Economic policy has focused on the dangers of inflation in recent decades. But lately, economic policy makers have begun to talk about a new worry — deflation.

Deflation is inflation's opposite. With inflation, prices rise. With deflation, they fall. The danger deflation poses for agriculture is especially severe because farm commodity prices tend to fall faster than the prices of other goods and services. That makes it harder for farmers to pay for inputs such as fuel and fertilizer. Falling prices also make it harder to cover fixed costs, such as land mortgages.

In the 20th century, severe bouts of deflation struck agriculture twice — during the Great Depression when the entire economy suffered falling prices, and again in the 1980s, when deflation was largely confined to agriculture. In each case farm prices and the value of farmland plunged.

To date, economists say the odds of deflation hitting agriculture are slight. But there are four developments that prompt concern.

  1. Inflation has all but disappeared.

  2. Federal Reserve Chairman Alan Greenspan has issued two recent warnings that deflation could occur.

  3. Prices in some sectors of the economy have been falling, including computers, automobiles and consumer electronics.

  4. Japan's economy, the world's second largest, is already mired in deflation.

“The Japanese have been struggling with deflation for 10 years, and that's one reason why economists in the U.S. are worried about it,” says Virginia Tech economist David Orden.

Should deflation strike, no one can say how long it could last. In the past, deflation has lingered for a decade or more. Moreover, the U.S. has already used up many of the tools normally employed to combat falling prices. Those tools — cuts in interest rates, tax cuts and deficit spending — have so far failed to ignite a broad economic recovery, which could halt sliding prices.

However, farm commodity prices are still strong. Even if they were to fall, the 2002 Farm Bill provides a safety net.

“Given that the farm program doesn't change, farmers are 100% insulated from drops in prices,” says Bruce Babcock, director of the Center for Agricultural and Rural Development, Iowa State University.

The farm program is likely safe for now with presidential and congressional elections a year away. But if farm commodity prices plunge, the Farm Bill would become much more expensive, adding to record federal deficits. If it becomes too expensive, at some point, “Congress can revise the Farm Bill,” says Philip Paarlberg, an ag economist at Purdue University. For example, he says Congress could reduce deficiency payments.

Cuts in the Farm Bill could have a ricochet effect, since land prices rise and fall in tandem with farm income. Falling land prices can cause two other problems. If land is worthless, it has less collateral value for a bank loan. In other words, you can't borrow as much money. Land can also become harder to sell as it falls in value. “In the early 1980s, when land prices fell 20-40%, there was no market for land,” Paarlberg says.

Should deflation and recession spread globally, farmers would face another problem. Exports would likely plunge. That, in turn, would push commodity prices lower, adding to the cost of the Farm Bill, says Virginia Tech's Orden.

How To Prepare For Deflation

Farmers can't stop deflation, but they can take three advance steps to minimize damage to their operation if deflation does strike, says Philip Paarlberg, ag economist at Purdue University. The steps are:

  1. Find ways to cut day-to-day expenses for items such as fuel, labor and irrigation costs.

  2. Reduce fixed costs. These include taxes, and interest and principal payments on short- and long-term debt. These must be paid even if prices fall. The lower they are, the easier they are to pay.

  3. Don't take on unnecessary new debt for land and equipment. If deflation strikes, says Paarlberg, you might not be able to cover the new debts and lose the farm. “That's what happened to a lot of people in the 1980s. They paid high prices for land at high interest rates. When farm prices fell, they couldn't make the payments.”