Friday, November 20, 2009

The Dollar Carry Trade

There's been a lot of buzz in financial news and blogs in the past few months about the dollar carry trade.  The dollar carry trade can be defined as:

...low U.S. interest rates enable investors around the globe to borrow dollars for next to nothing and invest them elsewhere at higher rates.

This bet -- known as the dollar carry trade -- appears to be one of the forces pushing down value of the dollar. Though there are few reliable figures on the size of the carry trade, the dollar's trend has clearly been down since stock and bond markets revived.

Link.   A big problem with having the dollar as a carry trade currency is that while the Fed can pump lots of money into the markets, it has no control over where those dollars go.  Because investors are able to buy dollars cheaply they can invest them in assets denominated in other currencies for a higher return.  Another consequence of this is declining faith in the dollar, further causing its devaluation relative to other currencies.

Google Trends has an interesting graph reflecting a recent uptick in interest in the dollar carry trade:

One thing that's quite interesting is where these queries originated.  In order: India, the USA, and then the UK.   Earlier this month, India bought 200 tons of gold from the IMF, half the amount the latter had planned to sell to raise money to assist poor nations.

It looks to me like a lot of people outside the US are looking at the monetary policy  of the Obama Administration and the Fed and asking, "WTF?!"

Look around your house and see what's made overseas.  Virtually all consumer goods ranging from your PC to your clothes to the gas in your car.  Now ask yourself what will happen if the dollar crashes and you want to buy more.  That's right, the price of imported goods is going to rise.

In our consumer based economy that's a recipe for disaster, especially when it's lumped on top of high unemployment, cratering real estate values, and the tax increases planned by the Democrats.

Have a nice weekend.

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