While most doomsayers are worrying about the lack of progress toward a fiscal cliff deal, I'm focusing on one aspect that isn't getting nearly as much attention -- the so-called "dairy cliff." Part of the overall fiscal cliff negotiations involve whether to renew the farm bill. If that doesn't happen, the price of many dairy products could soon double.
In a nutshell, laws will default back to 1949 rules if the farm bill doesn't get renewed. Farm subsidies the government provides would use 1949-based cost assumptions, which would require the government to step in and start buying certain dairy products at roughly double their current price. This would effectively raise the going market price of these products, doubling the cost of milk, butter, yogurt, and other dairy products you see in the store. A gallon of milk for your kid's morning cereal could soon cost about $8.
If the farm bill isn't renewed, it could have a devastating effect on a number of companies. Major milk producer Dean Foods (OTC:DF) is an obvious target, but Dean may be saved by its majority ownership of WhiteWave Foods (NYSE:WWAV), which makes milk substitutes such as soy milk. Consumers unable to stomach high prices might quickly develop a taste for WhiteWave's soy and almond milks, or Smart Balance's (NASDAQ:BDBD.DL) healthy butter substitutes.
Less obvious companies that could be affected include Starbucks (NASDAQ:SBUX), which uses an estimated 93 million gallons of milk per year, and grocery stores such as Safeway (NYSE: SWY), which typically use milk as a loss leader to get customers in the store and park it in the back of the store to keep them there longer.
It's worth noting that milk has been undergoing a long-term decline in demand, but over the short term, milk price fluctuations seem to have little correlation to per-capita demand. Staples such as milk, eggs, and bread tend to have what economists call "inelastic" demand, because demand doesn't change much depending on price. However, there haven't really been any historical examples of a sudden doubling in price of milk, so we may soon find out just how elastic it can be.