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From The MPC Newsletter
January 16, 2009

Was This Wreck Predictable?  You Be The Judge
By Rob Vandenheuvel

Almost two years ago, on April 27, 2007, Geoffrey Vanden Heuvel published an article in this newsletter entitled, “Staying Profitable – An Idea.” The article opened with the following introduction:

“The dairy industry has gotten into a Boom and Bust cycle, which is getting increasingly violent with every passing turn. We had a downturn in the year 2000 and recovered in 2001. We had a downturn in 2003, that was, at least for me, twice as severe as the year 2000 downturn. We recovered in 2004/05 and went into another downturn in 2006, which we are just starting to recover from in 2007. The approximately 16 months of downturn in ‘06 and early ‘07 has been twice again as severe in terms of equity lost as was the 2003 downturn. Realistically we are probably looking at about 12 - 24 months of prosperity before we go back into the soup again. If nothing changes it is likely that the 2009 downturn will be horrific.” (Geoffrey Vanden Heuvel, 04/27/2007)

Fast forward to now. As you can see above, Fred Douma is projecting the January overbase price to be $10.40 – a level not seen since the summer of 2006. And while the milk price may be at the same level as it was in 2006, the cost of production has jumped from the $12-$13 per cwt range to the $17-18 per cwt range since then. It’s fair to say that Geoffrey’s prediction two years ago that 2009 would likely be even worse than 2006 has now painfully become a reality.

That same article included a chart (shown below) demonstrating the outlook for milk prices. The chart was created by economists at the Cornell University Program on Dairy Markets and Policy. Take a look at the gray line in the chart (the “baseline” projection). This was the projection they made if nothing was done to manage our national milk supply. While the Cornell economists may not have captured just how high and how low the market would go (the burst we got from the robust 2007 export market hadn’t been realized at the time of the modeling), that didn’t change the fact that they were able to predict – almost to the month – that we would be back in the low end of the cycle by 2009.

So their predictions were absolutely right about the timing of the current collapse; could they be right that we won’t get out of the doldrums until we’re into 2010? Only time will tell.

So what can we learn from this? First and foremost, this demonstrates that the current devastating wreck was entirely predictable. As Geoffrey wrote in the April 27, 2007 article:

“In the past when national supply exceeded demand and a correction was needed, there was a large exodus of small producers, mostly in the Midwest, which brought about the needed reduction in supply. There are no longer a large number of those types of producers around to make the adjustment. So larger, better-capitalized producers must leave the industry in order to achieve a supply reduction. Those producers do not die easily, so the economic downturn has to be that much more severe in order to break a sufficient number of producers to bring supply and demand back into balance.”

More importantly than being predictable, this experience should also demonstrate that the current wreck was entirely preventable. Again, I’ll take you back to Geoffrey’s article in 2007:

“What we need is an incentive for producers to manage supply. Europe and Canada have implemented strict production quotas to control supply. They do work, but the quota acquires a huge capital value (quota in Ontario Canada is currently selling for about $29,000 per cow) and growth of the industry is stymied. American dairy producers have never embraced this approach. We could go to a completely free market, but American producers have continued to support government regulation because of our belief that processors, if given the opportunity, would abuse their inherent market power over producers.”

As Geoffrey went on to explain, there is an idea right in the middle between mandatory quotas and a totally free market. That idea is the Growth Management Plan.

In 2007, MPC met with producer groups throughout the country to talk about the Growth Management Plan and how it would directly address the over-supply of milk that pushes our prices to the levels we’re seeing now. In those meetings, we explained that while the U.S. dairy industry needs to continue growing as our demand continues to grow, we need to be smart with our growth. The beauty of the Growth Management Plan is that it allows dairies the opportunity to grow, but in a manner that ensures there is market capacity to handle the increased production. The Growth Management Plan charges expanding dairies a “market access fee” that is redistributed to the dairies that hold their production in check. In essence, the expanding dairies are paying their fellow producers to hold their production in line to allow the market to handle the increased milk that results from the expansion.

The Growth Management Plan was a valid concept in 2007 and it’s a valid concept now in 2009. If you’re interested in reading Geoffrey’s 2007 article in full (or other information on the Growth Management Plan), you can find it on our website: http://www.milkproducerscouncil.org/GMP.htm.  With over-production back on the minds of producers throughout the country, Milk Producers Council has also contracted with Cornell University to update the modeling for the Growth Management Plan with more current information. So stay tuned…

 

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