The recent blockage of the Suez Canal had me thinking back to my international trade economics unit. Specifically, the flow of cargo worldwide; I remember being shocked at the sheer number of vessels moving around the globe daily. With the blockage of a critical waterway between Europe and the rest of the world, I thought I would investigate how the flow of commodities such as iron ore and coal are affected by disruptions in transport.
The Baltic Exchange Dry Index.
My research led me to the Baltic Exchange Dry Index (BDI), which provides a benchmark for the price of moving major raw materials by sea.[1] The index collates the transportation costs of liquid, dry and gas commodities per tonne on a daily basis, based on 23 select routes.[2] As most commodities are raw materials, the dry index is an appropriate proxy to determine how shocks affect transport costs.[3] The index is a coincident indicator of economic activity, meaning it moves approximately at the same time as the wider economy. The index (in its current form) was created in 1985 to facilitate transactions between customers who were often in different physical locations. In effect, it was to expedite transactions between buyers and sellers.[4] This stands in contrast to lagging indicators such as the prime rate, and leading indicators such as the S&P 500. It also has an advantage as an indicator devoid of speculators or manipulation, as only those who need to transport goods participate in the market.[5]
How good is the BDI as a predictive Indicator?
Coincident indicators are attractive as any prolonged shocks will predict changes in the broader economy. A case study of the impact of COVID-19 can illustrate how. While the pandemic halted global trade initially, once countries such as China contained the virus’ spread, they adopted comprehensive civil infrastructure projects to boost investment domestically. This benefited countries such as Australia, whose iron ore industry in Western Australia started increasing shipments to China. The strong demand, along with a supply shock in Brazil, has pushed prices to record highs not seen since the mining boom of 2011.[6] Australia’s economic imports have decreased whilst exports (iron ore/coal) have increased. If one remembers their national income identity: GDP = C+I+G+(EX-IM), we can surmise that consumption (C) has decreased, investment (I) constant for simplicity, government expenditure (G) has increased due to infrastructure incentives and spending domestically, and exports have increased whilst imports have fallen. This would imply that GDP should be rising; however, note that imports are generally an indicator of consumer confidence. If consumers are spending more on goods, they typically have a positive outlook on the economy. So, whilst Exports are rising, and government expenditure is also rising, imports are lower than pre-Covid levels, so the outcome on Australia’s economy may be ambiguous depending on the relative sizes of each component of the income identity. Note however, that the BDI indicates what is happening on a daily basis regarding the costs associated with sea freight on a range of commodities. Therefore, assuming that the increase in exports is large enough to offset decreases in imports then it can be useful in predicting economic recovery.
Figure 1: BID Index May 2020 – April 2021. Reprinted from: Trading economics Baltic Exchange Dry Index retrieved from: https://tradingeconomics.com/commodity/baltic
By looking at the index, we can see a sixfold increase (6X) in prices from 14th May 2020 to 22nd April 2021 indicating a strong demand in shipping (see figure 1). A strong demand in freight indicates stronger sentiments about the economy and recovery efforts. As the index updates on a daily basis, it can show wider sentiments about the strength of the economy. Therefore, the index provides a robust and straightforward measure of how global trade is performing. Due to the differences in how each country records net trade, it can be challenging to make meaningful comparisons quickly. This is the genius of the BDI; it shows the fluctuations in prices due to the simple demand and supply forces that direct international trade and, therefore, serves as an indicator of economic performance between countries.
However, there are some threats to the reliability of the BDI. Since the GFC, in an effort to become the world’s largest consumer of raw materials, China has doubled its shipbuilding capacity. This has skewed the BDI as the sudden increase in the supply of vessels has slashed prices. Additionally, it is not known how many new vessels have been produced or planned, which makes adjustments to the index hard for future predictive measures.[7] This, compounded with higher wages and rents in China, has led some industries to reshore manufacturing (the process of bringing production home domestically); as the marketing and political benefits of ‘made in the UK or USA’ outweigh the slightly higher production costs.[8] This reduces international trade, which in turn lowers prices.
Conclusion:
While the Baltic Dry Index has proved to be a useful economic indicator over the years, recent changes in global shipping have challenged its reliability. Economists in the coming decades will need to consider both its advantages and disadvantages when looking to the BDI for clues about the broader economy.
References:
[1] Jacks, M., & Stuermer, M (2021). Bulking up: booms and busts in maritime transport costs and their drivers. Retrieved from: https://voxeu.org/article/booms-and-busts-maritime-transport-costs-and-their-drivers
[2] Trading Economics. (2021). Baltic Exchange Dry Index. Retrieved from: https://tradingeconomics.com/commodity/baltic
[3] Baltic Exchange. (2021). Baltic Exchange FAQ. Retrieved from: https://balticexchange.com/en/who-we-are/faqs.html
[4] Rothfeder, J. (2016). The surprising relevance of the Baltic dry index. The New Yorker. Retrieved from: https://www.newyorker.com/business/currency/the-surprising-relevance-of-the-baltic-dry-index
[5] Ibid
[6] Jericho, G. (2021). Australia’s economy is more reliant on iron ore than ever. The Guardian. Retrieved from: https://www.theguardian.com/business/grogonomics/2021/mar/25/australias-economy-is-more-reliant-on-iron-ore-than-ever
[7] Rothfeder, J. (2016). The surprising relevance of the Baltic dry index. The New Yorker. Retrieved from: https://www.newyorker.com/business/currency/the-surprising-relevance-of-the-baltic-dry-index
[8] Sutherland, B. (2020). Manufacturers are coming home. Are U.S workers ready?. Bloomberg. Retrieved from: https://www.bloomberg.com/opinion/articles/2020-09-04/manufacturing-jobs-from-reshoring-will-be-different?sref=jQOUrnPx