Why we’re on the verge of a trade war with Canada (yes, Canada) over milk (yes, milk)

Last week, President Donald Trump was hot on the stump. At a campaign-style event at a factory in Kenosha, Wisconsin, the president was praising the American-made products of the local company. But, as he is wont to do, Trump veered into airing his grievances over a duplicitous trade partner.

“Some very unfair things have happened to our dairy farmers,” he bellowed. “We’re going to call [them] and we’re going to say, ‘What happened?’ And they might give us an answer, but we’re going to get the solution, not just the answer, OK?”

“It’s another typical one-sided deal against the United States and it’s not going to be happening for long.”

As they did during the campaign, these tough-on-trade lines earned thunderous applause. So which country had done the U.S. wrong this time? Was it Mexico, who’s been outsmarting the U.S. at every turn? Was it the perennial punching bag, China, perhaps?

It was neither of those countries. It was worse: Trump was talking about Canada.

Yes, Canada. America’s friendly northern neighbor, close military ally, and second-largest trading partner. Canada and the U.S. hardly ever fight about much — not since 1814, at least. What did the Canadians do to get such a public flogging from the president of the United States?

It has to do with complex Canadian dairy policy, desperate Midwestern farmers, and the potential for a whole lot of spilled milk.

A ‘loophole’ in NAFTA

There’s no question that the U.S., and Minnesota in particular, share a strong bond with our northern neighbors. That’s most evident in trade: Canada and Minnesota do roughly $19 billion in annual trade, and Canada buys $4.4 billion worth of Minnesotan goods.

Dairy products constitute a small part of that trade, but it’s significant enough to make a big difference for some Minnesota farmers. With just over 3,700 dairy farms, Minnesota is the country’s sixth-largest dairy producer, and its eighth-largest exporter of dairy. (California and Wisconsin are the first and second-largest producers in each category, respectively.)

In 2014, Minnesota exported $322 million worth of dairy: nearly a quarter of that went to Mexico, while 10 percent went to China and eight percent went to Canada.

Why does more Minnesota dairy end up on refrigerator shelves in China than in those across the border in Canada? It’s because Canada is notorious for tightly controlling its dairy industry with a supply management system that closely matches dairy supply with demand through strict quotas and price controls.

In order to keep foreign milk, including U.S.-produced milk, from flooding its market, Canada levies high tariffs on imported milk — tariffs that are explicitly allowed under the North American Free Trade Agreement.

That strategy has led to higher dairy prices in Canada, protecting farmers, and largely walling off the Canadian market from foreign producers like the U.S. The low Canadian market penetration for the U.S. under NAFTA — around three percent — is a perennial source of frustration for the U.S. dairy industry and its supporters in Congress.

According to Marin Bozic, a dairy industry expert at the University of Minnesota, dairy is a particularly protected sector even by the standards of agriculture, widely considered the most constrained of global commodity trade sectors.

For a time, though, U.S. producers found a way to get around that: ultra-filtered milk. A relatively recent innovation, ultra-filtered milk is what you get when you strain milk to separate its biggest proteins from the more liquid skim. It’s mainly used to make cheese and yogurt.

Canada employs a system that places different pricing restrictions on various classes of dairy products, but it did not include ultra-filtered milk as a dairy product within that structure.

As a result, Canadian processors could get ultra-filtered milk from the U.S. at a far cheaper price than milk product from Canada. “Call it a loophole, or an unintended channel through which we were able to export dairy products to Canada,” Bozic explains.

This loophole turned out to be lucrative for the U.S. According to the U.S. Census Bureau, in 2016, Canada was the largest U.S. market for ultra-filtered milk, with over $100 million in sales, accounting for about 15 percent of total U.S. dairy exports to Canada.

In March, that stopped: faced with a glut of domestically produced skim milk, Canadian authorities decided to drastically cut its price. Suddenly, Canadian producers that had been buying U.S. ultra-filtered milk could get Canadian-produced skim milk — a product that can be used to produce the same kinds of foods — for a much lower price. Overnight, the US ultra-filtered milk export market to Canada disappeared.

The Canadians had publicly been considering that move for some time, but its implementation set off shock waves south of the border. With Canada no longer buying U.S. ultra-filtered milk, a major exporter of the product, Wisconsin-based Grassland Dairy, informed some of its farmers that their milk was no longer needed.

Nearly 100 dairy farmers in Wisconsin and Minnesota received letters from Grassland; it’s believed that 19 of them were Minnesotan.

Spoiling for a fight

In the low-margin dairy industry — one in which families often invest millions of dollars to eke out a middle-class paycheck — Grassland’s move potentially spelled doom. Milk production typically peaks in the spring. If pickup trucks stopped arriving on May 1, the affected producers would take a huge hit.

Farmers in Wisconsin and Minnesota openly mulled retiring early, or shuttering altogether and denying the next generation of farmers the opportunity to take up the family business. They scrambled, frantically calling processors in the region that would take their milk — with a perishable product, they had a very limited time window in which to do it.

It’s unclear how many Minnesota farmers continue to search for buyers, but the Minnesota Milk Producers Association, the leading trade group for Minnesota dairy farmers, believes that all its members who have been affected by the crisis have found buyers for their product.

According to Gary Wertish, president of the Minnesota Farmers’ Union, this crisis was more dramatic than anything that has happened to dairy farmers in the past. “I’m not aware of anything else that has had this effect on our dairy farmers,” he said. (The U.S. dairy industry, in a letter to top D.C. officials, claims Canada’s protectionism on ultra-filtered milk costs them $150 million a year.)

But there are still a number farmers in Wisconsin and elsewhere who are facing significant financial consequences if they do not sell off their milk, and their predicament is attracting concern from Congress, and the president.

Trump, who won Wisconsin in the election and whose administration features several high-profile Wisconsinites, is clearly listening. Upon returning to Washington last week, Trump said what Canada has “done to our dairy farm workers… It’s a disgrace.”

On Tuesday, Trump told press, “People don’t realize Canada’s been very rough on the United States… They’ve outsmarted our politicians for years.” That talk prompted a call between the president and Canadian Prime Minister Justin Trudeau that was either amicable (according to Washington) or rather contentious (according to Ottawa).

Sensing a sympathetic ear in the White House, dairy-state politicians from both parties have joined Trump in criticizing the Canadians, and called on him to take further action. Sens. Al Franken and Amy Klobuchar, and Reps. Collin Peterson and Tim Walz, urged Trump in an April 13 letter to take on Canada over the ultra-filtered milk decision.

Peterson, the top Democrat on the House Agriculture Committee, has been a vocal critic of Canadian dairy policy for years, and is pleased — if somewhat exasperated — that the topic is finally getting some attention now.

Peterson believes Canada’s move is protectionist and violates its trade obligations. “What the Canadians are doing, the reason they shut ultra-filtered milk down, for them to maintain their supply management system, they have to have control of everything that happens in dairy in Canada,” he told MinnPost. “If someone can get in around the system, it hurts their overall progress.”

“I think this is clearly a violation of the WTO and NAFTA agreement. If this was to go through the regular process, there would be a complaint filed with the WTO. There would be a case, and I think Canada would lose.”

Blame Canada?

Until Canada releases specific details for how it is pricing certain dairy ingredients, however, it will be difficult to determine whether or not it is violating its WTO obligations.

The U of M’s Bozic is skeptical: “It’s being portrayed as a trade issue, but Canada, I believe they may actually be within the letter of the trade agreement,” he says. “I don’t think they’re necessarily violating the trade agreement, they just price milk differently now.”

According to Lucas Sjostrom, director of the Minnesota Milk Producers Association, Canada has to bear some of the blame for what U.S. dairy farmers are going through. “I have a lot of Canadian friends yelling me at this week,” he said. “I don’t think it’s Canada’s fault, but Canada’s switch definitely caused this… A trade change did cause this issue.”

The Canadians, naturally, have bristled at this blame Canada strategy. Though top Canadian politicians and industry officials have expressed regret at the plight of U.S. farmers, they have largely claimed it is a crisis of the U.S. industry’s own making.

Indeed, the U.S. has significantly increased its dairy production in the 21st century. Decreasing production costs and higher dairy prices led the U.S. to grow its exports from four percent of total milk production in 2005 to nearly 15 percent now — a period Bozic calls the “golden decade” for American dairy. (U.S. dairy exports now total about $5 billion.)

Canadians are now saying that the crisis is an unfortunate cost of the U.S. producing too much and getting too deep in the volatile export market.

“Let’s not pretend that we’re in a global free market when it comes to agriculture,” said Trudeau last week in Toronto. “The U.S. has a $400-million dairy surplus with Canada… So it’s not Canada that is the challenge here.”

Chrystia Freeland, the Canadian foreign minister, said her country’s dairy market is “in fact more open to imports than the U.S. market is… On dairy, we are fully compliant with all our NAFTA and WTO commitments.”

Canadian dairy groups have been more forceful, with the chief of Dairy Farmers of Canada accusing the U.S. of using Canada as a “scapegoat” for their own problems. The Canadian dairy farmers contend that U.S. ultra-filtered milk has cost them $172 million.

What can be done?

A resolution in trade court months or years from now, however, would be cold comfort to the dairy farmers harmed in the next 60 days by this crisis.

There are a range of options at the federal and state level to help ease farmers’ pain, experts say, but time is running out for them to have a significant effect.

Unlike with other commodities, the U.S. Department of Agriculture can’t simply buy up a massive quantity of milk. It’s perishable, and part of the issue is that U.S. dairy processors are operating at close to capacity. Even if they wanted to, they could not take much more milk to process into dairy products.

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Bozic says the quickest solution is for the USDA to “write a one-off check to each of these farms… as an emergency loan without recourse that they wouldn’t have to pay if they go out of business, so they make it through the next 60 days.”

In any event, it’s likely that milk from affected producers will get dumped and not reach the market — potentially up to one million pounds of milk a day in some areas, Bozic estimates. That’s not a great look for U.S. dairy, he says, in a country where millions still suffer from hunger. “It’s going to be ugly for a while.”

For his part, Rep. Peterson says he has a hard time imagining that the affected producers will not find a buyer for their milk. “I think it’s a stretch to say that if ultra-filtered milk can’t be sold to Canada that these farmers will be put out of business,” he said.

But will any short-term ugliness strain the U.S.-Canada relationship in the long term?

The Trump administration appeared to hit back at Canada on Tuesday, when it approved a 24 percent tariff on certain lumber products from Canada. That move raised the prospect of a protracted trade fight between the U.S. and Canada across various industries; it also raises the stakes for Trump’s promise to renegotiate its trade commitments with Canada under NAFTA.

Those in the Minnesota agriculture world are eyeing ripple effects of all this across different agricultural sectors. The ag economy is a deeply interconnected one — the prices of soybeans, corn, and grains that go into livestock feed are closely watched by dairy farmers, just as crop growers watch the price of milk.

The Minnesota Farmers’ Union’s Wertish says “no doubt” there is concern among farmers he talks to about other actions Canada might take in response to Trump’s aggressive approach.

Maybe Canada’s balance is fine for dairy, Sjostrom says, “but in the business of farmland, the business of producing protein, whether it comes out as soybean, corn, potatoes, you can export all those things.”

Canada, he says, “is right in a way, self-sustaining in the dairy industry. But this is a system. You can call it a closed system but anytime you’re importing and exporting — this is a big world we live in.”