I Still Have My Doubts ...
by Claus Vogt
Dear Subscriber,
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The Baltic Dry Index, which measures the freight rates for dry cargo traveling by ship, hit an all time high of 11,793 on May 5, 2008. Then it plunged to 663 on December 5, a decline of 94.4 percent. It was as if trade was coming to a standstill. However, freight rates soon started to recover ...
Since its December low, the index is up to approximately 4,000 for a whopping gain of some 500 percent! And the "green shoot" crowd is pointing to this surge as proof of the revival in world trade, even though the index is still down 68.6 percent from its May 2008 high.
Take a look at the chart below, and you'll see that this index has a very volatile history ...
The recession started in December 2007. But the Baltic Dry Index made its all time high five months later! So if you compare it to the business cycle, an important conclusion can be drawn: This index does not qualify as a leading economic indicator. At best it may be a coincident indicator ... and it's probably a lagging one.
So to use its current rebound as proof of a recovery in the world economy is, well, somewhat aspiring.
What the Index Is Actually Showing:
Chinese Inventory Buildups and
Speculation ...
The bulls argue that the jump in shipping rates, as shown in the Baltic Dry Index, indicates rising commodity demand and thus the revival of the world economy. But I think we have to look at China to get some important insights concerning this superficial argument ...
China's commodity imports have skyrocketed during the past months because of two important reasons:
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| Inventory buildup and speculation by the Chinese are driving commodity prices higher. |
- The Chinese are reported to have taken advantage of beaten-down commodity prices to build their strategic reserves. That makes a lot of sense for a commodity hungry country like China and can be seen as part of a typical inventory build up after a huge slump. This may be the prelude of a recovery. But it may also turn out to be just part of an inventory cycle due for another slump if no recovery shows up.
- There seems to be a commodity speculation frenzy going on in China. Many corporations have begun storing much more commodities than needed. This means that they're speculating on rising prices in a big way! On June 22, Bloomberg reported that China may begin a 'crackdown' on such speculation. And if the Chinese government has admitted speculation could be a problem, it has to be huge!
In 2008, hedge funds became the big victims when commodity prices nosedived. This time, Chinese corporations may be the main sufferers. And this may turn out to be an important aspect in evaluating the soundness of the Chinese recovery currently underway.
Other Freight Rates
Are Still Falling ...
The importance of Chinese commodity hording and speculation becomes clearer when looking at other freight rates.
For instance, container vessels reflect the movements of goods instead of raw materials. So their behavior is more representative of what's going on with sales of finished goods. And they exclude any possible commodity speculations.
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According to Germany's Commerzbank, freight rates of container vessels are down 75 percent from early 2008. More importantly, they declined by almost 30 percent this year and hit a new low in June.
This development does not bode well for world trade. And it shows that commodity prices may be at risk of a renewed slump. Speculation can go only so far!
The Decoupling Myth Revived ...
Two short years ago there was much talk about a decoupling of the Asian emerging markets from the U.S. However, since the U.S. was — and still is — the most important client of the Asian, export-oriented growth countries, I didn't buy that argument. Hence I expected the recession to become a global event ... a recession that was loudly heralded by an inverse U.S. yield curve and by the U.S. Index of Leading Economic Indicators.
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| Will China lead the world out of its economic slump? |
Sure enough, the U.S. economy took the lead and the rest of the world followed suit. And no decoupling took place.
Two years, a recession, and a severe bear market later, a variation of the same story is back in vogue. But can the Asian emerging markets, especially China, lead the world economy out of the slump. Is this story probable?
Mammoth Government Stimulus ...
Like so many other countries, China's answer to the global recession was massive stimulus. And why not? China never swore off communism, so government interventions are fully conforming to their political credo.
So far, the country's stimulus program has amounted to $585 billion, and the central bank triggered an explosion in credit by scrapping quotas on lending in November 2008.
As you can see in the chart below, that's exactly when the Chinese stock market bottomed ...
Now the index is up 78 percent from its November low. But even so, it's still down 50 percent from its October 2007 high.
Obviously, the huge stimulus and money printing by the Chinese central bank has already had some impact on their stock market. And the positive chart pattern suggests even more to come — after an overdue correction, that is.
On top of that, the stimulus has invoked the aforementioned wave of commodity speculation.
Put simply, easy money is sloshing around and chasing financial and commodity prices higher. But that is definitely not the government's desired goal!
So the big question is ...
How is China's Real Economy
Responding to the Stimulus?
In May, China's exports fell by a record amount ... down 26.4 percent from a year earlier. In June the government said unemployment was worsening, and a quick rebound in trade was becoming less likely. The State Council even said that "the foundations for an economic recovery aren't solid." And Vice Commerce Minister Zhong Shan added that trade faces "unprecedented difficulties."
Moreover, on June 22, Bloomberg reported that China Shipping Container Lines Co., the country's second-biggest box carrier, plans to almost double rates on Asia-Europe routes next month to help offset possible losses on weakening demand.
None of this sounds bullish to me!
Yes, China's economy is still growing, but a global growth engine? I still have my doubts. Emerging markets have always been and still are a leveraged play on the U.S., and if the world economy is due for a recovery, it has to come from its major force ¯ the U.S.
Bottom line: China may be on its way to displace the U.S. as the world's major economy and growth engine. But it has not yet done so.
Best wishes,
Claus
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