Trade Finance or Lack of Demand?

The sharp and sudden decline in trade since September, particularly amongst the Asian economies, has led some (site IMF) to speculate that an absence of trade finance is responsible. The story is plausible. The credit crunch has impaired the balance sheets of banks, which have then been unwilling or unable to provide letters of credit. In the absence of these letters, shipping companies have been unable to load their ships and trade has fallen.

Alternatively, the decline in trade could be attributed to a global fall in demand. A country’s exports are a good indicator of the domestic demand of its trading partners; while a country’s imports are a good indicator of its own domestic demand. A global decline in trade volumes then implies a global decline in demand. A likely story; however, the fall in trade seems larger than observed decline in demand.

These two stories are difficult a priori to differentiate. Neither contemporaneous demand nor trade finance or its importance are directly observable. For the former, GDP is released with a considerable lag relative to trade data and is subject to substantial revisions. For the latter, we have no systematic data whatsoever. We are forced to rely on anecdote and intuition alone.

Nonetheless, the two stories have very different global pricing implications. We can use imperfect data on regional prices to infer which story is more likely to be correct.

A fall in trade that is attributable to a fall in demand should be accompanied by a global fall in the price of traded goods. While there may be some regional variation, this fall in prices should be similar whether a country is a producer or an importer of the good in question.

In the absence of trade finance, some shipments that are economically desirable are not made. The absence of finance acts like an increase in trade frictions. In this case, the usual arbitrage that tends to keep global prices near one another should fail. Prices in countries with too much of the good (the producers) should experience a drop in prices, and prices in countries with shortages (the importers) should experience an increase in prices.

Timely micro data on domestic prices of goods is needed for this exercise. I do not have this data. Instead, I try to infer the evolution of micro prices by examining global trade prices. These prices are falling. Export prices across trade categories and across countries are declining and they are declining rapidly. Import prices show the same story. I see no systematic differences between exporters and importers.

Of course, if we stipulate that demand has fallen, it is difficult to determine whether trade prices have fallen more or less than we would have expected given the decline in demand. That is, we cannot tell if trade finance may be playing some role in the decline.

As an alternative approach, one can look for shortages of goods in importing countries. If trade finance is playing a role, then producers may desire more goods than our available and shortages may emerge. I turn to survey data. In the ISM survey, manufacturers are asked each month which if any commodities are in short supply. Over the last two months, no commodities have been listed. Producers do not perceive difficulties in obtaining the number of inputs they desire. Not an outcome I would have expected with increased trade frictions.

The jury remains out on the extent to which a decline in trade finance has reduced global trade volumes. However, I think the evidence is clear that falling demand is the main culprit. And I believe at this point the burden of proof lies with those who believe trade finance is the problem.

I would love to hear your anecdotes on relative prices, shortages, or trade finance reductions. Leave a comment or send me an email at secreteconomist at gmail.