By Michael Baxter 1 Dec 2009 [0 Comments | 388 views]
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You may recall, back in the boom we had this thing in the money markets called the carry trade. The rate of interest in Japan was zero, Japanese savers were unhappy with the lousy returns on their money, so they invested it abroad. Sophisticated investors borrowed money in Japan, and re-lent it abroad at a much higher interest rate. So money flowed from the land of the rising sun, to the land of the setting sun, and that place called Europe in between. This carry trade may have been one of the key pressures that pumped up credit earlier this decade, and may have been a major factor behind the property boom. During this period the yen fell, and the dollar rose.
At the time it was warned, including in this publication, that there was trouble ahead. Should Japanese, US and European interest rates move into closer alignment then the change this would force could be very nasty.
Well, that was then. Right now, things are working in almost the precise opposite way.
Money is now flowing from the US into Japan. Low interest rates in the US have changed it all. The yen is riding high, the dollar is crashing and gold is surging.
There are two explanations for rising gold. Explanation number one: the carry trade 2009 style.
The other explanation lies in investors sentiment. They have read so much about the evils of the Fed printing money, and perhaps more significantly the ballooning US fiscal deficit, that they have convinced themselves gold is the only safe refuge.
But, take a sniff. Go on. Really sniff the economic air around you. There’s madness in it.
Yes, it is true that the US fiscal deficit is mounting. Yes, it’s big. But to run from the dollar into the yen is just plain silly. For, in Japan, the fiscal deficit as a percentage of GDP dwarfs the US deficit.
We keep hearing about how the US and British fiscal deficit will bankrupt the respective economies, but the fact is Japan has managed a much bigger deficit for years and years, without its credit rating being hit.
The carry trade we are witnessing right now is potentially dangerous, but could ultimately prove to be a good thing.
It has left the Fed looking somewhat impotent. It boosts money, and much of it flows abroad.
But, at least this could eventually go some way to ending global imbalances and could be a key part in solving one of the underlying problems, namely that the US and UK and some other economies spend too much, while others save too much.
The craziness has another head too, however.
There is another reason why sentiment on the US economy is way, way, wide of the mark, and to find out why, click here: The demographic punch
