Quote:

...the "rally" is a consequence of the dollar carry trade - a destructive Godzilla that has infested our capital markets as a direct and proximate result of Bernanke's and Geithner's policies.

Could someone explain this phenomena in more detail? Are The Feds weakening the dollar so that Foreigners will invest in our equity markets with their currencies and thus make money on the fact that our dollar is going down or what?

Karl, please clarify a couple of points if you would to support your carry trade theory.
1. You mentioned in your radio talk yesterday that carry trade sucks the money out of the US economy and places it in risky bets such as the stock market. I don't quite get this since Bernanke has been clearly replacing this money either electronically or through actual printing of cash. I realize there is a limit to this, but the game may continue much longer than it did in Japan.
2. Not all of Japan's debt was in their own currency--ours is entirely and as such the comparison may not be quite there.

http://www.ft.com/cms/s/0/f3aec6c2-b99e-....

Financial Times interactive graphic representation of how the USD carry trade works

Max Keiser video explaining the same:
http://www.youtube.com/watch?v=VF0_OD4SO....

Interesting perspective on the current state of the dollar and carry trades here:

http://globaleconomydoesmatter.blogspot.....

So what are the risks of a repeat performance on this occassion? Well, the risks are certainly there, but perhaps we have the key to understanding why the Japanese carry trade unwinded so violently is to be found in the last paragraph, since the Yen carry went west so quickly due to a decline in risk sentiment, and the safe-haven surge in both the Yen and the USD was a response to this decline in sentiment, and not its cause. Yet presumeably, and at least in the short term, any move by Ben Bernanke to raise Federal Reserve interest rates would be a signal for a further rise in risk sentiment, and not a response to a decline, and as such it should in theory trigger another surge in carry appetite, and not its dissapearance. Unless, of course, the dollar rise was precipitated not by the Fed's rate tightening programme, but by perceived risk elements in the "other" currency in one of the pairs - that is the euro. Personally, I consider the situation in Spain to be much less of a "side-dish" in the current financial crisis than many seem to feel it is, and indeed I would take Spain as the largest and potentially most dangerous of the loose cannon we have floating about on deck as we try to steer our way forward and away from the storms.

Kwl88,
You might listen to some of Karl's Blogtalk shows, link at the top of this page.


http://www.blogtalkradio.com/marketticke....

Best

Kwl,

Karl explained this on his show on Monday. How it works is since you are a big bank, and you can borrow from the U.S treasury for 0% you then borrow a bunch of money..... or should I say a bunch of dollars.

Then you go to a country where their equivalent of T-bills or whatever yields 2-3%. Bam, you just insta-made some profit. This works as long as the dollar does NOT strengthen against the other currency. Here is an example, lets say that the EUR and USD are at par.

1 USD = 1 EUR

I borrow a bunch of USDs, and then buy some EU treasury bills (or whatever they have). They yield 3 %.

So as long as 1 USD = 1 EUR I make my 3% because the EU T bills yield that much.

If the dollar weakens, then Don't really care, I just borrow more dollars at 0% to get the same amount of EUR T-Bills and I still make my 3% because I am borrowing at 0.

The reason the carry trade is self feeding, is that you borrow more and more and more and more dollars, and then sell them in the market to then purchase something in another currency.

BUT if some event occurs, or something happens that all of a sudden a spike appears in the 1 USD to 1 EUR relationship, I get f-ed and f-ed very quickly. One such event could be a rise in interest rates. If in a short period of time, it starts costing me 2% to borrow, then I will sell my EUR T-Bills and then BUY BUY BUY dollars, causing the dollar to go UP in value, thus forcing other people to cover their margin calls because the dollar is worth more lets say 1.05 to 1 EUR. So the 5% strength increase relative to the other currency kills my 3% profit margin PLUS I need to now PAY additional 2%. And since in the FOREX markets leverage is about 100 to 1, anything above 1% basically makes me 'insolvent' as far as the margin on the Forex account is concerned.

At that point i have to sell ANYTHING I can to get more cash to cover my margin calls, and what will I sell? Equities, Bonds, or whatever else since I am so strapped for cash.

Thus the market goes lower, dollar strengthens, and the cycle repeats.

What's happening now is almost identical with what happened in the Fall of 1931. If you're interested, read Bernanke's take on what happened then (and what he thinks the Fed did wrong) here: http://www.federalreserve.gov/boarddocs/....

Cliff notes: Bernanke believes that when the dollar dropped and people moved out of dollars (and into gold, for example) due to artificially low interest rates, the Fed made a big mistake by raising rates to defend the dollar. My takeaway from this is that the dollar is going to continue to drop and you really don't want to be long dollars right now. As KD notes, Bernanke could stop all this by raising rates to 2% and the dollar would take off like a rocket (in the short term at least) but I just don't see it happening.

Danno,

What about the scenario that if the dollar weakens enough, our creditors will say 'um, for such a worthless piece of paper, I want a higher coupon' then don't we arrive at the same place as 1931? Interest rates go UP, dollar spikes and bam we are toast.

What system is there to stop a large foriegn interest from using the carry and then unwinding it quickly to start a crash?

Ilike: Nothing.

Nice Find Jhonab:
http://www.ft.com/cms/s/0/f3aec6c2-b99e-....

Financial Times interactive graphic representation of how the USD carry trade works

Aren't the banks making money two ways here:

1) Outrageous interest rates on credit cards, fees, etc.
2) Profitting by participating in the carry trade

?

It means a lower standard of living. If depreciating was a good idea, Latin America would be the land of milk and honey.

I think this is a designed policy between governments and central banks. If the EU cut rates to zero, there would be no outflow of USD to prop up dollardenominated debt in the EU and there would be no propping up of European stock indices or banks. Without the carry trade, European banks would have to call in loans and liquidate assets big time, causing bank failures and overleveraged house owners and consumers to go belly up in a very short time.

The US has exported inflation to the world for 40 years. Now it exports reflation, or tries to do so by effectively giving money away for free to banksters and their best buddies. Yes, this does indeed reward the crooks big time, and the argument for doing it will be the samme as used everywhere to excuse public propping up of the banking business - if we don't do it, the insolvency of these institutions will surface in no time, forcing them to call in loans for businesses and private costumers.

The TARP affair was the critical moment - at that time the whole thing was in flames due to a very rapid unwinding of the yen carry (I posted a chart showing the correlation between USD/YEN and Dow in the 'IMF/carry trade'-thread)- when it was decided that we neded the banks we've got, instead of letting insolvent banks go into bankruptcy and restarting a series of new banks as described by Karl on many occassions.

There is no turning back now, and because the carry feeds dollars not only to Europe but to emerging markets, the FED will be unable to raise rates for years, in my opinion.

Is there any chance that the market would interpret Bennie's raising interest rates as a sign the economy is recovering/growing and move higher?

OK... so the long and short of this policy is... GO LONG US EQUITIES?

I don't understand why the correlation between the dollar and the S&P indicates a carry trade.
If there is a dollar carry trade, then the borrowed dollars are converted into another currency and invested in assets denominated in that currency. The carry trade money could not be invested in the S&P as it is a dollar denominated asset. So, what causes the connection?

With the Yen carry trade the borrowed yen was converted into dollars and used to invest in the S&P (among other assets). When this trade was unwound we saw a tight correlation between the Yen/Dollar cross and the S&P. This makes sense because the S&P is a foreign asset with respect to the Yen.

Luke428, thank you for the great explanation of the carry trade. It really cleared things up for me.

Karl,

What if the banksters are doing the following.... or trying too....

accumulate enough cash through carry, trade. Unwind carry trade and short the US market for even larger profits...

Then we are in for a ****storm

but then Oil goes nuts, and creates another crash, and the Chinese go nuts as the Dollar keeps falling, so how can that be Bernanke's intentional policy?

When Grayson asked Bernake if it was a coincidence that the NZ currency strengthened verses the dollar after we "loan" then several billion dollars, Bernake's response: Yes.

So, the foreign countries on the other end of the trade, the ones accepting our dollars in exchange for treasuries, are cool with this for the moment bc their debt, like most debt, is denominated in US dollars, which they continue to need...?

Jubber, when GS, JPM, and whoever else has THAT much cash from destroying the economy and then buy things for pennies on the dollar...... when everything collapses. I feel sick to my stomach.....

They would become 10x the behemoth they are today.