Debt racked up by American farmers threatens to throw the agriculture industry out of its current economic boom and into a bust, according to a new study.
Released last month by the Federal Reserve Bank of Kansas City, the report warns that if farmers use their accumulated wealth instead of profits to finance their agricultural investments, they could end up in greater debt, risk bankruptcies and suffer the potential loss of their farms.
"The big concern is for 2014 and 2015, when commodity prices are expected to fall," said Nathan Kaufman, an economist at the Fed Bank in Kansas City and a co-author of the report.
"The Department of Agriculture has predicted a 25 percent drop in farm income in 2014, and if incomes levels for farmers fall, the tendency in the past has been for them to use their savings to keep buying equipment and land and putting themselves in bigger debt. That creates a financial crisis for them."
Adding to the worries is a possible bust in farmland prices, which have had three years of double-digit growth, said Kaufman. That's key because farmland accounts for 85 percent of a farmer's assets.
"Land prices are used as collateral for many farm loans, so if they fall, that could increase the amount of debt for farmers," Kaufman added.
Kaufman's report states that accumulation of debt by farmers—along with rising interest rates—preceded economic busts in agriculture in the 1920's and 1980's following booms in the 1910's and 1970's.
A decline in farm income as well as farmland values—a land value decline of some 27 percent from 1982-1987—led to a bankruptcy rate of 23.1 per 10,000 farms in 1987, based on 2.1 million farms. That's the highest annual farm bankruptcy rate recorded, according to the USDA.
"In both cases, we saw a rise in debt and farmers using their own wealth to finance themselves and buy tractors and other farm machinery or land," said Kaufman. "A heavy debt-to-asset ratio was a key indicator of the busts."
Another concern is interest rates. If they go up, Kaufman said, they will further increase farmers' debt burden.
"Higher rates would only add to farming debt," Kaufman explained. "Rates are certainly low now but if they go up, loans would get more expensive."
High Economic Stakes
U.S. agriculture created $98.1 billion in farm income in 2011 and is responsible for 1 out of 12 jobs in the country, according to the USDA. The U.S. exported some $137 billion worth of food in 2011, a 270 percent increase from 1988.
Also at record levels is capital spending by farmers. Kaufman's study said that farm investment—securing land and machinery—has risen at its fastest pace in the last six years since the 1970's.
Any kind of economic bust in agriculture would be hard felt, said Tanya Hall, an economic research analyst at Indiana University's Kelley School of Business.
"If it happened, there would certainly be a ripple effect," Hall explained.
(Read More: Tyson Profit Misses Estimates on Switch to Chicken)
"Agriculture is a small percentage of the population as whole, but it has a lot of influence," said Hall. "Here in Indiana, agriculture had almost $40 billion in economic output and supports 190,000 jobs, so an economic shock would be greatly felt."
At most risk to being swept up in an economic collapse are younger farmers or those just starting out, said Kaufman.
"The older farmers, the ones in their 50's and 60's, remember what happened in the 80's, so they're more conservative when it comes to debt and loans, " Kaufman went on to say.
"Younger farmers see today's high farmland prices and tend to be more aggressive when it comes to using the value to get the loans, so the worry is with them getting into bigger debt," said Kaufman.
Another worry is reduced funding from Washington. Congress is currently debating a five-year agriculture bill.
In an era of decreased federal spending, the Senate version calls for roughly $2.4 billion a year in cuts to agriculture, while a House version would save $4 billion out of almost $100 billion annually. Those cuts include more than $600 million in yearly savings from cuts that took effect earlier this year.
"Whatever farm bill ends up being voted on, farmers will see a reduction of their profits because of it," said Indiana University's Hall.
Profit and Investment Cycle in Full Swing
In his report, Kaufman states that American farmers are experiencing a profit and investment cycle. Exports and strong bio-fuel demands have helped farm profits reach record levels. That in turn has produced more capital investment by farmers. For instance, tractor and combine sales were strong last year and remain so this year, according to the Association of Equipment Manufacturers.
(Read More: Cramer's Great Restaurant Growth Story)
For now, farm debt levels remain low, according to Kaufman. Banks giving loans to farmers have been cautious in their approach and are demanding higher down payments to keep debt burdens low, he said.
Moreover, Kaufman said farmers can rely on crop insurance to keep profits from falling dramatically.
Still, both Hall and Kaufman said the situation needs careful watching so farmers don't let the past become present.
"It's always a possibility that a bust could happen," said Hall. "I think the industry is aware of what happened before and is taking pains to make sure it doesn't happen again."
"We have to be prepared for something like an economic bust in farming," Kaufman said. "It's not going to happen right away but it's a real concern."