An economic outlook and how our businesses might be impacted

Chris: Welcome everybody to another episode of the Ag View Pitch, and we are excited to bring to you today an economist that is going to be at the Ag View Executive Business Conference, again held on January 27th and 28th. Wanted to get that plug out there right away, but what we really want to do here today is having Dr. Bill Connerly with us today to talk about some of the things going on in the economy. And so I'm gonna give you a little brief inter— introduction here. Bill connects the dots between the economy and business. He is a business economist and does economic consulting as a senior contributor to Forbes and a Duke University PhD. He's worked in economics and the corporate planning at two Fortune 500 companies and at a major bank as senior vice president. So, Bill, welcome. It's great to have you on. Excited to have you here. How's it going?

Dr.

Bill

Conerly: Great chatting with you, Chris.

Chris: Well, it's— we're excited. We did decide, and you're able in your schedule to be at our Executive Business Conference on January 27th and 28th, so we're really looking forward to that.

Dr.

Bill

Conerly: Yeah, Phoenix in January sounds good to a boy from Oregon where it will be raining every day of the month.

Chris: Yeah, and it'll be about up to 10 below in Iowa and in the Dakotas and middle of the country. So yeah, Phoenix will be a good place to be and a good educational opportunity for everyone. And so again, really excited to have you on. I guess the goal though for this discussion is to just talk a little bit about the economy, just give everybody kind of a flavor from, for your take and some things. And I had sent you a few different items that I kind of wanted to touch on that kind of relate back to us as producers in the agricultural industry. And so where I want to start, if we could, Bill, is with inflation. And I want to preface this a little bit on the front end. You know, as producers, we're looking at probably the largest price increase we've ever seen.

I would venture to say, as things continue to go higher on the energy side of things, Anhydrous ammonia, you know, they're talking over $1,000 a ton. We're looking at a lot of fertilizer prices and things that are more than 100% higher than what they were last year. And so we're facing inflation straight on and want to have you just kind of give us a little flavor for what you're seeing. You know, they talked about this being transitory or short-lived. What's your take on inflation and how that's going to affect some of these industries and agriculture included?

Dr.

Bill

Conerly: Yeah, Chris. Well, inflation is certainly higher. Uh, this morning we're recording this on October 13th. Uh, we got new data on the Consumer Price Index that is not as bad. That's the best we can say. It's not as bad as it had been. Uh, I think that overall we're going to see more inflation over the next few years, but for, um, people in agriculture, They're probably more concerned on the cost side with energy-related inflation, which is both directly like diesel fuel, but also fertilizer, as you mentioned, has close ties to oil and natural gas prices. And energy kind of goes on a different cycle. It's up a lot more than overall inflation, and then it goes down more than overall inflation. And what is happening right now is the world is being surprised by the strength of economic growth and demand for oil and natural gas for transportation and factories, as well as heating.

And it takes a while for the petroleum industry to respond. You know, a few years ago, blinking on it, maybe 2012, uh, corn prices shot through the roof and other grain prices went through the roof. And the world's farmers said, oh, you want more corn? We can, we can grow more corn. And it took about one growing season for the prices to come down. Right. But in petroleum, it takes a long time to find new, um, uh, uh, fields, uh, do the exploration, development, pipe systems, refineries. It's like 10 years. To bring a lot of supply online. We'll be getting some smaller increments to supply in the next year or two. So I think the oil prices are not going to continue to skyrocket, but I doubt that they're going to come down very much from where they are today.

Chris: Interesting. Yeah. And you hit the nail on the head. You know, the commodity prices follow right along and benefit from the inflation on one side of the equation. On the other side, you know, the inputs are there, and as we look at 2022, pricing opportunities are actually pretty good. Margin opportunities are there even with where these higher prices are. You know, that's, that's the real challenge though. We're coming off of a year this year where there's some really high ROIs, you know, where we're seeing some good returns, and not as good a return next year because of those in increase in prices. But any, any thoughts on, on, you know, the length of time, you know, that— because there's just a lot of people buying into, you know, into the commodities on an inflation hedge or whatever. So do you see that continuing, or what's your thought there?

Dr.

Bill

Conerly: Well, yeah, Chris, commodity prices are very volatile, and some of it is speculation, right? But the underlying pressure here is the classic definition of inflation is too many dollars chasing too few goods. And we have a ton of stimulus from federal government spending, what in college you might've heard of fiscal policy in a Keynesian context. And we also have a very stimulative monetary policy from the Federal Reserve. We are just pushing a boatload of dollars into the economy, but we're unable to grow our production side very much. And that's not just the supply shortage, but we're just trying to get more stuff out of the economy than the economy can produce. And what happens is inflation.

Chris: Okay. So that leads me, that's a good segue to a couple of things, but I'm going to hit the labor piece first. You know, it seems like the labor thing is what's really screwing all this stuff up, isn't it?

Dr.

Bill

Conerly: It is, I think a majority of supply chain problems are labor-related, but there are some non-labor issues. The surge in demand for goods internationally is greater than the shipping capacity that we have. And it takes 15 months to build a container ship. And that's if there's no lead time, if you call up the shipbuilder. And he's ready to start work. So, it's going to be a while before that gets resolved. There are some snarls at ports. But when I scratch the surface on what's happening with supply shortages, I see labor. Like, one of my client— one of my consulting clients is a manufacturing company that uses a lot of brass, and their raw material inventory was getting low. So the purchasing person calls the brass supplier and says, "Where's our brass?" And the supplier says, "It's sitting on a trailer. I can see it from my office window.

We just don't have a truck driver to get it to you." And it's about 1,000 miles from us to them. So the brass shortage caused a plumbing product shortage, but it was all due to the labor shortage of truck drivers. And a lot of farmers are, are feeling the pinch of truck driver shortages. But it's not just truck drivers, all across the economy. Every business I know is looking for more workers and cannot find them.

Chris: Well, and that's just it, you know, the JIT or the just-in-time inventory is a scary thing now because I know we had a tire guy tell us, you know, we're in the middle of harvest as we speak and and, uh, all of our listeners, or many of our listeners, are in a similar situation. They told us, whatever you do, don't ruin one of your tires because we don't have any, you know. And so, you know, I mean, it's just— and it's the same thing with a lot of pretty key important parts, from the GPS equipment in, in, you know, in our machines to, to tires and everything in between. There's a lot of really key components that just aren't available right now. I mean, how long do you see that being an issue?

Because, you know, we're sitting here in California, you know, you, you see the pictures of the lines and lines and lines of these container ships, and that's, you know, that's just one side of the equation. Like you said, well, then you got to get it trucked and distributed, right? So how, how long does this mess take, do you think?

Dr.

Bill

Conerly: Well, it's going to take a while, but let me provide a little context. I have a friend who grew up in the Soviet Union in the communist days. And, you know, they were waiting, you know, they saw a line at a store that was gonna take them 4 hours, they'd wait in line even if they didn't know what was in stock, just to get anything they could. So, you know, everybody who's got the money to buy food is getting food. Maybe we don't get exactly the type of pasta we want, but we're able to get things. However, it is frustrating to have money to spend and you can't get it. I think that the labor shortage will ease as we move through this year, 2021. People are not getting the extra unemployment insurance anymore. And some people work when their bank account is low. Or the cash in their wallet is low, and we're farther away from those stimulus checks.

I think more people are going to be going into the labor force. Getting the kids back in school will help, especially with single mothers, and it will gradually get better. We'll still have the problem of too many dollars chasing too few goods, but I think that eventually, maybe in 12 months' time, we'll see the economy able to produce the kinds of things that the people want. Buy.

Chris: Okay, so I want to ask another question here about interest rates. As producers, we have a lot of, you know, in farming we have so many dollars invested. It's such a capital-intensive industry, and so when we have, you know, millions of dollars and our debt structure needs to be looked at and those kind of things, And, you know, we've continually heard, you know, interest rates are gonna stay low, stay low, and now they're gonna go up, now they're staying low, and you just get these mixed messages. Talk a little bit about interest rates, some of the things that you see coming, and some of the things that producers in agriculture, we should be thinking about.

Dr.

Bill

Conerly: Yeah, most of us see interest rates increasing. The Federal Reserve is communicating that they want us to anticipate what they're going to do. And they're going to begin by what they call tapering. Right now, uh, the Federal Reserve is spending about $120 billion, uh, a month buying long-term bonds and mortgage-backed securities. So when you're thinking about a term loan or a long-term mortgage, those are the interest rates affecting you, and the Fed has kept them low. Uh, but they're going to, uh, taper down, and I think we'll see long-term interest rates rising. Over the last couple of weeks, they have increased already, and I think we're going to see some gradual, um, gains. And, you know, a percentage point over 12 months, uh, might be the high end of what, uh, I would expect for long-term rates.

And then sometime next year, uh, the Federal Reserve will start pushing up short-term rates the way they usually do when they have to tighten. I think they're going to drag their heels as long as they can, but we're seeing so much inflationary pressure, they cannot drag their heels too long. When that happens, when the Fed really wants to change things, look for short-term interest rates, and this would be comparable to borrowing from a bank at prime or at LIBOR plus a margin. Short-term interest rates could go up 3 percentage points in a year's time. Once they start doing that. So lately, you know, a farmer budgeting for his interest expense was paying such a low interest rate it didn't much make a difference, but I think it is going to make a difference in a year or two years.

Chris: That leads me to another question along those lines, you know, and it's this way in any business, but, you know, with, with ag in the last several years, 2020 turned out decent for a lot of operations because of various things, and there was a lot of government, government revenue that actually came into the ag sector that kind of kept us in line and made us whole. And then this year, in a lot of instances, and there's areas I know that are not going to have a great year, but in the for the most part, a lot of operations are going to have another good year. We've gone, especially in the grain side of things, corn, soybeans, wheat, probably since 2012, having our working capital slowly, slowly, slowly get chewed away. Now we've had a couple of years where we've rebuilt working capital. Asking you, I guess, here in this question to put your consultant hat on for a second.

And, and, you know, the, the tendency is to want to pay down on some of those intermediate or longer-term debts when you have a bunch of cash sitting around, because you're sitting there thinking, well, geez, I don't, I don't, you know, I'm not doing anything with this cash. But on the same token, what you're telling me, if I understood this right, is that we could be seeing some pretty high interest rates maybe coming our way down the pike that that working capital is going to be pretty critical?

Dr.

Bill

Conerly: Um, yeah, first of all, my inclination would be to lock in as long a term as I can get right now. That's not always the best advice, but that's what, what my projections, uh, argue for, is, is lock in. And then I think the, uh, the next thing I would think about was just reducing total level of debt. And let me tell you a story from the corporate world, and you can tell me whether this actually applies in agriculture, because I don't know agriculture like you do. But in the corporate world, what we've seen is we see companies do mergers and acquisitions, or they buy more property, more equipment. And the companies that succeed the best in the long term use the good years to improve their balance sheet. They pay down debt, they accumulate some cash, and then in the bad years is when they start buying.

Whereas the common business thing is in the good years, that's when you buy, and yet you're buying at high prices and inflated valuations. And then the market turns down and you're saying, holy, you know, holy bad word, why did I buy at that price? Right. Um, and I've heard stories, you tell me if this makes sense, of, you know, farmers have a couple of good years and they're, you know, they're buying, buying, buying, you know, more land and shiny new machines. Does that make sense?

Chris: Yeah, it does. Exactly. And that's, that's what I'm getting at is, you know, that, you know, cash is king some of the time and, you know, paying down some of that intermediate stuff when that those, those dollars are there. Plus with this inflation, you know, just looking at our client base, we're seeing that, um, you know, as much as $100 to $150 an acre of additional cash requirement in '22 versus '21 just because of the inflationary components. So there's gonna— it's gonna require more cash to start with. And then, yeah, and to your point, land, you know, look at, look at what land value— I mean, there's a lot of land in Iowa where I live that has a number of farms have been sold for, you know, approaching $20,000 an acre. There's been some $14,000s, $15,000s, and some $20,000s, $21,000s, $22,000s an acre.

I mean, that's a long ways from cash flowing, and it's purely like you said, it's, it's driven by, quote unquote, good times, high commodity prices and inflation, and, and people with extra cash that bid against each other, and all of a sudden, we've, you know, we're creating another cycle, probably.

Dr.

Bill

Conerly: Yeah, yeah, and that is something to be worried about. And as humans, we get into this mood of, hey, things are good, let's expand, and that's often the time to be cautious. You know, I was working with copper and brass distributors 10 years ago, and copper prices were up. I shrugged my shoulders and said, "Well, your margin's about the same." He said, "Yeah." I said, "So what's the problem?" He says, "Well, we're moving as many bars of copper as ever before, but if the price of copper is twice as much, we need twice as much working capital." That hadn't dawned on me that Okay, his profit isn't higher, but his working capital needs are higher. So that's what you're talking about, is just, uh, you know, being able to put the cash out for the supplies, the fertilizer, the seed before you get paid. Yeah.

Chris: Yeah. The other, the other challenge is too is being cognizant enough to, to take advantage of opportunities when they're there too. It's always the, with commodity prices, it's tough because you're always dealing with those those two wild emotions called fear and greed. And one or the other is gonna drive the decision. It depends on the person. Some people are driven by fear and some are driven by greed, but you need to understand yourself and make sure you're managing that side of the equation too.

Dr.

Bill

Conerly: Yeah, what I have suggested to people in this kind of situation is long before you have to make the decision, set out your framework for how you're going to make the decision, what will be the key factors and how will you do the arithmetic. And if you do that, you're less likely, I believe, to get caught up by the fear and the greed and the emotions of the time. Does that ring true in the agriculture?

Chris: Yeah, absolutely. That's exactly what we do with our clients. We map that out because you really, You really got to know what your 3-year plan is, not just what you're, what are you doing tomorrow, you know, it's how, what's this look like and what do those projections tell you. So I have another question and I'm not throwing you into the politics world here necessarily, but I do want to ask a couple of questions on some of the policy proposals that are being thrown around on the tax side of things and I know there isn't exact verbiage on anything, but there are proposals out there floating around. Are there anything that concerns you or things that you're okay with? Or from an economic standpoint, what are some of your thoughts on some of these economic proposals that are out there, including the infrastructure, if you want to touch on that too?

Dr.

Bill

Conerly: Sure. Well, just between you and me, Chris, I'm not happy with any tax. Right.

Chris: Well, me too.

Dr.

Bill

Conerly: But the fact is we do need some government services, so I guess taxes are necessary.

Chris: Exactly. I've got kids in the military, so yeah, we need to make sure that they're funded.

Dr.

Bill

Conerly: So I agree. They need a paycheck. Exactly. No doubt about it. Not just need it, deserve it. But what I, as an economist, when I look at taxes, there are two questions. One is the total amount that the government takes. Taxes. And that's sort of a liberal versus conservative argument, how much money should be left to individual decisions by those who earned it versus how much money, uh, spent through political decisions. Uh, the thing that I keep coming back though is incentives. High taxes are disincentive to whatever is being taxed, whether that's a property tax on land or a, uh, an income tax on labor or a sales tax on buying cars and boats, whatever you tax is disincented. In terms of economic growth, the taxes that have the most negative impact on long-term economic growth begin with taxes on capital income, and that's profits as well as interest expense or capital gains.

Those are most negative. And the next on the bad list is income taxes. And there's a lot of activity that is discouraged by income taxes. So, somebody making a good bit of money says, "Gee, should I work another year or should I retire now?" Or you've got two earners in a family and one of them is thinking about not working The tax rate of the whole family is a big factor there. Then when you work down, things like the sales tax and property tax have very, very small impacts on long-term economic growth. If you want the economy to grow faster, the answer is do not tax returns on capital very high and do not tax income very high. But the folks who are concerned with equity and helping poor people say, "Well, you need to tax the folks with high income." So we have this conflict between what seems fair to most people and what will get the economy going.

What's going to help poor people in the long run is a stronger economy, but what's going to hurt poor people in the short run is taxing fuel and sales tax-like stuff. So it's not an easy problem to solve.

Chris: Well, and you know, if you look at what fuel prices or gas prices have done recently, you know, in the last 6 months or whatever, they've really gone up. That's almost like a tax too, right?

Dr.

Bill

Conerly: Yeah, and you know, a low-income person living in a rural area, you know, in a city, maybe the person jumps on a bus or drives 5 miles to work. But there are a lot of people in the country who are driving, you know, 50 miles each way to get to work, and the higher gasoline expense is really costly.

Chris: Yeah. So this kind of transitions to the last thing I wanted to just touch on here and wrap up, but is with the pandemic and the impact of that, this labor issue, it's led into the, you know, the supply chain issues that we've talked about and inflation. Probably all— it's probably impacted most of this stuff. Any, any comments on that or things that, um, in, in any industry, I guess? I mean, ag is just another industry of many, but any comments on that or, or things that we need to be paying attention to?

Dr.

Bill

Conerly: Well, in, um, in like manufacturing I think there's some analogies. The industry spent 2 decades trying to reduce their inventories, you know, just-in-time inventories. And now I'm saying to folks, "Gee, you know, you need to build up your inventory." One company has a small part that's a plastic part, and it's like, you know, a nickel each, and they use, you know, 100,000 of them, so it's not a big deal, but they come from China. And after talking, the guy just bought a whole year's worth of supply, which really contradicts the just-in-time thing. But he said, "I don't want to have to worry about a container getting here from China." And I think anybody who's critically dependent on things should be giving some thought to how much should I keep in storage? Now, maybe you don't have storage space, Maybe it'll rot depending on what it is or get stolen.

That's a legitimate concern. But your bank is paying you approximately diddly squat interest on your working capital. So maybe having it in inventory makes more sense.

Chris: Well, and that's just it. We've— in our operation this fall and through even last spring, I mean, we were buying extra parts and things like that just because of the concern of being able to get a hold of things too.

Dr.

Bill

Conerly: So yeah, and, and to tell you the truth, it makes a lot of sense, but it contributes to the supply chain problem. Yeah, if everybody's doing it right, if everybody's buying stuff they don't need, uh, that makes it tougher. But on the other hand, you know, you're running an operation, you got to keep it going, and yeah, there's a chance that you're going to blow a tire, and it might be good to have an extra one around.

Chris: Exactly. So anything on the economy? Last question, I guess, as we march toward the end of, you know, this year and look at 2022, anything that stands out that's like a flashing yellow light or possibly a red light that's like, hey, look at this, be careful?

Dr.

Bill

Conerly: Yeah, well, I'm going to suggest we look a little farther into the future, you know. You've got to look at what's happening right around you, but sometimes you need to lift your eyes to the horizon. And is that a gorilla out there coming my way? So, the gorilla on the horizon for me is a more boom-bust economy. The Federal Reserve is being slow, intentionally slow, to respond to inflation. I think they eventually will. But what we saw in the 1970s, late '60s and '70s and early '80s, was the Federal Reserve wanting to keep unemployment low and they'd goose the economy and then inflation would go up and they'd hit the brakes and then they'd cause a recession and then they'd hit the gas and the economy would go and inflation would rise and then they'd hit the brakes and it was a roller coaster.

Chris: Hmm.

Dr.

Bill

Conerly: I think that not in 2022 or even '23, but certainly by '24, I think the economy is going to be on more of a roller coaster with booms and busts. And it maybe won't affect total food consumption very much, but it will certainly affect product costs and production costs and may affect product prices with the inflation. Some discretionary purchases will be cut back in the recessions, uh, which is maybe more relevant to the livestock folks than the grain producers. I don't know, but I would expect, uh, what I have been saying is that the booms will be boomier and the busts will be bustier. And, um, I think everybody in business should prepare for a more up and down economy.

Chris: That's, uh, really good advice. Uh, in agriculture, it, it's exactly what we live on, is, is you get, get a couple of really good years, and then you get to try to figure out how to survive for a few years, and then you get a couple good years again.

Dr.

Bill

Conerly: So exactly. Joseph talked to that Pharaoh fella about using the good years to prepare for the lean years, and that's still good advice.

Chris: Yeah, exactly, exactly. Well, Hey, this has been an excellent conversation. It gives everybody kind of a little bit of flavor of, you know, kind of how your take is on things and being involved in a lot of different industries. I think you're going to bring a tremendous amount of value to our Executive Business Conference. We'll probably have you back on to just give us a short preview when we get a little closer to the conference that's going to be on January 27th and 28th in Phoenix. And so we're Excited to have you there. Really appreciate this podcast and conversation with you. It's been great to get some perspective.

Dr.

Bill

Conerly: Great. I've enjoyed talking with you, and I'm looking forward to talking to your producers at the Executive Business Conference. And it's not too early to start thinking about, uh, gee, what are the questions I want to ask this guy when I get him face to face?

Chris: That's right. And if anybody wants to start emailing Alyssa's ask some questions, I'm sure we can get them to you. So we'll encourage that, and that'll, that'll probably stoke the fire to get some sent our way. So appreciate that, Bill. Bill, thanks a lot, really appreciate you being on.

Dr.

Bill

Conerly: Good chatting.

Chris: Yeah, that's Bill Connerly, and thanks everybody for listening, and we will catch you again next time on the Ag View Pitch.