Customers take out a loan at a low interest rate with one institution – such as a works savings bank – and deposit the amount at a higher interest rate with another bank; generally an interest rate differential trade. – In particular: Investors take out loans denominated in the local currency – such as JPY – in a country with low interest rates in order to buy high interest bearing products in foreign currencies – such as USD – with this money. Such carry trades put limits on a central bank’s low interest rate policy. – When, in the course of the financial crisis that followed the subprime crisis, the U.S. Federal Reserve injected liquidity into the economic cycle at zero interest rates, many market participants took on debt and invested the money they had borrowed in more profitable assets all over the world, including corporate bonds and equities. The resulting selling pressure on the USD caused it to weaken, making such speculative trades even more attractive now. – In principle, carry traders invest cheaply raised money speculatively, preferably in stocks, commodities and real estate. However, experience shows that they immediately dump these investments when the possibility of a better return becomes apparent elsewhere in the world. Thus, capital is not permanently directed to the best host (most favorable allocation of scarce resources), but it seeks a high return in the short term. For this reason, some call for counteracting interest rate differentials by appropriate means – such as capital controls in particular. – It becomes dangerous when the flyback potential built up by the buildup of currency-related carry trade positions suddenly discharges, i.e. when the carry traders hastily switch from one currency to another. This can trigger extreme exchange rate fluctuations with far-reaching consequences for foreign trade and thus for the economy as a whole. – See arbitrage, cash deposit, chasing winners, three-year tender, money, cheap, monetary transformation, spatial, money oversupply, money, hot, capital controls, MSCI index, low interest rate policy, zero interest rate, quantitative easing, yield chasing, repression, financial, stealth policy, interest rate incentive, interest rate differential, interest rate, kept low. – Cf. Deutsche Bundesbank Monthly Report of July 2005, pp. 43 ff. (explanation of strategies; chart covering seven years; references), Deutsche Bundesbank Monthly Report of February 2007, pp. 32 f. (yield comparison of carry trading and currency futures), ECB Monthly Report of March 2010, pp. 101 et seq. (carry trade activities since 2004 screened; overviews), Financial Stability Report 2010, p. 41: overview of currency-related carry trades), Deutsche Bundesbank Monthly Report of July 2014, p. 18 et seq. (exchange rate-determined transactions: references).
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University Professor Dr. Gerhard Merk, Dipl.rer.pol., Dipl.rer.oec.
Professor Dr. Eckehard Krah, Dipl.rer.pol.
E-mail address: info@ekrah.com
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