Opinion

The Great Debate

Finance throws sand in wheels of trade

By J Saft
December 12, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own. –

Trade finance, a basic lubricant for the global economy, is becoming much more expensive and tougher to get, accelerating an already harrowing downturn.

Banks are reluctant to allocate scarce capital to trade finance, which funds cross-border buying and selling, and are very wary about being caught short by defaults by other banks which write letters of credit or by the importers and exporters themselves.

While not the prime cause of a slowdown in global trade, which is being buffeted by declining consumption and tighter finance to households and businesses, tough conditions for the obscure but crucial corner of finance that funds goods and commodities between dispatch and delivery is sand in the wheels.

Stunningly bad trade figures from China underlined the problem. China had been expected to show double digit growth in trade last month as compared to November 2007, but the data showed exports falling 2.2 percent from a year ago and imports down 17.9 percent.

“Global demand for Chinese products is vanishing,” said Gene Ma, an economist at China Economic Monitor, a Beijing consultancy. “Secondly, the credit freeze in importing countries has made it hard for Chinese exporters to sell abroad. I heard some Chinese exporters had to cancel shipments as they were worried about getting paid by their buyers.”

Chinese banks have been very nervous about accepting letters of credit from abroad, making it tougher for imports to China to get the needed financing. China and the U.S. pledged $20 billion to fund trade with developing countries last week, but that is a tiny balm for a huge market.

The rule of thumb is that 90 percent of global trade requires financing. Karl Alomar, chief executive of China Export Finance, estimates that letters of credit which had accounted for about 70 percent of Chinese trade finance in 2007 might now only have 30-40 percent of the market, in part due to concerns about international banks.

Many deals that would otherwise go through will inevitably be scrapped, while many more will be less profitable. The World Trade Organization Director-General Pascal Lamy said in November that some transactions that charged a “spread” of 80 basis points over bank benchmark rates a few months ago were now charging 500 basis points.

It may well take concerted international action by central banks and governments to bring trade finance back to life. But this is far from an easy ask; there are many calls on governments for capital and guarantees already and it could  prove politically easier to prioritize “purely domestic” issues like automaker bailouts over trade.

DEATH SPIRAL

For the weakest importers like British high-street retailer Woolworths, denial of trade finance can hasten a death spiral. “Woolworths is one of the better examples of that,” said Panmure Gordon banking analyst Sandy Chen.

“Because they couldn’t get the credit insurance to effectively fund their pre-Christmas inventory stocking they couldn’t put orders into shippers in the Far East. Because shippers couldn’t get the assurances on whether or not Woollies could pay they wouldn’t ship.”

Woolworths Group was forced to put its retail and distribution business in administration.

Even putting counterparty risks aside, trade finance is vulnerable in the current situation. Banks, and crucially many non-bank finance companies, are having their own difficulties raising funds and are being forced to pay more. They are also under considerable commercial and political pressure to channel what resources they have to areas that either have a big payoff or, like mortgage lending, win points with their government regulators and shareholders.

Trade finance, though it is vital in aggregate, doesn’t tick too many of those boxes. It is also fairly easy to pull back from without enormous immediate repercussions for the banks as it is short-term.
Difficulties with trade finance have also contributed to a 94 percent decline in the price for dry commodities space on large ships.

The Baltic Exchange’s chief sea freight index, which tracks prices to ship resources like coal and iron, is close to a 21-year low. Importers and exporters of commodities and their banks are simply worse risks than they used to be, making finance more expensive and scarcer.

The chilling thing about the trade finance situation is not its impact in isolation but the way in which it illustrates how easy it is to send a very highly integrated global economy into reverse.

“If there are significant increases in perceived counterparty default risks leading to a shut-down of one part of the supply chain it rapidly moves on to the rest of the chain,” Chen of Panmure Gordon said.

“It’s a cycle that feeds on itself.”

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on here. –

For full coverage of the crisis in credit, click here.

Comments
4 comments so far | RSS Comments RSS

” deflation and inflation going hand in hand ”

Economic Forecast

In the Netherlands we already had some deflation on housing prices but nothing dramatic yet cause In some places the housing prices still went up causing a very mild deflation of 0,6% over all.

But the chairman of the board of Rabobank (btw; Rabobank took a share in Rothschild lately), Bert Heemskerk was tooting his horne according to his colleques cause he wasn’t suppose to warn the sheople about the more severe deflation (20%)coming up ahead. The funny thing about this was that in fact deflation already happened on the housing prices but so little that inflation surely caught up. And I think this will be the sign for the coming period namely deflation and inflation going hand in hand in attempt from the Greenspan clones to ease the transition to the next expansion, But as Eisenbeis said. “They’re not going to expand lending when they’ve got a problem of leverage.”

So, what is the backup plan here?

I think that will be the devaluation in case things get even more out of hand, but while everybody thinks to hear some music, in reality the orchestra has gone home houers ago but the ears are still zooming from the music, thats all.

Oil won’t stay low forever in fact when the demand will grow too rapidley oilprices will explode just like the gold as predicted by Citigroup and many others before cause many long term investments have been cut in half or diminshed drasticly, alottof long term future investments are not even made at all now which could harm future delivery of gas en electric energy all around Europa says Cap Gemini consultants for the EU energy organisation.

Rabobank is also warning us for a dollar collapse and since they are in bed with the Rotschilds I’ll guess they know ;)

Till that time we are going to see deflation and inflation trying to stay going hand in hand.

Posted by Youri Carma | Report as abusive
 

I like to add;

1 – Banks have no sufficient machine after the death of Lehman Brothers to get the money to businesses and consumers.

2 – Banks are simply not lending money to businesses (even not for the regular business done for years before) and consumers because that’s what banks usually do in this situation (said by some Dutch banker).

3 – Banks don’t trust each other so the Banking lending chain is broken and the money never reaches businesses and consumers.

4 – The American Central bank pumps money into the economy but never reaches the businesses and consumers cause after a day or so the put it back into Treasury paper stimulated by these special money funds who, after the dead of Lehman Brothers, are only allowed to invest in Government Loans. When such loans are created everybody wants to have them.

5 – Fear of deflation will make this situation even worse cause no bank wants to lend and no consumer wants to spend. Dead Lock!

6 – In addition the lower rates are not given to the consumers by the banks but they keep it themselves so consumers don’t want to lend at this higher rate when they know they should get lower rates.

Posted by Youri Carma | Report as abusive
 

Strategists feel that forcing down interest rates frees up the money supply – since that is what all the text books say. But this is only looking at the demand-side of money. The demand-side guy says, “I want more money from you. I want more money because my rate of borrowing is less.” The supply-side guy says, “I’m not lending you more until you give me a better rate of return or your ability to pay improves.” Strategists who only look at one side of the equation, maybe because they only took introductory economics in high school, are accomplishing just the opposite of their objective. By reducing rates, they are restricting the availability of funds.

Posted by Don | Report as abusive
 

Seems like Bernanke is gonna be Bernankesan going the Japanese way – Zero Rates – quantitative easing – injecting more reserves.

Quote Bloomberg: ” The Bank of Japan has been the only major central bank in modern times to mix a policy of steep rate reductions with quantitative easing, or the strategy of injecting more reserves into the banking system than needed to keep the target rate at zero. Spur Growth – Japan’s central bank kept its main rate at zero from 2001 to 2006 while flooding the banking system with extra cash to encourage lending, spur growth and overcome deflation. The abundant funds failed to prompt lending by commercial banks, which expanded their reserves at the central bank almost nine times by early 2004.”

Posted by Youri Carma | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •