Road Warrior

Surprise from the Federal Reserve

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The announcement last week by the Federal Reserve’s Federal Open Market Committee (FOMC) of quantitative easing part three (QE3) came as a surprise to me and many others. I was attending a bank advisory board meeting made up of management and leading agricultural industry players, and when the announcement was made, groans were heard throughout the room.

The Federal Reserve will purchase $40 billion/month in mortgage-backed securities. The FOMC implied that it would maintain exceptionally low interest rates until mid-2015, an increase of six months from their prior forecast of December 2014. This accommodative action was designed to kickstart the economy and drive down the unemployment rate, which has been above 8% for the longest duration ever recorded. The current unemployment rate is 8.1%, or a U-6 rate of 14.8%, which includes discouraged workers and people who have given up on joining the workforce. Also, the labor force participation rate for men is now historically the lowest ever.

The printing presses at the Federal Reserve are alive and well. The key to the FOMC’s announcement was saying that this strategy will continue until the economy improves. The open-ended nature of the stimulus raises signals that the United States economy is in difficulty, thus requiring drastic action.

Implications to agricultural producers are that high commodity prices should continue strong, similar to the results of the two other stimulus strategies, QE1 and QE2. Those in the grain, oil and mineral businesses have benefited tremendously from the stimulus; however, their brethren on the livestock side are really experiencing margin squeeze, which has caused a reduction in the size of that component of the agricultural industry.

The stimulus strategy has been “sugar candy” to the stock, commodity and farmland markets creating rapidly increasing headline inflation, which includes food and energy. The dollar is losing value to other major worldwide currencies, which reduces buying power of those in the United States. Another part of the QE3 strategy is to encourage investors, who have $15 trillion in cash or near term cash or money market assets, to invest in the marketplace. Interestingly enough, Europe unleashed its stimulus, and China is utilizing this strategy as well to stimulate its economy, so this is a worldwide stimulus strategy.

Does the Federal Reserve have an exit plan and will it be transparent? Second, will this stimulus create demand destruction as commodities become too highly priced? Third, will investors place more money in short term and cash assets as uncertainty skyrockets concerning the strategy? Only time will tell, and if this strategy backfires, inflation and decline in standard of living in debt-ridden countries could be the outcome.

P.S.: Too much financial leverage on the balance sheet – whether business, personal or government debt – generally leads to problems. Just remember the following examples: Lehman Brothers, Fannie and Freddie (the secondary markets for housing), the housing bubble, the Savings and Loan Crisis, the Farm Crisis and even the Great Depression.

There are only three ways out: Grow the economy, incomes or business; default; or in the government’s case, print money, which reduces buying power.

 

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.

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Dave Kohl is an ag economist specializing in business management and ag finance. He can be reached at sullylab@vt.edu.

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