Central Banks Accelerate Their Inflation Stance

I started fixing things mid June. The worst part of replanting soybeans is considering it in the days after damaging rain. Once you actually make the decision to replant the crop and press the auto steer button things become much easier. It can be an anguishing decision to get to that point but generally speaking after it’s said and done you live with the decision. Hopefully, in a year where prices are very high, the road ahead in my production fields will get a bit easier. 2022 has certainly been a challenge.

In the cab of my tractor my satellite radio crackles with business programming. I have a set regiment listening to NBA radio in the morning but generally speaking switching to business radio throughout the day. I like the back and forth of the different analysts regarding business and economic issues. It just so happens this past week some of the fixation was on the US Federal Reserve increasing interest rates by a whopping 75 percentage points. That is unusual, usually it happens in 25-point increments.  It was like deciding to replant with double the seed the day after the four-inch rainstorm.

OK, I’m sure maybe that’s a bit of an overstatement as the US Federal Reserve and the Bank of Canada don’t make such rash decisions. However, the signal from the US Federal Reserve was telling. With inflation at a 40 year high in the United States, the US Federal Reserve is clearly positioning itself to beat back inflation by raising interest rates.  The benchmark federal funds rate now in the United States is between 1.5 and 1.75%.  This will translate into much higher borrowing costs for American consumers.

It is all quite interesting radio for me to listen to, but it also hearkens back to my academic background in agricultural economics. I used to love learning about how the mechanics of economics work, and it has stayed with me until this day. I remember very clearly back in the early 1980s as inflation rocketed into the teens, the then Bank of Canada ratcheting up interest rates over 20% to beat inflation back. It made capital very scarce at the time and it put a beating on inflation. When I hear news of US Federal Reserve raising interest rates by 75 basis points, it reminds me of that time. Simply put, we have a big central bank trying to dry up the pool of available capital. Raising interest rates has always been that lever.

In Canada, we are waiting for that shoe to drop from the Bank of Canada. The bank has raised interest rates repeatedly putting their benchmark right now at 1.5%, but this is expected to increase in the next few weeks especially with the US fed doing what they’re doing. It is no secret that we have a big inflation problem in Canada as well and raising interest rates will be the hammer to that problem. The only problem is at least from a farm perspective that usually means a rise in the Canadian dollar, which is bad for domestic grain prices.

That’s the rub I always talk about when it comes to the value of our Canadian dollar and grain prices. Generally speaking, the value of the Canadian dollar is an inverse relationship to the value of the US dollar.  A lower dollar will always increase Ontario and Quebec cash prices, the higher dollar does the opposite.  As farmers we need to find the balance on when we sell our grain in that environment. It just so happens now we are an environment where I expect the Bank of Canada to raise interest rates and usually this means that the Canadian dollar gains in value. Did somebody say $0.85 US?

I don’t know, but I can see that scenario happening in an environment with rising Canadian interest rates.  This will be especially so if these interest rates are much higher than US rates. The Bank of Canada does know that a higher Canadian dollar will mean lower prices for Canadian consumers for imported goods, and this can be seen as a good tool to fight domestic inflation.  It almost would seem then to be a win, win from a Bank of Canada perspective.

Yes, it is that easy and it’s not that easy to understand. All western governments have increased spending 10 times during the pandemic. It is pretty clear now that that increase in spending was a big part of the fire that has stirred inflation. Even though that government spending is being ratcheted down now we still have to deal with the inflation genie that got out of the bottle, partly through our own doing. Needless to say, the pandemic was costly, and people needed help so here we are.

The implications for Canadian farmers are many. There’s no question in my mind but the cost of borrowing is going up and probably going up considerably but not to the level that I faced as a young farmer. This is at a time when there’s been tremendous inflationary pressure on Canadian farmers. Do we need to head for the hills? No, but we need to be aware of the ground shifting underneath us. Sure, it’s done that with regard to our prices, but it’s doing it even more so in terms of the cost of capital and how that might impact us and our decisions in the next year or so. When it comes to taming inflation, sometimes central banks no matter on what side of the border can be fairly ruthless in what they do. That will manifest itself on Canadian farms.

As it is, it’s clear, it’s time for our central banks to fix this inflation problem. It’s almost like me fixing my soybean replant problem, except it’s probably far more complicated.  I’ll have a soybean crop this fall; I’ll make sure of that. However, I have no idea how our economy might look by then.  The Bank of Canada and the US Federal Reserve are surely wondering the same thing.