Increased “Capitalizing” On Canadian Farms Needs to Change

I talked with one of my favourite grain traders the other day.  He said, “we’re bullish when the market is at its top and we’re bearish when the market is at the bottom.”  We were both lamenting that no one predicted the run up in commodity prices started last September.

Of course I was at a meeting where commodity gurus were guessing what was going to happen next.  One farmer piped up and he said he had some $10 soybeans in the bin but right now he could only get $7 for them.  The point went unsaid that if he could get $10 for those soybeans he’d finally have some money to get some of those things he’s always wanted.

So I hope those soybeans do go to $10.  It would be a welcome respite for everyone.  However, the dark side of any price run up is the “capitalization paradigm.”  In other words, it is said if a farmer has a dollar to spend, he’ll spend it.  I’ve never really believed in that paradigm.  I’ve always said I’d save it first.  However, not everybody agrees with me.  Farmers are economic engines.  They do spend money when they get it.

Agricultural economist often talk about “capitalizing it back” into the farm.  In the end they say, “capitalization pushes up farm costs.  It’s like a leap frogging effect.  The more we re-invest, the more things cost in the future.  That’s one reason whey farm subsidies are such a black hole for some agricultural economists.  Every subsidy dollar given to farmers simply adds to long term higher fixed costs.  As time goes by agricultural infrastructure gets more and more expensive.

The quintessential example of this in Canadian agriculture is the supply management sector.  High quota values (quota being the “value of the right to produce”) are a result of many things but their high value has led to an industry with very high fixed costs.  To produce more milk for example you need more quota.  It’s vicious cycle, which goes round and round.

As many of you know I write farm management articles for Country Guide magazine in Canada.  In the latest issue respected journalist Tom Button writes about “capitalization” of land in his article “Will Land Market Bubble Burst?”  In this piece he quotes a mentor of mine, Dr. George Brinkman.  Dr Brinkman, or “George” as I used to like to call him is warning farmers about investing in land at the present time because the land market is showing signs of weakening.  He goes on to talk about how Canadian farmers are at risk because they have “capitalized” too much money back into their farm environment.

George cites an example of the typically American farm family.  It takes them 3.9 years worth of income from their farm to pay their debt.  For Canadian farmers it takes 15 years of income and in Ontario alone it takes 27 years or 7 times longer than in the US.  Put another way the average US farmer produces a dollar’s worth of income for every $23 in farm equity.  Canadian farmers on the other hand, produce a dollar on an average of $73 in farm equity and Ontario farmers it takes $146 of farm equity.  He goes on to muse it is unsustainable unless land prices go down.  With that there will be a lot of pain.

I have a lot of respect for George.  He’s got dirt firmly embedded under his fingernails.  He’s also got the best fishing stories in the world.  He’s right about most of this stuff, however, I think Ontario land values have more to do these days with the burgeoning GTA than the price of soybeans.  However, it pretty clear in Canadian farm country we’re capitalized to the hilt.  It’s partly agricultural economics, its partly the inherent nature of farmers themselves and its also part and parcel of being a cold country which is very good at agricultural production.  All that housing for Canadian livestock adds up in comparison with places like Australia, South America and the southern United States.

Our policy makers are very aware of this.  That’s why an acreage based stabilization program for the west, RMP in Ontario and similar programs have such a steep hill to climb.  As solid as our supply management sector is, our policy makers know its far too capitalized.  In the next few year that sector will surely do some naval gazing.

However, “capitalization doesn’t stop with agricultural policy.  High grain prices and low interest rate do the same thing, although usually short term.  These interest rates have been capitalized.  These perceived higher grain prices are sure to be capitalized too.

So are those $10 beans in the bin really worth $10 or are they worth $7?  Or are those beans really $7 but if we could we’d borrow like they were $10?  Or would we forget that those $10 beans in the bin are $10 when they go to $13 on the coattails of the great 2007 ethanol gold rush?  Let me give you a clue.  Those beans are $7, but they were $5.50 two months ago.  Let’s live within our means.  Increasing capitalization in Canadian agriculture has to change.  At the end of the day, whether we like it or not, we’d probably be all better off.