The Wealth Effect, and farm impact on the US economy

Though representing just 1.3% of the US GDP, if the farm sector has a major impact on US economic health, it may tie back to what economists call “the wealth effect”.

In today’s Digest, we look at “the wealth effect” and why political uncertainty over the Renewable Fuel Standard might lead to economic uncertainty, and impact on the 2016 Iowa Caucuses, and beyond.

In today’s Digest, noting that we are roughly nine months away from the 2016 Iowa Caucuses and the official beginning to the Presidential election cycle, we are looking in more detail at what we have termed “The Iowa Renaissance”, a substantial lift in the farm state’s prosperity in the past 15 years, and a complete turnaround since the days of Farm Aid and the 1980s farm crisis.

We are also presenting a special interview with Iowa Governor Terry Branstad, who last week took time with The Digest to offer his views, as a governor serving from 1983 to 1999 and again from 2011 through today — on the origins and drivers of the recovery in the farm sector that — we suspect — may be having a substantial knock-on effect on national GDP as well.

A key to prosperity: rising land values

When you look at the farm sector and its relatively small share of the national GDP, you might wonder what the fuss over Iowa is about. 1.31% of the GDP comes from farms, and 4.8% from all agriculture-related business, according to the USDA’s Economic Research Service. As we found out in the “real estate bubble years” of 2004-07.

At the same time, you might consider that the value of your home has virtually no impact on your own GDP, that is your direct income — yet the changing value of your home has a substantial impact on your feelings of prosperity and your own spending habits.

And that’s the key to understanding how the farm sector impacts the national picture. Though income from farming is not huge within the scope of the diversified US GDP, some 900 million acres of these United States are being farmed — out of 2.3 billion acres in the country as a whole. A lift in land prices has a substantial impact on the overall wealth of the country — and that’s where that knock-on “wealth effect” can have an impact.

The “Wealth effect”

If your story matches the average American investment experience, roughly half of your worth is tied up in your home, and with every dollar you gain from rising home values, you are likely to raise your spending as a consumer by more than two times as much as from a dollar gain in your stocks & bonds investment portfolio.

The relationship between wealth and spending, known as the “wealth effect”, is widely studied, and in recent years economists have generally made a distinction between the wealth effect in real estate, compared to other areas of investment.

As the USDA reports in a recent study: “Using U.S. data, they estimate that the immediate (next-quarter) marginal propensity to consume from a $1 change in housing wealth is about 2 cents, with an eventual effect around 9 cents, substantially larger than the effect of shocks to financial wealth.”

Not every economist agrees. As Forbes reported in 2013:

“In a June 2009 article in The Wall Street Journal, three U.S. economists – Charles W. Calomiris of Columbia University, Stanley D. Longhofer and William Miles of Wichita State University – argued that the wealth effect of housing has been overstated, and that the reaction of consumption to housing wealth changes is probably very small.”

But the consensus is more in line with Moody’s Analytics chief economist Mark Zandi, who pegged the wealth effect for housing at around 2.5 times the wealth effect for stocks.

In 2011, the Federal Reserve concluded:

A one dollar increase in housing wealth then generates an increase in annualized consumption of about 6 cents, and one dollar increase in non-housing wealth generates an increase in consumption of about 2 cents.

A trio of economists who are widely quoted on the topic, Case, Shiller and Quigley wrote in a paper for the National Bureau of Economic Research that:

An increase in real housing wealth comparable to the rise between 2001 and 2005 would, over the four years, push up household spending by a total of about 4.3%. A decrease in real housing wealth comparable to the crash which took place between 2005 and 2009 would lead to a drop of about 3.5%.

Farm investment returns compared

Though we are looking today at the period since 2000, the USDA’s most recent analysis looks at the 1990-2013 period in comparing investment returns from the S&P 500, from investing in gold, or as a farmland investor:

Farmland 4.4 percent

S&P 500 4.6 percent

Gold 2.5 percent

Investment in farm land, on the other hand, performed substantially worse in the 1980s, during the years of farm aid. But the USDA concluded: “Farmland values exhibited a relatively stable increase compared to the other investment alternatives, across all three investment horizons.”

The rise in farm values and the rise in GDP

In the US, average US land values were $1465 per acre in 2000 (inflation-adjusted), and $2950 as of last August, according to the USDA.

That translates into an increase of $1.37 trillion in national wealth, and an $82B-$123B annual uptick in GDP, depending on whether you are using the lower-end Fed or higher-end USDA measure of the “wealth effect” and the extent to which you subscribe to the idea that rises in farm land value translate into spending in the same way that rising in the overall real estate sector do.

If so, that translates into a 0.5% to 0.8% bump in US GDP. That’s, er, not nothing.

Rise in farm land values and renewable energy

As Kevin Dobbs of Midwest Energy News observed in 2011:

“Prosperity is closely linked to the United States government’s backing of corn-based ethanol. Farm incomes and farmland values have surged as the ethanol industry emerged and then swelled in the past decade, creating a new form of steady demand for corn and hastening the rise in value of the soil in which it grows…Farmers, historically subject to volatile prices, found a source of steady demand for a key crop while contributing to a developing way of addressing the nation’s ambitions of gradually weaning itself from foreign oil.”

Rising land values, productivity, and crop prices

The doubling of land values hasn’t resulted from a doubling of crop prices. In our baseline year of 2000, corn prices were $2.34, or $3.19 when adjusted for inflation.

 

Today, the May spot contract is running at $3.83, and contract prices have been as low as $3.50 this year. That’s an increase of 20% in 15 years, after adjusting for inflation.

The real story has been rising agricultural yields, which have surged from roughly 125 bushels per acre in 2000 to more than 170 bushels per acre last year. That’s an increase of 36 percent — and that’s what’s been driving land values.

The bioenergy connection

The investments in yield improvement have been accompanied by what the Washington Post termed “the dramatic rise in no-till farming which have…UNEP estimates that no-tillage operations in the United States have helped avoid 241 million metric tons of carbon-dioxide since the 1970s.”

There’s much evidence that the investment in genetics, breeding and yield enhancement would not have taken place at such an elevated pace without the additional markets for crops provided by bioenergy.

As form Pioneer Hi-Bred president Craig Oestreich observed in 2007, as second-generation biofuels efforts were getting underway:

“The first part of DuPont’s three-part strategy is about increasing yield per acre and enhancing ethanol yield of grain. We are doing this through biotechnology, enhanced and traditional breeding techniques, accurate product positioning on its customers’ farms and ethanol yield prediction analysis of its corn hybrids. Pioneer is offering and continues to advance a broad array of tools to help farmers maximize their yields.

“We are using biotechnology to greatly speed up our research and development process, allowing us to bring improved products to the market faster. Biotechnology advances such as Herculex(R) Insect Protection traits and drought tolerance are or will soon be protecting their potential from yield-limiting factors. Pioneer agronomists are working closely with farmers to assist them with production challenges from corn-after-corn production.”

The Iowa result

Iowa in 2014 produced 3.9 billion gallons of ethanol, 227 million gallons of biodiesel, and was home to two next-generation plants in Emmetsburg (POET-DSM, and Green Biologics), Blairstown (Fiberight), Shenandoah (BioProcess Algae), Clinton (Solazyme) and a new plant in Nevada expected to be completed this year by DuPont.

In 2000, the statewide average value of land was $1,857, according to Iowa State’s Land Value survey that year. Inflation adjusted, that’s $2,531 in today’s dollars.

in 2014, land value had risen to $8,500, a gain of 235 percent. That’s a real gain over the 30.5 million acres of farmland in Iowa of $182 billion.

Using our “wealth effect” formula, we can speculate that there’s been a $10-$15 billion lift in state GDP from the wealth effect. Not to mention the added value of rising farm incomes (in 2013, farm income was $8.6 billion), and the multiplier effect associated with rising spending levels.

Clouds on the horizon

Political uncertainty over the US Renewable Fuel Standard has been generally attributed by Iowa’s leaders for a downturn in sector confidence. In a report appearing in the Des Moines Register, Iowa State economist Chad Hart warned of as much as a $2.6 billion drop in farm income in 2014, from 2013, when the numbers are totaled up. Overall, US farmers are told to expect a 23 percent drop in income.

Last August John Deere announced it would lay off 1,000 workers, as uncertainty works its way into expectations around corn prices — with the company saying it had a 9% downturn in sales in 2014 and was expecting a drop of as much as 20 percent in 2015

And Iowa Governor Terry Branstad said that farm values had already dropped an average of 15%, and Steve Bruere, president of Peoples Co., a Clive farmland brokerage and management company, told the Register that he views “commodity prices more closely supporting 2008 farmland values, about 50 percent lower than today’s values.”

The wealth effect in reverse

Even if US ethanol and biodiesel demand stays static, let’s look at the impact of a 50 percent drop in farm land values on the Iowa economy. According to Case et al, the impact appears to be a little more muted on the downside, about 80% of the impact seen from rising real estate values. Still, that could translate into a hit to the Iowa economy of $6.15-$9.23 billion just from the “wealth effect”. Add to that a $2 billion loss in farm incomes, or so, and that could be a downturn of $8-$11 billion. That measures out to a 6-9 percent drop in the state GDP.

That’s potential impact, and over time — so keep that in mind.

The problem with farm confidence

What’s interesting in all this is that the debate in Iowa is currently being presented over the future of the renewable Fuel Standard. Governor Branstad and other state officials are working hard to ensure that the ties between the RFS and state prosperity are well understood by aspiring Presidential candidates on the GOP side.

But there’s another way to look at it — that what is being measured is not existential uncertainty over the RFS’s future, but the uncertainty resulting from the fact that the EPA has not released the 2014 mandate volumes for biofuels — as of April 2015, 17 months after they were due and four months after the year ended, and has not released a timetable for release of 2015 volumes, which were due five months ago.

Which is to say, Iowa’s prosperity might be in the balance owing in great measure to the Obama Administration’s oversight of the RFS, in addition to pressure brought to bear by efforts to overturn renewable energy legislation that generally have come from the far right.

Which, of course, raises the “competence” issue as a potential Presidential year issue in Iowa — a way for GOP national figures who may be iffy about renewable energy mandates to find a critique of the RFS that resonates within Iowa, instead of alarming Iowans.

Reminding us of the old hit jazz tune, T’ain’t What You Do (It’s the Way That You Do It), as recorded most famously by Ella Fitzgerald, but in recent years as a ska anthem by Bananarama and Fun Boy Three.

So there you have it. A success story in the agricultural sector. One that may well be having impact on the national economy all out of proportion to its share of GDP — owing to the wealth effect. A success story that may be in jeopardy owing to federal indecisiveness on enforcing the energy laws.

Farm belt prosperity — yes, it has a much greater impact on national GDP than perhaps most realize. And may well have an outsized impact on the 2016 Republican presidential campaign.

And that might well be the most long-lasting manifestation of the “wealth effect” we’ll see.