Sometimes It Pays To Have Common Sense

There is an article in the UK Daily Telegraph today headlined "Japanese grannies trounce Kiwi bank." It recounts the latest intervention by the Reserve Bank of New Zealand in the foreign exchange markets. Due to the high interest rate differential between the NZD and JPY, Japanese run-of-the-mill speculators have found it profitable to borrow the yen to fund purchases of the kiwi.

Who wouldn't when they can borrow the yen at .08% per annum, turn around, and lend it at 7.80% in New Zealand dollars? (See JPY ask interest and NZD bid interest below.) The difference is a return on borrowed capital.


Anyhow, as people bid up the kiwi in droves, the NZD/JPY exchange rate appreciates. This makes New Zealand's exports even less competitive. Excess capital inflows also accelerates inflation, which means that the central bank must raise its interest rate further to stabilize prices. Or, it can attempt to offset some inflows with outflows by selling its own currency in the forex markets.

So far, intervention by the RBNZ has proved to be difficult, if not ineffective. It's a small bank; it does not have enough cash reserves to fight off "speculators" on the hunt for high yield.

After all, capital markets are numbers' games. No matter who or what you are, you have to be on the side with the largest number of people, or the highest amount of capital, in order to make a difference. If you have nil for capital and you go against the market, tough luck. So what if you're a central bank? Whereas if you have a lot of capital, as the People's Bank of China does, you can pretty much make the market lean towards you.

During the last 3, 4 weeks, I have not materially participated in carry trades, largely because of fear and largely because I am living with the ghost of rationality. Coming from the academia, I always have this illusion of being smarter than the average trader. Hey, I have a working knowledge of all these arcane theories, so I have got to be, right? Wrong!

After AUD/JPY traded above 100, and USD/JPY, above 122, I basically stayed off them. "They're overvalued," I said. Little did I know, those two JPY crosses kept propping up and I've missed out on practically ALL appreciation and associated carry interest. Why? For no other reason than that I lack common sense.

Now it's too late to do anything about it. I can't really enter into carry trades right now because they are too popular. Everyone's talking about them. (Here's another article within the last 24 hours about carry trades.) This self-fulfilling cycle is about to become self-defeated. The present time is similar to the beginning of 2001, before the stock market bubble busted. On the other hand, I can't enter into counter-carry trades for the sake of my doom forecast, either. The consequences of my being wrong are too great: I would lose my trading capital in two ways 1) through payments of carry interest, and 2) through further strengthening of JPY crosses.

Great, now I've got mental paralysis from too much analyzing; I can't act. This is why sometimes it pays to have common sense. If I had common sense, I would know what the common trader is thinking and act on that. I would be much more successful than I am. No wonder successful traders have no Ph.D.'s, and no Ph.D.'s are successful traders.