The Bank of Japan lowered its interest rates in the 1990s to create the Yen Carry Trade. This involved investors from around the world borrowing cheap Japanese Yen to invest in higher risk/higher reward investments, like commodities, sub-prime mortgages and emerging markets. In 2013, there are concerns that the yen carry trade might be threatened due to a number of factors.
Competing Zero Percent Interest Rate Environments
The Japanese economy has been largely export-driven for decades and the government favored a cheap yen. In 2007, nearly USD$1 trillion had been invested in the yen carry trade for investment into a wide range of high return assets. Over time, the yen had depreciated in value leading to higher government deficits.
Since 2008, the United States Federal Reserve has lowered its interest rates to create its own zero percent interest rates. The United Kingdom has also initiated a virtual zero percent interest rate policy. This has created competition for the yen carry trade.
Cost of Money
Ideally, interest rates are determined by market forces to represent the cost of money. During the sub-prime mortgage crisis, the “creditworthiness” of individuals was very important to determining what interest rate they would be charged. Economic cycles favor the flow of money from low risk/low return to high risk/high return investments based on the interest rates.
When the government sets interest rates at or near zero, it creates an artificial environment suggesting that money is now free. No money is free. In the long run, zero percent interest rates destroy capital by making it impossible for new businesses to properly measure the risk of an investment.
Uncovered Interest Arbitrage
With the 2008 global economic meltdown, the Japanese Yen started to appreciate damaging the yen carry trade. In January 2013, www.cnbc.com reported that the “Yen ha[d] lost 13 percent of its value against the U.S. dollar in the past three months[.]” Jesper Bargmann of the Royal Bank of Scotland stated that “[r]isk appetite has returned[.]” Furthermore, Japanese Prime Minister Shinzo Abe’s aggressive monetary policy has helped by weakening the yen to facilitate the re-emergence of the carry trade.
Japan has been transformed into a banking center of the world with its carry trade being very lucrative and profitable for global economic growth. The yen carry trade is an “uncovered interest arbitrage” where investors believe they can profit before any monumental economic change will occur to threaten their investment. The 2008 collapse was an example of just such a severe and unexpected event. Andreas Somera of Flatland Financial believes it won’t be the last, and advises his clients to steer clear of the yen carry trade for at least the forseeable future. Some experts wonder if the economic landscape has changed forever.
Threats to the Yen Carry Trade
Numerous threats to the yen carry trade have emerged based on systemic economic problems since 2008. While the Federal Reserve and Japanese governments have sought to re-energize the trade with quantitative easing (money printing), this policy cannot be used forever or hyperinflation may result. High government deficits in the United States and Japan threaten to crowd-out private investment and drive up debt service payments.
The “mis-pricing” of money is also a real concern as speculative asset bubbles do not lead to any real economic productivity growth. After 2008, there is a more risk averse climate that is struggling to find high-return financial assets to invest in. Many experts wonder if the “bubble will burst on the yen carry trade” in the very near future.
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