Trouble With the Carry Trade

Secret World of Money
2007 – Q1
Trouble With the Carry Trade 

The Bank for International Settlements (BIS) in Basle, Switzerland, is the Central Bank’s central bank. It is the outfit John Kennedy referred to as the “Gnomes of Zurich”. Among its members are the central banks of the world, the G-7, such as the Bank of England, the Bundesbank, the Federal Reserve Bank, and the Bank of Japan.

The Bretton Woods Conference established the gold-backed dollar as the world’s reserve currency. The U.S., however, abrogated that standard by closing the redemption window in August 1971. From that point forward, no one could redeem dollars for gold. The Federal Reserve has ever since been creating un-backed dollars against which no gold was held. American banks led by Chase and Citibank acquired control of the world’s businesses with these freshly created dollars.

The U.S. left the gold standard, and the dollar began to float. In consequence, the U.S. national debt started to increase and now stands at over $9 trillion. While we had abandoned gold, the BIS was buying it. Today, the BIS stands as the single largest owner of gold with 350 billion dollars worth. The BIS’ goal of bringing down the dollar as the reserve currency has not yet been achieved, but it will be. To derail the dollar and the Wall Street miracle takes a lot of money. In August 1995, when bad loans and scandals threatened the Japanese financial markets, the BIS instructed the Japanese to lower their loan rates to 1/2%. The rate of 6 1/2% on U.S. Bonds created an opportunity for speculators, centered on the BIS, to borrow Japanese yen, sell the yen for dollars, and buy U.S. T-Bonds; thereby yielding a tidy profit on the difference.

This has been the strategy for 10 years now with mind-boggling volume. It has created a demand for U.S. bonds, which has rolled over into stocks and unnaturally buoyed the value of both. The same thing has been done with BIS gold, and gold from the London Gold Pool. The primary owners of the Federal Reserve and other speculators borrow gold from the BIS at about 1% interest and promptly sell the gold into the open market. They then use the dollars they receive to buy T-Bonds.  This scheme has created a potential nightmare.

Sooner or later these positions must be unraveled.

The gold and yen was borrowed and sold will have to be bought back, and the bonds that were bought with the borrowed money will have to be sold. The totals are well over 2 trillion dollars, almost 20% of the total U.S. debt. As long as gold and the yen are going down and bonds are going up, this so-called “carry trade” is quite profitable. But any one of a number of things could rekindle the rise in gold or the yen; or U.S. bonds might start to fall and then the other shoe will drop.

The resulting frenzy would feed upon itself. Margin calls would ruin the leveraged speculator in short order. There would be no way to stop the carnage. If the Japanese Prime Minister decides, as a great many others are contemplating, to sell off Treasury Bills and switch our funds to gold, then the bond market will lose a larger portion of its value.

If the Japanese cannot resist selling bonds near these highs, or buying gold near its lows, why should you?  Do you think bonds will stay up or that the gold will stop its ascent? Not very likely.

Pay attention and be prepared. The scenario has serious implications for the dollar. If the worlds’ investors lose confidence in the future of the U.S. and suspect the country may at some point allow inflation to erode away its debts, they may reduce their holdings of U.S. Treasury bonds. Noted financial experts have calculated that the country’s long-term fiscal gap between all future government spending and all future federal revenues will widen significantly as the current generation retires, and as the amount of money that the government will have to spend increases, the supply will have to rise accordingly.

The total fiscal gap could be a mind numbing $65 trillion.

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