Liu: The Cause of Recent Bank Failures and the Ripple Effect on Cotton Producers

Yangxuan Liu, Assistant Professor and Extension Economist, Department of Agricultural and Applied Economics, University of Georgia

Since March 2021, inflation has started to soar in the United States, reaching a 40-year high in June 2022 at 9.1%. History and economic theory show that if the central bank doesn’t get inflation back in place, that could result in a series of years where inflation is high and volatile. High inflation will cause economic hardship, eroding purchasing power, discouraging capital investment, and melting the economy. Thus, Fed remains strongly committed to returning inflation to the two percent goal. To quell inflation, the Fed hiked interest rates nine times over the last year, raising the Federal Funds Target Rate from 0.25% during the pandemic to 5% since March 22, 2023. Reducing inflation requires interest rates to remain relatively high for a long time. Fed expects the Federal Funds Target Rate to be 5.1% at the end of this year, 4.3% at the end of 2024, and 3.1% at the end of 2025. A high interest rate is likely to require a period of below trend GDP growth in the United States and some softening in labor market conditions.

The fast pace of rate hikes to fight inflation has its economic consequences, including the recent events of bank failures of Signature Bank and the Silicon Valley Bank. These two banks had significant exposure to the technology sector or cryptocurrency, whose business models are more sensitive to interest rate hikes. The ripple effects of 2023 bank failures are too soon to determine. But banking failures will likely result in tighter credit conditions for households and businesses, which would tighten financial conditions in the United States, including slowing down economic outcomes and weighing on labor market demand and inflation.

For cotton producers, what do these mean, and how would these economic events impact them? As discretionary items, the demand for cotton and cotton-related products tends to follow the economy. With the possibility of slowing down the economy, demand for cotton would possibly be on a declining trend, which would put downward pressure on cotton prices. As shown in Figure 1, since the U.S. Department of Agriculture (USDA) first reported the projection of the total cotton production, demand, and ending stocks for the 2022/2023 crop year, USDA has adjusted the total demand downward each month, reflecting a decline in U.S. cotton demand. Meanwhile, the building up of U.S. ending stocks in each month’s projection, especially in recent months, reflects the increased availability of cotton. With lower demand and higher availability, cotton prices are expected to drop. The current USDA price forecast for the 2022/2023 cotton crop is 83.0 cents per pound. This price forecast is before factoring in the recent events of the bank failures, which created a lot more uncertainty for the economy and, thus, resulted in more volatility in cotton prices. In addition, borrowing costs would remain at a relatively high level for an extended period for cotton producers. With the federal funds rate expected to remain relatively high until the end of 2025, cotton producers need sound financial risk management strategies in battling against high borrowing costs.

Figure 1. 2022/2023 monthly U.S. cotton production, total demand, and ending stock projections by U.S. Department of Agriculture. Total cotton demand includes domestic use and exports. The production and total demand are labeled on the left Y-axis, and the ending stock is labeled on the right Y-axis. Data retrieved from U.S. Department of Agriculture, World Agricultural Supply and Demand Estimates Reports (May 2022 – March 2023).

Yangxuan Liu
University of Georgia
Assistant Professor and Extension Economist, Department of Agricultural and Applied Economics