Monday, September 14, 2009

The real economy - trade flows

The timely and aggressive actions of governments around the world have seemingly averted disaster.  A variety of economic indicators point to stabilisation, if not outright recovery.  The liquidity that is sploshing around the global economy is finding its way into asset price inflation in an echo of the aftermath of the 1987 crash.
Is the global financial crisis over or is the real economic crisis just beginning?    I'm gonna try to have a deeper look at the liquidity effect later in the week - today the focus is on trade as an indicator of the 'real economic' situation.

Question: why has the Baltic Dry Index dropped by ~40% since the start of June while the S&P500 has risen by 13% over the same period?

The BDI is a composite measure of worldwide shipping prices for dry bulk cargoes which comprise the majority of worldwide cargo traffic.  It takes in 26 shipping routes and covers dry bulk barriers carrying a range of commodities (coal, iron ore and grain etc.).  As the departure point for many a supply chain, it is often considered a leading indicator for industrial production and world economic growth.

While over the medium term, the BDI will be impacted by the supply side of the shipping equation (China likes building big boats - expect overcapacity to be visiting a port near you sometime soon) in the short term it is much more sensitive to simple demand and supply for the commodities being shipped.

In that context, you can clearly see the impact of the global government spending spree that commenced in late 2008.  It's well documented that China was on a stockpiling binge over the first six months of 2009, which supports the ramp up in the BDI.

Then what?  The party seems to have hit the wall.

While governments and brokers point to the turning up in GDP and industrial production numbers in developed countries, the BDI is suggesting the near term run-up in commodities trade volumes is done.  This correlates with comments from the likes of BHP suggesting that China is finished stockpiling and hoping that Europe and the US take-up the slack in the form of re-stocking.  In short, the BDI is not signalling confirmation that the developed world is doing anything but trying to find a bottom at vastly reduced trading levels.

Consider the following chart of world trade growth from the OECD Economic Outlook June 2009:

This translates to world trade growth projections like the following:

OECD forecasts for year-on-year changes in world trade volume for 2009: -12.0% and 2010: +5.5%
World Bank forecasts for year-on-year changes in world trade volume 2009: -9.7% and 2010: +3.8%
IMF forecasts for year-on-year changes in world trade volume 2009: -12.2% and 2010: +1.0%

I'll leave you to extrapolate your favourite forecast onto a chart of trade volumes (data from CPB Nederlands as at June 09):

The clear point from this is that world trade has fallen a long way, and while it may have turned up, it is unlikely to recover its peak for a considerable time.

And here we have one of the core problems facing the global economy.  The trade imbalances that were financed by debt remain unresolved.  Untangling these is likely to be a painful process.

Have a quick look at the breakup of export flows for some of the major economies from 2008 (UN data).

Ideally, I was going to match up against imports - but this piece has run over budget.  However, some quick observations:

1) Germany is an exporting machine - but to Europe.  The periphery figures highly as the importing counterpart (and it would have been financed on credit).  Europe's trade imbalance hangs heavy over the future political stability of Europe and the Euro.  It's one of the key potential positives for the USD.
2) Japan has developed a handy export business to China.  It's been suggested that Japan may be one the key beneficiary's of the industrialisation of China in the long term.  This hasn't stopped Japan from being severely hit by a drop in exports (~30%) that has triggered deflationary forces internally.   
3) US relies on exports to Latin America and Canada.  The relative under-performance of the USD versus these regions assists its export efforts in this respect.  The problem is the import side of the ledger (not shown) where the US has been importing deflation.  (See Albert Edwards chart.)  It's just cheaper to get goods made in China (note that ~60% of China's trade surplus with the US comes from US companies that manufacture goods in China and then import into US).
4) China has built a diversified export empire.  Amazing.  But it remains dependent upon exports to support its economic growth model.

So not only is the trading pie getting smaller, the make-up of the pie is not conducive to a quick solution. The surplus trade economies remain hooked on exports.  The deficit countries are tapped out, unwilling and unable to continue to buy whether from exporters or their own economies.  The ideal objective is for the two to swap roles, at least for a little while.  That is going to be tough.


1) Expect 'protectionist' measures - resolving trade imbalances will be painful.  In the debtor nation, it requires falling living standards and for open market economies like the US, higher unemployment.  expect governments to come under increasing pressure to protect jobs and ensure that its spending stays at home (eg. US tariffs on steel and tires).
2) Expect surplus countries to export deflation  - their economies are geared to exports.  While China wants to increase its domestic consumption (36% of GDP), it will not happen overnight.  Not only is China a big lender to the US, its biggest customer is the US.  Chinese overcapacity will flow back into the US (and globally) as cheaper prices on goods (eg. steel into South Korea).
3) Expect China to buy the farm, not the produce.  While the Chinese have been stockpiling industrial commodities in the first half, and this has propped up trade volumes, we can question the longevity of this strategy.  It seems to me that they will be more inclined to buy the physical asset (the mine, the permit, the offtake agreement) than take the commodity out of the earth, ship it half way round the globe, just to have it sit in a warehouse.  (China annexing parts of Africa when the locals revolt against perceived empiricism.)

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