The opportunity to make significant changes in US farm policy will likely be squandered, more of the same the most likely outcome.

Implications: It appears that Congress may, yet again, renew many of the provisions in the 2002 program…pushing the issue of true reforms to be  played out in the courts of the WTO.  The US will eventually be forced to "level the playing field" on these issues, and it may be forced on the farm sector at a time when is will be much harder to swallow. Drop Direct Payments, they serve no purpose Drop Marketing Loans & LDP's, they disrupt market signals and rotations Put More Money into Counter-Cyclical Payments, they provide income stability to ag producers, and the entire ag sector, but don’t add much market signal distortion. Forget About Payment Limitations, the US needs a stable and adequate supply of food and bio-feedstocks and large commercial farms are the best suited to accomplish that. Don’t penalize farms for becoming more efficient.

Analysis:

The current 2002 US Farm Program has a payment limit per person of $360,000, and an income cap for eligibility of $2.5M (over the previous three tax years).  This payment limit does not apply to anyone earning 75% or more of their income from farming.  The Administration is proposing that the next US Farm Bill lower the AGI income cap to $200,000, and would also eliminate the exception for farm incomes.

 

However while Congress and the Administration fight the same old battle over what and who US Farm Policy is supposed to be for, the US is likely to ignore the structure of the payments, and that is where changes need to be made, in order to keep us out of trouble with the WTO, and in step with real-market signals for the world supply and demand for corn, soybeans and other program crops.

 

Review of Key Payments in Current Farm Program

There are four key payments that are a part of the 2002 program.

Direct Payments.

The direct payment rates (below) are multiplied by a farm's established base acres and yield.  Base acres can be from 0-100% of a farm's tillable area, are based on historical production records, and have been locked-in since 2002.  Farm-crop yields are also based on historical records or county averages, and have been locked in since 2002.

Wheat - Bushel - $0.52

Corn - Bushel - $0.28

Upland cotton - Pound - $0.0667

Soybeans - Bushel - $0.44

These payments are made regardless of market prices, and are not tied to the acres of actual crops planted each year, ie: a farm might be receiving a direct payment for soybeans, but have planted 100% corn.  These payments do not distort market signals for supply and demand.  However it is difficult to justify these payments, since they are not tied to market conditions, and are paid in both good times, as well as bad.

 

Countercyclical payments

Counter-cyclical payments are paid for covered crops whenever the effective price is less than the crop's target price.  The payment rate calculation is (TARGET PRICE) crop - (DIRECT PAYMENT RATE see above)crop - (higher of LOAN RATE or MARKET PRICE)crop.  The result of this calculation is then multiplied by the farm's base acres, and by the farm's established yield.  If the result is a positive number, 85% of that amount is paid out.  Target prices are as follows:

Wheat

$3.92

Corn

$2.63

Cotton

$$0.724/lb.

Soy

$5.80

Loan rates vary by year and by county to reflect current local market prices.  The following are the average 2007 rates.

Wheat

$2.75

Corn

$1.95

Cotton

$0.52/lb

Soy

$5.00

To get a sense of the variability by region, the corn and soy loan rates in Christian County, Central IL for 2007 are $2.05 and $5.16.

 

Obviously, no payments will be made under this provision during this current period of high crop prices.  These payments ARE tied to market conditions, and hence are easier to justify as a tool to reduce the risk for producers from low prices.  This payment also doesn't distort market production signals as the payments are NOT tied to actual production.

 

Marketing Loans

When prices fall below the LOAN RATES for program crops, farmers have the option of placing a crop under loan to USDA, with loan amount based on the LOAN RATE times ACTUAL HARVESTED BUSHELS for the farm.  The loan can then either be paid off for the principal plus interest…or if prices are still depressed, at their local MARKETING LOAN REPAYMENT RATES, more commonly known as POSTED COUNTY PRICES.  These rates are calculated for each crop and posted for each county, and are based on the USDA's estimate of local cash prices for the county.  During periods of low market prices, this effectively establishes a "price floor" for the commodity, at the crop's LOAN RATE.  With the introduction of the LDP in the 2002 Program, true Marketing Loans became a much less-used tool for producers.

 

Loan Deficiency Payments

The LDP is a variant, and much more highly utilized, form of the marketing loan, and basically allows a producer to waive their right to a marketing loan, and capture the differential between the LOAN RATE and the POSTED COUNTY PRICE, all in one simple, fast move.  With low prices that typically accompany harvest, farmers have become very adept at monitoring and capturing high LDPs, then waiting (although then without any price protection) for higher market prices later in the year to actually sell the crop.

The LDP was a new introduction in the 2002 farm bill, and during that period of time that proceeded the current ethanol boom, when we had very low prices, is became a very highly regarded price protection and income generating tool for producers.  These payments are based on actual bushels produced, times the calculated payment rate, so payments are often very large.  In fact, for many years, this has been by far, the largest single source of government program payments for most individual producers.  During these periods of low prices, the amount of income received for LDP's often exceeded a farmer's annual net farm income.

 

Problems With Loans/LDPs

 

They cause producers to ignore market signals

The marketing loans and LDP's, although extremely popular with producers, also create the most market production signal disruptions, as they create artificial price floors for the program commodities, which allow and encourage producers to continue producing a crop, even when the supply-demand situation is sending price-signals to reduce production.  Obviously, producers in other parts of the world would prefer that US producers stop producing when the world no longer needs more corn and soy….hence the round of recent challenges in the WTO against the US's Farm Program payment programs.

I have a unique perspective, farming both with market price floors (in the US) and without (in Brazil), allowing me to see problems created by a price floor encouraging overproduction in one country, on farmers in another.  World prices are forced even lower, as overproduction occurs, due to world supply-demand market signals being "drowned out" by US Loan Rate, sometimes to the point that production (in a country WITHOUT relevant artificial price floors) becomes non-profitable/feasible. 

 

They distort rotations

In addition, the relationship between the loan rates of substitute crops such as corn and soybeans, can and has distorted the rotational choices of producers.  Soybeans profited at corn's expense during the program's early years, as the loan rates become the effective "market" prices for these program crops, and at $5.00-to-$1.95, which created a soy-to-corn price ratio of 2.56 to 1, soybean acres boomed.  We are just now beginning to work down the surplus supply of those years of overproduction of soy.

 

But they create stability

However, it also is easy to see the effects of the stability that these price floors bring to the US agricultural sector, and which is missing from Brazil's.  US farms have focused on cost reduction, and grow at a slow-sustainable pace.  US ag businesses are relatively assured of having viable customers to sell to, or buy feedstock commodities from. 

This is missing from Brazil, which tends to move in more of a "boom-bust" cycle.  Agribusinesses there have to worry about how financially viable their customers will be from year to year.  Processors have to work to be sure that there will be a sufficient supply of their feedstock, as production escalates one year, then drops the next.

 

Missing a Perfect Opportunity

If I had to choose, I would of course choose stability.  However if creating stability in the US creates instability in the ag sectors of other countries, then I don’t believe it is viable in this global economy.  And stability that ignores the market, will not remain stable in the longrun.

There may never be a better time for a change in US farm policies, with the current environment of high-prices and record incomes in the US farm sector.  However, it appears that Congress may, yet again, succumb to the farm-agribusiness lobby and renew many of the provisions in the 2002 program…pushing the issue off to be  brought to a head in the courts of the WTO.  The US will eventually be forced to "level the playing field" on these issues, and it may be forced on the farm sector at a time when is will be much harder to swallow.

 

What Would I Do?

Drop Direct Payments, they serve no purpose

Drop Marketing Loans & LDP's, they disrupt market signals and rotations

Put More Money into Counter-Cyclical Payments, they provide income stability to ag producers, and the entire ag sector, but don’t add much market signal distortion.

Forget About Payment Limitations, the US needs a stable and adequate supply of food and bio-feedstocks and large commercial farms are the best suited to accomplish that. Don’t penalize farms for becoming more efficient.