Ship Rates Plunge as Credit Freeze Strands Cargo, Demand Slumps

Edited to add a bit more in the way of explanation:

Shipping prices are plunging - because demand for shipping raw materials is drying up - because of the frozen credit market.

Excerpt from a good explanation of the Baltic Dry Index (BDI) at slate.com (link: http://www.slate.com/id/2090303/)



The linked article was written at a time when shipping prices were increasing (due to fixed supply and increased demand). Now we are seeing the reverse - fixed supply and decreased demand. The decreased demand has come from the unwillingness of lenders to extend credit to anyone. The goods are there to ship, the demand for the goods is there on the receiving end, but since no one is guaranteed payment - the goods sit at the source, and the ships remain idle.

Here's a chart showing how the BDI has tanked in recent weeks:



Which point in your bailout addressed this, Hank? :shrug:

With the global marketplace changing so quickly, some of our essentials that are now only produced overseas may become scarce.

when you operate a business where you have to smooth out rapid fluctuations in cash flow (trucking/shipping is a big important example), you've got basically two approaches to choose from:

(a) you can maintain a cash reserve, and draw it down temporarily, and get paid back.
(b) you can maintain a line of credit, draw on it temporarily, and pay it back.

What's interesting is that to a first approximation, it seems that all businesses have gravitated to (b). I don't really have a moral problem with (b), but we sure are seeing the vulnerability of an economy that mostly uses (b) compared to an economy that mostly uses (a).

It also shows how little actual planning has happened in terms of economic policy. In some fictitious world where our fearless leaders took their jobs as economic stewards seriously, some team of economic wonks would look around, and say "Hey, I see that structurally we have a "type-b" economy. That means we should either take steps to move us more towards "type-a", or alternatively we should make very very damned sure that our credit-markets are bomb-proof."

Clearly, neither of those things happened, and even after the bomb went off, these people showed every sign of not immediately understanding the implications for our type-b economy.

Bummer.

and either don't give a rat's ass, or have some ulterior motive to utterly fail to address the situation appropriately.

Double bummer.

That's why businesses do it. It's not that they're stupid, it really is more profitable.

To understand why, you have to understand the mathematics of leverage. By that math, even a cash rich company is going to borrow money -- continuously. Even Microsoft had decided just before the credit crunch to issue bonds, even though it had billions of cash lying around.

The reason is complicated, but I can summarize it like this: The internal rate of return on money inside a business is almost always higher than the interest rate on money borrowed from outside. So if, by using as much of the businesses own money as possible to actually do things like buy supplies and pay salaries, I gain 15% internal rate of return, then I should do so; and in addition borrow at say 5%. I borrow more money, say $1,000 at 5%, and I earn a 15% internal rate of return, or $150 on internal uses, but only have to pay that 5% or $50 in interest. Every $1,000 borrowed therefore earns me $100 or 10% additional rate of return.

That's because internal uses of money has both higher risk and return. Debt is designed to give the lender a lower, but safer rate of return. The difference is how profits are leveraged by borrowing.

That's also why most non-business people can't grasp why businesses, both big and small, never seek to "pay off" their loans. (Consumers need to pay off loans because their loans are not earning them income.) That's why farmers borrow every single season, even though most could probably save enough over a few years never to have to borrow again. Businesses don't seek to pay off their loans; they seek to keep their loans "revolving," but at a low enough level that the risk difference between internal risk and credit risk is acceptable.

A cash reserve, by contrast, gets parked in a bank account that invariably earns a lower rate of return than the rate of return that leverage allows. So corporations and other businesses actually try to keep their cash reserves low.

One solution would be for businesses to invest their reserves in equity -- like stocks of other companies. But they are not allowed to because of the Investment Company Act (it would in other words make them into mutual funds). Another option is acquiring another company, which they do often.

plus there's a credit freeze
its the combination that creates this problem

And that's why Shipping is being hit. Peple are less likely to invest in containers of stuff if they aren't sure that customers will be able to buy it.

Also, over here the weak pound is also having a large effect. As dollars become more expensive, so do imported goods. The result is going to be higher prices.

...when we'll start seeing the real effects of this?

And what will happen? Will the shelves at CVS and Target not be stocked?

Will there eventually be shortages?

Sorry for all of the questions. I'm just trying to understand.

I'm trying to prepare our family as best I can. I'm thinking that
when the other shoe drops, it's going to come out of nowhere--and all
of a sudden, this country is going to be very, very different than it
was the day before.

http://www.democraticunderground.com/discuss/duboard.php?az=show_topic&forum=389&topic_id=4200077

The Financial Post of Canada is reporting that international food shipments are grinding to a halt as a result of the credit crisis:

http://www.financialpost.com/story.html?id=866310

Grain shipments stalled in credit drought

John Greenwood, Financial Post
Published: Tuesday, October 07, 2008

The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.

Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.

"There's all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit," said Bill Gary, president of Commodity Information Systems in Oklahoma City. "The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy."

...

The Baltic Dry Goods Index, the main measure of shipping rates, is down 74% from its high back in May when trade with China was still strong.

...

While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before.

<end quote>

So, here's why credit is absolutely essential to international shipping, including food shipments. International shipping relies on "letters of credit." A letter of credit is a bit like an international money order, but for very large sums, and that are crafted for the particular transaction.

It is a letter from a bank on behalf of a client (usually an importer/buyer) to an overseas seller. The letter says that I, bank, will pay you, seller, $500,000 (or whatever the amount is), if you present to me (bank) the right documents.

That document is often a "bill of lading." A bill of lading is a piece of paper that a shipper gives to the seller concerning the goods being shipped -- kind of like a receipt from the ship owner. So for example, if the seller is selling 10,000 tons of rice to Goa, India, when the rice is loaded at the port of departure, the seller receives the bill of lading and can now present the letter of credit to the buyer's bank, along with the bill of lading (proving the rice has been shipped from port). The bank must then pay the money because the agent presented the letter of credit and the right document -- the bill of lading. (It's actually a bit more complicated with the banks doing much of the trading of the bills of lading and letters of credit.)

If no one trusts the credit worthiness of banks, then no seller will accept a letter of credit. Moreover, if banks are not lending, then they are not writing letters of credit, which are often funded by the bank making a loan to the buyer.

The shipment of food, oil, manufactured goods, etc., is grinding to a halt as the credit crisis continues.

<end quote of my old post>

There are actually a few more loans involved because the actual transactions are a bit more complicated. Let's say in the example above, the seller is selling rice from the port of New Orleans to a buyer in Goa, India. The Bank of India issues a letter of credit to New Orleans Grain Company on behalf of buyer called Goa Importers. That in itself is a kind of loan by Bank of India to the buyer, Goa Importers. When N.O. Grain loads the rice on ship at New Orleans, and gets a bill of lading, N.O. Grain takes that bill of lading not to Bank of India (which is, after all, in India), but to Bank of America, N.O. branch. N.O. Grains gives the bill of lading and letter of credit to BOA-NO and BOA-NO pays him. In effect, BOA-NO has made a loan to Bank of India, by paying based on Bank of India's letter of credit.

BOA-NO now gives the letter of credit and bill of lading to Bank of India in India (that's one of the services banks do -- they have international presence). Bank of India pays BOA-NO. In effect, Bank of India has made a loan to Goa Importers.

Goa Importers cannot unload the rice without a receipt, the bill of lading. Bank of India will hold the bill of lading until Goa Importers comes up with the money, or enters into a loan agreement with Bank of India -- yet another loan. It's likely to be a loan so that Goa Importers only has to pay back Bank of India after it has sold of the rice in Goa.

When Goa Importers has the money or loan in place, Bank of India gives Goa Importers the bill of lading, and Goa Importers goes down to the port, hands the bill of lading to the ship captain, and the rice is allowed to be off loaded at Goa.

The entire thing depends on credit, trustworthiness and the routine nature of the transactions. Without those, shipping comes to a halt.