The Dollar Carry Trade
how the market makes money with the
zero interest rate policy, monetary inflation, and the dollars decline

Eric LaMont Gregory

 
Although outwardly irrational, in today’s wonderland world of monetary inflation and a zero interest rate policy - ZIRP, nonetheless otherwise bad economic news as it turns out, is actually good news for market traders.

Especially if one considers that, if it was not for bad news about the state of our economy, there would be no news at all.

If by championing bad news the market can scare the Federal Reserve into extending ZIRP and monetary inflation, because these policies send the value of the dollar even lower, fortunes are being made in the process.  For this reason alone, do not expect the Federal Reserve or the US Treasury to do anything to defend the dollar anytime soon.

Enter the dollar carry trade, that is, short selling the dollar.

The dollar carry trade involves selling a currency with a low interest rate and buying a another currency with higher interest rate yields, and making a profit on the spread between the two.

If this strategy resembles interest rate derivative trading, and credit default swaps, the two strategies that brought about the financial crises of 1998, and 2008, yes you are correct - its the same game.

The dollar carry trade exists because, at the level at which this game is being played, it costs virtually nothing, 1%, to borrow dollars.  And, you can use the cheap dollars to buy something that will give you more than a 1% return.

An example:

In the United States traders borrow one million dollars at an interest rate of 1%, therefore, at a cost of $10,000.

The investor then uses the dollars to buy a currency with a yield of 5%, earning $50,000 from the one-million investment.  The investor deducts the 10,000 cost of the dollars, and as a result of the interest rate spread between the two currencies, has earned the trader $40,000.

Usually, investors leverage these kinds of trades at 10 to 1, and earn $400,000 on such a transaction, and as the value of the dollar sinks further and further the more the investor stands to make.

This is the essence of what is known as the dollar carry trade, and is the reason the dollar continues to fall.

People frequently ask, where is all the money going that the Federal Reserve is pumping into the economy? A large share goes into bets like the dollar carry trade.

It is this trading, if you can call it that, that is undermining the Euro and several other world currencies.

This money is not going into the kind of purposes that would put people back to work, it is not going into debt repayment to shore up the US Dollar, in fact, it is a fact that the absence of the productive use of this money is exasperating economic recovery and is keeping the recession going.

To maintain the dollar carry trade investors fill the coffers’ of a number of Congressmen and women and Senators to fight against financial regulation, place the head of one of the Federal Reserve Banks at the helm of the of the US Treasury to create another asset bubble, and when the dollar trade asset bubble collapses to lead the public to believe that bailing out the creditors, the ones who are lending $1 million for $10k, is necessary to save the economy from ruin.

While the dollar carry trade, like its interest rate derivatives and credit default swap cousins, seems like a endless money maker, the entire trade in dollars collapses, however, when the dollar begins to rally, and all the traders in dollars try to sell-off their highly leveraged short positions and exit the game at the same time.

Remember, the crash will be as big as the bubble.

What the current administration and Congress has lost sight of is that it is the interests of the working man with which they ought to be concerned, because, in the words of the Graceful Conservative William McKinley, 'when the American people work; the American people save, and when the American people save; the American people invest; and when we work, save, and invest America prospers'.

Perhaps this 4th of July, as we remember the words of the Declaration of Independence, our leaders will re-dedicate themselves to the ultimate pledge, " ... with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor."