With my hectic travel schedule, I am a Weather Channel fan because it allows me to avoid some weather challenges, particularly with airlines. One of my favorite series is “It Could Happen Tomorrow” — a worst-case scenario when weather events combine to create disaster.
If you turn to the economy, it appears the disaster is happening today. For many of you who follow my column or have listened to me speak, I have discussed the probabilities of a code green, code yellow and code red in the economy, with code red being the potential disaster.
CODE GREEN: In today's economic forecast, the best that can be expected is a “recession lite,” which at this time has a 30% probability of occurring. To stabilize the economy, oil prices have to stay below $75/barrel, housing starts by next spring would increase to 1.2-1.5 million and jobless rates and unemployment rate must stabilize.
CODE YELLOW: The probability of a type of recession like we had in 1973-1974 and 1980-1981 is 40-50%. Signs of this type of downturn would include housing starts below 1 million, an unemployment rate of 7-9% and a global recession. The economic cards point in this direction.
CODE RED: This scenario is the category five economic hurricane or the F-5 economic tornado. Here are the scenarios to watch play out over the next six months:
A major global economic recession.
A decline in the Dow Jones Industrial Index to 6,000-6,500 and other worldwide markets following suit.
Falling confidence in the euro and the appreciation in the dollar to par or exceed the euro.
Oil near $100/barrel or above.
Housing starts declining to 750,000.
Unemployment rate exceeding 10%.
High nominal and real interest rates persisting.
A black swan or unexplained event taking place.
What is the probability of a code red scenario? Well, it is much higher than six months ago when I indicated it would be 10%. You do the math based upon the other scenarios. This would be the 9-11 and Katrina of the economy in the U.S. and worldwide. Let's hope it's not happening today.
These economic times have even the strongest financially positioned producers concerned about the future. Recent calls and e-mails support this contention. Let's dig a little deeper and examine some possible weak links.
Aggressive producers who have used profits, working capital and cash flow to expand operations by rental or purchase of land or a major capital expansion could potentially face tough times. These individuals have used valuable cash that may be needed if working capital lines become more difficult to obtain as some agrilenders re-evaluate their growth expectations.
One only has to look at how quickly liquidity and cash have dried up or become locked up in the domestic and global economies to see how this can bring some of the best-operated businesses to their financial knees.
Another strategy centers on tax management. That is, tax benefits for this year on capital purchases may lead to a three- or five-year borrowing obligation. These monies will most likely be paid back in times of tighter margins and reduced cash flow.
Others may suffer when input costs are prepaid to a supplier or market contracts are not fulfilled, resulting in losses as an unsecured creditor or having a crop or commodity not paid for.
Now is the time to build up your cash reserves and a strong balance sheet to weather the storm.
Dave Kohl, PhD., Corn & Soybean Digest trends editor, is professor emeritus at Virginia Tech. He's published four books and over 500 articles on financial and business topics. You can reach him at sullylab@vt.edu.