Vitamin D Is for Deficit

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On Saturday, the National Milk Producers Federation announced a plan to cut short the lives of 52,000 milk cows, about 0.5% of the total milk cow population in the U.S. What does this have to do with investing? Just take a look at the price of a gallon of 2% on your next trip to the corner 7-Eleven (NYSE: SE). I'll bet it isn't what you remembered it being a year ago. Somebody's benefiting from that price hike -- and it isn't the consumer, or even always the companies that produce dairy products.

It's a simple fact of economics that, when you decrease the supply of a product for which demand is as inelastic as milk, the price is going to rise. That happened this summer, in the aftermath of last year's cull, in which 35,000 milk cows were killed off. By June 2004, milk had reached the highest price in recent memory -- at a national average of $3.57 per gallon. It has dropped back to about $3.16 since then, but America's dairy farmers don't necessarily think that's a good thing.

The effects of last year's kill-off were felt widely by consumers and dairy companies alike. A few examples: Everyone from little kefir maker Lifeway Foods (Nasdaq: LWAY) to ice cream makers Dreyer's (Nasdaq: DRYR) and Unilever (NYSE: UN) (which makes Breyers) to dairy king Dean Foods (NYSE: DF) saw their profit margins come under pressure as the price of raw milk skyrocketed far faster than they could pass the price increases along to consumers. Unilever, at least, tried to mitigate the damage by quietly decreasing the size of its "half gallon" ice cream cartons to 1.75 quarts (yep, that's why you keep running out so quick).

Now, as bad as the price hike may be for you and me, and for the shareholders of dairy-producing companies, it's worth pointing out that America's dairy farmers are not just, shall we say, squeezing us all dry. Milk prices hit 25-year lows last year, and the only way a lot of dairy farmers were able to make ends meet was through subsidies approved by Congress in a May 2002 law. That law is set to expire in the fall of next year, and the farmers may be culling their herds in anticipation that the subsidy will not be renewed.

That'll come as small consolation to the shareholders of the dairy companies, of course, unless they can find a way to pass their higher costs on to consumers -- in which case, it will come as small consolation to the rest of us.

For more Foolish analysis of the impact of higher raw milk prices, read:

• Wimm-Bill-Dann's Spilt Milk
• Dean Wrestles With Pickles
• Lifeway's Cost Crisis
• Dean's Downward Dip

Fool contributor Rich Smith owns no interest in any of the companies mentioned in this article.