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BGI ProphetLately there has been a flurry of activates on the net because a relatively obscure index, the Baltic Dry Index (BDI) has surpassed the low it experienced as a consequence of the 2008 debacle. According to pundits, economists and mis-informed "opinionators" out there, this drop in the index is "ushering" (as in novels) the beginning of a new calamitous economic period. The world is going downhill now, now, now! This is yet another case of people having no idea whatsoever what they are talking about or how to interpret information. They are indeed false prophets of the quick buck, hoping to cash in on the latest (and ever so fleeting) hype.

INTRO

What the heck is the Baltic Dry Index? As its name indicates, it is an Index! Basically it measures the cost of shipping goods through maritime routes the world over. Period. That's it? Yup. If you want the long explanation, go to Wikipedia and search for "Baltic Dry Index".

CORRELATION IS NOT CAUSATION

This is an old saying that scientists almost never forget and everybody else almost always ignores. The idea is simple, just because data A behaves (more or less) as data B, this does not mean that A is a consequence of B or vice versa. For example, there is some significant correlation between the phases of the moon and the behaviour of certain markets. However, nobody in their right mind (well, almost nobody) would actually believe that the moon is causing changes in those markets. Yes, there is correlation but no, there is no causation.

Something similar happens with the BDI and in order to explain it, we refer you to the graph below.

Baltic Dry Index

As you can see, the BDI seems to be correlated with events leading to the 2008 debacle. Thus, many pundits reason as following:

The BDI represents the price of maritime shipping however, considering that large shipping vessels are slow to be build, we can consider their supply more or less constant (or as economists would say "inelastic"). Thus, if we have a constant supply of ships, the only thing that will determine the price of shipping is the demand for shipping. If the demand goes up, the price will go up and thus the BDI will go up. If the demand goes down, then the price will go down thus the BDI will go down. This is what happened in 2008. The demand for shipping collapsed and thus the BDI collapsed with it. Thus, as the BDI collapsed again in Feb 2015, this means that the demand is dropping like a stone and thus we are facing an economic disaster.

Presto! Instant economic forecasts!

No, not really. Frist off, we must remember that the BDI measures price, not manufacturing or some other economic variable. Thus, even in the best case scenario, we are only measuring economic activity indirectly. But not even this is true. There are two assumptions in the logic above that are false:

  1. The BDI is only mildly correlated (and has no causation) to economic activity (this is simply not true). Furthermore, the BDI is a lagging indicator, which means the best case scenario would say that the BDI represents what happened in the economy 2 to 3 months ago! We can see this because the BDI reacted months after the 2008 debacle, not before. So much for forecasting anything.
  2. The second issue is that the inherent assumption for the BDI to act as an economic indicator, is that the quantity of cargo ships is inelastic. This is, the amount of ships remains more or less constant. But this is not true either. Take a look at the graph below.

Growth Cargo Fleet

As you can see, since about 2006 the size of the cargo fleet world-wide has been increasing steadily. Which means the supply of cargo ships is huge when compared with the previous years between 1993 to 2004 where the growth of the fleet more-or-less kept pace with ship decommissioning.

Furthermore, we can see that the exact opposite to the assumption of cargo ship fleet "inelasticity" is taking place. As we can see from the blue line, the growth of sea trade remained more-or-less constant while the amount of cargo ships grew astronomically!

What this is telling us is that contrary to public opinion, the BDI is an index that is capable of forecasting only the size of the commercial cargo ship fleet in relation to the sea trade! It is telling us almost nothing with regards to current or future economic conditions!

Yes, it is true that after 2008 the BDI responded to the economic catastrophe, but this only means that the BDI is affected (in the very short term) by cataclysmic economic events, just like any other economic or price index. But this does not imply anything else.

CONCLUSION

So please! Stop spreading the idea that the world economy is going to collapse just because the BDI has reached yet another low. What this is telling us is that there are so many cargo ships out there, that shipping costs are dropping like a stone and this is good for the average consumer!

So, no. The BDI is useless when it comes to forecast world-wide economic activity. On the other hand, this does not mean that a mega-collapse is not coming to your country near you in the very near future. It is. Undoubtedly, it is. The problem is that its date or month or year of arrival is utterly un-forecastable.

But then again, you believe that governments will "do something". Coincidentally, we also believe. The only problem is that what they will do just to keep the party going a little bit more will be fantastically destructive. You have been warned. If you choose not to believe us, you are gambling your entire future on the very same people that have been creating massive booms and busts for the last 200+ years. But that's OK. It's your life. If you enjoy profit-free risky investments, who are we to oppose you.

Note: please see the Glossary if you are unfamiliar with certain words.

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