Why did the carry trade trap spring shut? Brandon Smith of alt-market.com explains why central banks typically coordinate their moves in secret – and what happens when they don’t…
From Brandon Smith
In 2022 there was considerable debate among alternative economists what the Federal Reserve was likely to do in the face of rising stagflation.
There were people who argued that the Fed would capitulate to investor demands, stop raising interest rates and return to QE. These analysts operated on the assumption that the central bank wants to save the US economy from substantial deflationary crisis and that they will happily print money forever in order to delay such an event.
Some of us, however, understand that the Fed is not loyal to the US economy, nor is it necessarily interested in self-preservation as an institution. In 2022 in my article It’s a Fact That Needs Repeating: The Federal Reserve Is a Suicide Bomber, I predicted:
This leads us to the final question – what happens next? That’s easy to answer: The fed continues to hike rates well into next year and will not reverse course or capitulate and return to stimulus. The dovish predictions were wrong. The people that said the Fed would not raise rates were wrong. The people that said the Fed would never remove support from investors were wrong. This process is ongoing and the effects will grow as the months pass, but those that were hoping for a manic return to the days of bailouts and QE are going to be deeply disappointed.
This prediction proved correct. I noted at the time that the Fed is not following its own program, it’s following a global program coordinated by the International Monetary Fund (IMF) and the Bank of International Settlements (BIS).
In order to understand why the Fed does the things it does, one must accept that they don’t care about the current world order.
They care about facilitating a new world order.
Behind the smoke and mirrors
Now, I usually don’t put much energy into watching CNBC or Bloomberg because all that’s a side show. Their entire programming is primarily built on a tissue of economic delusions and false hopes, broadcast to an eager audience of greater fools. Bubbles inevitably pop when their delusions are confronted with reality.
That said, every once in a while the smoke and mirrors fade, and you can get a glimpse of the high-finance hijinks happening behind the scenes.
For the first time since 2009, the Federal Reserve isn’t backstopping U.S. and European financial systems any more. Artificially low interest rates that were feeding cheap money into speculative leverage? Gone. Despite endless spin and questionable data from the Biden administration, the deflationary side of the crisis is starting to rear its ugly head.
A weaker-than-expected jobs report last week has fueled concerns about an imminent recession and calls for an immediate, even an emergency, interest rate cut from the Fed. Employers hired 114,000 workers last month, falling well short of expectations of 185,000 new jobs, U.S. Bureau of Labor Statistics (BLS) data showed.
The unemployment rate climbed to 4.3%, the highest level since October 2021.
Keep in mind that BLS jobs data has been rigged for years; the majority of jobs “created” since January 2021 are part-time, low-wage jobs (and most have been going to illegal immigrants, not to American citizens). The same illegal immigrants that Biden has allowed into the country through open border and amnesty policies.
This trend is only going to get worse going into winter.
Why? Because the effects of the high interest rates are taking hold. It happens slowly at first, then all at once.
As noted, the August economic panic has been partly driven by weaker-than-expected U.S. economic data at the end of last week. The readings led investors to worry that the Federal Reserve may be behind the curve in cutting interest rates to fend off a recession.
But why does the Fed continue to keep rates high if this is the case?
There are two reasons.
First, as I have mentioned over and over since 2018, the end of QE and the raising of interest rates is a Catch-22. A trap.
The U.S. economy has become so addicted to cheap money from the central bank that it can barely function without it. We are seeing the addict, deprived of his fix, begin to collapse. The trillions of Covid stimulus funding kept the system hobbling along for another few years, but now that hit of helicopter money is fading. The high is over. And the next fix is nowhere to be seen.
At the same time American families find themselves crushed in a stagflationary hydraulic press.
Prices continue to climb on most necessities and the cumulative inflation is around 18% (officially) on average since 2021. Compare receipts from 2020 to today, though, and you’ll find a 50% to 100% increase in prices on most goods and services.
The White House has been operating on the narrative that inflation has been defeated. The Fed knows that this is a lie – and so does everyone else who lives in the real world. Who doesn’t have a personal chef to handle their cooking and a chauffeur to keep their car filled up. The moment the Fed cuts rates, prices will spike again and the false narrative will fall apart even faster. There are just way too many dollars floating around chasing the same goods and services compared to four years ago.
Personally, I am doubtful that they will commit to rate cuts before the November election.
The second issue is what appears to be a “carry trade trap.”
The carry trade trap
Carry trades refer to operations in which investors borrow in a currency with low interest rates, such as the Japanese yen, and reinvest the proceeds in higher-yielding assets elsewhere (in this case, in the U.S. where the Fed’s refusal to cut interest rates has made buying debt more attractive). This trading strategy is a considerable driver of investor returns since the Fed tightened up the money supply.
This month’s panic was triggered by fears that the Bank of Japan might hike interest rates, coupled with expectations that the Fed will cut rates due to the recession threat.
This one-two punch, raising the cost of borrowing while also lowering its profitability, would utterly annihilate the yen carry trade the carry trade. Leverage and volatility act like angry siblings, feeding on each other during tantrums – and wiping out investors who’ve built fortunes “on paper.” Movements that would normally take months occur in a few days.
Just to get an idea of the scale we’re talking about, consider:
- Margin balances in Japan are at an 18-year high (margin means leverage, and leverage increases volatility)
- Margin balances in the U.S. are about $809 billion
- No one really knows the true scale of the yen carry trade, and estimates vary wildly (from $350 billion to $4.5 trillion)
There’s a lot at stake.
The yen carry trade is big enough to destabilize both the Japanese and American financial systems at the same time.
To prevent a destructive carry trade unwind the Fed would have to coordinate with the BoJ and introduce a new stimulus program to soften the blow. But, as I mentioned above, if the Fed does this inflation will skyrocket yet again.
It’s a Catch-22 on top of a Catch-22.
I believe there is no way out of this and that central banks deliberately maneuvered the U.S. into this predicament. The only thing left is for them to do is pull the plug when the timing is most advantageous for them. After the elections makes the most sense, especially if we see a red sweep and conservatives come out on top. Then, the whole mess can be wrapped up and thrown in their laps.
A disaster of that magnitude would make Bidenomics look pleasant in comparison.
One thing the events of this month prove is that the system is so unstable that even the hint of a change in the status quo could mean a global economic disaster. Don’t assume that banks will keep trying to kick the can down the road; they’re operating on a timeline that serves the interest of the global establishment, not you and me.
Expect more economic volatility in the months ahead, especially as the election approaches.
About Brandon Smith
Brandon Smith has been an alternative economic and geopolitical analyst since 2006 and is the founder of Alt-market.us
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Birch Gold Group.