AGRICULTURAL INCOME AND FINANCE October 5, 1998 October 1998, AIS-69 Approved by the World Agricultural Outlook Board ------------------------------------------------------------------------------- AGRICULTURAL INCOME AND FINANCE Situation and Outlook is published three times a year by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20036-5831. This release contains only the report text. Tables and graphics are not included. Subscriptions to the printed version of this report are available from the ERS-NASS order desk. Call, toll-free, 1-800-999-6779 and ask for stock # AIS, $30/year. ERS-NASS accepts MasterCard and Visa. ----------------------------------------------------------------------------- Contents Highlights Farm Sector Income Outlook Farm Finance Outlook Operator Household Income Outlook Farm Business Conditions Financial Performance Measures by Farm Typology Sector Wealth and Financial Ratios 1997 Sector Financial Indicators Crop and Livestock Costs of Production Highlights Net farm income for 1998 is currently forecast at $42 billion, down $7.9 billion from the near record high attained in 1997. Net cash income is currently forecast at $53 billion, down $7.8 billion from 1997. Both net farm and net cash income earned in 1998 will be about the same as earned on average in the first half of the 1990s. The value of crop production from U.S. farms in 1998 is forecast to drop $7.9 billion, led by a $3.5-billion drop in sales of feed crops, mostly corn. The value of livestock production is forecast to be down $2.3 billion, led by a $4.3-billion drop in sales of meat animals. Lower prices received by farmers account for much of the decline in value of production and the resulting decrease in income. Declining demand for exports and increases in supplies available from foreign competitors are major contributors to the lowering of prices. Recently enacted legislation gives farmers an additional option for boosting cash flow in 1998, by authorizing producers individually at their option to receive prior to January 1 a larger percentage of the 1999 fiscal year government payments to which each is eligible. The legislative change does not increase the amount of money farmers, individually or as a group, are eligible to receive under the 1996 Farm Act but only allows them to receive the money at an earlier date. Both Congress and the Administration are currently proposing additional funding for farmers and ranchers to ease the impact of this year's lower commodity prices. If additional government payments become available, producers' incomes could rise. On the expense side, total farm expenses are forecast to be lower in 1998, the first year-to-year decrease since 1992. Interest rates and fuel costs are currently quite favorable for farmers, and low fuel costs help to keep nitrogen fertilizer prices low. Livestock producers will also incur lower expenses for feed and feeder livestock. Since most farms and ranches are really family-owned operations, off-farm income usually plays a major role in the well-being of the business. On average, farm operator households earned about $52,000 in total income in 1997 and the 1998 outlook is for incomes to remain fairly stable. Off-farm income is an important source of total household income for all size farm operations, even large family farms. On the balance sheet side, debt-to-asset ratios are expected to stabilize at about 15.3 percent for 1997 and 1998. They have improved throughout the 1990s as the rise in the value of farm business assets, especially farm real estate values, has been proportionally greater than the increase in farm business debt. The improved equity position of most farm operations during the 1990s has given producers an added margin to lessen the impact of short-term declines in income. Farmers are expected to use their available credit lines more fully in 1998. Use of farm debt repayment capacity (actual debt expressed as a percentage of maximum feasible debt) effectively measures the extent to which farmers are using their available lines of credit. This ratio indicates that, in 1998, farmers are expected to use over 61 percent of the debt that could be supported by their current incomes. While this is the highest value this measure has attained since 1986, it is substantially below its levels during 1979-85, when it consistently measured above 70 percent. In 1997 the Secretary of Agriculture established the National Commission on Small Farms to examine issues facing small farms. The Commission considered a farm to be "small" if its gross sales did not exceed $250,000. The Commission set the cutoff high enough to include more farm families of relatively modest income who may need or want to improve their net farm income. As a result, the Commission's small farms category includes nine out of ten U.S. farms and ranches. In response to the Commission, ERS developed a "farm typology" that sorts farms on the basis of the major occupation of their operators, their farm sales class, and other household and farm characteristics. The typology divides farms into smaller, more homogeneous groups. Using this new typology and USDA's most recent farm finance survey (1997), it was found that farm households with agricultural sales under $100,000 relied almost exclusively on off-farm income to cover family living expenses. These groups also did not generally report farming as their major occupation. Two months ago ERS released its first official estimates of 1997 farm income which replaced earlier forecasts. These estimates showed that 31 of the 50 States experienced declines in net farm income of varying degrees in 1997. These declines were in contrast to the across-the-board increases the prior year. To retain perspective, it is again important to remember that 1996 was a truly exceptional year. Farmers benefited from record yields for major crops in 1996 and prices that remained unusually high, particularly given the high levels of production. The value of crop production soared, reflecting rebounds in acres harvested and yields for major crops, both of which had declined in 1995. California continued to lead the Nation in 1997 cash receipts and farm income by substantial amounts, reflecting both its substantial land mass and its commodity mix, which is heavily weighted toward commodities with a high value of production per acre. Four States had their net farm income plummet by more than 50 percent: North Dakota (-90 percent), Maine (-75 percent), Wisconsin (-66 percent), and New York (-51 percent). Costs of producing most crops and livestock commodities showed little change in 1997 with many declining slightly. Farm Sector Income Outlook Incomes of U.S. Farmers Track Falling Commodity Prices in 1998 Production continues high, but falling crop prices are leading to lower value of production and to reduced net income. Effects are unevenly distributed and vary by mix of commodities produced, inputs used, and geographic location. Net farm income for 1998 is forecast to be $42 billion, down $7.9 billion from 1997 and $11.4 billion below 1996's record level. Net cash income is forecast to be $53 billion, down $7.8 billion from 1997 and $3.4 billion below 1996. However, each income measure in 1998 will be about the same level as the average for the first half of the 1990s. Lower commodity prices account for much of the decline in income. Prices received by producers for corn, soybeans, wheat, upland cotton, and hogs (figures x-y) in 1998 have been well below those of the previous 2 years. The reduction in net farm income is largely attributable to lower prices for these five commodities, which comprised 32 percent of farm cash receipts in 1997. Large expected harvests of most crops have maintained pressure on domestic market prices throughout 1998. The U.S. soybean harvest is expected to be a record, the corn harvest will be just below the record established in 1994, and the wheat harvest is higher than the last 2 years. Since a significant share of domestic production of these crops is exported, prices U.S. farmers receive are strongly affected by supply and demand conditions in the global marketplace. Good growing seasons, both here and in other exporting countries, have resulted in abundant world supplies. As a result of slowing economic growth, demand is down considerably in numerous countries that have purchased U.S. exports in recent years. Farm exports have been further dampened by the relative strength of the dollar, which raises the price of U.S. produced goods in importing nations, while making goods produced by our competitors relatively less expensive. BEGIN BOX Net farm income, a value of production measure, is the farm operator's share of the sector's net value added to the national economy from production activities within a calendar year. Net cash income is the cash earnings realized within the year from the sales of production and the conversion of assets, both inventories (in years in which reduced) and capital consumption, into cash. Net cash income cannot be maintained for more than a year or two without being replenished through production. Both income measures include Government payments and farm-related income. END BOX Value of Production Declines Lower commodity prices have contributed directly to the projected decline in U.S. agricultural sector income and to the anticipated reduction in the value of production (final output in the value added accounts). Final output is forecast to be $221 billion in 1998, down $9.8 billion from 1997 and $7.5 billion below 1996. While down from the past 2 years, output values for both the crop and livestock sectors in 1998 will remain considerably above those attained in 1990-95. Income effects will not be distributed evenly over all producers, but will vary by the commodity mix produced, by the types of inputs used, and by geographic location. The value of crop production from U.S. farms in 1998 is forecast to drop $7.9 billion, led by a $3.5-billion drop in sales of feed crops, mostly corn. Food grains receipts are forecast to be down $1.7 billion, with wheat accounting for nearly all of the reduction. Oil crop receipts are forecast down $2.2 billion and cotton receipts are forecast down by $700 million. Price declines account for the fall in the value of production, as abundant harvests of major crops are probable in 1998. Cotton is an exception, with prices trending upward during the summer as a significant drought in Texas and the Southeast is reducing the per-acre yield for upland cotton. The value of livestock production is forecast to be down $2.3 billion in 1998, led by a $4.3-billion drop in sales of meat animals. Cattle prices have declined recently. Prices for hogs and for milk and dairy products have turned up in recent months after declining earlier in the year. Broiler prices have been rising through early September. The projected 1998 reduction in value of livestock production follows an excellent year for most livestock operations. Production and sales of livestock and products were up substantially across the board in 1997, led by a $5 billion rise in cattle cash receipts. Sales of hogs and broilers also rose in 1997. Much of the production gains occurred in the second half of the year as the prices of grains declined, reducing the feed costs. Government Payments Higher in 1998 Farmers received production flexibility contract (PFC) payments of $5.2 billion in 1996 and $6.3 in 1997 under the 1996 Farm Act. These payments were substantially higher than farmers would have received under the previous legislation, which, given the relatively high market prices during these years, would have provided reduced deficiency payments. Recently enacted legislation has given farmers an additional option for boosting cash flow in 1998, by authorizing producers individually at their option to receive prior to January 1 up to 100 percent of the 1999 fiscal year PFC payments to which each is eligible. The legislative change does not increase the amount of money farmers, individually or as a group, are eligible to receive under the 1996 Farm Act, but only allows them to receive the money at an earlier date. Total authorized payments are $5.65 billion for the 1999 fiscal year. The current estimate of 1998 farm income in this report includes about $1.1 billion of fiscal '99 PFC payments. The extent to which farmers will choose to advance the date on which they receive payment is not clear at this time. Farmers will make a choice depending on their individual circumstances. If advancing the timing of receipt is critical to paying family and production expenses or to remaining current on debt payments, the producer will likely choose to do so. However, tax considerations may cause many farmers to choose not to advance payment dates into 1998. The choice of tax year in which to receive the money can affect how much an individual producer retains after payment of taxes. This is because income, including Government paymets, is taxed when it is received. Advancing the receipt of funds into 1998 will advance the due date on any tax obligations by 12 months. As prices of crops eligible for placement under Commodity Credit Corporation loans have declined throughout the year, they have fallen to levels at which farmers are qualifying for loan deficiency payments (LDPs). These payments are based on the difference between the county loan rate and the posted county price (a proxy for local cash price). They are designed to allow prices to drop to market-clearing levels, while guaranteeing the producer a minimum revenue per unit. The current estimate of LDPs included in 1998 farm income is about $637 million. These payments should provide some cushioning to further price declines from recent levels, and LDP payments could total $3.3 billion in calendar year 1998, with as much as $2.5 billion of these coming in the fourth quarter. Farmers are likely to receive additional income support from enhanced government financial assistance programs during 1998 and 1999. Proposals currently under consideration call for added spending of $3.9 billion to $7 billion in the 1999 fiscal year to assist farmers adversely affected by declining commodity prices, adverse weather, and production shortfalls. While such payments translate directly into an increase in net income, the impact on net farm income in both 1998 and 1999 depends on the timing of receipt of the payments. There is obvious uncertainty in any estimate of 1998 government payments. Depending on the degree of acceleration of receipt of fiscal year 1999 production flexibility contract payments, the ultimate level of LDPs, and the size and availability of a likely financial assistance package, net farm income could rise by $5 billion or more above the $42-billion level projected under current assumptions. Crop and Livestock Inventories Adjust Typically, an extraordinarily large harvest will generate substantial additions to inventories and will then be reflected in a drawdown in inventories the following year when production returns to long term trend levels. However, in 1997, production of corn (the leading crop in value of production) exceeded the 1996 production. As a consequence, farmers sold off the big carryover from 1996 to make way for the equally large quantities of the 1997 harvest retained in yearend inventories for future sale. Consequently, the value of the change in crop inventories at yearend was about the same in 1997 as in 1996. The rapid structural change occurring in livestock farming, with production units becoming larger and more specialized, is reducing the amount of on-farm crop inventories that diversified farm operations previously maintained to feed to livestock enterprises. Regional shifts in production and consolidation into large operations (e.g., hogs in North Carolina and dairy in California) has led to a higher percentage of feed being purchased, rather than being grown on the farms producing the livestock. Consequently, the percentage of the crops sold in the open market is higher. For example, in 1996 the percent of the corn used on farms where produced dropped from 20.46 percent to 16.73 percent, a difference of 3.71 percentage points. With a 9.3-billion-bushel crop, this translates into an additional 350 million bushels of sales. At 1996 prices of about $3.20 per bushel, this boosts sales to over $1 billion. The increase in quantities available for sale in 1997 and the first half of 1998 were about the same, but prices received by farmers were lower. Livestock inventories are also adjusting to market signals. Beef production rose in 1997, particularly in the third and fourth quarters, due in large part to increased marketings of fed cattle and the slowing in the liquidation of the cattle herd. The movement of feeder cattle into feedlots slowed in the latter part of the year, but the inventory of cattle in feedlots remained high at the end of 1997, as steer prices tailed off in the fourth quarter. Cattle prices were relatively firm in the earlier months of 1998 before trending lower. The expansion among hog farmers that started in the spring of 1997 continued at a rapid pace through the rest of the year and was especially apparent in the fall pig crop. The big increase in the fall pig crop substantially boosted sales and was also reflected in the end-of-year inventory of hogs and pigs on farms. Prices of hogs declined substantially in the latter half of 1997 as the growth in pork exports slowed. In 1998, production has followed prices downward. Expenses Moderate Total farm expenses are forecast to be lower in 1998, the first year-to-year decrease since 1992. Interest rates and fuel costs are currently quite favorable for farmers, and low fuel costs help to keep nitrogen fertilizer prices low. Livestock producers will also incur lower expenses for feed and feeder livestock. Production expenses rose $5.7 billion in 1997, contributing to the decline in net farm income from the 1996 record. Farm production expenses in 1998 are reflecting the low-inflation environment of the overall economy, as prices in many other sectors are flat or falling. Reflecting the decline in capacity utilization and sharply increased productivity, producer prices fell in the first half of 1998. The spot crude oil price dropped to below $14 per barrel, down sharply from the $23 peak of last fall, and prices declined for most farm inputs originating off the farm. Farm fuel prices fell 16 percent in the first half of 1998, while fertilizer prices declined 5 percent, led by a double-digit fall in nitrogen-based fertilizers. While fertilizer demand weakened with lower field crop price expectations, the supply of nitrogen-based fertilizer rose as lower natural gas prices cut production costs. The tight U.S. labor market has generated higher real wage rates in 1998. The farm sector was no exception, as farm wages rose 6 percent in the first half of 1998. Global Events Influence Farm Income Forecasts 1996 was a truly exceptional year with record high farm income, above average yields for major crops, and prices that remained unusually high. The large production was absorbed by export markets, with rapidly growing emerging economies maintaining strong demand for U.S agricultural products. The situation in 1998 has changed considerably. The slowing of global economic growth has exerted downward pressure on prices of all types of primary commodities, including crude oil and metals. Most countries for which exports of commodities are a significant component of economic activity have suffered adverse effects. The U.S. farm sector has been seriously affected, but, since agricultural production is only about 1 percent of gross domestic product (GDP), the decline in agricultural exports has had a minimal impact on the national economy. In Canada and Mexico, where commodity exports are a larger component of total exports, the effects on GDP have been greater, adding to pressure on the value of their currencies relative to the U.S. dollar. Agriculture's performance in 1998 has been given little assistance from the domestic economy, as U.S. GDP growth slowed sharply from the first quarter's 5.5-percent rate to 1.6 percent in the second. Farm operators rely on off-farm sources for a substantial portion of their household income. Those employed in rural manufacturing industries have been affected by changes in global economic growth. Rural manufacturing employment fell in late 1997, reflecting its sensitivity to demand changes induced by a strengthening dollar and weakened world growth rates. While most farmers and their producer organizations remain optimistic about the longer term potential for U.S agriculture in a market-oriented global economy, the income outlook for 1998 reminds us that international markets offer risk as well as reward. The lower domestic prices for most agricultural commodities reflect the combined effects of increases in supplies available from competing exporting countries, and declining demand for exports. Brazil and Argentina have just concluded an exceptionally good production season, with large harvests of corn and soybeans in the second quarter of this year. The firming of forecasts for a record soybean harvest by U.S. farmers is continuing to place downward pressure on soybean prices due to prospects of large world supplies. Pressures on corn prices from an expected large corn harvest of 9.74 billion bushels may be mitigated by higher than anticipated corn exports. Growth in the economies of Southeast Asia in 1995, 1996, and the early months of 1997 translated into demand for U.S. agricultural products that helped to support commodity prices and boost farm income. These economies began to falter in the summer of 1997 and have yet to recover, which has depressed demand for imports of agricultural commodities. In 1998, economic difficulties in Japan have led to a substantial depreciation in the value of the yen, which reduced import demand in Japan and simultaneously lowered the prices of Japanese exports. These consequences are contributing to lower economic growth and rising concern about maintenance of currency values in the countries of Southeast Asia and China. The recent precipitous decline of the Russian ruble and the decline in the Canadian dollar and Mexican peso add to the pessimistic outlook for exports. Because the U.S. dollar is the currency to which individuals and companies in other countries seek to convert their capital in periods of economic crisis, the value of the dollar has risen and may continue to appreciate against the currencies of some or all of these countries. The immediate consequence of appreciation of the dollar is a relative rise in the foreign currency price of U.S. agricultural products accompanied by a drop in demand in potential importing countries and a decline in competitiveness relative to several other exporting countries. Soybeans is one of the commodities most affected by depreciating currencies because many countries export soybeans. Wheat, corn, hogs, beef, and hides have also experienced declines in export demand. Impacts of Reduced Income Vary by Type of Farm, Region Not all farms will share equally in the projected decline in 1998 net farm income. Farmers who specialize in the production of grains and soybeans are currently experiencing declining commodity prices, while farmers who specialize in cattle production are benefitting from lower feed costs. Beef accounts for about 17 percent of the agricultural sector's total value of production. Prices are up from their lows of 2 years ago and low grain prices translate into lower feed prices and higher profits. The economic cycles in the livestock sector and crop sector can be counter to each other, with conditions in one being on the upswing as the other is less favorable. Since net farm income is a production-based measure, the quantities of production are key income determinants for the United States and any geographic subregions. Some areas will be adversely affected by production problems to a far greater extent than is evident in the national forecast. Disease has been affecting wheat production in the Northern Plains for several years. Excessive rainfall in California caused production problems earlier in 1998 and dry conditions have severely affected production in Texas, Florida, and parts of the Delta. Corn is the nation's biggest crop in terms of value. Corn yields are quite sensitive to weather conditions during critical stages in the production process. As a consequence, corn production has accounted for much of the volatility in net farm income over time. In 1998, the Corn Belt States have so far had favorable weather for the third consecutive year, a rather unusual sequence of good fortune, but the large supplies negatively affect market prices. Farmers Manage Inventories to Maintain Cash Income Net cash income is a measure frequently relied upon as an indicator of farmers' resilience in times of economic and financial stress, because it is a solvency measure of cash earnings generated from business activities within the calendar year. Net cash income is what is available to meet family living expenses and make debt payments. It does not allow for replacement of capital stock consumed in the production activities but does indicate if farmers can stay afloat. Normally, in years of lower production, farmers maintain cash earnings by drawing down inventories. Farmers managed net cash income by selling an unusually small percentage of the large 1996 harvest prior to the end of the year, postponing the sales to 1997. The unsold portion of the 1996 harvest was reflected in 1996 via additions to inventories. This inter-year postponement of sales shifted cash income from 1996 to 1997. Crop harvests in 1997 were as large as those of 1996, and farmers carried substantial stocks into 1998. Consequently, farmers are in a position to offset some of the effects of low prices by selling large quantities in 1998. However, because capacity utilization in grain elevators is higher in 1998 than in recent years, the lack of stage space for the fall harvests of corn and soybeans means more of these crops are moving directly to market, depressing prices further. World stocks, which are largely owned by grain merchants and governments, influence market prices, but only farmer-owned stocks contribute directly to farmers' net cash income. Fortunately, producers do have large supplies of commodities to sell in 1998, both from inventories and new production. Each farmer also has the option of choosing the timing of sale to suit his/her individual situation. If they need money in 1998 or are not optimistic about the outlook for prices, farmers may sell in 1998. If they have expectations of higher prices in 1999, they may maintain large quantities in inventory and postpone sales. Farm Finance Outlook Farm Business Debt Rise Anticipated To Slow in 1998 Farm debt is expected rise over 4 percent in 1998, following an increase of 6 percent in 1997. Commercial banks' share of total farm debt is projected to rise in both 1997 and 1998. Lower net cash income and higher debt will translate into a rise in farmers' use of debt repayment capacity in 1998. Use of credit capacity is expected to rise above 60 percent for the first time since 1986. Farm business debt is anticipated to reach $172 billion by the end of 1998, its highest level since 1985. The expected increase of $6.6 billion during 1998 will mark the sixth consecutive year of rising farm debt. The expansion in outstanding loan balances follows a rise of over $9 billion in 1997, the largest such increase since 1980. Farm Debt Up 6 Percent in 1997 The rate of growth in debt is expected to fall slightly in 1998 from 1997's 6-percent rate, which represented an acceleration of the steady growth of indebtedness that began in 1993. The increases in loan balances during 1997 and 1998 constitute a significant rise in the annual growth rate of farm debt, which has approached 3.5 percent only twice since 1980. By the end of 1998, total farm business debt is expected to have risen almost $32 billion since the beginning of 1993, a cumulative increase of 24 percent. However, yearend 1998 debt is expected to stand about $22 billion below its 1984 peak value. The 1997 and projected 1998 increases are relatively small compared with annual debt growth during the 1970s, when outstanding loan balances rose at an average annual rate of over 12 percent. The rapid growth in debt financing during that period is an often cited contributor of the farm financial crisis that emerged in the mid-1980s. While the recent rise in debt may result in additional financial difficulty for some farm operators, it does not indicate widespread financial distress in the farm sector. Despite the increase in debt during the 1990's, farm business balance sheets have shown steady improvement. Debt-to-asset ratios, expected to stabilize at about 15.3 percent for 1997 and 1998, have improved throughout the 1990s as the rise in the value of farm business assets, especially farm real estate values, has been proportionally greater than the increase in farm business debt. Debt levels are expected to remain at about 18 percent of equity, near the level of the past three years. The improved equity position of most farm operations during the 1990s has given producers an added margin to lessen the impact of short-term declines in income. Farmers' Use of Repayment Capacity To Rise in 1998 Farmers are expected to use their available credit lines more fully in 1998. Lenders generally require that no more than 80 percent of a loan applicant's available income be used for repayment of principal and interest on loans. This income available for debt service (measured as net cash income plus interest expense) can be used to determine the maximum amount of loan payment a farmer could make. Given current market interest rates and an established repayment period, the maximum debt that a farmer could carry with this loan payment can be determined. Using current bank interest rates and a 7-year repayment period, maximum feasible debt conceptually measures the line of credit that could be available to farmers. Farm debt repayment capacity use (actual debt expressed as a percentage of maximum feasible debt) effectively measures the extent to which farmers are using their available lines of credit. This ratio indicates that, in 1998, farmers are expected to use over 61 percent of the debt that could be supported by their current incomes. While this is the highest value this measure has attained since 1986, it is substantially below levels during 1979-85, when it consistently measured above 70 percent. Comparison with more recent history provides additional evidence that some farmers are likely to experience rising financial difficulty in 1998. Use of debt repayment capacity rose from 45 percent in 1993 to 56 percent in 1995, then dropped to 51 percent in 1996, as high net cash income levels and lower interest rates offset the effect of the rise in outstanding debt. In 1998 continuing favorable interest rates will not be sufficient to offset the combined effects of rising debt and lower net cash income, causing debt repayment capacity use to rise from 53 percent in 1997 to 61 percent this year. Nonreal Estate Debt Rises 8 Percent in 1997 The bulk of the 1997 increase in total debt was due to changes in nonreal estate debt, which rose almost 8 percent. Nonreal estate debt is anticipated to rise almost 5 percent in 1998. Much of these recent increases can be attributed to financing of farm equipment sales, which has been robust throughout the 1990s, and especially so in the first half of 1998. While machinery sales are expected to slow during the second half of the year as lower farm income softens demand, credit for purchases during the first half has already been extended. After reporting an increase in net sales of 8 percent for the first half of 1998, Case Corporation announced a 9-percent farm equipment production cutback in anticipation of slackening demand in both domestic and international markets. Farm real estate debt is expected to rise less than 3.5 percent in 1998, following a 4.5-percent gain in 1997. Demand for good agricultural land may be supported by farm operations seeking to expand to increase production efficiency. Banks' Farm Loan Growth Accelerated in 1997 Farm debt is held by commercial banks, the Farm Credit System, USDA's Farm Service Agency, life insurance companies, among others. Farm debt held by banks is expected to rise about 5 percent in 1998, following an increase of nearly 9 percent in 1997. Bank debt rose over $24 billion from the beginning of 1989 through the end of 1997, a gain of almost 57 percent. During that period banks' share of the total farm debt market increased from less than 33 percent to almost 41 percent. Bank nonreal estate debt is projected to rise about 5 percent in 1998, despite a first-half surge in nonreal estate loan balances, which stood 8.5 percent higher than at the end of June 1997. This follows year-to-year increases of 10 percent in first- quarter 1998, and 9 percent in fourth-quarter 1997. The changes were at least partially due to farmers' yearend management of inventories for income tax considerations. Loans secured by farmland rose over 8 percent in 1997 and are expected to increase by almost 6 percent in 1998. Agricultural banks entered 1998 well capitalized, reporting ample funds to meet the credit needs of qualified borrowers. Some bankers have reported that current credit analysis, using market prices prevailing in the late summer of 1998, suggests that a growing number of borrowers may have difficulty cash flowing loans. Charge-offs may rise during the remainder of 1998 as banks now move to quickly resolve problem loans, but banks are well positioned to deal with borrower difficulties. Bank officers responding to surveys conducted by various Federal Reserve Banks indicate that problems may be building in the areas served by the Minneapolis, Chicago, Kansas City, and Dallas Federal Reserve Districts, where bankers report lower loan repayment rates and higher numbers of renewals and extensions. These factors, together with the current projections for 1998 net cash income, expected to be about 13 percent below 1997 levels, suggest that some farmers may begin to experience repayment difficulties in 1998. However, bankers in most areas also report that demand for loans has remained strong and fund availability is generally adequate. Banks continue to report rising loan-to-deposit ratios, which averaged 0.689 at the end of the first quarter of 1998. This measure, up from 0.55 during 1990-92, has reached its highest level since the early 1980s. But changes in banking, including expanded access to nondeposit funds, cloud interpretation of this rise. Even though banks in the Chicago District recorded average first quarter loan-to-deposit ratios of .726, about 82 percent of district bankers felt that this ratio was at or below the desired level. Despite the potential to use Federal Home Loan Bank and Farmer Mac funding for loans, substantial additional increases in the loan-to-deposit ratios might put downward pressure on farm credit availability, as some banks reserve their more restricted supply of loanable funds for their most credit-worthy borrowers. Farm Credit System Loans Rise Farm business debt owed to the Farm Credit System (FCS) is forecast to increase about 4 percent in 1998, following increases of 6.5 percent in both 1996 and 1997. FCS mortgage debt is projected to rise about 4 percent in 1998, adding to gains of 5.3 percent 1997 and 3.5 percent in 1996. The increases indicate that recent attempts by FCS to regain farm mortgage market share have been successful, following a decline from over $46 billion in 1984 to less than $25 billion during 1993-95. Projections for 1998 indicate that yearend FCS farm mortgage debt will surpass $28 billion for the first time since 1988. FCS' share of the farm mortgage market is expected to reach 32 percent, a level not attained since 1993. Preliminary projections indicate that growth of FCS nonreal estate loans will slow in 1998, as an increase of less than 4 percent follows gains of almost 9 percent in 1997 and about 12 percent in both 1995 and 1996. FCS nonreal estate debt is projected at almost $16 billion by the end of 1998, up more than 80 percent since 1988. During the period of relatively slow growth in loan volume prior to 1995, FCS institutions streamlined through mergers and profited from improved net interest margins. FCS' share of the farm business debt market appears to have now stabilized at about 25 percent. FCS institutions appear to be well positioned to be a competitive force in farm credit markets in the future. The FCS reported solid financial results for the first half of 1998. A survey recently conducted by the Farm Credit Council indicates that some problems may on the horizon. Farm Credit associations indicated that loan demand was strong through the first half of 1998, but more associations were experiencing a decline in loan performance, and most anticipated additional financial stress over the next year. Operator Household Income Outlook On average, farm operator households earned about $52,000 in 1997, according to USDA's most recent farm survey data. The 1998 outlook is for incomes to remain fairly stable. Off-farm income is an important source of total household income for all size farm operations, even large family farms. Farm operator households received an average of $52,300 in total income in 1997. On average, most of their income ($46,400) came from off-farm sources. Across all farm sizes and types, approximately $6,000 per household came from farming activities (appendix table x). Compared with the previous year, there were no statistically significant changes in average total household income, income from farming activities, or income from off-farm sources. The share of household income from farming activities, however, declined from 15.7 percent in 1996 to 11.4 percent in 1996. This reflects the lower net cash farm income generated by the farm sector in 1997. The forecast for 1998 indicates household income about the same as in 1997. Dependence on Farming An average of only $6,000 in income from farming activities per operator household may seem low. The low average, however, reflects the very small size of most U.S. farms. The official farm definition requires only $1,000 worth of sales to qualify as a farm. Limited sales typically result from a modest level of resources devoted to farming or from a low return on farm assets. Approximately half of U.S. farm households operated farms with sales less than $10,000. There is substantial variation among farm households in their dependence on farming. Households operating very small farms typically depend much less onfarm income than households operating larger farms (figure 1). For example, farms with sales less than $10,000 actually lost an average of $4,300 per farm from farming. Fortunately, their off-farm income averaged $50,500. Most operators of farms with sales less than $10,000 reported that they had a nonfarm occupation (59 percent) or that they were retired (27 percent). Households operating farms with sales between $10,000 and $49,999 also lost money farming, but not as much. In contrast, the share of income from farming for households operating larger farms ranged from 23 percent for households with sales between $50,000 and $99,999 to 82 percent for households with sales of $500,000 or more. Nevertheless, households operating farms in the higher sales classes still may receive substantial off-farm income, which can help buffer them from adverse conditions in the farm sector. A similar variation also occurs when examining the distribution of households by the specialization of the farm they operate (figure 2). Households operating farms that specialize in beef or "other livestock" lost money from farming, while households specializing in other commodities averaged a positive income from farming. Again, a high percentage (48 percent) of farms were in groups that lost money farming, on average. Farm Typology The National Commission on Small Farms was established in 1997 by the Secretary of Agriculture to examine issues facing small farms. In its report, A Time to Act, released in January 1998, the Commission considered a farm to be "small" if its gross sales did not exceed $250,000. The Commission set the cutoff high enough to include more farm families of relatively modest income who may need or want to improve their net farm income. As a result, the Commission's small farms category includes nine out of ten U.S. farms. In response to the Commission, ERS developed a "farm typology" that sorts farms on the basis of the major occupation of their operators, their farm sales class, and other household and farm characteristics (see box). The typology divides farms into smaller, more homogeneous groups. Typology groups with substantial average earnings from farming are: higher-sales small farms, large family farms, and very large family farms. In contrast, households operating limited-resource farms, retirement, residential/lifestyle, and lower-sales small farms received practically all their income from off-farm sources, on average. Again, households that depended heavily on off-farm income accounted for 85 percent of operator households. Economic Well-Being Earnings of the operator household from farming activities are not a complete measure of economic well-being provided by the farm. They leave out some resources the farm business makes available to the household. For example, depreciation is an expense deducted from income that may not actually be spent during the current year (see box). Nonmoney income, such as the imputed rental value of a farm-owned dwelling, is also excluded from the farm earnings measure. Nonmoney income represents a business contribution to household income because it frees up household cash that would otherwise be spent on housing. Finally, earnings of the operator household from farming activities do not reflect the large net worth and real estate base of many farm operator households. BEGIN BOX The Farm Typology Small Family Farms (sales less than $250,000) 1. Limited-resource farms. Any small farm with: (1) gross sales less than $100,000, (2) total farm assets less then $150,000, and (3) total operator household income less than $20,000. Limited- resource farmers may report farming, a nonfarm occupation, or retirement as their major occupation. 2. Retirement farms. Small farms whose operators report they are retired. (Excludes limited-resource farms operated by retired farmers.) 3. Residential/lifestyle farms. Small farms whose operators report they had a major occupation other than farming. (Excludes limited-resource farms with operators reporting a nonfarm major occupation.) 4. Farming occupation/lower-sales. Small farms with sales less than $100,000 whose operators report farming as their major occupation. (Excludes limited-resource farms whose operators report farming as their major occupation.) 5. Farming occupation/higher-sales. Small farms with sales between $100,000 and $249,999 whose operators report farming as their major occupation. Other Farms 6. Large family farms. Sales between $250,000 and $499,999. 7. Very large family farms. Sales of $500,000 or more. 8. Nonfamily farms. Farms organized as nonfamily corporations or cooperatives, as well as farms operated by hired managers. END BOX BEGIN BOX Estimating Farm Operator Household Income The Agricultural Resource Management Study (ARMS), conducted by ERS and the National Agricultural Statistics Service (NASS) provides the data necessary for estimating operator households' income. Estimates based on the ARMS differ from what would have occurred if a complete enumeration had been taken. However, the coefficient of variation (CV), a measure of sampling variability, is available from survey results. According to the guidelines for use of the ARMS, any estimate with a CV greater than 25 percent must be identified and used with care. The operator of a farm is the person who makes most of the day- to-day decisions about the farm, regardless of whether others share management responsibility. The number of farm operators is the same as the number of farms. The number of farms for which the ARMS collects household income data, however, is slightly smaller than the total count of farms. The ARMS collects information about the operator household only if the farm is organized as an individual operation, a partnership, or a family corporation. The Current Population Survey (CPS), conducted by the Bureau of the Census, is the source of official U.S. household income statistics. Thus, calculating an estimate of farm household income from the ARMS that is consistent with CPS methodology allows comparing income between farm operator households and all U.S. households. The CPS definition of farm self-employment income is net money income from the operation of a farm by a person on his or her own account. CPS self-employment income includes income received as cash, but excludes in-kind or nonmoney receipts. The CPS definition departs from a strictly cash concept by deducting depreciation, a noncash business expense, from the income of self-employed people. Farm self-employment income from ARMS is the sum of the operator household's share of adjusted farm business income, wages paid to the operator, and net rental income from renting farmland (see appendix table x). Adding other farm-related earnings of the operator household yields earnings of the operator household from farming activities. Finally, total operator household income is calculated by adding earnings from off-farm sources. END BOX Farm Business Conditions Financial Condition of U.S. Farm Businesses Are Sound Entering 1998 At the beginning of 1998, financial statements reported by farm businesses indicated that two of every three farms were in a favorable financial position, a very slight decline from a year earlier. More than half of all farms continued to report no debt outstanding on January 1, 1998. Just over 4 percent of farms reported debt-to-asset ratios greater than 70 percent, compared with 12 percent in 1987. Most farm businesses began 1998 on a sound financial footing. Even though 1997 prices for many commodities retreated from 1996's unusually high levels, a turnaround in the cattle industry and near record crop harvests generated widespread profits to the Nation's farms and ranches. But not all farmers registered a good year in 1997. This was particularly evident in the Northern Plains region, where poor growing conditions (spring flooding), and diminished wheat yields resulting from scab left many producers with substantial losses and considerable financial uncertainty entering 1998. Agriculture is a diverse sector represented by a complex mix of business enterprises. This section focuses on the income and financial condition of farming operations with $50,000 or more of gross farm sales. These farms generate the majority of economic activity in the sector. This analysis draws from data reported in USDA's 1997 Agricultural Resource Management Study (ARMS). Overall Financial Performance Even though most farm businesses are financially sound, each year some have financial difficulty. On January 1, 1998, USDA classified two of every three farm businesses (65.4 percent) in a favorable financial position (figure 1). This represents a modest decline from a year earlier when 67.9 percent of farms were considered to be in a favorable financial position, but remains one of the highest of the 1990s. These profitable, low-leveraged operations entered 1998 with sufficient funds to take advantage of investment and expansion opportunities. At the opposite extreme, 5.6 percent of farm businesses began 1998 in a vulnerable financial position. The share of vulnerable farms was slightly higher than the previous year, but below the 7.8 percent registered in 1995. While the 1998 scenario of large crops, a strong dollar, and falling exports may be reminiscent of conditions leading to the farm financial crisis of the 1980s, farm operators have since undertaken many cost-containing production adjustments. Balance sheet improvements contribute to a more financially resilient U.S. farm sector entering 1998. Overall, farm businesses are much better positioned to absorb the shock of temporary income declines than they were in the 1980s. BEGIN BOX Classification of Overall Financial Performance The following perspective on the overall financial performance of farm businesses simultaneously combines income and solvency measures. Favorable = Positive net income and a debt/asset ratio less than 0.40. Marginal income = Negative net income and a debt/asset ratio of 0.40 or less. Marginal solvency = Positive net income and debt/asset ratios above 0.40. Vulnerable = Negative net income and debt/asset ratios above 0.40. END BOX This is not to suggest that farms in all regions of the country recorded financial progress in 1997. Deterioration in overall financial performance occurred in the Lake States, Northern Plains, Corn Belt, and Pacific regions. Each of these regions exhibited an increase in the percentage of farm businesses classified in a vulnerable financial position. Despite a decline in overall financial performance, the Corn Belt retained its ranking as one of the regions with the highest percentage of financially favorable farm businesses. Farm businesses that specialized in the production of cash grains, particularly wheat and corn retreated from 1996's financial success, while beef cattle farms and ranches had noticeable improvement in overall financial performance in 1997. Producers of the major crops are not likely to fare as well in 1998. Anticipated large harvests of soybeans, wheat, and corn, coupled with declining demand in export markets, has kept downward pressure on prices through most of the summer of 1998. Despite high production levels, cash receipts for these commodities are expected to decline from 1997. Operations in regions experiencing reduced production due to crop disease, pest infestation, or dry weather could face increasing financial difficulty, since they will likely receive sharply lower prices for smaller crops. Farm Business Income Farm business before-tax earnings in 1997 were relatively consistent with the widespread profitability enjoyed in 1996 (table 1). Net farm income, a comprehensive measure of farm business profits, averaged $58,943 in 1997. This was a slight increase from 1996's $55,384 and one of the highest levels reached during the 1990s. Larger gross incomes from higher livestock sales, steady amounts of Government payments, and increased earnings from farm-related sources such as custom feeding generated an income increase that, on average, covered increased production expenses. Farm Business Balance Sheet Average net worth of farm businesses increased for the third consecutive year. Increasing farm real estate values and modest increases in debt not only spurred increases in net worth, but also helped to hold the average debt/asset ratio at 1996's 0.17. Since the late 1980s most farm businesses have been reluctant to take on burdensome debt loads. That trend continued in 1997 with more than 80 percent ending the year with a debt/asset ratio below 0.40, indicating a small potential for cash flow problems from debt commitment and relatively little risk of insolvency. Just over 4 percent of farm businesses faced risk of insolvency. This group had a debt/asset ratio above 0.70. The number of highly leveraged farms was consistent with levels observed during the previous 5 years and remains well below the mid-1980s when more than 10 percent of farms were in this position (figure 2). While the balance sheet for the farm sector as a whole is expected to show little deterioration during 1998, some farm operations will likely experience increased financial stress. Lower incomes may tax the ability of heavily indebted farmers to meet their current debt service requirements, and debt loads may increase as farmers borrow against assets to meet short term production and living expenses. Rents and land values may begin to decline in some areas if lower income and profitability levels are perceived as continuing for an extended period of time. The potential combination of higher debt loads and lower asset values would worsen the financial position of affected farm operators. Financial Performance Measures by Farm Typology Financial Performance Varies for Different Farms Classified by Farm Typology The financial condition of farm operator households and the financial performance of farms they manage differ considerably among household units classified by ERS' recently developed farm typology (see page XXX). Analysis of 1997 ARMS data illustrates the diversity of U.S. farm operations. The farm business performance analysis presented previously concentrated on the farm business income and financial condition of operations with sales of $50,000 or more. In contrast, this analysis addresses both the farm and nonfarm dimensions of all farm operator households, including those with limited farm sales. Application of farm business financial performance measures to operations in various typology classes reveals notable differences (table XX). Comparing overall financial performance with that presented in the previous section, adding farms with sales less than $50,000 to the analysis reduces the portion of farms classified as favorable and vulnerable, and increases the share of farms with both low incomes and low debt levels. This is to be expected, since many smaller farms do not produce profits in their farming activities. Over 7 percent of limited resource farms were considered vulnerable in 1997, as were about 5 percent of farms with sales over $250,000. Almost 78 percent of retirement farms were included in the favorable classification. Comparison of farm financial performance measures recommended by the Farm Financial Standards Council reveals differences in farm viability of farming units in the various typology classes. Farms with sales under $100,000, on average, run negative operating profit margins, and do not cover the full economic costs of production, generating inadequate farm income to report positive returns to assets and equity. Limited resource farms tend to operate with small asset bases, use little debt financing, and generate fairly low levels of income. Moreover, low levels of working capital suggest that these operations have little cushion for financial emergencies. The debt/asset ratio for these farms is slightly below the average for all farms. On average, these farms generate negative returns to assets and equity and off-farm income barely covers expected family living expenses. Even though retirement and residential/lifestyle farms employ more assets and generate slightly higher farm earnings, they rely on off-farm income to meet living expenses and keep farm debt levels manageable. Retirement farms appear to exercise fairly tight cost control measures, while farm income on residential/lifestyle farms falls short of operating expenses. In contrast, operators indicating farming as their primary occupation are likely to manage farms that generate sufficient income to cover operating expenses. For the 1997 calendar year, farms with sales of $100,000-$250,000 reported economic cost-to- output ratios slightly above 100 percent, indicating that they were unable to cover full economic costs of production. Generally, only farms with sales greater than $250,000 produce enough revenue to meet the full economic costs. On average, these farms have additional working capital and household off- farm income to contribute to family living expenses and to augment farm income shortfalls. Farms with sales of $250,000 or more appear to be viable self- sustaining economic units. They own assets averaging more than $1 million, have manageable debt levels, generate sufficient farm income to cover operating expenses and economic costs, and record economic profit levels that allow them to generate reasonable rates of return on assets and equity. While over 26 percent of very large farms report debt/asset ratios exceeding 40 percent, this class generates average operating profit margins of 19 percent. While farm households in these classes receive average off-farm income of $35,000, the majority of their income is from farm sources. Lenders Serve Various Farm Typology Groups The recent rise in farm debt has not been evenly spread across all farm operations. While many farmers operate with seasonal production loans that are taken out and repaid within the same calendar year, fewer than 45 percent of all 1997 ARMS farm operator respondents reported any debt outstanding as of December 31, 1997 (table XX). Outstanding loan balances for the surveyed operation's four largest loans were reported, with the credit source identified from a list of 16 potential lenders. The lender classes presented here correspond with those reported in the sector balance sheet. Yearend loan balances were reported by fewer than 20 percent of limited resource and retirement farms, but almost 80 percent of the large and very large farms reported debt outstanding on December 31, 1997. This suggests that operations incurring debt are the larger, more efficient units, which are best positioned to benefit from the strategic use of credit. Limited resource farms averaged only $9,000 in outstanding debt, and reported owing proportionally more to the Farm Service Agency and the category of Individuals and others. Banks provided over half the debt reported by retirement and residential/lifestyle farms, while the Farm Credit System furnished proportionally more of the debt owed by the three classes of farms with sales over $100,000. More than 48 percent of reported Farm Credit System debt was owed by large, very large, and nonfamily operations. The Farm Service Agency appears to be serving smaller operations, with over 62 percent of its loans going to limited resource and small farms reporting the operator's primary occupation as farming. These limited resource and small farms also accounted for about 34 percent of debt owed to both the Farm Credit System and banks. Farm Typology Groups Use Differing Levels of Debt Repayment Capacity Debt repayment capacity utilization (DRCU) for the farm sector, as presented previously, is expected to rise from 53 percent in 1997 to 61 percent in 1998. That measure is defined as the ratio of actual farm debt to the maximum feasible debt that could be supported by the current farm income of the sector. As described there, DRCU provides an historical overview of farmers' relative use of credit capacity from 1970 through the end of 1998. Data collected in the 1997 ARMS provide a more detailed analysis of DRCU, allowing the influence of off-farm income, family withdrawals (living expenses), and payment of estimated income taxes to be included in the calculation of income available for debt coverage. The maximum principal and interest payment that a farmer could make based on that income, and the maximum loan that the payment could service, can be estimated more precisely for farmers within each farm typology classification. Comparison of actual total liabilities with maximum debt supportable by income from all sources gives a more comprehensive measure of each respondent's individual DRCU. This analysis does not include any nonfarm debt owed by the farm operator's household. Including the contribution of off-farm income to farm debt service, DRCU averaged 32 percent for all farms in 1997. Retirement farms owed less than 8 percent of the debt that they could service with current income from all sources, while DRCU for limited resource operations averaged almost 60 percent. DRCU for farms reporting the operator's primary occupation as farming averaged less than 50 percent, and that of very large farms averaged 38 percent. Farms can often meet short term income shortfalls with savings and liquidation of assets. However, if DRCU exceeds 1.2 (meaning the operation owes 20 more debt than can be serviced with current income) this debt may be at risk of default. About 35 percent of the operations reporting debt outstanding at the end of 1997 had DRCU greater than 1.2, but these farms owed 48 percent of all debt. Over 80 percent of limited resource farms were in this high debt group, and these farms reported 83 percent of all debt owed by this typology class. Small farms with farming as the operator's primary occupation generally were slightly more likely to be in the high DRCU class, while large and very large farms were slightly less likely to be in this group. Impact of Reduction in Farm Income Differs by Typology The impact of hypothetical reductions in gross farm income on farmers' ability to service debt can be simulated using ARMS data. As expected, those households reliant on farm income, and with the lowest off-farm earnings, would be most affected by a fall in agricultural incomes. Smaller farms that rely extensively on farm earnings, and that lack access to off-farm employment opportunities, would be most adversely affected by declining farm income. Given a hypothetical gross farm income decline of 20 percent, average DRCU rises from 32 percent to over 40 percent. The percentage of indebted farms with DRCU greater than 1.2 rises from 35 percent to 45 percent, and share of debt held by these high debt operations rises from 48 percent to 64 percent. Farms would not be equally affected by a decline in income. For residential/lifestyle farms, which generate substantial off-farm income, the change in DRCU is negligible, rising about 1 percentage point. Farms in the larger size classes would experience an increase in DRCU from about 40 percent to about 65 percent. The impact of a 20-percent gross farm income decline on smaller farms reporting the operator's primary occupation as farming would differ considerably between high- and low-sales classes. Operations in the high sales group would see a DRCU increase from 47 percent to 71 percent, while DRCU for those in the low sales class, benefiting from slightly higher off-farm income, would rise from 40 percent to 47 percent. Sector Wealth and Financial Ratios Farm Assets, Debt, and Equity Are Expected To Continue Upward Through 1998 With the value of farm real estate rising 5-6 percent and debt increasing slightly less, equity in the sector is expected to improve. Farm business sector assets, debt and equity values continue to rise despite an environment of lower commodity prices, declining returns, lower real interest rates, and increasing market risk and uncertainty. Farm sector asset, debt and equity values reflect farm investors' and lenders' collective decisions and expectations about the relative profitability of farm and non- farm sector investments. Although 1997 U.S. farm business asset estimates have not yet been finalized, they are expected to exceed $1 trillion and forecast at $1.1 trillion for 1998. The value of farm real estate, the largest share of the sector's assets, increased 5.9 percent during 1997 and is expected to grow 5 percent in 1998. Farm business debt grew more than 6 percent in 1997 and now is expected to grow nearly 4 percent in 1998. This implies a rising net worth (equity) for the farm sector in 1997 and 1998 (FIG. A - Farm assets, debt, and equity, fig_A.wk1) Farm asset values have grown nearly 4 percent per year during the 1990s. Farm business debt is projected to have reached $165 billion by the end of 1997, and to reach over $172 billion in 1998. Despite the increase in debt, farm business balance sheets have shown steady improvement throughout the 1990s, especially since 1992. Debt-to-asset ratios have improved, as the increase in farm business debt has been more than offset by the rise in the value of farm business assets. The value of farm real estate has risen a third from 1992 through the end of 1997, while farm mortgage balances have increased less than 12 percent. As a result, the degree of U.S. farmland leverage has declined, providing most producers with an added equity cushion to lessen the impact of any short-term declines in income or asset values.. Farm Real Estate Values Rise More Slowly as Commodity Prices Decline Continued relatively strong farm income and returns to farm assets in 1997, as well as lower real interest rates, provide a foundation for rising farm real estate values in 1998. However, generally declining farm commodity prices are lowering estimates of income and returns. Several factors are key in understanding the short- and longer term outlook for farmland values: 1) the Federal Agriculture Improvement and Reform Act of 1996 (1996 Act), which fundamentally redesigns income support programs by "decoupling" program payments from program participation, 2) deregulated and expanded markets for farm credit, and 3) increased globalization of the world economy. These factors have increased the variability of returns to farm investments, but have also created new opportunities for new capital investment in the sector. U.S. agriculture, like the economy in general, has become more high-tech and increasingly export-driven. Financial markets have become more efficient and global. Connected through computer and other information technology, farm investors now have ready access to financial and commodity price data worldwide. The "decoupling" of farm commodity prices under the 1996 Act and the lowering of tariff and non-tariff barriers have helped U.S. agricultural products become more competitively priced in world markets. However, these developments have also exposed the farm sector to greater fluctuations in export demand, increasing price risk. Long-term expectations for an increasing level of farm income, stable interest rates and sufficient access to credit markets, along with the outlook for agricultural exports, are key factors supporting the demand for farmland, machinery and equipment, and other farm assets. Nonetheless, the recent world declines in commodity markets (including agricultural commodities) are lowering estimates of returns to the U.S. farm sector in 1998. Continued demand for agricultural land along the fringes of urban areas and demand for rural land for recreational purposes are also contributing to the growth in real estate values, especially in the Northeast and in some Western States. Nonreal estate values are expected to increase about $3.8 billion (1.7 percent) in 1998. The value of machinery and equipment, crops stored, purchased inputs, and financial assets are all expected to rise slightly. However, livestock and poultry inventories are expected to decline slightly. Farm Sector Equity Continues Upward Farm business equity is expected to continue rising in 1998 as farm asset values rise more rapidly than farm debt. In current dollars, sector net worth should total about $957.2 billion. Farm sector equity by the end of 1998 is expected to be almost $80 billion more than in 1996, and over $300 billion greater than the trough in 1985. The long-term farm equity comparison is a little different if the numbers are adjusted for inflation. Real farm equity in 1998 is forecast to be $849.6 billion. In 1986, farm equity had an inflation-adjusted value of $705 billion, compared with an estimated peak of almost $1.4 trillion in 1980. Consequently, farm sector wealth in 1998 is still $503 billion below the inflation-adjusted value of farm equity in 1980. Debt-to-Asset Ratio Stable Indicators measuring the solvency of the farm sector as a whole remain reasonably favorable for 1997 and 1998. The debt-to-asset ratio indicates the relative dependence of farm businesses on debt and their ability to use additional credit without impairing risk-bearing ability. The lower the debt-to-asset ratio, the greater the overall financial solvency of the farm sector. The debt-to-asset ratio is forecast to be 15.3 percent in 1997 and in 1998. The share of debt to total asset value has been declining steadily in the 1990s, from 16.5 percent in 1991. The level of this indicator of solvency has changed markedly from 1985, when the debt-to-asset ratio stood at 23 percent. The debt-to-equity ratio is forecast to be 18.0 percent in 1998, compared with 18.1 percent in 1997, and up from 17.8 in 1996. Profitability of Farm Sector Investments Reduced Rates of return on farm assets and equity, indicators of the profitability of farm sector investments, likely fell in calendar 1997. The rate of return on farm assets from current income was 3.1 percent in 1998 compared with 4.0 percent in 1997. The rate of return on farm equity from current income was 2.3 percent in 1998 compared with 3.0 percent in 1997. Both returns on assets and returns on equity from current income in 1998 will remain above the average returns earned during 1993-95. Total returns on farm business assets (including capital gains) are estimated at 6.2 percent in 1997 (with 4.0-percent growth in current income and 2.2-percent growth in capital gains). Total returns on farm business assets are forecast at 5.8 percent in 1998 (with 3.1 percent growth in current income and 2.6 percent growth in real capital gains). The "net real return on farm assets" measure of profitability includes the real capital gains component of total returns. The net real return on farm assets is the total real return on assets minus the real cost of debt. As the total real return on assets has been rising faster than the real cost of debt, the net real return on assets has been rising from negative values since 1984. The net real return on farm assets (RNROA) turned positive in 1996 (1.5 percent) and is forecast to be 1.2 percent in 1997 and 0.0 percent in 1998. This indicates that for the farm business sector as a whole, debt financing is still profitable. Correspondingly, farm business capital expenditures are forecast to remain in the $17- to $18-billion range, up from the $13- to $14-billion range in 1994-95. BEGIN BOX Measures of Farm Sector Profitability Real capital gains (losses) mean "adjusting the nominal capital gains for inflation in that year." Yearly inflation changes the purchasing power of funds tied up in assets (or debt). The real net returns on farm assets and equity are estimated as follows: For farm assets: ROACI (rate of return on assets from current income) + ROARKG (rate of return on assets from real capital gains) = ROATOT (total real rate of return on farm assets) - RELCSTDT (real cost of farm debt, which is the average interest rate on farm debt minus the real rate of return on farm debt) = RNROA (real net return on assets) or expressed slightly differently RNROA = (current income + real capital gains on assets)/total farm assets - (interest + real capital gains on debt)/total farm debt For farm equity: ROECI (rate of return on farm equity from current income) + ROERKG (rate of return on farm equity from real capital gains) = ROETOT (total real return on equity) Other Key Financial Ratios Continue To Improve Net cash flow provides an indication of the total resources available to farm businesses for investment in the farm sector, and to meet current debt obligations. Net cash flow expands upon net cash income by accounting for both internal and external sources of funds. The ratio of debt to net cash flow rose from 2.6 in 1996 to 3.0 in 1997. Debt to net cash flow is forecast to remain at 3.0 in 1998. During the 1990s, debt to net cash flow has fluctuated within a narrow range of 2.3 to 3.0. From 1980 to 1985 the ratio ranged from 4.4 to 5.9 (FIG F -- Debt-to-net cash flow). The debt-to-returns to farm assets ratio rose to 9.1 in 1995 as farm debt increased and returns to operators fell. However, the ratio fell to 5.0 in 1997 and is forecast to decline to 4.9 in 1998. This means there is $4.90 of farm debt per $1 of returns in 1998, compared with $5.00 in 1997. Conversely, there are fewer dollars of returns to meet farm debt obligations in 1998 than in 1997. END BOX BEGIN BOX Net cash flow (after interest expenses) is defined as: Net cash income + change in farm business debt + net change in other financial assets + net rent to nonoperator landlords (excluding capital consumption) - capital expenditures (excluding operator dwellings) - interest expenses (excluding operator dwellings) 1997 Sector Financial Indicators Farm Sector Net Value-Added and Net Farm Income Decline from Highs of 1996 USDA just released its 1997 estimates of national and state-level farm income. While farm income dropped from 1996, it was still the second highest in history. Net value-added and net farm income both declined by $3.5 billion in 1997, but each measure was surpassed only by the record values attained in 1996. Both measures had risen substantially from 1995 to 1996. Consequently, even though net value-added fell 3.7 percent in 1997, it was still $17.9 billion greater than in 1995. Because net value-added represents the total value of the farm sector's output of goods and services, less payments to other (non-farm) sectors of the economy, it reflects production agriculture's addition to national output. It also represents the sum of the economic returns to all the providers of factors of agricultural production: farm employees, lenders, landlords, and farm operators. The value of the sector's production (final output) increased $2.3 billion in 1997. This increase, however, was exceeded by the $5.7-billion expansion in out-of-pocket costs (intermediate consumption outlays). The result was $3.5 billion less in net value-added to be distributed among the providers of resources to the farm sector in 1997. Hired workers and lenders received 3.9 percent and 3.5 percent more for their contributions to farm production in 1997 than in 1996. By contrast, the earnings of non-operator landlords were down 7.4 percent. The decline in earnings to landlords reflected lower returns to holders of share-rent contracts, which, in turn, can be traced directly to the $3.1-billion decline in value of crop production. Most share-rent arrangements involve crops, and while the harvest of many major crops remained near or even exceeded the record levels of 1996, prices received for commodities were significantly lower than in 1996. Net farm income is that portion of net value-added earned by farm operators (defined as those individuals and entities who share in the risks of production). Typically it is the farm operators who benefit most from the increases and absorb most of the declines arising from short term, unanticipated weather and market conditions. In fact, an amount equal to the total 1997 drop in net value-added was absorbed by farm operators, as increases in factor payments to hired labor and lenders offset the lower payments to landlords. Declining prices accounted for much of the drop in net value-added in 1997 and are reflected in net farm income. Net cash income rose $4.3 billion, a 7.7-percent increase from 1996 to 1997. Net cash income is the cash earnings realized within the year from the sales of production and the conversion of assets, both inventories (in years in which reduced) and capital consumption, into cash. Net cash income, a solvency measure, represents the funds that are available to farm operators to meet family living expenses and make debt payments which, in the case of a family owned business, are not independent decisions. Net cash income, unlike net farm income, does not include the value of home consumption, changes in inventories, capital replacement, and implicit rent and expenses related to the farm operator's dwelling -- none of which reflect cash transactions during the current year. Consequently, net cash income is more appropriate as an indicator of solvency than a measure of the value of the sector's output. The value of sector output is viewed more accurately using either net value-added (for the sector) or net farm income (for operators). Net cash income exhibits less volatility than net farm income, as producers try to manage their cash flow to meet multiple objectives: payment of debt and family expenses, smoothing of year-to-year income fluctuations in order to minimize income tax liabilities, and maximizing income by postponing sales in anticipation of higher prices or accelerating sales in anticipation of lower prices. However, net cash income cannot be maintained indefinitely without being replenished through production, which would be reflected in net value-added and net farm income. Value of Agricultural Sector Output Up 1 Percent in 1997 Final agricultural sector output (the value of the agricultural sector's output of commodities and services before expenses) rose a mere $2.3 billion from 1996 to 1997, but the level in 1996 had exceeded the previous record (1994) by a whopping $20 billion. Increases of $5 billion in the value of cattle production and $3.5 billion in the value of soybean production in 1997 more than offset the declines in value of other commodities where lower prices decreased earnings. Yet, the higher value of output only partially offset the $5.7-billion increase in intermediate consumption outlays. The outcome was a $3.5-billion fall in net value-added. The total value of final 1997 crop output was down $3.1 billion, reflecting significant price declines for many major crops . In 1996, crop prices were high in the first half of the year, but began to decline in the second half. In general, lower prices continued on through 1997. Soybeans were an exception, as prices ascended to unusually rarified levels of $8 or more per bushel during the first half of 1997. Although soybean prices began tailing off in the second half of 1997, they still finished the year in a range favorable to producers. With large crop harvests in two consecutive years, farmers sold approximately what they harvested in 1997, incrementing inventories by a modest $323 million. Inclusion of the inventory change enables a full accounting of a current year's production in the tabulation of the calendar year's farm sector output. The total value of livestock production in 1997 was $4 billion higher than the previous year, the second consecutive year with a significant increase. The value of cattle produced jumped $5 billion and hog producers added another $498 million to the value of meat animal receipts. Beef cattle prices were steady throughout the year, after staging a comeback from the lows reached in first half of 1996. The $5 billion rise in cattle receipts resulted from a jump in production in response to improved market prices. Producers reversed the strategy of herd liquidation they previously had been employing to minimize the consequences of an ongoing cost-price squeeze. Market prices for hogs and broilers declined sharply in the latter half of 1997. However, the output of hogs continued to increase. The value of dairy products declined $1.8 billion. Dairy prices, after bottoming out during the first half of 1997, turned up in the summer of 1997, but not enough to bolster sagging receipts. The rapid structural change occurring in livestock production, with regional shifts in production and consolidation into large operations (examples: hogs in North Carolina and dairy in California), has led to higher production and lower prices. Restructuring will persist until higher cost production ceases in sufficient quantities to achieve an equilibrium. As an aside, a consequence of this restructuring is that a higher percentage of feed is being purchased as opposed to being grown on the farms producing the livestock. Production inputs purchased and used within the current production year, called intermediate consumption outlays in the context of value-added accounting, rose $5.7 billion (5.1 percent) in 1997. Livestock purchases were up, reflecting the upturn in the beef cycle. Expenditures related to crop production were little changed, in line with the acreage planted. Net government transactions, the net flow of funds between the agricultural and government sectors, were only $56 million in 1997, continuing a multi-year slow decline. After 10 years of running into billions of dollars, net government transactions fell below the $1 billion in 1994. By 1995, net government transactions dropped to $106 million, declining further to $98 million in 1996. Recently the agricultural sector has paid government (mostly state and local entities) nearly as much in taxes and fees as it received in (Federal) payments under various farm programs. Net government transactions reached a record high of $11 billion in 1987, in the midst of the farm sector's financial crisis. The significant decline in this measure is a reflection of both the general decrease in government payments (most of which were developed to support farm operator incomes) since 1987, and the steady growth in licensing fees and property taxes collected from the agricultural sector. (Income taxes are not included in the accounts because they are not incurred in production.) Lower government payments in the 1990s (except for 1993) were due to the relatively high commodity prices and low deficiency payments, partially the result of an expansion in demand, including growth in exports of agricultural commodities. Farm Marketing Receipts Up in 1997 World economic growth and trade liberalization have provide increased opportunities for U.S. exports. This environment translated into strong export growth for the U.S. crop and livestock sectors from the early 1990s through much of 1997, when demand was diminished by economic problems in Asia. In 1997, the value of marketings of all farm commodities rose $9.1 billion. Continuing an unbroken trend stretching back to 1994, cash receipts from sales of crops in 1997 exceeded that of the previous year by $5.5 billion. Cash receipts from crops have risen nearly 40 percent since 1990. In contrast, livestock receipts, which rose $3.6 billion in 1997, have been up and down in the 1990s. In 1997, the increases in livestock receipts were powered by a $5-billion increase in cattle sales, which were partially offset by a $1.8-billion decline in dairy product sales. Receipts from sales of meat animals were up $5.5 billion as hogs added another $500,000. Production and sales of livestock and products were up substantially across the board in 1997. Much of the production gains occurred in the second half of the year as grain prices declined, reducing the cost of feed components. Beef production rose in 1997, particularly in the third and fourth quarters, due in large part to an increase in marketings of fed cattle and the slowing in the liquidation of the cattle herd. The movement of feeder cattle into feedlots slowed in the latter part of the year but the inventory of cattle in feedlots remained high at the end of 1997. Steer prices tailed off in the fourth quarter. The expansion among hog farmers that started in the spring of 1997 continued at a rapid pace through the rest of the year and was especially apparent in the fall pig crop. The big increase in the fall pig crop substantially boosted sales and was also reflected in the end-of-year inventory of hogs and pigs on farms. Prices of hogs declined substantially in the latter half of 1997 as the growth in pork exports slowed. Broiler production continued its long-term growth trend, and egg producers expanded their flocks of layers, resulting in a noticeable increase in egg production. Farmers reaped a large harvest in 1996 and sold an unusually small percentage prior to the end of the year, postponing the sales to 1997. The unsold portion of the 1996 harvest was reflected in 1996 via additions to inventories. In 1997, the boost to cash receipts from sales of beginning-year inventories was offset by the accompanying lowering of inventories within the year. This inter-year postponement of sales shifted cash income from 1996 to 1997. Typically, an extraordinarily large harvest will generate substantial additions to inventories and then be reflected in a drawdown in inventories the following year when production returns to more normal levels. However, in 1997, production of corn (the leading crop in value of production) exceeded the 1996 crop. As a consequence, farmers sold off the big carryover from 1996 to make way for the equally large quantities of the 1997 harvests retained in yearend inventories for future sale. Consequently, the value of the change in crop inventories changed little in 1997. In 1996, strong growth in U.S. grain use supported commodity prices, and 1996 was a very favorable year for feed-crop farmers, who planted more acres, benefited from higher yields, and sold their production at high prices. Domestic and export demand were strong, with low carryin stocks. In 1997, export demand declined. Demand dropped in Asia due to regional economic problems, and competition from other exporting countries increased as the value of the dollar rose against the currencies of many other countries. It cost more to buy U.S. exports because the prospective purchaser would first have to acquire dollars to pay for the U.S. agricultural commodities and the price of the dollar had risen relative to many domestic currencies. In 1997, corn sales changed little from 1996. A continuation of corn sales at near the record set in 1996 was impressive in itself, particularly since 1996 sales had exceeded the previous record by nearly $2 billion. Production was slightly above the 1996 harvest, and prices received by producers were lower than in 1996 (particularly pre-harvest prices). Sales of soybeans were up an impressive $3.5 billion in 1997, a 24-percent gain over 1996, which had also been a record year. Soybean production also set new records in both 1996 and 1997. Farmers were able to dispose of soybean inventories carried into 1997 at exceptionally favorable prices in the first of few months of the year. Prices exceeded $8 at one point in 1997. Prices declined with the second consecutive record harvest but ranged from $6-$7 for the remainder of the year. Neither wheat nor cotton were much of a story in 1997. Prices remained steady for most of the year but began to weaken near the end as the effects of the economic crisis in Asia began to affect demand for exports. Wheat sales declined 2.6 percent and cotton sales 7.2 percent. Cotton prices did decline noticeably as the harvest progressed, which contributed to the larger drop in sales. Production and sales of perishable crops for direct human consumption supported farm income in 1997 and cushioned the adverse impacts of the more storable, major field crops on the sector's earnings from production. Sales of vegetables rose 3.5 percent in 1997 and sales of fruits and nuts rose 3.4 percent. Producers of greenhouse and nursery products have consistently achieved sales gains of around 4.5 percent in recent years and extended that trend into 1997 with a 4.8-percent gain. Total Expenses for Production Inputs and Services Rose 5 Percent in 1997 Total intermediate consumption outlays--production inputs such as feed and fertilizer and services such as repairs and custom work- -were estimated at $118.6 billion in 1997, up $5.7 billion (5.1 percent) from 1996. The increase was the largest since 1993. The biggest increase was in livestock and poultry purchases, which rose $2.5 billion. Miscellaneous expenses rose $1.5 billion. The only significant decrease was in electricity expenses, which were down $180 million. Feed expenditures were $25.2 billion in 1997, nearly unchanged from 1996. For 1993-96, feed expenses have posted the largest increase among individual production expenses. In 1996 and 1997 feed expenses stood $5.9 billion (30.5 percent) higher than in 1991. A larger proportion of animals are being raised on large, specialized operations that buy most of their feed. In addition, dairy and hog production has expanded in the Southwest and mountain areas where raising feedstuffs other than hay is uneconomical. The leveling off of feed expenses in 1997 was due to offsetting movements in quantities fed and feed prices. The number of cattle on feed was higher in each quarter of 1997 than in 1996. Hog producers responded to favorable returns due to lowered feed costs and improved pork prices in late 1996 and early 1997 by expanding herds. Although the number of dairy cows fell 1 percent, grains and concentrates fed per cow increased 2.9 percent. Poultry production continued to expand, although a slower rate. Livestock and poultry purchases rose $2.5 billion (22.5 percent) in 1997 to $13.8 billion. Interstate sales of cattle and calves1/ rose $2.2 billion (26 percent) to $10.6 billion in 1997 as average liveweights rose 8 percent and prices rose 17 percent. Prices were abnormally low in 1996, however, because unusually high slaughter rates raised beef production, dropping retail prices for beef. Prices in 1997 were still 18 percent below their 1993 peak. Prices began rising in 1997 because 1996 slaughter rates diminished the inventory of feeder cattle outside feedlots. In-shipment liveweights were up due to the tremendous increase in heifers being sent to feedlots during the year. For a second year in a row, the value of hog and pig in-shipments increased more than 50 percent. In 1997, hog prices rose 13 percent and in-shipment liveweights increased 41 percent. 1/ Interfarm sales of cattle and calves within the same State are counted as neither receipts nor expenses. Crop production expenses were mixed in 1997 as total acres planted of the major crops was virtually unchanged. Seed expenses were $6.7 billion, up 8.0 percent from a revised 1996 estimate of $6.2 billion, due primarily to price increases. Fertilizer, lime, and soil conditioner expenditures were $10.9 billion in 1997, nearly identical to 1996. Prices paid for nitrogen and mixed fertilizers, of which nitrogen is the largest component, fell . However, prices for phosphorus and potash rose. Soybeans use these two fertilizer components heavily, so the increase in soybean acres contributed to the increased use of these two primary nutrients. Expenditures for pesticides were $8.8 billion, 3.5 percent higher than in 1996. Herbicides constitute between 65 and 70 percent of pesticides applied and is the principal pesticide used on corn. The small change in corn acreage led to very little change in herbicides applied. Interest expenses were $13.7 billion, up 3.5 percent from $13.2 billion in 1996. Interest expenses have risen in each of the last 4 years after a long string of decreases from 1983 to 1993. Interest on nonreal estate debt was $7.1 billion, up 4.0 percent from $6.9 billion in 1996. However, nonreal estate interest excluding interest on Commodity Credit Corporation (CCC) loans rose only 3.4 percent. Interest on CCC loans rose nearly 40 percent in 1997, inflating the total increase. Interest on real estate debt was $6.5 billion, up from $6.4 billion in 1996. Contract and hired labor expenses were estimated at $18.6 billion in 1997, $1.1 billion higher than in 1996. Total labor expenses have risen every year since 1991. In 4 of those 6 years, total labor expenses have increased more than $975 million and 6 percent. Total labor expenses in 1997 stood $4.7 billion (nearly 34 percent) higher than in 1991. Contract labor expenses 2/, increased 21.9 percent, the largest increase since 1989. Wage rates for agricultural service workers in California, which employs more than 30 percent of such workers, rose 5.5 percent. Orange production was record large in 1997, contributing to the rise in labor expenses. Also, utilized production of noncitrus fruits (apples, grapes, and berries, for example) was up estimated up 10 percent from 1996. 3/ 2/ Under The Department of Commerce sector accounting model, contract labor is considered to be in the service sector rather than the agricultural sector. 3/ Source: Fruit and Tree Nuts, March 1998, FTS-282. Capital consumption, including operator dwellings, was estimated at $19.5 billion, up $100 million from 1996. However, operator dwelling capital consumption rose more than 6.0 percent due to a rise in operator dwelling values. Capital consumption for farm business items was $16.6 billion, down 0.4 percent. Capital consumption of service buildings decreased steadily from 1981 to 1994, as nominal new expenditures fell as low as 30 percent of their 1979 peak during 1985-92. Since 1992, service building capital consumption has been around $2.9 billion. However, while the building construction price index has risen 35 percent since 1985, capital consumption is only 84 percent of its 1985 level. After increasing $488 million to $2.2 billion in 1996, building construction reached $2.4 billion in 1997. Tractor and farm machinery capital consumption in 1997 was estimated at $10.9 billion, down from a revised estimate of $11.0 billion in 1996. After reaching a low point in 1987, tractor and farm machinery capital consumption climbed more than $1 billion to 1990. Since then, it has ranged between $10.6 and $11.0 billion. Almost all of the increase from 1987 to 1990 was due to increases in tractor capital consumption caused by double-digit hikes in tractor prices paid. Net Farm Incomes Declines in Many States in 1997 Thirty-one of the 50 States experienced declines in net farm income of varying degrees in 1997. These declines were in contrast to the across-the-board increases the prior year. To retain perspective, it is important to remember that 1996 was a truly exceptional year. Farmers benefited from high yields for major crops in 1996 and prices that remained unusually high, particularly given the high levels of production. The value of crop production soared, reflecting rebounds in acres harvested and yields for major crops, both of which had declined in 1995. Macroeconomic Influences Crop prices were much higher in the first half of 1996 relative to the same period in the prior year, and tended to remain stable in the latter half of the year despite the rebound in production. Corn and soybeans led the recovery in crop production, and producers of these two crops and hogs were among the principal beneficiaries of favorable prices. Growth in the economies of Southeast Asia in 1995, 1996, and the early months of 1997 raised demand for U.S. agricultural products and helped support commodity prices and boost farm income. The Southeast Asian economies began faltering in the summer of 1997, depressing demand for imports of agricultural commodities. Economic difficulties in Japan led to a substantial depreciation of the yen, which in turn caused declining demand within Japan for imports and simultaneously lowered the prices of Japanese exports. These consequences had a ripple effect of applying downward pressure on currency values in the countries of Southeast Asia and in larger countries such as Russia, China, and Brazil. Individuals and companies in other countries often seek to convert their capital into U.S. dollars during periods of domestic economic crises to avoid losses when local currencies depreciate. Because of the increased demand for U.S. dollars, the dollar appreciated in value against the currencies of some of the above countries. The consequence was a relative rise in export prices of U.S. agricultural products, accompanied by a drop in demand in potential importing countries and a decline in U.S. competitiveness with other exporting countries. Wheat is one of the commodities most affected by depreciating currencies because many countries export wheat. Contrasts in Conditions for Commodities There were substantial contrasts in the production and market conditions faced by farmers in 1997, depending upon the types of commodities they produced. Cattle producers experienced stable prices throughout the year, at levels significantly above the lows of 1996, and also benefited from lower feed costs as a consequence of declining grain prices. Hog producers were the beneficiaries of rising prices in the first half of 1997. With rising hog prices and low feed costs, hog producers stepped up production only to see prices drop once the extent of the production increase became known. Soybean producers experienced soaring prices in the first half of the year as world stocks dwindled, but saw prices retreat to near beginning-year levels in the latter half of the year. Perhaps wheat producers suffered the most market adversity. At the beginning of 1997 market prices were low and declined throughout the year. Reduced demand for U.S. wheat exports was a principal factor, as depreciation in currency values in many countries reduced the effective import demand by consuming countries and, at the same time, increased the competitive advantage of wheat-exporting countries. Dairy prices were affected by additional supplies of milk in States not traditionally known for dairy farming. California, in particular, has experienced a large increase in milk production. The expansion in California is occurring in large, dry-lot dairy operations. By all indications, this type of dairy operation appears to incur some of the lowest costs. The implication is that other, higher cost producers will have to leave the industry to bring price and quantity into equilibrium. This process is not unlike what has been occurring in hog production over the last 5 years and what occurred in the broiler industry several decades ago. These contrasting commodity situations yielded some distinctly different regional effects. Leading cattle States, particularly those with cow-calf operations, were the leaders in year-over-year gains in net farm income. Income was up more than 90 percent in Oklahoma and Wyoming. Income was down more than 50 percent in New York (-51 percent), Wisconsin (-66 percent) , Maine (-75 percent) , and North Dakota (-90 percent) . The first three states are traditional dairy producers, while North Dakota depends heavily on wheat sales. North Dakota wheat producers suffered a one-third drop in production due to lower yields, which meant that they had much less to sell at 1997's lower prices. Economic Indicators Reveal the Varied Effects Net value-added from production reflects the sector's contribution to the national economy and the income available to the participants in agricultural production activities. Nationally, the net value added by the agricultural sector fell 3.7 percent in 1997. But this national average masks a wide range of changes among the States, reflecting their changing values of production. Net value added rose 49 percent in Oklahoma, the largest percentage gain of any State. Four additional States had percentage increases of at least 20 percent, Wyoming (31 percent), Ohio (27 percent), Alaska (21 percent), and Kentucky (20 percent). In contrast, eight States experienced declines of at least 20 percent, led by North Dakota (-46 percent). The other six were: Maine (-32 percent), Minnesota (-25 percent) , Nebraska (-25 percent), Washington (-23 percent), Pennsylvania (-21 percent), New York (-21 percent) and Wisconsin (-20 percent). California continues to lead the Nation in cash receipts and farm income by substantial amounts, reflecting both its substantial land mass and its commodity mix, which is heavily weighted toward commodities with a high value of production per acre. California's net farm income in 1997 slipped slightly, to $5.8 billion from $5.9 billion in 1996. Iowa, with $3.7 billion, remained as the State with the second largest net farm income in 1997, despite a reduction of 6.5 percent. Two additional Sates earned at least $3.5 billion in net farm income 1997 --Texas ($3.6 billion) and North Carolina ($3.5 billion). Three additional Sates exceeded $2 billion -- Georgia, Illinois, and Nebraska. Supplementary Economic Indicators Add Perspective Net farm income statistics do not fully convey the magnitude of the economic activity represented by production agriculture. The amount of factor payments and intermediate consumptions outlays incurred in generating net farm income are supplementary indicators reflecting the level and impact of the sector's contribution to a State's economy, providing additional perspectives on the contributions of farm businesses. Payments to the owners of factors of production represent earnings of the nonoperators who do not share in the risks of production but supply land, capital, and labor employed in the farm production processes. Intermediate consumption outlays represent purchases of inputs from other sectors of the economy and produce a multiplier effect through the generation of additional profits and employment by expanding the volume of business, which in turn leads to additional purchases and business opportunities. In total, factor payments were unchanged in 1997, as an increase of 3.9 percent in expenditures for hired labor and a 3.5-percent rise in interest paid were exactly offset by a 7.4-percent drop in net rental payments to nonoperator landlords for use of their land. Labor markets were tight nationwide with the strong economy increasing demand for workers at all skill levels. Farmers were required to pay higher wages and benefits to obtain the services of laborers. The interest costs largely reflected the continuing upward trend in debt held by participants in the farm sector, as interest rates did not rise in 1997. The lower rental payments reflect the 2.7-percent drop in value of crop production, particularly in cases of share-rental arrangements, where landlords receive a portion of the harvest. In 1997, landlords shared in the substantial huge harvests but also in the misfortunes encountered in marketing their share at the lower prices available to tenants. Intermediate consumption outlays rose a solid 5.1 percent, led by expenditures for livestock purchases (up 23 percent) and contract labor (up 22 percent) . The big jump in the purchases of livestock, which consists of feeder animals and breeding stock, reflected the improved expectations of beef and hog producers. In 1997, factor payments totaled $42.9 billion. States with at least $2 billion in factor payments were California ($6.2 billion), Iowa ($2.7 billion), Illinois ($ 2.4 billion), and Texas ($2.4 billion). The agricultural sectors of the four States are quite different, which is reflected in the distribution of factor payments. In California, expenditures for hired labor comprised 69 percent of total factor payments, while net rent accounted for 11 percent. California was the only one of the four States in which factor payments rose appreciably in 1997 and the hired labor component was the reason. Factor payments declined in Iowa and Illinois because of a drop in rent paid to landlords. Net rental payments far exceeded payments to labor in both Iowa (51 percent to 10 percent) and Illinois (56 percent to 13 percent). In Texas, the three factors of production shared almost evenly in the payments. California's production mix is highly diversified and dominated by labor- intensive vegetables and specialty crops. The production mix in Iowa and Illinois is predominantly corn, soybeans, and hogs, which are conducive to mechanization, allowing capital to be substituted for labor. In Texas, the combination of cattle and cotton necessitates a more balanced employment of production factors. In 1997, intermediate consumption outlays totaled $118.6 billion. States with at least $5 billion in such purchased inputs were California ($13.5 billion), Texas ($8.7 billion), Iowa ($ 6.2 billion), Nebraska ($5.9 billion), Kansas ($5.9 billion), and Minnesota ($5.3 billion). Nationally, intermediate consumption outlays were up only 5.1 percent in 1997 and this was generally the case across the States also. Farmers were geared up for full production during 1994-97 and the vagaries of weather and market prices, occurring beyond the stage when farmers have committed to expenditure outlays, accounted for the differences in value-added and income in the 4 years. Net Value-Added Measures Changes by State Net value-added reflects the value of all goods and services produced within the year, whether sold or added to inventory, net of the production related expenses paid to other sectors of the economy (as defined by the U.S. Department of Commerce). This net value-added is affected by changes in value of output and production expenditures. California, the Nation's leader in net value-added, exhibited an increase of $118 million (1 percent) in 1997. The total value of California's farm sector production rose $1.5 billion to near $26.8 billion, and the expenditures associated with this production (intermediate consumption outlays and factor payments) was up $1.3 billion. Factor payments were up by $218 million due to the higher labor costs. The net result was a 1.7-percent decline in net farm income earned by farm operators. California produces mostly high valued commodities with much of the water requirements supplied through irrigation. As a consequence, its production is generally less susceptible to the vagaries of the weather. Except for rice, California is also not a leading grain producer, and therefore escaped the problems associated with declining grain prices that plagued the Northern Plains and to a lesser extent the Midwest, which benefited from favorable soybean market conditions. Oklahoma had the largest gain in net value-added (49 percent) . Because operators bear the risks of production and reap most of the short-term gains and losses, it is not surprising that Oklahoma's farm operators also had the biggest percentage gain in net farm income (96 percent) . Cattle comprised 46 percent of commodity sales in Oklahoma and 1997 was a good year for cattle producers. Cattle and Dairy Leading Commodities in Cash Receipts Cattle and calves remained the top generator of cash receipts for 1997, as sales surged $5 billion or 16 percent. In fact, sales of cattle and calves are still $3.3 billion or 8.3 percent below the peak attained in 1993 but 1997 represented a significant reversal of the slide. Historically, cattle production and the related herd size have followed the existence of a multiyear cycle and indications are that cattle had previously been in the downward phase of that cycle. As the largest of the animals produced in significant quantities, cattle have by far the longest gestation period and the longest growth stage, which contribute to the length of the cycle. Texas led in cattle and calf receipts with $5.8 billion, up $454 million (8.4 percent) from the prior year but still $340 million (-5.5 percent) below its 1993 peak. Nebraska ($4.4 billion) and Kansas ($4.4 billion) were the second and third leading producers of cattle. Dairy products ranked second in cash receipts, with California remaining the sales leader with over $3.6 billion. Dairy sales in California slipped $97 million (-2.6 percent) in 1997, but the State's sales have risen $955 million (36 percent) since 1993. This shift is significant both geographically in the replacement of production in the Lakes States and structurally in the production of milk via large operations. The rapid population growth in California and other adjacent States has created an explosion in the demand for dairy products sufficient to enable large dairies capable of achieving economies of scale to be cost competitive, regionally. Wisconsin was second in dairy sales but lagged considerably behind California, followed by New York, Pennsylvania, and Minnesota. These five States, the only ones with sales of dairy products exceeding $1 billion, had over 50 percent of all dairy sales. Corn and soybeans were the third- and fourth-ranked commodities in the Nation, with Iowa and Illinois the undisputed leaders in sales. Iowa's corn receipts were highest at $3.8 billion, followed by Illinois with $3.5 billion. Iowa also led in soybean sales of $3.3 billion followed by Illinois, with $3.1 billion for 1997. This is first time any States have reached $3 billion in soybean sales, which indicates how exceptional 1997 was for soybean producers. Broilers were the fifth-ranked commodity, with Georgia and Arkansas the leading producers with sales in excess of $2 billion. Alabama, North Carolina, and Mississippi each had broiler sales exceeding $1 billion. California, Texas and Iowa Leading States in Cash Receipts The top 10 States in cash receipts for all commodities in 1997 were California, Texas, Iowa, Nebraska, Illinois, Kansas, North Carolina, Minnesota, Florida, and Georgia. The share of total cash receipts derived from crop or livestock sales varied greatly among these 10 top-ranked States. California led the Nation in crop sales with $19 billion, and was the top producing State for eight of the sector's top 25 commodities: dairy products, greenhouse and nursery products, hay, grapes, tomatoes, lettuce, almonds, and strawberries. The value of California's output is high because milk and other commodities in which California is a leading producer, tend to be perishable and expensive to transport, either because they are bulky or they require special handling, such as refrigeration. Three-quarters of California's farm sales were from crops; fruits and nuts equaled 30 percent, vegetables 24 percent, and greenhouse and nursery 9 percent. Florida's pattern of cash receipts is similar to California's, with vegetables, fruits and nuts, and greenhouse and nursery accounting for 69 percent of agricultural sales. By contrast, 61 percent of Texas's cash receipts were from livestock, and 71 percent of that was cattle and calves. Over 8 percent of the Nation's livestock sales value was attributed to Texas. Iowa's sources of cash receipts are, in contrast to those of Texas, more heavily weighted to crops, which comprise 57 percent of the total. Feed grains and oilseeds represented 56 percent of Iowa's sales, while hogs accounted for 23 percent. Iowa leads the Nation in corn, soybeans, and hog sales. In 1997, 12 States had crop receipts valued in excess of $3 billion and, in order of sales, were: California, Illinois, Iowa, Texas, Florida, Nebraska, Minnesota, Kansas, Washington, Indiana, North Carolina, and Ohio. The 12 States represented 63 percent of the cash receipts earned from crop sales. High-valued fruits, vegetables, and speciality crops were the major contributors to crop cash receipts in California, Florida, Washington and North Carolina. Grains and oilseeds were the major components of cash receipts in Ohio, Indiana, Illinois, Iowa, Minnesota, Nebraska, and Kansas. The commodity mix within these and all other States is determined by comparative advantages. For example, the Midwestern States contain some of the Nation's most productive soil and receive adequate rainfall, but are too far north to produce most of the specialty crops, such as tobacco, cotton, and citrus. Ranked by cash receipts earned from livestock, the top 10 States were Texas, California, Nebraska, Iowa, Kansas, North Carolina, Wisconsin, Minnesota, Georgia, and Arkansas. Collectively, these States represented 52 percent of the livestock receipts for the Nation. Texas, Nebraska, and Kansas, ranked 1 through 3 in livestock receipts generated from cattle sales, accounting for 40 percent of total revenue from cattle and calves. The largest shares of dairy receipts were produced by California and Wisconsin. Dairy production has surged in California but declined in Wisconsin. Large dry-lot operations, which are common in California and benefit from economies of both specialization and scale, have enabled the State's producers to gain a competitive edge. Hogs, a key component of livestock sales in Iowa, have rapidly grown into the leading commodity for North Carolina. The value of hogs marketed in each State exceeded $2 billion. In 1975 North Carolina was tenth in cash receipts from hogs, accounting for 3 percent of the Nation's sales. By 1997, North Carolina was second in hog sales, representing 15 percent of the market. Broilers were the leading commodity in both Georgia and Arkansas, and the second leading commodity in receipts for North Carolina. Greenhouse and nursery production is one of the fastest growing segments of U.S. agriculture. In 1975 greenhouse and nursery products were 1.9 percent of farm sales. By 1997 they had reached 5.5 percent. In 1997, greenhouse and nursery cash receipts ranked first in farm sector sales in six States (Alaska, Connecticut, Florida, New Jersey, Oregon, Rhode Island). In all, greenhouse and nursery ranked as one of the top five commodities in agricultural sales for 23 States. A common characteristic is that most of these are coastal States, but the causality linking greenhouse/nursery production to these States is the higher density of population there. Greenhouse and nursery products tend to be bulky and perishable, making shipment over long distances costly. Net Cash Income Declined in Half of the States Net cash income was lower in 25 of the 50 States when compared to 1996, but in most cases the decline was less dramatic than the decrease in net farm income. Net cash income is a measure of solvency, in contrast to net farm income, which is a measure of the value of production after netting out all of the operator's outlays. Net cash income is the cash earnings realized within the year from the sales of production and the conversion of assets (both inventories -- in years in which reduced -- and capital consumption) into cash. a. Net cash income represents the funds that are available to farm operators to meet family living expenses and make debt payments. The decisions as to how much of the cash income to allocate to each are not independent of the other. b. Net cash income exhibits less volatility than net farm income as producers manage their cash flow for several objectives: payment of debt and family expenses, smoothing year-to-year incomes in order to minimize income taxes under progressive tax rates, and maximizing incomes by anticipating future prices-- particularly postponing sales into the next year when large harvests depress prices. c. Because it may involve a drawdown in assets, net cash income cannot be maintained for long without being replenished through production. Farmers are able to adopt strategies in managing their business activities to achieve specific cash-flow objectives, and the choice of strategy will be dependent on the production income scenario for the year. For example, farmers can adjust inventories to manage their cash income despite variability in production. Current year sales, not output, are the basis of net cash income. In 1995, farmers sold off stocks of crops, valued at $5.4 billion, which had built up from their 1994 bumper crop, thus benefiting from higher prices associated with a substantial decline in crop production in 1995. Consequently, farmers were able to maintain or increase cash receipts for major crops in 1995 despite a mediocre production year. With the rebound in crop production in 1996, farmers rebuilt crop inventories by $8.9 billion, postponing sales into the next year. This strategy frequently brings benefits in two forms: from prices that typically rebound from harvest lows in years when production is high and from smoothing their annual incomes to reduce income tax obligations under progressive tax rates. In 1997 farmers produced a second consecutive year of large crops, which is a rare occurrence. In adapting to the resulting low prices, farmers sold within the year approximately what they harvested, incrementing inventories by a modest $323 million. In essence, they emptied their storage facilities of sufficient quantities to make room for the new crop and maintained a large inventory, perhaps in hopes that market prices might rebound. To illustrate what farmers can achieve from strategies to maintain net cash income for family living expenses and debt payment, net farm income declined in 31 States while net cash income was down in only 25 states. Even more telling, the largest decline in net cash income for any State was 36 percent, while eight states suffered a drop in net farm income of at least 37 percent. The largest two declines were 75 percent in Maine and 90 percent in North Dakota. Occasionally producers find there are no strategies for managing their net cash income, and in some situations, they may not have much incentive to do so. For example, net cash income in Wyoming was up 147 percent in 1997. Prices were strong for feeder calves in 1997 and calves can't be held in inventory solely to smooth out the income flow. Consequently it was an excellent year for Wyoming's cow-calf operations. Net cash income from farming was highest in California ($6.2 billion) and exceeded $2 billion in ten additional States: Iowa ($4.6 billion), Texas ($3.8 billion), North Carolina ($3.7 billion), Nebraska ($2.9 billion), Illinois ($2.8 billion), Georgia ($2.7 billion), Kansas ($2.3 billion), Arkansas ($2.1 billion), Florida ($2.0 billion), and Ohio ($2.0 billion). Net cash income was higher than in the preceding year in all 11 States. With the possible exception of California, the combined effects of large corn and soybean crops, favorable soybean prices, and big jumps in cattle and hog production, and lower feed costs contributed to a rise of cash income in these States. Crop and Livestock Costs of Production Cost and Return Highlights by Commodity, 1997 Little change seen in 1997 production costs Costs of producing most crops and livestock commodities showed little change in 1997 with many declining slightly. Since the crop costs and returns estimates are on a per-acre basis, one does not expect major year-over-year changes. On a per bushel or per head basis, however, yields can have a dramatic effect on costs. Production cost and return estimates by region can be found in the appendix. Corn -- Average corn yields changed little from 1996 to 1997, but harvest-period prices were about 11 percent lower. Corn harvest prices fell from more than $2.80 per bushel in 1996 to about $2.50 in 1997. As a result, average returns above cash costs fell more than 20 percent from record highs in 1996. Residual returns to management and risk were down about $30 an acre to - $18.78 on average among all U.S. corn growers. At 1997 costs and yields, break-even corn prices at harvest were $1.57 to cover cash costs and $2.66 for economic costs. Despite little change in corn production costs between 1996 and 1997, declining corn prices in late 1997 likely dampened expectations for 1998. Soybeans -- Higher soybean yields in 1997 more than offset lower prices to eclipse the record returns of 1996. The average soybean yield was up about 15 percent from 1996, while the average price was down about 5 percent. The result was record cash returns of $153 per acre and returns above economic costs of nearly $40 per acre. Break-even prices at 1997 costs and yields were $2.95 per bushel for cash costs and $5.61 for economic costs, well below the $6 plus soybean prices obtained at harvest. However, declining prices late in 1997 indicate that lower returns are likely for 1998. Wheat -- Nationally, 1997 wheat production was up around 10 percent from 1996 spurred by a 22-percent increase in yields. Total cash costs rose 2 percent from 1996 while economic costs remained stable at $180 per acre. However, costs on a per bushel basis declined 15 percent, due primarily to a good winter wheat crop. The prices received at harvest averaged $3.49 per bushel, down from 1996. This was more than enough to cover cash costs, but not enough to cover total economic costs. Cotton -- Area planted to cotton continued to fall across the United States in 1997. Cotton acreage declined 100,000 acres in California because of pest problems, but acreage increased in Georgia by the same amount. Total lint production rose only slightly while per acre yields improved. Cash and economic costs at the U.S. level were roughly the same in 1997 as in 1996. Residual returns to management and risk were negative, but improved about $10 per acre. Cotton growers in the Southeast and Delta had positive residual returns in 1997. Substantially lower yields in the Southeast reduced gross value by roughly $100 per acre and residual returns were almost $100 per acre lower as a result. Delta growers had yield increases of 25 percent (more than 150 pounds per acre), and saw residual returns improve by more than $100 per acre as a result. Residual returns remained negative (but improved) for growers in the Southern Plains and the Southwest. Costs changed little in the Southern Plains, but improved yields and prices raised gross value by about $60 per acre. In the Southwest, yields improved slightly, price improved somewhat, and returns improved by about $40 per acre. Rice -- Harvest-month rice prices in 1997 rose above 1996, but lower U.S. yields kept market value about the same. Total economic costs were up slightly, however lower fertilizer and fuel expenses helped reduce variable cash expenses. Break-even rice prices at harvest were $7.82 per cwt for cash costs and $11.69 for total economic costs, compared with a harvest-month price of $10.10 per cwt. Sorghum -- Area planted to sorghum was down 25 percent from 1996, but above 1995 levels. Production was down nearly 20 percent from 1996, but substantially higher than in 1995. U.S. sorghum yields rose from 1996 to 1997 due to higher yields in the Southern Plains. Average yields fell slightly in the Central Plains, but were still considerably higher than in the Southern Plains. Average price per bushel was down about 90 cents in the Southern Plains, but less than 25 cents lower in the Central Plains. The total cash cost of producing sorghum in 1997 was almost the same as in 1996. Economic costs were only $1 per acre more in 1997 at the national level. Regionally, however, cash costs in the Southern Plains were slightly above 1996 levels while cash costs were lower in the Central Plains. Economic costs were about $7 per acre higher in the Southern Plains than in 1996. Residual returns to management and risk remained negative across the United States, declining almost $20 per acre in 1997. Sorghum growers in the Central Plains faired relatively better than growers in the Southern Plains. Central Plains growers saw receipts drop $20 per acre due to both lower price and yield. Residual returns also dropped almost $20 per acre. Barley -- Value of the 1997 barley crop at harvest time decreased 24 percent from 1996 due primarily to lower prices. Cash costs and total economic costs fell from 1996. Break-even prices at harvest were $2.61 per bushel for cash costs plus replacement and $3.60 for total economic costs, compared with a harvest-month price of $2.28 per bushel. Oats -- Oat plantings for 1997 continued to decline as in previous years. Yields and harvest-month prices were also down, reducing gross value of production. Although costs of production also decreased, the drop in gross value was larger. Residual returns to management and risk on a national level turned from positive in 1996 to negative in 1997. Sugar Beets -- U.S. sugar beet yields in 1997 were up 5 percent from 1996. Total fixed cash and economic costs and returns cannot be discussed at this time, as they depend on 1997 beet prices that are not yet available. The 1997 production costs and returns will be updated next year. Peanuts -- Area planted to peanuts rose slightly from 1996 to 1997, mostly due to continued increases in Texas. Area planted continued to fall in Georgia, North Carolina, Oklahoma, and Virginia. There was a slight decline in overall peanut production. Peanut prices were mostly unchanged. Growers in the Virginia-Carolina region continue to have the highest yields, although 1997 yields were down nearly 10 percent from 1996. Yields in the Southern Plains rose nearly 10 percent, but this region had the lowest per acre yields in the country. Total cash cost of producing peanuts was up in 1997 due to sharp increases in fixed costs. Variable cash expenses were up only slightly, but fixed cash expenses rose $30 per acre. Lower gross value and higher cash expenses led to negative residual returns to management and risk of $40 per acre at the national level. Residual returns to management and risk were negative across all regions, as well. Residual returns in the Southern Plains, while still negative, improved by $35 per acre, mostly due to improved yields. In contrast, growers in the Virginia-North Carolina region saw yields fall more than 200 pounds per acre and residual returns fell $125 per acre from 1996. Tobacco -- On a per acre basis, costs of growing both flue-cured and burley tobacco changed little in 1997. However, 1997 burley yield fell about 100 pounds and flue-cured yield rose about 150 pounds, which pushed per hundredweight costs for burley up and for flue-cured down. The estimates for flue-cured tobacco are based on new survey data from the 1996 crop. The new format of presenting the estimates is now consistent with the format for all other commodities in the costs and returns accounts. This should make it easier to compare tobacco production costs with other commodities that can be grown on the same farm. Milk -- Returns to dairying in 1997 declined in all six farm production regions. Most of the decline in returns was due to higher feed costs and lower milk prices. For farms with good supplies of homegrown forage, 1997 incomes were not tight compared with most recent years, particularly if they also produced some of their own feed grains. On the other hand, farmers who had to purchase forages were hit hard by soaring prices of dairy-quality hay. Alfalfa hay prices in 1997 averaged about a fourth higher than just 2 years earlier. A wide variety of weather-related problems limited output of top quality hay in 1997 in most regions. The impact could have been worse if another good crop of corn silage had not been available in much of the country. Returns in 1997 were not enough to alter the position of those producers under long-run income stress, even after the strong 1996 returns. However, some farms continued to expand. But the lack of assured supplies of good forage increase the risks of rapid herd expansion. Hogs -- Average hog prices during 1997 were higher than in 1996, but varied substantially. Market hog prices surged to near $60 per cwt by mid-1997 and then fell to about $70 in late 1997. As a result, the value of market hogs was largely unchanged from 1996 whereas feeder pig values rose about 25 percent. Hog production costs were generally lower due mainly to a decline in corn and soybean prices. Feed costs were about 10 percent below those in 1996. Average returns to hog production improved about $4 per cwt for farrow-to-finish operations and nearly $25 per cwt for feeder pig producers, but declined about $2 per cwt for hog finishers. However, residual returns to management and risk remained negative as they have since 1992. Negative average returns to resources used in the hog sector help explain the declining number of hog operations. The total number of U.S. hog operations fell about 11 percent from 1996 to 1997. Cow-Calf -- Based on new survey information for 1996, cash costs for U.S. cow-calf operations in 1997 increased from 1996. Although feed grain prices were lower in 1997, pasture and range conditions once again were disappointing and hay prices were at record levels, indicating very tight forage supplies. The present cattle cycle entered the liquidation phase in late 1995 and intensified in 1996 as grain stocks declined and prices set new records due to a sharp decline in the 1995/96 grain harvest. Conditions for cow-calf producers were further exacerbated by a severe drought that spread from the Southwest in late spring into the Central Plains, the heart of the cattle raising industry, by midsummer. Drought sharply reduced grazing prospects, leading to higher hay prices that forced cattlemen to cull herds sharply and retain fewer stocker cattle. Reduced forage supplies lowered the demand for stocker cattle to be retained for pasture gain and, at he same time, rapidly rising grain prices reduced the break-even prices cattle feeders could pay for feeder cattle. Beef cow slaughter in 1997 remained somewhat large as less efficient cows were culled due to continued tight forage supplies. Without larger numbers of heifers being retained and bred, beef cow numbers declined, and thus, the calf crop declined. Consequently, supplies of feeder cattle outside feedlots and available for placement declined and feeder cattle prices rose. END_OF_FILE