The Baltic Dry Index Tells The Real Story Of China's Economy

There is a growing chorus of analyst voices calling for an economic collapse in China. This is based in part on how poorly Chinese stocks have done this year, and it sets up all sorts of worries about what an economic slowdown in China might do to prices of commodities, and to other world financial markets.

I have a different view, and it is based on the comparison we see in this week's chart. The Baltic Dry Index (Source: bloomberg.com BDIY:IND) is an index of dry shipping lease rates. In other words, it reflects how much it costs to rent a freighter for hauling non-liquid stuff. The Baltic Exchange also tracks lease rates on oil tankers, and on specialized ships like Panamax ships designed to transit the Panama Canal, and Capesize ships that are too big to fit through the Suez Canal and which thus must go around Cape Horn. The Baltic Dry Index includes pricing for Handymax, Supramax, Panamax, and Capesize dry bulk containers.

Economists and analysts like to watch the Baltic Dry Index because its pricing reflects demand for shipping stuff across the ocean. Because the supply of such ships is fairly inelastic, changes in demand will flow through very quickly into lease rate pricing. It takes a while to build new freighters in response to high lease rates, and that is part of the explanation for why BDIY crashed in late 2008. A lot of shipyards had ramped up production earlier that year, and then those new freighters flooded a collapsing freight market during the 2008 financial meltdown. This is a classic case of what's know as the Avocado Effect, or the Hog Cycle.

It is not surprising to see a correlation between Chinese stock prices and some indicator of world economic activity. China is a mercantilist country which seeks to export a large amount of what it produces. So when there is a change in world demand for "stuff", that is going to affect the country producing the stuff. And because stock price movements can often precede changes in GDP, the big drop in Chinese stock prices during 2011 has people understandably concerned.

But the Baltic Dry Index is not confirming that drop. BDIY bottomed in January 2011 and has been trending higher, in direct disagreement with the Shanghai B Stock Index. When the two disagree, I have found that it is worth listening to what BDIY is saying.

BDIY did not confirm the higher highs in the Shanghai B Index in late 2010 and early 2011. Now, as Chinese stocks are unwinding that big top, BDIY is saying that things are actually not as bad as the stock price decline seems to imply.