From Chris Gaffney in The Daily Pfennig:
The best performers over the weekend were the Japanese yen and Swiss franc, both traditional funding currencies of the carry trade. As Chuck [Butler] has explained several times in the past, when market volatility increases, traders typically start to exit the carry trades which are only profitable during times of relative calm in the markets.
The reversal of the carry trades means investors sell the emerging markets and high yield currencies and use the funds to pay down loans which they had taken out in the low yielding 'funding' currencies of Japanese yen and Swiss francs. The Japanese yen strengthened as much as 3.4% vs. the US dollar overnight, and the Swiss franc had the biggest one day gain in six months.
We think that gold is also being used as a carry trade 'currency' as well, as the central banks lease their gold bullion cheaply to the commercial banks, similar to the low interest rates carried by the yen and Swiss franc.
The gold is sold off, probably to the ETFs and the metals markets, and is largely not returnable to the central banks in many cases. This is one of the reasons why the gold price is becoming so volatile; the 'printing' of gold by central bank leasing does not really create anything, it only distorts the market longer term.
Some day that volatility may become breath-taking.
Chris Gaffney continues:
I have to say I am surprised Treasury Secretary Paulson stayed away from helping another bunch of his Wall Street buddies. I read where Paulson said Wall Street has been aware of Lehman's troubles for a long time and had time to prepare for any crisis at the company. I know we closed out all of our currency trades with Lehman a couple of months ago, and hopefully most other prudent companies did the same.
I hope this weekend's events are an indication that some sanity has returned to the Treasury department, and a line has been drawn after the widest expansion of federal safety nets to the financial system since the Great Depression. Its about time we quit guaranteeing the losses at these huge financial firms.
More likely Lehman was a token gesture to free markets as we had suggested last week it might very well be. Paulson and Company appear to be willing to do whatever it takes to control the situation and the markets, to 'inspire confidence' in the system, to feed the bull market in insensible complacency.
In the short term this is a viable strategy, but at the cost of a disabling of the free market system, and significant unintended consequences down the road.
We wish them well, but don't think they have the right motivation and character to achieve a sustainable solution hat would involve systemic reform. They are creatures of the status quo.
