Opportunities and challenges for agriculture. How will agriculture and the swine industry fare in today s economic climate? Opportunities.

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2 The outlook for the swine industry and its relationship with the global economy Brian C. Briggeman Associate Professor and Director of the Arthur Capper Cooperative Center How will agriculture and the swine industry fare in today s economic climate? Through the recession and financial crisis of - 9, most of agriculture held up quite well. Rural economies benefited, but slumping demand curtailed livestock profits The U.S. and global economy are recovering from a steep contraction in growth. Still, there are plenty of questions surrounding the sustainability of future growth. To address the question above, ten opportunities and corresponding challenges are identified. Opportunities and challenges for agriculture Opportunities 1. Economy is recovering. Food expenditures are rising 3. Business and financial markets have improved. Low cost of borrowing 5. Farm income is very positive. Agricultural exports have surged 7. Global food demand is changing. High commodity prices 9. Farmland values boom 1. Swine outlook: cautiously optimistic Challenges 1. Recovery is anemic. Elevated unemployment rate 3. Uncertainty abounds. Inflation risk 5. Will expected profits falter?. Risks facing global growth 7. Who will meet this changing food demand?. High commodity prices 9. Will they bust? 1. Managing volatility and risk is critical 11 Allen D. Leman Swine Conference 5

3 Brian C. Briggeman The economy is recovering from a steep recession. Will recent soft data adjust growth forecasts? Annualized percent change from previous quarter Actual Real GDP growth Advance estimate WSJ Forecast 7:Q :Q :Q 9:Q 9:Q 1:Q 1:Q 11:Q 11:Q 1:Q Source: Bureau of Economic Analysis and Wall Street Journal July 11 Forecast Survey (Average) Consumption growth is key for the economic recovery in the United States About 7 percent of U.S. GDP comes from consumption. Consumption plummeted during the most recent recession. When tax credits expired, the housing sector slowed considerably. Inventories remain elevated. Housing starts remain low. Are prices reaching a bottom? Consumer confidence is shaky. Savings rate has risen and debt is being reduced. Should consumers spend like they did in the 199s and early s? Percent change from year ago 1 - Personal consumption expenditures Recession (gray bar) - Jan-9 Jan-93 Jan-9 Jan-99 Jan- Jan-5 Jan- Jan-11 Source: Bureau of Economic Analysis 1 11 Allen D. Leman Swine Conference

4 The outlook for the swine industry and its relationship with the global economy After slumping in 9, food sales have rebounded. Food retail sales Grocery store sales Restaurant sales Percent change from year ago Jan-7 Mar-7 May-7 Jul-7 Sep-7 Nov-7 Source: U.S. Census Bureau Jan- Mar- May- Jul- Sep- Nov- Jan-9 Mar-9 An elevated unemployment rate weighs on consumption. United States unemployment rate Recessions indicated by gray bars May-9 Jul-9 Sep-9 Nov-9 Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Percent Jan-9 Jan-73 Jan-77 Jan-1 Jan-5 Jan-9 Jan-93 Jan-97 Jan-1 Jan-5 Jan-9 Source: Bureau of Labor Statistics 11 Allen D. Leman Swine Conference 7

5 Brian C. Briggeman Since, business investment has improved, but will it continue? Nonresidential private fixed investment Private fixed investment in structures Private fixed investment in equipment and software..15 Percent change from year ago :Q1 1999:Q3 :Q1 :Q3 1:Q1 1:Q3 :Q1 :Q3 3:Q1 3:Q3 :Q1 :Q3 5:Q1 5:Q3 :Q1 :Q3 7:Q1 7:Q3 :Q1 :Q3 9:Q1 9:Q3 1:Q1 1:Q3 11:Q1 Source: U.S. Census Bureau Since the financial crisis of, financial stress has eased considerably. Financial Stress Index (FRBKC) Feb -9 Dec-9 Above zero: Financial market stress exceeds the long run average Below zero: Financial market stress is below the long run average Oct-91 Aug- 9 Ju n- 93 Apr- 9 Fe b- 95 Source: Federal Reserve Bank of Kansas City Dec-95 Oc t-9 Aug- 97 Ju n- 9 Apr-99 Feb- Dec- Oct- 1 Au g- Ju n -3 Ap r- Fe b- 5 De c- 5 Oc t- Aug- 7 Jun- Apr-9 Feb- 1 De c-1 11 Allen D. Leman Swine Conference

6 The outlook for the swine industry and its relationship with the global economy In general, uncertainty hinders household and business decision making. According to economic theory, uncertainty will cause households and firms to take a wait-and-see approach when making decisions. In a number of articles, Nicholas Bloom supports theory through empirical findings. Unemployment rate following 9/11/ United States unemployment rate Actual unemployment rate 9/11/1 Event date 199:Q1 199:Q 1991:Q3 199:Q 1993:Q1 1993:Q 199:Q3 1995:Q 199:Q1 199:Q 1997:Q3 199:Q 1999:Q1 1999:Q :Q3 1:Q :Q1 :Q 3:Q3 Forecasted unemployment rate on August 3, 1 Source: Bureau of Labor and Statistics, Survey of Professional Forecasters With interest rates at historically low levels, bank liquidity has surged. To stimulate the economy, the Federal Open Market Committee (FOMC) dropped the Fed funds rate to the zero bound and pumped liquidity into the market (QE and QE). With low interest rates, large amounts of liquidity and limited to no borrowing activity, excess reserves of depository institutions held at the Fed surged. Could this set the stage for a rapid rise in future inflation? Percent Fed funds rate and excess reserves Upper bound of intended Federal Funds Rate (Left axis) Excess reserves of depository institutions (Right axis) 3-Jan-7 3-Jan- 3-Jan-9 3-Jan-1 3-Jan-11 Source: Federal Reserve Board of Governors, 1,5 1, 5 Billion dollars 11 Allen D. Leman Swine Conference 9

7 Brian C. Briggeman To understand the current environment for inflation, it is helpful to pull a page from Econ 11. A rapid rise in inflation occurs when too much money is chasing too few goods. Quantity Theory of Money Price = Money * Velocity Quantity of Goods = M * V Q So, for rapid price inflation: M * V Q Today, headline and core inflation remain well below levels experienced during the 197s and 19s. Percent change from previous year Personal consumption expenditures price index PCE Price index (headline) PCE Price index excluding food and energy (core) Jan-71 Feb-75 Mar-79 Jun-3 Jul-7 Aug-91 Sep-95 Oct-99 Nov-3 Dec-7 Source: Bureau of Economic Analysis Allen D. Leman Swine Conference

8 The outlook for the swine industry and its relationship with the global economy Why is inflation low? Velocity has plummeted. One way to measure velocity is by calculating the ratio of gross domestic product (GDP) to money (M). This ratio is essentially a turnover ratio of how quickly money is turned into output. Today, velocity is very low. So, what will it take to raise velocity, and when might this happen?.5.5. United States velocity of money Recessions indicated by gray bars GDP/M (right axis) Source: BEA and Federal Reserve Board of Governors Net farm income is subject to booms and busts. Real US net farm income 1 1 World War II Exports jump Russian grain deal 5 constant dollars (billions) 1 Protein demand surges with Atkins Diet Ethanol and exports Source: USDA 11 Allen D. Leman Swine Conference 11

9 Brian C. Briggeman 1 Agricultural exports have surged led by Asia. Real US agricultural exports World total (left side) Asia (right side) 7 1 constant dollars (Billions) Ja n- 5 Ja n- Ja n- 7 Ja n- Ja n- 9 Ja n- 1 Ja n- 11 Source: USDA constant dollars (Billions) Will China s exponential income growth continue? 3, China s per capita gross domestic product, 5 constant US dollars, 1, 5 1, Source: World Bank 1 11 Allen D. Leman Swine Conference

10 The outlook for the swine industry and its relationship with the global economy What happens if the Chinese economy slows? Since dipping into negative territory in 9, China s inflation rate has surged to over %. To cool rising inflation and very rapid growth, China s central bank has: raised the one-year deposit interest rate from to 3.5 percent raised reserve requirements for Chinese banks China s substantial growth has been led by a robust real estate sector. Some economists and investors fear this growth has led to a bubble. Another risk to the global economy is the Eurozone sovereign debt crisis. Spread between ten year government bond and German bund -Aug-1 -Aug Percent Greece Ireland Portugal Spain Italy United States Source: Thomson Reuters 11 Allen D. Leman Swine Conference 13

11 Brian C. Briggeman A growing world population boosts international food demand, but what will they eat? Households owning a refrigerator Households owning a microwave oven Percent United States 5 Russia Brazil China India Percent United States 5 Russia Brazil China India Source: USDA, Euromonitor Will consumer-oriented products continue to lead agricultural exports? Value of US agricultural exports 5 Bulk Products Consumer-oriented products Intermediate products 35 Indexed (199 = 1) F Source: USDA Foreign Agricultural Service 1 11 Allen D. Leman Swine Conference

12 The outlook for the swine industry and its relationship with the global economy 1 US crop prices have surged, boosting crop incomes. United States crop prices Soybeans 1 1 Dollars per bushel 1 Wheat 1 Corn Jan- Jan-7 Jan Jan-9 Jan-1 Jan-11 Source: Commodity Research Bureau Despite rising crop prices, livestock profits have improved. Cattle Breakeven Price Dollars per hundredweight Cattle Price Hog Breakeven Price Hog Price Source: USDA and Iowa State University 11 Allen D. Leman Swine Conference 15

13 Brian C. Briggeman Rising commodity prices have pushed world food prices above highs. 5 World food price index Index - = / 7/ 1/1 7/1 1/ 7/ 1/3 7/3 1/ 7/ 1/5 7/5 1/ 7/ 1/7 7/7 1/ 7/ 1/9 7/9 1/1 7/1 1/11 Source: Food and Agriculture Organization Interest rates can affect farmland values through two avenues Allen D. Leman Swine Conference

14 The outlook for the swine industry and its relationship with the global economy Interest rates can affect farmland values through two avenues. Affect Expected Farm Income Interest Rates = Farmland Values Affect Capitalization Rates Over time, real interest rates and capitalization rates tend to move together Nebraska Cash Rent-to-Land Value Ratio Yield on 1-year U.S. Treasury Security - adjusted for inflation Percent Percent Sources: USDA, Federal Reserve and BLS 11 Allen D. Leman Swine Conference 17

15 Brian C. Briggeman Over time, real interest rates and real net farm income tend to move in opposite directions. Constant 5 dollars (billions) Real Net Farm Incomes Less Government Payments (Left Scale) Real 1-year U.S. Treasury Securities Yield (Right Scale) Sources: USDA, Federal Reserve, BLS Percent With low capitalization rates and elevated farm income, farmland values have surged. Non-irrigated Cropland Values (Percent change from 1:Q1 to 11:Q1) Source: Agricultural Finance Databook, Federal Reserve Bank of Kansas City 1 11 Allen D. Leman Swine Conference

16 The outlook for the swine industry and its relationship with the global economy Historically low capitalization rates help support current cropland values. ollars per acre 1, Dollars per acre 9,, 7,, 5,, 3, Eastern Nebraska Irrigated Cropland Value = $5,3 Historical average cap rate, Farmland values drop by 1/3, 3.% 3.5%.%.5% 5.% 5.5%.%.5% 7.% 7.5%.% Farmland capitalization rate Authors calculations assuming bushels per acre, a corn price of $5.35 per bushel, and 5% of gross revenues capitalized into land. If capitalization rates return to their historical average, then record high corn prices could support current cropland values. Dollars per acre Dollars per acre Eastern Nebraska Irrigated Cropland Value = $5,3 9 average corn price, Farmland values drop by 1/ Authors calculations assuming bushels per acre, the historical average capitalization rate of 7.5%, and 5% of gross revenues capitalized into land. 11 Allen D. Leman Swine Conference 19