The 96% collapse in the Baltic Freight Index last Summer was an early warning of the remarkable slump in global trade that has accelerated since October. Things are so grim that according to Lloyd's List shippers in Asia are offering zero fees for containers to Europe. Outbound shipping traffic from LA/Long Beach is down 18% yoy, and Japanese exports have dived so fast that the country is now facing trade deficits for the first time since the 1970's, despite the fall in commodity import prices.

Taiwanese exports (largely electronic components/subassemblies into China) were down 42% yoy in December. The chart below details the stunning reversal in China's imports from Asia in recent months, and support my long-held view that the country faces a hard landing. Interestingly, Asian exports to Europe are falling even faster than to the US (possibly as much at 10% this year, against 6-7% to US), suggesting the Eurozone is slowing much faster than consensus. Overall, it looks like 2009 will be the worst year for global trade since WW2. So what are the investment implications?

The chart indicates that China, having run a trade deficit with rest of Asia for many years, has suddenly spiked into surplus, as the sudden collapse in US and European consumer demand has reduced the local demand for components to assemble into finished products (Taiwan, Sth Korea) and capital goods like machine tools (Japan). Chinese imports from Asia grew 22 per cent year-on-year in the first 10 months of 2008, compensating for sluggish demand from the US and Europe, but this came to a sudden halt in November when Chinese imports from Asia dropped a staggering 23.8 per cent year-on-year. Chinese authorities are likely therefore to push for an even weaker Chinese currency in 2009 versus the dollar in a bid to help their ailing exporters, but it's hard to see Congress swallowing this willingly.

Clearly, both the Euro and Yen look dangerously exposed to a reversal in investor sentiment (and indeed intervention in the case of the Yen) as their trade surpluses reverse dramatically this year, just as the US trade deficit closes fast. I've been a fundamental bear of Japan and Europe through 2008; the last few years of growth in the Eurozone was largely driven by a temporary boost to domestic investment from disappearing risk premia in the aftermath of the adoption of the Euro and by external demand from buoyant emerging markets. Both demand sources fizzled out by the second half of 2008, leaving the Eurozone very vulnerable given the absence of credible central fiscal/monetary actors like the Fed/Treasury. The latest record low readings of leading and sentiment indicators point to a severe recession ahead in 2009 something like  a 2.5-3% decline, with negative growth in each of the four quarters of the year. The Euro looks fundamentally overvalued on that basis, and European corporates, notably financials, look riskier than US.

The AUD looks exposed to further weakness as well as commodity exports suffer, as well as the domestic housing/consumer economy. It is a scenario that certainly undermines the weak dollar consensus view; not only will the US have a far smaller trade deficit to finance, but it will increasingly be seen as 'first out' of this downturn because of the radical action already taken. The US trade deficit plunged almost 30 per cent to a five-year low of $40.4bn in November as month-on-month imports fell 12 per cent, while exports declined 6 per cent. A relatively strong dollar, combined with continuing high unemployment in the US, will exacerbate trade tensions, particularly with China.

Another implication of the collapse in trade for surplus countries will be to undermine the financial stability and debt ratings of key Asian exporters like South Korea (and indeed commodity exporters like Russia and Australia) which will face steady sovereign rating downgrades as their trade balance deteriorates. Bad as things seem in the US as accumulated global trade, savings and capital flow imbalances forcibly correct, it's looking a lot worse in Europe and Asia in 2009.