Can the Price of Transporting Goods Predict Future Economic Output?

The Baltic Dry Freight Index (BDI) is considered a leading economic indicator by economists and investors. The Index measures the daily shipping rates for commodities like iron ore, coal, building materials, and grains, and therefore acts as a proxy for the supply and demand of raw materials. As the demand for raw material increases, the dry shippers are able to charge a premium for their services. The index is an appealing predictor of future economic output because firms generally purchase raw materials when they are immediately required for production. Because investors like to look at the BDI, the Index is provided through a variety of business news networks, including Thompson Reuters, Bloomberg, and CNBC.

The Index hit a high of 11,793 in early 2008, but fell by 94% to 663 by the end of the year due to the Great Recession. As the economy improved, the Index rebounded up to 3,000 and consolidated its position through most of 2009 and 2010. However, this past month the BDI fell to 706 in spite of other indicators of a recovering economy, such as the four year high of consumer confidence.  Such a low BDI would indicate that we should expect another downturn.

On its face, this argument persuasive; however, the Index is no longer a good predictor of future economic output. Even though the Index is very low, demand for commodities is at a multi-year high, suggesting that BDI no longer tracks commodity demand like it used to. The reason for the poor predictive power of the Index is rooted in an expanded supply of dry freight tankers. While this supply is hard to expand quickly, the shipping companies ordered many new tankers in 2007 and 2008. This glut of tankers is only now becoming operational, and as a consequence ships are charging remarkably low rates in spite of high demand. The end result is that the Baltic Dry Freight Index is no longer a viable economic indicator and should be ignored for now.

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