The term “irrational exuberance” was first used (we believe) by Alan Greenspan in 1996 when describing the dot.com boom in Silicon Valley. That term was then co-opted as the title of a book by Robert Shiller, the guru of real estate and housing analysis. He used the book to describe the housing boom in 2005, and, like Alan Greenspan, was prescient in his analysis of an economic bubble. Now the same man, Robert Shiller, recently said that farmland is his “dark-horse bubble candidate for the next decade.”

The Federal Reserve, worrying about such irrational exuberance in the farm belt, is now conducting stress tests, scrutinizing lending standards, loan documentation and risk analysis in most of the 2100 U.S. farm banks. With many farmland prices up over 50% in the past few years, one could believe we are in a bubble. Although farm prices nationwide average about $3000 per acre, they are over $9,000 in California and $12,000 in New Jersey. Even the Corn Belt is seeing prices for dry-land farms above $7,000. In the stress tests conducted by the Federal Reserve Bank, banks must undergo many hypothetical assumptions including 50% commodity price declines, 50% productivity declines, input costs rapidly climbing. Will farm banks collapse under those assumptions?

What is missing from the farm price question is the other side of the equation, namely Supply-Demand, and how it will affect risk of collapse.

On the supply side, most of the world’s productive farmland is already in production. Of course, there are still large tracts of land in South America and Africa that are undeveloped, but most are far from any infrastructure to get goods to market, far from water sources, and/or unable to produce financially viable crops; the cost to develop has long constrained their development. Furthermore, we have seen millions of acres around the world go out of production because of urbanization, erosion, desertification, water-logging, and loss of fertility. Saudi Arabia used to be self-sufficient in wheat, but now they farm little, and are buying land in Africa to grow food for their population. The 2007 Agriculture Census found there was an increase in the number of U.S. farms, but most of the increase was attributed to rural living choices, and those small farms produced relatively little. Finally, the rate of productivity growth, despite still increasing, is growing at a decreasing rate today.

Then there is the supply and quality of water, something of real scarcity in many parts of the world, and expected to grow worse with global warming and lack of recharge of underground aquifers.

On the demand side, almost every measure we see says growth. First, demographers predict that the world’s population will grow another 50% before it tops out at about 9.2 Billion people in 2050 or 2060. Second, as people reach middle class, as so many Chinese and Southeast Asians are now doing, they demand more calories, more of those calories will be from meat, and meat requires about 6 btu’s of feed to produce 1 btu of meat. As a result, while the population is predicted to grow 50%, food production will need to grow 70% to feed that population. There are other research papers which state that food production must rise 100% to meet demand, and they make a credible case.

What invariably happens when supply and demand get out of balance? Price goes nuts, and it does not take much imbalance in supply to cause a huge increase (or decrease) in price. Witness what just happened over the past couple of years when many commodity prices rose 50-100%, and some are still exceedingly high relative to prior years. Luckily for us as farmers, because the farm output cost is a relatively small part of the final retail price to consumer, a 50% farm level increase might net a 2-3% consumer price increase.

If we move this supply--demand--price analysis (grossly over-simplified) back to land prices, we can conclude that commodity pricing should carry farmland pricing today. But, and that is a BIG “but,” we are talking averages, and one is average temperature when he has one foot in the fire and the other in a bucket of ice. We are also reminded of that time-worn adage “Fools rush in where angels fear to tread.” In short, we believe in care and caution before any purchase decision is made. Any astute real estate investor will concur that profit is generally made on the buy side.

We are lucky in the Intermountain West because we have not seen nearly the land price appreciation as seen in most areas of the country, and we still have recorded comparable annual cash return on our crops. Hence, we believe there is less danger and more opportunity.