The Contrarian

“In the investment markets, what everyone knows is usually not worth knowing.”

Return To Disinflation and Deflation?

Until recently analysts have talked about rising inflation, saying that the efforts of the major central banks to eliminate deflation and generate inflation was working. My view was that the rise in inflation numbers may have been just a technical bounce that would not endure. However, there was no way to know for sure.

Since mid-April, the commodity indices have broken down, the rally of the past eight days not withstanding. This excerpt below of an article by analyst Wolf Richter discusses the agricultural sector problems, which are caused by price pressures.

Commodities Bust Hits Farm Lenders, Delinquencies Surge 225%

When it comes to agricultural debt, the numbers aren’t huge enough to take down the global financial system. But this shows how much pain the commodities rout is producing in the farm belt just when the farmland asset bubble that took three decades to create is deflating, and what specialized lenders and the agricultural enterprises they serve – some of them quite large – are currently struggling with in terms of delinquencies.

This is what delinquencies on loans for agricultural production – not including loans for farmland, which we’ll get to in a moment – look like:

From Q4 2014 to Q1 2017, delinquencies have soared by 225% to $1.4 billion, according to the Board of Governors of the Federal Reserve, which just released its report on delinquencies and charge-offs at all banks. This is the highest amount since Q1 2011, as delinquencies were falling after the Financial Crisis. That amount was first breached in Q4 2009.

These were the loans associated with agricultural production. In terms of loans associated with farmland, delinquencies have soared by 80% from Q3 2015 to Q1 2017, reaching $2.15 billion:

Farmland values have surged for three decades but are now in decline in many parts of the US. For example in the district of the Federal Reserve of Chicago (Illinois, Indiana, Iowa, Michigan, and Wisconsin), prices soared since 1986, in some years skyrocketing well into the double-digits, including 22% in 2011, and nearly tripling since 2004. It was the Great Farmland Bubble that had become favorite playground for hedge funds. But starting in 2014, prices have headed south.

This chart from the Chicago Fed’s AgLetter shows farmland prices in its district in two forms, adjusted for inflation (green line) and not adjusted for inflation (blue line):

Adjusted for inflation, farmland prices in the district fell 9.5% over the past three years. The exception is Wisconsin:

         Illinois -11%

         Indiana -7%

         Michigan -12%

         Iowa (since their 2012 peak) -15%

         Wisconsin +4%

The Chicago Fed adds this about the deflating farmland asset bubble, in inflation-adjusted terms:

“Even after three annual declines, the index of inflation-adjusted farmland values for the District was nearly 60% higher in 2016 than its previous peak in 1979.”

Does it mean to say that there is a lot more air to deflate out of the farmland bubble and a lot more pain to come and that this is just the beginning? Or is it saying that this is no big deal?

These falling farmland prices are making the debt much more precarious. So on a nationwide basis, the delinquency rate of farmland loans, according the Fed’s Board of Governors, jumped from 1.46% in Q3 2015 to 2.0% in Q1 2017.

In terms of magnitude of the dollars involved, agricultural and farmland loans pale compared to consumer or commercial loans. So the problems in the farm belt won’t cause the next Global Financial Crisis, and it progresses on its own terms. But it is putting strain on agricultural lenders, growers, and their communities.

Our view:  we are seeing an increasing number of economic sectors going into contraction. Each one is deemed to be too small to cause a systemic problem by the majority of analysts.

It reminds us of February 2007, when the defaults in subprime mortgages were skyrocketing. The Fed chairman, Ben Bernanke, said that the sector was too small to infect the credit markets because only 2.8% of all mortgages were subprime.

At the time, we replied in our WELLINGTON LETTER that he was counting all mortgages of the past 30 years. But subprime were fairly new. Had he counted the percentage of all mortgages made over the prior two years, he might have seen the incredible size of the systemic problem.

Look at the decline of farmland prices. A top in this doesn’t reverse easily, not until after a substantial shakeout. It doesn’t give false signals.

Merrill Lynch research just lowered its year-over-year inflation forecast for end of 2017 from 2.3% to 1.9%. They do good research. Such a revision shows the trend. We believe that downward inflation revisions will continue during the year.

You can read more of our current analysis and forecasts on the global stock markets, bond markets, and global economies in our award-winning WELLINGTON LETTER, now in its 40th year.

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