More Warnings From The Baltic Dry Index

Tuesday, November 18, 2008

More Warnings From The Baltic Dry Index

The following post by blogger, London Banker, is worth a good read: Systemic Risk, Contagion and Trade Finance - Back to the Bad Old Days

We are now starting to see the contagion effects of the current liquidity crisis feed through to the real economy. We are about to go back to the bad old days. Whether the zombie banks are kept on life support by the central banks and taxpayers of the world is highly relevant to whether the zombie bank executives pay themselves outsize bonuses and their zombie shareholders outsize dividends with taxpayer money. It appears sadly irrelevant to whether the banks perform their function of intermediating credit and commercial transactions in the real economy along the supply chain. The bailout cash and executive and shareholder priorities do not seem to reach so far.

The recent 93 percent collapse of the obscure Baltic Dry Index – an index of the cost of chartering bulk cargo vessels for goods like ore, cotton, grain or similar dry tonnage – has caused a bit of a stir among the financial cognoscenti. What is less discussed amidst the alarm is the reason for the collapse of the index – the collapse of trade credit based on the venerable letter of credit.

Letters of credit have financed trade for over 400 years. They are considered one of the more stable and secure means of finance as the cargo is secures the credit extended to import it. The letter of credit irrevocably advises an exporter and his bank that payment will be made by the importer's issuing bank if the proper documentation confirming a shipment is presented. This was seen as low risk as the issuing bank could seize and sell the cargo if its client defaulted after payment was made. Like so much else in this topsy turvy financial crisis, however, the verities of the ages have been discarded in favour of new and unpleasant realities.

The combination of the global interbank lending freeze with the collapse of the speculative, leveraged commodity price bubble have undermined both the confidence of banks in the ability of a far-flung peer bank to pay an obligation when due and confidence in the value of the dry cargo as security for the credit if liquidated on default. The result is that those with goods to export and those with goods to import, no matter how worthy and well capitalised, are left standing quayside without bank finance for trade.

Adding to the difficulties, letters of credit are so short term that they become an easy target for scaling back credit as liquidity tightens around bank operations globally. Longer term “assets” – like mortgage-back securities, CDOs and CDSs – can’t be easily renegotiated, and banks are loathe to default to one another on them because of cross-default provisions. Short term credit like trade finance can be cut with the flick of an executive wrist.

Further adding to the difficulties, many bulk cargoes are financed in dollars. Non-US banks have been progressively starved of dollar credit because US banks hoarded it as the funding crisis intensified. Recent currency swaps between central banks should be seen in this light, noting the allocation of Federal Reserve dollar liquidity to key trading partners Brazil, Mexico, South Korea and Singapore in particular.

Fixing this problem shouldn't be left to the Fed. They aren't going to make it a priority. Indeed, their determination to accelerate the payment of interest on reserves and then to raise that rate to match the Fed Funds target rate indicates that the Fed are more likely to constrain trade finance liquidity rather than improve it. Furthermore, the Fed may be highly selective in its allocation of dollar liquidity abroad, prejudicing the economic prospects of a large part of the world that is either indifferent or hostile to the continuation of American dollar hegemony.

.If cargo trade stops, a whole lot of supply chain disruption starts. If the ore doesn’t go to the refinery, there is no plate steel. If the plate steel doesn’t get shipped, there is nothing to fabricate into components. If there are no components, there is nothing to assemble in the factory. If the factory closes the assembly line, there are no finished goods. If there are no finished goods, there is nothing to restock the shelves of the shops. If there is nothing in the shops, the consumers don’t buy. If the consumers don’t buy, there is no Christmas.

Everyone along the supply chain should worry about their jobs. Many will lose their jobs sooner rather than later.If cargo trade stops, the wheat doesn’t get exported.

If the wheat doesn’t get exported, the mill has nothing to grind into flour. If there is no flour, the bakeries and food processors can’t produce bread and pasta and other foods. If there are no foods shipped from the bakeries and factories, there are no foods in the shops. If there are no foods in the shops, people go hungry. If people go hungry their children go hungry. When children go hungry, people riot and governments fall....

Oh, and the Baltic Dry Index seems to have found a 'bottom' for now. The good news is that the Index has stopped its plunge. The Baltic Dry Index last closed at 856.

However, it does not appear to me that this is something to be happy about. Yes, it's good to see the index has stopped plunging but, for me, based at current index level and the longer the index stays at current levels, how could the shippers even survive? And the longer it stays at current levels, what's the index saying about global trade?

And on today's Business Times, Moody's has downgraded Asia-Pacific shipping industry outlook! It's rather too late for such a downgrade eh?

Moody's downgrades shipping industry outlook

Rating agency Moody's has downgraded the Asia-Pacific's shipping industry's outlook from 'stable' to 'negative' for the next 12 to 18 months.

The agency cited continued vessel overcapacity, weaker demand for commodities, and volatile prices for bunker fuel.

The negative outlook applies to all three sectors: dry bulk, tankers and liners.

"The excess of supply in vessels has worsened as growth in commodities demand has slowed, in line with the global economic downturn, the freezing in credit, lower consumption in the US and Europe, and volatility in currency and other financial markets. An easing in demand for oil is another factor," Moody's said in its report entitled "Asia-Pacific Shipping Sector: Preparing for Volatile Times".

It said the excess supply is apparent in all three sectors and expected to take a long time to correct.

Today, the order book for capsized bulk carriers is similar in size to that of the current global fleet. For the tanker sector, the order book for Very Large Crude Carriers (VLCCs) and Suezmax tankers is about half the size of current fleet capacity, and these new- builds will be delivered over 2008-2012.

As for the liner sector, it has an order book for 6.5 million TEUs (20-foot equivalent units), representing 55 per cent of current fleet capacity.

Moody's said rated issuers facing over-supply in vessels include PT Humpuss Intermoda Transportasi in dry bulk; MISC Bhd and BW Group Ltd in tankers; and Wan Hai Lines Ltd and MISC in liners.

"However, MISC benefits from business with (parent) Petroliam Nasional Bhd and other major oil companies, and is thus partly protected from the over-supply situation," it added.
Apart from vessel overcapacity, unstable operating costs - due primarily to volatile bunker costs - have also undermined profitability in all three sectors.

Meanwhile, Moody's said while its industry outlook is negative, the rating outlook for most of its rated issuers is stable.

The reason for this disparity is that rated shipping companies such as MISC, BW Shipping, NYK and MOL are supported by use of many of their vessels under long-term agreements, adequate liquidity, based on good access to bank financing, and diversified trade and vessel types.