To carry trade or not to carry trade. That is the question.
In the last few weeks a host of different banks have stepped forward to question both the depth and degree of the current dollar carry trade. Among them have been Goldman Sachs, UBS and Barclays Capital – all claiming the risks of executing speculative dollar-funded carry trades still outweigh the potential returns, meaning the trade isn’t half as popular as the market is making out, nor is it contributing to any such thing as a global asset bubble.
Considering the above then it’s interesting that Sean Corrigan of Diapason Commodities does his best to prove the exact opposite in his latest note.
To do so, he provides some pretty compelling evidence given, as he states, hard numbers are impossible to come by.
Exhibit a) comes in the shape of the following chart:
As Corrigan explains (our emphasis):
The first (which we have adduced before) shows the uncanny correspondence between the outstanding stock of commercial paper issued in the US by foreign financial institutions with the inverse of the US dollar trade-weighted index since the crisis intensified last year (i.e, the greater the appetite for cash, the weaker the buck).
If we assume that the 25% fall in non-cash assets and the coincident and hugely disproportionate 150% increase in cash holdings experienced by foreign-related commercial banks in the US over the past year is a sign of a certain anal retentiveness re their basic role, qua banks, this suggests that CP is not being used to finance any active, economic purpose in the Land of the near-Free Loan itself – an inference further reinforced by the fact that domestic financial CP outstanding has plummeted to what is at least a 9-year low. Thus, the correlation between funding and forex hints that the raising of dollars for use abroad is indeed what is at work.
But that’s not all. Exhibit b) provides further evidence of how funds are flowing out of the US:
As Corrigan explains, the chart is drawn from monthly Federal Reserve figures showing the stock of US banking claims on — and liabilities to — foreigners which are payable in US dollars. These figures, he says, reveal a pattern of reduced foreign holdings of US assets alongside a roughly equal and opposite expansion of US lending to foreigners. Corrigan interprets that as follows:
…given the anaemic nature of the recovery in trade or, indeed, any form of business outlay, one presumes must be funding either government deficits or feeding the swelling bull market in — well, just about anything and everything, really.
Ever the Austrian, Corrigan is naturally compelled to warn about the consequences of such flagrant carry-trade practices:
One of the main evils of easy money — utterly overlooked by its ragbag of macromancer advocates — is that it leads to a gross mispricing — and hence an ultimate misuse — of capital. While the simple proportionality between a given stock of money and a general price level (whatever that really means) seems intuitive enough, the Gordian tangle of ceteris paribuses involved in that assumption make it harder to spot in practice. Much more critical, as we Austrians are ever keen to point out, is the malign effect on relative prices, rather than on average ones. This is especially true of the relation between the prices of present goods and the entrained future ones which comprise capital goods.
According to Corrigan, you see, one of the greatest perils of easy money is that it detaches capital asset prices from those of the underlying capital goods upon which they are supposed to represent claims (a bit like the disconnect we’re experiencing in the oil markets we would presume).
Hence, the big danger is that money printed by central banks has gone straight into the hands of buyers of capital assets rather than capital goods — especially as the latter is still largely fixed on reducing outlays.
Of course, as the former has a problem with holding cash in rising markets, it’s fair to assume a type of tangential fractional reserve process has been created in which every QE recipient inevitably tries to reduce their own cash ratio to an acceptable minimum. That ratio, by the way, falls ever lower as markets rally.
Quid pro quo, a dollar carry trade is very likely fuelling a global asset bubble after all.
Related links:
Debunking the size of the carry trade - FT Alphaville
Roubini: Mother of all carry trades faces an inevitable bust – FT
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