How sad - as we yell out for all to hear that we are nothing like Japan we are piece by piece taking the role - from zombie banks supported by government, stimulus out the rear end for pork projects, a lost decade in the market, long term stagnant economic growth despite government report hocus pocus, and now the US peso has replaced the disrespected yen as the world's cheap source of funding for speculation worldwide. I can't stress enough to US readers how every day the US dollar loses value, you lose purchasing power and over time a standard of living. But since most in this country live in a nominal world versus the real world, they are not understanding the implications of our solutions.

A good opinion piece in Bloomberg (Hedge Funds' ATM Moves from Tokyo to Washington) on the implications of the world's RESERVE currency also turning into its CARRY currency.

  • China’s real problem is how quickly the dollars they hold in great quantity are getting all the respect of pesos these days. Sound like hyperbole? Not when you consider what may be the hottest investment of 2010: the dollar-carry trade.
  • Move over Japan. Investors spent a decade borrowing in zero-interest-rate yen and putting the funds in higher-yielding assets overseas. It’s the U.S.’s turn to flood the world with cheap funding and the risks of this going wrong are huge.
  • The carry trade has never been a proud part of Japan’s post-bubble years. Officials in Tokyo rarely talk about the yen’s role in funding risky or highly leveraged bets on markets from Zimbabwe to New Zealand. Japan never set out to become a giant automated teller machine for speculators. (well I guess in that 1 area we are different from Japan; it appears to be the government's plan to be the ATM for all the world, especially American consumers. House ATM gone? No problemo - government ATM is here to replace it) It was a side effect of policies aimed at ending deflation.
  • The perils of the carry trade were seen in October 1998. Russia’s debt default and the implosion of Long-Term Capital Management LP devastated global markets. It was a decidedly panicky and messy period culminating in the yen, which had been weakening for years, surging 20 percent in less than two months.

Do you notice a common theme of the problems before we go on? Central banks anyone?

  • Now imagine what might happen if the world’s reserve currency became its most shorted. Carry trades are, after all, bets that the funding currency will weaken further or stay down for an extended period of time. It’s also a wager that a central bank is trapped into keeping borrowing costs low indefinitely.
  • Think about the turbulence that would be unleashed by the dollar suddenly shooting 5 percent or 10 percent higher with untold numbers of traders around the globe on the losing side of that trade. It could make the “Lehman shock” look manageable.
  • Yen borrowers bought everything from Shanghai properties to Google Inc. shares, bars of gold, Zambian treasury bills and derivatives contracts. The odd thing, however, was the lack of credible data. When I asked Japanese officials in recent years for estimates of how big the yen-carry trade had become, I got blank stares.
  • That’s what makes such a trade worrisome and easy to dismiss as a threat to markets. No one knows how big it is -- how many companies, hedge funds or mutual funds borrowed or how much. So when a currency turns suddenly, the magnitude of the unwinding is often a surprise. (sound familiar? unknown size of derivatives market anyone? As I've been saying for over a year - the solution to our problem simply has shifted the risk from the private to the public; and the public is represented by the currency)

Boo Yah.

  • “The dollar is the cheapest funding currency bar none and only challenged by the U.K. in terms of the risks from money printing and escalating deficits,” says Simon Grose-Hodge, a strategist at LGT Group in Singapore.
  • Really, betting against the dollar would seem to be as safe as assuming Japanese 10-year bond yields will stay at less than 2 percent. And if Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke aren’t careful, the dollar will become the main trade dispute with China.

And round and round we go, where the Federal Reserve bailouts end, nobody knows.

  • What if, for example, a U.S. recovery comes faster than expected, sparking a massive reversal of the carry trade? Its implications would be felt far more widely than shifts in yen bets. Increased dollar volatility could even bring down a few hedge funds and the odd investment bank.

And let's end with the most important points:

  • The dollar-carry trade says nothing good about confidence in the U.S. economy.
  • It’s also a reminder that the side effects of this crisis may be setting us up for a bigger one.

Nah. It always works out in the end. Just call up the Federal Reserve and have them backstop every asset on the planet. And let's cover Mars while we're at it. Problem solved.

I can only think of one thing as I watch this all play out