Let's Try Some Perspective

The drumbeat against the euro is increasing daily.  It will fall apart, it will be limited to a hard core of Northern countries, it was a bad idea to begin with, you can't have uniform monetary policy without uniform fiscal policy, etc etc. The cacophony is so loud it is making common sense impossible to break through, particularly since "the free market" is screaming at the top of its lungs.

Let's try some perspective on that "free market", eh?  

• Gross Folly #1: How come the eurozone's financial center is... London?!!  What this means in practical terms is that a scrum of bottom-line-is-everything bonus-hungry twenty-somethings hardly out of school are running the show.  And to top it off, they and their country (the U.K.) are not even members of the eurozone. They don't use it, they don't believe in it and, if anything, they hate its guts.  Literally.  This like trusting a bunch of juvenile delinquents who amuse themselves with setting cats on fire to run the pet shelter. 

• Gross Folly #2:  We let those same kids deal in sovereign bond CDS (credit default swaps) in an unlimited amount, without any regulation, in a completely opaque OTC market.  They don't have to hedge their positions with the underlying sovereign bonds, they don't have to account for their actions to anyone but their immediate boss - who is also in line to make a huge bonus from their profit - and they don't give a damn if they push some poor country into bankruptcy and its people into starvation.  Literally.  This is like giving the nuclear missile launch keys to a bunch of manic-depressives and telling them they have to compete amongst themselves for their meds.

•  Gross Folly #3: We have allowed huge amounts of public and private pension monies to be managed by "alternative-investment" firms, e.g. hedge funds who are compensated on the outrageous 2/20 schedule.  (The US Social Security is still OK, as it can only invest in Treasurys, but it came close to succumbing a few years ago.)  This is like giving a bunch of convicted arsonists a tank-farm full of gasoline, asking them to put it to profitable use.

• Gross Folly #4:   The people of Europe have entrusted management of the whole shebang to politicians, their appointees and committees of clueless bureaucratic mandarins who wouldn't know the difference between a CDS and a CDO if it sat up and hit them in the face. (Again, the US is somewhat better at this since key government positions are frequently filled by experienced financiers.)  This is like staffing Bedlam with a bunch of  South Italian city managers, soviet-era Russian chefs from Vladivostock and over-sized German nurses named Helga.  All overseen by the ghost of Joe McCarthy come back to life.  No doctors.  Oh, and only Wagner allowed in the rec room.

Have a nice weekend...

PS  A friend in the business sent me this picture today.  While I may not exactly agree with it, it is definitely indicative of sentiment towards Germany these days...

European Family Photo

How To Restructure PIGS Debt - A Modest Proposal

With Ireland in political turmoil over its application to receive bailout funds, it is becoming obvious that we are getting caught between a rock and a hard place: on one side, markets (a euphemism for the unholy alliance of public pension money and the private money of the ultra-rich) are no longer willing to roll over the existing debt of the over-indebted, never mind increasing their exposure, at anything approaching reasonable interest rates.  On the other, austerity programs attached to bailouts are causing  high unemployment, pay and benefit cuts, tax increases and service cuts.  

How long can this go on before things get seriously crushed, resulting in one or more massive unplanned defaults by sovereign borrowers, or massive social upheavals? Or both?  It is my opinion that time is running out.

A solution must be found, and the sooner the better.

Let's lay some ground rules:

          1.  A solution should include structural reforms, where appropriate.  For example, Greece must radically reform its public governance which is shot through with graft, corruption and ridiculous inefficiencies and raise the competitiveness of its economy so that it can produce goods and services attractive and attractively priced to the global marketplace.  Ireland should re-think its corporate tax policy and start generating significant domestic savings to fund itself locally, instead of relying on foreign portfolio investors who can - and do - disappear at the first hint of trouble (Ireland sports an external debt of 1,000% of GDP).

          2.  A solution should not trigger a credit event for credit default swaps (CDS).  Apart from not rewarding vulture speculators who bear significant onus for the current mess in sovereign bond markets, there is a systemic reason for avoiding a credit event.  Before the explosion of the CDS market a default would result in well-defined losses: debt outstanding minus recoveries.  For example, a "haircut" of 50% meant that lenders lost half  their capital.

Today, however, there is at least $2.4 trillion outstanding in sovereign CDS,  $2.2 trillion of which  is sold by dealers, i.e. big global banks.  If a credit event is triggered no one knows who will be pushed over the cliff by the tumbling dominoes, all happening in a matter of days (remember AIG?).  Most positions are "offset" in dealers' books, of course, but no one gives a damn about offsetting  when counterparty risk enters the equation in times of crisis (remember Lehman? or Bear? or Merrill? or Citi?).  Here's what it is: under no circumstances is Goldman going to offset positions with Deutsche today if it thinks there's a risk of the latter filing for bankruptcy tomorrow, and vice versa.

CDS Prices For PIIGS 

By allowing unrestricted CDS activity on sovereign debt we have increased credit exposure (more "debt" outstanding) and we also included more participants on the possible default list (the issuers of CDS).  Oh, and if sovereign CDS comes second in amounts outstanding with $2.4 trillion, guess who is first?  Oh yes, financial institutions, with $3.3 trillion.  The systemic collapse that will follow a large sovereign default is too scary to contemplate.

          3.  A solution should provide for meaningful debt relief, i.e. result in the cancellation of 30% to 50% of debt outstanding and, soon thereafter, resumption of borrowing from free markets at reasonable rates.

How is this to be accomplished?

Step One: The European Central Bank (ECB) purchases in the open market sovereign bonds of the countries most at risk.  Right now, this means Greece and probably Ireland.  Depending on maturity, Greek Government Bonds (GGBs) are trading around 55 to 75 cents on the euro.

Step Two: ECB returns the bonds to the issuing country at cost and accepts as replacement new bonds of face amount equal to the ECB's cost.  Maturity and interest rates remain the same.

Example: ECB buys 10 billion face amount of 30 year GGBs with a coupon of 4.60% at the current market price of 53, for a cost of 5.3 billion euro.  It returns them to the Greek state and gets 5.3 billion face of new 30 year bonds bearing a coupon of 4.6%.  Resulting debt reduction: 4.7 billion euro.

The operation is entirely voluntary for original bond holders, who don't have to sell.  However, given that the ECB is going to be in the market all the time, bond dealers will have to sell, or raise their offers in order not to be lifted.  Either way, the market will achieve a balance consisting of part debt reduction, part higher bond prices.


Benefits: debt reduction, bond market stabilization, CDS market coming back to earth, lower borrowing costs (eventually) for troubled countries, minimum political wrangling amongst EU nations, fast action.

Downsides: 

• Troubled countries may rely on ECB interventions and not implement needed structural reforms.  That's why the ECB should act only in conjunction with requirements already in place, moving deliberately and stepwise as reforms are enacted. 
• Bond prices may jump inordinately under ECB's buying program.  If this happens then ECB just doesn't buy, leaving the market to function on its own. Some patience and lots of market savvy are definite requirements for this plan (but not much money!).
• The ECB's balance sheet will expand, at least initially.  But it already boasts 1.9 trillion euro in assets, so even if it bought half of all GGBs and Irish Government bonds outstanding at a discount, it would only have to spend some 100 billion euro.  With markets being what they are, I doubt it would even have to be that much.

Objections:

• It's not ECB's business to bail out nations.  Oh really? Is it its business to bail out only financial institutions, then?  Let's keep in mind that central banks are, above all else, public institutions working for the benefit of the people.  And in such a plan the ECB is not really performing a bailout but a financial intermediation.
• ECB may be stuck with too many sovereign bonds for too long.  This will happen only if nations themselves don't quickly put their finances in order.  Reforms being a necessary condition for participation in the solution, this should not be a serious problem.  Once primary budgets are balanced and markets work smoothly, ECB will be able to sell the bonds - perhaps even at a profit.

One final point from the market-participants' point of view: CDSs are wasting assets, i.e. if a credit event doesn't happen within the period specified in the contract (typically 5 years) holders will lose their entire investment.  By today's prices of Greek sovereign CDSs, that's $5,000,000 (five annual $1 million payments), paid for covering $10 million face amount of bonds.  If ECB adopts this plan it is certain that CDS prices will collapse as dealers try to get out of positions as quickly as possible, further normalizing bond markets.

Ireland (Plus Mrs. Merkel)

Ireland is about to become the second country in the EU to get a bailout (Greece was first). News and analysis  on the subject can be found everywhere, so I'll just throw in a few charts.

Until recently Irish public debt was quite low, around 30% of GDP.  But when the property and banking bubble burst things changed very fast.  Government liabilities exploded from 60 to 140 billion euro in less than three years (see chart below).

 Chart: Central Bank of Ireland

Irish Government Liabilities

The main culprit of Ireland's demotion from prince to pauper is its failed banking system. Ireland boasts  a GDP per person that is second highest in the EU (in purchasing power parity terms) and yet... why did they go so massively in debt?  The private sector is in debt to the tune of some 350 billion euro (~175% of GDP), with home mortgages alone accounting for 110 billion (see table below - click to enlarge).

Chart: Central Bank of Ireland

Home prices are now slumping across Ireland, but as the chart below shows the bubble was a long time forming.

 Chart: ESRI

TSB/ESRI House Price Index

So, what happened in Ireland?  In a word, hubris.  When it entered the European Union in 1973, Ireland was a poor agricultural society - indeed, the poorest country in western Europe.  In a determined effort to bootstrap itself, Ireland focused on education and started attracting foreign (mostly American) manufacturers of high tech equipment and services, offering ultra-low corporate tax rates as an inducement.  It worked marvelously well, turning the country from pauper to prince.

And it all went to their head in the end,  as it always does in the human race.  Dublin became a must-got-to place, a sort of Rome-in-the-Guinness-belt.  Home prices soared and kept on soaring, despite the fact that incomes could not possibly keep up with spiking prices.  Irish home buyers borrowed heavily and in turn their banks borrowed from abroad, particularly from Germany (note the imbalance between debt and domestic deposits in the table above). 

It is estimated that German lenders currently hold about 150-180 billion euro worth of Irish liabilities, making the Irish Problem a very serious one indeed for the German financial system.   And it serves as a poignant counterpoint for Mrs. Merkel, the German Chancellor who has made so much political hay at home at the expense Greece, even though German banks hold only some 30-40 billion of Greek bonds.

P.S. A final prediction, for what predictions are worth: Europe is going to go the way of the US in bailing out its economy (-ies) and Mrs. Merkel is not going to make it past April 1, 2011 as Germany's Chancellor.

The Tri-Polar Era

The Bretton Woods agreement of 1944 established the preeminence of the U.S. dollar as the world's sole reserve currency.  The six decades that followed were the Unipolar Era for matters monetary, even after  Richard Nixon in 1971 unilaterally canceled the dollar's convertibility into gold.

The Maastricht Treaty of 1992 set forth the requirements for the creation of the euro, the European Union's common currency, which started circulating officially in 2002.  Thus began the Bipolar Era, a time of increasing concern for the United States since the euro challenged its monetary preeminence and threatened the very foundation of The Dollar Empire.  

America's serial troubles with the stock market crash of 2000, the 9/11 terrorist attacks, the Iraq and Afghanistan wars and the housing and debt implosion which started in 2007 and is still ongoing, have  only added to the dollar's woes, since Americans have chosen to combat their intractable socio-economic problems with a mere placebo, an anodyne as it were.  To wit, the loosest possible monetary policy and increasingly massive quantitative easing, i.e. the printing press.  

Naturally the dollar is losing value against the euro, prompting virulent  and under-handed attacks against the latter's credibility by American and allied economists, bankers analysts and associated flotsam and jetsam.  For example, the hugely disproportionate negative publicity surrounding Greece's public budget deficit - a laughable 0.25% of the EU's combined GDP.
 
Much more dangerous for American living standards, however, is the loss of the dollar's value against wheat, corn, copper, gold, oil and all other commodities.  The CRB index has zoomed back to its all-time highs not because of strong current or incipient demand from industrial users - the global economy  being still quite weak - but because the dollar is increasingly viewed with well-founded suspicion (see chart below).

CRB Commodity Price Index

And that's where the third pole comes in: China has become the world's second largest economy, but when it comes to its currency it is still acting like a poor, underdeveloped country.  The yuan's hard peg against the dollar is not exactly a sign of national economic confidence, never mind pride.  It's like a 6 ft. tall teenager feeling so unsure about riding a bike that he keeps the side-wheels on. 

An economy of such magnitude and global importance as China's cannot and should not use another country's currency, as it is effectively doing now through the yuan's peg to the dollar.  "It just ain't natural"- and what's more, it's clearly no longer in  China's best interest.  To use but one adverse example, what are the likely consequences of QE2 on the roaring Chinese property bubble?

It is time for China to completely un-peg its currency from the dollar and allow it to float freely, thus causing the world to enter the Tri-Polar Era.  From the perspective of balancing trade and geopolitical power, the existence of three major globally and freely traded currencies is more desirable than only one, and even better than two (the third will act as a buffer).

Furthermore, a tri-polar exchange regime is far superior to antiquated gold benchmark notions currently being thrown about (hopefully containing no serious intent).

Bernake As Greenspan

What is Mr. Bernanke doing with QE2 (quantitative easing part two)?  By his own admission, he is unleashing a flood of money into the system in order to forestall deflation.  And how is more (fiat) money going to help the so-called "real economy"?  Again by his own admission, by pumping up asset prices (i.e. stocks),  creating a wealth effect and thus giving birth to a virtuous cycle of confidence, consumption and investment.  

Here's an excerpt from  the link above, an op-ed Mr. Bernanke wrote for the Washington Post a few days ago.

"And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion." 

That's an astonishing statement of intent, coming as it does from the Federal Reserve, but let's accept it at face value (but, really, could you ever imagine that a head of the nation's central bank would act as a stock jobber for the S&P 500?).

Still, is Mr. Bernanke's asset-bubble strategy any different from what Mr. Greenspan did following the dotcom whump-and-dump of 2000-02?  Oh, not really - except that Uncle Alan chose housing and crappy mortgages, while Brother Ben's choices are shares and Treasurys.  I guess the former was burned by his correct but ill-timed Irrational Exuberance comment (and in markets timing is, after all, everything), whilst the latter has no such inhibitions.  Yet.

What can I say...? Does it matter what you drink, if you end up face down in the gutter in an incoherent alcoholic stupor?

One more time: what we need, and what needs to be seriously targeted by all concerned, is higher earned income (wages and salaries), not more debt-inflated asset prices.  

Period.

Common Sense

For today's elections I have only one thing to say.. OK, two:

1. Smart people don't cut off their nose to spite their face.
2. Remember the Alamo (you know... Bush?).

Enjoy the balloting.

P.S.  Here are some rather shocking data on wage distribution in the U.S.A. from the Social Security Administration. (Data refer to 2009 during which there were a total of 150 million wage earners.)

• The largest group of wage earners - a massive 24 million or 16% of the total - made between 1 red cent and $4,999.99.  On average they earned $2,016.
• The average wage for everyone was $39,054, but the median was a mere $26,261.  Two thirds of all workers made less than $40,000.

  Middle class? What middle class?  Look at the data...

An Excellent Idea

According to Bloomberg: "President Barack Obama will make the case that his proposal to let companies take immediate tax deductions for the full cost of new equipment will help the economy grow and create jobs by encouraging about $50 billion in new investments through 2011."

I think that's an excellent idea.  It should be expanded and embraced by other countries, as well.

In my opinion, if the developed world (US, Europe and Japan) is to transform its bankrupt consumer spending economic model (which ultimately involved unsustainable borrowing) it must undertake and sustain very large capital investment, preferably in energy and transportation infrastructure.  For example, investing in upgraded electricity grids, instead of shopping malls and ski chalets.

By definition, such an economy involves more knowledge, more technology, more highly skilled workers and more value added per hour worked.  That's exactly what "developed" is all about - or should be, anyway.  And that's exactly what our resource-stretched, environmentally-challenged world needs, right now.

It would also rather quickly reduce pernicious trade imbalances which are spilling over into the foreign exchange battleground (that's code for US-China relations and the yuan peg).

Congress should move immediately.

Making Real Things For Real People (tm)

Three years into the crisis we can say that the world did not come to an end, the economy did not fly off the cliff and markets are operating in "safe" mode.  Not to mention that Wall Street is smugly preparing to pay huge bonuses once again.  Credit must go to the Fed and Mr. Bernanke personally for making so much, well, credit available to everyone who asked for it and even to some who didn't.  

But is it, in fact, credit that we must give the Fed? 

During the past three years the Federal Reserve has assumed a role never envisaged by its founders or anyone who ever worked there - Mr. Greenspan included, I'm sure.  Despite his "heli-Ben" moniker, I even doubt if Mr. Bernanke himself ever truly believed that the Fed would have to go as far as it has under his guidance. 

Because it's one thing for the Fed to respond to challenging economic conditions by lowering interest rates down to ZIRP.  But it's quite another, a quantum leap (of faith?), to become the major shaping force of the economy by inundating it with so much money as to reverse the natural ebb and flow of capitalism, to forestall what Joseph Schumpeter called creative destruction.

They say that the road to hell is paved with good intentions, and I am afraid that we have all of us allowed Mr. Bernanke to lead us a merry journey that may end in a very hot place, indeed.  He has good intentions, undoubtedly: to "save us" from a financial meltdown which could have resulted in another Great Depression.  He has used monetary policy to an incredible extent, encouraged, it must be admitted, by an executive branch that was so intertwined with Wall Street as to be practically indistinguishable.

So, monetary and fiscal policy both opened up fire on the Great Recession using the only big guns they could bring to bear: money and government borrowing /spending.  They fired so many rounds of such heavy gauge that the "enemy" was stunned and is - at the moment - still dizzy from all the noise and smoke.

But the enemy is definitely not dead, because money-for-nothing and government spending are to him as effective as flash-bang grenades.  Lots of smoke, lots of noise - but no damage.

• Point: The real enemy is widening income inequality.  The vast majority of people have seen their real income remain stagnant for 40 years and had to burden themselves with ever-increasing debt to make ends meet.  

Massive debt is, therefore, but the proximate cause of the crisis.  It's actually a resulting effect of the ultimate cause, which is high income disparity (see chart below).

Chart: FRB Survey of Consumer Finances

Obviously, easier credit (more debt) and government deficit spending (even more debt) do nothing to solve the income inequality problem, which can be summarized thus: lower and middle income people spend a far greater percentage of their income than the rich, who amass wealth instead. Therefore, it is imperative for the former to have growing income to maintain their spending out of earnings and keep the economy healthy.

The obvious solution, most will say, is as as old as Robin Hood: take from the rich and give to the poor.  Really?  While the egregious favoritism shown to the rich in previous tax laws must definitely be rolled back, taxation alone cannot do the job of repairing decades of yawning income inequalities.  Instead, we should pay great attention to the most fundamental economic concept of all: adding value through peoples' work.

What I am trying to say is that real incremental wealth, and the social "fairness" that results from its more equitable distribution, cannot come about from re-distribution, but only from the creation of new useful real assets that generate added value for society at large.  For example, an upgraded electric grid that reduces losses and permits two-way power flow;  such an "asset" can be put to work immediately and will generate profits (added value) for all, i.e. it's useful to the vast majority of people.  Its design, construction and maintenance will create tens, even hundreds of thousands of new, skilled jobs that will command high wages, precisely because of the grid's profitability.  That's how income gaps get smaller (think Ford, Model T, etc.).

Contrast this with trading CDS's.  While there is a small theoretical benefit to society at large from such an activity (I could argue that it's actually a cost, but that's another discussion), the benefits that accrue are not real but purely actuarial or monetary, i.e. virtual.  Furthermore, because of the nature of the financial industry itself, those benefits end up in the hands of a tiny part of the population which is already super-rich.

In conclusion: we have reached, nay surpassed, the limits of monetary and fiscal policy in dealing with this Great Recession.  What we urgently need now is -gasp- an Industrial Policy.  Yes, that's making real things for real people (tm).

P.S.  There is at least one guy who "gets it".  Robert Reich was Labor Secretary under Bill Clinton and has just come out with a book about exactly this matter.  Aftershock: The Next Economy and America's Future is well written, well argued, brief and to the point.  It also includes several workable ideas on how to close the income gap.

The Peoples' Slice Of The Pie

Economists are forever trying to come up with theories to explain unemployment and wages.  It is always a "hot" topic, and the Bureau of Labor Statistics (BLS) monthly release on the employment situation is arguably the one statistic which can - and does - move markets most.

I won't go into the various economic theories on how wages, unemployment and inflation all come together to shape (or "clear"), the labor market.  I have a more fundamental question, instead:  How important are wages in today's economy, overall?  Or, to put it more precisely, how come we have allowed gainful employment and earned income to become so unimportant?

The following chart shows that wages and salaries as a percentage of GDP have been dropping steadily for 40 years, from a high of 54% of GDP in 1970 to a low of 43.5% this year (see chart below).  Including other forms of compensation like pension and medical benefits does not alter the picture appreciably: total compensation of employees went from 60% of GDP in 1970 to 54% this year.

Simply put, then, working people are getting a smaller slice of the economic pie.

Yeah, The Pie Is Bigger But Your Slice Is Smaller

This is as major of a transformation of the economy as it gets but it is almost never discussed by academic economists, who are forever trying to figure out how to model unemployment, or interest rates, or whatever econometric datum strikes their fancy.  It's like pondering the price of candle oil while Rome burns.  And they get Nobels for it, too!

(A small aside about the Nobel Prize for economics: it was not part of Alfred Nobel's will in 1895.  It was instituted and funded much later, in 1969, by Sweden's central bank;  it is formally known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.  Considering its provenance in the depths of Money Central, it's highly unlikely that a more "radical" economist is ever going to be awarded one. )

Anyway, who's been eating the Peoples' Slice Of The Pie (TM) then?

Is it proprietors of small businesses or farms?  Hardly.  Their income as a share of GDP was 8% in 1970 and it's still around 7% today.

For a clue, look at the following chart of net dividends as a percentage of GDP: they have steadily climbed over the years and literally soared after 2003 to nearly triple what they were in the 70's.

If stock ownership was even somewhat evenly distributed amongst Americans I would have no real problem with this picture.  But, it isn't - not by miles and miles. The richest 10% families owned in 2007 a mean $700,000 worth of stocks, while the next 15% owned a mere $53,000.  The rest, i.e. 75% of the people, owned next to nothing at all (see chart and table below). 

 Chart: FRB Survey of Consumer Finances, 2007

The United States, indeed the entire West, has in recent times been transformed from a society defined by the constructively paired work-income relationship, to one oriented towards an asset-debt pair.  Even worse, most assets are now owned, controlled and exploited by an ever-shrinking minority of super-rich, forcing the vast majority of the people into virtual debt slaves.  That's what Virulent Capitalism is all about, in my opinion.

But does anyone really give a hoot?  Are important economists really screaming bloody murder?  Are politicians really taking notice? The short answer is no.

Notice my main recommendation on the right: Animal Spirits is an excellent book authored by George Akerloff and Robert Shiller, two economists who hardly fit the classical model.  For example, they make mincemeat of the deeply-ensconced theory that humans are constantly acting in their so-called "rational" self interest when they make economic decisions.  Akerloff ans Shiller are willing - and scientifically able - to tear down the entire foundation upon which classical economics has been resting for centuries.

And yet...

Whilst they correctly identify the causes of the current crisis and properly point accusingly to all the proper directions, what is it that they recommend as a solution?  That the Fed should target credit expansion, i.e. make as much credit available to the economy as possible.  Not a word about the huge deficit in earned income, not a peep about the enormous asset ownership gap.  Instead, more credit, more debt for the masses.   

Sorry guys, that's plain insane.

Don't get me wrong.  Animal Spirits is an otherwise excellent book, well worth reading for its spirited departure from classical metrics-based economic theory.  Buy it, read it, profit from it.  But, my point here is that even such forward-thinking economists atavistically fall back to old remedies when faced with financial crises.  It's like a modern day doctor correctly diagnosing TB and then prescribing a long stay in a Swiss mountain sanatorium as a cure.  Well, good luck with that...

(Maybe it's because Akerloff's wife is none other than Janet Yellen.  Yup, maybe he's being very rational, after all.  From a personal peace-in-the-family standpoint, of course.  Eh...)

P.S.  This post was written during the weekend, so I should seriously consider testing myself for ESP because the Nobel committee just announced its choices for the aforementioned Economics prize - and guess what?  They gave it to three economists for their work on unemployment, job vacancies and wages.  Same old, same old unfortunately. 

Where's The Yen Carry Trade Now?

Three years ago I was shaking my head at the yen carry trade (As The Yen Strengthens).  Today's decision by the Bank of Japan to formally ZIRP (Zero Interest Rate Policy) itself into a corner, to - as it hopes - stop the yen from strengthening further, underscores how far the yen carry has unraveled since then.

This so-called "strategy" of borrowing yen at low interest rates to speculate in financial markets all over the world was one of the major generators of hot money and, thus, a big enabler of the bubble finance that ended up as The Crisis.

In August 2007 I estimated the size of yen-carry money at around $1 trillion, based on data from the Bank of International Settlements (BIS).  The updated chart below shows what has happened since then - I call it the rise and fall of the yen carry trade and it largely confirms my initial estimate of $1 trillion.  Notice how nominal amounts of yen FX swaps and forwards spiked upwards by about $1 trillion at the top of the bubble folly, only to come down by the same amount as soon as the bubble burst.

Data: BIS

I thought the yen carry trade to be so risky as to be downright foolish, at the time.  It made no sense to assume very high currency risk (the yen was at multi-year lows) in order to place highly leveraged bets on instruments providing very small spreads over Treasuries and over borrowing costs.  One example was buying second-tier European debt (e.g. Greek government bonds) at minuscule spreads of 50 basis points over bunds.  What followed is history, and it is still unfolding.

But now is now, and if I was a betting man - which of course I am, being in this business - I would be quite interested in putting on some new yen carry trades at this juncture.  

For the record,

• JPY borrowing costs: essentially 0% (assuming, of course, that you can borrow at all).
• Greek 10-year bond spreads over bunds: 800 bp
• USD/JPY: 84