Macroeconomic Outlook: Implications for Agriculture

1. Macroeconomic Outlook: Implications for Agriculture John B. Penson, Jr. Texas A&M University November 18, 2008

2. 2 Change, Change, Change

3. 3 When I spoke to you back in 2004… Real GDP growth was approximately 4%. Inflation was approximately 2%. Manufacturing capacity utilization was rising. Consumer confidence was rising. Consumption expenditures was expanding. The civilian unemployment rate was 5.4%. The price for crude oil was $44 a barrel. The price of corn was $2.06 a bushel.

4. 4 How much have things changed? With the current market turmoil, what is the easiest way to make a small fortune?

5. 5 How much have things changed? With the current market turmoil, what is the easiest way to make a small fortune? Start off with a large one.

6. 6 How much have things changed? I went to an ATM this morning and it said “insufficient funds”

7. 7 How much have things changed? I went to an ATM this morning and it said “insufficient funds” I wondered if it was them or me!

8. 8 How much have things changed? What is the difference between Lehman Bros. and a large pizza?

9. 9 How much have things changed? What is the difference between Lehman Bros. and a large pizza? A large pizza can still feed a family of four.

10. 10 So Much for Jokes….There is nothing funny about today’s economy!

11. 11 It has been 26 years since we have experienced a significant recession

12. 12 What is a recession?

13. 13 Defining a Recession

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19. 19 The Great Depression Over-indebtedness caused by easy money in the 1920s fueled speculation and asset bubbles. Large scale lack of confidence by consumers. Firms expanded output into 1930s but consumers did not buy; hoarding of money. Smoot-Hawley Act doubled duties on exports, which fell sharply – hard on agriculture. Fiscal policy – increased marginal tax rates. Monetary policy – money supply shrunk by 33% during 1929-33. Fed failed to add liquidity. Businesses could not get new loans, some old loans not renewed, investment ground to a halt and asset values declined.

20. 20 The US economy today

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27. 27 Let’s compare the current condition with recent recessions

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29. 29 Quarterly Change in Real GDP

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36. 36 Consumer Credit and Recessions

37. 37 Consumer Credit and Recessions

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39. 39 Recession Drivers 11/73-3/75: quadrupling of oil prices with high government spending due to Vietnam war. 7/81-11/82: Iranian revolution increased oil prices. Tight monetary policy to combat inflation carried over from 1970’s. 7/90-3/91: Unsound lending practices led to S&L crisis and government bailout ($160 B). 3/01-11/02: Collapse of the “dot.com” bubble, the 9/11 attacks and accounting scandals. Today: Sub prime loans, collapse of the “housing” bubble, cost of war on terror, high oil prices, lack of capital market oversight and government bailout ($??? B or T).

40. 40 Any Common Threads? Oil price effects (73-75, 80-82, 90-91,today) Bursting of bubbles (01-02, today) Unsound lending practices and regulation, Fannie Mae quarantees (90-91, today) Military actions (73-75, 90-91, today) Fraud and abuse (who knows?) The Enron scandal, for example, contributed to the 01-02 recession. Government financial bailouts (90-91, today)

41. 41 Today Vs. Recent Recessions Fed funds rate much lower today than in recent major recessions. Unemployment rate much lower today but increasing. Oil prices much higher today but softening at present. Inflation much lower today. The value of the dollar is lower today but increasing in recent weeks. Drop in manufacturing smaller today but increasing. Consumer credit much higher today relative to their disposable income. Net loan losses at commercial banks smaller today but increasing.

42. 42 Things are bad globally Major countries entering a recession this year include: United States Most if not all EU countries Japan Emerging economies Major countries avoiding a recession this year include: China India

43. 43 Where does the US economy go from here?

44. 44 2009-10 Street Forecasts Length of recession – the 1981-82 recession lasted 16 months. Depth of recession – the 1973-75 recession, while also lasting 16 months, was not as deep as the 1981-82 recession. Goldman Sachs this week forecast the deepest recession since 1981-82. They see the economy shrinking 3.5% in the 4th quarter and 2% in the 1st quarter of 2009. The 4th quarter drop worst since WWII. They also see the unemployment rate climbing to 8.5% by the end of 2009.

45. 45 Goldman Sachs Forecast

46. 46 1. Policy Options The reasons for these recessions and the problems today reflect some similarities, but also some significant differences that affect available policy tools. A major difference is that the Federal Reserve today has little room to lower interest rates much further. The Fed will likely lower its benchmark Federal funds target another 50 basis points. Then what? Recent cuts have bought little increase in bank lending. Lowering reserve requirements may also have little effect in the current real economy. The money supply, which was likely too low in 2006-07, is up markedly today!

47. 47 2. Policy Options This leaves the Fed in the position of acting as a commercial bank (buying commercial paper) and “printing money” (Treasury announces tax rebate, issues bonds to finance it, gives them to the Fed in exchange for deposits, and draws on this account to clear checks mailed to taxpayers). The major governmental stimulus to address the length and severity of today’s recession therefore has to come from Congress and the administration.

48. 48 3. Policy Options The use of the $700 billion “bailout” has been hotly debated, and modified greatly since the original proposal. Few sectors have not asked for access to these funds in recent days. Yesterday the Senate began debate on loaning $25 billion to US automakers. Little or no direct attention has been given thus far to the housing market, where the credit crunch problem manifested itself. Redo loans under more favorable terms that lowers foreclosure pressures? Whatever, we need policies that reduces further foreclosures.

49. 49 4. Policy Options Tax cuts, or at least a clear statement that the Bush tax cuts will not be rolled back by the incoming administration, would also provide incentive (reduce uncertainty) to business investment. Finally, some are calling the +50% decline in gas prices a “tax cut.” Let’s not lock this lower price of a “cartel controlled” natural resource at the current level. Sure demand is off globally, but OPEC is hardly dead. It’s recently announced cutback is obviously being violated by some member countries.

50. 50 My two cents… Address the housing market directly. Fiscal stimulus that increases jobs, which will enhance consumer confidence, (now at lowest level since 1957) and backs consumer loans (a bank asset), which will increase consumer lending. Postpone discussion of tax increases by the incoming administration until healing occurs (more later)! Avoid deflation. Inflation may actually be a good thing in the near term if it prevents deflationary pressures, increases asset prices and improves public finance.

51. 51 Implications for Agriculture

52. 52 The 5 R’s: Key Macro Linkages to Agriculture Rate of interest Rate of growth in real GDP Rate of inflation Rate of unemployment Rate of foreign currency exchange

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54. 54 Recent Macro Conditions Weak dollar (good for Ag!) Expensive fuel (bad for Ag!) Low inflation (good for Ag!) Low interest rates (good for Ag!) Low unemployment (good for Ag!) Low income tax rates (good for Ag!)

55. 55 Troubling Look at 2009-10

56. 56 Potential Macro Scenario Expensive fuel (bad for Ag!) Rising inflation (bad for Ag!) Higher interest rates (bad for Ag!) Stronger dollar (bad for Ag!) High unemployment (bad for Ag!) Higher income taxation? (bad for Ag!)

57. 57 Lessons from History Agriculture has historically been adversely affected by rising inflation, interest rates and a strong dollar. Deflation, on the other hand, would be hard on real estate values, which represents 85% of most farm balance sheets. Remember the 1980s. External credit rationing (price and quantity) by banks and Farm Credit System entities may be a problem in 2009. Fortunately much of agriculture has benefited from historically high prices and is in a good cash position. Stress for highly leveraged firms.

58. 58 Looking Forward

59. 59 Commodity Prices Prices for many program commodities hit record highs the past two years. Lower oil prices and slowing client economies will keep prices well below the highs seen this year. High input prices for fertilizer, seed, etc will squeeze profits/create losses. Land values will not increase at double digit rates seen the last 3-4 years, and may well decline in 2009.

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64. 64 2009 Central Illinois Corn Budget

65. 65 Debt on Balance Sheets Balance sheets in agriculture are in a much better condition than the 1981-82 recession. USDA points to great solvency status. Solvency ratios however reflect high land values which may fall in 2009-10. Furthermore, two-thirds of farmers have no term debt. Thus, one-third of farmers owe all term debt outstanding!

66. 66 Liquidity and Debt Strategies Producers will need to be well prepared when visiting their lenders for 2009 financing. Those who used previous profits to purchase fixed assets may face cash flow constraints. Don’t expect previous LOC’s to be renewed at previous levels, especially if previously unused. Pay down debt – best investment you can make in the current environment. Look for ways to increase efficiency. Retain sufficient liquidity – Dave Kohl recommends net working capital be 33 percent of total expenses. Varies by enterprise.

67. 67 Politics? A new administration brings questions about where we go from here: Market regulation? Income taxation? Focus of government spending? Energy policy? Strategies adopted to revive the domestic economy? Global macroeconomic policies and impacts on agricultural trade? Global unrest?

68. 68 For example…. Joseph Stiglitz, a Nobel Prize-winning economist, said in a Washington Post article on November 9th that it will take the Obama Administration 18 months to turn around the economy even if everything goes perfectly. Stiglitz urges the new administration to role back the 2001 and 2003 tax cuts. He also urges that capital gains be taxed as ordinary income. Says it would reduce the deficit, have few short-term adverse effects on an already reeling economic, and make the tax code more fair.

69. 69 In Summary… Economic signs going forward are confusing. 2009-10 however will present increased economic stress. High input costs for fertilizer, seed, land rental rates a concern in agriculture. Inflationary monetary and fiscal stimulus may lead to higher interest rates and stronger dollar over time. Changes to current energy policy, taxation, etc?

70. 70 Some Signs are Hard to Read The 50-50-90 rule: anytime you have a 50-50 chance of being right, there is a 90% chance you will be wrong. Profits will be under stress. Maintain sufficient liquidity in current environment. Liquidity is king for now. Paying down debt a safe investment. Examining the sensitivity of investment decisions in fixed assets to a changing economy will lead to better informed decisions.

71. 71 Thank You for Your Attention