Editor's Note: Farm Management Editor John Otte offers this commentary on agriculture, prosperity and why the two don't always work together.
We hear a lot of chatter about the need for a farm safety net. Any risk management safety net is woven from numerous pieces. A short list includes:
* What’s in the best interest of farmers?
* What’s in the best interest of organizations that have a product to sell to help weave the safety net?
* Requiring farmers to provide broader benefits to society such as installing conservation practices to be eligible for income transfers from taxpayers.
We’re defeating ourselves
While interest groups are weaving safety net proposals, we ourselves are rapidly cutting holes in our own risk management safety net.
Thirty some years ago, an aging cowboy told me, “Only one true risk management strategy exists. That is, have something stashed away in the sock.”
The stash can be cash or equity.
High crop prices are generating lots of cash. Some farmers may be stashing cash.
However, many farmers are using current cash flows to bid up cash rents. High-equity landowners are using earnings from existing land to bid land prices well above the level the cash flow from an add-on parcel alone could support.
Rapidly rising land prices add equity to the farm balance sheet. That creates an equity cushion farmers can borrow against should the need arise. Rapidly rising land values also create a higher barrier to entry to players not already in the game. But that’s a topic for another story.
Farmers are acting rationally
Farming is an industry with a large number of participants operating independently. The normal profit in such an industry is zero. That’s because the independent players will bid up the price of the fixed resource so as to erase all profits.
The fixed resource in farming is land.
Whatever form a safety net takes, farmers will bid its value into land prices.
Fixed payments are one form of safety net. Farmers can easily bid those payments directly into land values.
Crop insurance is another form. It makes income more reliable. Farmers can bid reliability of income indirectly into land values.
Everything in ag is cyclical
What goes up comes down. And we’ve already seen that what was down—in terms of grain prices - goes up.
The question is what happens when:
* Grain prices retreat from lofty levels?
* The dollar rebounds making U.S. ag exports less competitive in world markets?
* The next energy shock ratchets fuel and fertilizer costs another notch higher?
The answer is obvious. Farmers will face a financial squeeze. Who gets squeezed and how severely depends on a host of factors. A few are:
* How far and how fast input and product prices move.
* How highly leveraged one’s operation is.
* What commodities one produces. Many livestock producers contend that the squeeze is already here.
How well one comes through the coming financial setback also depends on a host of factors. A few are:
* How adept one is in detecting subtle changes in markets and financial indicators that signal a major change is coming.
* How nimble one is in readjusting the farm debt/asset and financial portfolio to the new economic environment.
* How much cash or equity one stashed away in the sock before the downturn.
One thing is clear. Any safety net, whose benefits farmers have already bid into land values, will not provide enough support for some, possibly many, farmers.
- Otte is Farm Management Editor at Farm Futures