The Rising Sun’s Setting on Easy Money

The sun is setting in the Land of the Rising Sun.

The world awoke Monday morning to news of Japan’s 10-year bond yields surging to 1.84%—the highest since 2009. Now, rising yields certainly sounds pretty good; everyone wants to earn more money, even the Japanese.

But rising yields on Japanese bonds bring chaos—because the bonsai roots of Japan’s low-yield system are finally breaking the container they grew up in.

That’s because of a very dry topic called the “yen carry trade.”

Sorry to do this to you, but I have to ‘splain the yen carry trade briefly so you understand how dots will begin to connect from here. And you know by now how much I love connecting me some dots!

The yen carry trade in a nutshell:

• Investors all over the world borrow yen they don’t own and immediately sell it. In doing so, they are paying interest to the buyer of those yen. But interest on yen has been on the floor for decades, so the cost is peanuts (keeping with the nutshell theme).
• Those investors take the proceeds from selling yen and put that money to work in higher yielding currencies and assets such as US dollars, Aussie dollars, South African rand, real estate, crypto, tech stocks, etc., and they collect a return from that.
• The returns they earn from the high-yield assets they buy exceed the interest payments they make on the borrowed yen. So, they’ve effectively created free money. Or, mostly free money.

That’s the yen carry trade… borrow one asset on the cheap to invest in another asset that generates higher returns… and then pocket the spread between what you pay to borrow and what you earn from investing the borrowed proceeds.

Easy money.

So easy, in fact, that over the past few decades, the yen carry trade has grown to about $20 trillion, only slightly smaller than the entirety of the US economy.

Now, however, the borrowing side of the carry trade math is suddenly fakata, a great Yiddish word meaning that the carry trade is now all screwed up because the cost of borrowing yen is on the rise.

And because of that, carry trades are unwinding worldwide, which is where the danger arises.

Though you’re probably not hearing anything about this on the nightly news shows, the carry-trade unwind is one of the reasons the dollar has been losing value this year. It’s a primary reason stocks are down in recent weeks. And it’s a key factor in bitcoin sliding hard from $120,000 to the mid-$80k range.

Now all that mostly free money from the yen carry trade is no longer mostly free.

Investors are selling assets the world over to buy back the yen they borrowed. That demand for yen, in turn, is driving up the value of the yen on global currency markets… which causes even more selling because as the yen rises in value, the cost of buying back all the yen one has borrowed is increasingly more expensive.

Now here’s where we start connecting dots that start in Japan but end up at the Eccles Building, where America’s Federal Reserve lives…

• The Bank of Japan, the country’s central bank, is hellbent on normalizing interest rates after decades of super-low rates that birthed the carry trade in the first place.
• The Trump administration, meanwhile, is equally hellbent on driving US interest rates down to 1%. That’s a likely endpoint, given that Trump is about two minutes away from firing Fed Chair Jerome Powell, announcing on Tuesday  his intention to replace Powell early next year. It’s almost guaranteed we’ll see a Fed chair much more acquiescent to Trump’s low-rate desires.
• As USD rates fall, and as yen rates rise, the dollar and the yen could reverse roles at some point, with the USD becoming fuel for the global carry trade, since borrowing rates in USD would be minimal relative to potential returns on risky assets.
• All that selling of borrowed dollars means the yen and other currencies would strengthen even more against the USD… Which exacerbates inflation in America because the US necessarily imports so many raw and finished products and has no option to stop doing so.
• Japan and other countries would likely increase their selling of US debt because of low yields, and they would increase buying of domestic debt or even yen-based debt, which would carry yields higher than the US. Lack of US debt demand pushes USD even lower.
• And when debt demand drops enough, the US faces big problems in trying to sell enough bills, notes, and bonds to fund daily operations and to make interest payments on existing debt. The Fed would have to step in as the buyer of last resort and print dollars to buy US debt…
• Which drives the dollar even lower and pushes inflation even higher.

And all of those dots mean that the surge in Japanese bond yields today is a huge warning sign to America for tomorrow.

Several dots down the line, we get to a point where the Fed must rapidly print more and more money, leading to greater and greater inflation, and a weaker and weaker dollar… which is going to be fantastic for gold and, ultimately, bitcoin.

We’re in a risk-off moment right now because the rising sun of the yen carry trade is setting, forcing investors to sell assets to close their carry trades.

But when Trump forces interest rates down to fit his economic narrative, flawed as it is, and when the Fed is then forced to step in and buy US debt to keep the government bond market from seizing up… risk-on assets will soar.

Now is the time to start regularly accumulating bitcoin and gold.

Soon enough a new rising sun is going to shine even brighter on those two assets.