Thursday, June 23, 2016

The Surprising Relevance of the Baltic Dry Index

On January 11th of this year, online financial circles lit up with dire news. “Commerce between Europe and North America has literally come to a halt,” one blogger wrote. “For the first time in known history, not one cargo ship is in-transit in the North Atlantic between Europe and North America. . . . It is a horrific economic sign; proof that commerce is literally stopped.” Although the Web site that first broadcast this information is prone to hysteria—there are, in fact, many cargo ships on the world’s oceans, in plain sight—more pessimistic market experts, such as Zero Hedge and the Dollar Vigilante, eagerly quoted it for their millions of readers. The story fit neatly into a narrative: the global economy, despite outward signs that it has clawed its way back from recession, is a small step away from an enormous crash.

But if sober-minded, mainstream economists were tempted to dismiss this ostensible trade calamity outright, they found that they couldn’t. The index that inspired these warnings, known as the Baltic Dry Index, was until recently viewed as a credible, if obscure, source—one that has accurately signalled prior systemic failures, and one that economists of all stripes have routinely consulted as a trusted proxy for trade activity. Based in London, this gauge reflects the rates that freight carriers charge to haul basic, solid raw materials, such as iron ore, coal, cement, and grain. As a daily composite of the tonnage fees on popular seagoing routes, the B.D.I. essentially mirrors supply and demand at the most elementary level. A decrease usually means that shipping prices and commodities sales are dropping (the latter because shippers are competing over fewer consignments). Shipping is a direct indicator of whether people want goods, and softness in shipping prices is therefore a sign of weakness in manufacturing and construction.

In January, when the B.D.I. surfaced as a heated topic in certain geeky economic corners of the Internet, it had fallen to a record low of 429, an eighty-per-cent decline from December, 2013, and far below its record high, in May, 2008, of 11,793. It continued to plunge for another month, hitting a nadir of 291 on February 12th. The index has rebounded a little since then, but not enough to dampen some concerns raised by its descent. While the catastrophic scenarios offered by the pessimists aren’t quite plausible, the B.D.I.’s dramatic plunge does appear to have indicated a genuinely alarming economic trend about the strength of global trade, with implications for jobs and corporate profits, that many economists had overlooked. Which raises the question: Why did economists color their judgment by discounting the B.D.I. in the first place? (...)

It was at St. Mary Axe that the Baltic Dry Index d├ębuted, in 1985, in response to technological advances that allowed the exchange to conduct its dealings electronically. The index was conceived as a way of standardizing global cargo prices, by taking a daily canvas of Baltic’s network of sea-based freight brokers and compiling the costs of booking shipments of raw materials. The price list that resulted would allow freighter transactions to be agreed upon with little haggling or human intervention, no matter where buyers and sellers were located. “We created the index to lubricate shipping, especially as shipping agreements are increasingly consummated over long distances and electronically,” Jeremy Penn, the C.E.O. of the exchange, told me. “We didn’t create it to be used for any other purpose.”

But economists saw things differently. To them, the Baltic Dry Index was a rare gem: a coincident indicator. You might be familiar with lagging indicators, such as the prime rate, which reflect the economy as it was months earlier. And you may also have come into contact with leading indicators, such as initial claims for unemployment insurance and the S. & P. 500, which supposedly presage the short- to medium-term future state of the economy. But their predictive track record is poor, because any number of exigencies—from a terrorist attack to a devastating natural disaster to an overnight rate change in Europe—could intervene to detour the economy.

By contrast, a coincident indicator, like non-farm payroll and industrial production, is an immediate and frequent snapshot of some aspect of the economy. Absent extenuating circumstances, any sharp and continuous movement in a coincident indicator will more than likely foreshadow a significant change, even if its implications aren’t immediately obvious. Indeed, the simplicity of the Baltic Dry’s message is what made it so attractive to global financial analysts.

by Jeffrey Rothfeder, New Yorker |  Read more:
Image: Carlos Jasso, Reuters