Baltic Index Bodes Badly

The Baltic Dry Index (BDI) measures the cost of moving raw materials by ocean freighter. This index, which is a leading economic indicator, has dropped from its lifetime high of 11,793 on May 20, 2008, to 666 on December 5, 2008, a 94.35% decline in six months. Such a precipitous decline indicates a huge drop in demand for shipping—everything from textiles to raw materials and commodities. The lack of demand for shipping stems from consumers’ need for cash to reduce existing debt, leaving little money for the purchase of future goods.

The drop in demand for shipping has also been exacerbated by the need for letters of credit before goods can be shipped. Such letters are hard to come by these days.

In the short run, this drop in demand for commodities suggests that lower prices are yet to come, with a possible rise in bankruptcies before prices hit bottom. But then that’s the nature of a recession, which, according to NBER, the United States entered in January 2008.

In the medium term, the central banks of the world (laboring under the notion of inflationomics) will try to guarantee the deposits in their country’s banks and bail out the companies that are “too large to be allowed to fail.” Unfortunately, this bailout process could destroy the central banks’ creditworthiness as happened in Iceland. When this happens, the local currency will dive (see what has happened to the Icelandic Krona), depressing the domestic economy and impoverishing its workers. With the current credit crunch, such a phenomenon could spread around the world. See what’s happening in Great Britain and China. Imagine a bankrupt Great Britain, worthless Pound and a revolution in China with millions of unemployed workers (workers unite…you have nothing to lose…but your paper currency.)

For the central banks that survive the threat of collapse in the medium term, there will still be the consequences of their credit expansion and easy money bailouts. The question is, how long will we be in a recession before the central banks create a new bubble (in commodities) with their credit expansion and easy money bailouts?

Robert Jackson Smith

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