Producers today face higher economic peaks and lower economic valleys than their predecessors. And events during this past year have shown once again how intertwined agriculture and consumer economies worldwide have become. 

Take for example the effects of Hurricane Katrina.

While the cost in the U.S. is estimated at $250 billion, the cost worldwide is expected to reach $1 trillion, David Kohl, professor emeritus of agricultural and applied economics at VirginiaTechUniversity, told attendees at the North American Agricultural Lending conference last month.

The initial impact from Katrina was on energy and oil, which led to high prices for gas, diesel and even record-high prices for fertilizer. Fast forward a few months and people around the world are now seeing their cost of insurance jump. For example, says Kohl, insurance premiums in London, England, are going up 10 to 15 percent. That cost increase has been attributed to Katrina because many of the companies that write insurance policies now do so in many countries, if not globally.

Those rising gas prices are a good study of the economic and psychological thresholds that cause people to make a change. Kohl calls those thresholds: attention, reaction and action. For example gas prices at $2.50 per gallon got people’s attention; at $3 people started to react and gas consumption dropped 4 percent; and at $3.50 people started buying smaller, more fuel-efficient vehicles.

Now, says Kohl, let’s apply those thresholds to long-term interest rates. He uses 6.5 percent as attention but still a seller’s market; 7 to 8 percent is reaction and it becomes a buyer’s market; and above 8 percent is action where the result will be corrections in housing prices, cash rents and land values.

While ag land values are strong, they do not face the bubble that housing markets currently do, says Kohl.   Factors attributing to that housing bubble include:

  • Housing prices have doubled in that past five years.
  • 27 percent of all home sales are bought for investment and “flipped.”
  • Many home loans are interest only.

This is not just a U.S. housing bubble. Kohl says “the housing bubble is bursting worldwide.”

Add to that the fact that consumer debt in the U.S. has surpassed $2 trillion and the delinquency rate on credit cards has reached its highest level ever of 4.8 percent, says Kohl. In addition, in the past few years, housing refinances and consumer spending have been a lot of what has kept the U.S. economy going. However, consumers today are really in the situation where ag was in the 1970s, says Kohl.

Producer to do list
A change in the level of consumer spending can and will impact farm income. With that, Kohl advises agricultural producers to position their business to weather the valleys by adhering to the following rules:

1. Know your cost of production. To make wise business decisions, producers today must know their cost of production. However, if you don’t, you must then manage your finances differently -- keeping your debt to asset ratio below 40 percent.

2. Asset-lite strategy. Carefully analyze all asset investments. Make sure you are getting the most out of your human and capital assets before investing in more.

3. Manage for the extremes. To do that you must have good cash and working capital reserves to weather the valleys.

4. Invest in enterprise analysis. This is a must for all producers. And research now shows that those who do use enterprise analysis increase profits by 2 percent.

5. Grow earned net worth by 6 percent annually.

6. Use accountant and advisory boards to double your profits.

7. Focus on efficiency first, then growth. Failure to grow your business in this order often leads to “burying yourself sooner.”

8. Do strategic planning. Producers and lenders that use a strategic plan double their rates of return.

9. Look for new ideas. Early adopters and trend setters earn 1.5 times greater profit than their counterparts.

10. Invest in good management. Invest in supervisors who, like sports greats Wayne Gretsky and Larry Bird, elevate the level of play of those around them.