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What happened to the carry trade?
Remember when investors would borrow in Japanese yen, at low interest rates, to invest in higher-yielding currencies such as the Australian and Kiwi dollars? For a long time it seemed like free money was just sitting there on the table.
Well, two days ago the Australian dollar dropped 12 percent against the yen and the Kiwi dollar dropped ten percent, both in a single day. Calculate that return on a yearly basis and you can see the problem; toss in leverage if you wish.
Here is one article on the destruction of the carry trade. I suspect they are not planning on awarding the Nobel Prize this year to Eugene Fama (is Bob Shiller a better bet?), but in fact the selection of Fama, despite his association with the "efficient markets" idea, would be quite timely.
Posted by Tyler Cowen on October 8, 2008 at 07:37 AM in Economics | Permalink
Comments
The people picking up the pennies finally felt the steamroller's wrath
Posted by: angus at Oct 8, 2008 9:04:03 AM
As David Merkel points out, the carry trade works best in a low-volatility environment. We now have anything but.
From Brad Setser, more carry currencies behaving badly.
Posted by: anonymous at Oct 8, 2008 9:22:36 AM
We can all be heartened by the choice of Mr. Cash-Carry to manage that $700 billion!
Posted by: abc at Oct 8, 2008 11:56:28 AM
Peso problem?
Posted by: Alex at Oct 8, 2008 12:11:09 PM
I have been wondering whether the bailout and the subsequent inflation in the US would suggest better value of foreign stocks even if they fall the same percentage as their U.S. counterparts.
Posted by: Yan Li at Oct 8, 2008 12:34:34 PM
Fama and Barro - IMO, those are the two economists that HAVE to win the Nobel eventually.
Thaler and Feldstein aren't far behind.
Posted by: Tim L. at Oct 8, 2008 3:26:24 PM
(I feel so much poorer these last two weeks)
Posted by: Eric Crampton at Oct 8, 2008 6:51:45 PM
If you want an idea of the returns you would get by engaging in the carry trade, look up quotes for ticker "DBV" on your favorite finance website -- it's an ETF that does a pretty much automated carry trade on G10 currencies. The return since October 1 is not looking very good...
Posted by: Ricardo at Oct 8, 2008 10:17:35 PM
My wife and I had a large bundle of yen sitting in the safe in Australia, deciding not to convert it because I knew the dollar was overvalued.
It was 84 yen to the dollar at the time.
It reached 107 yen to the dollar. Well, at least cash still has a positive real interest rate when the currency is deflationary.
Eventually, years later, my decision is vindicated suddenly, suddenly suddenly.
Posted by: Richard Green at Oct 9, 2008 2:19:58 AM
