Global Trade at Risk

The following is an article today from Alan Kohler. He and a few other commentators were talking about this issue a couple of weeks ago. It appears to have worsen significantly, and yet it doesn't even pop up on the nightly news or the front of main stream newspapers.

Kohler's articles can be viewed daily at: http://www.businessspectator.com.au

The global shipping crash continues to get worse and this morning’s GDP data shows the US recession is already deeper than 2001 and probably 1990-91 as well.

Meanwhile the International Monetary Fund seems determined to make the whole thing worse by imposing the most ruinous strictures on supplicant nations.

Yesterday the Baltic Dry freight rate index fell below 1000 for the first time in six years and last night it fell another 40 points to 885. In June the index was 11,900, so it has fallen 93 per cent in a few months – a crash far worse than anything ever seen in the stockmarket.

The spot daily rental for a Capesize ship is now $6365, down from $234,000 per day over the space of a few weeks. Maybe that previous price was absurdly inflated, but at $6365 it is just $365 above the average daily cost of crews and fuel.

As a result the world’s ports are filling with empty ships because shipowners can’t afford to run them, as well as some full ships because the owners of the cargo won’t unload without a bank letter of credit, which banks are refusing to supply.

Shipping companies are starting to file for bankruptcy in increasing numbers as they breach loan covenants, and a shipping researcher, Andreas Vergottis of Tufton Oceanic has told Bloomberg that a fifth of the world’s dry bulk companies may soon have negative net worth because the market for second hand ships has collapsed and the value of their fleets is below outstanding debt.

Like property-based loan agreements, shipping companies’ debt covenants have loan to value ratios that are typically 70 per cent. As the value of their fleets decline, banks are making margin calls.

Meanwhile, as expected, US GDP fell in the September quarter – by 0.3 per cent. The only reason it wasn’t worse was government spending, which added 1.1 per cent to the rate of GDP change. There was another 0.6 per cent from private inventories – that is, unsold goods.

In any case, US economic data is always rushed out quickly, based on guesswork, and then revised later. Most of the guesses in this morning’s figure look optimistic, so it is very likely to be revised downwards.

Even on this morning’s optimistic estimate, it is the first year-on-year decline in GDP since 1991, so this recession is already worse than 2001 and clearly has a long way to go.

And remember that in 1990-91 – and 1980 and 1973 and 1961 for that matter – the monetary and fiscal authorities were more or less in control. Or rather – they started it.

Those recessions were caused by central bank and government efforts to control inflation. This time it’s all about a spontaneous collapse in private sector credit and governments around the world are desperately trying to counteract its effects with interest rate cuts, liquidity injections and fiscal stimulus.

That is…all except the IMF. It is imposing the most horrendous conditions on bailout loans to bankrupt countries.

As the rest of the world’s official interest rates come down, Iceland’s this week went up 6 per cent, from 12 to 18 per cent, as a condition of its $US2 billion rescue package.

Hungary, Serbia, Belarus, Pakistan and Ukraine are now facing the most excruciating choice: default on their debts or ask the IMF for money at the expense of crushing their economies under the weight of a massive increase in interest rates.

As Ambrose Evans-Pritchard writes in last night's London Telegraph: “A deflationary strategy of this kind could prove counterproductive – or worse – if applied in enough countries simultaneously. It would defeat a key purpose of the rescues, which is to stabilise the global financial system.”

Meanwhile China, the world’s greatest creditor nation, is now cutting interest rates as its economy slows.

The emerging world in general has “recoupled” (if it was ever decoupled) and the removal of hedge fund investments in their currencies, government debt and sharemarkets will, in many cases, result in deeper recessions in those countries that in the US – where it all started.

Which is why global shipping has collapsed: it is the harbinger of the end of the era of trade, in which third-world labour costs kept first world inflation down and allowed interest rates to fall and stay low and debt to be increased to an historic degree.

That process of importing deflation (or, more precisely, disinflation) from developing nations – especially China and India – relied on trade: raw materials in; finished goods out.

The fall in freight rates for both dry bulk carriers and container ships is telling us that it’s over.

Australia is potentially in the most vulnerable position. Commodities could potentially be on the brink of collapse if ships do not start to move soon. Already we are currently witnessing Mount Gibson Iron (MGX.ax) in a trading suspension because China will not/cannot move its ships to buy MGX's iron ore. MGX is by no means a small Australian company. It is in the ASX100, and would be in the top 20 resource companies in Australia.

The fallout of a huge resources bust is almost unthinkable. A few zinc mines have shut (or reduced output) over the last few months in Australia. Now at current spot prices, even OZ Minerals Century Mine (formally Zinifex) near Mt Isa, the 2nd largest zinc mine in the world, is unprofitable at current prices. Commodity prices need to rebound quickly along with ship movements, or Australia will enter deep recession within a year. Commodities make up around 60% of Australia's exports, and it is no coincidence that the Australian Dollar has fallen by 40% in only a couple of months!

Picture this: A truck driver working in a mine in the Pilbara earning over A$100,000 p.a. suddenly looses his job because the mine shuts down. Only a year earlier he took out a mortgage on a new house in Perth. However, 100,000s of other people are in the same situation. Mines closing, exports decreasing. Australia hits recession and there are few jobs. The miner, who expected to maintain employment and a high income is suddenly unable to pay the monthly mortgage with no solid income. Property prices across Australia then start falling sharply on weak buyer demand and falling expectations.

This is a real possible situation which may hit Australia soon if the resources boom comes to a grinding halt which is increasingly looking more likely.

Scott