Harry Long

The Dogma of Low Interest Rates Is Wrong

Brilliant, William. I couldn't have said it better myself. Elegantly said.


On Oct 08 10:20 PM William Ramseyer wrote:

> Carry trade.
> First, good article. Low interest rates do not always stimulate the
> local economy, and even when they do the cost can be high.
> It’s true that low interest rates do encourage economic activity
> in the short run--somewhere. But the money borrowed will be invested
> where it appears to bring the best gain. Since weak economies are
> more likely to lower interest rates lower than stronger economies,
> the borrowed money will often go overseas. This is the carry trade.
> We saw it in Japan during the last decade or so, and we see it now
> in the US. It’s true that some money may be invested locally, and
> so there is some stimulus, but at a high cost.
> One side effect of the carry trade is to lower the value of the lender
> nation’s currency. This happens as follows: investors borrow in the
> local currency, and then exchange it for foreign currency in order
> to buy foreign investments. The more the local currency drops the
> greater the value of the foreign investments and so the carry trade
> tends to accelerate, driving up asset values and driving down the
> local currency further. This can create a dramatic feed back loop,
> similar to what Soros describes in his theory of reflexivity as applied
> to asset/lending bubbles. Back to the point—the lowered local currency
> makes the local nation’s exports cheaper and does stimulate the export
> section of that economy. We saw this in Japan during its carry trade.
> There are costs of course—imports become more expensive, and foreigners
> become less interested in lending to the local nation—both factors
> that might push up interest rates and end the carry trade. The carry
> trade can also unwind if currency exchange rates change (due for
> example, to nations entering into the currency market—Japan buying
> US dollars for example), or if asset values fall. The carry trade
> can unwind very rapidly driving up the USD in the present case and
> driving down stock prices internationally.
> So where do we go from here? I believe that the Fed can not raise
> interest rates until the unemployment rate stabilizes (and maybe
> until it actually declines in a decisive way). Thus, the USD will
> continue to fall, absent major intervention in the currency markets
> or a fall in world stock markets. The continued carry trade will
> be our last great bubble, driving up asset prices all over the world.
> However, as I or someone else said, “asset bubbles do not an economy
> make.” The falling dollar will make it difficult for other countries
> to export to the US. Whether they will develop their own consumer
> economies is an open question, but unlikely to happen in the next
> year or two. In the interim, there is massive money to be made as
> long as the carry trade continues to drive up asset prices. All of
> the talk about the economy recovering will be silly noise—ignore
> it. Dance if you dare while the music plays, and try to leave the
> party before the music stops. Thank you. Bill