oftwominds-Charles Hugh Smith

The Yen Carry Trade, Risk, Fear and More


Judging by the market's impressively euphoric rally the past few days, it seems Euphorestra has been dumped into the water supply in D.C., New York and Boston. Another explanation presents itself, however: the exquisitely sensitive Yen carry trade.

If you look at the Yen, you will soon note a striking linkage between the Japanese currency and the U.S. stock markets. When the Yen was strengthening to 117 on Friday, the U.S. market tanked. As the Yen recovered to 118 on Monday, the U.S. market leaped. As the Yen now approaches 120, the markets are on massive doses of Euphorestra.

The standard mantra is "the market is positive about the Fed meeting and Cisco's earnings," but these non-events are not the cause: it's the Yen carry trade. If the yen weakens further, the U.S. markets will continue to rise. If it strengthens back to 117 or lower, the U.S. markets will suddenly decline. Regardless of what other conditions are blamed, look at the Yen as either a cause or a trigger to any Euphorestra hangover.

To quote from Stock Market Meltdown, which was sent in by frequent contributor Harun I:

"Keep an eye on the yen. The ongoing troubles in subprime and hedge funds are pushing the yen upwards which will unwind trillions of dollars of low interest, short term loans which are fueling the rise in stock prices. If the yen strengthens, traders will be forced to sell their positions and the market will tank. It’s just that simple. The Dow Jones will be a Dead Duck.

So far, Japan ’s monetary manipulations have been a real boon for Wall Street--enriching the investment bankers, the big-time traders and the hedge fund managers. They’re the one’s who can take advantage of the interest rate spread and then maximize their leverage in the stock market. It works like a charm in an up-market, but things can unravel quickly when the market retreats or starts to zigzag erratically. The recent rumblings suggest that the volatility will continue which will push the yen upwards and cut off the flow of cheap credit to the stock market. When that happens, the end is nigh."

Readers responded to the week's entries with a number of astute comments.

Harun I.

Cramer's tantrum is the result of the moral hazard created by the Fed. As I have stated before, we must understand what a bailout means not just in who has to pay but who is going to get paid and at how much interest. Cramer's plea that the Fed should open the discount window means that the Fed, a private central bank, needs to buy bonds or debt. What debt? Treasury (government) debt which must be paid back at interest by the American public. Could we infer that the Fed, a private central bank, were it to open the discount window, would benefit from a situation it created? Could we say that, being a lender of last resort that has the ability to produce money out of nothing backed by nothing and lend it to the Federal government with the guarantee of payment by the American people, the Fed, a private central bank, is in a winning situation regardless of what happens and that this situation may invite dubious behavior?

I have emphasized private here because apparently too few Americans understand that the Fed is a private corporation with no transparency controlling our money and therefore imposes a tremendous influence on our lives. Not even the Chairman of the Congressional Banking Committee is allowing to attend its meetings. When legislation was introduced to promote greater transparency President Clinton felt that to do so would undermine the public's confidence in the Fed. This of course is patently absurd but is consistent with many absurdities uttered by Clinton.

In conversations I have with various people it is remarkable how many think the Fed is in control of something. Let's consider that LTCM's lineup consisted of Nobel laureates, Myron Scholes (Black-Shcoles option pricing model) and Robert Merton. With all of their genius and elegant mathematical formulas they still managed to blow up a hedge fund. What does the Fed know that these gentlemen didn't? Well for one the Fed knows or should know that it doesn't have to control anything, they get paid regardless of what mess they create because of an implied ability to extract money from the American taxpayer at will. Bubbles don't have to be prevented because after the bust the Fed creates money not backed by any asset or reserve that the taxpayer has to pay back out of the existing pool of real money. Therefore, is it possible that bubbles create profits for the Fed? If so, wouldn't this constitute a dangerous conflict of interest?

At some point we are going to have to deal with causality and not effects. Economic distortions of the present magnitude are not causes, they are effects. Effects of what? Poor policy?

I have heard that our Founding Fathers couldn't have conceived the threats we see today and therefore we need to change the Constitution. I disagree. The Constitution was written to protect us from human nature, which transcends time. No matter the era we are still Mark 1, Mod 0 human beings. The desire to control and dominate is neither greater nor diminished than any other period in history. It is these primitive tendencies that the Constitution attempts to overcome. It beckons us live from the highest psychological level and intellect, but will we answer the call?

1927-1933 Chart of Pompous Prognosticators.

The link is to a chart that supports the timelessness of human nature. What remains to be seen is whether a president will declare "financial martial law" as did Roosevelt.

Harun just added these links and comments:

Stock Market Meltdown:

From the article at the above link:


The impending economic crisis is part of a much broader scheme to remake the political system from the ground-up so it better meets the needs of ruling elite. After the crash, public assets will be sold at firesale prices to the highest bidder. Public lands will be auctioned off. Basic services will be privatized. Democracy will be shelved.

The unsupervised expansion of credit through interest rate manipulation is the fast-track to tyranny. Thomas Jefferson fully understood this. He said:

“If the American people ever allow private banks to control the issue of our currency, first by inflation, then by deflation, the banks and the corporations that will grow up will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.”

We are now in the first phase of Greenspan’s Depression. The stock market is headed for the doldrums and the economy will quickly follow. Many more mortgage lenders, hedge funds and investment banks will be carried out feet first.

As the disaster unfolds, we should try to focus on where the troubles began and keep in mind Jefferson ’s injunction:

"The issuing of power should be taken from the banks and restored to the people to whom it properly belongs."

Rep. Ron Paul is the only presidential candidate who supports abolishing the Federal Reserve.

This link shows that there was another in favor of abolishing the Fed.


Zeus Y.

Another quick observation, regarding a point Mish made in his blog.

The operative phrase is in the first line: "The widening fallout in the U.S. mortgage industry has reminded investors of a risk they had forgotten: the fear of risk itself." A contradiction is arising, leading to a deadly irony: Using fear to manipulate people toward your financial advantage can backfire when the illusions dissolve and ACCENTUATE a irrational fear-based reaction in the other direction.

The fear that I might never buy a home if I don't hop on the exploding house market leads me to get out a loan with all kinds of fees that swallows my entire salary. This leads to unsustainability and inevitable disillusionment where others who have acted as I have are resistant to buying a home simply for fear of being stung. Homes used to represent "making it" and "security". Now they are hung with the stigma of "bankruptcy", "foreclosure," and "insecurity".

Bush promises "security" if you just fear, fear, fear, trust him, give up your civil liberties, "go out and shop." Then Katrina hits, Iraq is bungled, and now Bush has no credibility even if he makes a reasonable point. Everything he says and touches is now tinged with the label "incompetence" and "dishonesty".

Investors follow, they head toward the door. Some play chicken, looking to pick up some bargains, but even if the market is stronger than all this gluttony and fraud would suggest, it might not matter, because fear will drive people to dump even below the mean, which is often what happens in dramatic market corrections.

Was it Buffett who said, "Fear when others are greedy, and be greedy when others are afraid." I'm still sticking by October.


Bill Murath

"The Great Schooling"! People are going to get "schooled" in a big way, as you and most of your readers know. I am really glad to see after watching Cramer that the cockaroaches will be getting a good whuppin also. I feel so bad for all of JC's friends. Maybe you could run a bake sale and we could send them some money. Maybe the rest of the folks will finally wake up and see how things really are when their pain gets past the point of the maximum safe dose of reality deluders. We have been so removed from the idea in culture that there is a lot to be learned at the school of hard knocks. I know from first hand experience that the only time I am truly willing to change is when things just suck. The School of Hard knocks is where I got my P.H.D

Gotta run but I will gladly buy a dozen Kroika brownies to help out the hedge fund managers.


Michael Goodfellow

And as for bailouts, I'm always amazed at how fast people will change their tunes when their circumstances change. When California had rolling blackouts (in 2001, I guess), I was working in Silicon Valley. Surrounded by die-hard capitalists, you'd think they'd want market solutions to the power problem -- more plants, more power lines, less regulation. Instead they all started to scream about "there ought to be a law! Enron is ripping us off!" Enron was ripping them off, but only because California politicians were willing to pay absolutely anything for power, and refusing to pass any of the cost along to consumers (who would then have moderated demand.) So instead of arguing for real market forces, they let Gray Davis hang a "kick me" sign on the state, and asked for more of the same. Weird!

I have the same reaction to conservatives who love free markets until they get upset at the Middle East. Then it's "pass a higher gas tax, or require minimum mileage, or both!" Suddenly, they like command and control economics. Sigh.


Kip S. provides an explanation of what happens when a condo owner doesn't pay their association fees:

I was a board member and president of a large (1000+ unit) condo association for 3 years when I lived in Northern Virginia (moved to the West Coast 2 years ago). My experience is based on Virginia (so it may be different in California) AND I am not a lawyer.

In short, the association will dun the non-paying member, send notices, etc. just like any creditor. They can (and will) file suit to enforce non-payment. They can (and will) get a judgment and place a lien against the property (which will require payment before the property can be transferred). And finally, the association can file to enforce the judgment -- in other words, force the sale of the property.

It's ugly. Very ugly. And very expensive. My only experience (prior to my tenure) was when an owner willfully refused to pay the association fees (long story short -- when she bought the unit the dues were around $200/month; by the time she settled the dues had increased by 10% and she refused to pay the dues). The association eventually filed suit and moved to enforce the judgement. Ugly all around.

From my experience, working on an association board is one of the most thankless jobs imaginable. It's voluntary, time consuming, and the only reward is feeling that you're making a small difference in your community. Being on the board often felt like being in a shark tank. Much like any government (and don't kid yourself, an assocation is just like a government), there's no incentive to do anything cost-effectively, everyone's your boss, and everyone want something for nothing (or something for a lot!)

If any of your readers are thinking about purchasing a condominium, I strongly recommend that they look very closely at the condo documents and particularly at the association financial statements. Special assessments are usually the result of deferred repairs, unexpected damages, or collecting insufficient dues. But dues and assessments are related to the ongoing operation and maintenance (including expensive future maintenance) of the building(s) and infrastructure. So a "low" condo fee is not necessarily a bargain; if the building has (for example) elevators and there isn't enough money put away each month to replace them some day, well hello special assessment!

One issue of greater concern that I've heard rumours about (and can believe) is that the builder will set up a separate company and award long term contracts to it on behalf of the association for services (e.g. lawn care). While I have no examples of this, I can certainly believe this.


Thank you, readers, for a variety of information and informed opinion.