A special guest joins this mostly macro-level episode of The Milk Check. Dr. Andrew Novakovic compares today’s inflation with U.S. inflation eras past, and the group examines evidence toward the unlikelihood of another Great Recession as well as downward pressure holding back a forceful economic rebound.
Both Ted Jr. and T3 still see some upside in dairy markets, Dr. Novakovic sees a continuation of the trend toward larger farms finding more success and T3 expects inflation to “pull back significantly.” To close out the podcast, Ted Jr. and Dr. Novakovic talk Federal Orders, “urgent marketing” and the challenges in removing or updating federal regulations and/or terms of trade.
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T3: Hello and welcome, everybody, to the Milk Check podcast. This month, we have the pleasure of welcoming Dr. Andrew Novakovic, professor emeritus at the Dyson School at Cornell University, professor of dairy markets and policy. Andy, it’s a pleasure for us to have you on our podcast this month. Thank you very much for joining us.
Dr. Andrew Novakovic: Yeah. It’s always a pleasure to work with you guys, and I’m anxious to see where the conversation goes.
T3: So we also have, besides the usual suspects, my father and Anna, Josh White, and Jacob Menge from our trading team are joining us as well. So I’d like to start off this conversation this month, Andy, by asking you a question that’s been on my mind since you and I were talking a couple of months ago, and you mentioned this almost as a passing comment, but it really piqued my interest. And it was this. We were talking about inflation and how inflation was probably going to affect our economy. And you mentioned that the inflation we’re going through this time in 2022 is a lot more like the inflation of the 1940s and ’50s than it is like the inflation of the 1970s and ’80s. What did you mean by that? What’s the difference? What are we experiencing right now?
Dr. Andrew Novakovic: So of course, inflation means that prices pretty much across the board are rising, so it’s not a sector event. It’s not we had a bad corn crop, and that’s having an impact on beef. It’s something broad. So what kind of things have that broad sweep of effect? And like so many thing in economics, there’s a supply side and a demand side that could theoretically be at play. And a lot of times when we look at inflationary periods, they come from a certain amount of government overheating, fiscal policy that’s relaxed where money is kept in consumer pockets, as opposed to going into government coffers.
So we reduce taxes, and people get to keep more in their pocketbook, or we spend money in a way that gains income for people. It might be through jobs, it might be through direct income subsidies or what have you. Those people go out and spend that money, and that heats up the economy.
The other inflationary route is supply side, which is leading to cost. And there was an element of the ’70s that for sure does relate to what we see now, and that’s energy. OPEC had been around for a while. Their obvious goal was to monopolize, to a certain degree, world oil markets. The first time they tried that, it didn’t really work. But in the ’70s, they started to get their act together. And those of us who lived through that time can remember just this catapulting of gasoline prices going from 20, 30 cents a gallon to over a dollar a gallon. You had to change all the pumps to put on an extra digit. That was pretty remarkable. And of course, energy is a big part of what’s going on now.
But when we were talking, what struck me is that when you think of all the supply chain stuff that’s occurring now, lot has to do with labor, but computer chips and resin availability for plastics, and just a variety of things that are impacting supply chain. That reminds me a little bit more of post world war disruptions that we saw in the late teens, early ’20s. Late teens also was a pandemic period, so there were some labor issues there. Following World War II, we also had some supply chain stuff. And the American economy was humming along, but it was humming along to supply material for the war. And switching that, while at the same time you’re swapping out jobs with veterans coming back and many women exiting the workforce, created a period of some supply chain disruption. And that’s a part that I see being a little bit more similar to what we see now, which had really nothing to do with what was going on in the ’70s, which was the last big inflationary period in fairly recent memory.
T3: So in the 1970s and early ’80s, that was… They call it stagflation because there were both high prices, but there was also high unemployment. 1940s, 1950s, there wasn’t a high unemployment issue. Is that another part that’s similar?
Dr. Andrew Novakovic: Yes, indeed. And again, part of it is not only how many people are working, but how many people want to work. And as we came in post World War II, there was a reshuffling. And part of it was women in the workforce, and women were incredibly involved during the wartime effort, but a lot of those women voluntarily exited the workforce, and that was fine. As we got back into the ’80s and ’90s, the big revelation was women coming back into the workforce, and so that really changed that equation. So we got to keep both of those pieces in mind.
But the economy was growing. Europe especially, Japan to a certain degree, Asia, East Asia to a certain degree, did not have the ability to [inaudible 00:04:35] their economies. And so we became suppliers to the world. America in 1950 was just astonishingly different from America in 1940, politically, diplomatically, economically. So part of it was our growth, but part of it was the absence of folks that would be otherwise competitors in world markets. And so that was a period of tremendous growth, a little reshuffling of the labor force, but really no big problem with employment or lack of jobs to be sure.
T3: So in the 1940s and early ’50s, that led to almost two decades of unprecedented growth for the American economy. Are we potentially in the same situation today? Or what are some of the differences, if our growth rate may not be as good as it was back then?
Dr. Andrew Novakovic: Yeah, it’s an interesting question. We took leaps forward during the 1940s as a country in many different ways, but in no small way, really unleashing the capacity of Americans and the American economy to be productive. Interestingly, we saw evidence of that during the Civil War 100 years earlier, but at that point it was the North that was the economic powerhouse, whereas the South was more agriculturally oriented and lacked a lot of those same materials. But we stretched ourselves, at least in the North, during the Civil War and got a taste of that. During World War II, it was really the entire country coming together and making investments and leaping forward.
And as an academic, maybe it’s predictable that I’d be the one to say this, but no small part of what we accomplished in terms of economic growth in the ’50s was because of that investment in technology and science and industry that we did because we were more or less forced to by the war effort. It’s maybe a little hard to appreciate, but we did not enter World War II supremely confident we were going to win. This notion of pulling out all the stops and we’ll worry about how we pay for it later, and it’s time to make big moves forward was the order of the day.
And I don’t see that quite now. We’ve had impressive, regular, predictable technology improvement, and I think there’s a real sense that the winners in the 21st century economy will be the ones who grasp and develop technology most impressively, but it doesn’t feel like quite that rocket launching off the tarmac scenario that we had in the ’50s now. And with the bottlenecks on chips, concerns about the availability of rare materials that are needed to pull together a lot of this modern technology, that’s going to be a little bit of a brake while we’re also trying to mash our foot on the accelerator.
Jacob: Let me add one thing that is the starkest difference here. And I do love some of the manufacturing stories. You have Frigidaire, the appliance manufacturer, making machine guns for the war effort. They got a ton of money poured in and were able to diversify, but the catapult you mentioned, being blunt, it’s largely because our manufacturing sector wasn’t obliterated in the war.
Dr. Andrew Novakovic: Yeah.
Jacob: That’s really what the US’s leg up was, the reason we were very fortunate. And I would argue was probably the single largest factor in our catapult, if you will, after. And what is a similar catalyst today? I couldn’t point one out.
T3: So with that in mind, how do we think inflation plays out over the next five to 10 years?
Dr. Andrew Novakovic: Yeah. Well, there’s two questions, aren’t there? One is what do we see in terms of inflation, and whether or not it leads to recession. Both important questions, somewhat related, although not necessarily cause and effect.
I guess I’m in the economics camp that’s fairly optimistic. I think we’re going to get through our supply chain problems. I think energy is going to sort itself out. I’m a little surprised we haven’t seen more response in energy production with these higher prices, but I think part of the explanation for that, and I’m no expert in this area, is so much of the petroleum-based energy industries have been taken a step back because of the electrification of the economy, that making long term investments and what seems to be likely to be a declining demand sector didn’t make any sense. So that could be solving of the energy discretion caused by Russia. May take a little while to dig out of, but at the end of the day, in the short term, we’ve got plenty of energy resources.
Dr. Andrew Novakovic: So I don’t see that as being a huge restriction. And again, not my area of expertise, but the physical availability of rare materials on planet Earth, nevermind the fact that a lot of them are located in parts of the world that we don’t have good access to, is also, I think, somewhat of an upper bound constraint on our ability to solve some of these bottlenecks that we’re seeing now. So while I’m optimistic, I am mindful that there are at least speed bumps, if not fences along the way.
Ted Jr: It looks to me that we’re probably entering a mild period of either consolidation or recession, but there certainly isn’t any layman brothers involved in what we got right now. We may see some inflation. We’ve got to burn off all the money that was pumped in to keep the economy floating during the COVID period. And there’s an adjustment, I think, that’s going to be necessary, but it’s hard to imagine that we’ll see a collapse similar to 2007 and ’08. I don’t think the mechanics are there for that.
Dr. Andrew Novakovic: Yeah, I agree. The financial phenomenon that led to the great recession just is remarkably different from what we’re looking at today. So the indications are quarter one, economic growth was down one point something percent. A lot of folks are expecting that quarter two is going to come in down about the same amount, which this starts to feel like a recessionary trend, but the people who are very thoughtful about the economy and look at the numbers and think about it, I think are all pretty much expecting that whatever slowdown we have is not going to be dramatic, that there’s too many factors in place for a lift. And it’s not a bubble, as Ted was pointing out.
Ted Jr: So is it the issue that we need to address is how does this affect the dairy farmer?
Dr. Andrew Novakovic: Yeah. Well, chime in, guys, any time you’re ready. But one of the things that’s obviously-
Ted Jr: You lead off, Andy.
Dr. Andrew Novakovic: One of the things that’s obviously going to be an issue that we’ve almost forgotten about could even happen is interest rates. Borrowing money is going to be a thing you got to think about pretty carefully, whereas for a good chunk of time, you were nuts if you weren’t pouring money into your business because money was so cheap.
Other things are going to be expensive too. One of the things I’ve been talking about for well over a decade now is increasing automation of agriculture. Robotic milking is the poster child for that, but there’s just all kinds of ways in which this occurs. What people are doing with tractors, for a kid that grew up on a two plow tractor, dragging something behind you for hours on end to get a field plowed, it’s just astonishing to think about what we can do with those mechanics. People get all excited about some Google car bumping around on the lamppost and saying he did a pretty good job. Ought to see what John Deere is doing out in the fields.
So that’s all to the good, but if there’s a supply chain bottleneck that slow the adoption of that, that’s going to make some difference in how quickly we can accomplish all that. And I’m sure we’re going down that road, but it’s maybe a little slower than if we had our druthers.
So that’s going to be part of the constraint on agriculture, unless we have some really massively interventionist agricultural policy that specifically puts money towards smaller scale farmers. I don’t see any change in the trend towards larger scale farmers being able to prosper and thrive under the challenges that are coming in front of us, including meeting environmental requirements. I think there’s very few things a large farmer can’t do well compared to a small farmer, except for the fact of being small itself.
T3: One of the things that I think at some point, and I don’t know if this is in the next five years, in the next 10 years, in the next 30 years, but that I do think I’m starting to see a limit on in terms of growth, is I’m not seeing the land availability necessary to scale a dairy farm to the size, in order to continue the growth curve that we’re on. And I’d even say money’s part of it. There’s ways to come up with the money. I’m talking about putting the land together to do it. As our population continues to increase, the size of individual plots of land actually continues to decrease. And at some point, you just don’t have the ability to put together the 10,000, however many acres necessary to build a really large scale dairy farm, especially when you tie it from a feed supply perspective.
Dr. Andrew Novakovic: Yeah. There’s two things at play here, it seems to me. Land obviously, but water, big time.
Land without water is a sandbox. It’s not the place where you’re going to do much with cows, unless you bring all the feed in. And this water availability issue is not just some Central Valley, California thing. This is very much the Western states. Texas is seeing almost obscene levels of growth, to the point where they don’t even know what to do with all the milk that’s coming on there. And they’re having water issues and will increasingly. So, there’s a part of me that looks at that and says areas of the country that arguably could support growth, have had growth, may find that a whole lot harder as water becomes at least more expensive, or at most realistically, not available.
I think there’s a flip side of that coin that says, gosh, I drive due west of Milwaukee and my hometown where I lived in the ’50s and ’60s, and I’m stunned at some of the most fertile land in the state that’s now growing million dollar houses, and that’s not coming back. But then you go look at Kansas, Nebraska, South Dakota, and you got to say, yeah, getting land out there is a different proposition than getting land in Southeastern Wisconsin, or pick whatever favorite state you have. I think that’s where we’re going to start seeing more of this growth, where the open land and availability of water meeting a happy boundary.
T3: In California-
Dr. Andrew Novakovic: You start seeing those Western states decline, that’ll be another question.
T3: I think California may be our test case of urban needs for water versus farmer needs for water, the way things are going up in the Central Valley.
Dr. Andrew Novakovic: Oh yeah, absolutely. And I’m sure my California friends wouldn’t be super happy to hear me say this, but I’ll just go on record and say we don’t need the state of California for milk production, but we need them for lettuce and citrus fruits and a whole bunch of other stuff that I am not going to be producing in the Northeast or the upper Midwest.
Ted Jr: That’s a good way to put it. It’s interesting to see the demographics of the industry change over the years. And remember we used to have, back in the ’50s, the dairy country was the rolling hills, even almost semi mountainous, where Eastern Tennessee and Western Carolinas and Kentucky, there was a thriving dairy industry in that whole area.
And then it gradually, over the next 30, 40 years, migrated more towards the corn and bean country, where they could raise seed. And thus came California as the leading dairy producer in the country. And I got to wonder now if, particularly in view of the water issues, and maybe this time they’re serious. We’ve heard water issues from California since day one, but it looks like this time, it might be a serious issue. So you wonder if maybe that’s not starting to move back towards production more in the upper Midwest, particularly in the I-29 corridor and in that area. It just looks to me like that migration not only is caused by feed, but also by pricing and by hauling. Look at the changes now that doubling, or probably more accurately tripling, of the hauling rates have caused with regard to where you’re going to buy your cheese. It’s going to make a difference in the industry as to how it progresses coming forward. And so, the issue from our perspective is how are we going to keep up to it, because we’re obviously going to have to adjust.
Dr. Andrew Novakovic: Yep.
Josh: I have been shockingly quiet. The main reason, I think that my kids will be quick to say that I’m old and half of the people on here will laugh, and the other half will maybe agree. The message is there’s a lot of 40-somethings that have no idea how to deal with inflation. None. It’s completely disrupting our decision-making model.
And what I mean by that is you have an entire third generation of dairy farming families, that their decision making model is built on cheap interest rates, large scale expansion, and now they’re asking questions. Does that make sense? Does it make sense to sign paperwork for a dairy in two years? You’ve got large grain farms that are renting a lot of ground. Their decision-making model’s a little bit disrupted. Do we want to continue to do this? What does all this mean?
And I think there’s two ways to learn, it’s experience and studying it. And there’s a lot of us two decades removed from the university that are studying pretty hard right now. And so, I just don’t think that we can ignore the fact that there’s a lot of people out there that this is something that our parents experienced, and they know they can manage it. We’re at least taking pause and trying to figure out what this means for our business decisions going forward.
Jacob: So I want to just ask the question to the group then. Yeah, inflation is tough to deal with as business, but the bottom line is real interest rates have gone down. Inflation is outpacing what the interest rates are doing. It’s not telling you to go to cash. Even though the interest rates are marginally better, it’s still saying you got to fight inflation some other way, because it just doesn’t pay to sit in a savings account yet. So what do you do? Why wouldn’t you keep investing in your business? This is what I would push back on.
Dr. Andrew Novakovic: Yeah. Fair point.
T3: I’d agree with that. The only pushback I’d give on you, Jake, is I wonder how much those measurements were not accounting into the proper lag, in terms of how changes in interest rates lagged inflationary growth and economic growth. If we already know that we raised inflation or interest rates enough that the housing market has significantly pulled back, the mortgage refinancing market has significantly pulled back. I think the private equity leveraged buyout equity markets have significantly pulled back, all because interest rates are higher. That’s going to ultimately trickle through the economy, infect everybody. So I think ultimately, we get back to inflation slightly exceeding interest rates or interest rates exceeding.
Jacob: Interesting. So you think either inflation… So let’s just say really all you can earn on your money today is 2% at best. I guess it could be a little more if you do a CD or something like that, but really 2, 3%, let’s just call it. So you are proposing inflation drops below that, and the rates stay that high?
T3: I would actually say it differently. I am expecting inflation to pull back significantly in the next 12 months, back to something in the 2 to 3% range. I will qualify that by saying I’ve got the same challenge that the Fed does, which is once you start changing interest rates and other things, you’re never quite sure how much it’s going to react. So I don’t know exactly what it’s going to pull back to, but I think the effect is already getting baked in. We just haven’t seen the measurements of that result yet.
Dr. Andrew Novakovic: Which I think reminds us that the notion of using interest rates or monetary policy to either stimulate or retard the economy, that’s pretty well understood. And folks that pay attention to that stuff have a sense of what the levers are, but it’s still a lot of art. It’s not just all science. And I think there are delays in response.
The Fed watchers seem to be pretty convinced that the Fed is going to continue to move interest rates up. And I think Teddy’s point is it’s not unbelievable that they would be moving them up beyond or longer than actually might prove to be necessary. It’s just hard to anticipate when that magic moment is.
The other thing that strikes me is the United States of America is made up of households that have astonishingly different profiles when it comes to household income. I’m sure Jeff Bezos and Warren Buffett and pick your list of favorites, are going to have some massive amounts of red on some spreadsheet. And who cares? Those guys are not going to be wondering where their next carton of milk is coming from at any scenario. But for a lot of more modest income folks, these inflationary trends and what happens with interest rates are a big deal. And it doesn’t really make a hell of a lot of difference what’s going on in the stock market or in your savings account if you only got one paycheck’s worth of savings to begin with.
T3: I would agree with that. So what do we think dairy prices will do? With the background of this discussion about inflation, what do we think dairy prices will do between now and the end of the year and into 2023? And I’ll go on record in saying my gut all along has been… We went from about $16 Class III milk in the summer of 2021 to $26 milk in the summer of 2022. And I do expect us to pull about halfway back, so it might be something right around 20 to 21, but then is that enough? Or do we have to pull back more, or do we bounce off that and go right back to where we are? And how much of that is due to the demand side that has to do with the inflation that we’re experiencing today in the supply side, which is the reality that we’re not seeing much in terms of any anticipated significant increases in milk production in the next 12 to 18 months? Who wants to go first?
Ted Jr: You want me to take it?
T3: Go for it.
Ted Jr: You’re always on the other side of the fence. I tend to think that if the recessionary reaction is mild, we’re going to see increasing in dairy prices. We’re not looking at $30 cwt, but I don’t think that all of a sudden people are going to start switching to oat milk or switching to cheaper alternatives and so on in mass. I do think that there will be an adjustment, probably in the form of a lower upside than we have been expecting. We’ve been expecting the upside to be much higher. The issue that is how strong will the fourth quarter be. And I guess from my perspective, given the fact that cheese is our big item, and while cheese inventories right now are longer, it’s hard to imagine that suddenly, all of these sales are going to disappear and we’re not going to see a relatively strong market at the end of the third quarter and through the fourth quarter.
T3: Dad, this may surprise you, but I actually think you’re exactly right.
Ted Jr: Andy, Ted always thinks the cheese market milk prices are, are just ready to bottom out.
T3: I believe that we’re not going to see a huge increase in the unemployment rate due to the increase in interest rates. And I want to qualify that. Interest rates have gone up, certain industries have had to pull back. That will affect the growth rate negatively. But those people who find themselves out of a job because of the way their particular businesses were affected by an increase in interest rates are still going to be able to find another job because the backlog of available jobs of companies looking to hire is so large that I don’t think people are going to find themselves out of work for a very long period of time, which means that we have this pullback, and then we get our legs again and shoot forward.
Ted Jr: You’re right. But on the other hand, right now the… And I’m not sure how to interpret this, but the workforce is what, 60 odd percent of the available people are in the workforce. That’s a very low number. If these people suddenly jump into the workforce, when they find out that their checks from various sources are not forthcoming, then how is that going to affect the unemployment rate and the overall economy?
T3: Well, the thing about that 60% is this. I’m going to ask you and Andy the same question. Are either of you going back to work any time soon?
Ted Jr: No.
Dr. Andrew Novakovic: I don’t know about your dad, but it looks to me like he hasn’t exactly completely left.
T3: But that’s my point. The reason that number’s dropped so much is because people are living longer but not necessarily retiring significantly later than they used to. And so a larger percentage of the total population is retired today. And there’s not a big structural change in the percentage of people between the ages of 20 and let’s say 70 that aren’t working. If anything, it’s increased because you have more and more women in the workforce. But I don’t think… as low as 60% is, I think it’s a demographics issue. I don’t think it’s changing anytime soon. Going up, at least.
Ted Jr: A lot of trucks that need to be repainted when all this occurs, because on the back of every truck you see, they’re guaranteed that their drivers are home on the weekend and they’re going to earn $100,000 a year. This is going to have to run its course.
Josh: Ted, to pull it back, you were asking about dairy pricing the rest of the year. Cheese has come off quite a bit. Is that enough to stimulate some demand? And then secondly, what happens when this crazy summer travel ends? It’s pretty well predicted that travel is going to slow down pretty dramatically once the fall comes on. Does that stimulate buying of cheese because you’re around the house more? I still haven’t ever got a clear answer on, do people consume more cheese at home?
T3: I think what we learned during the pandemic is that people consume different cheese at home than they do when they’re out. They consume a lot more mozzarella when they’re eating out and a lot more cheddar when they’re eating at home. The good news is I think we have more than an adequate supply of cheddar in storage right now to handle that.
Dr. Andrew Novakovic: I think you guys are all touching the elephant, but in different places. Because nobody has said anything that isn’t right, but it’s right in different circumstances. And again, I’m going to come back to the fact that there’s lots of different kind of consumers out there. I’m guessing that most of us on the screen here, if you want to go into a grocery store and buy some piece of cheese you really like, you just buy it. You don’t really agonize over what the price per pound is. On the other hand, there are families who do not have that luxury, and they’re going to down trade. They’re going to skip cheddar cheese that they normally buy and start buying American. Not because they like it better, but because they can afford it, and they can make as many sandwiches for their kids to go off to school with and so on.
One of the big phenomenons of the last few years, even with very little inflation, is shrink inflation, putting stuff in smaller packages. That’s been fooling folks a little bit as to what the price of stuff is, but that’s obviously a strategy that’s being done because sellers are concerned that their customers are price sensitive, particularly for signal items, things that you buy with some frequency.
The good news is price inflation on food is considerably less than price inflation in other parts of the dairy economy. Price inflation on dairy products, as much as we talk about it, is considerably less than what we’re seeing for meat and vegetables. So is it higher? Yes, but it’s still a pretty good buy, and you don’t buy this stuff in isolation. You buy it relative to what else is available out there. There’s positives, but we have to recognize that there are certain challenges and that they don’t fall equally on different families.
T3: I think that’s a really good point.
Ted Jr: I think it’s a good point also. Do you mind if I switch gears a little bit and ask Andy a question, Teddy?
T3: Go for it.
Ted Jr: We’re seeing a continuing drop in Class I sales, and we’re seeing a reduced percentage of participation now in the federal order, some of which is due to the fact that de-pooling is increasing because of the lower subsidy or impact of the producer settlement fund from the premium on Class I sales. What’s your feeling as to how this is going to play out? I asked this because in Hoard’s Dairyman, there’s an article on how the dairyman will react in the event of the collapse of the federal order. And I know there are a lot of dairymen that are, particularly larger dairymen, who think that this is going to be such a good thing. And I’m, of course, not persuaded that they really understand what they’re talking about.
Dr. Andrew Novakovic: Be careful what you ask for, huh?
Ted Jr: Yeah.
Dr. Andrew Novakovic: Yeah. Well, you just asked about 19 questions, so there’s a lot of moving parts in all of this. Let me go with the one about what are the benefits of some regulation and maybe be a little vague about just exactly what this regulation is, but something that impacts how the terms of trade are established between a buyer and a seller in the dairy industry. We’ve got minimum pricing. Maybe we could do some other things or different versions of that thing.
And I think this goes back to what led to this pricing system and ultimately federal intervention in the first place, and that is this overarching sense that dairy farmers have a hard time representing themselves in the marketplace when it comes to buying and selling milk. And I think there’s a number of really reasonable reasons for this that… I hesitate to use the word unique, but really are relatively unique for dairy.
Not the least of which is it’s an incredibly bulky product that’s highly perishable and has really no feasible storage opportunities on the farm. This leads to a condition I call urgent marketing. And you couple that with the fact that certainly historically, dairy farmers were so busy making milk, they didn’t really have a whole lot of extra time to think about marketing milk. In today’s world, it’s a little bit different. You’ve got people that not only can be managers, but they can hire managers. So that’s changed a bit, but this urgent marketing situation hasn’t changed fundamentally. And I think that is a key factor in putting farmers at a disadvantage. So some thing that levels that playing field, I think has some appeal.
And you might say, “Well, what about this guy? He’s got 100,000 cows. Okay, he’s selling to Walmart.” I don’t care if he’s got 100,000 cows. His buyer is still got a heck of a lot more leverage than he does. And at the end of the day, if he’s too much of a nuisance, they’re just going to run up their own dairy farms.
So I don’t really see the change in technology, the change in farm scale as really fundamentally assaulting this issue that economists refer to as oligopsony, the buyer having a marketing advantage. The question is, what can you do about that?
Over 100 years ago, there were farmers that came together in small scale cooperatives that hatched this idea of classified pricing and pooling. And that was driven by the notion that customers all the way down to consumers are less fussy about price on beverage milk, because it’s a staple good, you feed it to your children. Of course, you don’t want to pay anymore than you have to. But if you’re asked to pay a little bit more, it isn’t going to damage sales all that much. There was this intrinsic understanding, before words like elasticity of demand were even used, there was this intrinsic understanding that there was this capability. So this system was developed. Pooling, of course, if you differentiate a price and one guy gets a high price and another guy gets a low price, if you don’t share those revenues, the low guy is just going to come after your market. That’s going to be self-defeating. So bam, before long, you’ve got classified pricing and pooling.
This started in the private sector 40 years before Franklin Roosevelt and the Congress of the 1930s decided to codify it into law as a federal program. This was organically developed by sellers in this marketplace. Now it’s been taken over by the government, and everybody thinks it’s been forever, that somewhere after Adam and Eve walked out through the gate, we had federal orders, and it’s not really how it worked.
Could we get along without it? I’m one of the first guys to say if we abolished all this stuff, I’m still going to be able to walk to the grocery store and buy a carton of milk. I think doomsday scenarios about getting rid of this stuff is going to be horrible are a bit of a stretch, but that doesn’t mean it doesn’t have consequences, that it wouldn’t make a difference in how milk is produced, who’s producing it, who’s making the money and so on. And we can see evidence of how this has rolled out in other countries around the world that have had a degree of regulation, maybe not that different from us, and have taken it away and what’s happened.
And in England, you’ve got grocery stores, literally grocery stores, buying milk from farmers and using processors as tolling agents. In Australia in the last couple years, they’ve developed a pretty serious expansion of their commercial code to create special requirements for dairy. It would be like amending the UCC. Well, in fact, the Edge Cooperative recently came out with a list of things that they thought would be pretty cool to do. Almost all of that stuff is really about the uniformed commercial code. It’s not about Federal Milk Marketing Orders. It’s about transparency in contracting, and everybody gets the same deal. That’s not federal order stuff, that’s terms of trade UCC stuff.
So if we didn’t do this thing, I think it’d be very tempting to do something else to get to this similar end of how do you deal with a situation that inherently makes it tough for a dairy farmer to negotiate a reasonable price over time.
Ted Jr: Andy, do you think that the minimum price requirements have lived to see this problem? What’s happened with the minimum requirements under the order? And what’s happened is that you have supplying Walmart, for example, you supply them when they want it. And then you undertake balancing obligations for when they don’t want it. Well, Walmart means, okay, I’ll be obligated under the minimum price, but I don’t have to undertake any of the balancing obligations. And so, the supplier then is obligated to have a dryer. Cheese plants serve a limited balancing function, but mostly it’s, for a cost reason, it’s the dryer that does the balancing.
And so we wind up with this fork price system, the classified pricing system, in order to accommodate a minimum price under the order. There’s areas there which we might be able to be a little bit creative. Maybe the minimum price would only, and this is just for example, Monday through Friday, you have the minimum price under the order, but Saturday and Sunday, Walmart could buy it at a negotiated price. Something like that, which takes the balancing obligation and transfers it from one to the other and also presents the opportunity maybe for the bottled milk business to get some of their customers back. I’m just looking down the road a little bit, and what we’re doing right now ain’t working. Obviously, there’s going to need to be a solution coming forward sometime.
Dr. Andrew Novakovic: Yeah. It’s a very interesting question. One of the things that strikes me is a lot of people can think of eight ways from Sunday why they don’t like the system we have, but then when you start talking about, okay, what would be better? Oh man, it’s pretty hard to get any kind of agreement.
And if you’ve developed a competitive advantage because you understand this system, or at least you maybe think you do, but maybe you actually, really do, then what exactly is your incentive to give that up? To say let’s abolish it and just have everybody start from scratch with something new? So there’s some stickiness to maintaining the system. That doesn’t deny that there’s some challenges.
But the other thing that also strikes me, and you guys are one of the few entities that really has a broad perspective, but when you start saying, okay, what’s the issue in your area? What’s the problem with federal orders? Holy gamole, you get a completely different answer if you’re in Tennessee or Texas or California or North Dakota or New York. And yeah, how about that Class I market? Okay. All right. We’re going to… Yeah. How about it? But it’s a different answer after that, when you go in into these very different areas. What makes a lot of sense to the folks in the Southeast isn’t going to make any darn sense whatsoever in the upper Midwest. Trying to think through what the answer is really begs us coming back to making sure we understood what the question was in the first place.
The other thing that I think is very interesting is you look at the upper Midwest order. Poor Vic Halverson has just got a bunch of mail in his mailbox about making it even easier to pool milk in the upper Midwest because Class I is getting smaller all the time. And how much money do you get on a pool draw in the upper Midwest anymore? It’s pennies, right? And yet everybody wants to be in, unless Class III is a bad deal, and then they want a de-pool. But take that aside, you got a whole lot of milk that’s in the upper Midwest order that has no remote chance whatsoever shipping milk to a Class I plant. Well, why is that? I step back and say, you tell me your reason, but there’s a reason why you’re there that’s different than the Class I price. There’s something else that you see a value besides the Class I price and the pool draw. What is that thing? I could think of several answers, but my point is there’s more to why you might like this regulation or favor it than just what’s going on with Class I.
Ted Jr: I think one of the things… You’re very astute in the reference. One of the things that a lot of dairy farmers look at is they think the federal order system is there to increase their price. The classified pricing system means that his customer doesn’t have to invest in two outlets. He can spend a half a billion dollars building a cheese plant, but he doesn’t have to spend another 300 or 400 million to build a butter powder plant to go with it. And of course, that logic is lost… the conversation is long over by the time you try to explain that to even the best of dairy farmers, what kind of capital investment is involved in this industry and so on, and how that comes back to his milk price.
Dr. Andrew Novakovic: One of the comments you hear from time to time that always tickles me, usually you hear it in the context of milk promotion and product development and that sort of conversation, is, “Oh gosh, look at Europe. Those guys are so creative. They’ve got all these interesting products that we don’t have.” Okay. Credit where credit is due, I guess. But necessity is the mother of invention, exactly to Ted’s point. If you don’t have any way, any system for helping you with balancing skim solids or fat that you don’t need, and if you don’t have a guy that has some reason to be your friend when you’re the one that needs to get rid of some stuff, you come up with creative ways to use every molecule of milk you can that’s going to come into your front door.
And so why do we see buttermilk? And I don’t mean the fermented beverage that we call buttermilk, but actually the whey stuff that comes off of butter. Why do we see that packaged up in a bottle and sold in European grocery stores? Because these guys make butter, and they’ve got it, and they got to do something with it. And there’s just so much you can dry and put into a pastry. It’s not because they’re creative and inventive. It’s because they got to figure out some way to use all this stuff. And we can do that too. I’m not 100% convinced that would actually in some way be better, but that would be one of the consequences if we didn’t have a classified pricing system that made it much easier to do balancing.
Josh: I think our whey products industry is a fairly good example of that necessity and what they’ve done through innovation over time.
Dr. Andrew Novakovic: Absolutely. Absolutely.
T3: Well, good. This was a fantastic conversation. Does anybody have any more questions before we wrap it up? Jake? Josh?
Dr. Andrew Novakovic: Oh, can I ask the last question?
Dr. Andrew Novakovic: Because I was trying to keep track, but I got my pen and paper here. And so anybody whose first name is Ted, am I buying or am I selling November milk?
Ted Jr: Now you’re really starting a problem. I think as far as T3 is concerned, you’re selling-
T3: No, no. I actually, believe it or not, I actually would probably buy November, but sell all of 2023. That’s probably where my head is.
Dr. Andrew Novakovic: Interesting.
Ted Jr: Yeah. I don’t agree with that either, Andy. Although I will concede, there’s a hell of a lot of uncertainty with regard to how next year is going to play out. But I don’t regard the current price level on the Class III as particularly high. I don’t think it is. Jacob can chart this stuff out and show the Class III swings that have occurred over the years. The swing over the last two or three years is probably that really not that remarkable, particularly compared to the one that occurred in 2013 and ’14.
Dr. Andrew Novakovic: Well, I don’t know what Jacob is thinking, but I’m thinking there are a whole lot of farmers that are still coasting on last year’s feed or the prices that they locked in. And it’s a whole new ballgame next year. And I don’t know what the heck’s going on with the Russia and Ukraine, but energy and grain. It doesn’t get too much more basic and important than that for a dairy farmer.
Ted Jr: Fertilizer’s going to be the issue before this is over.
T3: Dr. Novakovic, we really appreciate it. Thank you very, very much. This is a fantastic conversation. Thanks for joining.
Josh: That was great, thank you. Nice to meet you.
Dr. Andrew Novakovic: Thanks, guys. Take care.
Ted Jr: Take care.
T3: Thanks, everybody.