Japan’s ‘Carry Trade’: Tokyo Breaks the World
Peter St. Onge /
Editor’s note: This is a lightly edited transcript of the accompanying video from professor Peter St. Onge.
Did Japan just break the world?
The central bank clowns who make a living torturing Japan’s economy have spent three decades stepping on every banana peel in the zoo. It looks like they just hit a big one.
In just two days, Japan’s stocks had their worst two-day decline in history—worse than the Black Monday crash of 1987.
Nearly one-fifth of the Japanese stock market evaporated. It would have been worse, but they halted trading with circuit-breakers.
The crash piled on U.S. markets, already in near panic over collapsing jobs reports.
So what happened to Japan? Why did it blow up so fast?
The key to Japan’s latest crisis is something called the “yen carry trade.” This is where hedge funds borrow yen and use it to buy U.S. treasuries or Nvidia. They do this because it costs roughly zero to borrow in yen, then they put the money on treasuries earning 5% or Nvidia paying more.
So, it’s free money. And hedge funds need free money to keep them in hookers and blow. Er, to keep returns consistent.
Estimates put the carry trade at at least $4 trillion—which is almost as big as the entire gross domestic product of Japan.
Sadly, as always, there’s a catch: The small detail of ‘What if the yen suddenly gets stronger?’ Now you borrowed $100 million of yen but suddenly you owe, say, $120 million.
At that point, you get every hedge fund’s worst nightmare: a margin call. The bank wants more collateral.
That’s exactly what happened last Wednesday, when the Bank of Japan announced it was ending 20 years of near-zero interest rates. That sent the yen soaring, since it means Japanese assets won’t pay such crappy returns.
Toss on Friday’s jobs report suggesting Fed interest-rate cuts are coming, which also makes yen assets look better, and the yen went, in short order, from 162 per dollar to 141.
Cue the margin calls.
At which point hedge funds do two things: They sell all those treasuries and Nvidia for dollars. Then they use the dollars to buy yen and unwind the loan. They pay it back.
That means everything they used to own goes down, from treasuries to Nvidia.
And it means a tsunami of dollars sold for yen—which drives the yen up.
That’s when the fun starts, because, remember the rising yen was the problem. That’s what was wiping out the hedge funds to begin with. And now the hedgies are pumping the yen even more. They’re swamping their own lifeboat.
So, the yen keeps rising. More hedge funds get margin calls. More treasuries and Nvidia get dumped.
How far does it go? In theory, $4 trillion—roughly one-fifth of all bank accounts in America. At which point, the hedgies are bled out and the yen resumes its long march to oblivion.
Either way, barring a small-government miracle, Japan is screwed. The only question is: Does it take us down with it?
So, what’s next? When hedge funds topple countries, the collateral damage is always the normies. In this case, the yen-reliant companies of Japan along with the global investors—us—who just got flattened by a stampede of coked-up hedge funders fleeing margin calls.
The question at this point is, does this week amounts to a 1987-style flash crash? Or is it a trigger for a 2008 recession or something worse?
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