Ed Lotterman: Fed policies hinder the farm economy

May 23, 2014 

Because I jam the truck with tools, extra clothes, a laptop and a gun case, there isn't much room for me to take Janet Yellen and Narayana Kocherlakota, two noted monetary "doves," along the next time I go to our farm - much less the other members of the Federal Open Market Committee. And they would be likely to get rained on sitting in the open bed.

But this would be a good way to show them the pitfalls of the loose money policy that the Fed continues to follow. Even if it's among the least-bad options available, near-zero interest rates distort incentives and risk wasting resources.

Examples abound in southwest Minnesota. I just saw a stark example: On the south side of the road, tile drainage at extremely close spacing had been installed in a field of rich cropland. This is expensive. Directly across the road, the components of a new center-pivot irrigation system lay on an equally fertile field, awaiting assembly.

So how is this evidence that quantitative easing is harming our economy?

Farmland prices have risen dramatically in recent years, although the rate of increase is now moderating. For many observers, including me, prices are now well above levels that can be justified by long-run trends in product prices and input costs.

Even Robert Shiller, a Nobel-winning city slicker economist at Yale, has been pointing to a farmland price bubble for the last few years. Since he was one of the few economists to warn of the housing price bubble before things began to collapse in 2008, his views have some weight.

When farmland gets more expensive, there is an economic incentive for owners to make existing land more productive by investing in improvements such as irrigation or drainage.

There also is reason to plow up land that was better used as pasture when the value of cropland is lower. Similarly, it now pays to bulldoze out old groves or windbreaks to gain a few more rows of corn.

If it costs you $10,000 to buy an additional acre of land that will produce 200 bushels of corn per year, it may make more sense instead to spend thousands of dollars on irrigation or drainage that will increment up production on acres you already own.

Optimal crop production depends on Goldilocks-like water availability. It has to be just right. Either too much or too little reduces yields. Even if land in its natural state produces good crops most years, the price paid in terms of lost yield to flood or drought on occasion may warrant precautionary investments.

Moreover, the higher crop prices are, the greater the return to the capability of changing moisture levels even marginally in the direction of optimality.

Usually land that requires drainage does not need irrigation and vice versa. But, taken to extremes, it is not irrational for a farmer to choose to install both, drainage to help get rid of excess water in the spring and irrigation to supply it in the dry weeks of summer.

Things have been taken to extremes and the Fed is partly responsible. There are three different ways this occurs.

First, unprecedented low interest rates are one reason land prices have gotten so high. For any given level of annual rent or profit, the lower the interest rate, the higher the purchase price that is justified.

This goes back well before British economist David Ricardo formally described it in 1821. And doesn't just affect farmers. There is a "flight to yield" going on right now as fund managers pile into any alternative that may pay higher returns than bonds or other traditional investments. Farmland, "catastrophe bonds" and debt from African countries are all affected by this.

Secondly, lower interest rates make it less expensive for farmers to pay tiling contractors or buy center pivots. Just as, for a given dealer price, people are more likely to buy new vehicles when car loans are 5 percent rather than 12 percent.

Finally, all other things being equal, low interest rates put the U.S. dollar at lower value compared with foreign currencies.

A lower-priced dollar makes U.S. exports, including farm products, cheaper than they would be with a "stronger" dollar.

So we sell more corn and soybeans and pork to Europe and China and myriad other countries because the FOMC is keeping rates low. That means higher farm product prices and those lead to higher land prices.

Hence farmers bury drain tile, erect irrigation rigs and 'doze out old cottonwoods.

Farmers investing to improve productivity is a good thing as long as it correctly reflects good information about the long-run need for farm products. But if driven by false information stemming from unsustainable short-term monetary policy, new tile, irrigation equipment and combines are wastes of resources than make our society poorer.

Yellen, Kocherlakota and colleagues in Washington can be forgiven if they are making a mistake.

Economics has failed in analyzing the effects of excess money growth on asset prices. All the emphasis has been on how cheap money affects consumer prices.

Japan is trying to drive up inflation right now to get households out of a spending slump.

Leaders of the European Central Bank announce that they are alert to signs of deflation and will open the monetary taps if they fall short of their targeted, albeit low, inflation rates.

Economist Edward Lotterman writes in St. Paul, Minn. Write him at boise@edlotterman.com.

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