by Kyle Johnson
Free money.
Sounds too good to be true. But for years, the Japanese yen carry trade has been the closest thing to free money investors have… or had. This carry trade involved borrowing Japanese yen at near-zero interest rates, converting the yen to US dollars, and purchasing assets with higher yields.
The safe play would be to buy US Treasuries. But many got greedy and purchased US equities and other speculative investments.
The risks are obvious. Investors could purchase assets that fall in price, not rise. And on July 31, the Bank of Japan threw investors a curve ball by announcing a plan to simultaneously raise the target interest rate on Japanese government bonds (from 0.10 to 0.25) and a reduction in bond purchases. This broke a ten-year policy of easy money.
Markets got spooked on August 5. Globally, the flash crash wiped out an estimated $6.4 trillion. Despite some using the metaphor, it wasn’t a Black Monday (1987) level massacre. But it was ugly and significant.
As usual, people of influence and power gave no warnings. With the markets in turmoil, some remained silent. Many used the opportunity to push their own agenda. Here’s a smattering of comments from some key players:
Paul Krugman offered my favorite take on August 5:
So, even though I’ve been arguing for rate cuts—50 in September for sure—I wasn’t calling for an inter-meeting cut, because that might signal panic.
But since we may be seeing panic anyway, that argument loses its force. Real case for an emergency cut soon.
The very next day he published a piece entitled Market Crashes Happen. They Don’t Necessarily Mean Much. Therein Krugman insists, “the truth is, however, we don’t know what caused the panic.”
Jeremy Siegel (economist and Wharton professor) immediately demanded an emergency 0.75 rate cut. (Days later he changed his tune, saying he just wanted to “shake things up.”)
Jerome Powell hasn’t made a public statement regarding the yen carry trade.
Janet Yellen has largely remained silent. She did admit that carry trades are “risky” and noted that interest rates disparities between Japan and US will likely continue.
Donald Trump believes the president should “get a say” on the Fed’s interest rate decisions.
Kamala Harris (speaking through an aide) reasoned the Fed should make decisions independent of the president.
President Biden hasn’t commented.
Krugman didn’t even mention the yen carry trade in his op-ed. He was puzzled why Japanese stocks fell so much relative to US stocks and why the calamity began there. Imagine that. Knowing how to “fix” the economy without knowing why it’s broken to begin with.
Genuinely bizarre. But this is what passes for expert analysis in modern times.
The takeaway?
My hope is that you feel a bit more confident in going against the grain and disregarding many who we’re told to respect.
I don’t have a crystal ball. But we could see significant market turmoil again in the relatively near term.
The yen carry trade meltdown dominated headlines for about a week. Then everyone moved on to other things. But it doesn’t mean the dust has settled. Morgan Stanley estimates—with wide error bands—that roughly 60% of the Japanese yen carry trade has unwound. JPMorgan Chase estimates 75%. This could rear its head once again.
Also, don’t forget about the trouble brewing in commercial real estate. And it’s impossible to deny that geopolitical tensions remain high.
Official and unofficial economic data show weakness in the US and global economies. In my book, Team No Landing has been proven wrong. But we’re still in the process of figuring out if Team Soft Landing or Team Hard Landing made the best call.
Officially recognized or not, a recession seems likely. We could very well be in one at this very moment.
Gold responded as expected during the flash crash. Its price fell as people in distress sold to gain liquidity. But after the gold–dollar exchange ratio bottomed near $2,365, it soared to over $2,500 for the first time in history.
Now would be a good time to consider gold if you haven’t yet joined the party. Don’t wait for an official invitation from the ivory tower—it either won’t come or will be too late. Permit yourself to investigate if it’s right for you.
KJ
P.S. For more detailed information on gold stocks and the economy, consider subscribing to our free, no-hype, no-spam newsletter: the Speculator’s Digest.
