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The 2012 Drought

posted on July 27, 2012

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High and dry.  Iowa corn fields dry.  Corn markets high.  We're assessing the economic effects with two Midwest economists -- Creighton University's Ernie Goss and Iowa State University's Bruce Babcock on this edition of Iowa Press.

Borg: Hot and dry weather searing Midwest farm fields is fading the green from the corn and soybean plants and from farmers' potential profits.  It's those profits, both in grain and livestock, that have been rippling through Main Street Iowa, up until now buoying Iowa's economy.  The question now is how far still-evolving crop losses will ripple beyond the rural economy and how powerful those economic shocks might be.  We're seeking insight now from Creighton University Economic Forecast Director Ernie Goss who also directs the Denver-based Goss Economic Research Institute.  And Iowa State University Agricultural Economist Bruce Babcock who also directs ISU's bio-based energy center.  Gentlemen, you've both been here before.  Welcome back to Iowa Press.

Babcock: Thanks, good to be here.

Borg: And also at the table, Political Writer James Lynch of the Gazette published in Cedar Rapids and Radio Iowa News Director Kay Henderson.

Henderson: Gentlemen, this past week we learned that the gross domestic product, something that economists such as yourselves look at to see how the economy's health might be, was just 1.5% in the last quarter.  That did not measure any impact from the drought.  The next time the GDP is measured, Mr. Goss, will there be any impact from the drought in that measure of the national economy?

Goss: Oh absolutely, Kay.  In our surveys, we do several surveys of this part of the country, and one of them is ag based and that number, our latest form for July dropped below growth neutral.  And it was -- we hear about flash floods, this was a flash drought.  In other words, this came on very quickly and we, of course, depending on the weather we're going to see some significant impacts and this is going to roll across the U.S. all the way from we're talking about Wisconsin, Indiana, Illinois, Nebraska, Iowa, Minnesota, less impacts up further north.  Missouri, very significant impact.  So this will have some impacts on GDP.  And, as you say Kay, 1.5% that is bad.  We should be at 3% to 4% growth.  We're at 1.5% so this is going to shave some growth off of that for the third quarter and that is, of course, not good.

Henderson: Mr. Babcock, same question to you.  There was a huge drought in Texas last year and I don't think many people in Iowa felt that.  I'm not sure that the national economic measures showed that.  Do you believe that there will be some national impact because of the drought that seems to be unfolding here?

Babcock: Well, the drought is far bigger this year and it is affecting the feed grain complex, corn and oil seeds, soybeans most likely.  And the drought in the Southwest primarily affected cotton and cattle producers.  And what we saw with cattle I think most Midwesterners mainly felt the Southwest drought because now we're experiencing higher beef prices over the last six months because the herds got cold and we're now at our smallest cattle herd size in I don't know how many years, 50 or 60 years.  So that was the primary effect then.  Now we have potentially another round of shrinking the cattle herd again because of this drought but also because of higher feed grain costs.  So this should be a wider spread event.

Lynch: It's not a very optimistic picture that you're painting here and I just want to ask, are we facing the likelihood of a double dip recession?

Goss: I think our survey says it's a rising likelihood.  We do several surveys, one ag-based that I just talked about, but another one which will come out next Wednesday.  I looked at the results.  I asked my assistant to give me the results so far.  70% of the companies have already reported that number is below growth neutral for the first time since the recession.  The national number, which will come out also next Wednesday the 1st, was below growth neutral for June.  It's probably going to be again below growth neutral.  So I'm not saying recession, I'm saying the probability of a recession is going up each month and has been over the last few months and this drought that we're talking about, depending on the length and the depth of the drought, it certainly doesn't help.  And in terms of this part of the country we're talking about benefiting, as you said earlier Dean, about the benefits that we have enjoyed over 2011 was a record year in terms of farm income and now we're, it's all turned around and we're seeing that.

Borg: Do you think, Mr. Babcock, as Jim has said, you're painting a very dreary picture here but I don't think the broad population in this nation understands because the numbers are really too big, from what you're estimating here, too big to really imagine.  Do you think we're underestimating right now the effects of this?  Or is it too early to get a handle on how much losses might be?

Babcock: Well, I think that it's easy to actually exaggerate some of the financial impacts of this drought both in the Midwest and nationally.  A lot of the slowdown in the national economy comes about because our trading partners are slowing down.  And what was a bright spot, manufacturing, has slowed down because Europe and the Euro crisis is slowing down, China is slowing down.  So that also plays a big role.  And we have to remember that it's really the livestock sector that is going to be taking the big burden here through higher feed costs.  It's not necessarily the crop sector.  Even though a drought is there it's not like we're going to produce zero.  And what we do sell is going to be sold at a higher price.  And so crop income is going to be somewhat buffered.  It's going to be the livestock sector I think that is going to feel the brunt there.

Borg: Mr. Goss?

Goss: But there's another impact -- we asked the bank, there are bank CEOs in rural portions of ten states and average community size of 1300 -- we asked the impact of this drought.  Now, we just completed it in July, the third Thursday.  We asked about the impact on ethanol plants and biodiesel.  And two-thirds of those with ethanol and biodiesel plants in their area reported that there were either cutbacks or shutdowns, temporary shutdowns of course.  So it's not just the ag sector, it's not just livestock, it is a broad range of industries.  Our -- we have an ag equipment sales index, dropped to recession levels this month.  In other words, back to I think it was February of 2009.  So farmers obviously even though you may get crop insurance you do cut back on your purchases of farm equipment and that is an important industry for Iowa and Nebraska.

Henderson: A lot of Iowa's politicians, when comparing today to the depths of the farm crisis of the 1980s, say things are much different now, the state is much more diversified.  Is that true, Mr. Goss?  Or is this ag slowdown or drought going to show that that's not true?

Goss: It is more diversified but I went back and looked at the numbers in 1983 when there was a drought.  Farm earnings as measured by the Bureau of Economic Analysis take the numbers, I had to take a second look at it, it went from $818 million -- now these are 1983 dollars, '82, '83 and it went to $6 million.  $818 million to $6 million, that was the drop in '83.  So my point here is depending on how severe this drought is we're going to see some spillovers and of course there is crop insurance and there is more diversity and as Bruce is saying, internationally we're doing much better there in terms of reaching out to other nations in terms of selling whether it is South Korea or China or Europe so there is some potential there.

Henderson: Mr. Babcock, do you see the state's economy, let's just sort of zero in on Iowa, being diversified enough to sort of weather the storm of a drought?

Babcock: Well, it's the diversification actually helped us weather the storm of the big recession that we had over the last two years because the ag sector was the strength of the economy and the health sector also spending and that has been expanding a bit in Iowa.  So we had two areas that weren't hit as hard by the recession and so that diversification helped.  Plus we had a weak dollar and we had John Deere and manufacturing and a rebound of manufacturing and that helped the economy too.

Borg: The weak dollar helped exports?

Babcock: It sure did.  And so the dollar only strengthened later on in the, during the recession.  So Iowa has a pretty diverse economy and I think that it's going to, this recession, the slowdown caused by the drought I think there's going to be some stabilizing factors there and one of them is that farmers are going to be selling quite a bit of grain at a high price.  Crop insurance indemnities may flow in, in the tune of $4 billion this year.  And so that is kind of almost a Keynesian counter-cyclical kind of stimulus that is going to go on in the farm economy.

Lynch: We've been, the state has been riding this wave that you've just spoken of and tax revenues have been going up and accelerating.  Should we expect that to change, to drop off?  And should the state be preparing for a downturn in revenues?

Borg: Mr. Babcock?

Babcock: That's hard to say.  I don't track state revenues but I think total revenue in the agricultural sector, at least in the crop sector, it may not go down that much.  And why I say that, think of the, if we have a 30%, let's look at the corn crop, let's say we have a 30% drop in the corn crop.  In 1988 the drop was 33% so about equivalent.  Well, the price of corn has gone up by about 40%.  So if you just take 30% drop in quantity and increase the price by 40% you're up 10%.  So, again, we have kind of a natural hedge going on with the corn and the soybean crop.  Depending on how the livestock sector can weather this and I'm particularly thinking about the hog sector in Iowa and cattle and chickens I think that they're going to shrink over the next twelve months in response to these higher feed costs.  So, again, I think that we're going to be seeing the crop sector being somewhat stabilized by crop insurance and the natural hedge but the livestock sector shrinking a bit.

Lynch: But if farm equipment manufacturing is hit and those sorts of industries, are we going to feel it?

Goss: Oh, it will be felt and I agree with what Bruce is saying.  But on the side of caution, if I'm a legislator, if I'm in the administration I'm going to air on the side of caution and understand that there could be some significant, depending again on the length of this drought, could be some significant cutbacks or certainly slowing of the growth and even maybe some negative growth numbers in tax collections.

Borg: In the area of how well this is understood across the nation, Mr. Babcock, the farm drought is getting some urban attention right now.  It may not be completely understood.  But you were interviewed on "The Colbert Report" earlier this week and here is a bit of that conversation.

"The Colbert Report" - July 25, 2012 - Colbert: What happens if the crop is completely wiped out?  Do the farmers have any protection?

"The Colbert Report" - July 25, 2012 - Babcock: 90% of Iowa farmers have crop insurance.  It's a federal program that --

"The Colbert Report" - July 25, 2012 - Colbert: Wait, wait, wait, hold on sir, a federal insurance program?  That is just Obamacare for our corn.

"The Colbert Report" - July 25, 2012 - Babcock: Well, in essence you are right, it is Obamacare for the corn.

"The Colbert Report" - July 25, 2012 - Colbert: So that means eventually all of these farmers will be facing death panels?

"The Colbert Report" - July 25, 2012 - Babcock: Well, the hope it starts raining and then next year they hope they keep these high prices and it rains again.  And so farmers usually look on the bright side of things.

Borg: Mr. Goss, "The Colbert Report" there, not quite understanding what crop insurance -- help us understand because we've already said here, Mr. Goss I think said earlier, that livestock producers are going to feel the effect more severely than are farmers who have crop insurance.  Mr. Colbert in that report says this likens it to health insurance but is it -- let's pose the question this way -- is a farmer who has crop insurance likely to go out next year, he's been hit by drought this year, and buy a new combine?

Goss: No, absolutely because they're not insured up to 100%.  There are some farmers out there that bought, they are protected say 70%, 80%, 90% so even those who are 100% insured effectively then you're just going to spend less.  And we asked the question to the bankers about, this was again last month in June before this, I'll call it again, flash drought, we asked about liquidation of herds.  In other words, because of the dryness they were already in that time, it was about 15% at that time, this is June, liquidating herds.  So what we're going to see is some real hits to the livestock sector but, again, there that spills over into other sectors.

Borg: Mr. Babcock, doesn't crop insurance also just insure the input, that is what has been invested in seed, fertilizer?  It doesn't guarantee a profit.  In other words, farmers just don't get a paycheck this year?

Babcock: Well, it really depends on the position of the farmer.  I think that is probably most descriptive of cash renting famers, that the crop insurance that they buy is covering their costs of production including cash rent.  The farmer that I farm with bought 85% revenue protection so only a 15% deductible and he says the worst he can do is break even.  And he rents most of his land or crop shares most of his land, that's right.  But one feature of the kind of crop insurance that almost all farmers buy in Iowa is that the yield loss gets indemnified, gets valued at the higher of the price in the fall or the spring.  So this ramp up in price in the fall is going to ramp up the indemnities that they receive.  And so, again, we have another stabilizing force in play with crop insurance.

Borg: For those who are growing crops. 

Babcock: That's right, that's right.

Borg: Now, let's differentiate here, why are you saying, Mr. Goss, that livestock producers are going to be hit harder?

Goss: Well, obviously they are paying the higher feed costs and, of course, $8 plus in terms of corn prices if they are using that.  They are hit by the lack of distiller's grain from the ethanol, depends on that or the higher price from distiller's grain for their, to feed their cattle.  And then, as Bruce said earlier, we've already had liquidation of herds last year and now we're going to liquidate.  So we're looking at beef prices, in some cases beef and pork, coming down because of the liquidation but wait until we see it when we see even record low herds, size of herds.  Now I'm not an ag economist, Bruce is much more equipped to answer that question.

Henderson: Mr. Babcock, one of the things that the comedian Steven Colbert referenced was Obamacare for our corn.  Isn't that the reason the farm bill is stuck in Congress because you have this fight among republicans, some of whom think that it is a subsidy that should go away?  And this is something you've gone to D.C. to talk to people about.

Babcock: Well, I usually go to D.C. to explain things because the crop insurance program is so complicated that very few people know what's going on.  And so the Obamacare analogy came up and why it's appropriate is that the subsidies have been so large that the pool of insured represents the population of farmers now, which Obamacare is trying to subsidize and tax people into that pool to make it representative of the population at large.  And the further analogy is that crop insurance subsidies are justified in order so that people don't demand disaster assistance whereas with Obamacare the subsidy is to get them in the pool so that they don't go to emergency care for their primary physician.  So, in fact, it kind of is Obamacare.

Henderson: The other thing I think you told me in a phone call a couple of weeks ago was that if you consider the amount of federal subsidies, federal subsidies cover about 62% of the cost of an average farmer's premium.  Is that correct?

Babcock: The average, if you average across all the policies people buy it's about 60% of the cost of the premium.  Plus usually insurance premiums cover the profit for the company, the administrative costs, the underwriting costs but those are borne by the taxpayer too.  So it's really a federalized, subsidized program that is put in place in order to keep farmers from needing or demanding ad-hoc disaster programs when years like this hit.

Lynch: As Kay mentioned, the crop insurance portion of the farm bill is one thing that is holding it up and House leadership has said they may not take the farm bill up until September or even after the election.  And at the same time we have Secretary of Agriculture Tom Vilsack saying, hey, people are already hurting, we need action.  What is the impact of not having a farm bill in place as we head into harvest season?

Babcock: Almost none.  Again, the big stabilizing force in the crop sector is crop insurance, it's there.  The only thing that might, if there are some livestock disaster provisions that would come about because of the farm, the new five-year farm bill that would be included, that would help the livestock sector because the livestock disaster provisions that were in the 2008 farm bill expired in 2011 as part of a budget gimmick to get the thing scored right.  That and the SURE program.  And so those have expired.  So there's talk now of resurrecting some of those on a one-year extension and so that would be really the only justification or reason for needing a farm bill in order to deal with this drought.

Henderson: Mr. Goss, also on "The Colbert Report" there was a joke about the comedian would be fighting his Audi for lunch. You referenced the ethanol industry.  Is this the tipping point right now?  Because corn prices are going to keep escalating.  How are Iowa ethanol plants going to keep operating in this environment?

Goss: It's going to be tough, it's very tough and also oil prices have come down.  So that is part of it as well.  And we've got a sensitivity that I think we economists have a responsibility at least we should sensitize folks to is what is the value of the dollar.  That has huge impacts on crop prices.  And I have said in gest in the past maybe we should have Bernanke be the Secretary of Agriculture, not to necessarily replace Mr. Vilsack, but he's done a heck of a lot for ag by weakening the dollar.  But we also have to watch in terms of trade, we have to, in terms of opening up South Korea which is now there.  So back to your question, it is reported 30% to 40% of the corn is used for ethanol.  So if we see -- it's not just the price, it's also the availability of corn and soybean for biodiesel.  So we have to wait and see what happens in terms of the weather though.

Henderson: I don't want to leave livestock producers just yet.  I want to talk a little bit about the size of operation.  Is this an episode in which you'll see smaller producers go out of business and the larger producers will be able to withstand this economic storm, Mr. Babcock? Will the size of the operation determine the economic stability?

Babcock: I think so.  And the reason is the bankers are going to stand behind the more efficient production units and typically larger production units are more efficient.  In the 2009 dairy industry wipeout that we saw those dairies that were able to stay in business were the ones that had the financial backing of their banks.  And the banks basically chose the most efficient ones to back and kept them in business.  I think you're going to see exactly the same thing in the livestock industry.  And so I think we're going to see more consolidation.  So these are the episodes that speed along the consolidation that has been going on for the last, well in the hog industry the last 20 years, 25 years.

Borg: Mr. Babcock, because of your expertise in biofuels I want to come back to ethanol and finish up what Kay was starting there.  Are you more worried about the survivability of the ethanol industry in Iowa than you are about row crop farmers?

Babcock: No, I'm not at all.  The capital base, the industry is here.  You don't have to build this industry.  It's capable of producing 15 billion gallons.  It produces a valuable fuel, it's called ethanol.  And oil is still at $90 a barrel.  Wholesale gasoline is at $2.50.  And there is a mandate in place to use this year 13.2 billion gallons, next year 13.8 billion gallons and the idea that Congress is going to change that mandate it's not there.  I think we're going to see some drop in production of ethanol this year, maybe from the 14 billion gallon range down to 11 in order to -- because they have this carryover credits that they have because they overblended ethanol in the past, they can use those to meet their obligations to the mandate this year and next year.  But after that we're going to see production ramp back up.  So I'm not worried about the ethanol industry.

Borg: Jim?

Lynch: We've talked a little bit about some of the impacts, we might see a downturn in state revenue, some impact on smaller producers.  Is there anything the state should be doing right now, steps to take right now or steps that the legislature should be considering when they come back in January?

Borg: Mr. Goss?

Goss: I think in the long run it's a lot to do with trade.  I think the legislative leaders, administration leaders have a great opportunity and responsibility to cement trade deals whether it is opening up South Korea under the expansion of the South Korean market, is a great opportunity.  So I think that is one of the keys --

Lynch: But that is beyond what the state can do.

Goss: Right.  And I would not be able to comment on actual policy, state policy toward relief in terms of the drought.  I just don't know enough about that.

Lynch: Some of the steps we saw in the 1980s during the rural crisis, do we need to go back and look at those and see if they need to be taken up again?

Goss: Well, they are right now in Nebraska and Iowa allowing harvesting of some of the hay along the interstates, of course that is being done.  But those are small steps.  Beyond that I wouldn't be able to comment.  I'm sure Bruce could.

Babcock: Well, these are global markets for the commodities that Iowa grows and the global markets are responding to the drought in the Corn Belt and it's going to be responding in terms of hog prices.  The extent to which our hog producers now depend on exports is phenomenal.  Last I looked it was in excess of 20% of hogs are being exported in terms of meat.  And keeping that open, keeping the Iowa hog industry competitive with the rest of the country and internationally is some steps that the state can do for sure.

Borg: But you're raising a point there that, Mr. Goss, he says, indicates that livestock is going to be higher priced to me, the consumer, my pork chops.  But the farmer doesn't put a price tag on a gallon of milk or a pork chop.  So how do high grain prices get translated into higher costs for pork chops?

Goss: Well, the USDA is now saying prices are going to go up 4% to 5%.  You look at the numbers, you say well where, if we're talking about pinching the consumer not that much.  The real pinch is going to be to the food processor, to the farmer that doesn't get the adequate crop insurance revenues, the livestock producer that doesn't have, that has had a significant loss.  Another issue to raise here in our latest survey is land prices.  Farmland prices have been growing 20% to 25% depending on the area.  Our last survey we saw a downturn, not a cut in the farmland prices, the growth came down significantly and I don't think that is an entirely bad thing to see some of that.

Henderson: Why did you laugh?

Babcock: Well, it couldn't be sustained at the rate of increase that it has been over the last two years --

Goss: Absolutely.

Babcock: It's been unbelievable which would suggest that the balance sheet, the overall balance sheet of Iowa agriculture, Nebraska, Corn Belt agriculture is great when you value that land at current market prices.

Henderson: So when does the bubble burst?

Babcock: Frankly I don't think it's a bubble unless Ben Bernanke switches gears and starts raising interest rates and immediately you'll see land prices come down with interest rates.

Goss: I'm not sure -- we ask about cash financing, the financing among farmers is growing.  In other words, it was a lot of cash sales, now there's a balance so there is I think a potential for a bubble and that does concern me that you could burst that bubble.

Borg: Mr. Babcock, just a quick question.  If you were a hardware dealer in Grundy Center, Iowa would you be worried about this drought?

Babcock: Yes, I would be.  I think that from a short run, psychological viewpoint of things don't look good in the farm fields I think that farmers are going to close their wallet a little bit, but not the long run.

Borg: Yes or no?

Goss: Yes, truck sales, for example have been great.  Truck sales aren't going to be as strong.

Borg: Thank you.  We're out of time.  And this is the final edition of Iowa Press for this season.  We're taking a break during August, returning for a new season on the weekend following Labor Day, that is Friday, September 7th.  I'm Dean Borg.  Best wishes for a pleasant summer and thanks for joining us today.


Tags: agriculture Bruce Babcock drought economics Ernie Goss Iowa weather