The Farm Economy Is So Healthy, Some Government Subsidies Go To Millionaires

Includes: CORN, DBA, DE, JJG
by: Duru

In "Why Taxpayers Pay For Farmers' Insurance", Planet Money recently took on the sensitive subject of subsidies to farmers. My sense has always been that these subsidies are more controversial amongst us city slickers. So I took great interest in hearing farmers explain why taxpayers should support their businesses, in this case through farm insurance.

According to Planet Money, most farmers have crop insurance. Eighty-four percent of the crops eligible are covered. The U.S. spends $7B a year to help farmers pay for it, covering about half the premium each farmer pays. The Federal government also supports the private insurance business. The Federal government pays about half of a farmer's crop insurance premium and supports private insurance businesses as well. Specifically:

"The U.S. subsidizes farmers' premiums for multiperil coverage, which protects against a loss of revenue or production due to drought, hail, wind, frost or other natural causes. Private insurers sell and administer the coverage, and the federal government backstops them with payments and reinsurance." (from "S&P warns private crop insurers could face $5B in losses", August 21, 2012)

A new farm bill proposes to expand the program including additional complicated rules about how to calculate assistance.

Planet Money interviewed farmers in Fairbury, Illinois who happen to be millionaires based on their wealth in farmland. According to one farmer, just about each farmer in the room waiting to fill out claims for farmer's insurance is worth millions.

I knew that in just the past few years, land prices have doubled in Iowa. Still, it never dawned on me that soaring land values had created such wealth (on paper of course). Here is the latest data available from the U.S. Department of Agriculture on the value of farmland per acre in the United States since 1929 (excluding Alaska and Hawaii). I did not find data adjusted for inflation, so I only took the graph back to 1970 to show the sharp contrast in the trend starting around 2004.

Average value of U.S. farm real estate per acre

Source: United States Department of Agriculture (USDA), Economic Research Service: Farm Income and Wealth Statistics

Data in constant dollars are available for farm assets, which includes machinery. Data are only available back to 1960, but you can see how the current 20-year run-up in assets matches a similar run-up starting in 1960. This time, debt-to-equity has plummeted to its lowest levels since 1960. Taken together, the data suggest America's farm economy is quite healthy in aggregate.

U.S. Farm Assets vs. Debt-to-equity ratio (1960 - 2010, Forecast for 2011 and 2012) - Constant Dollars: 2005 = 100 GDP)

Source: United States Department of Agriculture (USDA), Economic Research Service: Farm Income and Wealth Statistics

Given this apparent health, why is it that farmers need insurance subsidies, especially millionaires?

When asked whether taxpayers should be subsidizing insurance, here is what one farmer hesitantly had to say (my transcription):

"Oh, I have an aversion to it. But they think they should have. So, you're not going to turn it down. Because society is kind of that way. I don't see that government is going to be less involved in crop insurance."

Another farmer responds:

"I don't know what the right answer to that is…I think it's a good thing that there's a safety net out there, so guys can continue farming when there's a drought like this."

The reporter noted it was hard to find anyone to talk to her on the mic about why taxpayers should subsidize crop insurance.

An insurance agent had this, unsurprisingly, to say:

"The government has always taken care of the farmer since World War II. That's our livelihood. Ours. Yours. When you go to the grocery store…that stuff doesn't just automatically jump on the shelves. Someone has to raise the cattle, hogs, chickens. I mean, that's what you live on….we have to protect the farmer so that they all don't go broke. And that's what the crop insurance is all about."

I am guessing the rich farmer's ambivalence toward the crop insurance program does not just come from their status of wealth, but also that these are guys who likely feel like self-made men. They have built their businesses with their own bare hands and sweaty brows. That is not an image which reconciles well with the agent's characterization of a farm economy so dependent on government support.

Overall, state and federal government assistance is substantial but at least it tends to be counter-cyclical, rising in the bad times and dropping in the good times. The chart below shows that farm income remains well off its all-time highs. Since 1980, farm income has remained relatively stagnant except in the last few years (2011 and 2012 are forecasts). This highlights the special benefits farmers are receiving from land values as truly paper wealth. Regardless, there is certainly enough income here, net of direct payments, to pay for programs to help fellow farmers.

U.S. Farm Net Cash Income versus Direct Government Payments (Constant dollars: 2005 = 100 GDP)

Source: United States Department of Agriculture (USDA), Economic Research Service: Farm Income and Wealth Statistics

So, overall, the U.S. agricultural economy is looking better than it has ever looked. As Deere (NYSE:DE) mentioned in its last earnings call (Seeking Alpha transcripts):

"…farmers entered the year in perhaps the strongest financial condition ever…the financial health of the farm sector is as strong is it has been in modern times."

Investing in the continued success of the agricultural economy makes sense.

In the commodity crash playbook from last summer (long overdue for an update!), the thesis for buying agriculture rested on Jeremy Grantham's conclusion that a changing climate will continue to wreak havoc on an agricultural economy already suffering a decline in productivity relative to fertilizer use. A reversion to the mean in weather was supposed to provide a unique buying opportunity, but Grantham's projections have yet to occur. The drought-induced jump in grain prices is unmistakable. They have helped the PowerShares DB Agriculture (NYSEARCA:DBA) to lift off recent lows.


The U.S. drought has pushed PowerShares DB Agriculture off recent lows

After selling JJG early in the rally, I recently decided to buy long-dated puts on Teucrium Corn (NYSEARCA:CORN) as sort of a hedge that some weather-related event (like a good rain) will cause corn prices to correct in anticipation of better crops in the future.

Teucrium Corn

Source for charts:

Absent a notable change in weather conditions, Deere's assessments point to strong prices for the foreseeable future (I edited the quote from Seeking Alpha transcripts for readability):

"Just a couple of months ago we had a much different business outlook than we have today. At that time we were looking for some softening of food demand against expected large harvest resulting in increasing stocks and softer commodity prices. In fact there was much media discussion about the end of the cycle for agriculture.

Today the business outlook is vastly different as severe disruption in annual production is occurring owing to the most severe drought [in] at least half a century in the US, drought in the Black Sea region, and a diminished monsoon in India along with newly emerging concerns about crop conditions elsewhere. In the foreseeable future the global agriculture plant will be hard pressed to keep pace with demand and replenish stocks to [a] more comfortable level…

…Although this was the largest [corn] crop planted since 1973, production is now forecast to be 13% below last year and the yield of 123.4 bushels per acre is down almost 24 bushels per acre from last year."

Finally, farmers in need of disaster-relief, millionaire or not, appear to be better prepared than ever to handle such calamities:

"…crop and revenue insurance opportunities are much improved and coverage is far more widespread than in any previous calamity and while the livestock sector is very severely impacted in parts of the country, the Congress is expected to provide some kind of disaster package to help ameliorate the distress, and farmers now have available much better crop genetics, machinery, technology and management practices than ever before."

Be careful out there!

Disclosure: I am short CORN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long CORN puts