Inflation erodes asset value. Marlon Norling, a lender at First Interstate Bank, who has witnessed the effects of inflation and interest rates throughout his professional life fills us in.
Inflation in ranching with Marlon
Marlon was a young man growing up on a farm in Southeast South Dakota. He entered the lending business in 1980, a time of high inflation. During this period, assets, such as land and commodities, were increasing in value. Interest rates were relatively reasonable, hovering around 7-8%. However, the situation changed drastically in 1983 when the government decided to prioritize fighting inflation. Interest rates began to rise, and commodity prices declined. Farmers and ranchers faced challenges in meeting loan repayments, and collateral values suffered.
Marlon emphasizes that inflation erodes asset value. While the numerical value of assets may increase due to inflation, their real value diminishes. He gives the example of a 40-20 tractor that sold for $15,000 in 1973. Although the same model may still sell for the same amount today, its purchasing power has significantly decreased over the years. Inflation has devalued the asset, making it less valuable in terms of what it can buy.
This highlights the negative impact of inflation on asset value. As inflation increases, the purchasing power of money decreases, making it more difficult for individuals and businesses to maintain the same level of wealth and financial stability. While inflation may lead to a temporary increase in asset prices, the long-term effects can be detrimental.
Inflation and rising costs explained
Inflation and rising costs are topics of concern for businesses and individuals alike. As the price of goods and services increases, the value per dollar decreases. This is a fundamental concept of inflation, where the purchasing power of money diminishes over time. Many businesses are raising their prices due to higher input costs. They attribute this to factors such as increased demand after the COVID-19 pandemic and the injection of money into the economy through programs like the CARES Act.
The impact of reduced production during the pandemic on inflation was huge. With supply chain disruptions and decreased output, the availability of certain goods and services declined, leading to higher prices. The Federal Reserve can raise interest rates to discourage borrowing and spending, thereby reducing inflationary pressures.
The agricultural sector, specifically the cow-calf industry, is an example of how rising costs affect businesses. The high prices of corn impacts the cost of feed for cattle. Drought conditions have led to higher hay prices and reduced yields. These factors, combined with increased diesel prices, create a challenging environment for ranchers.
Young operators and those with low debt may find opportunities to start or expand their businesses at lower prices. They draw parallels to the 1980s when some individuals were able to purchase land and equipment at bargain prices due to economic hardships.
While there is no definitive answer, we suggest that businesses should consider their inputs and ensure that their costs are accounted for. Also note that inflation can benefit landowners, as the value of their land tends to increase over time. Similarly, the value of cows can also rise with inflation, although it is largely dependent on the value of their calves.
Interest rates and business decisions
Consider interest rates when making financial projections and planning for the future. Stress testing various scenarios, including higher interest rates, can be beneficial to assess the viability of business operations.
We caution against falling into a trap where businesses have to sell land to cover losses, resulting in capital gains tax obligations. This highlights the need for careful financial management and the potential consequences of failing to make loan payments.
While current interest rates may seem low in comparison, it is essential to consider the relative impact on individual businesses. We also need to question the long-term effects of low interest rates and advocate for a more predictable and steady economic environment.
Don't panic, plan and adapt
This is just another opportunity to address and overcome these challenges. The focus should not solely be on what is produced, but rather on how much is left after all expenses are accounted for. This highlights the importance of managing costs and maximizing profitability.
The discussion then delves into the topic of cattle farming, using it as an analogy for business operations. Smaller and more cost-effective calves were historically more profitable than larger and more expensive ones. This serves as a reminder to businesses to evaluate their strategies and consider alternative approaches that may be more efficient and profitable.
The importance of analyzing and understanding market trends is emphasized. Observe what others are doing and consider doing the opposite if it proves to be more beneficial. This highlights the significance of staying informed and adapting to changing circumstances in order to stay ahead of the competition.
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