The dollar carry trade, Chimerica and de-zombification

This is an interesting video I ran across. It illustrates some of the dangers of low interest rates. While the Fed thinks that low interest rates help stimulate the economy, they instead encourage speculation. In this video Warren Pollock shows how investors can borrow US dollars at 1% and buy Australian bonds for 4% and make an arbitrage profit.

Here are some more thoughts it triggered in me. Borrowing money has another positive aspect to it as it allows you to short the dollar. If a lot of people either go long or go short on a given asset, it can become a self-fulfilling prophecy, e.g. people buying real estate drives the price up. So the huge debts, denominated in dollars, can actually drive the dollar lower, in a reverse bubble. And since investors profit on this and as other investors jump in, the dollar falls even more. Our government is in a sense, also a speculator in this market, because it is borrowing money now that it can repay in cheaper dollars in the future. The losers are those who are long the dollar, i.e the Chinese investors in US t-bonds. Anyways, to me, this illustrates some of the dangers of very low interest rates.

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Another relative mini-topic has to do with the "false bull market". Instead of people buying Australian bonds, they might invest in the stock market. By borrowing money to do this they can short the dollar, so this is another example of the dollar carry trade. Keeping the rates artificially low benefits those who can borrow at low rates and do the dollar carry trade. It is form of fiscal stimulus, but only a few rich people benefit. They should call it a trickle-down stimulus.
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Another unrelated issue I have been thinking about has to do with Chimerica, which Niall Ferguson described. Chimerica is the dysfunctional marriage of Mr. China and Ms. America. America is a wild crazy unpredictable woman who likes to go shopping and max out her credit card. China is the boring hard-working man who is in love with America and keeps paying her bills in the hope that she will love him back. But she never will. And someday China is going to wake up and complain about being taken advantage of and will want a divorce. But not today. China is an enabler and encourages America in her self-destructive behavior.

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Yet another topic I want to blog about but don't want to make a separate post has to do with de-zombification. A zombie bank is one that has a negative net worth but is still kept alive. Creditors of a zombie bank may value its debts at face value, whereas if the bank were to die, the debts would be worth much less. The suspension of mark-to-market allows banks to value assets at their 2006 peaks instead of current fair market value. This discourages them from trying to resell foreclosed houses because if they resell them they would have to recognize losses whereas if they keep them on the books they can pretend that they are worth much more. The banks are not crying over spilled milk because they are pretending that the milk never spilled. They are living in denial in a fantasy land.

Debtors can also be zombies if they pretend that they can someday pay their debts when it is clear that they can't. The reason for hanging on to toxic debts can be pride and refusal to face reality, but it doesn't do them or their creditors any good. Being a zombie prevents you from actually living and fulfilling your capacity. And it also stops those who are relying on your false promises from moving forward.

It is time for a break from the past, which is necessary to move forward to the future. It is time for de-zombification, for deleveraging, for debt destruction on a massive scale. Yes, this will cause many banks to fail, but that isn't such a bad thing. We can live without credit or debt and this would be very empowering. Yes this will cause deflation but that is a good thing because it will make the dollar stronger and encourage savings. Those who are against this are those who are benefiting from the destruction of the dollar, like the dollar trade speculators.