Is Reverting to the 1949 Agricultural Act Really a Possibility for Dairy Price Supports?

Program on Dairy Markets and Policy Information Letter

Is Reverting to the 1949 Agricultural Act Really a Possibility for Dairy Price Supports?

Information Letter 13-04; December 2013; Andrew M. Novakovic∗

Short answer: NO!

A year ago, as 1 January 2013 was approaching, there was much speculation about what could happen if Congress failed to either enact a new farm bill or extend the old one. In the lingo of the day, this date was referred to as the "dairy cliff". After much political bantering about the need to pass a new farm bill, the Food, Conservation and Energy Act of 2008 (FCEA) was simply extended for another 12 months by American Taxpayer Relief Act of 2012, which was signed into law on 2 January 2013. This paper slightly revises and updates a 2012 Information Letter that was written to explain the almost unimaginable possibility of reverting to agricultural price support policies passed in the wake of World War II, as required under the permanent law contained in the Agricultural Act of 1949.

September has come and gone and once again the passing marked the ending of a current farm bill, actually the last extension of a current farm bill, but with some positives that didn't exist last year. First, it looks like Congress actually will pass a farm bill, although it will likely be mid-January before the process is complete. Second, everyone in Congress, as well as USDA, gets it that reverting to permanent law is a very bad idea.

With delays and controversies abounding, there are lots of stories and comments floating around about what will or won't happen to agricultural and food programs in the absence of a new Farm Bill. The paper attempts to review what we know and what we don't know, especially as it relates to dairy programs.

The current status is this:

  • On 10 June 2013, as it did a year earlier, the Senate passed a complete "farm bill" called the Agriculture Reform, Food and Jobs Act of 2013 (S. 954; the 2012 version was S. 3240).
  • The U.S. House of Representatives passed the Federal Agriculture Reform and Risk Management (FARRM) Act of 2013 (H.R. 2642) on 11 July 2013. This bill was an amended version of the 2012 FARRM Act that was approved by the House Committee on Agriculture in 2012 (H.R. 6083), but which never made it to the floor of a House that year. A very significant difference is that H.R. 2642 was stripped of the so-called Nutrition Title (typically Title IV) concerning domestic food assistance programs, in particular the Supplemental Nutrition Assistance Program (still commonly referred to by its former name – food stamps).
  • For dairy sector interests, another major difference is that the Dairy Security Act provisions that were endorsed by the House agriculture committee were replaced by a substitute amendment called the Dairy Freedom Act. The vote was resounding and bipartisan. Both versions of a dairy title include a Dairy Producer Margin Protection Plan. The House and Senate versions of the DPMPP are similar in concept, but not identical in detail. However, the Dairy Freedom Act does not contain a Dairy Market Stabilization Plan. The Senate bill contains the full language of the Dairy Security Act, i.e., both a DPMPP and DMSP.
  • The House passed the Nutrition Reform and Work Opportunity Act of 2013 (H.R. 3102) as an alternative to a conventional farm bill Nutrition Title on 19 September 2013.
  • On 28 September 2013, after various procedural volleys between the Senate and the House, the House merged its separate farm bill and nutrition title bills into one bill, setting the stage for a conference between the House and the Senate to finally consider a complete package of agricultural and food policy legislation.
  • On 1 October 2013, the Senate (re)appointed its conferees. On 12 October 2013, the House conferees were appointed. On 30 October 2013, the Conference Committee had its first meeting to begin the process of finding a compromise to which both chambers can agree.

Speculation is running rampant about what happens next. In 2012, despite general agreement that it would be better to pass a new bill, Congress ended up doing a one-year extension of the 2008 farm bill. Once again, there is common agreement that an extension should be avoided; indeed prominent Congressional voices are insisting that they will not support another extension. In the meantime, Congress, and the agricultural conference committee has been faced with seemingly irreconcilable differences between the House and Senate versions of a new farm bill. The huge gap in SNAP is a major stumbling block but there are vexing differences in basic agricultural commodity programs as well. Although recent news reports are very encouraging about a pending deal, it is clear that the process won't be completed before 31 December.

Consequences of a Failure to Act
What about reverting to the 1949 Act? Every time Congressional farm bill deliberations get close to a 30 September deadline, the specter of reverting to permanent agricultural law, in particular the Agricultural Act of 1949, is raised like some approaching tsunami or crack in the earth. In point of fact, this kind of brinksmanship has become more the rule than the exception of late.

The 2008 Farm Bill was supposed to be a 2007 Farm Bill. In 2007, the House passed its version of a new farm bill in July. The Senate didn't get its version done until December. The 2008 Farm, Conservation and Energy Act wasn't finalized until June 2008. As this bit of drama unfolded, USDA pondered the consequences of reverting to permanent legislation. Some of the following comes from their white paper on the subject (www.usda.gov/documents/fbpaper022908.doc). The 2002 Farm Bill wasn't passed on time either.

There are several bits of permanent legislation.

Much of the price support system for crops was made permanent in the 1938 Agricultural Act. The big crops in the 1938 Act were corn, rice, wheat and cotton; in fact, they are referred to as "basic crops". The 1938 Act also has provisions for other "non-basic crops" that are supported by a form of production quotas rather than price supports. The list of non-basic crops includes butter but not farm milk or other dairy products. It includes turpentine (a wood product) and tobacco, but doesn't include soybeans. The 1949 Act is mostly remembered in dairy circles because it created and made permanent the Dairy Price Support Program, which effectively covers all milk and dairy products, not just butter. The DPSP played a role in setting a floor under the market price of milk from 1949 until 1990, when it was became so low as to be almost meaningless. The 1949 Act also added Irish potatoes and Tung nuts to the list of non-basic commodities.

The 1949 Act focuses on price supports related to parity prices, but implements them in different ways. Corn must be supported at 50-90 percent of parity, which can be achieved by loans or purchases. Wheat must be supported at 65-90 percent of parity, which can be achieved by a similar combination of loans or purchases but wheat growers are only eligible if they planted no more than their "acreage allotment". (New York had a big allotment in 1938.) Milk must be supported at 75-90 percent of parity, and this is achieved by offering to purchase commodity butter, cheddar cheese and nonfat dry milk at wholesale prices calibrated to yield the desired farm level support price for milk used in manufacturing (this translates to Class III and IV prices in today's jargon and system.)

The parity price equivalent for any of these agricultural crops or products is calculated from price data collected by the National Agricultural Statistics Service of the USDA. The general procedure is to calculate a Parity Price that essentially answers the question "how high would the price of product X have to be now to ensure that it has the same relationship to the prices farmers pay for inputs as they had during a base period when farm output selling prices were good compared to farm input buying prices". That magical time was 1910-14. In other words, the parity price is a kind of cost-of-living increase, where the cost-of-living is calculated based on a time period before horses were more common than cars, milk was delivered to your front step, and few homes were wired for electricity or had indoor plumbing.

For crop farmers, these programs are established for crop growing seasons. The definitions of marketing years vary a bit but the bottom line is that crop farmers for the current season are covered under the programs they signed up for last Spring. They wouldn't have to worry about their wheat allotment or whatever unless we somehow manage to let all of this go slack until the next planting season.

Milk, of course, is harvested daily, but it also has a "marketing year". In the 1949 Act and for the effective life of the old program, the dairy marketing year was simply the federal fiscal year, beginning on 1 October. Beginning in 1990, the establishment of a new price support level was effectively changed to 1 January. This was more a convenience of timing for that particular legislation, not some carefully considered decision about the optimal timing of price support changes for milk. The January date has since stuck. The 2008 Food, Conservation and Energy Act specifies that the Secretary shall support the prices of cheese, butter, and nonfat dry milk from 1 January 2008 through 31 December 2012. The extension that was passed as part of the American Taxpayer Relief Act of 2012 simply changes that ending year to 2013.

Thus, dairy price supports won't revert to their 1949 version until 1 January 2014, assuming there is no action by Congress to avert it before then. A literal interpretation of reverting to the 1949 Act would be that the Secretary would be obliged to announce a support price for milk of no less than 75% of the parity price for milk on 1 January, based on the parity price calculated for December 2013.

It is easy arithmetic to calculate a Parity Price for milk, using data provided monthly by the National Agricultural Statistics Service of USDA. The parity price in November 2013 is $49.60. The December number is likely to be lower, but let's use the November price as an example. The minimum support level that the Secretary could set based on that number would be $37.20 (75% of the parity price). This would roughly equate to a Class III and IV price in Federal Milk Marketing Orders or a Class 4a and 4b in California. Prices at this level for these manufactured product classes would equate to a national average price for all milk of close to $40 per cwt. This compares to a current (November) all milk, national average of about $21.

So, if there is no new legislation or an extension, does this mean dairy farmers should start planning how to spend milk checks that are about twice as large?

Although the 1949 (and 1938) programs literally become the law of the land upon expiration of the current farm bill, nothing actually happens until USDA takes certain actions. This is a tricky bit of business for the Secretary. The law is clear. It is his duty to implement the provisions of law that pertain to the US Department of Agriculture. On the other hand, establishing a genuine support price and corresponding purchase prices for dairy commodities equivalent to $37 or thereabouts for the next 12 months would create disruptions to dairy markets almost too absurd to imagine. It would kill our ability to export and invite a flood of imports. Pizza chains would be looking at recipes that don't require cheese. Burger joints would remove cheese from their menu or make it an expensive add-on. Schools would struggle to serve milk or put it in shot glasses instead of cups.

The Secretary can announce a $37 support price for milk, but until USDA announces the purchase prices for dairy commodities and releases the formal invitations for offers at those purchase prices, nothing happens to markets, other than perhaps rampant speculation. It is USDA's purchases of butter, cheese, and nonfat dry milk at specific prices that moves market prices, not a simple declaration by the Secretary about the support price for milk. USDA could take a while to get all that machinery in motion, while Congress presumably came to its senses and retroactively stopped it all.

Inasmuch as the Secretary has a fair amount of flexibility in how he implements the DPSP, it is conceivable that the Secretary might invoke a rule-making procedure to solicit comments from the industry on how to implement a required support price of $37 or whatever it might be. This could forestall actual market intervention for a period of time.

The specific calculation of dairy product purchases prices since 2000 is based on the same formulas that are used to calculate Class III and IV prices in Federal Milk Marketing Orders. The Secretary has latitude in balancing the specific combination of butter, cheese, nonfat dry milk and dry whey prices that yield the equivalent of a $37 price. Approximate values that illustrate the kinds of prices one might get from a $37 support price for milk used in manufacturing would be as follows:

  • Butter = $2.46 per pound (September price of about $1.43)
  • Nonfat dry milk = $3.11 per pound (September price of about $1.81)
  • Average of cheddar blocks and barrels = $3.22 per pound (September price of about $1.80)
  • Dry whey = $1.04 per pound (September price of about $0.58)

How these wholesale commodity prices would translate to retail prices for corresponding products is subject to a variety of factors, but it certainly would not be proportionate. Assuming retailers would keep a somewhat similar absolute margin, retail prices might be something like:

  • $4 for a pound of butter
  • $7 for a pound of cheddar cheese.
  • about $4.50 to $5 for a gallon of milk would be, based on typical relationships between retail milk prices and the class price under federal orders.

Keep in mind that doubling the farm price of milk does not double the retail price of products made from milk. Costs of packaging, transportation, refrigeration, labor, etc. do not change because of the price of the raw ingredient. The farm price of milk is generally 30-50% of the total retail price for a dairy product.

Beyond Simple Price Arithmetic

Another caveat involves the action that would be taken by marketers. In the past, USDA was often described as buying products as if it walked into a store and loaded up its grocery cart. In fact, USDA issues offers to purchase very specifically defined products, in specific containers, manufactured in inspected plants that conform to various government procurement rules. If no manufacturer cares to sell to the USDA, then there is no sale and no corresponding price effect. This actually happened in the 1980s and at times in the 1990s. During the 1990s, for example, brief periods of wholesale market weakness left manufacturers wondering if it was worth the bother to reformulate and repackage commodities for government sale.

With the opportunity to sell butter or nonfat dry milk to the government at twice the prevailing market price, it is probably hard to imagine manufacturing cooperatives not pushing all they could in Uncle Sam's direction, but even a cooperative, who wants to maximize returns to its farmer owners, would likely think twice before shorting existing customers for the short term high of selling to USDA in a program that no sane person could expect to continue for long. Dairy economists have no idea what this part of the dairy products demand curve looks like, but it is safe to say that Fonterra and every dairy buffalo owner in India would be tempted to export to the US well before US manufacturers tried to achieve $2.50 butter or $3.35 cheese (wholesale value) in US markets.

Market Incentives Under Regulated Pricing

A reinstalled Dairy Price Support Program would first affect markets by inflating the wholesale prices of dairy commodities, in particular butter, nonfat dry milk and cheddar cheese (but not dry or any other kind of whey product). These prices would in turn be reflected in the market values USDA collects under the Mandatory Dairy Price Reporting Program. Those prices in turn are used to calculate Class prices under Federal Milk Marketing Orders. What this means is that Federal Orders would ensure the very efficient transfer of wholesale prices to farm values. This also means that manufacturers of these dairy commodities would not enjoy any windfall profits on milk. Indeed, their far bigger concern would be the near obliteration of product sales if in fact market prices were raised to supported levels. Of course, manufacturers selling to the Commodity Credit Corporation under the Dairy Price Support Program would have an outlet to sell products that commercial markets eschewed, but even then there would be no great manufacturer's profit from those sales.

Processors of products not purchased by the CCC would face higher costs of milk under federal order class pricing. They would have some ability to depool (i.e. avoid federal order pricing regulations) but this is not without some consequences as well. If a DPSP implementation were persistent, federal order depooling is likely. It is not especially obvious how a manufacturer would respond to a DPSP that was in effect for a few days or a few weeks. This situation would apply to all yogurt, ice cream, other soft or perishable products, mozzarella and other non-cheddar, non-bulk cheeses, and all whey products. Fluid milk processors would not have the option of depooling and would have to simply absorb the higher prices.

Summary

If one is willing to suspend reality and just suppose the 1949 Dairy Price Support Program became effective in January 2014, it is possible to follow the rules, do some dairy arithmetic, and estimate possible prices. However, the economic consequences of doubling the farm price of milk are so far outside the range of experience it is hard to take any of the usual dairy price relationship thumb-rules seriously.

This scenario doesn't rise to the level of economic consequences ascribed to defaulting on the national debt, but it is in a similar realm of imagination. It is far easier to imagine, indeed to be confident, that Congress will pass a short-term extension and USDA will stall for time if it needs to do so.

*Andrew M. Novakovic is the E.V. Baker Professor of Agricultural Economics in the Charles H. Dyson School of Applied Economics and Management at Cornell University. The Information Letter series is intended to provide timely information or an interpretation of current events or policy development for Extension educators, industry members and other interested parties. The author reserves all copyrights on this paper, but permission is granted to quote from the paper or use figures and tables, provided appropriate attribution is made.

(1) The first time that the US government purchased dairy products in an effort to prop up the price of milk was in 1930. Following a proposal from Land O'Lakes, on 9 January 1930, the federal Farm Board made a loan to the leading butter manufacturer and cooperative to purchase surplus butter. LO’L purchased 5 million pounds during the Spring and sold it back in the Fall at a profit – in other words, market prices rose. The Agricultural Adjustment Act of 1933 once again authorized the Secretary of Agriculture to fund and use LO'L to purchase surplus butter. Eleven million pounds were purchased and donated to Federal food programs. During this time, the price of butter increased from 18 cents to 24 cents a pound - 33%. Dairy products were purchased from 1933 to 1941, but purchases were small and geared to food relief and school feeding programs. During WWII, as part of an effort to ensure that there were sufficient price incentives to maintain food production, the price of milk was supported at a level of 85% or 90% of parity by an unlimited government offer to purchase dairy commodities at correspondingly high wholesale prices. After the war, the government had intended to discontinue price-supporting activities but economic hardships in the aftermath of the war resulted in just the opposite. Price supports were made permanent, but the Secretary had rather wide discretion in setting a support price level.

(2) Actually, in late December 2012, speculators took positions on options to sell Class III milk at very high prices. Normally such options prices trade at very low cost, because they are so improbable. From 18 December to 24 December the CME price of these options rose from 1¢ to 12¢ per cwt. Buyers of these put options paid a small premium for the right to sell at a ridiculously high price. Had the DPSP actually taken effect, they would have made a lot of money. Instead, they lost their premium for the chance of the gamble.

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12.10.2013