A History of the U.S. Cotton Program: 1930-Present

Thursday, May 21, 2009

For all of you history buffs out there, the following report traces the evolution of U.S. cotton support programs from their inception in the 1930’s to the current debate about the need for another round of program reforms. This report was originally published in a study we (Globecot, Inc.) issued several years ago on the history and future of the U.S. Farm Program. I think this report helps to identify those forces that helped to shape U.S. government policy and how that policy may evolve in the future.

The U.S. cotton program has a long history dating back 75 years. Over that time, the program has changed dramatically as alternative program provisions were used to “manage” the market. Early programs used mandatory production and marketing controls to restrict supply enough to support prices and incomes through the market. The programs evolved over time, with increased emphasis on competitive pricing to encourage domestic and export demand and on delivering support independent of the market through direct payments. Most recently, the program has focused even more heavily on pricing U.S. cotton competitively and delivering support though decoupled payments. This move has come at significant budget costs.

The current debate centers on whether the cost of cotton programs, and commodity programs more generally, has become high enough to spark another round of reforms. The debate this time, however, differs from past debates in that the questions being asked include whether or not the sector should be supported as well as how to support the cotton market.

I. Introduction

The U.S. cotton sector operated for much of the last 75 years with a series of government programs in place that determined who produced and marketed how much cotton at what price. The programs were designed initially to address a temporary downturn in the cotton market in the late 1920’s but ultimately became a permanent mainstay in on-going efforts to manage the market and strengthening producer prices and incomes. As with many of the other basic agricultural commodities, the cotton sector proved to have significantly more capacity to produce than the market could absorb at “reasonable” prices and incomes. This excess capacity overshadowed the market except for relatively short periods during World War II, the Korean War, and the export boom of the 1970’s.

Government cotton programs were generally successful in that the market was more stable than swings in yields and exports would have suggested and prices and incomes were above marketing-clearing levels. The programs were also successful in slowing the exit of excess resources from the sector to the rest of the economy to a manageable pace. The cotton sector evolved from requiring 35-45 million acres farmed by over 1 million operators in the 1930’s and 1940’s to operating with 12-14 million acres and 30,000 operators currently.

The success of the cotton programs came at several costs. For much of the time, the cotton programs’ acreage provisions slowed the movement of production from high cost to lower cost producers and from high cost to lower cost regions. The programs’ emphasis on controlling acreage to control production also encouraged producers to adopt input-intensive, yield-maximizing technologies rather than take full advantage of often lower-cost, land-intensive technologies. The program also worked much of the time, given the U.S.’s position as the world’s largest exporter, to support prices and incomes and encourage production in competing exporting countries. This worked in turn to erode the U.S.’s share of the world market. Closer to home, supporting cotton prices also boosted demand for competing man-made fibers with both of these factors ultimately exacerbated cotton’s excess capacity problem.

Finally, there is considerable research suggesting that over the long run, the programs contributed less to supporting prices and incomes than traditionally believed. With program benefits capitalized into the value of inputs such as land, the cotton program boosted prices and gross incomes in the short term, but not necessarily the net income of producers over the longer term.

Chronology of Selected U.S. Cotton Support Programs

The Agricultural Marketing Act of 1929
The Agricultural Adjustment Act of 1933
The Soil Conservation and Domestic Allotment Act of 1936
The Agricultural Adjustment Act of 1938
The Agriculture Act of 1948
The Agriculture Act of 1954
The Cotton and Wheat Act of 1964
The Food and Agriculture Act of 1965
The Agricultural Act of 1965
The Agricultural Act of 1970
The Agriculture and Consumer Protection Act of 1973
The Agriculture Act of 1974
The Food and Agriculture Act of 1977
The Agriculture and Food Act of 1981
The Food Security Act of 1985
The Food, Agriculture, Conservation, and Trade Act of 1990
The Agricultural Reconciliation Act of 1990
The Federal Agricultural Improvement and Reform Act of 1996
The Food Security and Rural Investment Act of 2002

Source: Congressional Record, various issues, 1929-2004

Cotton programs have been reformed several times over their 75-year history. More recently, the 1985-2002 Farm Acts changed the structure of cotton supports dramatically to enhance the role of the market in determining supply, demand, and prices. The Acts largely decoupled support from market operations. This was done by abolishing acreage controls and allowing cotton producers to plant on the basis of market signals rather than program provisions. Incomes are supported through direct payments made regardless of market conditions. The non-recourse loan program was continued, with provision for loan repayment at market prices to prevent the loan rate from becoming a price floor. Step 2 payments to cotton mill operators and exporters were instituted to insure competitive pricing of U.S. cotton on both the domestic and export markets. Lastly, the Acts provided for counter cyclical payments to offset the impact of particularly wide swings in prices. This move toward more market orientation came at the expense, however, of large government payments averaging $2-3 billion per year.

Pressure for yet another round of cotton program reform is mounting; at issue first and foremost is capping and reducing the federal deficit. However, several other forces are also at work. The Framework adopted in 2004 by the WTO negotiators as the basis for arriving at a final Doha Agreement includes provision for reducing trade-distorting domestic farm support programs by at least another 20% over and above the 20% cut provided for in the Uruguay Agreement. While far from resolved, the Brazilian cotton case also raises questions about the structure of the U.S. cotton program and agricultural support programs more generally. With a new Doha Agreement in place and a final decision in favor of the Brazilians, the challenge will be shifting cotton support to less distorting programs and living within spending caps.

The global market setting will definitely affect any upcoming program debate and will be a critical determinant of how cotton producers will operate in the years ahead. Yet in light of the global recession and the likely fiscal limitations faced by the U.S. government, it is highly unlikely that the current program and the funding levels associated with it could emerge unchanged from any pending policy debate.

II. Cotton Policy From The 1930’s To 1985

Evolution of Policy in the 1930’s

The 1930’s were marked by several attempts to address growing concern about low cotton price and producer incomes. The cotton sector had faced market downturns before, but not to the extent following the post World War I boom. Efforts started in the late 1920’s with calls for purely voluntary cutbacks in production but evolved into mandatory government programs. These efforts met with only limited success and ultimately established several “givens” that shaped cotton policy into the 1980’s. The experience of the 1930’s convinced Congress, USDA, and cotton producers that:

• the cotton sector had significantly more capacity to produce than the market
could absorb at “reasonable” prices and producer incomes;

• this excess capacity problem was more or less chronic and required sizeable cutbacks in production, as opposed to short term stock adjustments, to avoid sharply lower prices, incomes, and asset values; and
• managing the cotton market to insure reasonable prices and producer returns required public intervention based on the understanding that producers would cut back on production in return for government program benefits.

By the 1942 advent of World War II, these givens formed the basis for what had become routine government intervention to limit cotton supply by reducing acreage and to set market prices above what would otherwise have been depressed market- clearing levels.

The earliest efforts to rebalance the cotton market date to the late 1920’s. The downturn in commodity prices following the post-war boom was exacerbated by the unwillingness of cotton producers to follow advice from USDA and farm lending institutions to reduce production voluntarily in the face of weakening demand for cotton in the mid 1920’s (Figure 4-4). Most cotton producers responded to low prices and incomes compared to wartime and post-war highs by maintaining or expanding output. Farmers kept acreage planted over the 1925-29 period at a record high 43.9 million acres despite erosion in prices from $.30 per pound during World War I and $.22 per pound in the early 1920’s to $.17 in the late 1920’s.

Congress ultimately intervened and established the Federal Farm Board (FFB) as part of the Agricultural Marketing Act of 1929. The FFB was empowered to loan money to marketing cooperatives to finance the purchase and storage of surplus commodities viewed as a temporary drag on the market, but its activity failed to boost prices and incomes for a number of reasons. For example, the initiative included no provision to control production and the onset of the Depression lead to further weakening in cotton demand. Over the 1929-32 period, cotton prices fell to less than $.10 per pound while planted acreage stayed high at an average of 40.8 million acres.

This deteriorating situation in the cotton sector was common to all the major commodities and led the Administration to sponsor and Congress to pass the Agricultural Adjustment Act of 1933. The Act responded to the FFB’s shortcomings by providing for production controls for “basic” commodities including cotton through acreage reductions programs. The Act was also noteworthy for its commitment to restoring the purchasing power of commodities using the 1910-14 ratio between farm prices and the prices of other goods and services in the general economy as a reference. This concept of “parity” was to be used by the Secretary of Agriculture in setting cotton prices for the next 30 years.

The Act was augmented before the end of the year to establish direct price supports in addition to production controls. Prices were to be supported through a USDA non-recourse loan program that offered producers a $.10 per pound loan, with the crop posted as collateral. Should a farmer choose to default on the loan, the USDA had no recourse other than to accept the collateral as payment in full. Legislation was also passed in 1934 providing for marketing quotas than insured that program benefits were restricted to program participants and limited the quantity of cotton that program participants could market.

In order to cut cotton acreage and production., the USDA aggressively used these Acts. Planted acreage fell to 27.9 million acres in 1934 and averaged 28.8 million acres over the 1933-36 period before the legislation was declared unconstitutional. In return for controls restricting cotton production and marketing, producers received price support that pushed cotton prices up from a Depression low of $.05-.06 per pound in 1931-32 to $.11-.12 over 1933-36.

The 1936 Soil Conservation and Domestic Allotment Act addressed the constitutional shortcomings of the earlier Acts but kept the same basic structure. Payments were made to farmers who adopted soil-conserving practices and shifted land from soil-depleting crops in surplus production (such as cotton) to soil-conserving crops (such as grasses). However, the Soil Bank failed to take enough acreage out of production, given further weakening in cotton demand, to balance the market. The 1938 Agricultural Adjustment Act was passed providing for mandatory price supports via a non-recourse loan program and marketing quotas keyed to acreage allotments. Over the 1938-42 period, USDA used the authority provided in the Act to reduce acreage to an average of 24.2 million acres. What with yields increasing due to growth in productivity and the retirement of more marginal acreage, this cut back was ultimately too small to balance the market. Cotton prices averaged $.09 per pound until war-related strengthening in demand pushed prices up into the $.17-.19 range in 1941-42.

Temporary War-Time Respite

Over the 1943-49 period, the cotton market was strong enough that there were no limits on production. Planted acreage averaged 22 million acres—roughly half the highs of the 1920’s and 1930’s-- and prices averaged $.27 per pound.

By 1948, the post-war boom in the major commodity markets had weakened enough for Congress to pass the Agriculture Act of 1948 and the Agriculture Act of 1949. The 1949 Act reaffirmed the programs provided for an earlier legislation and became the permanent legislation referenced in future acts. It provided for a return to allotments, quotas, and mandatory price supports if producers approved marketing quotas. The legislation was to be in effect to 1953 but was suspended for 1951-53 due to the upturn in the market sparked by the Korean War. The Agriculture Act of 1954 returned to allotments, quotas, and price supports that were in effect for the next decade.

The effect of the program weakened over time, however, as the minimum allotment levels specified in the legislation combined with yield increases to keep supplies large relative to domestic use and exports. Over the 1954-65 period, planted acreage averaged 14.6 million acres and prices averaged $.317. Stocks built up as the loan rate essentially set the market price and producers forfeited a significant share of their crops each year. Stock peaked in 1965 at 17.5 million bales or 117% of production. By the mid 1960’s it had become clear that legislated minimum support prices and allotments isolated farmers from the market and, when combined with yield increases, translated into large stocks that kept prices even lower than they would otherwise have been.

Reform in the Mid-1960’s

The 1964 Cotton and Wheat Act addressed some of these concerns by authorizing the Secretary of Agriculture to pay a subsidy to handlers and millers to lower the price of cotton used in the domestic market to the level of export prices. This effectively ended the two-tiered pricing system in effect for more than decade and was designed to expand demand for cotton while restricting production. The Act also allowed for smaller allotments than called for in the legislation if the Secretary offered a direct payment to producers planting within the reduced allotment.

The 1965 Food and Agriculture Act in effect from 1965 to 1970 consolidated elements of past legislation but introduced several new provisions as well. It provided for a cropland adjustment program but also provided for cotton pricing at world market levels. Loan rates were to be set at 90% of estimated world market prices. Income support was shifted from supporting market prices to making direct payments to producers tied to their participation in annual acreage reduction programs. In 1966, the Secretary was also authorized to offer paid land diversion programs to producers when added reductions in acreage were needed to reduce production. Over the 1965-70 period, planted acreage averaged 11.5 million acres. But market prices averaged only $.242 per pound, with basic supply and demand forces rather than price supports tied to a measure of parity setting prices.

With this new market orientation and added supply controls, USDA used the Act to reduce stocks to more normal levels by 1970. The program was viewed in many quarters as having effectively balanced the market while insuring producers reasonable returns. However, the direct payment element of the program eventually resulted in large and rising Treasury costs that exceeded $500 million.

Hence, the 1970 Agriculture Act was written against the backdrop of a more balanced cotton market with stocks at 25-35% of production. Legislators were confident enough of the market to provide for a voluntary cotton program by suspending marketing quotas. A cropland set-aside program was authorized but not mandated, along with provision for a paid land diversion at the Secretary’s discretion. The Act continued emphasis on insuring market-clearing prices for cotton by setting the loan rate at 90% of the average world price in the previous 2 years. Growing concern about the Treasury costs of an otherwise successful program was addressed by providing for a limit on payments of $55,000.

The 1970’s and 1980’s: Variability And Concerns About An Income Safety Net

The Agriculture and Consumer Protection Act of 1973 was written against the backdrop of strong export demand for all the major commodities and the generally held belief that chronic surpluses were a thing of the past. Prices moved from $.20-.30 in the 1960’s to $.43-.64 in the early 1970’s.

Legislators focused on providing producers with an income safety net without disrupting the operation of a bull market. The Act provided for target pricing, discretionary acreage set-asides, and disaster assistance. Target prices were used to establish minimum income support in years with temporary downturns in prices. Direct deficiency payments were to be made to producers to the extent that market prices fell below target levels. Target prices were to be increased each year to reflect increases in production costs adjusted for growth in productivity. Loan rates were set at 90% of market prices for the 3 previous years. The maximum deficiency payment was set at the difference between the loan rate and the target price. The bullish export market was expected to limit any government budget exposure.

The Act also provided for set aside authority to be used at the Secretary’s discretion. Payment limits were dropped to $20,000 to ease possible pressures on the Treasury. Disaster assistance was to be provided to producers who experienced low yields or were prevented from planting due to weather or other natural disasters. In addition, the Act provided for the calculation of program benefits on the basis of a national acreage allotment base set by the Secretary keeping recent plantings in mind. Plantings over the acreage allotment were not eligible for support but were not penalized.

The Agriculture Act of 1974 reflected legislators’ concern about the rising cost of cotton production and the failure of the 1973 Act to provide producers with an effective safety net. Despite significant cost-price pressure on incomes in 1973, no deficiency payments had been paid. This same concern played a major role in the 1977 debate. The Food and Agriculture Act of 1977 ultimately set target prices on the basis of the cost of production and kept the loan rate linked to the market prices, but with a minimum specified at $.48 per pound. From an acreage perspective, the 1977 Act made a significant shift in regard to where cotton was produced possible. The Act changed payment calculations from being based on historical allotments that dated back to the 1950’s and 1960’s to being based on acreage actually planted. This ultimately led to shifts between producers and across region based on comparative costs.

On balance, the Act encouraged cotton production and pushed acreage over the 1977-81 period up to an average of 14.1 million acres, with cotton prices averaging $.60 per pound.

The Agriculture and Food Act of 1981 again focused on concerns about providing producers with an adequate safety net. Experience in the late 1970’s and into 1981indicted that the cost of production formula for setting target prices included in the 1977 legislation was not working. It failed to adequately reflect rising production costs and left producers vulnerable to a cost-price squeeze. Legislators concluded that they could raise target prices and build-in increases over the 1981-85 life of the legislation since export demand was expected to keep market prices up and limit budget exposures.

The 1977 loan formula with its link to market prices was retained but with the minimum raised from $.48 to $.55. The Act also built on the 1977 legislation by moving even further away from historical allotments. The Act established new crop acreage bases to serve as the basis for acreage reduction initiatives in the future. The change reinforced the movement of cotton acreage. When all was said and done, legislators were convinced that they had provided producers with an effective safety net without disrupting the operation of what they expected to be a bullish domestic and world market.

Market circumstances intervened. Exports and, to a lesser extent domestic mill use, proved to be substantially weaker that anticipated. Even with acreage reduction programs in place, large stocks accumulated. With loan rates at a minimum of $.55 per pound and target prices at $.76, treasury costs increased sharply. Direct payments alone were $550 million in 1981 and $654 million in 1982.

This market downturn led the Secretary to announce a three-part production adjustment program in 1983. The program consisted of an acreage reduction component that required participating producers to plant no more than 80% of their base if they were to qualify for target price support. It also included two diversion components that paid producers cash to divert an additional 5% of their base and paid producers in-kind for diverting an additional 10-30% of their base. Cotton acreage dropped from 11.3 million acres in 1982 to 7.9 million acres in 1983---the lowest on record. Production dropped even more sharply due to drought-reduced yields from 11.9 million bales in 1982 to 7.8 million bales in 1983. Market prices were still below the target price and deficiency payments were made bringing the total cost of the cotton program in 1983 to more than $1.5 billion.

While stocks were down sharply as a result of the 1983 program, the Secretary announced another acreage reduction program in 1984 set at 25%. No diversion program was announced. With record yield in 1984, stocks built up again despite heavy participation in the acreage reduction program.

The Secretary also announced a 30% acreage program in 1985 that provided for a 20% acreage reduction program and a 10% diversion program. Producers were required to idle 20% of their base to qualify for program benefits but received a cash payment for the 10% diversion. With another record yield, supplies were large. With prices at $.547, almost $900 million was paid out in deficiency payments along with $200 million in diversion payments. With the loan rate well above the world market price, U.S. cotton could not compete on the world market and exports dropped to 2 million bales. As a result, stocks rose almost 5 million bales to 9.3 million bales.

III. Cotton Programs from 1985 to the Present

While there were many milestones in the evolution of cotton programs over their 75- year history, the 1985 Act stands out in retrospect as marking the beginnings of the program structure currently in place. The 1985 Food Security Act continued much that went before it regarding income support and acreage controls, but began the move toward using market loan provisions to insure competitive pricing. The 1985 Act introduced and the 1990 and 1996 Acts built on the concept of tying loan repayment rates to world market prices in bearish years to insure that U.S. cotton was competitive in the domestic and the export markets without undercutting the loan program’s contribution to farmer marketing efforts.

The 1985 Act also began a move toward more producer flexibility in making planting decisions with its introduction of 50/92 provisions. The 1990 Act expanded on the initiative. By the passage of the 1996 and 2002 Acts, support was fully decoupled from producer planting decisions. Acreage controls were a thing of the past and farmers were free to plant whatever they chose (with the exception of selected fruits and vegetables) without losing their support eligibility.

The legislation that followed the 1985 Act also shifted income support from deficiency payments linked to the current market situation to direct payments decoupled from the market. This decoupling reinforced the notion that farmer decision-making should be based on market supply and demand fundamentals rather than government payments that could mute market signals. The 1985 Act’s concern with limiting government budget exposure also laid the base for 1990 and 1996 provisions limiting the program payment base to a share of the acreage base (85%) and to frozen historical yields.

The 1985 Food Security Act

The 1985 Food Security Act was legislated against the particularly bearish market backdrop of 1981-84. As the 1985 season progressed, the cotton market weakened in response to large supplies, sluggish domestic mill use, and disappointing exports. High fixed loan rates functioned as effective price floor that priced U.S. cotton out of the export market. Exports fell by over half to hit an unprecedented low of 2 million bales while stock increased 4 million bales. At the same time, high target prices and loan-rate prices kept government outlays high. Despite large government outlays over $1 billion, producers faced a cost-price squeeze. Providing farmers with a more effective safety net while strengthening market orientation and controlling Treasury costs were emphasized repeatedly in the farm bill debate as the new Act’s primary concerns.

The Act ultimately drew on many elements from earlier legislation. The Act provided for acreage controls, non-recourse loans, and target pricing. However, the Act included new provisions designed specifically to insure competitive pricing in the domestic and export markets and more flexible acreage management. It also included provisions designed to reduce government budget exposure and provided the Secretary with considerably more flexibility in managing the program.

For example, the Secretary continued to have authority to implement both acreage reduction and acreage diversion programs if he determined that the supply of cotton was excessive. The legislation went further to suggest that a 4-million-bale carryout goal be used in assessing the need for acreage programs. However, the legislation also included a “50/92” provision that allowed farmers to collect program benefits on 92% of their permitted acres so long as they planted cotton for harvest on at least 50% of their permitted acres. This added flexibility was designed to promote more producer responsiveness to the downturns experienced over the 1981-84 period.

The loan program was continued, with the loan rate tied to market prices. However, the loan minimum was set at $.50 and the Secretary was authorized to reduce the loan rate as much as 5% from year to year. The most far-reaching change in the loan program, however, was the provision allowing the Secretary to authorized lower loan repayment rates if the original loan rate interfered with the competitive marketing of U.S. cotton. In what was eventually referred to as the marketing loan program, the Secretary was directed to monitor and publish a weekly adjusted world cotton price. If the Secretary determined that this adjusted world price was below the loan rate, one of two plans had to be implemented.

Under Plan A, the Secretary could lower loan repayment rates up to 20% and allow producers to redeem and sell their collateral at competitive prices. Under Plan B, the Secretary could adjust the repayment rate as the season progressed to track changes in the world price. If either Plan A or Plan B failed to keep U.S. cotton priced competitively, the Secretary was also authorized to issue marketing certificates to first handlers that were redeemable for cotton. The certificate payment rate was calculated as the difference between the loan repayment rate and the adjusted world price.

The target price program was also continued. However, contrary to past legislation, target prices were frozen and reduced each year over the life of the legislation. Target prices were frozen for 1986 at $.81 per pound and lowered to $.729 by 1990. Deficiency payment calculations continued as specified in earlier legislation. However, program yields were frozen as part of an effort to reduce government budget exposure. The Act also limited deficiency and diversion payments to not more than $50,000 and disaster payments at not more than $100,000 in an on-going effort to control outlays and target assistance.

USDA’s experience with the 1985 Act was mixed, particularly with regard to the marketing loan program. Acreage over the 1986-1990 life of the legislation averaged 11.2 million acres while prices averaged in the $.52 to $.68 range. After working the first year to insure competitive U.S. pricing, the marketing loan program proved difficult to administer in 1987 and 1988 and pricing problems reemerged both years. This led to disappointing exports and some stock build up. By 1989, the Secretary had experimented with Plan A and Plan B and opted to draw on industry advice to change the calculation of the adjusted world price and the operation of the program. The marketing loan program was overshadowed in 1989 and 1990 by tight markets both years. The Secretary called for 25% and 12.5 % acreage reductions that worked to keep U.S. and world stocks tight. With world prices above the loan rate over most of the two years, the market loan program was not operational. Even with the target price frozen and reduced over the term of the Act and program yields frozen, deficiency payments were made each year. Direct government cotton payments were $1.4 billion in 1986, $1 billion in 1987, $1.3 billion in 1988, and $.8 billion in 1989.

While it did not impact cotton directly, the 1985 Act also established a Conservation Reserve Program. The Reserve language allowed the Secretary to enter into long term (10 year) rental contracts for qualifying land. By the end of the 1985 Act, over 34 million acres had been enrolled in the program. With 1-2 million acres of traditional cotton acreage enrolled in the program, the CRP allowed farmers to reduce planting of marginal acres with low yields. This contributed at least indirectly to tighter markets from 1988 and 1989 on and made the acreage reduction programs more effective in limiting supply.

The 1990 Food, Agriculture, Conservation, and Trade Act

The 1990 farm bill debate followed two years of falling stocks, expanding domestic use, and high exports. Government payments in 1990 dropped to less than $500 million. Legislators focused on building on the 1985 Food Security Act to increase producers’ planting flexibility and fine-tune the marketing loan program to reinforce competitiveness while attempting to limit government outlays and protecting the environment.

The Food, Agriculture, Conservation, and Trade Act of 1990 and follow-up legislation included in the Agricultural Reconciliation Act of 1990 authorized the Secretary to operate acreage reduction and acreage diversion programs if cotton supplies were excessive. In an effort to avoid any burdensome stock build up, the Act provided for acreage reduction programs of 0 to 25%, with the acreage reduction set to insure a 30% stocks-to-use ratio at the end of the year. The acreage reduction calculation was also changed, with the reduction calculated using a producer’s crop acreage base rather than planted acres to determine the number of acres a producer had to idle to qualify for program benefits. In addition, the Secretary was authorized to offer a paid land diversion of up to 15% if stocks were projected at 8 million bales or higher.

The Conservation Reserve Program was continued with provision for added sign-up and more effective environmental targeting. The program continued to ease pressure for cotton acreage reduction programs by idling 2-3 million acres out of the CRP’s 34-36 million total that would have been available for planting to cotton.

The target price program was continued, with target prices for 1991-1996 set at $.729 per pound. The Secretary was also given authority to adjust target prices downward if needed to insure competitiveness. However, deficiency payments were to be made on only 85% of a producer’s cotton acreage base in a move to limit budget exposure. Heretofore, payments had been calculated using 100% of the base. However, part of the savings was lost with the Act’s provision that payments were to be calculated for a producer’s total production on the reduced acreage rather than production calculated using 1985’s lower program yields.

The 50/92 program was continued, with the addition of a new flex acres provision designed to increase producer flexibility further in making planting decisions. Producers could plant up to 25% of their crop acreage base to any commodity other than fruits and vegetables and still retain eligibility. This was in addition to the 15% of the crop acreage base excluded from the deficiency payment. The Act also provided for a 0/92 program. Under the program, a participant could commit program acres to a conserving use and qualify for up to 92% of deficiency payments.

The non-recourse loan program was continued with the same basic loan rate minimum. However, the 1990 Act also “fine-tuned” the marketing loan program. To start with, Plan A and Plan B were abolished and the minimum loan repayment rate was set at 70% of the loan rate. If the adjusted world price fell more than 70% below the loan rate, payments had to be made to first handlers to insure competitive pricing. The Act also provided for a 3-step program to further insure competitive pricing during market downturns and to insure adequate cotton supplies during periods of high prices.

Step 1 wrote the results of USDA’s experience linking loan repayment rates to adjusted world prices into law. The Secretary was authorized to set the cotton loan repayment rate at the lesser of either the established loan rate or the prevailing world market price for upland cotton adjusted to reflect U.S. quality and location. The Secretary was charged with monitoring this adjusted world price and was authorized to adjust the adjusted world price further to make U.S. cotton competitive if the world price was less than 115% of the current crop year’s loan rate and the U.S.-Northern Europe price quote exceeded the average Northern European price quotation.

The Secretary was also authorized to adjust the adjusted world price based on other factors including the U.S. share of the world market, current export sales and shipment levels, and other data as warranted. However, the adjustment could not be larger than the difference between the U.S. Northern European price and the prevailing Northern Europe price.

Step 2 authorized the Secretary to operate a marketing program for cotton users. The Secretary was authorized to issue marketing certificates or make cash payments to domestic users of cotton and to exporters for documented cotton sales in any week following a consecutive 4-week period during which the U.S.-Northern Europe price quotation exceeded the Northern Europe price quote by more than $.0125 per pound and the adjusted world price did not exceed 130% of the loan rate. The value of the payment was set at the difference between the U.S.-Northern Europe price and the Northern Europe price during the 4th week of a 4-week consecutive period minus $.0125 times the quantity of domestic purchases or export sales. Payments under this provision virtually guaranteed that U.S. cotton would be competitively priced on the world market and was attractively priced domestically. Certificate and cash payments could not be made when a special import quota was in effect. And expenditures under the program over the life of the 1990 Act could not exceed $701 million.

Step 3 was designed to insure adequate supplies of cotton during bullish markets. The Secretary was instructed to operate a special import quota for cotton if the weekly average quote for U.S.-Northern Europe cotton exceeded the Northern Europe price by more than $.0125 per pound for any consecutive 10-week period. The import quota was to be set at 1 week of domestic mill use and the cotton in question had to be purchased within 90 days and delivered within 180 days. Quota periods could overlay. But the quota program could not be operated if a global import quota was in effect. The Secretary was also authorized a limited global import quota set equal to 21 days of domestic mill use if the average monthly price of base quality cotton in specified spot markets exceeded 130% of the average price in the same markets for the proceeding 36 months. If a limited quota had been announced within the last year, the quota amount was to be either 21 days of mill consumption or the quantity necessary to increase supply to 130% of demand. The cotton imported was to be treated as if it were in-quota cotton not subject to the higher over quota tariff.

Payment limitations were also adjusted again. The limit on deficiency payments was set at $50,000, with the limit on combined deficiency, marketing loan, and loan deficiency payments set at $75,000.

With the 1990 Act’s language virtually guaranteeing competitive pricing, exports over the 1991-96 life of the Act were generally high enough when combined with strong domestic mill use to keep cotton demand high and acreage well above levels for the previous decade. Planted acreage for the 6 years averaged 14.3 million acres or 2-3 million acres per year above the average for the as previous decade. Yields were generally good, resulting in 6 consecutive good to excellent crops. Prices ranged from $.55 to $.765 and averaged $.65, or low enough to trigger deficiency payments in 5 of 6 years. Government payments were over $1.4 billion in 1992, $1.5 billion in 1993 but dropped sharply in 1994.

Further Changes in Program Fundamentals

The 1996 Federal Agricultural Improvement and Reform Act made another round of fundamental changes in cotton program provisions in an effort to increase market orientation. The most radical change was made in the delivery of income support and management of the sector’s acreage base. The marked changes in loan program operation provided for in the 1985 Act and refined in the 1990 Act were continued.

Looking first at income support, the 1996 Act revamped the income support framework based on target prices, deficiency payments, and acreage reduction programs that had been in place for several decades. In its place, Congress substituted predetermined annual contract payments to be made regardless of market developments to producers and landlords who would have been eligible for support had the 1990 Act continued in forces. In order to qualify for the payment, producers and landlords had to sign production flexibility contracts (PFC’s) that committed them to keeping their acreage in an agricultural or agriculture-related use and complying with conservation requirements for the 1997-2002 term of the contracts. Contractors were given complete flexibility to produce any crop--except selected fruits and vegetables--on PFC acreage. Conversely, cotton could be planted by any producer on any acreage regardless of their participation in previous farm programs.

The legislation specified that the contract payments would be determined and made on a commodity-by-commodity basis. The initial cotton PFC payment was set at $647.8 million for 1996 and fell each year thereafter to $466.1 million in 2002. Payments over the 7-year life of the program totaled $4,134.2 million. Payments to individual cotton contract holders were based on a single national payment rate calculated as the national payment total divided by eligible production. The quantity eligible for payment was calculated as 85% of the acreage base that would have been in effect if the old program had continued times a payment yield specified in the legislation. The Secretary was authorized to advance payments and to insure that payments were shared equitably between landlords and operators. The maximum PFC payment was set at $40,000 per person, down from the $50,000 limit included in earlier legislation. The limit on marketing loan gains and loan deficiency payments was continued at $75,000, with the same 3-entitiy rule applying.

The 1996 Act continued the previous loan program. The program continued to be non recourse, with the loan rate set at 85% of a moving average of cotton market prices for the previous 5 years minus the high and low years. However, the minimum loan rate was set at $.50 per pound and the maximum was set at $.5192 per pound. All PFC production was eligible for the loan. The Secretary was also authorized to offer loan deficiency payments to producers who, although eligible for a marketing assistance loan, agreed to forgo obtaining a loan in return for a payment calculated as the loan rate minus the loan repayment rate times eligible production.

Cotton acreage planted over the 1997-2002 life of the Act was higher than longer- term levels and averaged 14.6 million acres compared to 13.2 million for the previous decade. This increase in acreage reflected the Act’s flexibility. While relatively little cotton was planted by producers without a history, traditional cotton producers reacted to strong market price signals in 1997-98 and the decoupled PFC payments by planting more acreage. Acreage continued high over 1999-2002 after prices weakened as many producers looked to market prices to cover variable costs and the PFC payment to cover fixed costs. Production over 1997-2002 averaged 17.4 million bales compared to 16.4 million over the previous decade.

The market reacted to larger cotton supplies by pushing prices sharply lower over 1999-2002. The season average farm price averaged $.44 or well below the loan rate. While domestic mill use fell off despite lower prices under pressure from expanded apparel and textile imports, exports of textiles and raw cotton proved strong enough in 2001 and 2002 in particular to keep stocks moving down from a 2000 high of 7.4 million bales. The regional pattern of cotton production also shifted further in response to the acreage flexibility provided for in the 1996 Act. By 2002, 20 years of acreage shifts had boosted acreage in the Southeast to about a quarter of the total, while acreage in the Mid-South and Southwest was relatively stable (Figure 3-6). The acreage planted in the West declined but, with yields as much as 3 times higher than in other areas, the region continued to be an important producer.

2002 Program Reinforces 1996 Changes

The Food Security and Rural Investment Act of 2002 built on the major provisions of the 1985, 1990, and 1996 Acts. The Act continued with the direct payment, the marketing loan, and Step 1-3 provisions included in earlier legislation. It also added provision for a counter cyclical payment designed to provide producers with more support during market downturns.

The 2002 Act continued the 1996 Act’s shift in income support away from target prices, deficiency payments, and acreage controls to direct payments. The direct payment was decoupled in the sense that it was made independent of the market situation and regardless of what the recipient planted on program acreage. The Act provided for six annual cash payments modeled on the PFC payments in return for the recipient’s agreement to keep their land in agricultural or agriculture-related uses (with the exception of planting selected fruits and vegetables) and to follow conservation guidelines. Recipients were required to enroll annually in the program in order to qualify for payments and were given a one-time opportunity to update their planting histories. Payments were calculated as the payment rate times 85% of base acreage times a direct payment yield of 601 pound per acre specified in the legislation. The payment rate of $.0667 was derived by dividing the $622.l million in annual funding for the program provided for in the legislation by eligible production.

Cotton producers were also eligible for counter cyclical payments made in years when a cotton target price was higher than the effective price. Cotton target prices were specified in the Act at $.724 per pound for the 2003-07 life of the legislation. The effective price was defined as the higher of the season average farm price plus the direct payment or the loan rate plus the direct payment. This put the minimum effective price at the $.52 loan rate plus the $.0667 direct payment or $.5867 per pound. This put the maximum counter cyclical payment at $.1373 ($.724 - $.5867). Payments were calculated as the payment rate in effect for the crop year times 85% of the acreage enrolled in the program times a counter cyclical program yield set at 636 pound per acre for the life of the legislation.

The 2002 Act continued the marketing loan program largely as specified in the 1996 Act. The program offered farmers non-recourse loans at a rate of $.52 per pound. The Act continued provision for the Secretary to authorize loan repayment at less than the basic loan plus interest when the adjusted world price was below the original loan rate. The calculation of the adjusted world price continued as provided for in the 1996 legislation. The 2002 Act also continued provision for loan deficiency payments. A producer could receive payment for a marketing loan gain (roughly the difference between the loan rate and the loan repayment rate) either by putting his crop under loan and forfeiting or by foregoing the loan and accepting a loan deficiency payment equal to the difference between the loan rate and the loan repayment rate. This was designed to further minimize USDA stock holding and to encourage the orderly marketing of cotton at competitive prices in the domestic and the export market.

The 2002 Act reinforced loan program provisions by continuing Step 1-3 provisions. The 2002 language drew on the 1996 language and included authorization for Step 1’s repayment of loans at rates tied to the adjusted world price, Step 2’s use of marketing certificates or cash payments to domestic mill operators and exporters to insure competitive pricing, and Step 3’s provision for cotton import quotas during periods of tight supplies and high prices.

Cotton producers continued to face the same payment limitations facing other program participant. The limit on direct payments was set at $40,000, while the limit on counter cyclical payments was set at $65,000 and the limit on marketing loan gains and loan deficiency payments was set at $75,000. The 3-entity rule also continued to apply.

The 2002 legislation has worked to date to keep acreage in the 13.5-14 million acre range or below the 14.6 million acre average for the 1996 legislation. However, high yields in 2002, 2003, and 2004 kept cotton production up and put supplies in the record breaking 24-million bale range. Mill use continued to erode despite Step 2 payments in the face of substantially larger product imports. Market price strength was due entirely to strong export demand pushing export sales of raw cotton and textiles to all time highs in 2002-2004.

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