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Friday, June 22, 2007

Carry On Up The Carry

Bloomberg this morning

Japanese finance companies will market more than 1.5 trillion yen ($12.1 billion) of foreign-currency investment trusts before month-end, according to data compiled by Bloomberg. The funds are aimed at individuals seeking higher yields.

Hegel once famously said that "theory is grey bu life is green". Here we have another very clear example of just how right he was. We are still far from understanding what the long run implications of all this are likely to be. But open a tear in hyperspace, and through they go.

In one sense what is happening is an enormous rebalancing, since "underheating" in domestic demand in some elderly economies (Japan, Germany, Switzerland) is feeding through to "overheating" is domestic consumption in some younger developed countries (New Zealand, Spain, Ireland), some Eastern European economies with structurally damaged demography (Latvia, Lithuania) and in dome new young developing economies (India, Thailand, Brazil). What is curious here is that since Japan needs to maintain growth (and this means export growth) to keep the fiscal deficit from going completely out of control (some current estimates put the present deficit at around 170% of GDP) then the Japanese economy is the direct beneficiary of overheating elsewhere, hence if economics is a game where each one pursues their own self interest, then the Japanese have every interest in keeping this one running.


``There's been a lack of warnings from the monetary authorities on the yen's weakness,'' said Seiichiro Muta, director of foreign exchange at UBS AG in Tokyo. ``As interest rates have to be kept low, it can't be helped that the yen is somewhat weak. A weak yen also benefits exporters.''


Anonymous said...

i am still not able to fathom the outcome of all this..
what happens if:

1. BOJ keeps the interest rates low like current, and keeps supplying money for the carry trade?
2. India and china dont let their currency appreciate and keep supplying cheap exports for-ever?
3. US currency keeps losing value with other currency except for india and china (or any other manipulator)

i was thinking that as long as usa is supposed to pay in USD they can just let their currency depreciate against those who dont manipulate and let china,india and others just keep accumulating dollars worth less than the goods??

how long can it go??

i just read that New Zealnd(NZ) is having a tough time because of this carry trade since they are not able to control inflation and rising interest rate is not helping, any comments on this?

Edward Hugh said...

Hi again Techy,

I appreciate the difficulties you are having following all this. Don't be too dismayed, even the professionals are having a hard time now. Much of what is happening upends a lot of conventional economic thinking.

My view is that when there is a "missmatch" between reality and theory, then it is theory which needs to adapt, not reality.

The key to all of this is the classic notion of capacity, and what globalisation has done to this. Basically local (ie national) ideas of capacity are no longer valid, and we need to think about global capacity and flows of capital and labour.

Reading this piece from Richard Fisher at the Dallas Fed might help you see what is involved. I examine one concrete case - Ireland - in this post, and I look at another - Latvia - here, and this one is interesting, since I think it makes the demographic component in the process pretty clear.

"i was thinking that as long as usa is supposed to pay in USD they can just let their currency depreciate"

Yes, but remember this isn't going to happen overnight (even if some think it is) and the process will probably be slow and long term. What we have is an unwinding of huge imbalances which have basically built up since the industrial revolution - with some societies accumulating population while others accumulated wealth - and all we can hope for is that this takes place in a more or less orderly fashion.

"i just read that New Zealnd(NZ) is having a tough time because of this carry trade since they are not able to control inflation and rising interest rate is not helping, any comments on this?"

Yes, this is significant, but it is hard to see what anyone can do. It is simply a by-product of the whole situation, and there is no obvious policy remedy. At the moment it is simply "grin and bear it".

Similar issues arise in Latvia, if you read the post, since if the Bank of Latvia raise rates they will simply attract more capital inflows (as long as the EU and the ECB are acting as guarantors, and it is hard to see how they could avoid doing this, that is why the speculators would be on what appears to be a safe bet), and thus the move would not have the intended effect.

At the moment virtually everyone has too few policy instruments. We had just better hope that the ship rights itself the easy - and not the hard - way.

Basically as far as I can see you are getting a very rapid class in macroeconomics from all this, and all I can suggest is that you keep reading around.

btw, interesting to know that my guess that you were from India was well-founded. I understand your concerns about social tensions. Virtually all my Indian friends tell the same story - naxalites in Bengal etc - but it is hard to tell what will really happen. For the sake of its people India needs to take risks at this point. As you can see, you have the good fortune - at least in liquidity terms - that you have the wind behind you.

"India and china dont let their currency appreciate and keep supplying cheap exports for-ever?"

No. This is unlikely to happen, since both these countries will at some point have OECD type living standards, and will thus buy as well as sell (although there may be a hard road to travel till we get there). However there are preoccupations in the Chinese case due to the lengthy application of the one child policy, and the rapid population ageing that this is about to produce.

A good recent example is this post by Brad Setser on the Japanese Yen.

Edward Hugh said...

Sorry, the Brad S link at the end was a "bad edit". What I wanted to say was look in comments on that post, since I explain a bit more of what I think about structural characteristics of the importers and the exporters.

Edward Hugh said...

Oh, and don't miss Brazil:

Never have Gucci, Porsche, Jaguar, Prada and Tiffany been so in love with Brazil, home of the world's best-performing currency over the past three years.

The waiting list for Prada SpA's new spring-summer line of leather bags has swelled to 120 people at Dona Santa, a luxury goods store in the Brazilian coastal city of Recife. The most expensive bag in the collection costs $3,600, equal to about half the annual income of the average Brazilian household.

Porsche AG has sold more sports cars and SUVs in the South American country this year than it did in all of 2002 and 2003 combined. Grand Cru, the country's second-largest importer of premium wines, forecasts a doubling of sales this year.

The Brazilian real's three-year, 60 percent rally has pared the cost of imports, fueling a surge in luxury goods sales. That boom is part of a doubling of imports in the past three years that is curbing growth in Brazil's trade surplus and leaving the currency vulnerable to a decline in commodity exports.

Anonymous said...

edward...sorry for this off topic comment.

i feel that they are not balanced view....but trying to scare people into buying gold....comments please?



Edward Hugh said...

Hi again Techy,

"..comments please?"

Well really I am out of my depth with the gold issue. I look at underlying macro economic fundamentals, and I have no idea at all whether gold is realistically priced or not. So I can't help really. But I could say that people who understand very little economics do tend to get rather obsessed with all this. Also I noted this:

"All this takes us to a rather disturbing bi-modal endgame," writes Stephen Roach of Morgan Stanley in a note – "the bursting of the proverbial Big Bubble that brings the whole house of cards down, or the inflation of yet another bubble to buy more time."

Basically I have a completely different underlying approach from Roach, who just seems to think that most of what is happening is some kind of hype which will eventually run out of steam. I essentially don't agree, which doesn't mean we couldn't see a sharp correction at some point, but I would look at Japan, or Italy, or Eastern Europe for this, and not the US or India or China, becuase my essential reasoning is different.