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I have received the following letter from a
reader of my column.
Mr. Fekete:
I have been reading your work for a number of
years and always look forward to your thoughts, particularly when they run
counter to conventional wisdom. In your latest piece you suggest that the
falling dollar (or rising yen) actually strengthens the yen carry trade. My chartwork argues otherwise, and your logic escapes me. I
would welcome clarification of one particular paragraph of yours, especially
on the last sentence that, I believe, is central to your analysis. You wrote:
"This is where I take issue with
conventional wisdom… What they miss is the fact that the bear market in
the dollar actually helps rather than hurts the yen-carry. The terms of trade
for those who sell yens to buy dollars is improved
immensely by the fall of the dollar. The yen carry trade can be described as arbitrage with short leg in the yen bond market and
long leg in the dollar bond market. Profits on the long leg increase faster
than losses on the short as a result of dollar devaluation."
I don’t follow this. Yes, borrow yen at
1 percent and go long dollar bonds at 4 percent. But over the holding period
you lose on the dollar’s depreciation.
I agree that a falling dollar means that over
time you can buy more and more dollars with borrowed yens. But for borrowers,
who short the yen, the ever more ’favorable’
terms of trade work the opposite way in the end. It costs you more and more
dollars - and then some - to buy those yens back and repay the loans
(assuming that finally you do close the trade).
Concerning the last sentence quoted, it is
true that as long as the US longer term rates stay low or, better still, fall
further, there are capital gains that might override forex
losses. You don’t explain it that way, though, so I am not sure that
this is what you mean. If so, it is not the falling dollar that assists the
carry, but the falling US
interest rate. And I question whether long rates are are
as closely tied to forex rates as short rates
sometimes are.
Appreciatively,
Peter Bond
Dear Mr. Bond:
The paper of mine you have quoted from was
written two and one half years ago. You take me to task for saying that,
contrary to widespread belief, the weak dollar helps rather than hurts the
yen carry trade, adding that your chartwork argues
otherwise.
The fact is that during the past two and a
half years the dollar lost quite a bit of ground, yet the yen carry trade was
not visibly hurt. If anything, it was further emboldened. In other words, my
2005 insight turned out to be correct. The question you should ask is whether
there is any explanation, other than mine, of the conundrum that dollar bonds
do not weaken, and may even strengthen marginally, in the face of the falling
dollar.
Please notice that I am not an investment
advisor and I am not writing manuals for the benefit of small time bond and forex traders. I am writing for the benefit of the
intellectually curious, who want to understand the markets as they unfold
under the global regime of irredeemable currencies. In doing so I am painting
a broad-brush picture, ignoring minute details such as the question how bond
bulls cover their forex risks through dynamic
hedging or otherwise.
You would be justified to ask the question
whether I still stand by my 2005 analysis, or whether I see reason to modify
it in view of events in the interim. My original paper had the title „The decoy of the falling dollar”,
suggesting that the real show is the bond market. The forex
market is a side show at best. Neither market is free, far from it. Both
markets are dominated by extremely powerful players (among which you can
count China
with a better than one trillion dollar stake). They are the puppet masters of
the other show in the forex market. It is not in
their interest, nor will it be in the foreseeable future, that the dollar be
scuttled. Controlled decline, yes; collapse, no. They want to, and can, make
sure that their long position in dollar bonds will continue to be profitable
enough to cover losses on their short position in yen bonds. For these
reasons I stand by my predictions of 2005. The bond bull is still alive and
kicking. It may get ready to resume his charge. The dollar is sick, yes, in
all likelihood terminally so. It is on the life-support system for the time
being by a powerful clique of bond bulls that can well afford to keep the
comatose dollar alive. They will pull the plug when it is no longer
profitable for them to continue the yen carry.
The main point is that the sliding dollar helps rather than hurts the
yen carry trade. That’s just the clever part of it,
which confounds even experts such as Pimco’s
Bill Gross. As I said in my 2005 article, the terms of trade for those
selling yens to buy dollars is being improved as the dollar falls. Never mind
how the arbitrage will be unwound eventually. As long as the dollar is not
collapsing it hardly matters. Positions can be rolled over, while forex losses are taken care of through dynamic hedging. This
is a cat-and-mouse game. Cats are the bond bulls. Mice are the dollar bears.
You guess who will gobble up whom in the end.
Please don’t misunderstand. This is not
an investment advice to you, or to anyone, to buy US dollar bonds. I am
merely sharing my insight into the operation of the deceitful world of
irredeemable currencies. In the end, like in games children play, ”they all fall down”. But there are
differences. Differences in the timing of the fall, and also differences in
the way they fall. Some may fall hard on a rock; others may have a
soft-landing on a pillow.
Is it possible that I am wrong and the dollar
will succumb sooner rather than later? While not impossible, it is unlikely.
Why? Because the clique of the
bond bulls has a vested interest in the charade to continue. Most
importantly, it has the power to make its wishes stick. Its members were
lucky enough to start riding the charging bond bull early. Make no mistake: China has been in it from start, since 1981
when US
interest rates were over 16 percent. Don’t be fooled: the
one-trillion-dollar kitty is not all trade surplus. So
much of it is profits from China’s
bond trading portfolio. Other bond bulls are similarly sitting on mountains
of paper profits. In spite of appearances, the Chinese are not stupid. They
will keep the game of musical chairs going. They are calling the shots. The
music will stop when they stop it. But not yet.
The yen carry trade in my view still has a
long way to go. It is the main prop that keeps the dollar from collapsing. It
may even cause the price of US bonds rise
some more. Why? The Bank of Japan will continue to feed the yen carry because it could not afford to let interest rates
rise for fear of bankrupting the Japanese government, to say nothing of the Japanese
banking system. The Fed will feed it because
it is cornered: the alternative is ’sudden death’ for the dollar.
The yen carry represents the only steady and reliable international demand
for dollars since America has effectively de-industrialized itself when
the exporting of paper turned out more profitable and less bothersome than
exporting manufactured goods. International speculators want the unilateral
dollar export to continue and to stoke the furnaces of the yen carry trade.
If you try to rebut me saying that it smacks
of a conspiracy between the Federal Reserve and the Bank of Japan, the answer
is: „you have said it”.
Antal E. Fekete
Professor,
Intermountain Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
Reference
The Decoy of the Falling Dollar, February 2005, http://www.24hgold.com/viewarticle.aspx?langu...articleid=99291
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
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