Bubble and Pop.

The history of New Zealand is speculation on farm land which stokes up debt, with disastrous consequences when the bubble bursts. The New Zealand industry is going through another one. 

During the Great War, farm land prices boomed. When farm product prices collapsed in 1920, farmers walked off their land. It was not that the land prices were too high. Farmers had borrowed to purchase their farms and with lower revenue they could no longer service the debt. (Much the same seems to have happened during the Long Depression of the 1880s, but there is not the statistics to trace it with any precision.)

Not all farmers walked off, of course. Those with low or zero debt and a modicum of luck – like reasonable weather – can usually survive such price collapses.

A similar thing happened in the 1930s. Again many farmers were carrying too much debt. I calculate they were not getting a reasonable return on their labour, even under the better prices of the 1920s, When product prices plummeted at the start of the Great Depression many could not now even service their debt let alone make a living, and they walked off their land.

Almost the same thing happened with the removal of land price controls by the first National Government after the war. Fortuitously, wool prices boomed in the early 1950s enabling farmers to ease back their debt burden. The same thing happened to some farmers with the wool price collapse in 1966.

My calculations in the late 1970s suggested that again farmers were carrying too much debt. Muldoon was bailing them out with SMPs and the like. When the Rogernomics government removed these in the 1980s, some farmers found they were unable to service their debt and walked off their land.

It seems to be happening again. When the Chinese markets opened up there was a surge in demand for dairy products which resulted in higher prices. To capitalise on them, dairy farmers increased supply in part by purchasing more land, borrowing to do so. Inevitably international dairy supply caught up (perhaps now the world is in over-supply) and prices collapsed. Some farmers find they have paid too much for their land, gambling on a long run price of $8 a kg of milk solids, while the current price is below $4kgs. They are now struggling to service their debt.

I am sure about what happens next. Some farmers will walk off their land as banks foreclose on them. Some farmer will demand government bailouts. Everyone will blame Fonterra; it may make mistakes but it did not purchase the overpriced land. The banks themselves are not under threat. Perhaps they were imprudent advancing debt on the basis of excess optimism about long run dairy prices but they have diversity in their lending and dairy loans are only a small proportion of the total.

There may well be a drop-off in dairy production. Feeding palm kernels is likely to be cut back, but a bigger worry would be if some farms went to ruin with deterioration in pastures and herds and inadequate maintenance of farm equipment, as occurred in the 1930s. Banks are, probably, not foreclosing on some farmers in order to avoid this.

In national economic terms, any falloff of production is compounded by the falloff in prices so that real incomes (purchasing power) fall more than production (as the National Accounts recently reported). There may be further production falloffs as the lower incomes result in less spending but there is not much evidence of this yet.

The revenue from higher prices for farmlands goes to the sellers – often retiring farmers. Some of them will have lost part of their savings in poor financial decisions (as in various finance company failures, but part of those losses were borne by taxpayers), some will have invested in housing (contributing to the bubble – they may lose part of their savings in a burst) and some will have been spent on consumption.

So the booming farmland prices have generated prosperity throughout the economy. Conversely, the collapse will generate the reverse. But those who benefited on the upswing will not be exactly the same as those who suffer from the downswing.

Why do we keep doing it? Don’t they ever learn? Perhaps they think this time it is different – it always is; it never is – or perhaps they do not know any history. Some may be gambling they will get out with a profit before the crash; some do, but in doing so they leave someone else holding the debt.

Too much of our farming is for capital gains. Too many farmers are willing to take low incomes relative to their assets and their effort, in return for a large capital sum when they sell out. Big capital gains usually require ‘high gearing’ – high debt to income – as high as your lenders will let you get away with.

At which point the debt financing activity becomes speculation and a crash is eventually unavoidable – as happened in 1928 on the American stock market and in 2008 in the American housing market and which may yet be repeated in the Auckland housing market.

What to do? The die is cast for this round of speculation and some are going to have to pay for it – including innocents who were not beneficiaries of the upswing. The precise responses depend on how the economy unfolds after the crash.

Later we might consider measures to dampen the booms. The easy solution would be a comprehensive capital gains tax – I’d go for a real and realised one, but that is a rather technical issue. But capital gains are so built into our farm sector, it is not obvious just how we can introduce one. It ought to be obvious though, that having a leading economic sector integrally dependent on a boom and bust speculative cycle is not in our best interests.