Identifying a Positive in Poor Economic News

Last week, the International Monetary Fund (IMF) announced it would reduce its global economic growth forecast for 2012. It was the latest in a line of unfavorable economic news from around the world, and it raises an important question: With global growth struggling in a time of increasingly globalized dairy markets, what does that mean to world dairy trade and U.S. exports in particular?

It is not an easy question to answer, as global economics and the dynamics of supply and demand are not predictably intertwined. A myriad of factors come into play, but the forbidding and indeterminate nature of Europe’s debt crisis is at the center of the current malaise. And the international interconnectedness that is part and parcel of globalization means the impact could be felt down to the U.S. dairy processor and farmer.

What is clear is that the EU’s debt problems are not going away quickly. Nine EU nations have officially entered recession and more are expected to follow. Authorities have so far responded by putting out fires as they occur, which has staved off disaster. But while the Greece fire smolders, bigger conflagrations likely lie ahead, possibly in the form of Ireland, Italy and/or Spain. If those flare up, no one is certain how the EU will put them out or if it can do so in a way that leads to solid long-term recovery.

The EU’s problems, in turn, act as a drag on the slow U.S. economic recovery. Both are bad news for Asia.

China and other Asian economies are export dependent. Fewer European and U.S. consumers buying Asian-made products translates to slower Asian growth. Slower Asian growth means regional income escalation loses steam, which suggests slower expansion of the continent’s middle class—the premier driver of world dairy consumption growth and the latent demand gap (as supply struggles to keep up), and a key factor behind U.S. dairy’s overseas success.

However, while the world’s economic news is unfortunate, there are reasons to remain confident that dairy demand will hold up.

In recent years, the rising income of those entering the middle class has been the primary driver of greater dairy consumption. Moreover, while the rate of Asian income growth may be moderating, the rate is applied to a larger base, so absolute growth may be as large as in previous years. Consequently, the gap between economic growth and inflation becomes more important.

China for example had been battling price inflation for the last two years. During 2010 and 2011, Chinese food prices rose a total of 19.1 percent. But income—measured by the real increase in GDP—grew at 19.6 percent. The gap between the two was sufficient to ensure that consumer dairy purchases continued climbing at a healthy rate, as apparent dairy consumption increased by 11.3 percent.

GDP growth alone is not solely responsible for overseas demand. The global economic slowdown may be blunting income gains, but it is also causing food prices to decline. The U.N. Food and Agriculture Organization’s Food Price Index fell for the third straight month in June. The dairy component declined for five straight months.

So even though incomes rise more slowly, consumers will still feel like they have more money to spend on food and will continue to spend it should food inflation ease. (Correspondingly, Chinese dairy imports are up nearly 20 percent through May. Plus, China is actively trying to foster a move to a less export-oriented and more domestic consumption-based economy with stimulus aimed at encouraging consumer spending.)

That is good news amid today’s economic dreariness. Demand is likely to continue to drive dairy trade gains. But there are still a handful of unknowns we are watching.

First, the gap between income and price growth deemed necessary for consumers to maintain the feeling that they can spend more on food is unknown.

Second, wholesale food price adjustments must be passed along to consumers to mitigate income declines. China’s most recent import data (May), for example, suggests that lower dairy commodity prices have not worked through the system yet.

Input costs outside of dairy ingredients—oil, labor, etc.—also could forestall price adjustments reaching consumers.

Additionally, the United States is mired in a drought, India’s monsoon season at press time was below par, while the prospect of a coming El Nino is beginning to create doubts about the next Oceania season. All support worries that disturbing long-term weather scenarios could reignite global food inflation.

Assuming the gap between food inflation and income does remain significant and purchasing continues to grow at a pace that supports dairy imports, the question then becomes whether the United States is going to be the supplier of choice.

Global economics plays a secondary role in terms of dairy demand. Should the EU remain mired in economic problems, its domestic consumption may decline, creating a larger than expected dairy surplus.

The EU in that case would not only be a stronger short-term export threat, it would by necessity focus on export opportunities, better positioning itself for 2015 when the bloc abolishes quotas.

Recent trade data show that U.S. suppliers are showing considerably more staying power in a tough sales environment than in past down cycles. Yet current conditions will test their export resolve. No matter the news from IMF or the EU, the fact is that dairy demand is not going to contract. The question is how fast is it’s going to grow and how U.S. suppliers position themselves in this competitive environment.

(This article first appeared in Cheese Market News in July 2012.)

The U.S. Dairy Export Council represents dairy farmers, proprietary processors, cooperatives, ingredient suppliers and export traders. Its mission is to enhance U.S. competitiveness and increase global sales of U.S. dairy ingredients and products.