“Roubini takes on those who are taking advantage of the bubble [using the carry trade] to rake in returns of 50% to 70% since March.”
Fed’s decision to hold short-term interest rates near zero has temporarily revived financial markets without addressing the economy’s underlying problems. Critics focus on the fact that low U.S. interest rates enable investors around the globe to borrow dollars for next to nothing and invest them elsewhere at higher rates. Goldman Sachs can now borrow at essentially 0.0% interest and gamble against the backstop of the taxpayers. This is of course an absurd result.
How does something like this happen? Answer – Check out how much Goldman Sachs execs give every year in political donations and how many ex-GS execs and partners serve in key positions in the U. S. government and regulatory agencies.
This bet — known as the dollar carry trade — appears to be one of the forces pushing down value of the dollar. The buck recently traded at its lowest level against the euro in a year, while the trade-weighted dollar index has dropped 14% since March.
There’s a huge carry trade going on right now where banks are borrowing from the Fed discount window at zero interest, shorting the dollar, and investing the spread in risky assets.
As long as the dollar keeps weakening consistently, banks can re-leverage at a negative effective interest rate (-20% or so). The Fed is basically paying the banks to invest free money.
While credit is tight for borrowers in the real economy, credit has never been easier for borrowers in the financial economy. This is unprecedented.
But the carry trade depends on a weakening dollar. When the dollar hints at a bottom, the rush to cover short positions will generate a global stampede and a truly epic asset bust.
This next asset bust will make the last one look like a training exercise in comparison.