U.S. dairy producers are caught in a classic "price-cost squeeze," with farm milk prices declining sharply from record highs while feed costs remain high. From January through September 2009, the all-milk price received by farmers was 36% below a year earlier. (The all-milk price is the weighted average farm price of fluid-grade and manufacturing-grade milk produced.) Meanwhile feed costs, as measured by alfalfa prices, were down only 20% from a year earlier. The deteriorating economic picture has prompted calls for policymakers to consider how well current dairy policies are assisting dairy producers and what other options might be available. The dairy market since 2007 illustrates how an agricultural boom can turn into a bust. Dairy farmers enjoyed excellent returns in 2007 and most of 2008 as strong demand pushed up the price of dairy products and the farm price of milk. In November 2007, the all-milk price hit a record $21.90 per hundredweight (cwt.). In 2008, milk prices remained high, but feed prices rose rapidly, creating concern for dairy farmers. The financial danger was a further escalation of feed prices or a price reversal in dairy product prices. Product prices have, in fact, dropped. Feed costs have declined some, but not enough to offset the drop in milk prices. One simple measure of today's price-cost squeeze affecting dairy farmers is the milk-feed price index, as reported by the U.S. Department of Agriculture (USDA). The ratio averaged 2.01 in 2008, the lowest since at least 1985 and down from 2.81 in 2007, a year with record-high milk prices. Thus far in 2009 (January-September), the ratio has averaged 1.56, down from the 10-year average of 2.90. A ratio near 3 or higher is considered positive for milk production. The major factors leading to the current economic stress in the dairy industry are continued weak demand relative to milk supplies and relatively high feed costs. In 2009, USDA expects the all-milk price to average between $12.05 per cwt. and $12.25 per cwt., down from $18.29 per cwt. in 2008 and 17%-19% below the 10-year average of $14.83. Productivity growth is a hallmark of U.S. agriculture, and dairy is no exception. Over the years, improved dairy cattle genetics and better feed management practices have increased output per cow. Dairy farmers continued the advancement last year: USDA estimates milk per cow in 2009 at a record high of 20,493 pounds, up from 20,396 in 2008 (one gallon of milk equals about 8.6 pounds). Normally, higher productivity is partially offset by a decline in cow numbers, resulting in more modest gains in total milk production. However, in 2008, dairy farmers increased herds in response to attractive returns, particularly in 2007. As a result, U.S. milk production rose 2.3% in 2008, compared with the increase in milk per cow of only 1.0%. Milk supplies expanded at about the same time that demand started to weaken. In 2009, lower returns have encouraged farmers to cull dairy cows, with the national herd declining 123,000 head or 1.3%. Productivity gains, though, are expected to offset some of the reduction in cow numbers, leaving U.S. milk production down just 0.8%. In 2009, the decline in production has been less than the drop-off in demand, resulting in sharply lower prices than a year ago. Dairy exports account for a relatively small but important share of U.S. dairy product sales. On a fat basis, exports were estimated at 3% of total use in 2007 and 4% in 2008. (On a skim-solids basis, the export shares were 12% in 2007 and 15% in 2008.) Growth in U.S. dairy exports stemmed from lower product availability from New Zealand and Australia (and other countries) and the lower-valued dollar. U.S. cheese exports saw particularly strong gains. Export prospects have weakened in 2009, with USDA forecast exports dropping below 2007 levels. Among the factors USDA cites for the decline in export demand are the global recession, lower incomes, higher dairy production abroad, and a stronger dollar. The drop-off in export demand means that more product must be sold on the domestic market, which has driven down dairy product prices and farm milk prices. Domestic demand has also reportedly slowed, given reduced restaurant sales and sales of premium food products, including some dairy items, as consumers reduce overall spending. However, increased purchases of food for home consumption are likely supporting the market to some degree in 2009. Feed costs rose sharply in mid-2008. Expanding corn demand for ethanol use, strong global demand for grain, and heightened investment in commodity markets collided with uncertain prospects for U.S. corn and soybean yields. In spring/summer 2008, massive flooding in the Midwest led to fears that the U.S. corn and soybean supplies would be sharply curtailed at a time when demand seemed limitless. In July 2008, the farm price of corn peaked at $5.47 per bushel, up nearly $2 per bushel from a year earlier. Alfalfa prices followed suit, with farm prices reaching $180 per ton in August compared with $135 a year earlier. The commodity price boom of 2008 began to collapse in September when financial and commodity markets faltered. Large amounts of investment money began to leave the market, and crop yield prospects for both corn and soybeans firmed up. Supply fears essentially evaporated. As 2008 came to a close, prices for dairy feedstuffs had dropped substantially from highs earlier in the year but remained well above year-earlier levels. Corn prices in December averaged $4.10 per bushel compared with $3.77 in December 2007. The price of alfalfa was $155 per ton in December 2008, compared with $135 in December 2007. In contrast, soybean prices, which had seen a faster rise the year before, averaged $9.24 per bushel, down from $10.00 in December 2007. Thus far in 2009, average prices for dairy feed have moderated from 2008 highs but remain well above 2007 levels. In recent months, USDA has revised its forecasts of 2009 corn and soybean prices downward based on prospects for larger crops this fall. Given the downturn in dairy farm income, dairy economists expect producers in 2009 to send more cows to slaughter and adjust feed rations to save money, which together would result in a slight decline in total milk production in 2009. On the demand side, dairy exports in 2009 have declined as global economic weakness slows foreign demand. Based on USDA forecasts, the expected supply adjustments and higher support prices announced by USDA on July 31 will lift milk prices in the last quarter of 2009. Average farm-level milk prices are expected to rise from $11.60 per cwt. in the April-June quarter to $12.90 per cwt. in October-December 2009 (midpoint of the USDA forecast range). The October-December 2008 prices averaged nearly $17 per cwt. In 2010, USDA expects milk production to decline further as farmers cull more cows following low returns in 2009. Also, exports are expected to pick up slightly as the global economy improves, although USDA expects export prospects will be limited by higher domestic prices and larger exportable supplies in competitor countries. With less milk and somewhat higher demand, the all-milk price is forecast to increase from $12.15 per cwt. in 2009 to $15.05 per cwt in 2010. U.S. dairy policy has been developed over the last seven decades. The early policies addressed three main problems: (1) producers lacked bargaining power with milk buyers; (2) producers suffered from volatile or low prices; and (3) market participants encountered severe shortages/gluts resulting from marketing a highly perishable commodity (fluid milk). The policy response resulted in the development of two major government activities that still function today: federal milk marketing orders (FMMOs) and the Dairy Product Price Support Program (DPPSP). While both FMMOs and the DPPSP have their roots in the 1930s and 1940s, the programs have changed modestly over the years as the industry structure and markets changed. Two other components of U.S. dairy policy are relatively new programs. First, the 1985 farm bill established the Dairy Export Incentive Program (DEIP) to counter foreign competitor subsidies. Second, the Milk Income Loss Contract (MILC) program was established in the 2002 farm bill as a government payment for dairy farmers in times of low milk prices. Like U.S. crop programs, the MILC program pays dairy producers when prices decline below a specified level. The following sections describe each of these four components and how they relate to the current market situation. Lower milk and dairy product prices since late 2008 have generated new program activity. USDA began purchasing dairy products last fall under the DPPSP; MILC payments were triggered beginning in February. The Milk Income Loss Contract (MILC) program pays dairy farmers when farm milk prices fall below an established target price. Section 1506 of the 2008 farm bill ( P.L. 110-246 ) extends authority for the MILC program until September 30, 2012. This program is similar to long-time subsidy programs for crops (e.g., wheat, corn, and soybeans) that pay farmers when farm prices drop below certain levels. USDA's Farm Service Agency implements the MILC program. Under MILC, participating dairy farmers nationwide are eligible for a federal payment whenever the minimum monthly market price for farm milk used for fluid consumption (Class I; see discussion on " Milk Marketing Orders ") in Boston falls below $16.94 per cwt.