Milk futures showing no sign of 'dairy cliff'

Getty Images The futures market does not seem to be all that worried about . The question is: Do the futures traders know something we don't? Milk now costs an average of $3.65 a

gallon. But the price of milk could shoot up if Congress doesn't act to pass a bill preventing a reversion to the 1949 farm law that would mandate government price supports at much

higher levels. Although it's not clear how high the price could go, some say it could rise to between $6 and $8 a gallon. The milk futures market doesn't seem to be forecasting

anything like that kind of increase. The January contract for Class III milk is trading at $18.08 at pixel time, which is lower than it was trading back anytime in October or November. This

is higher than what January Class III milk usually trades but certainly doesn't reflect a doubling of the price of a gallon of milk. So what's going on? Why aren't the futures

reflecting the threat of higher prices? Is the "Dairy Cliff" a figment of our imagination? One possibility is that milk futures traders don't believe that milk prices will

rise that much. One trader I spoke to said that the Dairy Cliff was really a "media scare story" that didn't reflect reality. He pointed out that prices won't necessarily

double right away because the Department of Agriculture will have some room to avoid forcing the price increases on the market, leaving room for Congress to act in the new year.

"We'll go off the Dairy Cliff but Congress will fix it, just like they'll fix the fiscal cliff," he said. This attitude is a bit troubling, however. The Farm Bill did not

just expire recently. It expired months ago. If Congress could not bring itself to act in the past few months, why should anyone have confidence that it will suddenly be able to reach

agreement next year? What's more, this approach seems to be based on the idea that letting milk prices double would be monumentally stupid. There's no doubt that this is true. But

stupidity is not always a bar against government action or inaction. Confidence that government wouldn't let catastrophe strike supported the price of Lehman shares until the company

went bankrupt. Many people believed we'd have resolved the fiscal cliff by now. To rework an old adage, Congress can stay irrational longer than you can stay solvent. The House and

Senate agriculture committees are currently working on a short-term extension and, despite all the focus on that other "cliff," they're expected to vote on it by Monday. Even

if they do nothing, milk prices aren't expected to double Jan. 1, they're more likely to rise gradually. Futures traders are not experts in congressional action, in any event. They

are likely to be good at judging supply and demand issues, discerning how weather and crop prices touch the milk market and perhaps understanding how rational regulators will set controls

on milk prices. But the Dairy Cliff is something no trader has ever experienced. Claims of market expertise here are just inapplicable. Another possibility, by the way, is that the Class III

milk futures don't properly track the price of liquid consumable milk. Class III milk is used to manufacture products such as cheese. It may be that while Class III ordinarily tracks

Class I (drinking milk), this tracking breaks down under government price controls. If that's the case, companies with larger exposures to the price of milk that use Class III futures

to hedge—such as Starbucks—could find themselves unprotected.