Is Market Speculation the School Yard Bully in the Dairy Industry?
By Kelly Moss, Owner of Mountain Shadow Dairy, LLC
Remember those see-saws on the playgrounds? Those were a lot of fun and worked pretty well when they were balanced with equally sized kids on each end. Unfortunately they could cause some pain and discomfort when one side was manned by a bully that would jump off when you were at the top, letting you come crashing down. That's kind of what it felt like in the dairy industry from 2008 to 2010. 2008 ended with all-time record milk prices accompanied by record feed prices, only to have milk prices plummet as we entered 2009. This caused many of us to wonder if we were living in a nightmare that we couldn't wake up from. All of agriculture in Arizona felt the pain.
Remember those see-saws on the playgrounds? Those were a lot of fun and worked pretty well when they were balanced with equally sized kids on each end. Unfortunately they could cause some pain and discomfort when one side was manned by a bully that would jump off when you were at the top, letting you come crashing down. That's kind of what it felt like in the dairy industry from 2008 to 2010. 2008 ended with all-time record milk prices accompanied by record feed prices, only to have milk prices plummet as we entered 2009. This caused many of us to wonder if we were living in a nightmare that we couldn't wake up from. All of agriculture in Arizona felt the pain.
We couldn't afford to keep milking at such a loss, yet we couldn't cut our losses by selling out because the cows, facilities and real estate had lost huge values as well. Some arizona agriculture producers were able to cut their losses and exit the industry with the help of the Cooperatives Working Together (CWT) program, yet most just continued to burn equity hoping that at some point the markets would readjust and at least return to break even before the equity ran out. This has obviously caused all of us in the industry to look for answers to the question, "What is causing all this wild fluctuation in the milk price?"
Historically, government support price has served the purpose of balancing the market, since production and demand cycle differently. Demand for fluid milk increases with the start of the school year, while butter and cheese demand increases around the winter holidays. Milk production usually peaks in the spring. Interestingly, when the program was first initiated, it was reported to have served both to stabilize prices and to generate a profit for the federal government. Unfortunately, over the years the focus changed from a market stabilization approach to an income enhancement program, with all the inherent politics.
Historically, government support price has served the purpose of balancing the market, since production and demand cycle differently. Demand for fluid milk increases with the start of the school year, while butter and cheese demand increases around the winter holidays. Milk production usually peaks in the spring. Interestingly, when the program was first initiated, it was reported to have served both to stabilize prices and to generate a profit for the federal government. Unfortunately, over the years the focus changed from a market stabilization approach to an income enhancement program, with all the inherent politics.
The extreme volatility in our milk prices began in the early 1990s following a couple of major changes. The first major change occurred with the lowering of the government support price in 1990 to $10.10 per hundred weight followed by a drop to $9.90 in 1996, where it remains to this day. The second major change was the introduction of futures contracts for dairy products in 1993. Looking at the graph nearby, one has to wonder which of those two changes are the most responsible for the volatility that we see today.
It is quite apparent that the volatility of milk pricing began with the lowering of the support price, but the ever increasing magnitude of the price swings followed the advent of futures trading for dairy products. Throughout history, market speculators have been reviled. Vladimir Lenin said, “For as long as we fail to treat speculators the way they deserve—with a bullet in the head—we will not get anywhere at all.” Even Abraham Lincoln was quoted as saying, “For my part, I wish every one of them [speculators] had his devilish head shot off.” After all, doesn't it seem logical that market speculation by traders who have “no skin in the game” could be responsible for the volatility that we see? These speculators are rewarded by market volatility. If the market were steady, there would be no incentive to trade. The question remains, “Are they responsible for the volatility?”
In the 1950s, U.S. onion farmers were faced with price volatility, as well, during which time onion futures began trading. Speculation was blamed for the volatility and shortly after it began, onion trading was outlawed by an act of Congress for the reason “that speculative activity in the futures markets causes such severe and unwarranted fluctuations in the price of cash onions…[a] complete prohibition of onion futures trading in order to assure the orderly flow of onions in interstate commerce” was enacted (United States Congress, 1958, p. 1). As a result, some claimed this as moderated volatility; while others claimed the opposite.
It is quite apparent that the volatility of milk pricing began with the lowering of the support price, but the ever increasing magnitude of the price swings followed the advent of futures trading for dairy products. Throughout history, market speculators have been reviled. Vladimir Lenin said, “For as long as we fail to treat speculators the way they deserve—with a bullet in the head—we will not get anywhere at all.” Even Abraham Lincoln was quoted as saying, “For my part, I wish every one of them [speculators] had his devilish head shot off.” After all, doesn't it seem logical that market speculation by traders who have “no skin in the game” could be responsible for the volatility that we see? These speculators are rewarded by market volatility. If the market were steady, there would be no incentive to trade. The question remains, “Are they responsible for the volatility?”
In the 1950s, U.S. onion farmers were faced with price volatility, as well, during which time onion futures began trading. Speculation was blamed for the volatility and shortly after it began, onion trading was outlawed by an act of Congress for the reason “that speculative activity in the futures markets causes such severe and unwarranted fluctuations in the price of cash onions…[a] complete prohibition of onion futures trading in order to assure the orderly flow of onions in interstate commerce” was enacted (United States Congress, 1958, p. 1). As a result, some claimed this as moderated volatility; while others claimed the opposite.
Nearby is a graph of the onion prices over a period of 28 years comparing them to oil, which is a heavily traded commodity. Interestingly, the onion fluctuation looks much worse than our milk price fluctuation over this same time period.
So what is the answer? Do speculators cause the volatility or not? After looking at the issue a little closer, I am beginning to suspect that while speculation may be responsible for some short term runs either up or down, over the long haul it really just boils down to the market forces of supply and demand. Should we try to get the speculators out of our market? Probably not. We probably only have ourselves to blame for much of our volatility. Our best bet as producers would be to exercise some self control and restraint over our natural tendency to overproduce while the market is hot, while at the same time pursuing increased sales of our products both domestically and in foreign markets.
So what is the answer? Do speculators cause the volatility or not? After looking at the issue a little closer, I am beginning to suspect that while speculation may be responsible for some short term runs either up or down, over the long haul it really just boils down to the market forces of supply and demand. Should we try to get the speculators out of our market? Probably not. We probably only have ourselves to blame for much of our volatility. Our best bet as producers would be to exercise some self control and restraint over our natural tendency to overproduce while the market is hot, while at the same time pursuing increased sales of our products both domestically and in foreign markets.
