How to become a billionaire


Japanese Yen.
Courtesy of Bank of Japan Currency Museum.

so I mistakenly thought the US real GDP for 2006 was going to be lower,
2.5 %, and it surprised with a high of 3.4 %. Then, what was it that
compensated the loss of growth in the US housing slowdown? From the latest BEA report and
looking at the fine print (Table 2), we find that the relevant items
with contributions above the 2005 GDP are:

  • The export of goods with a
    0.24 % contribution,
  • government expenditures (mostly at the state
    level) with 0.23 %,
  • and a surprising cleanup in US inventories to the
    tone of 0.56 % …

…Christmas sales went well… and the states helped with some extra spending.

But, looking around for an excuse to my… blindness, I ran into the whopping sums that the US financial sector is harvesting around the world
–which I found a lot more interesting.

And how is this possible..?  Traders are reaping these huge profits from the Yen carry-trade. To get an idea
of the magnitude involved, let me borrow the following comments from Hellasious in Brad Setser’s blog:

According to the Bank for International Settlements (BIS), as of end
June 2006 there were $3.1 trillion worth in such yen FX forward swaps
(and outright forwards) at banks and other financial institutions. This
should give us a pretty good idea about the carry trade. Not all $3.1
trillion, but $1 trillion is a certainty and perhaps $2 trillion. The
other figure, $34 billion is way way way too small.

And do we have any idea of how much money are the players making in this trade?
To answer, I’ll again refer you to Hellasious comments:
(And, here’s the lesson for the billionaire want-to-be.)

A hedge fund (or anyone else) can do a forward swap in one package with
his bank. The bank’s dealing room will put the trade on for him and
just charge him a spread on the "carry", i.e. instead of making 5%
"carry", the speculator will net 4.50%. No need to go through all the
individual steps outlined above. The speculator puts up margin money,
typically 5% of the sums involved and sometimes as little as 2%. So to
put on a $100 million swap all you need is $2-5 million in cash or
acceptable collateral. If it works out as planned, the speculator’s
annualized gain is $4.50 million, or a return on equity of 90%-225%.

Naturally, under such high leverage conditions the potential losses are very large too.

urge everyone to visit the BIS site and look up the relevant FX forward
data for yen. The amounts have jumped very substantially from $2.3
trillion to $3.8 in 5 years. A big part of the increase has come in
just 6 mos., going from $3.1 to $3.8 trillion between Dec. 2005 and
June 2006 (latest available data).

For a country like Japan
with near zero economic growth and interest rates, such a huge jump in
swaps points clearly to speculative activity rather than commercial

Ok, did any of you wake up with those percentages and the amounts being
traded? No wonder, the traders are making $58 million USD in bonuses…

To sum it all up, BoJ is the ATM for world credit at almost 0%, and
some very slick US operators have been using the new derivative
currency swaps to play the low volatility, low Japanese rates, for a
carry trade that has them making a killing –in the order of trillions
of USD, not bad… not bad at all…

BTW, Hellasious has this nice post on the Yen carry-trade that you might wish to visit. Also, Brad continued the theme in his next very interesting post.