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4
JUN 10

More on the Carry Trade
2 comment(s)

When we point to the carry trade as a problem we see claims that there is no correlation in this cross rate or that to interest rate spreads.  Remember correlation is not causation – the theory goes that exchange rates should be correlated and respond to trade flows but there is bugger all of either in that regard, trade is swamped by speculation. Guess who likes that outcome.

I repeat the NZ$ is traded daily at 43% of GNP that is madness from the point of view of the trade exposed economy.

Going to the correlation dicussion the spread at any given time has to be marked against the risk perception – in a happy pre-crisis world a few 100 basis points might be sufficient to ignite the carry, in crisis rife world; troubles here and there might require many hundreds of basis points for the same magnitude of carry. 

But differentials in interest rates fundamentally drive the flow of carry always moderated by risk.  A bit like ohms law, voltage is intermediated by resistance to determine current flow.
 


Roelof - 07 June 2010 at 12:28 p.m.
Not sure where to start....
I think one should go back to ist principles.. To the basic solid principles of economics.
I'll stick to responding to your comments.
The carry trade is not some kind of bad predatory money flow. It is a wonderful method of borrowing off shore money at favourable interest rates, (without having any exchange rate risk).....
It is not so much short term interest rates that drive it.... BUT our insatiable thirst for credit.
It is the differential in interest rates that determine the potential supply of carry trade funds...BUT... it is actual interest rates that determines the DEMAND for borrowing those funds. It is the Borrowers that determine the volume of carry trade investment. The Govt contributes to this..( next yr it will borrow $12.5 billion .. maybe half of that will be offshore )
It is truely perverse that our borrowing actually strengthens our dollar.... this is madness and suggests that there are some serious structural flaws in the Global Monetary system.
The relationship between trade flows and exchange rate movements ceased to exist when President Nixon took the world off the gold standard in 1971.
What USA, Japan, China, Eurozone do in a Monetary policy sense has far more impact on NZ than our own Monetary policy.
The core funding ratio has not changed that.
The core funding ratio is not a solution to what are structural imbalances.
http://www.rbnz.govt.nz/finstab/fsreport/fsr_may2010.pdf
Don't get me wrong... The CFR is a really good thing.. it has put the yield curve back where the Reserve bank has more direct control over managing monetary policy.AND it has mitigated the risks of banks borrowing short term to lend long term.

To summarize .. the real madness is that it is our need for borrowing that strengthens our $NZ.. yet the paradox is that our borrowing is actually weakening our economic intergrity and makes us less robust and less healthy.
Ponder this graph of global monetary aggregates. http://dollardaze.org/blog/?page_id=00023

Have the worlds Central Banks done a good job .????
Are there some very serious flaws in the western worlds monetary system..??
cheers Roelof
John Walley - 08 June 2010 at 15:33 p.m.
Hi Roelof - this will be a longish answer, will put up a new post on this later on. Thanks for the response.

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