1) Japan -> Australia

carry trader: danger: jpyaud up, hedge: jpyaud long

contract prices in aud
jpy exporter: danger: audjpy down, hedge: audjpy short = jpyaud long
aud importer: safe

contract prices in jpy
jpy exporter: safe
aud importer: danger: jpyaud up, hedge: jpyaud long

2) USA -> Norway

carry trader: danger: usdnok up, hedge: usdnok long

contract prices in nok
usd importer: danger: nokusd up, hedge: nokusd long = usdnok short
nok exporter: safe

contract prices in usd
usd importer: safe
nok exporter: danger: usdnok down, hedge: usdnok short

Seems like there are more natural counterparties for the carry trader in case 2.

Btw. very interesting discussions about carry trade on this blog. Thanks to all participants.

Macroman — so who takes the $ long in the derivative position? if it is someone who then has to hedge via a real money outflow to take an offsetting $ short, it ends up adding to the United States’ funding problem.

If by contrast it is someone who thinks the $ has fallen far enough and wants to be long the $, it doesn’t produce an offsetting outflow — but the fact that the $ long offsetting a $ short means that someone else needs to take a $ long to fund the US current account in dollars.

why do posts on the c. trade produce better discussions than posts on China?

Andrew, to answer your query…I really don’t know what to buy against the dollar as a “carry” story. My preference is to bet on BWII springing significant leaks- buy GCC, JPY, hell, even CHF. In a higher volatility world, carry is less attractive…so it seems to me that the optimal strategy is to buy currncies where there is either an embedded or implicit short position, or a realy policy need to alter the current regime. It sounds as if the GCC, for example, is “smoking” again. Another option might be RUB, where inflation is clearly running out of control and they have yet to deliver the usual early-year reval in the basket; quite the contrary, as the RUB has weakened against the basket so far this year!

seconded – the scales have fallen from my eyes; I can see clearly now… how arbitrary The System has become, which I think at least one Fed Prez gets:

“…the dynamics of production and demand among the new participants in the global economy nonetheless impact us in different ways at different times. As these new participants joined the global economy, they provided significant tailwinds, helping us grow by providing cost savings, new sources of productivity enhancement and new sources of demand, helping fatten both the top line and bottom line of our businesses while also holding down inflation… I think it is now clear that the winds have shifted. The growing appetite for raw inputs from the new participants in the global economy represents an inflationary headwind that is unlikely to soon abate… If I am correct, then the situation today is the flip side of the 1990s and early 2000s: In delivering on our mandate to be monetary policy ‘owls,’ we will have to err on the side of running tighter policy than would otherwise be justified if we wish to limit upward inflation pressures…”

“To be owlish, and to avoid the imbalance of emphasis that gave rise to needed harsh discipline imposed by the Volcker FOMC, one has to bear in mind that the seeds of inflation, once planted, can lie fallow for some time, then suddenly burst through the economic topsoil like kudzu, requiring a near-toxic dose of countermeasures to overcome.”

&

“Inflation is like absinthe. The narcotic allure of inflation is a dangerous thing. It might seem like the remedy to bail out a government or a bad book of business and forget your troubles. Yet our experience in the past has taught us only too well that inflation is a dangerous elixir that ultimately proves debilitating for businesses, consumers, investors—including those foreign investors who have lately come to the aid of some large balance sheets here—and especially for the poor, the elderly and people on fixed incomes. It even inculcates bad financial behavioral patterns in the young by encouraging spending rather than investment and saving. Inflation is bad for Main Street and Wall Street and even for Sesame Street.”

&

“As a voter on the FOMC this year, I stand ready to take substantive action to support growth and provide insurance against downside risk, as long as inflation expectations remain contained. You will note the operative qualifying words there were ‘as long as inflation expectations remain contained’… I have no intention of being party to any action that might shake faith in the dollar.”

&

“The late Dame Mary Douglas was no Ben Franklin. Nor was she a Philadelphian. She was a brilliant British economic anthropologist who wrote a pathbreaking book titled Purity and Danger. In it, she wrote something that Franklin or Stephen Girard or any good central banker since the onset of time has understood implicitly: ‘Money can only perform its role of intensifying economic interaction if the public has faith in it. If that faith is shaken, the currency is useless.’ ”

&c.

there is still a translation* that can be made from the arbitrary nominal world — where K-Fed albums have currency — to the ‘real’ world (thru the inflation rate – however measured and/or believed). if I may presume, moldbug would like to do away with the monetary abstractions of the nominal world (or at least make them explicit – it’s mold, not gold, of course!) and would instead have us operate or ‘program’ on bare metal, so to speak. for me, I think abstractions are convenient yet prone to misinterpretation if not abuse — there are good and bad translations (even languages, if you subscribe to Sapir-Whorf) — so in the end how these abstractions (or lack thereof) affects the real world** should provide the basis for any analysis; real rates are what matter, imo…

—
*moldbug’s apparent adeptitude at software programming on top (knowing the pros & cons) of ISA level hardware abstractions, I think makes him particularly suited to the task
**altho our understanding of what constitutes the real world should also be open to interpretation

presumably there are two main sources of $ liquidity in the eurozone: central bank $ deposits in european banks (eurodollars, in the original sense) and the accumulated profits of US MNCs that keep profits offshore for tax reasons, but generally prefer to hold $ rather than euros for balance sheet reasons.

good discussion; it forced me to sharpen my thinking.

The Federal Reserve’s unexpected inter-meeting cut of 0.75% in the Federal Funds rate to 3.5% was accompanied by a sharp rally in the dollar bond market, as the 10-year Treasury bond yield dropped to 3.4%. With inflation well above 4% and rising, one can only ask: why? Why would anyone buy the obligations of a shaky deficit-ridden political system in a currency that appears fundamentally unsound?

In the short term, the specter of inflation is looming ever nearer. Sharp reductions in interest rates and insertions of liquidity into the system have increased the supply of money chasing goods, at a time when commodity markets are already stretched. Hence, not only is the dollar likely to decline owing to the extra liquidity, but commodity prices are likely to rise further. The result cannot fail to be accelerating inflation; as I wrote last week, I expect even reported inflation to hit an annual rate of around 10% by the end of 2008.

In summary, like General Motors in 1970, the United States does not deserve its AAA rating and its obligations, particularly those denominated in the local “Bernanke pesos” should be avoided.

a) As Brad points out, apart from the current account component, the “tailwinds” of gross capital outflows from a carry currency host country such as Japan must be offset by the ‘headwinds’ of required offsetting gross capital inflows.