For farmers burdened with heavy debts, historically low interest rates can seem to be salvation. Lower payments for equipment, for land loans, for bills past due — it’s life support for financially squeezed farms and, for that matter, for most other kinds of business other than banks and other lenders, which can’t get much profit out of the tiny spread between what they have to pay depositors and the rates at which the market allows them to lend.
For students borrowing money with loans, though interest is tax deductible, loan principal can be hard to repay. If there’s no job, paying back the loan can stretch out to many years. Cheap money, low interest rates in other words, makes it easier to carry the loans.
Cheap loans can become a drug that borrowers can’t shake once they are used to them. Farm operations that appear to be profitable when lines of credit are below four per cent can die if rates climb to eight per cent. Cheap money is a crutch that can break.
Bill Campbell, president of Manitoba’s Keystone Agricultural Producers, the well-known agricultural industry representative body, puts it in stark terms:
“Interest rates now are not enough to replace capital,” Campbell explains. “But that is not our major concern. It is true that very low interest rates encourage farmers to buy more machinery, but we are in a time when government seems to say it does not matter that loans be paid back. So much money goes to borrowers out of public funds that there seems no expectation for repayment.”
You could say that low rates are bait for putting ever more money into land, livestock and equipment. As long as interest rates stay low, cheap money oils the wheels of farms and business. However, if rates return to 1990s levels of eight to 10 per cent on home mortgages and small business loans, today’s low rates will become a grim reaper taking down businesses and farms. Consider interest at 15 per cent in the early 1980s. Unlikely to return with corresponding inflation, but it is almost unthinkable.
The monetary scythe is not going to show up any time soon, however. Josh Nye is a Toronto-based senior economist for the Royal Bank of Canada. “Returns on investment are lower in the present environment,” Nye explains. “That is what is adding to pressures to hold down interest rates. Inflation is low, but large debt levels are having an impact on growth.”
Cheap money has a cost
It turns out that very cheap money, which encourages borrowing, does have a cost. National governments can raise taxes or use their top-drawer credit ratings to borrow ever more. They can also print money. But sub-national governments, like provinces, cities and towns, have only the power to tax. Their collections tend to rise and fall with economic expansion or contraction.
For a farmer who has to pay bills, when today’s low nominal rates, which are negative when inflation — currently running about one per cent per year — is taken into account, mean land, capital and inventories will not rise much in price from one year to another. These days, interest rates on mortgages and lines of credit are still more than inflation, so heavily leveraged borrowers can and will face troubles when rates rise.
In Japan, where low inflation and low interest rates have been in effect for two decades, stagnation is a problem without solution, Nye explains. “Japanese debt is 90 per cent of the country’s gross domestic product. We don’t know the breaking point, but very low rates have not encouraged spending. Rather, they have driven people to save even more for retirement, thus making the stagnation problem even worse.”
Bait and switch
Low interest rates turn out to be a kind of bait and switch problem. Low rates bring in borrowers to load up on credit and then, one day, rates rise and what was cheap becomes a burden.
Don Forbes, a farm advisor and head of the financial advisory service for Forbes Wealth Management in Carberry, Man., explains. “Even if a farmer has been paying his loans on time, when rates rise and trigger higher lending rates, banks will make it harder to get a loan. As money becomes more expensive to borrow, lenders will guard it ever more carefully.” In the end, low interest rates and cheap money only postpone a day of reckoning for farms and businesses that don’t pay their way.
When interest rates rise, it will be because business conditions have improved, explains Chris Kresic, head of fixed income and allocation for famed money manager Jarislowsky Fraser Ltd. in Toronto. “If interest rates rise, it will be because the economy is doing better. Businesses that have locked in low rates will do better.”
True, of course, but the relationship between debt and ease of payback is parallel only if the debt taken on is productive. The trouble with very low rates is that the discipline to ensure money is well invested weakens. That’s part of the boom-bust cycle of economic expansion and contraction that is supposed to be managed by central banks.
“We see an unprecedented decline in economic activity offset by an unprecedented monetary policy and fiscal policy,” explains Nicholas Leach, vice-president for global fixed income and head of high-yield investing at CIBC Asset Management in Toronto. In effect, money is almost free and taxes are postponed until folks want to pay them.
At a corporate level, the COVID-19 recession has made business conditions tough. Last April, Ford Motor Credit had to borrow at nine per cent annual interest. Ford has been rated below investment grade by two out of the three big international agencies — Standard & Poor’s, Moody’s and Fitch. Ford has a good name and a vast industrial base. Its problem, selling cars and trucks, is a sign of how hard it is to make money when shoppers hesitate to buy even with cheap money.
Low interest rates are a lifeline, but they also postpone the day of reckoning. If the only reason to add debt to the family farm is that money is cheap, think again. It won’t always be that way.