Tuesday, 6 October 2009

Dairy bubble starts to pop – and guess who’s holding the pin?

The housing bubble went pop a long time ago, and now the dairy bubble is starting to burst.  The Crafars are the tip of a $28 billion pyramid of debt – a pyramid propped up by the very assets that have been inflated by all that debt.  I blogged about this back in June [Read the post: The credit/debt delusion: The faster you go, the bigger the mess]:

    “New Zealand farmers are in debt to the tune of $45 billion, 61% of which is in the dairy sector, leaving dairy farmers ‘reliant on continuing asset gains as income was never going to meet debt-servicing commitments’.  In other words, we’re looking at an agricultural debt bubble that is only being held up by an agricultural asset bubble that the debt itself has helped to inflate.
    “Oh dangerous times.
    “Many farmers have apparently been riding the bubble -- ‘farming for asset gains’ the Agriculture Production Economics report calls it – leaving them exposed on three fronts . . .”

  Home Paddock says “the announcement that Crafar Farms has been put into receivership is not unexpected.”  She got that right. The Crafars’ collapse indicates the first major signal that defeat on all three fronts is now upon us:

    “Bernard Hickey [analyses] the problems with the operation . . .      However [says Home Paddock], it’s not the size of individual farms or operations that’s the problem, it’s the rapid growth of dairying which has led to a shortage of good staff.”

Are you surprised?  Mainstream economists might be, but this is precisely what Austrian economists expect to see as the “rapid growth” of a credit-created boom turns into debt-based bust.   You see, Austrian economists understand two relevant things here that mainstreamers don’t:

  1. The first result of debt-based monetary expansion is that those borrowers who are ‘first in’ get first use of the new money before the inflationary results of that monetary expansion are noticed through the rest of the economy.  But the inflation of prices in the class of assets in which the new debt is invested is inevitable – even if it is confused for “growth” and “prosperity” instead of simply price inflation.
  2. The reason for the inevitable bust is not simply that these asset prices are inflated beyond real values.  It’s that the resources don’t exist to allow all the projects that the money has been borrowed for to be completed.

The first point is the problem of ‘farming for asset gains’ which I’ve already talked about before.  It’s this second point that Home Paddock identifies, and which I want to talk about here: that when all that “rapid growth” is happening, the resources necessary for all that growth don’t actually exist in either the quantities or at the prices that all the borrowers’ plans require..

Resources are now too short to complete all the projects all the dairy farmers planned, because the newly-created money funding all the new projects wasn’t funded out of the pool of real savings, but out of debt-backed credit created out of thin air – it’s what Austrian economists like George Reisman call counterfeit capital.  And since it’s unbacked by real resources, the resources for these new projects have to be bid away from where they used to be.

Now being ‘first users’ of all the counterfeit capital dairy farmers were certainly able (for a while at least) to bid resources away from those who hadn’t borrowed so heavily, and (for a while at least) were able to delude themselves that all was well, but in the end the resources simply don’t exist to allow all the projects they were planning on to be completed.

Home Paddock highlights the shortage of good staff. As Gene Callahan explains here so concisely,  that’s precisely the sort of shortage every debt-financed bubble inevitably experiences. The economy simply “runs out of gas.”

This is an important point to grasp about the booms created by our fractional reserve banking system, in which debt-based money is simply created out of thin air under the aegis of the Reserve Bank: that the resources don’t exist to allow all the projects backed by that newly created credit to be completed. It’s this shortage that is the primary cause of the inevitable busts of every credit-created boom.

If the credit was funded out of the pool of real savings however, then this problem wouldn’t exist. The pool of real savings would have been built up as a result of savers who abstained from current consumption -- allowing entrepreneurs to put those physical resources into long-term productive — and, the entrepreneur hopes, profitable — pursuits in the meantime.  But this is not the case in the fractional reserve system – the new money hasn’t appeared because consumers forewent their consumption, so those resources on which the borrowers relied are needed elsewhere, and it’s precisely the long-term projects that are crying out for them that suffer. As Tom Woods explains (based on the insights of Ludwig Von Mises), the entrepreneurs have been deluded by the artificially lower interest rates of the counterfeit capital into starting more projects than the economy can finish:

    “Mises draws an analogy between an economy under the influence of artificially low interest rates and a homebuilder who believes he has more resources—more bricks, say—than he really does. He will build a house much different than he would have chosen if he had known his true supply of bricks. But he will not be able to complete this larger house, so the sooner he discovers his true brick supply the better, for then he can adjust his production plans before too many of his resources are squandered. If he only finds out in the final stages, he will have to destroy everything but the foundation, and will be poorer for his malinvestment.”

In the case of New Zealand’s dairy farmers, one of the “bricks” on which they obviously relied was good staff – and in the end there’s not enough of them to go round.   A shortage of good staff is the primary resource of which they’re short.

And the really sad thing is that this effects good operators as well as bad: since those who have borrowed heavily are able to bid staff and other resources away from those who haven’t, the inevitable price competition acts to raise costs for both kinds of operations. And as resources become more and more scarce – as the “bricks” of each operation become harder and harder to come by – ( as Gene Callahan explains) the bottom lines of both kinds of operators suffer.

Essentially you discover at the fag-end of the whole process of credit expansion that all the new credit that fuelled the boom hasn’t actually funded new production at all : it’s simply inflated the prices of assets, it’s raised costs all round, and it’s funded increased consumption all round – including the consumption of real capital.

As Frank Shostak points out, everybody eventually discovers they’ve been robbed. Every entrepreneur discovers the resources weren’t all there, and certainly not  at the prices he planned on; everybody holding dollars discovers that their purchasing power has been diluted by all this new unbacked money; and everyone holding assets discovers all the price gains they’ve been celebrating have only been an illusion.

In other words, everyone’s been “robbed by means of loose monetary policy.”

So if you want to get angry at someone, don’t get angry at the Crafars – get angry at those responsible for creating all the credit-backed profligacy: at the denizens of the Reserve Bank.

It was them who inflated the bubble.  It’s reality that’s now holding the pin.


  1. In other words, everyone’s been “robbed by means of loose monetary policy.”

    So if you want to get angry at someone, don’t get angry at the Crafars – get angry at those responsible for creating all the credit-backed profligacy: at the denizens of the Reserve Bank.

    It was them who inflated the bubble.

    No - RBNZ takes *some* blame but personal responsibility rests on the Crafar's and their ilk.

    Citigroup warned about dairy conversions here years ago - just as they warned about Finance Companies and related party lending. In both cases they were roundly vilified at the time.

    So greed from both parties comes into it I'm afraid.

  2. Note of course that the Crafars were not real dairy farmers, but a breed of property developers, that instead of traditional property such as housing estates, office blocks or apartments, constructed dairy farms out of previously marginal land. They not only ran into problems because of financial over expansion they also had their 'leaky building' problems in compliance issues with environmental and animal health standards.

    To the analysis can be further added that the State itself competes in the labour market problems in the farming industry by providing a raft of income streams that do not require one to get out of bed at 4am.

  3. I think you are talking through a hole in your arse.

    Crafar's represent an extreme case of agricultural incompetence coupled with very high leverage. They have been known for at least twenty years as the 'factory farmers' of the dairy industry and the only surprise is that they haven't fallen long ago.

    The reality is that banks are working with their highly geared clients and those who are prepared to take the tough decisions to change management styles and cut costs continue to enjoy the confidence of their bankers. Those who have their heads in the sand will be forced out but they are very few.

    You will not see a spectacular bursting of any bubble.

    When are you starting writing for the Sunday Star Times?

  4. Adolf, you said, "I think you are talking through a hole in your arse."


    So there's been no credit-backed growth at all in dairying in recent years? No noteable asset price inflation? No troubles meeting debt-servicing commitments? No malinvestments? No shortage of skilled staff to keep the expansion rolling, and the SPCA away from the farm gates?

    Yes, you're probably right. The Crafars are just bad apples. Their story of expansion and collapse is unique,and has no bearing on any other facts.

    If you really believe that, then look again at all the figures -- and look more closely too at Gene Callahan's example (to which I linked) of Sensible Software, Inc., and the effect on it of Dotty Dotcom. If you'd like to make the example more concrete, call the two something closer to home: maybe something like Discerning Dairying and Crafars' Cows.

  5. "Citigroup warned about dairy conversions here years ago".

    That's interesting. If so they were likely right. They were certainly correct about the Chrysler Corp. back in the '80s. Chrysler were close to bankruptcy during at the time. They approached the federal government for emergency loans. At the time Citi said that the govt should not get into lending money to industry and definately not to Chrysler. They lobbied hard and long against Chrysler receiving govt loans. Not the job of govt to bail out failing businesses they said. Moral Hazard. Market needs to be allowed reallocate the resources to the more efficient uses. Taxpayer funds shouldn't be used like that. And so on...

    Not so many years later Citi got into untold trouble itself. How swiftly they approached the govt and begged for a bailout. My how their arguments changed then...



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