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Guest Post: Tipping Over The $1.5 Trillion Carry Trade
Submitted by Thermidor
Last week in the FT the deputy governor of the PBOC was quoted as saying that his biggest fear for markets in 2010 was the risks to the $ carry trade, which China estimated was worth $1.5 trillion, dwarfing the yen carry trade at its height. Indeed, he's right to be worried, especially, as I believe, the lynchpin of the carry trade is now the Fed's balance sheet, which they are actively discussing shrinking.
To illustrate the point take a look at the attached chart, which shows the Fed's broad $ index vs. the size of their own balance sheet. In September and October of 2008 the Fed blew out the balance sheet as private financing collapsed, catapulting the $ higher. Indeed, the $ didn't really seem to stabilise until December, only falling again from February 09 when the Fed's balance sheet expanded decisively beyond $1.9-2.0 trillion. Indeed, it appears that this size of balance sheet is necessary to obtain broad equilibrium in FX markets, with expansion beyond these levels causing $ weakness and conversely anything below that strength. Indeed since February the 20 week correlation between the Fed's balance sheet and the broad value of the dollar has run basically between 0.7 and 0.9
This means that more than any time during the whole Yen carry trade, the façade of normality in today's markets depends on low US rates and especially the continued abundant supply of $'s. That's why recent Fed moves to normalise rates are so dangerous. If they step too quickly they could easily spook markets and tip things over. However, the real risk will occur when the various liquidity programmes expire on March 31st and their balance sheet should start to shrink as assets prepay or mature. Indeed, I find it rather worrying that there's a core of FOMC members who appear singularly focused on shrinking the balance sheet and I worry that Bernanke may trade the balance sheet size in return for continuing to hold Fed Funds low. We estimate that given the high coupons on their MBS portfolio that it's possible their balance sheet might shrink below what appears to be the key $1.9-2.0tln by mid summer. That's when we risk tipping the $ into a highly asset deflationary rally.
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Exactly the stupidity of Japan. So the implied solution is continued printing money and expanding balance sheet. This in the end does not and will never solve the problem of too much leverage in all areas within all majory economies. The only solution other than Japan is a slow slow haul of repair.
Surely you're not suggesting that we refuse to learn from the mistakes of others...
[/sarcasm]
Well, you see, in the limited worldview of an economist, Japan wasn't really a "mistake" per se. They just started too late/employed too little stimulus/allowed their tax cuts to expire prematurely/didn't monetize enough private debt.
So, you see, it's a completely different situation.
No that is the stupidity of humans running a ponzi scheme that is compounding interest. You want the rats to go down with the ship, well, rats are looking for other rats to go down with the ship, but nobody wants to volunteer for the job.
There is no escape the results of using compounding interest as the basis of your system, you and your children will be paying a huge price for the use of compounding interest.
They are not looking for volunteers, we the people (middle and lower class) have been nominated for the job (sacrifice) and are totally unaware of this action cause we are a bunch of sheeple ignoramuses that have no power or say in anything anymore.
When a tank is running you down then you can say you were volunteered. You haven't seen anything yet, you are still living in the very good times. The pit will be very dark and deep this time.
Ignorami?
Ignorami?
Risk sending the dollar what?
up.
Buy gold and/or farmland. When the UK's biggest gold trader retires to run one of the largest dairy farms...you know something is afoot.
Meanwhile, the market shows no indication it cares about any of this, and continues rifling higher.
I don't understand all these arrows and squiggles.
How many times can you fit "indeed" into an article?
Indeed.
5 times. Is that a lot? I could proably get 10 in it.
Risk? Worry? That's a goddamn cause for celebration!
I don't get it. It looks like an argument to add a CMBS purchase program (or other QE-style equivalent) at the end of March. Grow that balance sheet or all hell is going to break loose! C'mon, man!
Ah, yes, painting by the numbers is serious shit. All you got to do is get the numbers right and then the world will be right.
"..the Fed's balance sheet, which they are actively discussing shrinking."
Yes, like my brother-in-law is actively discussing finally painting his house.
"...the Fed's balance sheet, which they are actively discussing shrinking."
Besides the shrinking value of the toxic assets they are still absorbing, they won't be shrinking anything for the foreseeable future in any meaningful way.
I'm more concerned with the Brazillian carry trade. (although all carry trades are worthy of your concern of course)
Brazil carry trade -> Santander -> RBS and the rest of the Inter-Alpha Group -> QoE
When that blows up, it blows up the legacy of our adopted imperialist system.
Remember 20-30 percent Brazillian REAL appreciation + 8.75 percent interest is hiding a lot of bad debt in these Inter-alpha group banks. A TON OF IT. If you have a bunch of this on your side you can literally hide even if half your loans are non-performing. At least as long as it lasts.
Once that is removed, the entire euro banking system, and thus the world will go up in smoke. (if something doesn't destroy it from numerous other ways first)
I just have to think that when it reaches the core, it'll be bigger than others on the periphery.
Monetize, bitches!
Free money, one way perma-bull markets, 10:1 leverage IS NOT NORMAL but in some coutries in the debt drunk "first world".
This economics are mathematically impossible.
Why stupid status quo powermongers are saying "tightening equals Doom"
Their poposal: never stop the presses and hope the world will be growing forever, what about 5 cars and 2 houses per-capita.
DEFLATE THIS!
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