November, 2002

The Truth About Milk Pricing


The situation for dairy farmers is dire.

The current crisis has not gone by unnoticed by the media nor by our government officials. Yet there are few proposals for action to address the problem of low milk prices. We have not seen the state step in to save our farms - and our rural economy which depends upon our family farms - in the way we have seen the state take action when IBM threatens to lay off 700 workers. Instead, there is a prevailing sense of helplessness.

This helplessness is a reflection of a misconception about why milk prices are so low. Farm gate prices, it is typically explained, are driven by impersonal market forces which cannot be influenced. Prices are low, it is said, because farmers are over-producing and Americans are drinking less milk.

But think about it: how can the law of supply and demand really work in dairy economics, especially in a global market? If American consumers must drink enough milk to keep up with the global supply then supply will always far outweigh demand. Furthermore, a dairy farm cannot respond to market signals: if demand declines, farmers cannot simply turn off a switch and decrease production. Cows must be milked.

Neither do the facts support the claim that milk prices are low because milk supplies are up and consumption is down. The US is a milk deficit nation: we are importing more dairy than ever before in the form of MPCs (milk protein concentrates), butter substitutes and other pseudo foods like ‘Food Prep’ (a cousin to MPC).1 MPCs are being substituted for domestic nonfat dry milk in cheese-making and other foods because it is cheaper and produces higher yields (though lower quality). Cheese production in the US increased in the last year by 2.4 percent - which means consumption is rising, not declining.

In truth, the law of supply and demand cannot explain today’s low milk prices. The reality is that milk prices are not determined by impersonal market forces; milk prices are determined by cheese prices which are determined at the Chicago Mercantile Exchange (CME), a cash auction market where cheese is traded by a handful of traders. Although only a tiny fraction of all cheese transactions is traded on the Exchange (approximately .02 percent), it serves as the primary mechanism for determining prices. It is there where milk prices are influenced - if not rigged.

What happens on the Exchange doesn’t necessarily represent the conditions of supply and demand in the real world. All it takes is one big player to dump carloads of cheese onto the trading floor to shift the balance and depress prices. And that is exactly what goes on.

That big player is Kraft.

It is an open secret that Kraft has been manipulating prices on the Exchange for years. In 1996, the Wisconsin Department of Agriculture produced a report prepared by expert economists at the University of Wisconsin who studied the trading at the National Cheese Exchange (NCE, which subsequently moved to Chicago) between 1988 and 1993. ("Cheese Pricing: a Study of the National Cheese Exchange. A Report of the Food System Research Group." Department of Agricultural Economics, University of Wisconsin-Madison.)2 The report concluded unequivocally that the trading conduct of the leading traders on the Exchange is " motivated primarily by a desire to influence prices."

How Kraft Controls Prices
Originally, the National Cheese Exchange was a bona fide agricultural auction where representatives from cheese factories met with dealers to buy and sell. In the nineteenth century there were approximately 1,300 cheese plants, most of which were located in Wisconsin or New York. But in today’s world, a central cash auction where buyers and sellers physically meet no longer exists. Modern transportation and communication systems, as well as the dwindling number of manufacturers, make the Exchange an anachronism. What it has become is a central control center where the largest dairy corporations can control so-called "market forces" by manipulating prices.

Outside of the small circle of trading on the Exchange, manufacturers buy their raw product (cheese or milk) through contracts which spell out an agreed-upon price based upon the closing weekly price on the Exchange. Given that 90 - 95 percent of all bulk cheese sales — and virtually all milk sales — are determined by trading on the Exchange, the incentive to influence prices there is great.

While trading on the Exchange is dominated by nine major traders, it is overwhelmingly dominated by Kraft. In the five years under study, Kraft made 74 percent of all sales on the Exchange; the next biggest seller made only six percent. Kraft was exclusively a seller and never a buyer — which is suspicious in itself.

Kraft contends that it sells on the Exchange in order to unload its surpluses - not for the purpose of influencing prices. But Kraft has more profitable alternatives to selling on the Exchange: it can sell on the spot market or to the USDA for better prices. Instead, Kraft sells on the Exchange at a loss. Why?

This is what economists call trading against interest. "To sell on the Exchange at a loss when other more profitable outlets are available... is irrational business conduct, unless Kraft expected to influence NCE prices to its benefit," the report stated.

If Kraft can earn windfall profits by selling at a loss a tiny fraction of what it buys at rock bottom prices, then it is not irrational. But it is criminal. By dumping carloads of cheese on the Exchange at low prices, Kraft depresses prices. Kraft can then make up for its losses on the Exchange – and then some – by purchasing the milk it needs to feed its plants at the low prices it has determined by its manipulative trading.

The authors of the report found that "although Kraft lost about $1.5 million on NCE sales during 1987 - 92, every one cent per pound reduction in NCE prices lowered Kraft’s raw material procurement costs by over $10 million annually."

The report also shows that low prices as determined by the Exchange are not necessarily consistent with surpluses on the real market. They are, however, consistent with Kraft’s heavy selling on the Exchange.

Consider 1991, when Kraft made over 90 percent of the sales on the Exchange: prices plummeted and yet the market at the time was quite tight. Neither Kraft nor the industry had excess inventory at the time.

In October 2001 - a pivotal month - when prices plunged, USDA reported a 49 million pound decline in cheese production. In the same month, Kraft was a leading seller on the Exchange, dumping several hundred carloads of cheddar on the trading floor, driving down prices.

Closing the Secret
We currently have a system where the trading that occurs for 30 minutes every weekday by a handful of large manufacturers and coops – overwhelmingly dominated by one trader – who conduct only .02 percent of the nation’s cheese transactions, shapes the entire economic landscape of dairying, from Vermont to California. Kraft’s trading conduct has been unambiguously demonstrated, and yet little has changed since these facts were brought to light in 1996. Armed with the report, a group of Wisconsin dairy farmers
sued Kraft and other cheese manufacturers under state antitrust laws, but the court ruled against them. The case has gone all the way to the US Supreme Court, which refused on December 2, 2002 to hear the case, arguing that federal law prohibits people from suing for damages over rates set by a federal agency. What the farmers would have demonstrated in court, however, is that federal price minimums were based on NCE prices - not the other way around. "The courts simply bought Kraft’s argument," says Bunting, "that prices are set by the federal government. They just don’t understand how it works."

What has changed is that the National Cheese Exchange was moved from Green Bay Wisconsin to the Chicago Mercantile Exchange. Wisconsin’s then Governor Thompson formed a commission in response to the findings of the report, to establish trading rules that would prohibit "trading against interest." Rather than submit to regulation, the NCE picked up and moved to Chicago. (As Dexter Randall, a Vermont dairy farmer, put it, "It’s the same rats feeding on the same block of cheese only in a different house.") One big difference, however, is that while the trading on the NCE was public knowledge, trading at the CME is not.

"It’s one thing to control prices," says John Bunting, a dairy farmer who writes about milk pricing for the Milkweed, a farmer journal on milk marketing. "It’s another to control the discussion."

Controlling the Truth
Trading on the CME is conducted in secrecy. Our agricultural spokespersons further shroud the realities of dairy economics with mythologies of ‘supply and demand’, ‘market forces’ and ‘economies of scale’ — which, upon examination, make little sense. The law of supply and demand in these discussions has become a quasi mystical, mysterious force. "It’s as if the God who set down the law of natural selection were an economist," says Bunting. These mysterious forces are accepted on faith and are so enshrined that they are rarely challenged - even by reality. Where there is mystery there is power, and that power has a name and a logo: Kraft.

The realities of dairy economics do not support these mythologies. Farmers have been told that if they expand, industrialize and become more efficient they will survive. But modernization of dairying is clearly not helping the New England dairy farmer. Small farms, in fact, are weathering the current crisis better than large farms. And typically, low prices are explained by a simplistic, mechanistic view of the law of supply and demand. For example, a recent article in the Addison Eagle ("Local Farmers Struggle With Low Milk Prices," Nov. 14, 2002) on milk prices explained: "As economic theory would dictate, if supplies are short, prices rise rapidly. When there is a surplus of supplies, prices drop....This year, the demand [for dairy products] has only risen by one percent, while production rates are steady or rising."

If only it were so simple. The reality is far shadier. In October 2001 - the beginning of the current slump - prices dropped within weeks after the dairy compact expired. Coincidence? Pete Hardin, editor of the Milkweed, suggests prices were propped up until the compact expired, when prices subsequently were allowed to drop. Stories about farm foreclosures would not have played well for opponents of the compact - there would have been an insistence on its reauthorization. If you take imported MPCs out of the equation, no surplus existed in 2001 to justify a drop in price. Instead, we are told there was a drop in consumption. But dairy imports increased, and Kraft et al would not have been importing MPCs, Hardin reasons, if the demand wasn’t there.

MPCs provide another means for Kraft to control prices and squeeze the American farmer. MPCs serve the double purpose of providing a cheap raw material, while swelling the market to maintain conditions of surplus. "It’s a kind of extortion" says Bunting – because Kraft can always threaten to turn to the global market to source its raw materials wherever it can find them at the lowest price.

A global corporation like Kraft can stand to lose its domestic milk producers. If dairying in the US disappears altogether, Kraft can source its milk and ‘Food Prep’ elsewhere. But the smaller manufacturers and local coops - if they are not all gobbled up by globalizing corporations - have reason to fight to keep our farmers on the land.

Think Locally, Act Locally
In short, illegal imports, price-fixing and unprecedented corporate consolidation (which is supposed to be illegal) are responsible for low milk prices. Federal and state governments have turned their backs on this activity. Worse, government is opening its arms to foreign imports which will further erode and ultimately devastate our agricultural economy.

Here in Vermont, public officials typically throw up their hands, claiming that milk prices are a federal issue over which the state has no control. But this is to leave the fate of our dairy farms to a system that is thoroughly rotten and corrupt. To do so is to doom Vermont’s dairy farms to extinction. "The solution," reflects Bunting, "must be local."

The only silver lining is that if the farm crisis is a crisis by design, if it is the consequence of irresponsible and illegal behavior by corporations with the complicity of government, then the extinction of the family farm is not "inevitable".

In other words, something can be done.

1. MPC imports have skyrocketed in recent years, displacing domestic milk and depressing prices. (To learn more about MPCs, see Farm Policy Network News # 16.) ‘Food Prep’ is a combination of dairy ingredients specifically designed (like MPCs) to evade US quota and tariff rules for imported dairy products. According to the Milkweed, imports of ‘Food Prep’ are also rising astronomically. (Milkweed, October 2002.)
2. Prepared for the Wisconsin Department of Agriculture, Trade, and Consumer Protection Investigation into Cheese Pricing, by Willard F. Mueller, Bruce W. Marion, Maqbool H. Sial, and F.E Geithman. March 1996. To read the report, go to:

Farm Policy Network News, No. 17
15 Barre Street. Montpelier, VT 05602
(802) 223-7222