The.Economist.2007-02-10 (966424), страница 40
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This, in turn,lures more investors into the same strategy, amplifying the distortion. Mr Paulson may be revealing morethan he intends when he says the yen is “market-driven”: the market is chasing its own tail in defiance ofthe economic fundamentals.An elusive numberNobody really knows how big the carry trade is. Japanese official figures show little evidence of large netlending to foreigners. For much of 2006 Japan actually had a net inflow of bond investment. Estimatesbased on the short-term net foreign lending of Japanese banks put the carry trade at only $200 billion.But hedge funds do not need to borrow yen and then buy higher-yielding currencies.
Instead, the carrytrade is typically done through transactions, such as currency forward swaps, that are off-balance-sheetand therefore do not show up in official statistics. A better clue comes from record net “short” positions inyen futures on the Chicago Mercantile Exchange. Estimates of the total size of the carry trade range ashigh as $1 trillion.The term “carry trade” usually refers to leveraged trades by speculative international investors, such ashedge funds.
But Japanese households have also shifted money out of their low-interest-rate bankaccounts to earn a higher return in, say, New Zealand bonds. These outflows are certainly large, but theyare of a very different nature. If markets suddenly become more volatile, hedge funds can very quicklyunwind their short yen positions, whereas households are more likely to sit tight. It is the volatile type oftrade that central bankers lose sleep over.The received wisdom in the markets is that yen carry trades will continue as long as the BoJ raises ratesonly slowly. It would take a rise in Japanese interest rates of at least two percentage points to underminethese trades, and nobody thinks that likely in the next year or so.
Furthermore, goes the argument, aslong as interest rates stay low, so will the yen.In fact, the main trigger for an unwinding of carry trades is likely to be not Japanese interest rates, but anupsurge in currency volatility. That is what happened in 1998, when enormous yen carry trades had builtup. After Russia's default in August and the subsequent near collapse of Long-Term Capital Management,hedge funds reduced their leveraged positions and the yen started to rise.
Then in October the Japanesegovernment announced a plan to recapitalise its crippled banks, which further bolstered the currency,forcing those who had bet against it to cover their positions. The yen jumped by 13% within three days.Nouriel Roubini, at Roubini Global Economics, says that the lesson of 1998 is that it takes only a smallpiece of positive news to unravel such trades.
Suppose there is suddenly some good news about theJapanese economy at the same time as America's appears to be stalling. An initial rise in the yen couldcause today's carry trades to unwind just as rapidly, causing the currency to soar, American interest ratesto rise and risk spreads to widen. The volume of yen-related leverage is probably greater now than in1998.The G7 should be concerned about carry trades not just because they could suddenly unwind and triggerfinancial turmoil but also because the yen's misalignment is distorting the world economy.
The yen carrytrade has amplified global liquidity (see article), further inflating asset-price bubbles across the world. Thetrade has also prolonged global imbalances by making it easier for countries such as America, Britain andAustralia to finance their large current-account deficits.A severely misaligned exchange rate calls for action. It is true, as Mr Paulson says, that Japan is notintervening to hold down the yen. But since Japan still holds almost $900 billion of foreign-exchangereserves, accumulated a few years ago when it was intervening, it is hard to claim that the currency istruly market-determined. Stephen Jen, an economist at Morgan Stanley, argues that Japan's Ministry ofFinance should consider selling some of those reserves to break the one-way bet against the yen.
There isa risk that such a move could itself upset financial markets. But the lower the yen slides, the greater thethreat of an even sharper rebound.Copyright © 2007 The Economist Newspaper and The Economist Group. All rights reserved.About sponsorshipWeather riskCome rain or come shineFeb 8th 2007From The Economist print editionHedge funds find a new way to profit by taking on the weather godsWEATHER has toyed with mankind ever since the first cavemanblinked into the baking sun. Some of his descendants eventuallybecame insurance underwriters, offering to ease the sting ofdroughts and storms for a fee. But only recently has the speciesworked out how to turn nature—with all its vagaries—into atradable asset in its own right.As the world's weather grows more volatile (see article), interest intrading it is likely to grow, too.
Hedge funds, in particular, favourthree sorts of instruments linked to the changeable climate:weather derivatives, catastrophe bonds and sidecars. All arewelcome innovations in risk management as insurance andbanking increasingly overlap. And all are in growing demand (seechart).Weather derivatives are normally used to hedge againstunexpected swings in climatic conditions. On exchanges, they focus on widely followed measures such astemperature and rainfall in designated cities.
Bilateral deals crafted off-exchange can be more creative,perhaps involving variations in the height of waves or the humidity in certain places.The most common users are energy companies (or hedge funds trading energy risk), which account for46% of the market. Many of them are hedging natural-gas prices that are very sensitive to warm or coldweather. Agriculture accounts for 12% of the derivatives market. This share could be bigger, but freegovernment crop insurance in many countries has dampened demand.
Aid agencies have also usedweather derivatives to help poor countries cope with drought.Catastrophe bonds, meanwhile, allow the insurance industry to spread the risks from extreme naturaldisasters (hurricanes, earthquakes and such) to capital markets. A popular form of insurance-linkedsecurity, cat bonds allow insurers or reinsurers to lay off narrowly defined risks onto secondary marketsshould the defined event hit a certain loss level. Investors, typically hedge funds, buy high-coupon bondsthat are often divided into tranches.
If no catastrophes occur over the designated loss level during the lifeof the bond, investors get back their principal and a premium. But they can also get burnt. Cat bondissuance was about $2.1 billion in 2005 (a year of big hurricanes), up 75% on the year before, andissuance rose again in 2006, says Erwann Michel-Kerjan of the Wharton School.So far, mainstream investors, such as pension funds, have held back from the weather. But that has notstopped banks from trying to attract them. ABN AMRO, a Dutch bank, recently brought aspects ofstructured credit to the catastrophe market.
It bundled together nine different types of swaps—onAmerican hurricanes, European windstorms, Japanese earthquakes and such—and sold tranches toinvestors (including banks and insurance firms).Sidecars are the third type of alternative weather-risk tool being used more frequently by hedge funds.Like cat bonds, they are complex instruments, offering reinsurance by issuing debt to investors. Butsidecars typically involve a bigger investment (at least $200m) than cat bonds and are shorter term: theymostly self-liquidate or renew in two years or less, says Mr Michel-Kerjan.
He reckons that hedge fundsput more than $3 billion into sidecars in North America alone between November 2005 and July 2006.It is not just weather that moves the market; people can too. Last month, the disaster-prone state ofFlorida expanded its hurricane-catastrophe fund, in effect removing $4 billion from the private reinsurancemarket. Bermuda, where many reinsurers are based, was especially hard-hit. A likely knock-on effect willbe a redeployment of catastrophe cover elsewhere, probably driving prices lower for a time.
Just likenature, weather risk moves in cycles too.Copyright © 2007 The Economist Newspaper and The Economist Group. All rights reserved.About sponsorshipButtonwoodMutiny in the ranksFeb 8th 2007From The Economist print editionReasons not to savour that fat bonus cheque“IT'S the rich wot gets the pleasure, it's the poor wot gets the blame.” The soldiers who sang that ditty inthe first world war may have been reflecting on the contrast between their lice-ridden, shell-shockedexistence and the creature comforts available to aristocrats back home.There was an enormous disparity between the income and wealth of the top and bottom classes of societyin the early days of the 20th century, as there is today, another era of boisterous global trade.
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