The Baltic Dry Index - A Valid Worry??

[Duckster]

The Baltic Dry Index (BDI) is a number issued daily by the London-based Baltic Exchange, which traces its roots to the Virginia and Baltick coffeehouse in London’s financial district in 1744. Every working day, the Baltic canvasses brokers around the world and asks how much it would cost to book various cargoes of raw materials on various routes (e.g. 100,000 tons of iron ore from San Francisco to Hong Kong, or 1,000,000 metric tons of rice from Bangkok to Tokyo).

Source: Baltic Dry Index - Wikipedia

On 21 May 2008 the index reached its record high level since its introduction in 1998, reaching 11793 points. Less than half a year later, on 4 November 2008, the index had dropped by 93%, to 815 points, the lowest since 1999. These low rates move dangerously close to the combined operating costs of vessels, fuel, and crews.

Source: Ibid.

Peter Kerr-Dineen, chairman of Howe Robinson ship brokers, said: “The scale of change in rate is utterly staggering – the market has come down from super-boom territory to pretty close to bust, effectively in two months.”

Contracting demand for imports in recession-wary economies across the world is a factor, as are steadily falling commodity prices and the mechanics of supply and demand in the shipping industry itself. But the real trouble is less obvious, largely unprecedented, and potentially devastating.

The wheels of international shipping are greased with "letters of credit"issued to buyers of bulk cargo by their banks. These guarantee the value of the shipment once it is in transit but before it is delivered. The problem is that the credit crunch, with the resulting liquidity problems in the international banking sector, is taking its toll on the availability of these entirely routine instruments. “We have the hugely worrying and unprecedented development where there are perfectly creditworthy shippers and receivers unable to open perfectly standard letters of credit,” Mr Kerr-Dineen said.

Cargos are sitting on docksides because the finance is not available to ship them, with the gravest implications for the future. “This is a nuclear bomb in the freight market, and in world trade,” Mr Kerr-Dineen said. “Liquidity has to return because if there is insufficient money to provide standard finance, world trade will be sharply cut back and economic growth will implode.”

Source: http://www.independent.co.uk/news/business/analysis-and-features/shipping-holed-beneath-the-waterline-995066.html (06 Nov 2008)

This site says the Baltic Dry Index is the only economic indicator worth tracking right now (13 Nov 2008 posted).

Bloomberg’s article from just before Halloween is a bit more reserved, but it still pulls no punches.

Does discussion of the economy at this level turn it into a self-fulfilling prophecy? Just more scare tactics about the unknown? Should I stock up on extra laundry detergent to clean the future mess in my undies are going to be filled with if these numbers cross into other areas of the economy (or should I just buy new underwear)?

Or, since I can’t do a damn thing about this economic mess, would it be better to order a half a ton of fine sand to bury my head to get away from all of this news?

[hawthorne]

You do understand that the financial system as it has existed at least from the 1970s has utterly collapsed, right?

It’s pretty bad, although not (yet?) as bad as it could have been.

[Duckster]

@hawthorne

You do understand that the financial system as it has existed at least from the 1970s has utterly collapsed, right?

It’s pretty bad, although not (yet?) as bad as it could have been.

Yeah. I’ve been diligently tracking numbers for the past 12 months or so. My retirement funds are a mess, even though retirement is a ways off. Still, when the graphs all look like a cliff edge, and still falling, the concern is there. Add in the claptrap promises of politicians and there is little to go on.

I’m not into Chicken Little fears. At the same time, my pragmatic gut keeps saying this isn’t good at all and the bottom isn’t yet in sight. Also, I do my best to keep my tinfoil hat in the drawer, yet I can’t stop thinking that only bandaids are being used, and will magically fall off after January 20th and expose the wound is infected and deeper than we are all led to believe by the current administration and Congress.

[hawthorne]

OK, a little more about what the BDI says: here are the numbers. Yes, it’s low, but it’s coming off insane highs. That’s because there’s been an almighty boom. Big ships take time to make, so capacity is highly constrained in the short term. Demand is also inelastic, so prices and returns are highly responsive to changes in demand conditions (which is what makes it a good indicator).

But that also means that its low value at present doesn’t mean that much, since the index has been historically high for most of the past five years. That has been a signal to invest in new capacity (and the adoption of cost-saving measures). The new capacity (presumably) coming on line means that with the downturn returns are going to be driven much lower. Much of the variation, then, is not because of imminent disaster, but because some of the investment in new capacity was driven by the boom and that investment was always going to be unprofitable if the boom ended *without *a crash. That doesn’t mean the letters of credit stuff isn’t an issue, just that the numbers don’t insist that anything like that is the driver of the index.

My guess (I’m an economist, FWIW) is that the financial panic is mostly done and what is left is the real fallout and the various issues about who pays the bill. Whilst governments have not responded optimally they have, I think, staved off global financial meltdown. It remains to be seen how bad the real economy effects are. I don’t think there will be breadlines in the US or 25% unemployment in a year’s time. There will be (almost certainly, there is) a recession. There will be a huge bill and an enormous mess whose effects will be felt for decades to come. But from where we were 3 months ago, that’s success.