Lately we’ve been getting a lot of concerned emails about this chart.
That chart is a 1-year look at the Baltic Dry Index, which measures the spot cost of shipping goods by ship around the world.
As you can see, it’s plunged nearly 66 per cent since its recent highs, and understandably, people are wondering whether this remarkable deflation means the global economy is falling straight off the cliff, or at a minimum indicative of a rapid hard landing in China.
To answer this question, let’s first put the latest move in the index in context.
Instantly you can see a couple of things.
The first is that the current decline is nothing like the declines we saw the last time the global economy went into recession in 2008. You should also see, hopefully, that this index is VOLATILE.
It might be hard to figure out some of the moves due to the scale of the chart, but from May 21, 2010 to July 14, 2010 it fell from 4078 to 1708, a decline of 58 per cent.
Conversely, from September 24, 2009 to November 16, 2009, the index jumped nearly 200 per cent.
Again, these kinds of big swings are par for the course with the Baltic Dry.
But to really understand what’s going on, you need to understand that the Baltic Dry Index is not merely a reflection of shipping demand, but also ship supply.
Back in May 2009, former BI writer Vincent Fernando published a pretty fantastic Baltic Dry explainer of the index.
To start he noted:
Why do shipping rates seem to jump all over the place? Due to near-term supply of ships versus demand for commodities. Its just a matter of bottleneck problems. If rates go up it can come from either of two things: not enough ships at the time or too much commodities demand at the time. In a situation where ship owners match demand, which over the long run they will, then rates won’t skyrocket and will just track their costs plus some margin for their effort.
He then offered up this very obvious example to explain the volatility …
Imagine you have 10 loads of iron ore and 9 ships, and that every load of iron ore must be sent no matter what while every ship must be filled no matter what. Imagine the bidding war between those 10 iron ore consumers fighting over just 9 ships. Shipping costs would skyrocket since they all need to ship regardless of cost. Now imagine if a week later two more ships enter the market. Now imagine the bidding process. Suddenly the tables have completely changed. You have 11 ships, that all need to be filled no matter what, and only 10 loads of ore. Shipping rates would plunge, despite a period of just a week passing by. This is, in a simplified nutshell why the BDI is so volatile.
And he concluded…
Now, add to this the fact that predicting ship supply and commodities demand has a pretty high margin of error, at the same time remembering how sensitive the BDI is to small mismatches due to the inelastic nature of its underlying supply and demand, and you quickly realise that predicting the BDI is a fool’s game and also that it is not a reliable forward indicator given that it is a spot rate index in a market where both sides are basically forced to close a deal due to high fixed costs. The BDI is a measure of supply/demand mismatch at the moment, and can change drastically on a dime. It’s little else beyond this. It hit its peak not when the global economy was in its healthiest state, but in early 2008 when things were already starting to come apart, but Chinese commodities demand growth still had some steam and just kept outstripping stagnant vessel supply growth. For a moment. And then it all collapsed.
The bottom line is that because it has so many moving parts it’s just not that good of an economic indicator, though unfortunately a lot of stories have been written about how great it is, and how people should pay attention to it. Also, because it’s so volatile, you can tell a heck of a story using it.
So for all the people emailing us about the plunge, we’d just like to say: Chill.