It's Not Just the Carry Trade

In The Unintended Effects of Bad Policy (May 18th), I wrote that:

"[L]ow interest rates often have the opposite of their intended effect. Extremely low interest rates can vacuum liquidity out of nations. Japan has been referred to as a nation where loose monetary policy was like "pushing on a string." There was no push. It was a pull. Liquidity was sucked out of the country as the Yen became the world's carry trade currency of choice. Borrowing in a currency is the opposite of investment. It is liquidity-draining to the carry trade currency nation. For all of the talk about about using monetary policy to dampen the business cycle, no result could be more damaging or procyclical."

I concluded the article by saying:

"Americans may finally realize that there is a free lunch after all--we will be supplying it as speculators borrow in our low-yielding currency to invest elsewhere."

We are living in truly interesting times. If Warren Buffett was correct in saying that the 19th century was the British Century, the 20th Century was the American Century, and the 21st Century will be the Chinese Century, there are multiple factors at work on seven different levels creating the boom in emerging markets.

I. The carry trade. Our interest rates are anemically low. Emerging market interest rates are higher. Capital goes where it is treated best.

II. Emerging market GDP growth rates. In March, everything was cheap. When you have compressed valuations, the smart money goes with the highest growth rate.

III. Emerging market competitive advantages: low cost labor, light regulation, and governments which want to help industry and job creation.

IV. Conversely, America seems hell-bent on destroying its economy: huge government deficits, the breaking of the social pact of property rights with the mal-treatment of GM debt holders, an inability to show backbone in demanding true free trade (foreign countries trade mostly freely with us, we are not allowed full access to foreign markets), the government demand for position limits on the commodity exchanges (forcing the very transactions off-exchange which the government would rationally want centrally cleared), horribly complex and ineffective regulation, the rise of zombie banks.

V. A turn towards the very socialist ideologies which successful emerging countries such as China have rejected (affirmative action for the formerly rich and stupid, bank investors, bank executives, etc).

VI. A rejection of our unique "Americaness": the values of self reliance, property rights, and rugged individualism which made us a great and prosperous nation.

VII. An increasingly crushing tax burden on those who produce and save in order to subsidize those who do not produce and spend(insolvent banks, California, etc).
The end effect of all of these factors has been to make emerging market equities even more attractive than emerging market debt. It's not just the carry trade at work. It is the combination of the carry trade with very attractive economic fundamentals. Indeed, countries such as China are seeing GDP growth rates that we have not seen in the U.S. for generations.
Disclosure: Long EEM, FXI, PGJ, FCHI, HAO and EWZ. Positions may change at any time.

Comments

[Mad Hedge Fund Trader]

iin The euroyen cross has served as my faithful lapdog for 20 years, accurately forecasting the global risk appetite, rising when hedge funds were eager to roll the dice, and retreating when they went into hiding (see my earlier work by clicking here ). But lately this pet has forgotten its house training, much to the delight of my dry cleaner, delivering an unpleasant stream of false signals. When Japanese overnight rates were at zero, and the rest of the world was at 5%, it was easy to let Japan be your piggy bank and finance everything for free by denominating your debt in yen. This carry trade of choice became a strategy on its own. Leverage it ten to one and you earned a handy 50% annual return, and more, if the yen then depreciated. The problem is that the rest of the world has become Japan, with overnight rates everywhere at, or converging on zero, sending the predictive value of euroyen down the toilet. Thus, it joins the dustbin of history with other indicators that drew our collective gazes, like the money supply, the trade deficit, and rail car loadings. If I find a new one, I’ll let you know. Does anyone out there have any suggestions?

2009 Sep 17 11:29 PM

[macro -N- ietzsches]

Thanks for the list. It matches up with an article/book I read that stated the America was a leader because of its foundation of "intangibles".(meaning the legal system,rightful ownership, accountability, stability) These are all being gutted,as you have pointed out. It leaves investors between the rock of going where the returns are and the hard place of being able to do nothing to stop our own government from destroying itself and our future. The rock of returns implies the unwanted choice of not supporting your own countrys industry. International has been my best performer this summer.

2009 Sep 19 09:16 PM

[Harry Long]

Yes, I do.


On Sep 17 11:29 PM Mad Hedge Fund Trader wrote:

> iin The euroyen cross has served as my faithful lapdog for 20 years,
> accurately forecasting the global risk appetite, rising when hedge
> funds were eager to roll the dice, and retreating when they went
> into hiding (see my earlier work by clicking here ). But lately this
> pet has forgotten its house training, much to the delight of my dry
> cleaner, delivering an unpleasant stream of false signals. When Japanese
> overnight rates were at zero, and the rest of the world was at 5%,
> it was easy to let Japan be your piggy bank and finance everything
> for free by denominating your debt in yen. This carry trade of choice
> became a strategy on its own. Leverage it ten to one and you earned
> a handy 50% annual return, and more, if the yen then depreciated.
> The problem is that the rest of the world has become Japan, with
> overnight rates everywhere at, or converging on zero, sending the
> predictive value of euroyen down the toilet. Thus, it joins the dustbin
> of history with other indicators that drew our collective gazes,
> like the money supply, the trade deficit, and rail car loadings.
> If I find a new one, I’ll let you know. Does anyone out there have
> any suggestions?

2009 Oct 04 04:54 PM

[Leftfield]

Excellent summation and information. There is no reason the US can't have excellent prospects and growth even now but for wall to wall idiocy of policies. You touch on many of them.

2009 Oct 04 08:35 PM