06 September 2018

Is the Baltic Dry Canary telling us something?

The US economy continues to grow at a cracking pace, or so we are told again and again. Unemployment is down to record lows, and the stock market is back to record highs. Corporate profits are at record highs, and the (US) economy grew at 4.2% in the second quarter of 2018. Europe continues to grow, at least that is the message, Brexit or not. Not one month ago, the Baltic Exchange Dry Index (BDIY), a key measure of the cost of transport and a bellwether of international trade volumes, was at an annual high of $1774.

Is there anything to suggest that all is not well?

Officially, all is good in Economy-Land. Unless you are in the Emerging Markets (EM) where all is going to hell in a handcart. And if you do watch the BDIY as I suggested last month, you may have reason to worry.


Years of Growth Ahead?

Some time ago (18 August 2017) I asked if the collapse of the employment participation rate during and after the Great Recession of 2008 had actually set the US up for years of economic growth as ejected labour re-entered the market, creating a multi-year pool of “new” labor. Was the unemployment rate artificially low due to the definitions used to define “unemployed”, and was there, in fact, a giant pool of untapped labour just waiting to be absorbed?

Certainly, European economies have had a chronic underemployment problem for the past twenty years, so there should be no shortage of labour, unless your production is in Germany (a problem that was supposed to be solved through the importation of millions of ‘refugee’ migrants to provide the new working underclass). 

Or black Swans a swimming?

Or, as I pointed out last month (6 August 2018) are there too many Black Swans flocking, ready for the first to set off a global contagion? Some are pointing to the ongoing EM route and collapse of so many international currencies (Turkish Lira, Argentine Peso to name two) as the “Black Swan de jour” that may cause contagion in developed markets. Are the US markets being kept artificially buoyant with cash fleeing EM countries? 

Or, are tariffs actually beginning to impact? Or, the EM route simply an indicator of the level of international uncertainty, with tariffs being one re-enforcing element?

If tariffs and the EM markets are all part of the same flock of Black Swans, then we should be able to see the rot in international trade. 

On the 6th of August I wrote:
"We need to keep watching indicators from around the world, and look for specific activities. The Baltic Dry Index provides a good indicator for us to watch. In the past moths, the Index has risen from $1250 to over $1700 now. The Baltic Dry Index provides a reliable surrogate for global trade volatility, with higher trade volumes increasing the cost of freight, and falling freight volumes driving down the BDIY."
And so I have been watching the Baltic Dry Index, and it has not been pretty. In the month since I wrote the above, the BDIY has fallen from an annual high of $1774 down to $1477 today (6 September 2018), representing a 16% fall in that month.

As a reminder, the BDIY is a measure of the cost of freight, and as such is an indicator of volumes of international trade in terms of shipping. It is reasonable to expect the BDIY to rise and fall over time due to total shipping capacity, with fleets expanding too quickly for anticipated growth in trade resulting in a slowly lowering BDIY, and fleets falling as uneconomic ships are retired from the fleets and scrapped resulting a slowly gaining BDIY. But that is for the long-term trend line only.

What we have seen this year is the BDIY increase significantly in the second quarter, just as tariffs were being mooted, but before they were actually brought into force. As I speculated in early August, the robust second-quarter GDP print could have been a factor of forward-purchasing and inventory padding to ride-out any transitory tariff impact. If that were the case, I suggested that we would see a fall in trade volumes in the third quarter, with the BDIY providing an early warning sign of such a fall in trade.

We are now seeing that fall, and while one month and a 16% fall could be a transitory fluctuation, it could also be an indicator that trade volumes are being hit, and we should expect a must worse third quarter GDP print.

If the BDIY continues to fall, it will be the clearest sign yet that the tariffs are biting, and that trade volumes are indeed falling.

Even as the BDIY was increasing through July, the Netherlands Bureau for Economic Policy Analysis was reporting that global trade volumes fell in June (I await the July figures).

As I said in early August, I will continue to watch the BDIY, as this may be one of our best canaries in the global trade coal mine.

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