The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis (BUSINESS BOOKS)

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Protect yourself from the next financial meltdown with this game-changing primer on financial markets, the economy - and the meteoric rise of carry. money-printing presses went into overdrive. A myriad of emergency funding windows were opened to enable cash to be injected into the financial system, and from virtually any and all directions. Sovereign borrowing and credit guarantees were issued left, right, and center. Direct public funding was placed into all the major American banks and many of the smaller ones” This, “unprecedented deployment of liquidity and direct involvement in markets played a critical role in reconnecting the wires of the market system and restoring trust (p. 48, El-Erian) The financial shelves are filled with books that explain how popular carry trading has become in recent years. But none has revealed just how significant a role it plays in the global economy--until now.

We will only delve on as much history as needed to construct the foundation. At the precipice of the 2008 GFC, liquidity seized, and interbank trust evaporated. The fed’s immediate actions of: Both the extremely high level of the equity market, which cur­rently matches the previous peaks of 1929 and 2000, 18 and the low level of volatility over the past decade, indicate that we face a high risk of a major bear market. The Rise of Carry provides a timely des­cription of how this situation has arisen and an urgent warning of dangers ahead. This article originally appeared in American Affairs Volume V, Number 2 (Summer 2021): 46–59.

Tim Lee and Kevin Coldiron

The authors do not make this distinction sufficiently clear, defining carry as a trade with ‘short exposure to volatility’. This is correct for short volatility trading, but not for FX carry where only volatility in the wrong direction is problematic. But perhaps I am being too pedantic. Higher yielding currencies are usually emerging markets. These get hurt when risk levels are elevated, whilst lower yielding currencies are normally ‘safe havens’ like the US and Japan. To sum up the “anti carry” regime, it is essentially a world where inflation is alive and even potentially hyperinflationary. The authors seem to believe this as a solution can help clear up the debt burden in real terms and restore growth in the economy. The actual issue is far more complex and the only way to grow out of a debt overhang is real productive growth in the economy not by monetary inflation. The central thesis of the book is as follows. The financial authorities of developed countries artificially suppress volatility in financial markets. In the past few decades, selling volatility has been too profitable. The buyers of put option made significant profits in those rare periods when the bubbles collapsed. However, even despite it, buying volatility has been too unprofitable.

For me, the conclusion of the book is - the rich get richer because they never actually have to face consequences of their investment strategies. This is based on the fact that there is extreme volatility suppression aided by central banks. The ways that carry, volatility selling, leverage, liquidity, and profitability affect the business cycle Protect yourself from the next financial meltdown with this game-changing primer on financial markets, the economy—and the meteoric rise of carry.Interestingly, this expectation of ample liquidity runs counter to what has actually transpired when consensus views have changed and investors have sought to reposition their portfolios accordingly. In May–June 2013, when Chairman Bernanke uttered that famous word — “taper” — and raised questions about the Fed’s continuous support for markets, many investors were unable to complete their desired transactions for even the most vanilla-type securities (p. 115, El-Erian) For most of the twentieth century, the neoclassical synthesis in economics was generally believed to provide a solid basis for public policy. There were, nonetheless, significant dissenters. Hyman Minsky, for instance, wrote that “modern orthodox economics is not and cannot be a basis for a serious approach to economic policy.” 1 In the wake of the financial crisis and the great recession of 2008, such questioning became even more vociferous, and criticisms like Min­sky’s are now increasingly accepted. However the world has changed. Currently the US dollar has an interest rate more than 2% higher than that of the Euro. A carry trade where US dollar deposits are funded by Euro loans would not necessarily do badly in a global market crash.

The Rise of Carry provides foundational knowledge and expert insights you need to protect yourself from what have come to be common market upheavals—as well as the next major crisis. Worst of all, these idiots have become insolent because of years of impunity for their stupidity and theft. Central bank policies are largely to blame for that. After losing their fear, our dear leaders no longer see the need to strengthen the systems that keep them alive. Moreover, they are actively trying to destroy those systems. In Russian, we call it sawing the branch on which you are sitting.

My Book Notes

But, as the authors point out, carry trading is not limited to rogue traders. Collecting steady premia is what an insurance company does. Banks, who borrow and lend to earn an interest rate spread, are also carry trading. But insurers and banks diversify across many customers, transforming a portfolio of risky bets into a benign balance sheet. In contrast, most carry trades in the financial markets are correlated in market crashes, so true diversification is hard to find. Over at least the past 30 years financial markets have become increasingly dominated by carry trades; markets can be said to be in a ‘carry regime’. Carry trades have in common four features: 1) Leverage; 2) They provide liquidity to markets; 3) Short volatility exposure; and 4) a ‘saw tooth’ return pattern. Particularly because of the liquidity provision feature, carry trades have always had a role in the financial system. But certain non-market developments, particularly the increasingly dominant role of the Federal Reserve and other central banks, have led to the evolution of the carry regime. The main reason for the surge upwards in the indicator, to unprecedented levels, is the collapse of money supply, with my estimate being that for Q1 M2 will be -2.6% year-on-year, unprecedented in modern history.