Economic Update From The Bayou

I just returned from my seventeenth year teaching at the Graduate School of Banking at LSU. This year the school had over 600 bankers enrolled with over 200 graduates. I taught the rural and agricultural credit class; however, I attended Dr. Ed Seifried’s class on macroeconomics. I have not missed his class in 15 years and always come away impressed by how he can bring complex economic data down to the firm level to help in decision making.

The following are some of his thoughts from this year’s class:

Since 1984, Gross Domestic Product volatility in the U.S. is down 60% from previous times. This economic stability is the result of:

· U.S. investment in technology, education and infrastructure, which has resulted in productivity.

· Businesses stressing best management practices and constantly innovating to improve productivity.

· Strong monetary policy, particularly with Chairmen Volcker and Greenspan’s objective of keeping inflation under control. The difference between second and third world countries and first world countries is their ability to keep inflation under control.

· Better management control techniques that have led to reduced production volatility. In the past this volatility was represented by the overproduction of cars followed by layoffs of workers, etc.

Dr. Seifried indicated that these factors created an economic shield that has allowed the U.S. economy to take some hits (terrorists, Katrina, oil) without placing us in a recession.

Now, let’s examine some hits to the shield that could throw the economy off track.

Hits To The Economic Shield

First and foremost would be inflation. Last month’s report from the Federal Reserve minutes had a stronger bias toward inflation. This potential means that the Fed Funds rate could be increased to 5.75% by year end, which would equate to an 8.75% prime rate. These interest rate increases, if not properly measured, could result in an over-correction and stalling of the U.S. economy. The old rule of thumb is that for every one percent increase in core inflation rate, that Federal Reserve generally raises the Fed Funds rate by 1.5%.

A rise in long-term interest rates is another potential challenge. Long-term interest rates have been low because of the U.S. Federal trade deficit. Dollars that were traded overseas have been returned and invested into mortgage backed securities and T-Bills. However, if foreign central banks and investors decide to boycott the U.S., long term interest and bond rates would rise by 1.5%. Many of you reading this column would say, “That’s not much.” However in a globally competitive “world is flat” economy, a 1.5% rise in rates would be analogous to 15-20% rates in the early 1980s when margin and competition was not as intense.

The rise in long-term rates would reduce the bubble in real estate, which in turn could slow consumer spending. Thus, inflation and interest rates are two shots to the shield that could take the wind out of the U.S. economy and the air out of farm real estate.

The Road Warrior of Agriculture

My e-mail address is:

sullylab@vt.edu

Editors' note: Dave Kohl, The Corn and 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.

To see Dave Kohl's previous road warrior adventures type Dave Kohl in the Search blank at the top of the page.

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