions. In turn, their demand for agricultural exports such as food, fiber, and fuel has been strong. There now appears to be an economic moderation of these emerging nations with GDP growth rates between 4 percent and 5 percent.

Biofuels, particularly ethanol, have been a game changer on the agriculture and rural landscape consuming a large share of the domestic corn crop. Some draw comparisons of ethanol to the Russian wheat deal that propelled American agriculture in the 1970s. The winds of change appear to be accelerating with government agencies concerning this key variable in the economic health of agriculture and the rural landscape. Biofuels and increasing use of other sources of energy may be a variable that moderates prosperity in agriculture, particularly for grain producers.

The dysfunctional federal government has been a geopolitical risk that has stymied growth in the U.S. and globally. Estimates find that indecision in Washington, D.C. along with added regulation and issues relating to health care have taken 1 percent off the fourth quarter GDP in the U.S. The Federal Reserve and global central banks have come to the rescue with a variety of economic inducements. Historically low interest rates and easy money have created the wealth effect in equity markets as well as farmland and other real estate. More specifically, the wealth effect finds for every dollar increase in stock values, consumers spend four cents more. The wealth effect is more prominent in real estate with a nine cent increase in consumer spending for every dollar increase in real estate value. The Federal Reserve has created approximately $1 trillion worth of paper wealth on agriculture and rural balance sheets. The stimulus has been a driver of the emerging nations’ economies, which import a considerable amount of agriculture and natural resource output from rural America.

[rich-callout title="Farm Credit Bond" image_id="6270"]This chart illustrates that 30-day Farm Credit issues continue to stay at historically low levels through November 2013; however, the gap between long-term and short-term rates increases. Ask your FCS Financial expert about conversion options and the advantages of locking in low, fixed rates on real estate loan or other term loans.[/rich-callout] It appears that Dr. Janet Yellen will be confirmed as the new Federal Reserve chair. Historically, she has been in favor of very accommodative action to stimulate the economy. Expect interest rates to remain low in 2014 with additional stimulus. While one cannot predict when rates will ascend, watch three variables as cues for action. First, unemployment rates moving down towards 7.0 percent and 6.5 percent will be an indicator. Second, watch core inflation (not including food and energy) and headline inflation, which includes the volatile components of food and energy. Inflation of above 2 percent or a sharp rise will be signals to the central bankers to increase rates. Finally, GDP growth above 2.0 percent to 2.5 percent would be indicative of a growing economy.

With these variables in mind, general observations find that the economic prosperity of the grain sector most likely is in the eighth inning stage. Recent farm income databases find 50 percent of producers with a cost of production for corn above $5.00 per bushel. If soft commodity prices play out, negative margins could be the mode of operation for those with high cash rents and low efficiency. On the other hand, the livestock industry is observing an economic renaissance, possibly being in the third or fourth inning of the economic cycle.

This being said, farmland values that have appreciated by 30 percent to 50 percent over the past two years in many regions of the country are probably due to soften. It would most likely take multiple years of profit compression or negative margins for rent and land values to correct. Buying pattern shifts with more equity used as down payments and outside investors would suggest that change is in the wind in the red-hot land market.

What are strategies for success given the outlook?

  • First, make sure you know your cost of production and breakeven levels by enterprise so you can allocate resources to earn the greatest returns. Conduct scenario analysis with different price and cost scenarios to provide an objective schematic for decision-making.

  • Next, risk management will not be an option but be a requirement for 2014. Crop insurance along with marketing and risk management programs will be essential for profitable outcomes.

  • Third, soon after the first of the year, update your financial statements using accrual adjusted figures and several projected cost scenarios. Schedule an appointment with your lender to go over key ratios and benchmarks. It is good to have another set of eyes on your financials to conduct “but what if” analysis and reinforce positive outcomes that you can build upon.

Yes, the tide of economics is turning; however, those with good proactive planning and solid execution and follow through will be destined for favorable economic outcomes.
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