Thursday, May 04, 2006

Milk and Oil Do Mix.

You are farmer Brown, a dairy farmer for the past 25 years. You have invested a large amount of time, money, and sweat equity over these years for livestock, barns, pasture, feed, laborers, milking machines, trucks and other equipment. Milk prices over the past 25 years have been sporadic. In some years it has been so low that you were not able to buy feed, new equipment, pay laborers, and you had to sell some of your herd. In those years, you really questioned why you remained in this crazy business. Firing workers that you had become attached to was extremely painful. All this time you fought competition from cheap imported milk coming into the U.S. market. These foreign companies did not have to pay the taxes you paid, spend money on government mandated programs. You may not have liked your situation…and you may have complained on occasion…but all in all, you accepted all of this as part of the business and made the best of it.

Suddenly… and without warning… two countries (Alpha and Beta) with extremely large populations begin to implement free market principals in their economies and allow their private sectors to invest and make business decisions without government interference. Their pay scale to workers are extremely low compared to the industrialized world and their economies boom since they currently have a huge labor advantage. Alpha and Beta have full employment at wages that are much higher than in the old economy. The citizens begin to accumulate money and now have cash to spend on whatever they want….and they want milk! Alpha and Beta do not have enough milk cows to meet their countries demand. So Alpha and Beta begin to buy milk on the world market. In order to secure huge milk accounts from other countries, Alpha and Beta have to offer more money for the milk. Which they do, and they secure milk for their populations. Alpha and Beta buy so much milk that a shortage of milk results on the world market. Other countries who import milk begin to scramble to secure milk supplies for their populations. This results in the price of milk skyrocketing because demand exceeds supply. People want their milk and willing to pay a certain price for it.

Meanwhile, farmer Brown is minding his own business and notices that his milk purchaser is willing to pay more money for his milk. Soon he is getting calls from other milk purchasers wanting to buy his milk for unheard of prices. Being a prudent businessman, he sells his milk to the highest bidder. All his hard work over the last 25 years is paying off.

But what is this! Soon people show up on farmer Brown’s door step, yelling that he and Big Milk is gouging them…They ask “How can you do this on something as basic as milk? What kind of monster are you? You crook!” He tries to explain to these people that he does not set the price of milk. He only sells it to the highest bidder. They either do not want to hear that or are not capable of understanding how our economy works. They want to blame someone, even if it is unjust and unfair. Now these same people want the government to step in to regulate the price of milk and punish him by taxing him. Can any rational person who understands how our economy works expect this to fix the problem?

The problem here is a shortage of milk. Not farmer Brown, the milk purchasers, Big Milk… whatever. If the government regulates the price of milk, milk suppliers will still have to buy milk on the open market but will be limited in how much they can pay for it. If the going price for milk on the world market is $2.50/gallon and the government mandates that milk be $2.40/gallon, how can these milk suppliers buy any milk? Are you going to force milk suppliers to lose money? Would you? Won’t happen. So, the result of fixing prices is a severe shortage of milk.

What about punishing these farmers for their obscene profits through taxes? Hmmm. Does this add to the world supply of milk….No. What it does do is reduce farmer Brown’s profits at the expense of foreign competitors, who don’t have to pay the tax. If they place on import tax on milk as well, the price of milk goes up accordingly.

How do we fix this problem….well the easiest way is to increase the milk supply. Which means that more cows have to be raised. Well, cows take a couple of years to mature to the point that they are able to be milked. Plus, an increase in cows means that farmer Brown will have to purchase more equipment, build more barns, buy more feed, vet bills, hire more laborers, etc. He needs large sums of money (some of which he has to borrow) to pay for all of this. Unfortunately, the government just raised his taxes and have place restrictions on how many cows that he can have on a certain amount of acreage. Also, for every cow that he buys, there is a chance that the cow may grow up without the ability to give milk. We call those Dry Cows. Since his farm is surrounded by dairy farms, he cannot buy more land, therefore no more cows. Also, since cows belch greenhouse gases, the government is threatening to tax him even more to account for global warming. Farmer Brown feels the rewards are not great enough to exceed the risks. So he keeps the same number of cows. Unfortunately, his cows are getting a little long in the tooth. His cow population begins to drop. Now he is not producing the same amount of milk.

Welcome to reality people…

*written by someone in the oil business...:-)