A little over a year ago we sat down with a senior Trump administration official to discuss a looming trade spat with a variety of U.S. trade partners. The discussion included a frank exchange about the ill logic of a policy pathway that included tariffs and quotas, optimal tariff theory by industry and, ultimately, the need to begin putting together a bankruptcy and reconstruction business to assist distressed firms across American industrial ecosystems. One year on, the domestic stress caused by the administration’s trade policy is nowhere more evident than in the agricultural sector. If the current policy pathway not be changed, the farm sector is going to experience the greatest downturn since the late 1980s, driven by widespread bankruptcies and consolidation.
If the current policy pathway not be changed, the farm sector is going to experience the greatest downturn since the late 1980s, driven by widespread bankruptcies and consolidation.
To put this in perspective, according to the U.S. Commerce Department, the personal income of farmers declined by $11.8 billion through the first three months of 2019. This is not a function of market-derived pricing, or a sudden exogenous shock. Rather, it is mostly a function of a discrete policy choice, amid a longer-term shift in global demand, that can be altered.
A looming risk for community banking, linked to trade policy, lies in the nature of the agricultural sector. Farmers are both depositors and borrowers, depositing profits when commodity prices are high, and borrowing when production costs are higher than market prices. Bank liquidity can therefore be excessive when times are good and loans aren’t needed, and insufficient when agricultural clients need it the most.
Commodity prices—which are determined in a global marketplace and have been in a medium-term trend decline since 2011—re-established that trend and have been declining for two and a half years with a concurrent decline in nominal gross domestic product attributed to the agriculture sector (which, by the way, also includes forestry, fishing and hunting). So it’s not surprising that U.S. net farm income has been declining at an average pace of nearly 6 percent per annum since 2012.
Pressure from climate change
In addition, climate change is putting additional pressure on farm-sector finances amid a federal government that is not responding fast enough or in force to mitigate the impact of changing nature. Excessive rainfall in 2018 and 2019 destroyed crops in the field, while flooding ruined storage facilities and destroyed livestock. A recent report from Cornell University (Ariel Ortiz-Bobea) outlined the risks that climate change holds for agricultural. The report suggests that “the area of greatest concern is the Midwest, where rain-fed field crops like corn and soybeans have become increasingly vulnerable to warmer summers.” According to the analysis, as temperatures have moved higher, only a small increase in temperature can lead to a proportionally larger drop in agricultural production. So between falling commodity prices, rising temperatures, increased rainfall, and China’s retaliatory tariffs, the USDA reported a 16 percent single-year drop in net farm income in 2018. The Federal Reserve Bank of Minneapolis reports a sharp increase in Chapter 12 farm bankruptcies since 2015, both nationwide and in the upper Midwest.
Unintended consequence of a trade war — China’s soybean tariffs
In retaliation for U.S. tariffs on Chinese-produced solar panels, washing machines, aluminum and steel that were imposed in early 2018, China targeted the Midwest’s support for President Donald Trump and imposed tariffs on imports of U.S. soybeans and pork on April 2, 2018. It didn’t take long for the tariffs to have an effect; one soybean producer in Idaho reported a half million dollar loss within months. Indeed, soybean exports have been trending lower ever since, with the latest reports indicating that soybean exports are down by 15 percent relative to last April. A March 2019 report from The Federal Reserve Bank of Minneapolis says that “soybean exports to China since September are down by more than 80 percent.”
No matter how long the tariffs remain in effect, it may be difficult to repair damaged trade connections. Soybean production in Brazil has been increasing since 2007, with the United States and Brazil each now holding one-third shares of global soybean production. Brazil is already the largest exporter of soybeans, according to a recent Reuters report, and is expected to expand production capabilities in the coming season. So all things remaining the same, and with soybean prices determined in a global marketplace, it seems unlikely that the supply of soybeans will significantly decrease or that soybean prices will jump higher even if fields in the Midwest were to dry out or if China were to drop its tariffs.
According to analysis by the USDA, soybean farming is done in conjunction with other crops, with alternating plantings of corn and soybeans the usual cycle. So although corn production has remained profitable, soybean values have declined since 2012, even as costs of production have increased slightly.
For a more comprehensive review of the agricultural risk tied to current U.S. trade policy, watch for the June edition of The Real Economy.