The New Zealand Carry Trade Expects Hyperinflation
Elaine Meinel Supkis
 As the entire planet writhes and seethes with anger and distress, the US tries to continue sailing onwards, trying to restart the real estate and commercial lending markets. The Fed continues to consolidate power within its halls. We will take a little side visit to New Zealand to visit one of the biggest funnels for the Japanese carry trade to see how they are dealing with this reversal. The Canadian dollar is strengthening because they sell the US lots of oil. Oil is rising in price. Canada, like Japan and China, prefers a weak currency to aid export markets. Understanding how all this international finance operates is important. Even if we seem to lose every battle, the need to learn continues. Perhaps no one will read this until maybe 100 years from now, when a new international credit bubble forms!
First, the discouraging news:
Federal Reserve to gain power under plan – Washington Times
The Federal Reserve, already arguably the most powerful agency in the U.S. government, will get sweeping new authority to regulate any company whose failure could endanger the U.S. economy and markets under the Obama administration’s regulatory overhaul plan. Funny, how newspapers can’t quite tell the truth. The Federal Reserve is NOT an agency in the US government. The final plan due to be released on Wednesday — which originally aimed to streamline and consolidate banking and securities regulation in one or two agencies — now is expected to sidestep most jurisdictional disputes and simply impose across the board standards to be applied by all financial regulators, according to administration and industry sources.
The Federal Reserve’s own webpage makes this perfectly clear: http://www.federalreserve.gov/pf/pdf/pf_1.pdf
The Federal Reserve System is considered to be an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive branch of government. The System is, how- ever, subject to oversight by the U.S. Congress. The Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government; therefore, the description of the System as "independent within the government" is more accurate.
I read lots and lots of Federal Reserve memos and letters written long, long ago. I could run a regular blog, simply commenting on these. The Federal Reserve chiefs do NOT service ANY Presidents. They can and have been quite malicious, often raising interest rates to get a difficult President booted out of office, for example. Any President stupid enough to dispute banking policies with the Fed head should be prepared to have his head handed to him on Salome’s platter.
So it sits, INDEPENDENT of ALL CONTROLS, dead center inside of our supposed democracy. This is utterly unacceptable but then, Congress is corrupt and thus, disinterested in running the Fed properly. Note how hard it has been for Ron Paul’s excellent 1207 bill to simply audit the Fed has fared! It only just this week, limped into Congress! Who plan to rip it to shreds.
Dear Critics … – Forbes.com
Capitalism did not fail; government did. The government perhaps never better lived up to Groucho Marx’s maxim: "Politics is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies."
Despite this, we expect the economy to rebound from the panic and make up for the loss of growth relatively quickly. This is hard for some people to comprehend because if you listen to the business news or read the popular press, the economy has basically shut down.
But the system never shuts down. It may slow down, but as long as freedom exists, the system remains dynamic. For example, in the past 26 weeks, roughly 16 million people filed initial claims for unemployment insurance. But, as of two weeks ago, there were only 6.816 million people continuing to receive claims. In other words, possibly as many as 9 million people who might still be receiving benefits are not, because they found gainful employment.
Forbes is always nuttier than a squirrel. In this case, the writers don’t mention that many people fall off of the unemployment rolls because they ran out of time and have no help, now! This collapse is a combination of eliminating most if not all FDR banking and finance laws coupled with creating the Derivatives Beast and of course, free trade, which Forbes supports. The government just bailed out nearly everyone at the top and hopes this will trickle down to the lower levels.
Since we continue free trade and the Derivatives Beast is very, very much alive and waiting with eager anticipation for hyperinflation to fire up, I don’t see things being fixed. They are broken and getting more and more broken. Just because everyone wants us to be ’strong’ won’t make the fatal bleeding in the US economy stop.
Carney May Buy Bonds as Dollar Hits Canada Economy (Update1) – Bloomberg.com
A 16 percent gain for the Canadian dollar since March 9 is threatening to undermine the country’s already battered exporters. This raises the likelihood that Carney will follow the Federal Reserve, Bank of England and Swiss National Bank in pursuing so-called quantitative easing, said Nicholas Rowe, an economist at Carleton University in Ottawa.
"Every increase in the currency, other things equal like the price of oil, does increase the chances" of Carney purchasing assets with new money, said Rowe, a member of the Shadow Monetary Policy Committee at the C.D. Howe Institute, an independent research group.
Asset purchases would serve a dual purpose for the central bank: They would help cut borrowing costs for businesses and households, and weaken the currency by making short-term Canadian-dollar investments less attractive.
This is the main story: all our trade partners actively want a strong dollar so they can flood us with exports. The US government and the Federal Reserve both work very hard to enable this! Once upon a time, the US would force allies to strengthen their currencies. This was how the Bretton Woods II and Plaza Accords operated, for example. This is why the US dropped our gold peg in 1971, too! The US used to argue hard and long about trade imbalances.
Now, no one is representing the US! Our ‘negotiators’ are all best buddies of the trade rivals! And go to secret meetings where they all hobnob and rejoice in their lovely New World Order. And I see no one in the Obama administration fighting for the US in this arena. The GOP refuses, too. The only Presidential candidates who are anti-free trade get no press or are mocked over absolutely everything, no matter how tiny, so the populace looks at them as if they are clowns.
Moving on, Bloomberg has a top story today about an obscure hedge fund from New Zealand. They had huge profits this year! Whoopee. So I feel it is time to discuss New Zealand and the Japanese carry trade. The hedge funds there were a primary source of a great deal of global excess easy credit sloshing over everything on earth:
36 South Starts Hyperinflation Bet After Black Swan (Update1) – Bloomberg.com
36 South Investment Managers Ltd., whose Black Swan Fund gained 234 percent in 2008, is raising money for a new hedge fund, betting that government efforts to pump money into economies could result in hyperinflation.
The Excelsior Fund targets returns that will be five times the average annual rate of inflation of the Group of Five economies — France, Germany, Japan, the U.K. and the U.S. — should the rate exceed 5 percent, Jerry Haworth, co-founder of the firm, said yesterday. Raising $100 million for the fund would be a "good" amount, he said.
"There is a sharply increased risk of greater than 5 percent inflation starting from now," Haworth said in a telephone interview from London. "We are in the lag period between when the seeds of inflation are sown and when their off- spring, that is higher prices, are evident for all to see."
The reason we will get hyperinflation again [yes, AGAIN] is due to the differential between, say, a 5% inflation rate and the stubborn Bank of Japan’s ZIRP system. The New Zealanders played this game outrageously for three years and have high, high hopes of it restarting! Before we go back to visit the Bank of Japan on this business, let’s learn more about the New Zealand Absolute Return Association and the 36 South Investment Managers:
From the September 2007 Australian Hedge Fund Forum: The New Zealand Absolute Return Association
I am guessing that ‘directional strategies’ refers to the carry trade business. Secondly, they admit, the people playing this game are youths! No one is more reckless than youths. If there are not a lot of elders to put on the brakes, things can run off the rails, very easily. Now, the mighty 36 South Black Swan team has been paddling about the place for exactly…. less than 8 years. Wow, they really are investment babies! Evidently, four of the five New Zealand hedge fund organization members who have more than 5 years experience are on this team. Two of them are former South African gold traders.
The reason I am chewing away at this particular story is, New Zealand was a much-overlooked source of a great deal of the flood of easy lending that caused this credit bubble. To learn more, we go to the Bank of Japan for some analysis and statistics. The Bank of Japan doesn’t want to be responsible for the global mess so we will ignore that aspect but look at what they say about the Pacific pirate-island-style carry trade business:
http://www.boj.or.jp/en/type/ronbun/mkr/data/mkr0903.pdf
Box 8: Unwinding of Carry Positions
The yen carry trades are generally defined as trades where one makes short positions in the yen, a lower-yielding currency (a funding currency), and long positions in higher-yielding currencies (an investment currency), such as the Australian dollar and New Zealand dollar, to earn profits (hereafter "carry return"). The carry return is expressed as the sum of interest rate differentials between the two currencies and the change in the value of the investment currency.
During the bubble years, I noticed this intense Aussie/NZ carry trade business. But information was difficult to get. I am happy, the Bank of Japan finally got around to discussing this business. Japanese housewives went nuts for a year, playing the South Pacific FX markets.
According to the uncovered interest parity condition, investors cannot make excess returns because profits from the interest rate differentials are offset by the depreciation of the investment currency. In reality, however, they can make excess returns, at least in the short term, as the parity condition is not always met. Taking this as an opportunity to make profits, investors may increase their positions in the yen carry trades with leverage. In the process of gaining the carry returns, however, investors may undervalue potential losses from the depreciation in the investment currency and take FX rate risks that can arise from the process of rapid unwinding of positions.
This ‘leverage’ used to play the FX markets is key to the collapse. When people borrow money to play with bets on movements in money differentials between currencies, this makes an explosive situation go nuclear. This is why the US had laws against using leverage to bet on stocks. The unwinding of these leveraged bets hammer all markets as people either go bankrupt or call in all their investments to pay off loans that are now ‘underwater’.
Developments in carry returns show that investors were able to make excess returns from 2002 through 2007, the period when the FX markets were relatively stable (Box 8 Chart 1). During this period, it seems investors such as hedge funds made active yen-carry positions. For example, the IMM data of the Chicago Mercantile Exchange show an increase in short positions in the yen (Chart II-5-5). However, as volatility in the FX markets rose rapidly in summer 2007 and investors’ risk-averse behavior became evident, they rushed to unwind their yen-carry positions and higher-yielding currencies consequently depreciated rapidly.
And this sudden volatility was political. The US, EU and Japan all leaned very heavily on China to raise the value of their currency while the Japanese yen was very weak. China decided to retaliate and the yen suddenly took off and for several long months, rose in value and is still running strong against the US dollar, killing the Japanese export trade with the US.
Another type of yen carry trade is FX margin trading by Japanese retail investors. When these investors take short positions in the yen and long positions in other currencies in FX margin trading, they are credited with the yen by margin brokers for purchasing foreign currencies by way of depositing the margin, as collateral security, equivalent to a certain portion of credit in the brokers. This enables retail investors to take the yen carry trade with leverage, like hedge funds.
Thank you, Bank of Japan! Way back in 2005, I found it nearly impossible to get an accurate account as to how the Japanese carry trade worked! Now, it is increasingly easy since all the central bankers are finally admitting the obvious! ABOUT TIME!
Here is what is particularly evil with the hedge fund system: the brokers would allow the ‘investors’ to not use CAPITAL but used the short yen positions as ‘DEPOSITS’ which normally, are ‘CAPITAL’, not the basis of the betting that is already committed. So the sky was the limit and the investors placed more and more short bets on the yen as the Japanese government used their ZIRP system to undermine the yen for trade purposes.
Retail investors continued to increase their positions even after summer 2007, when higher-yielding currencies such as the Australian dollar and New Zealand dollar depreciated, or when volatility decreased. In fact, when the carry-to-volatility ratio (i.e., the ratio of the interest rate differentials to the volatility in the two currencies) increased through summer 2008 — in other words, when investors were able to make returns from the interest rate differentials under the low FX rate risk — they increased their positions to a remarkable degree (Box 8 Chart 2). Thereafter, however, such positions were rapidly unwound and higher-yielding currencies fell substantially, leading to a decline in the carry-to-volatility ratio.
Here are the Bank of Japan’s graphs. The carry trade stumbled along for nearly a year after it began to collapse and then finally fell off the cliff.
The peak is RIGHT BEFORE SEPTEMBER 2008. Then, the US financial systems completely collapsed as the biggest banks, hopelessly undercapitalized, capsized and sank. The only reason the remaining 5 big investment banks still survive is due only to extraordinary efforts of the Federal Reserve. We see from these graphs that the New Zealand carry trade business with Japan was the biggest peak. We can thank these stupid hedge funds who are now betting, they and the other gamesters will now create hyperinflation and thus, will resume business.
Fed Gets No Requests for TALF Loans to Purchase CMBS (Update2) – Bloomberg.com
The Federal Reserve received no requests from investors for loans to buy new commercial mortgage-backed securities under an emergency program aimed at reducing borrowing costs and reviving U.S. economic growth.
The New York Fed announced the absence of loan requests on its Web site today, the first monthly deadline for investors to apply for loans to buy new CMBS through the Term Asset-Backed Securities Loan Facility, or TALF. No issuers have publicly announced debt that’s eligible for the program.
New York Fed President William Dudley set expectations low, saying in a June 4 speech that he didn’t anticipate any activity today because the securitization process "takes quite a while to ramp up." He asked his audience not to "take that as a mark of the success of the CMBS effort, please."
I saw a headline claiming that housing building is resuming. Ack. Well, the last thing the US needs is a roaring real estate market. The distress we are in is due to the deindustrialization of the US. There is talk about flattening most of Detroit and Flint, Michigan! Here is the Federal Reserve trying to restart the catastrophic CMBS markets! These markets were the result of a credit bubble and all it did was dump debt on top of everything. Any building going on was mostly creating more outlets for consumer sales, not rebuilding our home industries so we won’t have to import most of our manufactured goods!
REIT Wrecks | High Yield REITs and Commercial Real Estate: December 2008
The CMBS market actually collapsed, and commercial real estate lending volumes continue to contract. In fact, those 2008 deals you see on the chart, all $12.1 billion of them, were largely the result of lenders desperately trying to unload the loans they made in 2007. One of the last of those deals, J.P. Morgan Chase Commercial Mortgage Securities Trust 2008-C2, closed in May of 2008 and 20% of its commercial real estate loans defaulted within just 6 months.
Clearly, huge demand for CMBS led to a decrease in underwriting standards, including (among other things), a relaxing of traditional loan-to-value criteria. Moody’s estimated that the gap between the Moodys LTV and underwritten LTVs reached record in the first quarter of 2007 (nearly 45%). The Moody’s estimate of actual LTV also reached a record of 106.5%.
It has been obvious for quite a while to most of us, that the CMBS markets were ridiculous from 2004- 2007. Trying to regain this is just pure lunacy. But then, the entire force and will of the government and central bankers is exactly that: to make the bubble years a permanent feature. To make this the new status quo. Not an aberration.
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