Aggregate Demand and Finance and the Collapse in Trade

From “Trade-Finance Pinch Hurts the Healthy,” WSJ, 12/22/08:

The global financial crisis is drying up the financing that firms depend on for trade. That’s making the global recession nastier and deeper than it otherwise would be.

As with all kinds of credit these days, financial institutions are making less trade finance available and charging more for it. But the squeeze in trade stands out because it pinches otherwise healthy companies that should be driving a recovery in global commerce. Already, the World Bank predicts trade will contract next year for the first time since 1982.

The Deteriorating Trade Outlook

Here’s the IMF’s recent forecasts for exports — from October and then November — for world trade, disaggregated into advanced and developing country groupings.

tradecredit1.gifFigure 1: Real goods and services exports by country group. Source: IMF, World Economic Outlook Oct. 2008; Nov. 6 WEO update.These developments in trade financing suggest that the recent drop-off in US exports and imports might be due only in part to macroeconomic factors. In particular, I suspect that some of the precipitous decline in US non-oil imports is driven by difficulty in obtaining financing. Similarly, for US exports.

tradecredit2.gifFigure 2: Log nominal goods imports ex oil (blue), and log real goods imports ex oil (red), in Ch.2000$. Gray shaded area denotes NBER defined trough and thereafter. Source: BEA/Census, October trade release, and NBER.

tradecredit3.gifFigure 3: Log nominal goods exports (blue), and log real goods exports (red), in Ch.2000$. Gray shaded area denotes NBER defined trough and thereafter. Source: BEA/Census, October trade release, and NBER. The article continues:

Despite better growth prospects in developing countries, many lenders are pulling back drastically from these regions. The institutions are cutting exposure to economies traditionally perceived as more risky in order to patch up holes in their balance sheets. Other big players in trade finance, such as Wachovia, have disappeared.

“For emerging markets, the deleveraging process is extensive, and dollar sources have dried up,” says Hung Tran, an economist at the Institute of International Finance, a Washington association of international financial firms.

Dating back to ancient commercial hubs such as ninth-century Baghdad, trade finance is the collection of hard-currency credit lines, insurance policies and guarantees that allows firms in different countries to do business with each other. It’s the oil that lubricates $14 trillion of global trade.

“The trade-finance business globally is under significant stress,” says John Ahearn, the global head of trade finance at Citigroup, one of the world’s biggest trade-finance sources. Some repricing is expected as the globe readjusts from a period where credit flowed too freely. “We are coming out of an incredibly benign credit environment when trust levels were too high,” says Stuart Nivison, head of trade and supply chain at HSBC Holdings.

Even big lenders such as Citigroup and HSBC that have expanded international credit lines to some markets recently are hitting obstacles. A big part of these banks’ business is setting up trade lines that are offloaded to smaller banks in a secondary market. These days, however, the smaller banks aren’t buying.

Consider what’s happening in Brazil, an emerging export power that sells the world everything from soy and beef to iron ore and jets. Brazilian companies need dollar-denominated credit to finance the sales. The cost of these credit lines — the bread and butter of trade finance — has soared, doubling in many cases. The phenomenon hits smaller firms the hardest: Some no longer qualify for the lines and others are squeezed out of shrinking market by credit-hungry giants like state oil company Petroleo Brasileiro.

At times, credit is available, but the higher cost of it exceeds the profit margins, so the deals collapse. That’s especially the case in commodities transactions.

By the way, the spike up in the value of the dollar (represented in the downward movement in the USD exchange rate), while often mentioned in journalistic accounts, is unlikely to have had a big impact in the September and October figures, given the lags usually estimated in trade flow equations (for a discussion of lag lengths, see this paper [pdf]).

tradecredit4.gifFigure 4: Log USD nominal exchange rate, broad basket (blue), goods exports, millions USD (red), and non-oil goods imports (blue), both seasonally adjusted. December USD figure is for statistics through Dec. 26. Gray shaded area denotes NBER defined trough and thereafter. Source: BEA/Census, October release, Federal Reserve, and NBER. The observed co-movement is ascribable to the common factor of flight to safety and reduction in trade credits in the wake of the financial crisis (see some stunning pictures in Brad Setser’s recent post).


Other coverage is in Globe and Mail, Journal of Commerce, Reuters, Bloomberg. Many of the articles focus on China, and we now have some feeling for the combined macro/finance impact: “According to Chinese customs figures, Chinese exports declined 2.2% and imports fell 17.9% in November, compared with a year earlier.” (Volz in FEER.) This suggests to me that the more rapidly the supply of export credit can be restored (at least partially), the less significant the downturn in Chinese exports, and hence in the Chinese economy.

From Reuters:

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.

Some Disparate Observations

In some previous posts, I observed that globalization was a function of trade — and other transaction — costs [1], [2], [3]. That observation was focused on transportation costs, but it’s clear (in retrospect) that one of the drivers of globalization was decreasing financing costs. With financing costlier for the foreseeable future, secular growth in trade flows may be even more muted than one would expect from the slowdown in global GDP.

There is a good news/bad news aspect to this conclusion. The bad news is that decreased international trade means a reduction (relative to counterfactual) in the gains from exploiting comparative advantage. This will show up in further reduced GDP.

The good news, such as it is, is that reduced import penetration in the developed economies will mitigate protectionist tendencies. In addition, higher transactions costs (due to higher financing costs) will likely act to reduce the marginal propensity to import, thereby boosting the Keynesian multiplier (as described by me, and Dani Rodrik) in a way that will not induce retaliation. Of course, the net effect is still likely to be toward greater protectionism.

Originally published at Econbrowser and reproduced here with the author’s permission.