Just a quick afterthought on my last post on the Swiss Franc carry trade. As I note there, Claus Vistesen had a post earlier in the week on Japanese housewives shorting the yen. Now interestingly a guy called Wim from the Netherlands immediately posted a comment pointing out that this isn't only a lucrative activity for the Japanese housewife, and that he was effectively able to do the same from his own living room:
"As a retail investor in Holland it is easy to short yen and invest in something else. You only have to open a brokerage account with InteractiveBrokers and you can do the same yen carry trade as these japanese house wives. I am doing it myself and invest the money in gold, commodities and mining companies. Gold expressed in yen is certainly in a bull market. JPY JPY LIBOR1 (Spot-Next rate) 0.613%"
So why is this important, well let's go back to what happened in Austria in the late 1990s. Dimitri Tzanninis explains the situation like this:
The practice of borrowing in foreign currency (mainly Swiss francs) began in the western part of the country, where tens of thousands of Austrians commute to work in Switzerland and Liechtenstein. This partly explains why the share of these loans was higher in Austria, even during the 1980s. Word of mouth and aggressive promotion by financial advisors helped spread the popularity of these loans to the rest of the country. By the mid-1990s, newspaper ads placed by banks began to appear, fueling public interest.
Now Dimitri Tzanninis refers to this as an example of "herd behaviour" (see note at foot of post), in the sense that the process is clearly non-linear, and subject to some kind of press driven and "word of mouth" process. The following charts of news stories in the Austrian press sum the situation up pretty well:
Now all of this could simply be though of as anecdotal, until we take a look at what is happening right now in New Zealand:
The New Zealand dollar rose to its highest against the U.S. currency since the central bank intervened on June 11 as the yield advantage enjoyed by the nation's debt widened.
The yield spread between New Zealand's December 2017 government bond and 10-year Treasuries rose to 1.68 percentage points, from 1.49 points on June 12, after a report showed a drop in U.S. home building. New Zealand's 8 percent benchmark interest rate is the second-highest after Iceland's among Aaa- rated countries, fueling a 22 percent gain in the currency in the past year.
The New Zealand dollar also rose to its highest in almost 20 years against the yen. It has gained 31 percent against Japan's currency the past year, buoyed by so-called carry trades, where investors borrow at Japan's 0.5 percent rate, the lowest of the major economies, to buy higher-yielding assets elsewhere.
Japanese individual investors, who have set up 600,000 accounts to trade currency with borrowed yen, stepped up purchases of the New Zealand dollar after the Reserve Bank said it sold the currency.
600,000 individual accounts, and from Japanese retail investors who are allegedly conservative and exhibit historically "home bias" (just like the Austrians in the mid 1990s?)! Clearly we have a "herd-type" phenomenon in Japan right now, and one which increasingly places central bankers under a lot of difficulty when they want to intervene. The long term implications of what is happening are hard at this point to foresee, but they surely are going to be important. Financial de-regulation plus the internet seems to constitute some kind of "killer-app". As Keynes famously said, in the long run we are all surely dead.
I reproduce below the explanation of the herd behaviour phenomenon offered by Dimitri Tzanninis.
Herd behavior occurs when people do what others do rather than rely on their own (incomplete) information, which might be suggesting something different (Banerjee, 1992). The suppression of private information could lead to “information cascades” when decisions are made sequentially and a large enough number of people choose identical actions. In such settings, the decisions of a critical few people early on are enough to tilt group behavior toward a certain direction. Mimicking the behavior of others might be rational because of uncertainty about one’s own information as well as the need to economize on information-gathering costs. Rational herd behavior is the subject of a recent strand of behavioral finance (see Montier, 2002, for an introduction).
Herd behavior can arise in a variety of environments, including in financial markets. However, it is difficult to disentangle empirically the effects of macroeconomic or other fundamental determinants from those caused by herd behavior. Herd behavior often results in volatility because it is susceptible to abrupt shifts or reversals, and thus has the potential to destabilize markets.
Empirical studies have shown that the dynamics of herd behavior often resemble an S curve: initially only a few adopt a certain behavior, but, past a certain critical mass, a take-off state takes hold where a rapidly growing number of people adopt this behavior. Toward the end of this process, a moderation of the dynamics takes place as the potential pool of adoptees is exhausted.
Banerjee, A. V., 1992, “A Simple Model of Herd Behavior,” The Quarterly Journal of Economics, Vol. CVII(3), pp. 797-817.
Montier, J., 2002, Behavioural Finance: Insights into Irrational Minds and Markets (Chichester: John Wiley & Sons Ltd.)
Waschiczek, W., 2002, “Foreign Currency Loans in Austria—Efficiency and Risk Considerations,” in Financial Stability Report 4, OeNB, pp. 83-99 (Vienna: Oesterreichische Nationalbank).
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