Collapsing Baltic Dry Index: Inauguration of an Era of Reverse Globalisation

Almost all the asset markets have performed by smartly appreciating during the course of the first three weeks of this years. Ironically, the only two indices that fallen sharply over the past three weeks have been the those related to the US Treasuries and the Baltic Dry Index (BDI). Shipping, like many other transportation indices is an important barometer of the economy. Its important grows manifold when we consider the fact that nearly 90% of the global trade is carried by ships. It is pertinent to note that on an average, the volume of Seaborne trade has grown at 4% a year since 1970. The volume of global sea borne trade by the end of 2008 was 89.79%, while in value terms it was 72.71%. In contrast, the volume of airborne trade was a mere 0.25%. The three important important components of shipping are (a) transportation of oil, (b) Containers, (c) 6 dry commodities transported in bulk. The Barometer for Bulk dry commodities is the Baltic Dry Index issued by the Baltic Exchange based in London. The Exchange has a history of more than 250 years and originally tracked the freight rates between England and its 13 colonies in North America.

The BDI has witnessed a roller coaster ride since 2007. It peaked at above 10,000 in first half of 2008, about six months before the collapse of Lehman Brothers (See Chart Below). It subsequently touched 666 in 2008 and gradually sprang back along with the eternal hope that accompanied unprecedented, probably the first gigantic coordinated, global intervention by Central Bank and Governments since the end of the Second World War.

Source: Bloomberg

A predominant view that has attempted to explain this causation is that the fall was triggered by a rise in global dry-bulk shipping capacity. Dry bulk shipping capacity rose by nearly 10% during the second half of 2011 and is expected to rise another 7% in 2012.There is undoubtedly some merit in the above statistics. However, it is likely that it is only part of the story - especially if we look at it in the context of financialisation. The case of Copper is illustrative: Demand for copper fell in 2011, but the price has gained this year - largely thanks to demand from financial investors.

Another factor that has been missed is, the dawn of a new era that has became more discernible after Japan announced its first trade deficit since 1980 has received less attention than it probably should. Interestingly, the only regulator who probably has not missed its significance is probably the US Federal Reserve: its announcement that US interest rates would stay low till 2014 was announced less a day after Japan’s trade figures were announced. US Fed has politely announced that the US economy is now in the firm grip of a deflation, if not outright economic depression. It is unlikely that US will enter a statistical depression as long as Bernanke is at the helm. Are these simply a confluence of coincidences? Maybe not, if we look at a BDI over a longer period of time – from 2001 (See Chart Below).

Interestingly, the chart clearly indicates that the BDI is back to 2001 levels (Close on 25th January 2012: 784), despite the fact that the volume of global merchandise has not risen dramatically since 2007. The chart below clearly illustrates the rise in the Volume of Merchandise over the decades, but it is clear that since 2007 the velocity of growth has slowed down remarkably. This despite the fact that the growth seems to be high in 2010. That rise may largely because of inventory re-stocking (companies seem to be getting used to the operating with razor thin inventories).

It is likely that it will revist the 666 level and hopefully it stays above that level.

Understanding freight rates is not an easy task. Theory states that price is always dependent on Demand and Supply, since demand has fallen last year (WTO points out that world trade likely declined by 5% in 2011),  what has been missed is the fact that is likely that Global Seaborne trade may be in the process of topping and may. That indicates that the breakneck speed of globalisation itself may be tempered over the next few years. If the BDI is an indicator and if my understanding of economic history (as well as my intuition) is right then a process of reverse globalisation may have already begun. A trend change that includes, High unemployment, declining incomes and wages across the developed world is well under way. If one includes factors like employee productivity and geopolitical tension, policy uncertainty and other risks in the emerging markets, capital and big business is likely to be rethinking their whole global business model based on a globally dispersed production supply chain. Instead it is likely to be one based on production within broadly defined economic geographies. It is unlikely that Japanese companies are likely to produce in India to supply US market: global finance and economy have become too complicated and no technology products or risk models can factor something like the timing of extremists among the US Republicans or in the Iranian government triggering another round of conflict. If the recent trend of increasingl investment in US rail roads is an indication, production for the local areas may be the beginning of a new trend.

The only asset class that is likely to benefit in this deflationary era: US Treasury bonds (at least till 2013-14) - I have been saying that for quite some time on this blog. After all, US will not default since it can simply print more US Dollars. The added benefit is that bonds of all hues, especially US Treasury are under-owned by individuals. Still doubtful of deflation in the USA? Don't look at Bloomberg headlines, instead look at the consumption of Petroleum and Electricity in USA.This fall in Petroleum usage and electricity output in the USA seems to have been missed by most of the observers. It is often an advance indicator of economic slowdown. Electricity output has been remarkably flat over the past year and has started falling quite drastically over the past three weeks.

Welcome to the New Era. If we survive this deflation unscathed, we will have great bedtime stories for our grandkids when we are more or less senile.