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HI RTs,
Some thoughts on "Carry Trade":
"Carry Trade" may not be the best thing in the world. We know the
"Dollar Carry"
in Indonesia. In early 90's, interest rates in the US were low because
the Fed was cutting rates to "bail out" commercial banks from the real
estate fiasco. In the meantime, in South East Asia, there was an
economic boom caused by lax commercial bank lending. The situation was
the most severe in Indonesia. See the "Dec. 30, 1997" issue of Wall
Street Journal, we know what had happened in Indonesia. The article was
at A1 and the title was "Speculators Didn't Sink Indonesian Currency;
Local Borrowing Did". Local bankers in Indonesia in early 90's found
out that the interest rates in Indonesia were much higher than those in
America because (1) high demand for credit and money in the midst of an
artificial boom; (2) high inflation due to the lax lending of the local
banks. So these "bright" local bankers found an easy way to make
money: be a middleman, borrow money from the US at low interest rates
and re-lend the money in Indonesia at high interest rates and then take
profit at the spread. How popular was this activity? "Borrowing US
Dollars was part and parcel of life in Indonesia. It was like going to
McDonald's, ' says Kenny Tjan, who runs Nomura Asset Management Co.'s
Jakarta Growth Fund from Singapore. " That was free money, wasn't it?
The only risk is the forex rates. Borrowing was done in USD and lending
was done in Rupiah. Hence, the cost was USD while the profit was
Rupiah. If USD rose against Rupiah, this "Dollar Carry" had to be
unwinded, which was exactly the case in the second half of 1997.
Since 1995, there has been a "Yen Carry" trade. Jap. interest rates
were (and still are) very low because of the recession there and BoJ's
attempt to "jump-start" the economy by cutting rates. Meanwhile, the US
economy has been booming as a result of the liquidity that the Fed had
injected into the system during early 90's was huge. Therefore,
"bright" middlemen borrowed in Japan and then bought US T-Bond and made
the difference. As the capital flowed into the US, USD rose against
Jap.yen and made this carry trade even more profitable. Is this free
money? Maybe not. There is only one risk. Borrowing was done in yen
and lending was done in USD. Hence, the cost was yen while the profit
was USD. If yen rose against USD, this "Yen Carry" has to be unwinded.
Thus, I have been a yen bull since the summer of 1998. I caught the yen
rise in Oct. 1998. I also went long yen in June 10, 1999 but 2 days
after I went long, BoJ stepped in and bought 30 billion USD in a series
of 7 interventions and the result is that I am still in a hole. Was I
wrong? Maybe not. Look at the yen chart and you will know why.
BoJ is still fighting against the soaring yen precisely because BoJ
wants to prevent this "Yen Carry" trade from unwinding. Of course, BoJ
is insisting that it is selling yen only because BoJ people are nice and
want to help Jap.exporters. Really? Since crude oil is priced in USD,
a rise in yen means cheap crude oil for Jap. manufacturers.
If a patient is sick, then we check his blood, urine, etc. If there is
no virus, fine. No big deal. The patient is going to be fine.
However, if the virus is found, then there is a problem.
If there is a high correlation between 1989 Jap.Gov't Bond and 1999 US
T-Bond, then we check yen-USD cross. If there is no surge in yen price,
fine. No big deal. T-Bond will not crash. However, if the rise of yen
is unstoppable, then we have a problem.
(Central banks nowadays are very sophisticated. I believe that they can
take care of the yen problem for at least 6 months if they act
together. )
All the above is for general information only, not for trading purpose.
Mervin
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