Carry trade

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A strong yen is causing concerns about Japanese export earnings, as
the US dollar fell below 96 yen, its lowest level for 13 years.
BBC 24 October 2008

In Tokyo, the Nikkei dropped below the 8,000-mark for the first time in more than five years.

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US dollar lowest level against the yen since May 2005.
By 1135 GMT the US currency was at 106.19 yen, off a low of 105.97.
BBC, January 16, 2008

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Yen hits 18-month high of Y109.13 against the dollar
Investors unwind carry trades
FT November 12 2007

Traders retreated from risky assets amid heightened nervousness over the state of the financial sector.
Analysts said sliding Asian equity markets had seen investors unwind carry trades, in which low-yielding currencies such as the yen are sold to fund the purchase of riskier, higher-yielding assets elsewhere.

Buy The Yen Now
You may recall that in only three days during the crisis surrounding
the 1998 crackup of Long-Term Capital Management, the yen rallied by 18%.
James Grant, Forbes 26/3 2007

The yen is a piece of paper of no intrinsic value. Then again, so is every other currency under the sun. Each derives its value from the stamp of a government. What sets the yen apart is its tiny yield, five percentage points less than the money rates available in the U.S. and U.K., never mind the customarily higher-yielding currencies of Brazil, Turkey, Indonesia and other such subprime nations.

I believe that the yen is a worthwhile investment. It's a bargain in fundamental, purchasing-power terms, for one thing. And it provides low-cost disaster insurance, for another.

Without exactly knowing, one can be mortally sure that the world is more highly leveraged than even the fretful central bankers suspect. If so, a bear market in any of the popular classes of investment assets would likely turn today's rush to borrow yen into an even faster race to repay it.

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James Grant's homepage at

James Grant at

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The G-1 (G-7 slang for the US) has traditionally led the opposition to multilateral exchange rate management. The Fed doesn’t want to subordinate domestic monetary policy to an external target.
Brad Setser Mar 13, 2007

Rolf Englund:
Nej, fast växelkurs, det är inte bra. Det lärde sig alla, utom Carl Bildt, hösten 1992.
That is why EMU will collapse.

Chinese purchases of yen
China reportedly wants to diversify large portions of its $1,000bn of foreign exchange reserves out of dollars. It is otherwise likely to sustain one of the largest capital losses in history
Fred Bergsten, Financial Times 13/3 2007
Very Important Article

China reportedly wants to diversify large portions of its $1,000bn of foreign exchange reserves out of dollars, where most of them are now held. It is otherwise likely to sustain one of the largest capital losses in history, in terms of both its own currency, the renminbi, and external monies such as the euro, as the dollar inevitably falls by 20 per cent or more against virtually all currencies over the next few years to help correct the unsustainable current account deficits of the US.

Chinese diversification of several hundred billion dollars into yen would promote both systemic and Chinese national interests. It is almost universally agreed, including in Japan, that the yen is substantially undervalued against all currencies, except the renminbi itself and perhaps a few other Asian monies, even after its recent modest rise. Adjusted for inflation, the yen is weaker today than in 1998, when the US and Japan intervened jointly to reverse its precipitous decline, and in 1985, when the Plaza Agreement initiated intervention by the Group of Five leading industrial countries to weaken the dollar, especially against the yen.

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The risks ahead for the world economy
Fred Bergsten The Economist print edition Sep 9th 2004
Very Important Article

Kommentar av Rolf Englund:
Problemet är att när yenen stiger mot dollarn så går det illa för alla som har ägnat sig åt Carry Trade i yen (Låna yen nästan gratis - köpa andra tillgångar - och tjäna en väldig massa pengar - until the music stops, as they say...

Carry Trade

När svenskar carrytradade på slutat av 1980-talet (före det här otrevliga 1992)

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Unwinding the Yen, Unravels Global Stock Markets
The Nuts and Bolts of the “Yen Carry” Trade
Gary Dorsch

Land of the rising yen
John Plender, FT, September 21, 1999

Currency markets, rather than policy makers, hold the key to the future of the world's two largest economies. There are few more sensitive prices in the world economy than the yen-dollar exchange rate.

And as finance ministers from the Group of Seven industrialised countries meet in Washington this weekend, they will be all too aware that the yen's surge against the dollar this year has the potential to blow the world's two largest economies off-course.

In Tokyo the Nikkei index has wobbled in recent days, reflecting fears that the yen's rise will throttle exports and undermine the fragile Japanese recovery. Meantime the depreciation of the dollar carries inflationary risks that will make it harder for the Federal Reserve to avoid raising interest rates.

Nervousness in the markets has been exacerbated by an extraordinary row in Tokyo between the Ministry of Finance and the Bank of Japan over the appropriate policy response. An argument about intervention in the currency markets has become entangled with the question of whether the Bank of Japan's recently won independence is under threat.

While the currency has fallen back from last week's peak of ¥103.25, short term market movements will hinge on the outcome of today's meeting of the Bank of Japan's monetary policy board and deliberations in Washington at the weekend.

But what are the longer term factors behind the large swings in the yen-dollar rate?

Between the spring of 1995 and August last year the dollar appreciated by more than 80 per cent. This astonishing surge was helpful in shifting demand from a buoyant US economy to a Japanese economy that was close to toppling over into deflation.

But there was an awkward side effect, as the weaker yen depressed the exports of Asian countries that pegged their currencies to the dollar. This contributed to the contagious currency crises that erupted in 1997-98.

With hindsight it is clear that the dollar's strength was reinforced by the accumulation of official reserves in Asia in the pre-crisis period. As capital poured into dollar-pegged Asian tiger economies, the Asian central banks had to sell their own currencies in exchange for dollars to prevent their exchange rates from appreciating.

Then when the dollar pegs gave way private sector flows took over from official flows as the driving force. With short term interest rates in Japan at close to zero, banks and hedge funds financed positions in higher-yielding currencies by borrowing in yen. This "yen carry trade", as it was called, helped keep the yen cheap.

The strategy assumed, bizarrely, that there was no risk that the yen would appreciate, thereby causing growing yen liabilities. Speculators seemed to think the currency movements could only be in one direction, and that their investments in other currencies would show a positive income return as well as an appreciation against the yen.

The carry trade came unstuck in the financial crisis last autumn. Spectacularly so: the yen-dollar rate saw the biggest one-day swing since the collapse of the Bretton Woods exchange rate regime in the early 1970s. Over two days on October 7 and 8 the US currency plunged by more than 13 per cent to ¥117.

An internal paper of the Japanese Ministry of Finance estimates that the carry trade was worth over $40bn at its peak in June last year. By this January it had slumped to zero. David Hale of Zurich Financial Services points out that the resulting reduction in leverage in the global system helps explain why the financial shocks of 1999 such as Brazil's devaluation proved less disruptive than the upsets of 1998 such as the Russian default and the problems of the Long-Term Capital Management hedge fund.

Meantime a recent rebound in the carry trade has been outweighed by conventional capital flows, as Western investors have responded to signs of recovery in the Japanese economy by buying the Tokyo equity market.

The snag is that the uplift in equity prices has started to look increasingly suspect because of the yen's continuing appreciation. From 1997 to 1998 Japanese exports fell from $409bn to $373bn. The average exchange rate in 1998 was ¥131 against today's much less competitive ¥106.57. If Japan remained in current account surplus last year, it was chiefly because of the collapse in imports (see chart).

Those who believe that Japan suffers from a structural savings surplus rather than a cyclical one are worried about a more fundamental problem. The personal sector of the economy is unlikely to reduce its surplus as long as industrial restructuring fosters insecurity and squeezes incomes. So growth is dependent on exports, which are very sensitive to the present overvalued exchange rate, or on government budget deficits.

As Andrew Smithers of fund management advisers Smithers & Co puts it, a budget deficit running at 10 per cent can only be a temporary stimulus to growth because it is unsustainable over the long run. And if the deficit is allowed to run at this 10 per cent level for any length of time, it is wholly implausible that investors will finance it at the record low interest rates that prevail in today's Japanese government bond market.

In fact there is a looming crunch in the market. During the next two years high interest Post Office accounts, which are traditionally invested in government bonds, mature. The money is unlikely to be recycled back in the traditional way into the government bond market via the government's Trust Fund Bureau.

The authorities will thus face a choice. They can let the bond market collapse and yields rise to whatever level will tempt the personal sector back into the market to buy the government's IOUs. Or they can monetise the government's debt, for example by selling it to the banks - the modern equivalent of printing money.

In the absence of such a signal, the markets may find it hard to convince themselves that the yen's change of direction last week is a genuine watershed. Without a palpable shift in policy, any attempt at concerted intervention in the currency markets after the G7 meeting would be unlikely to have a lasting impact because joint intervention tends to work well only when it goes with the market trend.

The US, meantime, faces an equal and opposite set of imbalances, which are not helped by dollar weakness. The US private sector is running a deficit of close to 6 per cent of gross domestic product, while the household savings ratio is negative for the first time since the inter-war Depression.

The counterpart of this private sector shortfall of savings against investment is in the balance of payments. There a deficit now approaching 4 per cent of gdp has operated as an inflationary safety valve, permitting excess domestic demand to be met from overseas supply.

A decline in the dollar is threatening on two fronts. First, the re-emergence of the yen as a credible repository for global capital means that the US payments deficit becomes harder to finance. Second, a weaker dollar increases inflationary pressure in the US economy.

The risk is that the Federal Reserve might be forced to raise interest rates further than would otherwise be necessary to stabilise the external account and curb domestic demand. This might be a wake-up call for the many US investors who have put their faith in new paradigms. The sudden discovery that the present looks more like the past than the happy visions of the future peddled by the more cheerful Wall Street pundits might cause a virtuous circle to break.

Decline on Wall Street would mean a negative wealth effect. People whose capital was shrinking would start to rebuild their savings from today's low levels. That would act as a powerful brake on demand.

Against that, it could be argued that a weaker dollar, far from being a scare story, is the natural mechanism to bring about balance of payments adjustment. And if that poses problems for the Japanese recovery, the Japanese government appears to be ready with another pump-priming fiscal package to keep the show on the road.

As for the policy impasse in Tokyo, if it persists, decision-making power will simply be transferred from the Bank of Japan and the Ministry of Finance to the bond market. But if, as seems likely, the printing presses roll, the yen will weaken. The resulting boost to exports will help perpetuate the economic recovery and provide the means to reduce budget deficits.

In the interim the scope for upheavals in currency and capital markets is nonetheless uncomfortably wide. A US recession induced by tumbling stock prices on Wall Street would not leave the world economy unscathed.

But nor need a correction or a bear market in the US be a disaster. The good news this autumn is that the continental European economies are at last powering ahead. The weakness of the euro against the dollar can now be seen to have played a constructive part in rebalancing global economic activity.

Moreover, stock markets in continental Europe are still so small in relation to the European economies that they are not particularly vulnerable to negative wealth effects if equity markets plunge. A lack of US hegemony in capital markets is in this sense helpful for global growth.

If the cure for imbalances in the US and Japan calls for currency weakness in both countries, the euro-zone will have to become a strong currency area for as long as it takes for these two countries to establish a more stable equilibrium. With trade accounting for a relatively small part of the euro-zone's gdp, and with recovery now under way, a policy of benign neglect towards the currency is something the Europeans can safely borrow from the lexicon of US economic diplomacy.

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