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0809 PD: Pig in a poke? Don’t buy supply management for its wiggle

Ben Yale Published on 18 May 2009

“Don’t buy a pig in a poke.” This phrase aptly cautions against assuming unseen risk. Understanding its semantics gives the phrase additional reason for caution. The term comes from some less-than-honest sales practices in the Middle Ages in Europe.

Sellers of piglets or suckling pigs would put other worthless animals, commonly cats, into bags, or pokes. They would offer the unrevealed wriggling contents as a piglet or suckling pig. The French had another expression describing the same rouse, but they called it by the result of the cheat: acheter (un) chat en poche or “to buy a cat in a bag.” When someone exposed the fraud, they were “letting the cat out of the bag.”

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To buy a pig in a poke is certainly a foolish thing, unless, of course, you only paid the price of a cat, not a pig. Or, and this is the call for additional caution, the buyer trusted the seller and accepted what the seller said based on the wiggle. But in any event when a key fact is unknown there is risk.

In commercial transactions, risk depresses prices. For example, a house is up for foreclosure. Houses sold with full disclosure and inspection run at a certain price, but consider the sale of a particular property that can only be seen from the outside. There is no indication of the condition on the inside. A buyer under those circumstances will pay a price assuming the worst – that the house is a cat and not a suckling pig.

Risk is the unknown. It is the poke that covers what you think you want or know. Unknown risk necessarily results in discounting. Sellers bear the risk; buyers avoid it in the price.

In marketing of perishable milk, there are several identified, key risks. First, the buyer wants to make sure that it purchases just what it needs and no more. The excess will spoil and be worthless. It knows it can get value from what it needs. Buying milk that includes the possibility of unneeded milk at any price reduces the value of the purchase, in a big way. When a plant is obligated to buy milk in the future in unknown quantities, it has to assume large quantities of unneeded milk and will price all of the milk at that price – nothing.

Second, a plant wants to know if it will pay more for its milk than its competitors. Without such price transparency, the buyer will assume that its competitors are paying less, much less, and seek a price that matches that imagined level. This natural economic psychology is recognized by cooperatives and marketing agencies in common when pricing over-order premiums. Plants will pay higher prices if they know that other plants are paying the same. Once they have an inkling that some have a better deal, the pricing structure falls.

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In dairy marketing, that is how it always worked. To provide enough milk to a plant all the time, there had to be produced through the year a multiple of that volume of milk. When milk was long (generally in spring), it was nearly worthless. Buyers priced milk for the year at that time. The result was that milk received too little for the farmer even in the fall, when supply met demand.

A risk also existed for the producers. That arose out of producers’ desire to sell only the milk that was needed and let others bear the cost of unneeded milk. Because the stakes were high (at that time surplus milk was worthless), producers in order to keep a market of the higher-valued market were forced to sell at lower and lower prices. After all, if you cannot sell it, you smell it.

The response was a two-priced system which separated the milk the plant needed from the milk it did not. The needed milk was classed and priced at its higher value. The extra, or surplus milk, would receive whatever it was worth, but the plant was not required to commit any price for that. In this way, the plant knew it was agreeing to only pay for the milk it needed, and thus without the risk of a surplus, it paid more. The key elements of the pricing and pooling systems we use today was the effort to eliminate risk in the marketing system: Plants pay based upon use (removing the risk of paying too much for worthless milk), and producers receive a blended price irrespective of use (removing the risk that they would be paid on all of their milk at the lowest price.)

In this way, without even considering the actual level of pricing, the recognition and elimination of these two risks in milk marketing resulted in a system that has allowed the value of milk to grow and an industry to flourish. This model of looking at risk-offsetting, or avoidance, to benefit everyone is a basis for future changes to our marketing programs.

Coming back to the pig (or is it a cat?) in the poke, one would wonder why anyone would buy a pig in a poke in the first place. Sometimes desperate people, in desperate times, will forego rational thought and gamble on the contents of the bag based on the wiggle. Our dairy industry is in one of those times.

The economic condition in Dairyland today is unprecedented. The financial and emotional stress is overbearing. In times like these, producers call for answers, any answer. “Give me a plan, any plan. We have to do something!” They seem to be saying, “Show me a wiggle.”

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Among the wrapped wigglers that come around every time we face such a crisis is supply management. The simple concept behind supply management programs is that low milk prices only come from too much production, which came from too much money, which came when supply was less than demand. If only there was less milk, there would be no low prices. Reduce supply and low prices disappear, so it wiggles. If we could only exactly match supply and demand we would have the perfect price, all the time. The problem is someone else wants to produce more milk and so he is the problem. Stop him and we have reached perfection.

For a hungry person, the wiggle in the sack can look like a pig, but it does not make it a pig. Wanting a perfect price does not make one. No one can have such a hand on the demand and production of milk to perfectly steer it straight. It will wiggle.

It is really more than that. It creates a huge risk because opportunities to grow the industry, particularly in global markets, will come to a halt. We only have the ability to predict and manage domestic growth. World markets are, as we are learning, volatile. But like it or not, the U.S. dairy industry is fully engaged in the world market. Producers benefitted greatly in 2007 and 2008 from high world demand for dairy products. The prices were driven higher because U.S. producers had milk that they could market overseas at higher prices. Those higher-priced sales fed back into the prices paid domestically.

Had there been no extra milk, only enough for domestic markets, there would have been no sales and no upward prices.

Today, the world market punishes us. But the world market will come back, and we can and should be willing to handle the excess demands of the world. Those additional sales will add more dollars to producers and the industry.

One has to look at a long timeline, not month-to-month. That is hard to do in tough times, but responding to short-sightedness is another form of accepting wiggle instead of reality. Supply management to operate as promised will necessarily make sure that when the world calls there will be no milk to sell. The opportunity to grow will be lost.

Supply management does not remove risk, it creates risk. Two big risks are loss of future markets, primarily global, and the risk that individual farmers will be compelled to reduce production at the worst time for their farm. The old and less efficient will be subsidized by the new and more efficient. Rather than an outward and upward-striving industry, a supply-managed industry will be looking backward and inward. Those who are green, grow; those who are ripe, rot. Growth management is for the ripe.

There are challenges to today’s milk marketing. The answer is not artificial interference in the supply and demand of marketplace, but instead, we must continue to identify the risks that undercut producer profitability in an ever-growing and dynamic market. From that, like those in the past with our marketing system, develop market and government tools that help producers and processors themselves, not the government, manage those risks.

When proposals come for review, look at the whole thing, out of the bag, and make a decision on not the wiggle but the reality. PD

Ben Yale
Attorney at Yale Law Office

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