Global Economy: Ignore the politicians' optimism, the outlook is DEPRESSING

Well folks, since our last analysis on Global Stock markets, I think it is time for us to look at what is in store for us in the Global Economy. As everyone knows we are certainly living in some exciting times. There are too many problems going on around the world and it seems to be getting from bad to worse with each passing day.

We have seen problems in Greece’s inability to form a government, contagion being spread to Spain with its 4th largest bank needing a bailout, bond spreads are sky rocketing in Spain, Italy and Portugal - almost too much to mention! So how do we view the Global Economy going forward? What indicator can we use to gauge the health of the global economy?

Baltic Dry Index

So what is the Baltic Dry Index?

This index measures the cost to carry dry freight over the world's oceans. The cost of shipping dry commodities, such as coal, iron ore and grains, forms the basis for the BDI. When raw materials are shipped, it is because they are needed to be made into finished goods and when grains are shipped, it is because somewhere there are demand for the product. In other words it represents economic activities that are going to be generated.

Forward and Backward Looking

This index is one of the leading indicators for measuring the economic activity. The BDI is one of the ‘Forward Looking’ economic indicators, meaning it acts as a precursors of economic activity that are yet to begin. Whereas consumer spending and other economic indicators are ‘Backward Looking’, meaning they are the result of what had already happened. By analyzing the BDI, you are able to gauge the level of economic activity that is going on around the world through the global demand for raw materials and infrastructures.

Below is the Chart of the Baltic Dry Index for the past 10 years. As you can see the index peak during the early part of 2008 it hit an all time high of about 11,400 points just before the Global Financial Crisis struck. After that it went off the cliff and dropped more than 10,000 points to less than 1000 by December 2008. This represents a drop of more than 90% from its peak. After that it only managed to recover to about 4643 points which is only 35% from its peak.

The three year Baltic Dry Index (BDI) as shown below seems to be loosing ground again. Since the 2008 crisis the highest point recorded is at 4643 on 18 Nov 2009 and the lowest recorded was in Feb 3rd 2012 at 648 points. That represents a drop of 3995 points or roughly an 85% drop. It managed to rebound in February to a high of 1157 and it is now again closed below the 1000 psychological level again at 986 as of yesterday.

However the bad news is that it dipped below the MA50 line which is an indicator of consumer sentiment. So we expect the BDI index to close lower soon and probably will test the new low of 648 which it set in February this year.

Why the BDI dropped?

One of the main reasons for the drop is the decline in European imports which also resulted in the decline in China’s exports. Due to the financial crisis in Europe its economic activity had slowed down. From manufacturing to consumer spending there had been a notable decreased in demand.

Another is the decline in world trade since the index represents the shipment of dry goods which mainly consists of commodities and raw materials. In a way a drop in the index represents a drop in movement of goods worldwide and hence the decline in world trade

According to Tianjin Shipping Line, global dry-bulk capacity will expand by14 percent this year which will outpace a 6 percent rise in demand. The increased in capacity has caused the Baltic Dry Index, to drop 47 percent in the past year.

The third reason is the over supply of world dry bulk fleet in 2011. According to ISL’s (International Shipping Line) data on World Ship Building, the dry bulk fleet is hitting over capacity as in 2011 alone there is an explosion in the addition of new ships. Further more according to China owned Cosco Shipping Line, it forecast a 32% drop in dry bulk traffic this year due to the oversupply of world shipping fleet coupled with a drop in demand. Commodities shipment this year will drop to 959 billion tons from 1.42 trillion tons last year.

BRIC’s economic contraction

As a result we don’t expect the BDI to recover very soon and in fact we are already seeing a contraction of economic activity in some large economies especially the BRIC nation. BRIC is an acronym invented by Jim O’Neill of Goldman Sachs to group together developing nations of Brazil, Russia, India and China..

China’s property prices keep going down after dropping for more than 2 years after the government’s step up its brake to control the housing bubble. Last week a government survey shows that out of 70 cities surveyed, 46 recorded a drop and only 3 recorded a rise. Since real estate make up of more than 10% of the Gross Domestic Product (GDP), a continual drop in home prices will not augur well for China’s economic outlook.

China current economic policy is to pursue economic growth of at least 8% but at the mean time wants to reign in property prices. This might result in what we called the ‘Paradox of Growth’. Due to the weakening of economic growth last year, the authorities last week announced a second cut in the bank’s Statutory Deposit Ratio which will free up more capital for banks to loan out. At the mean time the government is not loosening any of the measures that are implemented a couple of years ago to control the housing bubble. Well, you cannot have 2 things in one go, meaning you cannot increase the level of economic activity without having to loosen up the controls in the property market.

Paradox of Thrift and Growth

This is similar to the ‘Paradox of Thrift’. It is a situation where the authorities cannot achieve increased economic activity through consumer spending while at the same time they promote savings among the people. When people save more then less money will be spent and hence will result in a decrease level of economic activity. A good example will be Japan.

Brazil is the world’s 7th largest economy, also seen its share of economic decline. In 2010, Brazil’s economy grew at the rate of 7.5%, after a rebound from the Global Financial Crisis. In 2011, its economy only grew at 2.7% compared to 4.3% ad 9% for other BRIC nations like India and China respectively. Despite three rounds of interest rates cuts which currently stands at 9% which is historically low, its economy is still contracting. The main reason for not having any effect is that its consumers are already indebted up to their eyeballs.

The demand for loans dropped 8% since the beginning of the year because defaults are rising and banks are getting more conservative in their lending policies. More than 8% of their loans are 90 days overdue.

So in conclusion, we are bearish towards any rebound in global economies at any time soon. With the risk of Europe imploding, the risk of the contagion being spread to other countries and regions had been heightened. Global economies are already in a slowdown and remains fragile and if the contagion is not contained then it might help push the global economy into a Depression mode.

Malaysia Chronicle