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<p>Hey mino - I think you may have the Chinese Yuan, (or renminbi), confused with the Japanese yen. IR and I are concerned with the Japanese yen carry trade. </p>

<p>You are correct. The Yuan is mostly pegged. The Japanese yen is not.</p>

<p>Many, many hedge funds and other financial institutions have borrowed yen at low interest rates, and bought other asset classes with leverage. Imagine what will happen when those asset classes, (CDOs, ABCP, and other instruments), lose value and the yen appreciates at the same time.</p>
 
<ol>

Borrow Yen at (nearly) 0%.

Invest in higher yielding assets denominated in a different currency.

Profit.

</ol>

<p>Or....</p>

<ol>

Borrow Yen at (nearly) 0%.

Invest in higher yielding assets denominated in a different currency.

Yen appreciates rapidly.

Be forced to unwind your trade and lose your ass.

</ol>
 
Effen.....ok so you trade USD for YEN, then go buy US Backed Bonds with short maturities yielding 3.75% or whatever the rate is, when the Bonds are due you collect your yield, and then trade back into USD b/c the dollar has lost more value compared to the YEN?
 
<p>Borrow 100 yen @ 1% so you owe 101 yen in one year.</p>

<p>Pretend the exchange rate is one yen for one dollar, and exchange for dollars so you now have $100.</p>

<p>Lend that $100 @ 5% to Trooper so Trooper now owes you $105 in one year. Pretty good, huh? For no investment of your own, you make $4.00 after one year awhen you exchange $100 for 100 yen and pay back your loan, eh?</p>

<p>But, what if, after one year, you can only get 90 yen for $100? You now have $105, but you can only exchange for about 90.50 yen, and you owe 100 yen, so you have a loss of about 9.50 yen. Ouch!</p>

<p>And what if, instead of lending the original $100 out to Trooper for a bond, you loan her the $100 to buy a home, and after a year Trooper's home is only worth $90, she doesn't have the money you pay you, (she was planning on selling the home for $110), and she gives you the home worth $90. You can't even get 90.50 yen; more like 80 yen. This is getting worse, isn't it?</p>

<p>And what if, instead of just buyng just one mortgage with your $100, you leveraged yourself into a CDO? And it is worth maybe $0.30 on the dollar? And the yen is appreciating by the day? You have to get cash, and you have to get it quickly. You have to borrow and there are others in similar situations who need to borrow. There is competition for cash, or credit. This is called a credit crunch or credit squeeze. Sound familiar?</p>
 
mino2126,





Imagine there was a bank in Japan willing to loan you money at 1% interest. You can borrow as much as you want, but you must repay them in Japanese Yen. You take this money you borrowed at 1% and you put it in a CD here in the US and make 5%. You are now making 4% on the total amount of money borrowed. Under those circumstances, you would probably borrow a lot of money.





Now imagine you are a hedge fund investment operator. You borrow a billion dollars worth of Japanese yen and invest in home mortgages paying 7% or commercial real estate with an 7% cap rate. You are now making 6% on a billion dollars, and you don't have any of your own money invested. Not a bad deal.





Now imagine the cumulative effect of billions and billions of yen being borrowed from Japan, converted to dollars and invested this way. If you can imagine this scenario, you understand the carry trade.








Now, it is time to see the dark side:





Imagine what happens if the Yen starts to gain value against the dollar. Suddenly all these people who have borrowed billions upon billions of dollars worth of yen have to pay back the loans at a higher value. If the original loan was $10B, and the value of the yen increases 20% against the dollar, the borrower will have to repay $12B. This has a devastating effect on people who borrowed Yen and converted them to dollars.





Borrowers of Japanese Yen are suddenly faced with having to repay much more money than they borrowed. These borrowers react by selling the assets they purchased with the borrowed Yen, converting the dollars back to Yen and repaying their loans before they lose too much money. The impact of a massive selloff of assets owned in US dollars combined with the increasing value of the Yen caused by all the buying of Yen creates a downward spiral in the value of US assets. All the liquidity in our financial system provided by the carry trade will disappear. It will be a global credit crunch of unprecedented proportions.





That is what awgee and I are so concerned about.





Does that explanation help?
 
Yes, I forgot to mention the positive feedback loop that can form when the Yen begins to appreciate. Carry traders start covering their positions which forces the Yen even higher. This forces even more carry-traders to exit their positions. Lather, rinse, repeat.
 
Yen is over 115. If the carry trade can unwind slowly and in a somewhat organized fashion, there are few problems. It is only if the USD/Yen rate changes too quickly that the carry traders have to sell liquid and other assets quickly. It has been reversing quickly lately. The USD is sucking wind against the world's currencies, but it is mosly the yen against which it was carried.
 
<em>"So how do you borrow currency?"</em>





I don't know either. You can trade currencies on <a href="http://www.forex.com/">Forex</a>, but to actually borrow it for a carry trade play, you probably need to have contact with a Japanese bank.
 
Ok so lately then everyone that has been "utilizing" this trading platform has just been roling investments back into US Securities. However, since the USD is loosing value they are going to reanalyze their portfolio b/c now the carry-trade is going to get them in the dairy-aire?
 
Here is the other thing that can cause problems. If the hedgie is trading on margin (most are) and that $10bil borrowed is now really $12bil this could trigger a margin call. When this happens the hedgie either has to add cash fast or their broker/dealer will start selling their positions. The price will not matter and it could drop the value of the assets sold and the Yen could drop further. In fact this margin call scenario has killed several hedgies lately.
 
With all hedgie talk I thought posting this <a href="http://youtube.com/watch?v=LtcnXLDnXvs">H-E-D-G-E by Merle Hazard</a> again would be appropriate.
 
<p>Greenspan defends his cluelessness on 60 minutes this Sunday.</p>

<p>WASHINGTON (MarketWatch) -- Former Fed chief Alan Greenspan defended himself from charges that he caused the meltdown in the subprime mortgage sector in an interview with the CBS News program '60 Minutes' to be aired this Sunday. Greenspan said he "didn't really get it" that the subprime lending woes would hurt the economy until very late in "2005 and 2006." "While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late," Greenspan said. CBS News released some of the interview on Thursday. Greenspan said there was little the Fed could do to curb subprime lending. "While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late," he said. Greenspan said he had to keep interest rates low from 2001 to 2004 to "unfreeze the American banking system." He said he thought his replacement Ben Bernanke is doing "an excellent job."</p>
 
<p>http://www.sprott.com/pdf/marketsataglance/09-2007.pdf</p>

<p>Don't know how familiar y'all are with Eric Sprott and his services, but I found his latest advisory amusing. If you have any doubts about the guys credientials, check out his returns for the last four or five years.</p>

<p></p>
 
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