Sunday, 27 March 2016

The great dairy price conspiracy?

Let's say that your country was the world's largest consumers of an agricultural product (or at least, the largest buyers on the international market for that product), and that changes in your country's demand for that agricultural product were enough to produce significant shifts in the world price of that product. Now say your long-term goal was to move from being a global consumer of this product, to being a producer (or at least, securing your own supply so that you wouldn't have to rely on the world market any longer). How would you go about achieving this goal?

One way might be to invest in production capacity in your own country, or to purchase land and production facilities in other countries at market rates. It might take a while, but you might eventually purchase enough capacity to become self-sufficient (but at a high cost).

But wait... your demand for the agricultural product is so important to the world market that you can influence the prices (you have market power). So, if you decrease your demand for the agricultural product, then the world price will fall. The profits of farmers in other countries will decrease, and the value of land and production facilities will fall (because the demand for productive land is determined by the value of the marginal product of land - that is, by how much value that land can generate - and that value has fallen because the agricultural product it produces now receives a lower price). So, with lower demand for the agricultural product and lower land prices, you can buy the land and production facilities at a lower price.

But will farmers sell? Farmers with a long-term perspective will surely recognise that your lower demand for the agricultural product is temporary, and will be willing to endure some short-term pain in anticipation that your demand will return to normal in the future.

Realising this, you need to find some way of forcing farmers to sell. What if you first increased the demand for the agricultural product, buying lots of it on the world market, and driving up the price? This would give you a good buffer stock of the product before you moved onto Stage 2 of the plan (lowering demand). 

Even better, with prices high farm profits will be high and land prices will also be high. So, every time a farm changes hands it will do so at a high price, and since most farmers do not have large amounts of financial capital to spare, this price will be paid for by the new farm owners taking on debt.

So, when you lower your demand for the agricultural product and the world price falls, the indebted-and-vulnerable farmers who are faced with lower profits will be unable to meet their debt repayments. You'll get double-value if some other countries are simultaneously increasing their supply of the agricultural product when you reduce your demand, since the world price of the agricultural product will fall even further.

Now when the banks start to foreclose on debt-burdened farmers, those farms will come up for mortgagee sale (and at a low price because of the low price of the agricultural product), and your country can swoop in to secure the land and your own supply of the agricultural product at a much lower price.

So, is there a great dairy price conspiracy? Maybe all these things are coincidence:
  • Global Dairy Trade Index in April 2013 = 1573; Global Dairy Trade Index in March 2016 = 628 (
  • The Reserve Bank "...said many indebted farms were coming under increased pressure, which would be made worse if dairy prices remained low or if dairy farm prices fell significantly." (New Zealand Herald)
  • "The [REINZ] institute said its dairy farm price index fell by 14.3 per cent in the three months to February compared with the three months to January. Against February 2015, the index was down by 20.9 per cent." (New Zealand Herald)
You be the judge.

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