The Carry Trade, Unveiled At Last

Tim Coldwell, in his comment on the item below, points to a video made Friday by FT correspondent John Authers, pointing to the tight correlation between the Yen / Dollar ratio and the S and P 500.  In the U.S. on Friday afternoon, the same chart was being shown by Dennis Gartman on CNBC.

SNS members will hark back to February of 2007, when I was able to figure this puzzle out for the first time.  In March I gave warning on CNBC Europe that the carry trade had created too much liquidity, leading to asset bubbles, and recommended that people go into cash.  I put the same advice out to members the prior month.

The currency re-adjustments of Friday are carrying several stories, I think, but this is the most important: that a very large amount of the equities positions in the world were funded by “free money” from Japan.  What we saw Friday was the above charts, showing Part I of the unraveling, as investors sold leveraged equity positions to get back into Yen to pay off their debts, and Part II, a rush into U.S. Treasuries at any price.

The Yen ended up the strongest it has been for many years, followed by the dollar, and all other currencies took massive hits, or stopped trading altogether.

I’ll be writing more about the meaning of this carnage, where it goes next, and who the real winners might be, in our SNS Newsletter.  (New readers can sign up at )

Meanwhile, for what it is worth, it appears that Friday’s trading has put proof to the theory that led to the initial warnings of a global liquidity contraction.  At this stage, one can only hope that the big kids stop putting out each new brushfire, and turn their attention (perhaps at the coming Bretton Woods meeting Nov. 15th) to the global systemic problems that allow this kind of arbitrage.