Monday, March 25, 2013

A time for every purpose...  

Except debt, apparently. Carl Zulauf, whose work on farm policy I admire, posted and interesting piece on farm prices and input costs and came to this conclusion:

Last, the lack of a trend in the ratio of crop prices to input prices adjusted for productivity suggests that a key risk management strategy is to pursue the highest level of input productivity while not incurring large debt. Thus, history suggests a good risk management strategy is to use the current period of farm prosperity to improve farm productivity without incurring debt. [Source]
This is a non-sequitor , IMHO. What has debt got to do with it?

If debt can generate returns above the cost of servicing it, why not use leverage to expand (land) or increase productivity (tile)?

The statement seems to say: since you never can tell what your profit level will be don't borrow money. But it falls apart when real history is applied. During the above chart were there ANY times when debt paid off big-time?

Answer: you betcha. Suppose you mortgaged everything down to your socks to buy land 5 years ago - before land and rents doubled, and at modest rates - say 6%. Not only would you be reaping whacking capital gains, your debt service would be even more manageable because returns to ownership (rents) have climbed as well. Not only that, but you could be refinancing it now for 3.5% or so and adding to your windfall.

What the chart shows me is it is impossible to know when and how much debt will payoff, but there are times it is not just appropriate but very lucrative. The fact you cannot predict when that occurs seems to freeze economists into inaction, but leaves farmers who follow their extremely conservative advice as roadkill for those buy/rent aggressively.

In fact, a good question to ask the economic community is "When do you use debt to expand/improve"? I suspect the answer will be when it is indisputably predictable that debt service will be done without any cash-flow problems. In fact, I'll bet some of these guys have never urged farmers to borrow and buy in their career. Oddly enough, that has been the best thing they could have possibly done when done at the right moments. I grant it requires luck, but it really, really works!

Ag economists as a rule are categorically terrified of debt. (I blame tenure) Those who follow their advice slavishly will have been rolled over by those who took a risk and were proven right. The reward flows to risk, not to prudence. And it seems to me that trend is accelerating and the same advice we've gotten my entire career is essentially unhelpful to those of competing in a zero-sum game.

What actually would be useful is a matrix of conditions that would indicate more favorable (but still non-zero) risk profiles that producers could use help identify those moments of opportunity. Something like:
  1. The debt service margin (net rent minus payment) can withstand ax XX% margin decrease.
  2. Does this debt require knock on capital expenses? (More machines for more land, etc.)
  3. Does the debt generate efficiencies that lower costs by XX% of the amount required to service it? (e.g., new combine lowers labor costs and boosts timeliness for fall work)
When you are surrounded with examples of people who did just the opposite of what Zulauf is advocating - and won big-time - it's hard to take his analysis as anything other than an academic exercise.


Brian said...

Outstanding post. One of your very best. This should end up in a column in farm journal and top producer. This is the JP we know and love. By the way, Carl is a close friend and mentor of mine and I believe would respond thoughtfully if you contacted him.
Brian in Ohio

John Phipps said...


Thanks. I did contact him, but had not posted yet.

BTW - you're an anonymous example in an upcoming column: "The Only Farmer in the Room"

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