The Baltic Dry Index as an Indicator of Global Economic Health
Patrick Carroll
Embry Riddle Aeronautical University

Abstract
The purpose of this paper is to demonstrate the predictive qualities of the Baltic Dry Index and how it can be used as an indicator of potential economic activity. That by watching an index that deals with the cost of transporting raw materials it will signal both an upcoming rise and decline in the GDP . The very nature of the BDI prevents it from being manipulated by governments or other outside entities and since the supply of ships to haul materials is for all purposes inelastic, it is a true indicator of economic activity as the index will rise with demand as well as decline when there is a surplus of ships available.
What is the Baltic Dry Index?
The Baltic Index has roots all the way back to 1744 where ship captains and merchants would meet to discuss business deals at the Virginia and Maryland Coffee House in London. It later changed its name to the Virginia and Baltick to represent a more accurate description of the trading routes frequented by its customers. (The Baltic Exchange) Eventually in 1823 it adopted a more formal atmosphere that required membership with strict requirements. Fast forward to 1985, this is the birth of the Baltic Index as it is known today.
The index is essentially an average cost of what shipping companies charge to ship dry goods in bulk such as wheat, coal, ore, and so forth. It is compiled daily and is an excellent indicator of economic activity because the supply of available ships is fixed due to long lead times in construction of new vessels. It does fluctuate with the season due to the availability of ships, but overall an increasing index is a sign of increasing economic activity because producers are ordering raw materials to make goods to be sold on the market. Same as a decrease in the index is a sign of a slowing economy because fewer raw materials are being used.
There are some countries whose industrial activity is so large that they can affect the index, China in particular. This has been termed the “China Effect” which will be addressed later. Seasonal foodstuffs being sent to market from one hemisphere to another will also dictate changes in the index and can be cyclic in nature. The formula for calculating the index is not as complicated as one would think. There are four classes of ships used to calculate the index and it is based on DWT or Dead Weight Tons, which is how much a ship can safely carry not the weight of the ship. The ships types are Capesize (100,000 and up DWT), Panamax (60-80,000 DWT) also the largest ship that can fit through the Panama Canal, Supramax (45-59,000 DWT), and Handymax (15-35,000 DWT).
The Formula is:
(Capesize5TCavg+PanamaxTCavg+SupramaxTCavg+HandymaxTCavg/4)* 0.110345333
TCavg= Time charter average There are special cases where the index does decline even in increased economic activity such as when new ships are brought into the fleet. The decline is short lived as the available space is soon utilized. During a recession it is essentially a buyer’s market on the index as shipping companies would rather have their investment moving cargo at a discount than sitting idle and consuming capital. The index is currently recovering from the 2008 crash and is somewhat positive. As the Christmas season approaches it will climb due to the movement of raw materials to manufacturing centers such as China.
Recent Trends
Recent trends in the index are negative which would signal a decline in demand for raw materials but there is an anomaly because before the financial crises in 2008 ship operators placed orders for new vessels in order to meet the perceived demand. These ships were delivered in 2010-2012 which has increased capacity of the fleet result in more competition for loads and lower prices overall, “Vessel overcapacity is largely to blame for the continuing slide for the Baltic index. Deliveries of vessels that were ordered before the 2008 economic crisis are still outpacing demand for materials.” (Norris, 2012) Until that surplus capacity is utilized through increased orders for raw materials it will remain on the lower end of the scale. Another aspect of the “China Effect” also influences the number of ships placing downward pressure on the index.
“What really happened was a "massive oversupply of ships that skewed the index," says Natasha Boyden, director of maritime equity research at Cantor Fitzgerald in New York. Data from Jefferies & Co. show that the global fleet of dry-haul ships grew over 10% in both 2010 and 2011, powered by some overly optimistic ship-building orders placed prior to the 2008 downturn. In addition, a Chinese government initiative to keep its shipyards humming further flooded the market with vessels.”(emphasis added) (Constable, 2012)
In January 2014 the index has started to make an upswing again signaling the beginning of the recovery phase. But this could be misleading because of the “China Effect”: “The research firm expects the recovery of dry bulk rates to be sustainable due to China’s urbanisation and infrastructure projects which remain the main drivers for demand growth of dry bulk commodities” (Hellenic Shipping News, 2014) Again China influences the index through ordering raw materials for its building projects.
The China Effect
Not only does China cause an increase in the BDI because of its seemingly insatiable appetite for raw materials, it can also cause it drop rapidly during times when the government decides to restrain the economy.
In 2004 the Chinese government, trying to avoid the risk of economic overheating, announced an economic control policy by banning new investment in steel, automobile, cement, real estate, and electrolytic aluminum. As a result, the BDI, which was 4,229 on April 27, 2004, decreased continuously and reached 2,622 on June 22 of the same year. (Kim, 2011)
The effect of China’s economic activity on the BDI cannot be disputed and is probably one of the main influencers upon it.
BDI VS GDP
The difference in the time on when these figures are calculated allows the BDI to be a faster indicator of worldwide economic activity; The BDI is calculated daily whereas the GDP is calculated quarterly. This allows the observer to view almost real time data on the cost of movement of raw materials across the globe. “World economic activity is the most important determinant of the demand for transport service, and the Baltic dry index, loosely speaking, provides an assessment of the price of moving major raw materials by sea.” (Beth Mowry, 2008) Interestingly enough the BDI also began its downward cycle before the recession in 2008 was fully realized “The index… fell precipitously in 2008, giving an early warning of the trouble to come later that year.” (Blanchflower, 2010)
The predictive ability of the BDI will show indications of both an increase in economic activity and also a decline before the GDP calculations do. The BDI is not traded like a stock so it cannot be manipulated by outside forces; it is essentially the cost of doing business. More firms and economic researchers are beginning to pay attention to it.
The close association between the cost of shipping raw materials and the production of intermediate and final goods, has led some analysts and researchers to conclude that the demand for commodities and, therefore, economic activity, is reflected by movements in the BDI. (Nicholas Apergis, 2013)
Since manufacturing activity is a result of increased demand, and raw materials are needed to meet those demands, overall economic health and activity is reflected in the BDI faster than the GDP figures, simply put an increase in manufacturing is a precursor to an increase in GDP. The BDI is also a privately run index as opposed to the GDP which can be skewed by the government in an attempt to hide unfavorable economic conditions and is sometimes adjusted down when more accurate information is tabulated. The government can simply increase spending to raise the GDP without any other changes to the economy. Thus creating a false recovery in an attempt to stave off economic chaos, this is why the BDI is a more accurate reflection of economic activity because it deals with the movement of materials that are needed in manufacturing. If the historical charts of the BDI and GDP were studied it indicates a drop in the BDI before a drop in the GDP every time and a rise before the GDP rises as shown in the chart below. Blue is BDI and red GDP, before every change in GDP a change in the BDI is indicated, the index will both climb and decline before the GDP thus validating this theory.

Fig. 1 BDI Vs GDP from www.streettalklive.com Economic "Hope" Vs. Indicators Of Economic Reality June 11 2014

Conclusion
It has been shown that the BDI is a reliable indicator of overall economic activity even with the influences of outside forces such as the “China Effect”, the index shows the movement of raw materials which are used in the production of goods. It is not influenced by governments and is not traded. The supply of available ships moving those materials is essentially inelastic and fits perfectly into the supply/demand curve. When economic activity increases so does the demand for raw materials, which in turn causes an increase in demand for shipping services, and since the fleet has a finite supply at any given point the higher the index the more demand for services is an indicator of increased activity and vice versa. The index is also faster and more reliable than government figures as it is reported daily and is not an estimation, but rather the real cost of doing business.

References
Beth Mowry, A. P. (2008). Federal Reserve Bank of Cleveland, Economic Trends :Industrial Production, Commodity Prices, and the Baltic Dry Index. Clevland OH: Federal Reserve Bank of Clevland.
Blanchflower, D. (2010, August). The Baltic Dry signals trouble ahead. New Statesman, p. 17.
Constable, S. (2012, Feburary 11). Baltic Dry: Not Washed Up. Retrieved from www.online.barrons.com: http://online.barrons.com/news/articles/SB50001424052748704444604577207153303414024
Hellenic Shipping News. (2014, Janurary 13). BDI’s rising trend signals recovery of shipping industry. Retrieved from www.hellenicshippingnews.com/: www.hellenicshippingnews.com/29c27fe2-21e5-4729-9a58-966ae25fee21/
Kim, h.-g. (2011). Study about How the Chinese Economic Status Affects to the Baltic Dry Index. International Journal of Business and Management, 116 - 123.
Nicholas Apergis, J. E. (2013, July 24). New Evidence on the Information and Predictive Content of the Baltic Dry Index. International Journal of Financial Studies, 62-80. doi:10.3390/ijfs1030062
Norris, K. (2012, Feburary 5). Overcapacity sends bulk shipping index to historic low . Retrieved from www.ppimagazine.com: http://ppimagazine.com/logistics/global/shipping/overcapacity-sends-bulk-shipping-index-historic-low
Roberts, L. (2014, June 11). Economic "Hope" Vs. Indicators Of Economic Reality. Retrieved from http://streettalklive.com/: http://streettalklive.com/index.php/newsletter/current-issue.html?id=2254#
The Baltic Exchange. (n.d.). History of the Baltic Exchange. Retrieved from www.balticexchange.com: http://www.balticexchange.com/about-us/history/