Carry on Trading
By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Thursday, 6
September 2007, 7.45 am and 7.20 pm)
The power of belief can never surprise us enough. If
we believe in a powerful force above us, our actions tend to be
bolder. And we believe that we’ll be protected from
That’s probably what the 23 Korean Christian workers
thought when they set out for Afghanistan recently. Despite the
obvious danger, they directed their bus ride into hostile
In the world of finance, belief is very important. It
is our belief in the authority of the central bank that keeps
things running smoothly. Recently, belief in the power of the
Bank of Japan, or BoJ, might have prevented the global markets
from a worse meltdown.
This happened in the “yen carry trade”. First, let’s
remind ourselves what this is. It is the borrowing and selling
of currencies with low interest rates, and the buying of
currencies with high interest rates. The idea is to profit from
the gap in the two interest rates.
For example, an investor borrows 1,000 yen from a
Japanese bank, and then converts the money into US dollars and
buys a US bond. Let's say the bond pays 4.5% and the Japanese
interest rate is 0.5%. The investor stands to make a profit of
4.0% as long as the yen-US dollar exchange rate remains the
The profit can be bigger when there’s leverage, or
when the investor borrows money for his bet. If the investor
uses a leverage factor of 10, or he borrows ten times his
capital, he stands to make a profit of 40% from his original
The risk here is in the uncertainty of exchange rates.
If the US dollar were to fall 4% against the yen, the investor
would lose all his 40% profit. To prevent this, the investor
must unwind his carry trade by selling his US bond, convert his
dollar into yen, before the dollar falls 4%.
For many years, it was feared that the next time the
global markets fall, the unwinding of the estimated US$160 bn
in the yen carry trade would worsen the meltdown.
But this didn’t happen last month. It was not because
of the intervention of BoJ. Rather, it was because of the
intervention of a new breed of forex players. These are the
Japanese uncles and aunties.
For a long time, these uncles and aunties had been
just conservative bank depositors. But in the past two years,
they have moved into high-risk, high-return margin trading of
currencies. They are now big players, taking about 30% of all
During the recent meltdown, when foreign carry traders
were unwinding and buying the yen, these Japanese uncles and
aunties took it as the chance to sell yen and jump onto the yen
They did it because they believed that BoJ would
continue with its weak yen and low interest rate policies. And
they also believed that BoJ had the power to intervene
successfully if it wanted to. This belief arose from BoJ’s huge
success in punishing yen speculators in year 2004.
Because of the belief of our Japanese uncles and
aunties, the yen is only slightly stronger today, by about 7%.
This may have played a big role in cushioning the recent market
meltdown. Compare this to the 1998 Asian currency crisis, when
the yen strengthened some 30%. That killed many yen carry
While the belief of the Korean Christians took them on
a rough ride, the belief of our Japanese uncles and aunties may
have saved global markets from a rougher ride.