'Quantitative cheesing': Weak dairy prices led to a mini government bailout

This week, the US Department of Agriculture announced it would buy 11 million pounds of cheese for $20 million, after 61 congressmen and senators wrote a letter to the USDA asking for emergency help.

Why the sense of urgency? Dairy prices have dropped in the past two years, suffering from too much supply and not enough demand. That combination of supply going up and demand going down led to a textbook economics problem: Prices went down, a lot. Over 1,200 American dairy farms shut down last year, out of a total around 43,000.

Enter the federal government, with a $20 million buying spree using money that comes from a program called Section 32, which was passed as part of the Agriculture Act of 1935. The USDA sets aside a portion of import duties collected from customs receipts, using that money to buy agriculture products to stabilize prices. The food then goes to needy places like food banks and pantries, the school lunch program, international aid and even prisons.

CNBC contributor Ron Insana referred to the move as "quantitative cheesing." But if you're looking for prices to change on your next order of cheese pizza, don't expect much. Prices at the retail level take a lot longer to change, compared to futures markets where volatility is the norm.

"Dairy markets are inherently volatile," said John Newton of the American Farm Bureau Federation. "There's a lot of uncertainty and very high inventory levels. Reducing inventory levels could create an emotional response in the markets."

The seeds of the current crisis were sown two years ago, when high prices encouraged domestic farms to expand production, making investments in handling bigger capacity. In addition, the European Union removed milk production limits last year. Those two factors have only flooded the market with more supply, hurting prices.

That came at the same time international demand suffered, including a slowdown in China. Separately, Russia banned imports of Western dairy products as retaliation for sanctions put on it for invading Crimea.

Domestically, it's been a better story. Here in the U.S., cheese consumption is at record highs, averaging a robust 35 pounds per person.

Denis Balibouse | Reuters

In the past two decades, Section 32 has been used to buy dozens of different foods, including peaches, pork, beef, salmon, cherries and potatoes.

However, "there's been nothing for dairy like this since 2009," said Chris Galen of the National Milk Producers Federation. "That's why we made the request, and why the USDA put out a news release. It is unusual."

Industry experts note that buying 11 million pounds of cheese would take out less than 1 percent of the 1.25 billion pounds currently in storage. But they are optimistic it might spur higher prices in the commodity markets. And in case you're counting, of that 1.25 billion pounds of cheese in storage, most of it (about 760 million pounds) is American. The next most popular is cheddar.

"The industry initially asked for $100 to $150 million, but they only gave us $20 million, which is somewhat disappointing," said Zack Clark of the National Farmers Union. "The USDA is at the end of its fiscal year, so it only has so much money to go around. Perhaps next fiscal year it can do more."

It gets complicated fast

Some of the surplus can go to international markets, but donating food to other countries has its own complications. There was controversy in the past about an international aid effort to donate peanuts to Haiti, because it might have disrupted Haiti's own domestic peanut farmers. American Farm Bureau's Newton said that Congress asked for a number mindful of the U.S.'s role as a dairy exporter, so as not to stimulate an overproduction of milk.

What's next for the USDA is to actually buy the cheese. This week's news was just the announcement, the first of several upcoming steps. The USDA will now solicit bids to fulfill these cheese contracts at some point in September.

It sent a solicitation to approved vendors, who then have to apply. Contracts will be awarded by late September. The USDA's Food and Nutrition Service will give orders of what they would like but haven't received yet. Finally, deliveries of the cheese will start in November.