THE FARM BELT BOOM / THE WALL STREET JOURNAL REVIEW & OUTLOOK ( VERY HIGHLY RECOMMENDED READING )

REVIEW & OUTLOOK

DECEMBER 9, 2010

The Farm Belt Boom

Land prices are soaring. Is this another Fed asset bubble?

The overall U.S. economy may be struggling, but you wouldn't know it from a visit to the Farm Belt. A boom is under way across much of the rural Midwest, with agricultural land prices growing at a double-digit clip and farm auctions in certain counties fetching record sales.

One question to ponder: Is this boom rooted in genuine economic gains, or is it another Federal Reserve-induced asset bubble? We lean toward the bubble view.

The Federal Reserve Bank of Chicago reported in November that farmland values across the upper Midwest have jumped 10% since 2009. The year-over-year increases were even more dramatic in some states—13% in Iowa, 11% in Indiana. Irrigated cropland is up 11.8% in Nebraska and 12.2% in Kansas, according to the Kansas City Fed's most recent quarterly survey, which also relays this comment from one district banker: "Land fever is running rampant."

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The signs of a land-grab mania are everywhere. The Des Moines Register reported this week that two tracts in O'Brien County in the northwestern part of Iowa sold for $9,700 an acre, while one land broker estimated that farmland has appreciated on average by about $1,000 an acre since the end of the summer. Reports of bidding wars and $2,000 an acre premiums for top farms are common.

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By comparison, Iowa farmland values averaged $4,371 per acre in 2009, and $5,321 for the highest grade properties, according to Mike Duffy, an Iowa State University agricultural economist who conducts an annual in-state farmland survey. He'll release figures for 2010 next week, and the trend is expected to be higher.

More than anything, this real estate boom is a result of the extraordinary rally in crop prices. Even after record prices in 2007 and 2008, the price of corn has climbed 48% since June alone (see chart), while soybeans, wheat and other key grains are all trading well above their prices only a year ago. Last month, John Deere & Co. forecast that U.S. net farm cash income will climb 31% this fiscal year—the most profitable agricultural year in history—and then jump another 15% in 2011. Naturally, the cost of agricultural land is being bid up as farmers reinvest their margins in expansion.

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The land market is so strong that recent years have seen the rise of the so-called nonfarm investor, or the outside buyers who some consider speculators. The Iowa State survey shows that investors made a little more than a fifth of all 2009 purchases, though that figure ranged as high as 40% in 2005. Agriculture plays are a growing frontier for private equity and institutional funds, both foreign and domestic.
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Certainly some of this can be explained by rising global demand for U.S. farm products. Exports have rebounded amid disappointing harvests world-wide and as incomes and demand rise in China, India and Russia. Federal ethanol mandates have also fueled the appetite for corn. But the price surge has been so rapid and so broad across nearly all commodities—not merely corn or soy, but also oil, gold, base metals, etc.—that it can't merely be a function of new demand for specific grains.

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This is where monetary policy comes in. As the greenback declines amid easy Fed policy, commodities rise in value. Farmland booms have typically coincided with periods of Fed easing, such as the 1970s and the late 1980s. It's no accident in our view that the latest commodity price surge began this summer when the Fed's talk about another round of quantitative easing began in earnest.
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In the near term, this commodity boom is wonderful news for the rural Midwest. Rising grain and land prices flow through the larger agricultural economy, with farm equipment manufacturers, seed and fertilizer companies and rural financial services all along for the ride. Everyone feels great, no one wants it to end, and analysts offer explanations for why, this time, the price increases are permanent. Chinese demand!

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The problem comes if the boom is an artificial, money-fed bubble. The mid-2000s witnessed a similar euphoria over U.S. housing, with the Fed also declaiming that the boom was rooted in a natural growth in demand from immigration and younger families. We know how that turned out.
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The Farm Belt has seen its share of booms and busts over the decades, many rooted in the vagaries of monetary policy, as land prices crashed and bankruptcy waves rolled over the land. John Cougar Mellencamp sponsors a "Farm Aid" concert, and taxpayers are hit up for a bailout.
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As damaging, overeasy monetary policy and government subsidies (ethanol) distort investment flows and lead to a misallocation of capital. When a money boom chasing this or that asset bubble is followed by bust, hundreds of billions of dollars are lost that could have been invested in more productive purposes—say, biotechnology, telecom or new roads. As we're learning after the housing bust, it can take years to work through the economic wreckage.
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We hope Fed Chairman Ben Bernanke is right when he says asset bubbles and price spikes in commodities are nothing to worry about. Of course, he said the same thing about housing and oil in the last decade. We're not predicting an imminent bust, but we do hope someone at the Fed is watching prices grow in farm country.

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