How inflation impacts the ag community
Inflation is simply a general increase in the price level of an economy over time. As prices increase, each dollar experiences a reduction in purchasing power. Rampant inflation can be destructive in any economy and thus it is closely watched by those in the business world. As I meet with customers and prospective customers, the most common question posed is: “What are your thoughts on inflation and the accompanying (pending) large increase in interest rates?”
My simple thought is that while problematic inflation and much higher interest rates are possible, this scenario is not probable. Let’s explore why I believe the more likely scenario is that inflation moderates and that rates rise modestly over time.
The June 2021 reading on the Consumer Price Index (CPI) jumped 5.4 percent vs. expectations of 5 percent – which is the largest jump since 2008. It is important to note though that used vehicle prices made up nearly one-third of the overall increase in the CPI. Other significant contributors to this increase in prices were travel costs (including airline tickets) and transportation costs.
While these segments are seeing real increases — it’s important to keep in mind that each of these are clearly impacted by dynamics from the pandemic. These dynamics certainly could prove to be temporary in nature. Famed investor Benjamin Graham was asked about the stock markets value in 1955.
Mr. Graham remarked that “the market looks high, and it is high, but its not as high as it looks.” I would say the same about inflation today. According to the US Bureau of Labor Statistics, the Core CPI (excluding food and fuel) had been meaningfully below the Federal Reserve’s 2% annual target rate from 2014 until mid-2020. With the recent jump in core CPI this measure is now right on target when the 2 percent Core CPI target is looked at from 2010 to 2021. Put simply, inflation had been running meaningfully below the Federal Reserve’s target and has now caught up. When thinking about long-term inflation rates, it’s important to remember that a modest amount of inflation is healthy in a robust economy. Deflation is perhaps a more scary proposition as we learned from the Great Depression when prices dropped an average of 10 percent per year between 1930 and 1933.
So how should those of us in agribusiness think about and plan given the inflation that we are seeing? It is always prudent to look as far into the future as we can and make business decisions that are long-term focused.
Thus, it is smart to fix rates on term loans as you have the opportunity to do so. I would not, however, rework your business model or stress out about rampant inflation or dramatically higher interest rates. Ag folks generally own a lot of physical assets — which are a good hedge in times of sustained price increases. These physical assets like land, livestock and equipment should put your mind further at ease, as they will hold their own if dramatic inflation arrives.
Can inflation continue to run a bit hot? Yes. Can rates move marginally higher? Yes. Would I spend much time worrying about either? No. Fix rates as you have opportunity to do so, develop contingency plans should the facts change and run your business free from worry about runaway inflation and Volcker level interest rates.
It’s all possible, but I maintain that it is not probable.
Lance Albin is president of agribusiness at UMB Bank.