Running In Place

Say this for Uncle Sam, doling out disaster payments instead of complex subsidies has pushed recent farm income performance to decade-average levels. That's despite the fact that net farm income - adjusted for inflation - plummeted 21% between 1990 and 1998 (Table 1)."When we add in government payments, farm income was fairly strong in 1999. At issue, of course, is the distribution of that income,"

Say this for Uncle Sam, doling out disaster payments instead of complex subsidies has pushed recent farm income performance to decade-average levels. That's despite the fact that net farm income - adjusted for inflation - plummeted 21% between 1990 and 1998 (Table 1).

"When we add in government payments, farm income was fairly strong in 1999. At issue, of course, is the distribution of that income," says Alan Barkema, vice president and economist for the Federal Reserve Bank in Kansas City.

Indeed. Some coffee shop chatter across the country puts the current agricultural slump on par with the early 1980s. Although the economic hole may look similar, the path there last time was strewn with lost equity. This time around, it's all about prices and cash flow.

"Net farm income during the '80s went up and down like a bobber, except for cow/calf producers who put together a string of bad years," says Phil Kause, U.S. livestock and crops analyst for the Food and Agricultural Policy Institute.

In a nutshell, he explains that high interest, inflation and anticipated increases in demand drove up land prices and the equity needed to borrow more money. When overproduction and weakening export demand conspired to crash commodity prices, the bottom dropped out of land values and highly leveraged producers got buried.

This time around, Barkema says domestic and international producers were ramping up production when economic crises around the world knocked the stuffing out of exports. In fact, he explains beef, pork and poultry grew to record levels of production the last two years while U.S. agricultural exports declined 20% since 1996. Throw in a strong American dollar, four consecutive years of record global crop production and it's easy to see why prices got softer.

"Today, it's more of an income problem," says Kause. "Lower commodity prices are pressuring producers, but we haven't seen the decline in land prices. As a result, producers have been able to maintain equity, and interest rates have been reasonable.

Plus, the steaming economy that low commodity prices help build, ironically, has offered little in the way of inflationary pressure. Barkema explains, "We simply have a very healthy and strong economy. But, that doesn't imply that all boats are rising at the same time."

All told, Barkema says, "The industry's financial foundation remains stronger today...Total farm debt has been edging up, but it's still less than it was in the '80s."

For perspective, compare the industry's debt to asset ratio of 16.2% in 1998 to 23% in 1985 (Table 2). Likewise, the debt to equity ratio continues to hover below 20%, compared to almost 30% in 1985.

Economic Strength Is Relative But, producers are bringing in more off-farm income to stay in business. In 1992, for example, farm income generated 16.7% of the income for farm households. Farm income has accounted for even less since then (Table 3).

Both economists are quick to point out aggregate numbers hide the economic struggles of individual producers.

"Obviously, given price levels, there are definitely some people with both feet in hot water. On the other hand, some producers are talking about expanding, and obviously those folks must have their houses in order to do that with commodity prices so low," Barkema says.

However, even those looking to expand may see the commodity price hole grow deeper over the long haul.

"Prices will come back up, but over time I think we are moving to lower price planes as global production expands," says Kause. For instance, rather than bank on seeing $3.50/bu. corn, over time he says it's more likely to be $2.50-2.75. The same goes for every other commodity.

Just take a look at the '90s (Table 4). Adjusted for inflation, corn prices dropped 32.9% between 1990 and 1998, and calf prices fell 33.9%.

"Essentially, what we're looking at is supply and demand. Through time, the supply of agricultural commodities is growing faster or slower than demand, and through time we have generally seen production grow at least as fast as demand," says Barkema.

If technology can keep boosting production incrementally, he explains, "The population of the U.S. is growing at about 1 percent or a little less. Agricultural production in the U.S. is growing at about 2 percent or a little more. So, you can quickly see we'll have to find a home for that additional production or add more value to it and rely on income growth to pick up the slack."

Spun differently, Kause explains, "Agriculture is cyclical in nature because we are always trying to balance supply and demand, and without a system in place (farm programs) that tries to balance that artificially with acreage reduction programs and government storage, current policy allows the market to determine the price that clears it.

"Today, commodity prices are low because producers globally have had excellent growing conditions the past four years. Couple this with a reduction in demand caused by economic problems in Asia, Russia and South America, and the market has moved lower in order to spur usage," he says.

For perspective on how Freedom to Farm measures can impact commodity prices on a day-to-day basis, Barkema explains government grain stocks are still lower than they were in the '80s, even though they have grown substantially since 1995 when they were depleted by poor production years. Even so, those stocks have created more price pressure than in the '80s because in this new Freedom to Farm age they are considered to be free stocks, a liquid commodity that can move to market at any time, rather than with the bureaucratic wrangling it used to take.

Of course, the production sword does cut both ways. "If you look at trends in deflated dollars, there has been a long, sustained downward trend in prices," says Kause. "On the other hand, when you look at production trends, you see that trend line moving the other way."

Although prices are trending down, he explains producers have more units of production to sell today. So, even with lower prices, Kause says gross revenue per production unit hasn't changed all that much.

But, competition for consumers continues to pressure prices of all commodities, no matter the supply.

"The share of consumer disposable income that goes toward food has been declining, too, as savings are passed along to consumers," says Kause. That means consumers are not only paying less for food, they're paying less than ever before for food with added value and convenience.

Reality Vs. Opportunity Given these long-term price challenges, Kause says, "I think it will become more important for producers to know exactly what attributes their products contain and market them accordingly." He believes more buyers in the future will evaluate and pay based upon specific attributes of the commodity, rather than offer one price for a given commodity.

"I do think we're laying the ground for some real structural changes in agriculture," says Kause. "I think we are moving toward more supply chains. If you consider increasing awareness about food safety, these supply chains make it easier to monitor inputs."

Through vertical coordination, not necessarily ownership, he points out supply chains also lower transaction and marketing costs. That, while giving the system more opportunity to tailor products to specific consumers.

Whether or not producers are eyeing the value-added frontier, Kause suggests, "If I'm a producer today, given how tight these margins are, I want to know exactly what my production costs are and I want to evaluate each of my enterprises for cost and return...Then, I can make educated decisions about where I can cut costs and I can identify enterprises where I don't have a comparative advantage.

"Evaluate all management practices and make sure you have your house in order on the farm, then examine how and where you can add value to what you produce," Kause says. "You just have to take the time. With margins what they are today, it has to be done."