Interested in Interest?

Farming is capital intensive! There is no way around it. Just like nearly every other product in our economy, farm input prices have increased drastically in the past few years. Most farms of even modest size cannot produce their products each season without some help from a financial institution. The majority of expenses occur during the spring and early summer, while the income is often delayed until fall or winter. While some are able to self-finance their expenses, this is not reality for most farms. The solution is typically an operating loan. This is a short term loan (usually one year) with interest rates tied to the rates set by the Federal Reserve. As rates have risen the past several months, operating loan rates have risen in kind.

While meat and feed sales that are distributed throughout the year have drastically reduced my need for operating capital for farm inputs, I still maintain an open line of credit in case I need it. In the mail yesterday was my latest rate increase notice. The new rate for my operating loan, should I need to use it, will be 8.8%. For reference, it was 4% last year.

Four percent doesn't sound unmanageable, and I hope it has little impact on my farming personally, but it will have an impact on the farming sector as a whole. The median grain farm in the US is around 1,000 acres. According to the University of Illinois, the cost of inputs for an acre of corn was $785 in 2022. This equates to input costs totaling $785,000! If the entire operating cost were financed, the interest payment alone would be nearly $70,000. This is equivalent to the average household income in America, and more than $35,000 increase over last growing season. This increased interest payment comes directly from the expected profit of the farmer. The farm in this scenario will be effectively taking a $35,000 pay cut for the upcoming season without even knowing what their income will be.

Aside from input costs, many farm improvements such as machinery, buildings and grain bins are financed with short-term loans that are variable rate. Interest rate hikes will increase the cost of existing loans of this type, as well as potentially delaying future equipment and building improvements.

Farmers are particularly vulnerable to interest rate increases since they are generally at the mercy of the market when it is time to sell their product. Unlike many businesses, which can simply raise prices to absorb increased interest costs (or any other cost), traditional farmers have no mechanism to arbitrarily increase the price of their products.

"Here is a concept which strikes to the heart of the farmer's problem. It does not concern itself directly or solely with prices - with what the farmer receives - but with his net income, his return, the only figure which is meaningful in determining his standard of living, particularly in this age of the cost-price squeeze. For the farmer, is the only man in our economy who has to buy everything he buys at retail - sell everything he sells at wholesale - and pay the freight both ways."

-John F. Kennedy, campaign speech 9/22/60

There are mechanisms in place to protect the farmer to an extent from price vulnerability which are outside the scope of this article (forward pricing, puts, calls, etc.), but farmers cannot force the market to increase price levels to profitable levels for their particular farm. If the market tanks due to global political issues or some other factor beyond control of the farmer, their potential income will be lowered. However, their costs, including interest, are already set.

Furthermore, farmers are also at the mercy of the weather. It takes favorable growing conditions for crops to maximize their potential yields. Once more, the costs are already committed before the final outcome is clear.

This is particularly important in fringe areas like Kentucky. While there are large farms in Kentucky, the state does not represent a large enough percentage of the total US production for a drought or other yield reducing weather event to have much impact on the market price. A large portion of our state could experience poor yields without forcing the market to increase market bids based on projected supply shortages.

Farming is a bit like casino gambling. The farmer makes his bet each spring when he decides to plant his crops, and then rolls the dice. If prices drop too low, he loses. If costs increase too high, he loses. If the weather negatively impacts his yields too much, he loses.

Interest rate increases are just one more way to lose. Unlike fertilizer, feed or equipment costs, interest costs provide no benefit to the farming operation, but it is a cost that must be paid simply to play the game.

*The above article touches on the fundamental reason our farm has shifted our focus from commodity products, like grains and feeder calves, to retail products such as meats and feeds. My income and need for revolving credit is stabilized by year-round sales and profitability is far less impacted by market forces beyond my control. It's customers like you that make this delicate process work.