Why the world’s shipping industry is grinding to a halt: Kohler

Global shipping is grinding to a halt because of the refusal of banks to issue letters of credit.

Global shipping is grinding to a halt because of the refusal of banks to issue letters of credit.

I was alerted to this by TJ Marta, RBC Capital Market’s New York-based fixed income strategist, on the weekend during an interview for the ABC’s Inside Business program.

In fact the Baltic Dry Index of bulk shipping rates has collapsed by 89% – from 12,000 in May to 1355 last night. In October alone it has fallen 61%. Rates for Capesize vessels used to ship grains, iron ore and coal have fallen 95%.

In his column in the London Telegraph last night, Ambrose Evans-Pritchard wrote that he believed shipping was now slowing as fast as it did in late 1931.

Khalid Hashim, managing director of Precious Shipping, Thailand’s second-largest shipping company, was quoted in the Taiwan News yesterday as saying: “Letters of credit and the credit lines for trade currently are frozen. Nothing is moving because the trader doesn’t want to take the risk of putting cargo on the boat and finding that nobody can pay.”

Here’s another quote, from Steve Rodley, director of a London based shipping hedge fund called Global Maritime Investments: “The whole shipping market has crashed. But the biggest ships are suffering particularly.”

Letters of credit are issued by banks to guarantee payment at the other end of a shipping transaction. In effect, the bank substitutes its own credit for that of the customer, so the shipper doesn’t have to hunt around in a foreign land trying to track down payment.

The problem now is that not only are the letter of credit departments of some banks being closed down, the collapse of the interbank lending market has meant that many banks are refusing to accept other banks’ letters of credit.

As a result, trade transactions are failing because shippers can’t arrange short term funding for their vessels.

Exporters are getting caught up in the problem because their customers are saying “we can’t pay you until our customers pay us”, so there is a knock-on effect that is affecting manufacturers and bulk goods suppliers everywhere.

This is now taking over from the retreat of hedge funds as the cause of the decline in commodity prices; with ships sitting idle in ports and commodities building up in stockpiles prices are inevitably falling.

It means Australian mining companies may be forced to close capacity before long because there is nowhere to ship their ore to.

Like many of the other clogged arteries of global finance, letters of credit and therefore global shipping could presumably unclog fairly quickly if the interbank credit market got moving again.

But a big fall in shipping rates, as measured by the Baltic Dry Index, is always a harbinger of a downturn in trade and therefore economic activity.

This article first appeared on Business Spectator