I am a fan of Mel Brooks movies, and am particularly fond of Young Frankenstein. One scene that comes to mind is where Dr. Frankenstein and Igor (not Egor) were in a cemetery digging up the body needed to create what would become the monster.
Dr. Frankenstein complained it was a filthy job, but Igor responded by saying, “It could be worse, it could be raining.” As soon as these words rolled off Igor’s tongue, there was a flash of lightening, a clap of thunder and a downpour of rain.
It could be raining
How does a scene from Young Frankenstein have anything to do with dairy farming? Well, milk prices are currently at a five-year low; feed costs are relatively high, and it is difficult, if not impossible, for dairy operators to cash-flow.
It could be worse, however. Because on top of all these negatives, interest rates on farm loans could be much higher. Fortunately they are not.
Interest rates currently charged on farm loans are relatively low, largely because of the Federal Reserve’s “cheap money” policies that are intended to boost the U.S. economy out of the current recession. The Fed has been trying to make credit plentiful, and it recently announced plans for purchasing about $300 billion of long-term Treasury bonds and notes by September of this year. This bond purchase by the Fed should, in the near term, keep long-term interest rates down.
To this point, interest rates have stayed low because the Fed has been able to keep them low by expanding the money supply. But there is a limit to how much the Fed can do to keep interest rates down.
There is already a fear that money supplies have been increased to the point that inflation will again show up in the economy. If this occurs, interest rates will rise along with inflation, since all interest rates are tied to inflation.
Lock in your risk
Given the low interest rates currently being charged on farm loans and the likelihood that interest rates will rise, it may make sense for producers to lock in some of the favorable interest rates now being charged on long-term farm loans. This refinancing will help keep your interest expenses low.
More importantly it will help stabilize your payments if the refinancing is done with fixed-interest-rate loans.
Producers who are fortunate enough to lock in low-interest, long-term loans, will need some discipline when it comes to managing short-term cash surpluses. Most of the surpluses should probably be salted away in certificates of deposit or other savings instruments to ensure that cash is available when cash-flows are tight or non-existent in the future, as they are now. Spending interest savings, versus saving it, will generally negate most of the benefits of locking in the low-interest-rate loans.
There is no question that dairy producers are experiencing some very trying financial strains, thanks to low milk prices and high feed cost.
Things could be worse, however, in that interest rates could be sky-high, as they were back in the 1980s. For the time being, interest rates on farm loans are low.
So, it may be advisable to negotiate some re-financing arrangements that lock in these low-interest rates for a number of years into the future.
Bruce Jones is a professor of farm management at the University of Wisconsin-Madison.