Those Letter of Credits...

Dear readers,

First of all a Happy New Year. We had a bit of a delay to kick-start the year, but here we finally are with our first newsletter for the year. We would like to pick up the themes of our last letter in December and update our statements with some numbers and facts. For those who were still wondering that the light at the end of tunnel was near will quickly change their mind and realize it is the light of a train that is coming at high speed from the other side of that tunnel…

Just to freshen up the memory the four major topics we expected for 2009 were:

• Further de-leveraging of banks
• Increase of defaults and write downs of corporate debt
• Deteriorating conditions in Central and East Europe
• Second round of re-capitalizing banks

We are only 2 weeks in the new year and we see a couple of these themes crystallizing themselves already. The deteriorating conditions for Central and East Europe were already confirmed this week with the horrible industrial production numbers for the Czech Republic. They came out at their lowest point ever since inception in 1993 : - 17,4 % for the month of November against – 7.6 % the month before. Bear also in mind that the market consensus was – 8.9 %. This will also be a good indication to e.g. the Q4 GDP numbers in the US at the end of this month. People will be surprised how bad that number is going to be. Expectations are still at around – 6.5 %, but market consensus is clearly still underestimating the impact and or damage done after the Lehmann failure. We are clearly dealing with the nuclear fallout of that Financial China Syndrome.

Commercial trade came to a stand still after Lehmann’s event and I already pointed out in one of my weekly newsletter for the bank in October that the problems we were facing in the commercial paper market at the time were dramatic, but the sniper of the tightening credit conditions would be the Letter of Credit (LoC’s) which were frozen by banks.

To remind you about the importance of a LoC, in simple terms it is a document issued by a financial institution presented to another financial institution to obtain release of goods (commodities – household articles – food etc). If banks refuse to give you a LoC, you would simply have no economy.

Below is an article in the Financial Post of Canada that was written on the 10th of October.

“The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.
Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.
"'There are all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit,' said Bill Gary, president of Commodity Information Systems in Oklahoma City. 'The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy.'
"So far the problem is mostly being felt in U.S. and South American ports, but observers say it is only a matter of time before it hits Canada. 'We've got a nightmare in front of us and a lot of people are concerned it's going to get a lot worse,' said Anthony Temple, a grain marketing expert based in Vancouver.
"Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world's trade by volume goes by ship. 'The credit crisis has made banks nervous and the last thing on their minds is making fresh loans,' Omar Nokta, an analyst at investment bank Dahlman
Rose, said in an interview with Reuters.
"While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before."

A good indicator for the shipping industry is the Baltic Freight Index, which gives investors a good idea of supply and demand of shipped goods. That index decimated over the last couple of months. To come back to our example of the Czech Republic, the volume of industrial orders came in at – 30.2 %, which suggests that production figures in the months to come will get worse.

We can extrapolate those numbers for other countries or regions who are highly export driven as well. And if we are talking about export, we need to look at China too. Their exports suffered the deepest drop in a decade in December, -2.8 %. Keep in mind these are official numbers from the Chinese government. The real numbers will probably be even worse.

The news came as the World Economic Forum held its annual meeting in Davos this week and warned that a ‘hard landing’ is in the making, with annual growth dropping even below 6 %. If you look at the import number ( -21.3%) it clearly is a sign that also domestically China is falling of a cliff. If the Chinese economy is hit by slowing international trade volumes, its domestic economic activity is even slowing at a faster pace. Of the total of 130 million migrant workers already 10 million of them have been sent back to the country to start planting rice again.

The one million dollar question will be whether the danger of social unrest, where we warned for in our last newsletter in December, might break out sooner then expected.