Last week the Economist did the cover story on it and in process the finance minister of Brazil has officially announced that an International Currency War has already started. Certainly, a few isolated shots are being heard.
The intended target is non other than China. Emerging economies taking actions on their monetary front be it Brazil, Australia, India or Thailand; the recently action taken by Thailand- it has imposed a tax on foreign investors’ gains from local bonds, the latest in a series of countries seeking to curb their currencies’ rise either through curbs on capital inflows or direct intervention on the currency exchanges.
Whenever there is a volatile movement between the currencies speculators and arbitrageurs came into action and some new terminologies derived from them like Yen Carry trade, Super Carry trade and not to forget the haute couture Quantitative Easing.
Some FAQs on them:
The famous Yen carry trade:
This is where an investor, such as a hedge fund, borrows money cheaply in Yen, and then invests the proceeds elsewhere, such as a higher yielding currency. This is attractive because Yen interest rates are so low (near 1%), and investing in an alternative currency, such as US dollar bonds (at maybe 5% yield), provides a nice profit. In this example, the “positive carry” from the trade is 4% (5 -1%). An investor that does this trade accepts the risk that the yen appreciates. A 4% jump in the yen could wipe out an entire year’s worth of profit. The yen has been range bound, in a reasonable tight range for years, so many Hedge Funds and other investors have been happy to take the risk.
Super carry trade:
In the Yen carry trade the currency risk is always a major factor impacting the cash flow, Yen v/s Dollar, whereas in case of Super carry trade, countries like Brazil which offer dollar-denominated bonds, and the short-term interest rates in Brazil is 10.75% far higher than India. US banks today can borrow at virtually zero interest from the Fed and invest at high rates in Brazil, eliminating the currency risk termed as Super carry trade.
Central banks usually stimulate a slowing economy by cutting interest rates, which encourage people to spend by borrowing more or discouraging them to save. But with interest rates in the developed world already close to zero, that option is no longer available. In such situations, the central banks resort to pumping money directly into the economy, a process known as quantitative easing. It is done by buying bonds — usually government paper but can also be private bonds — from banks and financial institutions. The developed countries used quantitative easing to spur growth in the aftermath of the financial meltdown of 2008. (Source ET).
The world economy is now witnessing yen carry trade, super carry trade and quantitative easing, impacting the economies where cheap money from developed economies may flow into emerging economies and fuel asset bubbles and inflation there.