Global Economy, Recovery, and Linkage to Agriculture Kevin Bernhardt UW-Extension and Center for Dairy Profitability October 2009

Global Economy, Recovery, and Global Economy, Recovery, and Linkage to AgricultureLinkage to Agriculture

Kevin BernhardtKevin BernhardtUW-Extension and Center for Dairy ProfitabilityUW-Extension and Center for Dairy Profitability

October 2009October 2009

World Situation to Farm IncomeWorld Situation to Farm Income2

World Income

World Currency Exchange

Rates

Flow of Agricultural

Imports & Exports

Energy Demand

and Prices

Biofuel Demand

and Prices

Demand for biofuel raw

material (corn)

Agricultural Commodity

Prices & Production

Demand for U.S. Products (Exports)

Farm Income

How much

Who gets the business

Farm & Risk Management Team

© 2009

A Little Theory3

Q

P1

P0

SD0D1

All else staying the All else staying the same, as income same, as income

increase demand and increase demand and price increaseprice increase


© 2009

World Real GDP Growth Rate versus World Feedgrain Exports

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

40,000.050,000.060,000.070,000.080,000.090,000.0

100,000.0110,000.0120,000.0130,000.0140,000.0

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

World Feedgrain Exports

Real GDP Growth Rate

4

As World Growth Rates Go – So Goes World Exports


© 2009

World Real GDP Growth Rate versus U.S. Exports

5

As World Growth Rates Go – So Goes U.S. Corn Exports


© 2009

Canada’s Real GDP Growth Rate versus U.S. Exports

6


© 2009

China’s Real GDP Growth Rate versus U.S. Exports

7


© 2009

Mexico’s Real GDP Growth Rate versus U.S. Exports

8


© 2009

Japan’s Real GDP Growth Rate versus U.S. Exports

9


© 2009

Remember10

Q

P1

P0

SD0D1

As demand for U.S. As demand for U.S. exports increase then exports increase then

all else being the same all else being the same price increasesprice increases


© 2009

U.S. Corn Exports versus Nominal U.S. Corn Prices

11

As U.S. Corn Exports Go – So Goes U.S. Nominal Prices


© 2009

U.S. Corn Exports versus Real U.S. Corn Prices

12


© 2009

What’s the Point?

• As the world’s income (GDP) rises U.S. Exports increase

• And as U.S. exports increase so does U.S. prices

13

A Global Impact that affects U.S. A Global Impact that affects U.S. Ag Prices is real GDP GrowthAg Prices is real GDP Growth


© 2009

A Little Theory14

Demand also can Demand also can increase if your increase if your

currency becomes currency becomes comparatively comparatively

stronger. stronger.

That is, your currency That is, your currency buys more of your buys more of your

trading partners stuff!trading partners stuff!


© 2009

Real U.S. Exchange Rate Index versus U.S. Corn Exports

15

As Value of U.S. Dollar Falls – U.S. Corn Exports Increase

The exchange rate going down means the value of the dollar compared to other currencies is less.


© 2009

And as we have already seen increasing U.S. Corn Exports Increase Prices

16

As U.S. Corn Exports Go – So Goes U.S. Nominal Prices


© 2009

What’s the Point?

• If the value of the U.S. dollar is comparatively low then that gives our trading partners more money to buy U.S. stuff– Leads to increased demand for U.S. exports– As U.S. exports increase so does U.S. prices

17

A Global Impact that affects U.S. A Global Impact that affects U.S. Ag Prices is the exchange value Ag Prices is the exchange value

of the U.S. Dollarof the U.S. Dollar


© 2009

Two Global Impacts Ag Prices18

Exchange value of the U.S. DollarExchange value of the U.S. Dollar

Income, GDP, Growth of our Income, GDP, Growth of our trading partnerstrading partners

19

The Global The Global Recession Recession

Before and AfterBefore and After


© 2009

Real Gross Domestic Product Growth Rate (through 2007)

-4

-2

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005 2006 2007

World

AdvancedEconomies

EmergingEconomies

DevelopingAsia

Source: IMF:


© 2009

-4

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008

World

AdvancedEconomies

EmergingEconomies

DevelopingAsia

Real Gross Domestic Product Growth Rate (through 2009)

Source: IMF:


© 2009

Monthly Real Exchange Rate, per U.S. $ Jan 1980-Dec 2007 (2005 base) The lower the number the more attractive U.S. products.

00.20.40.60.8

11.21.41.61.8

Canada EU Zone


© 2009

Real Exchange Rate, per U.S. $ (2005 base) The lower the number the more attractive U.S. products.

00.20.40.60.8

11.21.41.61.8

Jan

-80

Jan

-82

Jan

-84

Jan

-86

Jan

-88

Jan

-90

Jan

-92

Jan

-94

Jan

-96

Jan

-98

Jan

-00

Jan

-02

Jan

-04

Jan

-06

Jan

-08

Canada EU Zone


© 2009

Real Exchange Rate, per U.S. $ (1980-2009, 2005 base) The lower the number the more attractive U.S. products.

020406080

100120140160180

Japan


© 2009

Real Exchange Rate, per U.S. $ (1980-2009, 2005 base) The lower the number the more attractive U.S. products.

020406080

100120140160180

Jan

-80

Jan

-82

Jan

-84

Jan

-86

Jan

-88

Jan

-90

Jan

-92

Jan

-94

Jan

-96

Jan

-98

Jan

-00

Jan

-02

Jan

-04

Jan

-06

Jan

-08

Japan


© 2009

Interest Rates, 1992-200926

Copyright © 2009 Mortgage-X.comSource: www.mortgage-x.comReprinted with permission

If i-rates come back to a more “normal” state then that slows

the engine a bit.


© 2009

Unemployment, 1990-200927

If unemployment returns to a more “normal” range then that increases income & consumption.


© 2009

Consumer Confidence28


© 2009

Dow Jones Industrial Averages, 2000-2009

29


© 2009

World Feedgrains and Wheat Ending Stocks (Source: FAS PSD Online)

0

50,000

100,000

150,000

200,000

250,000

300,000

1975

/197

6

1978

/197

9

1981

/198

2

1984

/198

5

1987

/198

8

1990

/199

1

1993

/199

4

1996

/199

7

1999

/200

0

2002

/200

3

2005

/200

6

2008

/200

9

MT

(00

0)

Feedgrains Wheat

Feedgrains: corn, barley, oats, and sorghum


© 2009

How Did We Get Here?

• Imbalance of trade, investment, and savings between trade surplus countries (China) and trade-deficit countries (U.S.).– U.S. has been at the party too long

Spending instead of saving and investing Running up debts on low interest rates Irrational Exuberance (aka: stupidity)

– Morning/Hangover came in 2nd half of 2008 Likely continue until the end of 2009 first half of 2010.

31


© 2009

Short Term Impact of Crisis

• Hit 1: Crisis was worldwide causing a fall in incomes and thus a fall in demand

• Hit 2: The U.S. while hit hard still had a stronger position than much of the rest of the world and thus the dollar actually strengthened– Causing U.S. products to be more expensive

Ag Exports fell Ag Prices fell

32


© 2009

33

U.S. $ Index, July 2007-Oct 2009

Copyright 2009 INO.com, Inc. All Rights Reserved.

July 2008


© 2009

Long Run ????????

• All Depends on the adjustments and re-alignments of savings, investment and trade.– Do we re-ignite the party

High U.S. spending High foreign investment in the U.S. Low U.S. savings That is: continued and further imbalances

– Result for U.S.: Fun in the short run, but a new hangover to follow

34


© 2009

OR ????????

• Do we rebalance exchange rates, savings, investment, and trade re-alignment that puts the world on a more sustainable economic growth path.– Good for the U.S. in the long run– A step back for the trade surplus countries

(China) that have been supplying the party.

35

World Situation to Farm IncomeWorld Situation to Farm Income36

World Income

World Currency Exchange

Rates

Flow of Agricultural

Imports & Exports

Energy Demand

and Prices

Biofuel Demand

and Prices

Demand for biofuel raw

material (corn)

Agricultural Commodity

Prices & Production

Demand for U.S. Products (Exports)

Farm Income

What the 2008/2009 WorldWhat the 2008/2009 WorldEconomic Crisis Means forEconomic Crisis Means forGlobal Agricultural TradeGlobal Agricultural Trade

August 2009 Report by the Economic Research Service

WRS-09-05

May Peters, Mathew Shane, & David Torgerson

37


© 2009

The Study

• Simulation model developed to reflect the onset of the Economic crisis from December 2008 forward

• Reference scenario plus two alternatives:

38


© 2009

Reference Scenario

• Based on:– World economic recovery beginning in late

2009– Slow appreciation of the U.S. dollar– Modest Economic (GDP) growth in the world

and in the U.S. Initial contraction Builds back to a long-term just over 2% per year.

39


© 2009

Ref. Scenario: Real U.S Trade-Weighted Exchange Rate (the lower the better for exports)

60.00

70.00

80.00

90.00

100.00

110.00

120.00

130.00

140.0019

7019

7219

7419

7619

7819

8019

8219

8419

8619

8819

9019

9219

9419

9619

9820

0020

0220

0420

0620

0820

1020

1220

1420

16

History Forecast

40

Source: ERS, 2005 base

Value of the dollar is going up, but that is from a near 30 year

low. Back to average.


© 2009

Reference Scenario, Real GDP 41

Return to a pre crisis state with slight edge in

favor of the U.S. vs ROW, thus the $

increase


© 2009

Ref Scenario: Real U.S. GDP Growth Comparisons (the lower the better for exports)

42


GDP recovers back to a long term average


© 2009

Reference ScenarioAg Commodity Prices• Initially

– Value of dollar rises– GDP Falls

Consumption growth rate falls (demand falls) U.S. Exports fall

Commodity prices fall• Dramatically in the beginning (we’ve seen that)

43


© 2009

Reference Scenario: Ag Commodity Prices• Long-Term

– Dollar continues to grow which dampens any big increases in commodity prices

– GDP levels off in a way that slightly benefits U.S. compared to ROW

– Stabilize around 2012 to an equilibrium price

44

What will the equilibrium price be?


© 2009

Must be a New Era (Nominal Corn Prices, 1866-2008

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

1865 1885 1905 1925 1945 1965 1985 2005 2025

45

5.24

4.13

3.14


© 2009

Nominal Corn PricesRanges based on all data recent and all periods and no outliers all periods and recent

0

1

2

3

4

5

6

7

8

2.25

4.864.42

6.326.70

4.60

3.00

4.635.26

3.31

4.214.01

5.24

4.13

3.14


© 2009

Class III Prices – 1988-Present

8

10

12

14

16

18

20

22

Jan-88 Jan-93 Jan-98 Jan-03 Jan-08

Cla

ss I

II/B

FP

Pri

ces

1988-Aug 98 Sep 98-Feb 04 Mar 04-


© 2009

Alternative Scenario 1:High Dollar Value• Continuation of trade and savings

imbalances– Developing countries (China)

continue large trade deficits with developed countries (U.S.)

continue larger savings rates and investment in developed countries (U.S.).

48


© 2009

Alternative Scenario 1:High Dollar Value• For the U.S. this means

– Investment and economic growth, maybe too strong!

– Strong economic growth makes our dollar strong which dampens the attractiveness of U.S. commodity exports

U.S. Dollar value is 40% higher in this scenario versus reference scenario.

49


© 2009

Real U.S Trade-Weighted Exchange Rate (the lower the better for exports)

50



© 2009

High Dollar Scenario vs Reference:Percent Change in Real GDP

51

After an initial recovery, U.S. may be partying too hard (again)


© 2009

High Dollar Scenario Results

• Higher dollar, less exports, lower Ag Commodity Prices

52


© 2009

Alternative Scenario 2:Low Dollar Value• In one word – Balance

– Significant reduction and realignment of world trade and savings imbalances.

– Re-balancing of capital flows– Economic growth is resumed, but at a more

sustainable long-term level.

• Results in long-term, less volatile, and sustainable growth and a lower valued dollar

53


© 2009

Real U.S Trade-Weighted Exchange Rate (the lower the better for exports)

54


Historically quite low, is that sustainable?


© 2009

Low Dollar Scenario: Real GDP Growth Compared to Reference Scenario – U.S. versus ROW

55

U.S. re-aligns in a way that results in longer term sustainable growth.


© 2009

Low Dollar Scenario Results

• Lower supply of capital from other countries• Increased savings in the U.S.• Higher interest rates• More sustainable growth compared to rest of

world• Lower dollar• U.S. Exports more attractive

56


© 2009

Low Dollar Scenario Results57

Higher Ag Commodity PricesHigher Ag Commodity Prices

BUTBUT


© 2009

BUT

• Lower dollar value bucks a LT history• Will President(s) and Congress be satisfied

with a GDP that “falls” to a sustainable level?• Impact of health care• Afghanistan• Will developing and emerging markets accept

policies that “correct” imbalances that currently favor them?

58


© 2009

So, What’s the Future? A Guess:• Economic recovery in 2010• Comparatively more by U.S.

– U.S. Dollar increases– Dampens prospects for any big increases in U.S.

Ag Commodity prices– Ag Economy slowly recovers to a steady state in

2011-2012 Potential 80’s style re-structuring (especially in the

Dairy Industry)

59

60

Longer Term Longer Term Historical Historical

PerspectivePerspective


© 2009

Gross Domestic Product Growth Rate (through 2008)

0

1

2

3

4

5

6

7

1960 1966 1972 1978 1984 1990 1996 2002 2008

World

Source: World Bank Group:


© 2009

Goss Domestic Product Growth Rate (through 2008)

0

1

2

3

4

5

6

7

1960 1966 1972 1978 1984 1990 1996 2002 2008

High income



© 2009


0

1

2

3

4

5

6

7

8

9

1960 1966 1972 1978 1984 1990 1996 2002 2008

Low &middleincome



© 2009


-2

0

2

4

6

8

10

12

14

1960 1967 1973 1979 1985 1991 1997 2003 2009

East Asia& Pacific



© 2009

Where is Population Growth



© 2009

Where’s the PopulationPop. (bil) % of World Rank

World 6.667

China 1.330 19.9 1

India 1.148 17.2 2

Indonesia .238 3.6 6

Bangladesh .154 2.3 9

Nigeria .138 2.1 11

EU .491 7.4 4

U.S. .303 4.5 5

45.1

Source: U.S. Bureau of Census


© 2009

Must be a New Era (Nominal Corn Prices, 1866-2008

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

1865 1885 1905 1925 1945 1965 1985 2005 2025

67

5.24

4.13

3.14


© 2009

Real Corn Price (2009 base)

0.00

5.00

10.00

15.00

20.00

25.00

1930 1940 1950 1960 1970 1980 1990 2000 2010

Corn

68


© 2009

Class III Prices – 1962-Present

2468

10121416182022

Jan-60

Jan-65

Jan-70

Jan-75

Jan-80

Jan-85

Jan-90

Jan-95

Jan-00

Jan-05

Jan-10

Cla

ss I

II/B

FP

Pri

ces

1962-81 1981-88 1988-Aug 98 Sep 98-Feb 04 Mar 04-


© 2009

Real Class III Milk Price (2009 base)

5.00

10.00

15.00

20.00

25.00

30.00

35.00

1962 1972 1982 1992 2002

Milk

70


© 2009

• It’s cliché, but it is a different world• Not worse, not better, just different

– Emerging markets– Information economy– Energy– Climate Change

71

Food For ThoughtFood For Thought


© 2009

72

Food For ThoughtFood For ThoughtWe have been here before:191419451975

• Swings between high, low, and zero profit margins will be– Greater– More often– More dependent on timing

• Need for greater cash management• Margin Management• Changing cost structure

73

• Increased lender requirements, documentation, and verification

• Information management• Heterogeneity• Opportunities!!!• Marketing Psychiatrist

74

Milk Price 19,000 21,000 23,000 25,000

10 (143,977) (123,977) (103,977) (83,977)

11 (124,977) (102,977) (80,977) (58,977)

12 (105,977) (81,977) (57,977) (33,977)

13 (86,977) (60,977) (34,977) (8,977)

14 (67,977) (39,977) (11,977) 16,023

15 (48,977) (18,977) 11,023 41,023

16 (29,977) 2,023 34,023 66,023

17 (10,977) 23,023 57,023 91,023

18 8,023 44,023 80,023 116,023

75

Production Matters

Price Matters

$137 hay, $4.00 corn, $300 SBM

Return to Management and Labor

-15% -10% -5%23,000

Avg 5% 10% 15%

10 (85,938) (93,206) (101,166) (109,923) (119,117) (128,311) (137,505)

11 (62,938) (70,206) (78,166) (86,923) (96,117) (105,311) (114,505)

12 (39,938) (47,206) (55,166) (63,923) (73,117) (82,311) (91,505)

13 (16,938) (24,206) (32,166) (40,923) (50,117) (59,311) (68,505)

14 6,062 (1,206) (9,166) (17,923) (27,117) (36,311) (45,505)

15 29,062 21,794 13,834 5,077 (4,117) (13,311) (22,505)

16 52,062 44,794 36,834 28,077 18,883 9,689 495

17 75,062 67,794 59,834 51,077 41,883 32,689 23,495

18 98,062 90,794 82,834 74,077 64,883 55,689 46,495

76

Input Costs Matter

Increase in Feed CostsDecrease in Feed Costs

Management Matters

• 110 MN and WI farms, 500-1,500 acres• Average of 2006 and 2007

77

Bottom 20%

20-40% 40-60% 60-80% Top 20%

Net Ret. 7,737 22,232 52,427 39,856 110,988

Acres 340 308 407 237 416

Yield 164 165 178 174 183

Direct Exp.

385 387 392 376 372


© 2009

Dairy Enterprise ($/cow) 1996-2007(101-200 cows, no org. or RG, MN&WI)

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

Net Return to Mgt/Labor

20 %-tile

50 %-tile

80 %-tile

Source: Center For Farm Financial Mgt.


© 2009

80

Futures Prices in Context(Comparison of Feb 7 to Sept. 14, 2007)

111213141516171819202122

C-I

II/B

FP P

rice

Average

75 %tile

(2/7) 2007Futures

(9/14) 2007Anncd &Futures

1996-2006 data

81

• Look Backwards - Meticulous Attention to Financials – Have a farm records system– Use the farm records system!

Know your costs of production, Know your margin

– Know “at risk” versus “secured” costs– Sensitivity analysis– Prepare accurate financial statements

AND Use them to evaluate your profit blueprint.

82

• Look Forwards: Cash Flow/Enterprise Budgets– Plan your production, plan your cash flow, communicate your

plan, work your plan– Evaluate sensitivity

• TOTAL Communications– lender, broker, and other advisors.

• Know what makes you money– Partial budgeting: production practices and inputs

83


© 2009

Partial Budgeting

Additional Costs Additional Revenues

Reduced or Lost Revenues

Reduced or Eliminated Costs

Dollars Lost =________ Dollars Gained = _____

84

• Know and use marketing tools and strategies Remember, It’s the Margin That Counts

• Farm Programs

• Insurance Instruments– LGM-Dairy, Crop insurance – Levels of coverage

85

• Strategies for Down Times– Flexible Lease Arrangements– Defer Capital Expenditures– Defer Income Taxes– Refinance long-term obligations– Borrowing against Equity capital, but with planned

repayment– Compare financing rates

Careful: one needs committed friends in down times

86

Source: Edwards, William. “Managing through a recession: options for farm operators. Ag Decision Maker, Iowa State Extension

• Aligned/Cooperative Business Structures

• Value-Added, Branded Products– Not less risk, just different

• Change Your Marketing Mindset

• Know where your risk is

87


© 2009

Sources: Websites

• The Oil Drum: http://www.theoildrum.com/story/2006/10/5/215316/408• Association for the Study of Peak Oil: http://aspo-usa.com/ • Oil Market Report: http://omrpublic.iea.org/ • Now and Future: http://www.nowandfutures.com/index.html • WTRG Economics: http://www.wtrg.com/ • World Bank Group: http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers• Farm Foundation: http://www.farmfoundation.org/ • USDA Economic Research Service: http://www.ers.usda.gov/ • Trading Charts, Inc: http://futures.tradingcharts.com/ • CHOICES: http://www.choicesmagazine.org/magazine/issue.php • Foreign Agricultural Service: http://www.fas.usda.gov/default.asp • University of Illinois Farmdoc website: http://www.farmdoc.uiuc.edu// • Iowa State University Ag Decision Maker: http://www.extension.iastate.edu/agdm/ • University of Wisconsin, Center for Dairy Profitability: http://cdp.wisc.edu/ • University of Minnesota Center for Farm Financial Management: http://www.finbin.umn.edu/ • International Monetary Fund, World Economic Outlook database:

http://www.imf.org/external/pubs/ft/weo/2009/02/weodata/index.aspx


© 2009

Sources: Written Articles

• Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices. USDA/ERS, July 2008. http://www.ers.usda.gov/Publications/WRS0801/

• Bahn, Henry. “Commodity Prices Rock World Markets: Structural Shift or Short Term Adjustments?” Choices, AAEA, 2nd qrt 2008 23(2). http://www.choicesmagazine.org/magazine/issue.php

• Westhoff, Pat. “Farm Commodity Prices: Why the Boom and What Happens Now?” Choices, AAEA, 2nd qrt 2008 23(2).

• Lawrence, John D., James Mintert, John D. Anderson, and David P. Anderson. “Feed Grains and Livestock: Impacts on Meat Supplies and Prices.” Choices, AAEA, 2nd qrt 2008 23(2).

• Irwin, Scott H., Philip Garcia, Darrel L. Good and Eugene L. Kunda. “Recent Convergence Performance of CBOT Corn, Soybean, and Wheat Futures Contracts.” Choices, AAEA, 2nd qrt 2008 23(2).

• Mark, Darrell R., B. Wade Brorsen, Kim B. Anderson, and Rebecca M. Small. “Price Risk Management Alternatives for Farmers in the Absence of Forward Contracts with Grain Merchants.” Choices, AAEA, 2nd qrt 2008 23(2).

• Abbott, Philip C., Christopher Hurt, and Wallace E. Tyner. “What’s Driving Food Prices?” Issue Report from the Farm Foundation, July 2008. http://www.farmfoundation.org/news/templates/template.aspx?articleid=404&zoneid=26

• Fortenbery, T. Randall and Hwanil Park. “The Effect of Ethanol Production on the U.S. National Corn Price.” Univ. of WI-Madison Dept. of Ag and Applied Econ: Staff Paper no. 523, April 2008.


© 2009

Sources: Written Articles

• Irwin, Scott. “Crop value and volatility in a new era” 2008 Illinois Farm Economics Summit, http://www.farmdoc.uiuc.edu//presentations/index.asp .

• Schnitkey, Gary. “Prospects for Crop Production Costs” 2008 Illinois Farm Economics Summit, http://www.farmdoc.uiuc.edu//presentations/index.asp .

• Schnitkey, Gary. “Farm Economics Facts & Opinions”, Department of Agricultural and Consumer Economics, College of Agricultural, Consumer, and Environmental Sciencds, university of Illinois at Urbana-Shampaign, FEFO 08-13, July 11, 2008.

• Duffy, Michael, and Darnell Smith. “Estimated Costs of Crop Production in Iowa- 2009,” Ag Decision Maker, Iowa State University, University Extension, FM-1712 Revised, December 2008.

• Duffy, Mike. “Estimating costs of crop production for 2009,” Ag Decision Maker Newsletter, Iowa State University, University Extension, January 2009

Documents

Global Economy, Recovery, and Linkage to Agriculture Kevin Bernhardt UW-Extension and Center for Dairy Profitability October 2009