Friday, October 31, 2008

Bloomberg: Credit Tsunami Swamps Trade

A very interesting story on Bloomberg which leads to the question I posed yesterday in the coal piece - how much of the "global slowdown" is true supply/demand characteristics and how much is outside financial influences - in this case the inability to access credit. We'll never know in aggregate but a lot of interesting anecdotal evidence is emerging that the credit situation is a major issue. Then once you have all that answered the next question is when does credit get back to a "new normal" and what will new normal look like. When you have those answers, please email me ;)
  • Richard Burnett's lumber company had started loading wood onto ships heading for China. More was en route to the docks. It was all part of an order that would fill 100 40-foot cargo containers. Then Burnett got a call from his buyer at Shanghai VIVA Wood Products Co. The deal was dead. He told Burnett, president of Cross Creek Sales LLC in Augusta, Georgia, he couldn't get a letter of credit to guarantee payment for at least six months. ``It was like a spigot got cut off,'' Burnett said, recounting the transaction that fell apart in July. The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said.
  • Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers. Coupled with declining demand, the credit squeeze is threatening international trade, one of the lone bright spots in the global economy.
  • Global trade volumes may sink next year, their first decrease since 1982, according to Andrew Burns, a lead economist at the World Bank. While there is still uncertainty over future prospects, trade may contract by as much as 2 percent, after annual increases of 5 percent to 10 percent over the past decade.
  • ``We only see this kind of shock when we have outbreaks of war, or maybe the oil shocks of the 1970s,'' said Kjetil Sjuve, a commodities shipbroker at Lorentzen & Stemoco AS in Oslo. ``This lack of credit was a shock to the entire economy. We were hit second after the banks.''
  • Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organization. Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter's bank, which then guarantees payment to the exporting company. The system breaks down when banks don't trust one another and are unwilling to accept a letter of credit as proof that payment is coming.
  • From 2000 through last year, the use of letters of credit declined to about 10 percent of global trade transactions, the IFC's Stevenson said. Over the past six months, they began ``roaring back into fashion'' as sellers sought to guarantee payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges.
  • The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.
  • ``The whole global trade production line relies on letters of credit,'' Matt Robinson, an analyst at Moody's wrote in an Oct. 23 report. ``No letters of credit, no transactions -- and no transactions mean no international trade.''
  • James Morrison, president of the Small Business Exporters Association in Washington, polled 1,000 of his members this month on the impact tight credit is having on their ability to trade. By a margin of six to one, companies that had tried to get export financing recently said they faced ``unusual difficulties.''
  • The same is true in Brazil. An Oct. 23 report from the country's Confederacao Nacional das Industrias, which represents 27 industry groups and 7,000 trade associations, found that Brazilian companies of all size are losing access to credit.
Well it appears our Federal Reserve has another thing to backstop - the worldwide letter of credit operations. I wonder what the price tag is - doesn't matter though. Our pockets are limitless and printing presses never wear out.

We'll have to see if this situation improves in the coming months now that the world's central banks have come to the rescue of the banks. I'm surprised the railroads which ship items to US ports did not talk about this or perhaps I just missed it.

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