Research Note
Hancock Agricultural Investment Group
An Assessment of How Current Problems in the Global Economy
Affect the Demand for Food
The historical performance of the agriculture sector suggests investment portfolios could benefit from the addition of
farmland investments. The risk inherent in production agriculture largely differs from the risk in nonagricultural sectors
of the economy and may help diversify investor portfolios. Investors, however, must consider many factors before
adding farmland to a portfolio. The current success of the U.S. farm sector in the wake of an extraordinarily weak global
economy underscores the differences. Portfolio managers have begun asking how recent events, such as the Eurozone
debt problem and the U.S. financial crisis, will affect global food demand and U.S. farmland investments.
A few facts are in order before addressing this question. First, the U.S. agriculture sector generates a trade surplus.
Second, the historically strong relationship between agricultural exports and farm income suggests future profitability in
the agricultural sector depends upon future foreign demand. Third, the current structure of production agriculture in the
U.S. has a strong export orientation. For example, from 2000 to 2010, the U.S. sold on average approximately 70 percent
of its cotton, 50 percent of its wheat and rice, 40 percent of its soybeans, and 18 percent of its corn to foreign buyers.
Lastly, the expectation of future agricultural exports influences the current performance of farmland investments because
the future return investors expect to earn from land in production determines the current price of farmland. Thus, the
U.S. agriculture sector has a vested interest in the strength of the global economy. This research brief provides a short-,
medium-, and long-term outlook for the U.S. agriculture sector in the wake of recent economic events and examines how
global economic events will likely affect the demand for food, and thus, the performance of institutional investments in
U.S. farmland.
Short-term Outlook
At first glance, the demand for U.S. agricultural exports in the short-term appears puzzling. The Federal Reserve asserts
its commitment to maintain an expansionary monetary policy until the middle of 2013, which will suppress the value of
the dollar for the duration of the short-term. The historically low value of the dollar helps support the historically high
demand for U.S. agricultural exports. Furthermore, forecasts of slower growth in China and other emerging markets
could weaken the demand for U.S. exports. A reduction in foreign demand, given slow domestic growth, high domestic
unemployment, persistent deficit spending, and previous bouts of quantitative easing in the U.S., could further deflate the
U.S. dollar. The value of U.S. agricultural exports, in U.S. dollars, should rise if the deflating U.S. currency compensates
foreign consumers for any reduction in income that results from slower economic growth.
The sovereign debt problems in Europe, however, somewhat counters the deflating effects because risk-averse investors
view the U.S. economy as a safer haven and have begun acquiring U.S. denominated assets. An increase in the demand
for U.S. assets raises the demand for U.S. dollars and strengthens the relative position of the U.S. currency. Thus, the
relative strength of the dollar should fall after global risk subsides.
An intact Eurozone helps the prospect of economic growth in China because Europe is the destination for over 20 percent
of Chinese exports. In 2010, China surpassed Canada to become the largest destination for U.S. agricultural exports
(FATUS). Continual economic growth in China, therefore, enhances the outlook for U.S. agricultural exports and
supports the price of U.S. farmland.
(Continued on page 2)
Hancock Agricultural Investment Group Research Note
An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 1)
Fiscal policy will also affect the U.S. farm economy in the short-term. The current Farm Bill expires in October
2012. The consensus among industry leaders suggests policy makers will reduce support for biofuel production in
the next Farm Bill. The Renewable Fuel Standard requires refiners to use a certain amount of ethanol to reduce
dependence on foreign oil. Research suggests the 13 billion gallons of ethanol production in the U.S. in 2010
translates into 445 million fewer barrels of oil imports. The U.S. spent $34 billion less on foreign oil because of
domestic ethanol production (Dinneen).
Currently, a 2.5 percent ad valorem tariff and a $0.54 per gallon duty on ethanol imports exist to help blenders meet
the Renewable Fuel Standard mandate. Ethanol blenders also receive a tax credit of $0.45 per gallon and biodiesel
blenders receive a $1.00 tax credit per gallon. The tariff and tax-credits expire on December 31, 2011 and their
reinstatement is uncertain.
The reduction in fiscal support will adversely affect the U.S. farm sector. Economists, however, have yet to agree on
the extent of the affect. Babcock (2011) suggests that without the ethanol tax credit in 2011 the price of corn would
drop from $6.11 per bushel to $5.68 per bushel, and without the tax credit and the ethanol mandate in 2011, the price
would be $5.09 per bushel. Babcock (2011) also found that eliminating the biofuel mandate and tax credit would
reduce the price of soybean oil 16 percent (approximately $0.09 per pound). Soybean prices, however, would only
drop 3.2 percent because the high demand for soybean meal would absorb the excess supply of soybeans that results
from the lower price of soybean oil. Finally, Babcock (2011) notes the import duty and ad valorem tariff have no
binding impact on corn prices because transportation costs and the price of ethanol in Brazil exceeds the market
price of U.S. ethanol.
A continuation of the current low interest rate environment should maintain or increase agricultural exports in the
short-term. Despite a potential reduction in fiscal support, strong agricultural exports will support farm income
levels, and should maintain or increase the aggregate price of U.S. farmland in the short-term.
Factors Affecting the Short-term Outlook of U.S. Farmland Prices (1-2 Years)
+
+
Eurozone breakup
Additional large-scale austerity measures in the Eurozone
Economic slowdown in China
Elimination of biofuel tax credits
Monetary policy maintains a near zero federal funds rate
Further monetary policy suppresses the relative value of the U.S. dollar
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An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 2)
Medium-term Outlook
Given long-term austerity measures underway in the Eurozone and the state of the U.S. economy, many investors
find the growth prospects of emerging markets compelling. In the absence of changes in real exchange rates, the
demand for U.S. agricultural exports will rise as emerging market growth resumes. Emerging market economies
continue to support development of a middle class, which should consume more agricultural products. The mediumterm outlook appears especially promising for U.S. agriculture because a further weakening of the dollar, as a result
of a global reduction in risk, should increase the relative purchasing power of foreign currency, particularly the
Chinese renminbi.
Risks in the medium term include a bout of inflation in the U.S. and continual problems in the Eurozone. Inflation
reduces the real interest rate, which lowers the rate at which landowners discount future farm income. A lower
discount rate effectively increases the present value of farmland. Inflation could also cause producers to adjust farm
operations if the cost of production does not uniformly rise or the input-cost to output-price spread does not remain
equal across commodities. If the Federal Reserve decides to combat inflation by reducing the money supply, then
the resultant higher real interest rate would lower the present value of farmland. A higher real interest rate would
also increase the demand for U.S. capital assets, strengthen the U.S. dollar, and reduce the demand for U.S.
agricultural exports.
Continual problems in Europe could also alter the medium-term outlook. A breakup of the Eurozone or further
large-scale austerity measures should only have a slight direct effect on the U.S. agricultural sector because the
Eurozone members import a small portion of U.S. agricultural exports. Nevertheless, the potential indirect effects
could hinder the U.S. farm economy because over 28 percent of the value of E.U. imports comes from emerging
markets. If the E.U. imports less from emerging markets, then emerging markets will import less from the U.S.
Factors Affecting the Medium-term Outlook of U.S. Farmland Prices (3-5 Years)
- The Federal Reserve Bank raises the real interest rate to combat inflation
- Eurozone breakup
+
Inflation reduces the real interest rate
+
Global risk subsides
+
Economic growth in emerging markets and lessor developing countries increases demand
+
Trade negotiations enable U.S. agriculture exports to penetrate new markets
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An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 3)
Long-term Outlook
Persistent deficit spending and mounting government debt puts downward pressure on the value of the dollar and
decreases the cost of U.S. agricultural exports for foreign consumers. The association between government debt and
the strength of the U.S. dollar, however, has not been an overriding factor driving expectations of long-term
agricultural export growth. Instead, the long-run outlook largely depends on the wealth of low- and middle-income
nations, and on the productivity of foreign agriculture producers.
Long-term Demand Considerations
Seven billion people currently inhabit the earth and the World Bank estimates the number will rise to 9.2 billion by
2050. The Food and Agriculture Organization of the United Nations recently undertook a global assessment of land
and water resources to analyze threats to food security and sustainable development. The results suggest agricultural
producers must increase global food production 70 percent to meet the future demand for food. Specifically,
producers must generate an additional 1.1 billion tons of cereals and 221 million tons of livestock products. The world
will require approximately 4.78 billion tons of cereals and 1.13 billion tons of livestock products in 2050 (FAO).
The trajectory of the demand for food largely depends on the wealth and number of consumers in developing
countries. Consumers in low- and middle-income countries spend a higher proportion of their income on food relative
to consumers in high-income countries. An increase in income will cause all consumers to spend more money on food
regardless of their income. The share of income spent on food falls, however, as people become wealthier. For
example, Muhammad et al. (2011) found the average consumer in India, China, and Russia spends, respectively, 38.8,
37.3, and 22.0 percent of their income on food and beverages. The average American consumer spends only 5.7
percent.
Consumers in low and middle-income countries will also change the composition of their diet as their incomes rise.
For example, Muhammad et al. (2011) found that if food expenditures increase by a dollar then meat consumption in
low-, middle-, and high-income countries will increase 0.77, 0.64, and 0.02 percent respectively. Cereal consumption,
however, only increases 0.51, 0.25, and 0.02 percent respectively. The results from the study emphasize how growth
in lower- and middle-income countries greatly increases the demand for food.
China stands as an excellent example of how income growth propels the demand for food. The average diet of a
Chinese consumer became more resource intensive because of a rapid growth in real income. For example, the real
gross domestic product per capita rose from $1,152 in 2000 to $2,802 in 2010. During the same period, the Foreign
Agricultural Service reports pork consumption per capita in China rose 25 percent. China now requires a fourth of the
global soybean production partly because one pound of pork requires 2.8 pounds of feed. Figure 1 depicts how the
growing number of increasingly affluent Chinese consumers altered the structure of U.S. agricultural exports. The
value of U.S. agricultural sector production headed for foreign markets has risen from 23.47 percent in 2000 to 32.88
percent in 2010, and China accounts for a large portion of the export growth. The share of total U.S. agricultural
production imported by China rose from 0.8 percent to 5 percent during the same period.
While China remains the primary catalyst of growth for U.S. agricultural exports, other opportunities exist. The U.S.
continues to negotiate a Trans-Pacific Partnership with Australia, Brunei Darussalam, Chile, Malaysia, New Zealand,
Peru, Singapore, and Vietnam, although the U.S. already has bilateral trade agreements with Australia and Chile. In
2011 the U.S. also ratified bilateral trade agreements with Colombia, Korea, and Panama.
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An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 4)
Economic growth in India would greatly enhance the outlook of the U.S. farm sector. Although the population growth
rate in India exceeds the growth rate in China, India currently restricts trade in agricultural goods to protect its large
population of rural farmers. In the long-term, the prospects of export-led economic growth should compel India to
reduce these restrictions.
Long-term Supply Considerations
Weak legal, political, and economic institutions in emerging markets and developing economies limit, among other
things, the direct transfer of U.S. technologies and production practices. Additionally, the higher cost of capital
reduces the return on investments. The high cost of capital and the inability to replicate U.S. crop yields and output
reduces the profitability of foreign farmland investments. The inability to replicate profitability reduces the incentive
to bring new farmland into production.
Replication would not pose a problem if every country in the world had institutions similar to the United States. For
example, suppose an increase in demand increases the price of a commodity. With equal institutions, farmland owners
across the world would bid the higher commodity price into the price of farmland if the owners expect the demand to
endure. The higher price of farmland would encourage people to bring more farmland into production. The additional
output from the new farmland would increase the available supply and lead to a reduction in commodity price.
Farmland owners would bid the lower price of the commodity into the price of land.
In reality, institutional risk prevents many people from bringing new farmland outside of developed countries into
production. Investors require a higher rate of return for operating in environments with weak political, legal, and
economic institutions. In some environments, the return an investor expects to earn from a farmland investment
simply does not exceed the required risk premium. For example, Brazil made significant advances in the production
of, among other commodities, sugar, orange juice, and soybeans. Corruption in the country, however, recently led to
the resignation of the Brazilian ministers of agriculture, sport, tourism, labor, and transport. According to the World
Bank (2011), Brazil ranks 118 out of 183 countries in ease of enforcing contracts and 126 out of 183 in ease of doing
business.
In other environments, institutions do not allow the markets to determine the efficient allocation of productive
resources. For example, the Chinese government prevents private ownership of farmland. Among other factors, weak
property rights and poor access to rural credit discourage investment, prevent farm consolidation, and inhibit the
expansion of farmland supply in many foreign countries.
Weak institutions present a challenge for emerging market and developing economies. The strength of the U.S. legal
system, the historical performance of the U.S. economy, the stability of the U.S. political environment, and the
infrastructure supporting the marketing and transporting of U.S. agriculture goods reduces the cost of transacting in
the U.S. relative to other countries. The strength of its institutions will continue to provide a competitive advantage to
U.S. producers throughout the long-term.
Factors Affecting the Long-term Outlook of U.S. Farmland Prices (Beyond 6 Years)
+
Foreign institutions facilitate productivity and expand the area under produciton
Economic growth in emerging markets and developing countries increases demand
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An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 5)
Conclusion
The current success of the U.S. farmland investments in the wake of an extraordinarily weak global outlook
underscores the difference between the agricultural and nonagricultural sectors of the U.S. economy. The future
performance of farmland investments depend on many interrelated factors. The government led effort to reduce
foreign oil consumption could soon change, which would reduce the demand for ethanol and potentially decrease the
price of corn and soybeans. Inflation could compel the Federal Reserve to increase its policy rate, which would raise
real interest rates and exert downward pressure on the price of farmland. Of the many factors upon which the price of
farmland depends, the growing demand for food by consumers in emerging market economies provides the most
stabilizing long-term effect. The strength of institutions in the U.S. should continue to provide U.S. farmland
investors with appealing risk-adjusted returns.
Figure 1. Top U.S. Agricultural Export Destinations: Billions of U.S. dollars from 1989-2010
$80
China
Canada
EU-27
Japan
Mexico
S. Korea
$60
$40
$20
$0
1989
1992
1995
1998
2001
2004
2007
2010
Source: FATUS
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An Assessment of How Problems in the Global Economy Affect the Demand for Food (Continued from page 6)
Citations
Babcock, Bruce (2011) “The Impact of US Biofuel Policies on Agricultural Price Levels and Volatility,” International
Centre for Trade and Sustainable Development
http://www.ictsd.org/downloads/2011/12/the-impact-of-us-biofuel-policies-on-agricultural-price-levels-andvolatility.pdf
Dinneen, Bob (2011) “Testimony before the Energy and Natural Resources Committee,” United States Senate
http://www.energy.senate.gov/public/_files/DineenTestimonyRFA.pdf
FAO (2011) “The State of the World's Land and Water Resources for Food and Agriculture,” Food and Agriculture
Organization of the United Nations
www.fao.org/docrep/015/i1688e/i1688e00.pdf
FATUS (2011) “Top 15 U.S. Agricultural Export Destinations, by Calendar Year, U.S. Value,” Foreign Agricultural
Trade of the United States
http://www.ers.usda.gov/data/fatus/DATA/Xcytop15.xls
Muhammad, Andrew, James L. Seale, Jr., Birgit Meade, and Anita Regmi (2011) “International Evidence on Food
Consumption Patterns: An Update Using 2005 International Comparison Program Data,” United States
Department of Agriculture Technical Bulletin
http://www.ers.usda.gov/Publications/TB1929/TB1929.pdf
World Bank (2011) “Economic Profile: Brazil,” Doing Business 2012, A Co-publication of The World Bank and the
International Finance Corporation
http://www.doingbusiness.org/~/media/FPDKM/Doing%20Business/Documents/Profiles/Country/BRA.pdf
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