Carry on

Whatever reason you may want to put on it (e.g., excess liquidity, diminishing supply of stocks, fund manager's warming to globabl risk), the linkage between the theories and the real world of making money these days has been the carry trade: borrow cheaply in yen or yuan, invest richly in Brazil or that other debt-ridden country, USA.

No wonder, then, that former Goldie Head, US Treasury Secretary Henry Paulson, has hosed down the Continental clammering (see below) to strengthen the yen.

Rex Nutting reports for MarketWatch:

There is no evidence of intervention or manipulation by the Japanese government to keep the yen weak, Treasury Secretary Henry Paulson told congressmen on Tuesday.

The yen is trading at a 20-year low, Paulson acknowledged, "but as far as we can see there has been no intervention." Paulson said he would be discussing the yen and other issues at the Group of Seven meetings this weekend in Germany.

"It is my job to be vigilant and watch all currencies," he said.

(Feb 6 Reuters, Reporting by Gertrude Chavez-Dreyfuss) -

The yen slipped broadly on Tuesday after U.S. Treasury Secretary Henry Paulson said the Japanese currency's value is set by fundamentals.

His comments suggested that the U.S. government does not see anything fundamentally wrong with the yen's broad weakness, analysts said.

The spineless Bank of Japan
by Philip Bowring

Japan has become, if only by sins of omission, a malign influence on the global economy. Finance ministers of the Group of 7 industrial countries meeting in Germany this week would do well to focus on those sins, the least-recognized cause of the bubbles and imbalances in the global economy and financial markets.

The prognosis is not encouraging. The Europeans are increasingly concerned about the weakness of the yen, which is causing the euro to bear the brunt of the dollar's decline.

But the United States remains fixated on the value of the Chinese yuan, not the Japanese yen, and the size of China's current account surplus, not that of Japan. The U.S. Treasury secretary, Henry Paulson, seems in a state of denial, suggesting that the yen's weakness is market-driven while China is deliberately keeping its currency undervalued.

Most central bankers, both in Asia and the West, are also guilty of lax monetary policies and are under political pressure to keep interest rates low. So there is limited appetite for finger-pointing at Japan. And with no Asian nations other than Japan represented at the G-7 meeting, pressure on Tokyo looks likely to be modest.

But let there be no doubt about the pernicious effects of Japan's interest rates being held near zero, despite steady economic growth and the end of deflation. The policy is sustained by pressure on a spineless Bank of Japan by Shinzo Abe's myopic government.

The major consequences of Japan's low interest rate, ultra-cheap yen policy are:

* The so-called carry- trade, by which yen are borrowed for investment in higher yielding currencies and assets ranging from New Zealand bonds to corn futures. The size of the carry-trade is in dispute, as leverage is provided through derivatives, but naked exposure could be as much as $1 trillion.

The carry-trade is a major contributor to the very low global cost of money and the collapse of the price of risk, which together have enabled global asset markets to rise almost in unison. This rise, most dramatically reflected in China and India, is potentially destabilizing.

As for the carry-trade itself, a sudden reversal could be catastrophic. It is a gigantic gambling game, reflected in the dramatic increase in the balance sheets of investment banks and the explosion in assets of private equity and hedge funds. The phenomenon is also perpetuating global trade imbalances by allowing deeply indebted countries — including the United States and Australia — to continue to over-borrow.

* The continued undervaluation of other east Asian currencies. Some of these are also used for carry- trade activities as interest rates are held down to prevent currencies rising against the yen. Countries that have allowed their interest rates and exchange rates to reflect economic conditions, such as South Korea and Thailand, have found their currencies rise rapidly, to the discomfort of exporters, pressuring them to impose capital controls.

The necessary re-alignment of all East Asian currencies cannot take place while the yen is held back by the Bank of Japan's interest rate policy. To expect China to agree to faster revaluation while Japan does nothing defies common sense — and exacerbates China's sense of grievance. The United States is unwise to focus on China, meanwhile Japan can never claim leadership in Asian financial affairs while it sustains a policy dictated by the narrow political interests of the Abe government.