Is the Baltic Dry Index Sending us an Early Warning Sign?

February 28, 2012

BY: Robert Hallberg, Topics: Economics, Baltic Dry Index

The Baltic Dry Index measures the costs of shipping commodities around the world and has served as an early warning sign of economic troubles. As the global economy came to a halt in the panic of 2008, the Baltic Dry Index expectedly crashed.

This index hit a new low in February of this year, and it is down more than 90% from its peak in 2007. However, the last time this index crashed the stock market plummeted along with it. But this time the stock market is booming. So what is different this time?

It is important to remember that the Baltic Dry Index represents both supply and demand. This means that the price of shipping will fall if fewer shipments of goods are made around the world. A drop in demand would definitely be a negative sign for the economy. However, the supply side of the equation is equally important. And if new freight ships become available, the Baltic Dry Index will fall as well, but this decline is not necessary as negative indicator.

The tricky part is to determine whether the drop in the Baltic Dry Index is because of lower demand, greater supply, or perhaps a combination of both acting together. Increased supply is part of the equation. It takes years to build larger freight ships, and construction of many of these ships was started before the recession, and they are only now coming online.

But there are issues with demand to consider as well. Many of the emerging economies, especially China, have been reducing its appetite for commodities. This combined with unfavorable weather conditions in Brazil, have led to a slack in capacity around the world.

Although the Baltic Dry Index has traditionally been a leading indicator of economic activity, it is impossible to say how useful this indicator is at this point. If the drop is caused by a lack of demand the world economy may be in serious trouble. But if this drop is driven by an expansion of supply there is no reason to worry. Regrettably, this index is not as good of an economic indicator as it once was, just when we could use it the most. The prudent thing for investors to do is to watch other indicators before reaching a conclusion on the state of the economy.

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