Author: John D. Anderson

While inflation is an immediate challenge to all economic stakeholders, the kind of broad-based inflation currently affecting the economy also raises the prospect of higher interest rates.  Rising interest rates are a significant risk for anyone regularly using short & intermediate term and/or variable rate financing, which includes a large portion of agricultural operations.    

Although rates remain low from a historic perspective, the U.S. weekly average 30-year fixed mortgage rate hit 5.25% in mid-May for the first time since 2009 (St. Louis Federal Reserve Bank).  The US bank prime loan rate is averaging 4.0%, rising from 3.25% in step with the Federal Reserve Board’s recent increases in the federal discount rate.  The discount rate is the rate commercial banks pay on short term loans from their regional Federal Reserve Bank.  As a monetary policy tool, the Federal Reserve Board of Governors raises the discount rate as a means of curbing inflationary pressure in the economy.  See Southern Ag Today – April 5, 2022  for a brief discussion of Fed policy tools.  Figure 1 compares a measure of inflation (year over year percentage change in monthly consumer price index) to the federal discount rate, clearly illustrating the relationship between the two series.

Figure 1.  Inflation (Year-Over-Year Percentage Change in Monthly CPI) versus Federal Discount Rate

When the pandemic broke out in March 2020, the Fed dropped the discount rate from 2.25% to 0.25% to bolster an economy that hit an abrupt wall.  In the next year, inflation began to climb but remained acceptably under 2% until early 2021.  Throughout 2021, the rapid rise in prices was thought (hoped) to be transitory, meaning prices would settle back to normal as temporary market and supply chain disruptions eased.  Now clearly not transitory, the Fed is engaging interest rates to tap the brakes on inflation.  In March, the Fed increased the discount rate by a quarter of a percent from 0.25% to 0.50% and followed that with a half point increase in May, moving the discount rate to 1.0%.  Looking ahead, the Fed has projected an intention to use half point rate hikes at consecutive meetings over the next year, presumably until they begin to see an impact on inflation.  

What level of interest rates are necessary and how long will it take to tame inflation?  Can the Fed manage inflation and avoid pushing the economy into deep recession?  What is the economic and political tolerance for higher interest rates?  

The last time inflation was at levels comparable to today, interest rates were exceptionally high.  The bank prime rate exceeded 20% in 1981.  It is difficult to imagine similarly high rates today.  The federal budget implications of higher rates are far different now than forty years ago.  In 1982, federal government outlays for interest totaled $85 billion against a total debt obligation of $1,120 billion.  That implies an average interest rate on federal debt of 7.59%, the highest at any time in the last fifty years.  Those 1982 federal interest payments amounted to about 2.5% of nominal gross domestic product (GDP).  In comparison, 2020 federal interest payments were $344 billion against total debt of $26,098 billion, an implied average interest rate of just 1.32%, and only 1.6% of nominal GDP.  Historically low interest rates over the last decade have clearly softened the impact of high federal debt levels on the federal budget.  For context, consider what federal interest payments would be on current debt levels at 1982 interest rates.  At an average interest rate of 7.59%, 2020 federal outlays for interest would have been $1,981 billion, equivalent to an unsustainable 9.5% of total GDP.  In the post-WWII era, federal outlays for interest have only rarely exceeded 3% of GDP, hitting a high of 3.15% in 1991.  The current level of federal debt suggests far less policy room to maneuver in response to rising inflation compared to the early 1980s.  The aggressive interest rate hikes that ultimately tamed inflation then would be far more expensive now for both the federal government as well as individual households.  Effectively, economic policy makers are caught between the rock of inflation and the hard place of higher interest rates.  

Economic uncertainty, inflation, and high interest rates present serious challenges for managers.  On a positive note, the financial situation in agriculture is better and should be more resilient to potential shocks compared 40+ years ago, and the likelihood of a 1980s-style farm sector implosion remains remote.  However, it is no time to get complacent.  In changing financial markets, shop for your best interest rates and terms.  Ruthlessly control costs (to the extent you have control), take profits when (if) they appear, jealously guard equity, and build your individual financial resilience.

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Anderson, John D., and Steven L. Klose. “Inflation and Interest Rates.” Southern Ag Today 2(23.3). June 1, 2022. Permalink

The April U.S. Bureau of Labor Statistics Consumer Price Index (CPI) update confirms what anyone who has gone to the gas station or grocery store in the last few months already suspected: prices are rising rapidly, particularly on food and energy.  The CPI is a composite measure of the cost of consumer related products, and a number of different CPI measures include different types or bundles of consumer products.  The CPI which includes all-items was up 8.5% from March 2021 to March 2022.  The March index for food only was up a bit more than that year-over-year, increasing by 8.9%.  The March energy index was up 32.0% over the past twelve months.  

While energy and food prices have clearly gotten a lot of attention, price inflation is occurring broadly throughout the economy.  The core inflation index (all items less food and energy) for March was 6.5% higher than the previous year.  This is the largest year-over-year increase in the core index since August 1982. So, while inflation may be most pronounced on energy and food at present, it is clearly not confined to those sectors.  The overall economy is experiencing the worst inflation in forty years.  Figure 1 illustrates the annual rate of inflation over the past half century, expressed as the year-over-year percentage change in the monthly all-items CPI.      

Figure 1.  Inflation, Measured by Percentage Change (year over year) in Consumer Price Index (CPI)

Rising prices are a challenge not only for consumers but also for businesses who must deal with rising production costs.  Many businesses will respond to increasing costs of labor, supplies, materials, or other inputs by raising the price of their output to maintain profits.  Competitive pressure can certainly constrain a business’ ability to raise prices, but many businesses generally have some latitude to adjust their product prices in response to higher input costs.  This is not the case for farmers and ranchers, who are price takers in both input and output markets.   That is, farmers and ranchers have no ability to influence the price they pay for inputs or to set prices on their output.  Thus, their ability to pass along increased costs to their customers is basically nonexistent.  

Figure 2 illustrates the long term trends in consumer prices and farm product prices.  It is clear that farm prices have not kept pace with broad consumer prices.  Effectively farm products are losing buying power relative to broad consumer products.  An aggregate bundle of farm products today is sold for 5.25 times the price received in 1970.  On the other hand, a bundle of consumer products costs 7.5 times what it would have cost in 1970.  Farm commodities today will only buy about 70% of the consumer products they would have bought in 1970, and that is only after the gap has narrowed considerably since the spring of 2020.  

It is important to note that the agricultural industry as a whole is in better shape than the chart alone would suggest.  To offset the erosion of buying power, farmers have increased the quantity of products they sell by relying on improved production efficiency, yield gains, and growing the size of their farm.  In other words, the erosion of purchasing power per unit of farm output has been offset by increases in the scale of production.  Necessarily over time, an increase in farm size also implies a decrease in the total number of farms (two trends that date back hundreds of years).  The challenge for the individual farm or ranch is to manage times of volatility and uncertainty while also navigating the normal long-term trend of attrition, and thus surviving to be one of the “fewer” farmers moving forward.  We appear to be in the middle of one of those times when price volatility is a significant management challenge.          

Figure 2.  Consumer Prices and Farm Product Prices

The warning on the horizon for agricultural producers is not the immediate problem of inflation.  Instead, the concern is what comes after.  Producers can weather inflation reasonably well, as long as, farm prices are moving more-or-less in conjunction with input prices.  Such a situation is not unprecedented: take the 1970’s as an example.  While the 10 years from 1973 to 1982 represent some of the worst inflation in this country’s history, we don’t talk about a 1970’s agricultural crisis because farm prices were mostly keeping pace.  In fact, in the face of extraordinary inflation, agricultural conditions encouraged farmer investment and taking on additional debt.  The crisis didn’t appear until the 1980’s.  As inflation moderated and commodity prices flat-lined, the burden of servicing debt at high interest rates (which were both a result of and the treatment for high inflation) became unsustainable for an industry that was not only highly dependent on short and intermediate term financing but that had also leveraged up to high debt levels.  The lessons moving forward in an uncertain economy where both inflation and farm prices are rising together: 1) farm prices are not likely to keep up with broader inflation rates indefinitely, 2) higher interest rates are very likely coming soon, and 3) don’t take on new debt based on the assumption that current conditions will continue. 

Anderson, John D. , Steven L. Klose. “Inflation and Farm Prices.” Southern Ag Today 2(22.3). May 25, 2022. Permalink

The Russian invasion of Ukraine has already had a significant impact on the global economy.  In a recent article on this site, Dr. Aaron Smith explored the grain and oilseed market implications of the conflict.  As significant as these are, they are not the only market disruptions of concern to the agricultural sector.  Russia is a major producer of energy and fertilizer, key inputs across the entire agriculture industry.

According to data from the U.S. Department of Energy, Russia is the third largest energy producer in the world and a significant source of oil and petroleum products for the U.S.  In 2021 the U.S. imported a total of 2.23 billion barrels of crude oil.  Only about 3% (72.6 million barrels) of this came from Russia – still enough to make Russia our fourth largest source of foreign oil.   Russia’s share of imported refined products is considerably larger than its crude oil market share.  In 2021, the U.S. imported 860.9 million barrels of refined products.  Russia supplied 20% (172.6 million barrels) of those imports, making that country our second largest foreign source of refined products (behind Canada).  Given Russia’s status as a major petroleum provider, it is not surprising that the sudden isolation of that market in response to the conflict has affected fuel prices.  For the week ending March 14, the U.S. average retail gasoline price (all grades, all formulations) was a record (in nominal terms) $4.414 per gallon, eclipsing the previous high from the summer of 2008. 

Russia is also a global leader in fertilizer production and exports, as shown in Figure 1.  Russia dominates global exports of urea and ammonium nitrate.  According to World Bank data, in 2018 (most recent complete data) Russia accounted for 17% of all urea exports and 40% of all ammonium nitrate exports.  With respect to ammonium nitrate, the second largest exporter (the EU) accounted for just 7% of world exports.  In 2018, Russia was also the third leading exporter of potash, accounting for just over 17% of world exports (far behind Canada’s 43% export share).

To be fair, fuel and fertilizer prices were on the rise well before the onset of hostilities in Ukraine.  Retail gasoline prices have increased steadily since their pandemic-induced low in April 2020.  Fertilizer prices began a steady march upward beginning last summer, topping out late last year before retreating in the first quarter of 2022.  But the effects of the Russian invasion – extensive sanctions on Russian products, loss of access to the global financial system for Russian companies, and the disruption of Black Sea trade routes – have reinforced and accelerated the inflationary trend on fuel and fertilizer.

For farmers, the market impacts of the conflict in Ukraine will make a high-cost year even worse.  Farmers had already planned for expensive fertilizer, and fertilizer purchases for the new crop have likely already mostly been made.  Rising prices for nitrogen may yet be a problem for some producers, and it seems possible – given global reliance on Russians supplies of nitrogen – that availability of nitrogenous fertilizers may become limited if the conflict drags on.  Fuel prices are going to be far higher than most planning budgets assumed, cutting into expected margins, particularly in more energy-intensive production systems (e.g., irrigation-intensive crops like rice).  The commodity market reaction to the conflict has created an attractive pricing opportunity on some crops, but this early in the production cycle – with planting barely underway – the decision of how aggressively to forward price can be a difficult one.

Figure 1.  Major Exporters of Selected Fertilizer Products

References and Resources

U.S. Department of Energy, Energy Information Administration Petroleum market data: https://www.eia.gov/petroleum/

 World Bank, World Integrated Trade Solution On-line Database International trade data by harmonized system (HS) code:  https://wits.worldbank.org/country-indicator.aspx?lang=en

Anderson, John D. . “The Russia/Ukraine Conflict and Farm Input Markets“. Southern Ag Today 2(14.3). March 30, 2022. Permalink