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The Milkman Cometh

 December 31, 2012 11:01 AM

It's the 11th hour in Washington, and unless Congress acts by January 1, the US will go off a cliff … the "dairy cliff."

Like its fiscal counterpart, the dairy cliff isn't an actual cliff (nor could it be, considering milk's liquid, unless we're talking about a butter sculpture). Rather, it's the snappy term for a widely feared milk price hike should Congress not pass a new farm bill by yearend.

Currently, milk prices are (sort of) set by supply and demand. Dairy farmers sell their milk to milk marketers, who label and re-sell it to supermarkets. Farmers' selling price is technically market-based. But if it falls below a certain level, the 2008 farm bill obliges the government to support prices by purchasing US-produced butter, cheddar cheese and nonfat powdered milk at minimum per-pound prices of $1.05, $1.13 and $0.80, respectively. And if milk prices fall below the cost of feed, the government will compensate farmers for the operating loss through the "Milk Income Loss Contract Program." In short, government tinkering likely makes a gallon of your favorite milk (and many other things) pricier than it otherwise might be.

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But this system, flawed as it is, is a free-market lover's dream compared to the pricing system that takes over absent a new farm bill. No farm bill passed since the 1950s contains "permanent" agricultural policy. Rather, they all temporarily suspend (typically for five years) the Agricultural Act of 1949, our last permanent farm law. The 1949 law is a study in flawed economic policy—13 pages of arbitrary price controls and government intervention. And by its decree, "The price of whole milk, butterfat, and the products of such commodities, respectively, shall be supported at such level not in excess of 90 per centum nor less than 75 per centum of the parity price." Instead of selling to milk marketers, farmers would sell to the government "to assure an adequate supply."

"Parity price" is a piece of economic arcana—a pricing mechanism introduced in 1933's Agricultural Adjustment Act to (theoretically) protect farmers' livelihoods. The parity price of an agricultural commodity reflects, in today's dollars, the purchasing power of the value of the same commodity from 1910 to 1914. Problem is, 1910 prices reflect 1910 labor and production costs and don't account for a century of productivity gains, making parity prices far more expensive than today's market prices. In November (latest available USDA data), US dairy farmers received about $22 per hundredweight (around 12 gallons), but parity price is around $52 per hundredweight. Hence, under the 1949 system, the Department of Agriculture would have to buy milk between $39 and $47 per hundredweight, potentially more than doubling consumer prices.

That's the bad news. The good news is this is highly unlikely to happen. Congress doesn't want it to, and the 2012 farm bill's in progress. Both chambers' Agriculture Committees have passed draft legislation, and on dairy policy, the House and Senate versions are similar. Both abolish price support in favor of the "Dairy Market Stabilization Program," which would compensate farmers whose operating margins fell below $6 per hundredweight for two months or $4 per hundredweight for one month. The bills' major differences lie in proposed cuts to food stamps and crop subsidies—longstanding lightning rods, but items politicians always manage to compromise on.

But this year's compromise has been delayed as farm bill negotiations take a backseat to that other cliff—which has some worried that if fiscal cliff negotiations stretch into 2013, the farm bill will expire and milk prices will skyrocket in January. It's entirely possible the farm bill could be delayed. Maybe we go a few weeks without a new bill, or maybe Congress passes a short-term extension of the 2008 act to buy more time. Regardless, it's a stretch to imagine the 1949 policy's suddenly becoming the law of the land—especially considering everyone in Washington agrees it's utterly senseless. For one, there's simply no mechanism or infrastructure for the government to become the country's sole milk marketer overnight. Private milk marketers would keep going about their business. And the government, anticipating a new bill in short order, likely wouldn't feel compelled to start bidding the market price up to 75% or more of the parity price. A wait and see approach seems far more likely—and far more sensible.

If this seems arbitrary, remember, our nation's entire agricultural policy scheme is arbitrary. The 1949 legislation remains permanent to incentivize Congress to compromise quickly on each new farm bill—it's a poison pill. And Congress insists on temporary bills because farm policy is an excellent wedge issue for campaigning and fundraising. There's no incentive to pass sweeping, permanent, sensible agricultural policy—in politicians' view, temporary milk law does a legislative body good.  

By the way, if this all sounds familiar, it's because this is largely how legislators operate in general. Pass a long-term, permanent sensible solution? No way! Why? (To understand that, you'd have to understand how a political mind operates, which is ultimately too dark a journey for most human beings.) So, we're stuck with the five-yearly political circus and fears of agricultural market disruptions should Congress not act. But considering milk futures markets aren't fussed over the potential delay, our guess is milk lovers won't get milked.

source: Market Minder
Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by Fisher Investments or performance of its clients. Such viewpoints may change at any time without notice. Nothin herein constitutes investment advice or a recommendation to buy or sell any security ot that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.


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