Carry trade

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The article completely misses the point.

There is no ‘cash pouring into’ anything.

Nor is there a constraint on lending/deposits in any non convertible currency.

It is not a matter of taking funds from one currency and giving them to another.

There is no such thing.

Yes, the interest rate differential may be driving one currency high in the near term (not the long term) due to these portfolio shifts.

But the nation with the currency seeing the appreciation has the advantage, not the other way around.

Imports are the real benefits, exports the real costs, which the author of this piece has backwards.

The nation with the stronger currency is experiencing improving real terms of trade- more imports in exchange for fewer exports.

The most common way to realize this benefit is for the government to use the currency strength to accumulate foreign currency reserves by ‘pegging’ its currency to sustain it’s exports. This results in the same real terms of trade plus foreign exchange accumulation which can be of some undetermined future real benefit.

Better still, however, is cut taxes (or increase govt. spending, depending on your desired outcome) and sustain domestic demand, employment, and output, so now the domestic population has sufficient spending power to buy all that can be produced domestically at full employment, plus anything the rest of the world wants to net export to you.

Unfortunately those pesky deficit myths always seem to get in the way of anyone implementing that policy, as evidenced by this
article below and all of the others along the same lines. Comments in below:

>   Steve Keen pointed me to it. Talks about the carry trade in US$ over to AUD$.
>   There are not Federal unsecured swap lines, would be interested in your take.

Foreign speculation on our currency is a bubble set to burst

By Kenneth Davidson

Oct. 26 (National Times) — The pooh-bahs running US and British hedge funds and the banks supporting them are more than capable of reading the minutes of the Reserve Bank of Australia board meetings and coming to the conclusion that RBA Governor Glenn Stevens is committed to pushing up the cash rate from the present 3.25 per cent to 4 to 5 per cent if necessary.

And they are already betting tens of billions of dollars on what has so far been a sure bet.

But is always high risk, and not permitted for US banks by our regulators, though no doubt some gets by.

These foreign financial institutions are up to their old tricks. After getting trillions of dollars out of their respective governments to avoid GFC-induced bankruptcy – which was largely engineered by their criminal greed – because they are ”too big to fail”, they are already using their influence to maintain ”business as usual”.
Why funnel the money gouged out of American and British taxpayers into lending to their national economies to maintain employment when there are richer pickings elsewhere?

As above, these transactions directly risk shareholder equity. The govt. is not at risk until after private capital has been completely eliminated.

Two of those destinations are Brazil and Australia. Their resource-rich economies are still doing well compared with most other countries because they are riding in the slipstream of the strong demand for commodities from China and India.

Cash is pouring into these economies, not for development, but to speculate on the local currency and the sharemarket. The rising value of the Brazilian real and the Australian dollar against the US dollar has had a disastrous impact on both countries’ non-commodity export and import competing industries.

Yes, except to be able to export less and import more is a positive shift in real terms of trade, and a benefit to the real standard of living.

Brazil’s popular and largely economically successful left-wing Government led by President Lula da Silva is meeting the problem head on. It has decided to impose a 2 per cent tax on all capital inflows to stop the real appreciating further.

Instead, it could cut taxes to sustain full employment if that’s the risk they are worried about.

Arguably, the monetary strategy adopted by Stevens has compounded Australia’s lack of international competitiveness for our manufacturing and service industries, especially tourism. Since the end of 2008 our dollar has appreciated 27 per cent (as of last week). This means that financial institutions that invested money at the beginning of January are enjoying an annual rate of return on their investments of 35 per cent.

Tourism is an export industry. Instead of working caring for tourists a nation is better served taking care of its people’s needs.
And those profits are from foreign capital paying ever higher prices for the currency.

US and British commercial banks can borrow from their central banks at a rate less than 1 per cent. The equivalent RBA rate is 3.25 per cent and many pundits are forecasting the rate could go to 3.75 per cent before the end of 2009. This will increase the differential between Australian and British and US interest rates and make the scope for speculative profits even higher.

They are risking their shareholder’s capital if they do that, not their govt’s money, at least not until all the private equity is lost.
And the regulators are supposed to be on top of that.

Since the beginning of the year, $64 billion has poured into Australia in the form of direct and portfolio (share) investment and foreign lenders have switched $80 billion of foreign debt payable in foreign currencies to Australian currency. Most of the portfolio investment ($41 billion) has gone into bank shares. Banks now represent 40 per cent of the value of shares traded on the stock exchange, and while shares in the big four bank shares have increased by about 80 per cent (as measured by CBA shares), the Australian Stock Exchange Index has risen by only 30 per cent.

When anyone buys shares someone sells them. There are no net funds ‘going into’ anything.

Also, portfolio mangers do diversify globally, and I’d guess a lot of managers went to higher levels of cash last year, and much of this is the reversal. And it’s also likely, for example, that Australian managers have increased their holdings of foreign securities as well.

Foreigners have shifted out of Australian fixed interest debt and into equities because as interest rates go up, the capital value of fixed debt declines. By driving up interest rates to curb inflationary expectations and the prospect of a housing price bubble the RBA is in far greater danger of creating a stock exchange asset price bubble as well as an Australian dollar bubble. Once foreigners believe interest rates have peaked, the bubbles are likely to be pricked as financial speculators attempt to realise their gains. This could lead to a stampede out of Australian denominated securities.

Markets do fluctuate for all kinds of reasons, both short term and long term. The Australian dollar has probably reacted more to resource prices than anything else. But again, the issue is real terms of trade, and domestic output and employment.

With unemployment expected to continue to rise, and the level of unemployment disguised by growing numbers of workers being forced to work part-time, there is little chance of the underlying inflation rate, already below 2 per cent, increasing as a result of a wages break-out. The last wages breakout (leaving aside the explosive growth in executive salaries in the past three decades) occurred in 1979.

This gives the govt. cause to increase domestic demand with fiscal adjustments, including Professor Bill Mitchell’s ‘Job Guarantee’ proposal which is much like my federally funded $8/hr job for anyone willing and able to work proposal.

The world has moved on but the obsessive debate about wage inflation and union powers hasn’t. Since the beginning of the ’80s, the problem has been periodic bouts of asset price inflation. It is the biggest danger now.

Instead of controlling the unions, there should be control of financial institutions. The Australian dollar bubble and the incipient housing bubble should be micro-managed. Capital inflow could be dampened by a compulsory deposit of 1 to 2 per cent to be redeemed after a year to stop speculative inflow. Home ownership has become a tax shelter. The steam could be taken out of the rise in house prices if negative gearing was limited to new housing. This would obviate the need for higher interest rates that affect everyone.

The Job Guarantee offers a far superior price anchor vs our current use of unemployment as a price anchor. Also, I strongly suspect that the mainstream has it wrong, and that it is lower rates that are deflationary.


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4 Responses to Carry trade

  1. Warren Mosler says:

    the tax i’ve proposed cutting is the fica/payroll taxes which are the most regressive punishing federal taxes we’ve ever had. 15% of everyone’s first dollar earned up to a cap of a bit over 100,000 in income is taxed away.


  2. Charles Yaker says:

    “Better still, however, is cut taxes (or increase govt. spending, depending on your desired outcome) and sustain domestic demand, employment, and output, so now the domestic population has sufficient spending power to buy all that can be produced domestically at full employment, plus anything the rest of the world wants to net export to you.”

    Maybe it’s my background and/or prejudices but every time someone talks of cutting taxes I see the “Rich getting Richer and the poor getting poorer”. I may not understand everything I read but intuitively I sense that Warren’s outlook is favorable to a more equitable distribution. IMHO this country is tax averse and part of the problem is that the focus is on cutting taxes because “there are no good taxes” (which as I understand Warren’s economics may not be so) Instead the discussion should be on a the proper management and uses of taxes and spending to achieve the outcomes we as a society want. I guess I either don’t understand or I am naive or both.


  3. Jim Baird says:

    Have you ever noticed that, no matter whether a currency goes up or down, the mainstream commentators can always be replied upon to portray the movement as a tragedy?

    Up? “Oh my god, how will we export? We’re doomed, I tell you, doomed!”

    Down? “Oh my god, think of the inflation! We won’t be able to afford to import anything! We’re doomed, I tell you, doomed!”


  4. RSG says:

    Looks like Roubini is at it again:

    Roubini Says Carry Trades Fueling ‘Huge’ Asset Bubble (Update1)

    By Michael Patterson
    Oct. 27 (Bloomberg) — Investors worldwide are borrowing
    dollars to buy assets including equities and commodities,
    fueling “huge” bubbles that may spark another financial
    crisis, said New York University professor Nouriel Roubini.
    “We have the mother of all carry trades,” Roubini, who
    predicted the banking crisis that spurred more than $1.6
    trillion of asset writedowns and credit losses at financial
    companies worldwide since 2007, said via satellite to a
    conference in Cape Town, South Africa. “Everybody’s playing the
    same game and this game is becoming dangerous.”
    The dollar has dropped 13 percent in the past year against a
    basket of six major currencies as the Federal Reserve, led by
    Chairman Ben S. Bernanke, cut interest rates to near zero in an
    effort to lift the U.S. economy out of its worst recession since
    the 1930s. Roubini said the dollar will eventually “bottom out”
    as the Fed raises borrowing costs and withdraws stimulus measures
    including purchases of government debt. That may force investors
    to reverse carry trades and “rush to the exit,” he said.
    “The risk is that we are planting the seeds of the next
    financial crisis,” said Roubini, chairman of New York-based
    research and advisory service Roubini Global Economics. “This
    asset bubble is totally inconsistent with a weaker recovery of
    economic and financial fundamentals.”
    The MSCI All-Country World Index of global equities has
    surged 69 percent from this year’s low on March 9, while the
    Reuters/Jefferies CRB Index of 19 commodities has jumped 32

    ‘Wall of Liquidity’

    An asset “bust” may not occur for another year or two as
    a “wall of liquidity” pushes prices higher, he said. In a
    carry trade, investors borrow in countries with low interest
    rates to invest in higher-yielding assets.
    Roubini said the U.S. recession seems to be over, though
    the economic recovery in advanced nations will be “anemic.” He
    said he’s “more optimistic” on the outlook for growth in
    emerging markets.
    The U.S. economy probably grew at a 3.2 percent pace from
    July through September after shrinking the previous four
    quarters, according to the median estimate of 65 economists
    surveyed by Bloomberg News before the Commerce Department’s
    report on gross domestic product due Oct. 29.
    The economy shrank 3.8 percent in the 12 months to June,
    the worst performance in seven decades.
    Roubini’s July 2006 warning about the financial crisis
    protected investors from losses in the Standard & Poor’s 500
    Index’s worst annual tumble in seven decades. The U.S. equity
    benchmark has surged 58 percent from a 12-year low in March even
    as Roubini said that month the advance was a “dead-cat
    bounce,” that it may “fizzle” in May and warned in July that
    the economy is “not out of the woods.”
    The S&P 500 was little changed at 1,067.13 as of 9:44 a.m.
    in New York.


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