End of easy money likely to have adverse impact on ‘carry trade’
Hans Greimel
Sun
A pedestrian passes by an HSBC Tokyo branch office on Tuesday. For five years, Bank of Japan’s soon-to-end zero interest rate policy helped pump up economies, stocks and foreign currencies. Photograph by : Koji Sasahara, Associated Press
TOKYO — Imagine a bank that doles out loans but charges no interest. For five years, that’s what Japan has been for the world economy — an all-purpose lender with next-to-nothing borrowing costs thanks to the central bank’s zero interest rate policy.
The trend helped pump up economies, stocks and foreign currencies from the United States to Australia. But concerns are mounting it could all unravel on a global scale with the Bank of Japan’s decision last month to finally tighten the taps on all the easy money.
At risk is a flow of funds known as the carry trade, an investment strategy that has lured people to Japan to borrow money on the cheap and invest it overseas for higher returns.
No one is sure how much money is at stake, but economists say stopping the flow could prompt global investors to sell their holdings of stocks, bonds and other assets outside Japan, particularly in the United States.
That could weaken the U.S. dollar, push up yields on U.S. Treasury bonds and boost interest rates in the U.S. and Europe.
“When it starts to reverse, it could lead to some real shock waves in the market,” warned Kenneth Courtis, the Asia vice-chairman of Goldman Sachs Ltd. in Tokyo.
The carry trade is driven by the gap between near-zero per cent interest rates in Japan and higher rates elsewhere in the world.
In an attempt to bail the world’s second-largest economy out of more than a decade of doldrums, the BOJ implemented a super-loose monetary policy five years ago to make it easy for companies to borrow funds.
Not only did the central bank hold interest rates close to zero per cent, it flooded commercial banks with about 35 trillion yen ($338 billion Cdn) in daily liquidity, nearly six times the amount banks actually needed, by many economists’ estimates.
It didn’t take long for global investors to start exploiting all this cash sloshing around at close to zero per cent.
They borrowed money from Japanese banks and invested it overseas for higher returns. In the 12-country Euro zone, the key interest rate is 2.5 per cent, while the U.S. benchmark rates are now 4.75 per cent.
Other popular destinations have been New Zealand, where the key interest rate is 7.25 per cent, and Iceland, where the central bank recently hiked rates to 11.5 per cent.
On March 9, however, the BOJ declared Japan’s economy is back on track and soon ready for higher interest rates — a trend that will squeeze the profit margin, or spread, on carry trades, making them riskier and less attractive.
It’s hard to know to what degree — and where — investors will move their money, but many experts believe that U.S. markets could suffer as a result.
© The Vancouver Sun 2006