10/08/2011 - 08:57

Analysis: why this time is really different

10/08/2011 - 08:57


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The Baltic Dry Index has barely moved over the past month, a fact which has escaped hysterical share traders and expert commentators, but one which is very good news for Australia, especially WA.

Failure of the BDI to crash as other indicators have, especially in Europe and the U.S., is a sign that this phase of the global financial crisis really is different, and more a political event than a business event.

A unique measure of trade in bulk cargoes such as iron ore, coal and wheat, the BDI tracks the cost of renting bulk carriers from the Handy size vessels which call at Fremantle to the Cape size giants which visit places such as Port Hedland.

Three years ago, when the first phase of the global financial crisis (GFC) hit the world the BDI plunged by more than 94% as world trade dried up and bulk carriers sat idle.

This time around the BDI has weakened marginally, but largely because of uncertainty in the minds of bankers, and not because of a sudden drop in world trade, or demand in Asia for the bulk commodities Australia supplies.

As an indicator of future demand for commodities, the BDI is arguably the best measurement available which is why any analysis of how Australia will be affected by trouble in Europe and the U.S. needs to factor in demand for ships.

Minimal movement in shipping costs is why some observers see the current situation being significantly different to 2008, including:

Different origins.

  • Different reactions, and
  • Different solution.

The difference in origin is extremely important because in 2008 the problem was caused by the failure of banking “experiments” such as the invention of sub-prime loans for housing to people who couldn’t (or wouldn’t) repay their debts.

Layered on top of sub-prime was a belief in the banking world that housing prices never fell, and that individual home loans could be bundled into a package called a collateralised debt obligation (CDO) which would be acquired by investors – who soon discovered that they had swallowed a poison pill.

This time the origin of the crisis is a collapse of confidence in the political system orchestrating a solution to slow economic growth triggering a “consumer strike” which is killing the retail sector, forcing unemployment up, leading to even slower growth, and civil unrest in places such as London.

The reaction of governments in 2008 was to flood economies with cash. Today, many governments are broke. They have run out of cash and are now having their access to debt markets cut off as their cost of borrowing soars. Investors no longer trust the ability of governments to repay their debts.

Households and businesses are, however, squirreling cash away as shown in Australia’s 11% savings rate, a dramatic reversal of a time when we spent more than we earned. In the U.S., the commercial banking sector is awash with cash with one bank, the Bank of New York, charging big customers a fee to hold their cash rather than pay them interest.

This time there will be no quick-fix. It will take years of hard work to calm markets, and force substantial cuts to government spending as politicians wake to the new reality of no new debt, leading to a fear that governments might resort to the printing press and simply print more money, cutting the value of what’s already in circulation.

The sharply higher gold price is a reaction to the possibility of politicians opting to “inflate away” their debts, repaying what they owe with debased currency.

Central bankers, always fearful of inflation, will resist the printing option, demanding (and hopefully getting) tough spending cuts in Europe and the U.S. where easy debt has replaced recurrent income from business activity.

In Asia it is different. Trade flows will undoubtedly be affected by what’s happening in Europe and the U.S., but not disastrously as in 2008 – which is the message contained in the relative stability of the shipping market as measured by the BDI.

Business in Australia’s part of the world might slow a little, and commodity prices will probably retreat from recent highs, but the outlook is not nearly as grim as it is elsewhere.


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