Monday, November 9, 2009

The "carry trade" and your 001k

Gold hit a new high today as the Dollar continued to decline. Long term oil futures are hovering around $100 and inflation protected instruments are big sellers. The stock market is up as well as the glut of cheap Dollars is driving everything up. Boom times for Goldman Sachs but the danger is building in an obscure class of investors called the "carry trade".

The "carry trade" is where investors will borrow currency in a country that has a cheap money policy and move it to country that has risky but profitable investments. This can be done with any currency and the difference doesn’t need to be that great since little "real money" is involved. It’s all done on margin, you know like 1929.

For the past couple of decades the Japanese Yen has been the favored currency for this purpose. This was what caused the collapse of the company Long-Term Capital Management in 1998 and exposed the folly of deregulation. The big Wall Street banks chipped in to take this problem off of Clinton’s hands and in return the last of the New Deal regulation of banks was done away with entirely. Since banks could take care of the financial services industry themselves, why should millions of taxpayer money be spent on regulation. (In the past year something like 24 trillion has been committed to the bank bailout as a direct result of this policy)

Cheap yen has been replaced by the cheap dollar, so now everything priced in dollars has been inflating the bubble. Dollars are flowing like water into all markets worldwide and it’s going to be a problem. Countries like Brazil fearing the inevitable collapse are restricting capital inflow and others like India and China are buying gold. As the Dollar continues to weaken from this illicit activity, it creates its own pressure for a reversal. Since there is no real restrictions on debt being used for leveraged investment the reversal creates a stampede to sell in order to cover margins calls since the market bubble is being financed with debt on margin. The ensuing panic drives people into Dollars making the non-Dollar investments worth even less triggering more margin calls and creating a spiral of credit defaults.

Nobody knows how much "carry trade" there really is, but it is a huge bubble and it really can’t be reversed once started, it will grow until it bursts. Since it is based on trillions in debt, it will drag everything down with it. This risk is spread across all types of investment and will destroy an unprecedented amount of paper wealth and will surge across the real economy as well. This is of course bad news for your 401k, 301k, 201k, 101k, until finally 001k. Unfortunately the past thirty years of Reaganomics has embedded the financial services industry into all aspects of the economy. Last year’s credit freeze is just a taste of what likely to happen. We will get change, whether we believe in it or not.


Unknown said...

It will take me 6-8 more readings of this post to even begin to understand what I do not understand in it! (That is not a complaint.)

I understand already that it's very bad news because my heart started beating faster as I read. (Sorry, P2, it ain't love.)

Could you do a post on something I read from George Soros today about what's needed to change capitalism to make it "good." Can he be trusted or is he just out to make more money?

PitchingDoc said...

How much higher do you think gold will go? I remember listening to the BBC last year and he predicted gold to break $1000 by the end of '08. It's about to break $1200. How high do you think it will go? Now that nothing is backed by gold, the dollar seems more useless than ever.

prairie2 said...

The new world trade "currency" will include gold since paper money is too easy to print.
It's impossible to predict the price of gold. A panic back into dollars could drive the price down. Total collapse could put people into a position where they would need to sell. Speculating is risky and I wouldn't buy any except as insurance if you have a lot of paper investments. Personally, I buy canned goods on sale. I make an excellent return.