Dairy economic crisis: Two eras compared

Using the milk-feed price ratio as a measure, the ongoing dairy economic crisis could rank among the worst, according to a USDA report. “A Collapse in Demand Distinguishes the Current Dairy Crisis from the  56-Month Crisis of 1972-1977,” by Dale Leuck, dairy economist, with USDA’s Farm Service Agency, was included in the Oct. 16 USDA dairy outlook report.

The report notes that, at 1.5, the milk-feed price ratio, a widely used indicator of profitability in the dairy sector, reached its lowest level in nearly 35 years in May 2009. The ratio has been below the long-term average of 2.74 for 21 consecutive months, from January 2008 through September 2009.

Leuck places dairy’s current economic crisis “at least a close second” to a 56-month crisis that extended from December 1972 through July 1977.

Comparing eras: Similarities

The current crisis shares one characteristic with the crisis of 1972-1977 – and has one important difference, Leuck noted.  The similarity is that both crises were at least partially precipitated by sharp increases in dairy feed costs.  Feed costs had been relatively stable from January 1970 through the fall of 1972.  However, as news of sudden and significant feed and food grain purchases by the (now) former Soviet Union as a result of several years of poor harvests emerged in late 1972, feed prices began to sharply increase.  With continued shortfalls in its grain production, the Soviet Union remained a major purchaser of U.S. feed and food grains, contributing to dairy feed ration costs that more than doubled by August 1974.  The dairy feed ration cost remained quite variable during the early crisis and thereafter, but at around a level roughly double its pre-crisis level.

Between the fall of 1972 and August 1973, the milk-feed price ratio dropped to 1.6 from near its long-term average of 2.74.  The decline occurred entirely because of the sudden increase in dairy feed costs, as the all-milk price generally continued to increase.

The milk-feed price ratio then began to increase in August 1973 as a result of higher dairy support prices (tied to parity) mandated in the 1973 Farm Bill.  In spite of the 1973 Farm Bill and other policies aimed at ameliorating this earlier dairy crisis, the crisis

persisted for an additional 3 years, which were characterized by general inflation and a 16-month recession extending from November 1973 to March 1975.  However, an important underlying cause of the 1972-1977 dairy crisis was that the

dairy sector had not adjusted to a doubling of its feed costs.

The current dairy crisis was also precipitated by higher feed costs, but initially these were largely offset by a nearly concurrent dairy-price-enhancing-surge of dairy product exports.  The cost of dairy feed doubled from a relatively stable average of about $4/cwt. from early 1998 to summer 2006, to more than $8/cwt. by spring 2008.  The sharply higher feed costs were not trade-induced as in the 1970s, but occurred at least partially because of policies that mandated higher ethanol use, along with higher oil prices that also encouraged more use of ethanol and strong grain exports encouraged by a weak U.S. dollar.

Increases in feed prices that began in the fall of 2006 were followed by proportionately greater increases in the all-milk price, as U.S dairy products surged onto world markets in 2007 that were growing as a result of strong world economic growth, a favorable U.S. exchange rate, and reduced supplies among major U.S. dairy competitors in Oceania (Livestock, Dairy, and Poultry Outlook. June 17, Special Section: Dairy Trade, at http://usda.mannlib.cornell.edu/MannUsda/viewDocumentInfo.do?documentID=1350).

Comparing eras: Differences

The major difference between the current dairy crisis and the 1972-1977 crisis is that this year’s collapse in the all-milk price was brought about partially by the collapse in world demand and partly by decreased domestic demand as a result of the U.S. recession.  While feed prices have also declined from their high in early 2009, they have not fallen in proportion to the decline in the all milk price.  USDA forecasts that feed prices are likely to remain significantly higher next year and into the foreseeable future than they were in the 8 years preceding the beginning of the increase in grain prices in fall 2006 (http://www.usda.gov/oce/commodity/).  Thus, in response to the current crisis, dairy producers must not only adapt to higher feed prices but also to international demand, which is unlikely to return to the 2007 level in the near future because of slower global economic growth and a resumption of more-normal dairy production in Oceania.

How long will it last?

While milk prices are forecast to increase and feed prices are expected to remain low relative to early-2009 levels for the remainder of this year and through at least 2010, the milk-feed price ratio is unlikely to exceed 2.74 before the end of 2010, based on October World Ag Supply and Demand Estimate forecasts.  The milk-feed price ratio would therefore remain below its long-term average for at least an additional 15 months.  Added to the 21 months from January 2008 through September 2009 in which it has already been below its long-term average, that would place it at least 36 months below its long-term average, making this crisis a close second as the worst dairy crisis in more than 40 years.

The August 2009 ERS Farm Income release projects average net dairy farm income down 94% in 2009, to $9,200 from $152,000 in 2008. (http://www.ers.usda.gov/Briefing/FarmIncome/Gallery/businessincome.htm).

The milk-feed-price ratio is published by NASS, and is defined as the number of pounds of a 16% protein mixed dairy feed equal

in value to the value of 1 pound of whole milk.  The price of commercial prepared dairy feed is based on current U.S. prices received for corn, soybeans and alfalfa hay.  The modeled feed uses 51% corn, 8% soybeans and 41% alfalfa hay.

Prior to 1984, NASS used a survey to determine the price paid by farmers for 16% protein mixed dairy feed.  That series was discontinued in the mid-1980’s and replaced by the current formula that uses the prices of corn, soybeans, and alfalfa hay.   Leuck recalculated the milk-feed-price ratio for months prior to January 1984 from data provided by the University of Wisconsin website that estimates the price of a 16% protein mixed dairy feed ration (http://future.aae.wisc.edu/tab/costs.html#16)  using the current NASS method to develop to long-term consistent price series for the milk-feed-price ratio.  The recalculated series indicates that the milk-feed-price ratio in May and June of 2009 was the lowest since August 1974, while the unadjusted series as reported by NASS indicated that the milk-feed-price ratio in May and June of 2009 was the lowest since December 1983.