There has been a lot of discussion in the past few months about the potential rise in interest rates.
As of now, that’s all it’s been, a discussion, as interest rates continue to hover at historical lows.
It is important to keep in mind that familiar warning signs indicate that this could change.
I recently attended a conference in the United States where five economists presented their thoughts on the economy.
Admittedly, the discussion was focused on the U.S., but our economies are related closely enough that it warrants our attention.
Read Also
Saskatchewan agriculture sector receives federal funding
PrairiesCan funding will assist in the continued growth of Saskatchewan’s ag research and manufacturing sectors.
There is a saying that you could line up all the economists in the world and they still would not reach a conclusion. However, during this conference, they all agreed on one thing – interest rates will rise significantly.
They did not agree on when this will happen, ranging in their predictions from 18 months to three years, nor did they agree on the severity or the duration. The range for the rate peak was nine to 11 percent.
One of the economists quoted Alan Greenspan as predicting 12
to 15 percent interest rates within three to five years.
The prediction didn’t deal with how long they would remain at those levels; only that they will be high enough to correct imbalances in the economy.
Warning signs
It is not possible to predict the future with certainty. All we know is the history of events and outcomes of similar circumstances.
In the past, periods of recession have been followed by inflationary periods. When governments spend money to break the recession, as is the case now, historically it sparks inflation followed by higher interest rates.
The degree of inflation is variable, depending on the
severity of the recession and the amount of government
intervention required to stimulate the economy.
Government is limited in what it can do to manage the inflationary pressures. One tactic is to use interest rates to manage the demand for capital that correlates to periods of inflation.
One economist talked about two types of inflation:
* Demand pull, where interest rates increase due to consumer spending.
* Cost push, where interest rates increase due to cost increases.
He noted that the last period of cost-push inflation was in the 1980s and we know how high interest rates climbed then.
Another economist warned that the world may stop buying U.S. treasuries. The U.S. dollar can provide forewarning as to the likelihood of this occurring.
As the rest of the world starts to come out of the recession and investors gain confidence in the recoveries, the world will begin to invest outside the safe haven of U.S. treasuries if the U.S. cannot report the same performance. This will cause the U.S. dollar to decrease in value and the U.S. would be forced to increase interest rates to prop up the dollar and attract investment.
Conclusions and forecasts from the presentations include:
* Higher cost structures and greater variability.
* Higher inflation.
* Higher interest rates.
* Changes within the business environment, including an increase in operating risk of business for farmers.
What a farmer can do
Working from the premise that you control what you can control, managing costs should be a priority, including interest expense.
For a long time, farmers have not had to focus a lot of management attention on interest costs, but higher operating risk should force you to reduce the amount you are leveraged and your interest expense.
It is easier to leverage up than it is to de-leverage. In a scenario where interest rates increase to 12 percent and farmers find themselves unable to sustain positive cash flow, will they be able to restructure their debt?
Farmers will be well-advised to pick a worst-case interest rate scenario and:
* Calculate the impact of the higher rates on cash flow.
* Calculate debt servicing ability with the higher rates.
* Determine the likelihood of being able to restructure current debt.
Give consideration to equity being available for security and historical earnings to support higher-term debt repayment requirements with the restructuring.
Terry Betker is a partner with Meyers Norris Penny LLP, working out of the Winnipeg office. He is director of practice development in agriculture, government and industry. He can be reached at 204-782-8200.
