Article

By Mark Ford

Over recent weeks it has become abundantly clear that the credit crunch that started in the US sub-prime mortgage market has bitten hard into the letter of credit market, and consequently into international trade and shipping.

In November, Barack Obama won the US presidential race. Of course, no one expects a new US president to instantly solve a global credit shortage that can lead to an immediate revival of L/C business, but Obama - assisted by the US Secretary of Commerce, the US Trade Representative and one of his erstwhile political rivals, Hillary Clinton as Secretary of State - will play a critical role in the future of international trade.

Assessing the crunch

The last few weeks have seen L/Cs featured in mainstream media articles, probably to an unprecedented extent, as it became apparent that the financial instrument now much more widely recognized as a facilitator of international trade has become too scarce a commodity.

Goods are reportedly piling up in the world's dockyards. Exporters and shippers are said to be unable to obtain L/Cs. Wary sellers are asking for L/Cs from importers used to dealing on open account terms, while buyers are simply finding banks less willing to write L/C business.

Banks with credit available are becoming far choosier about which other banks they do L/C business with. Beleaguered banks, such as Wells Fargo and Wachovia, have forced traders and shippers to look elsewhere for L/Cs. Chinese banks have tightened standards for L/C issuance.

Moreover, major trading firms have had to issue reassuring statements on L/Cs - Glencore International had to announce it has had no problems in obtaining L/Cs to finance transactions.

Beyond banking

The impact of the L/C has been felt beyond the banking system. Merchant fleets are becalmed. The Baltic Dry Index, which tracks shipping costs for commodities, thereby providing an indicator of demand for shipping, seems to be disappearing. By early December it had plummeted by more than 90 per cent in a few months, and a component of the index indicated that Panamax vessels could be chartered for just 5 per cent of the charter rate quoted on the index in October 2007.

The depth of the L/C shortage has yet to be revealed. The failure of international buyers to obtain L/Cs to pay for lucrative Christmas orders from Chinese manufacturers was expected to contribute to the collapse of thousands of Chinese smalland medium-sized enterprises. A report by JPMorgan confirmed that pre-Christmas orders from China suddenly ground to a halt, as sufficient credit simply could not be found.

Some countries have tried to make L/Cs more attractive. The State Bank of Pakistan has removed a 35 per cent cash margin requirement on import L/Cs for certain items. The US Export-Import Bank has widened availability of L/Cs for US firms.

A few non-bank entities - including specialist commercial export finance houses and quasi-public sector entities - such as a UK chamber of commerce that is offering its own L/Cs - are reporting increased L/C demand.

The L/C market is certainly not dead in the water. First-tier traders and shippers say there is still availability in the market, but overall the outlook looks grim.

Bail-outs

Governments across the world have launched bail-outs. The US introduced a USD 700 billion bail-out plan, while the UK launched a £500 billion rescue package. China will invest nearly USD 3 trillion to stimulate domestic demand.

So far, none of the bail-outs have made banks less wary of taking each other's L/Cs which, if they are offered, are priced far higher than they were. The problem is particularly acute for businesses in emerging markets, according to the directorgeneral of the World Trade Organisation, Pascal Lamy, who says trade finance is being offered at 300 basis points above LIBOR and, even at this high price, it has been very difficult for some developing countries to get trade finance.

Lamy also highlighted the difficulties any government or body would have fitting a "safety harness" to the global financial system that, in his view, "suffers from a lack of regulation, a lack of transparency, a lack of accountability". Moreover, he argues that no international agreement on finance or climate change is possible today without China, India, Brazil or Indonesia on board.

International trade and the US

Other nations need to be on board too, not least the US, where the global financial crisis ranks along with terrorism at the top of the new administration's chief national security, let alone economic, problems.

International trade will be one of the most important catalysts for improving - or not improving - relations among nations, so that the US president's policy on trade and his choice of who he has appointed to shape relations between the US and the rest of the world are critically important.

During the presidential campaign, those looking for a fresh approach from Obama to improve global credit conditions required for L/Cs to start flowing again could have been disappointed by Obama's campaign talk. A fight for fair trade was one of his key campaign themes, but he made clear that this meant opening up foreign markets to US goods. The new president also said he would use trade agreements to spread good labour and environmental standards around the world.

These policies sounded inward-looking to those hoping for a new world leader to take a lead in solving a problem that might have started in the US but is now a global one. Obama the campaigner sounded even more anti-trade, talking negatively about the Central American Free Trade Agreement and the North American Free Trade Agreement (NAFTA).

Obama's choice to run the Treasury Department, former head of the Federal Reserve Bank of New York, Timothy Geithner, may also have disappointed those looking for a fresh approach to today's financial sector mayhem. Geithner was former Treasury Secretary Henry Paulson's de facto right-hand man, and some complain that he and Paulson failed to see the crisis coming and allowed Lehman Brothers to go bankrupt, deepening the global financial crisis.

But three years ago Geithner accurately flagged the risks that would combine in 2007 to create today's financial crisis, and he has experience in international trade through his involvement in the bail-outs of Mexico, Indonesia, Korea, Brazil and Thailand. His appointment was received well by Wall Street. According to one senior New York banker, he is "a fantastic choice to help lead the financial markets out of the wilderness".

Commerce and the US trade representative

Free trade advocates suffered a blow when New Mexico Governor Bill Richardson was compelled to withdraw his name as President Obama's secretary of commerce because of an ongoing investigation in his home state. Richardson's nomination seemed to reflect the reality that the economic downturn faced by the US is part of a global crisis, which directly affects Washington's relations with the world. By first nominating Richardson, a former US ambassador to the UN, the new president clearly signalled that he wanted international relations managed by an experienced person on day one.

Richardson's appointment had been particularly encouraging to those who thought Obama's campaign talk sounded too protectionist. Richardson was a staunch pro-free-trade Democrat, and his initial selection indicated that the new administration was less likely to follow a protectionist course. Richardson had cut his political teeth on his support for NAFTA and the Clinton administration when most of his Democratic colleagues fiercely opposed both the idea and the president.

A more problematic Obama choice was that of Ron Kirk to be the US trade representative. The trade representative is responsible for the nation's international trade policy. It is a cabinet-level position with the rank of ambassador. The representative sits as a member of the board of the Export- Import Bank and the Overseas Private Investment Corporation. The officer also represents the country for all activities related to the World Trade Organisation and negotiates on behalf of the United States with the Organization for Economic Cooperation and Development (OECD).

Kirk, a former mayor of Dallas, has little background on trade issues or organized labour in the US. Also, some Republican senators, seemed less than enthusiastic about him. In accepting his nomination, Kirk said that he would balance the interests of robust trade as well as the interests of America's workers - code words, some believe, for a tougher US stance on trade.

China

One of Hillary Clinton's first stops if international trade is to be restored will likely be Beijing. The Chinese regime that Secretary Clinton will approach is increasingly the US' de facto banker. The Chinese have accumulated USD 2 trillion in cash reserves and, over recent years, have been buying increasing amounts of US debt, a process that is likely to gain momentum as the US continues to finance its recovery programmes.

Clinton and her colleagues will therefore have to negotiate with the Chinese from a weaker position than her predecessors. Several issues will probably be on the table - including energy and the environment - but the global economic crisis is the most volatile.

Neither Obama's anti-trade rhetoric, nor measures such as China's increased tax rebates for exporters - which make Chinese goods cheaper in the US - seem to bode well for restoring confidence in the credit markets and rejuvenating world trade. But new presidents have a way of surprising the markets. In any event, negotiations between Washington and Beijing will have to be on the top burner.

Mark Ford's e-mail is markford@gotadsl.com