The yen carry trade

This demands explanation. Logic would dictate the manic creation of yen would make each one worth less. But during this period global borrowers, rather than Japanese borrowers, swooped in to take advantage of the cheap JPY. The colossal purchases of U.S. Treasury securities by official Japanese institutions (read: the Bank of Japan) during this period is but one example of what became known as the “yen carry trade.” A non-Japanese borrower would borrow JPY at near-zero percent rates, swap the JPY for their currency and then lend that currency at the higher available rate.

The risk of this trade was JPY appreciation, but as the Bank of Japan’s policy appeared to be to keep the JPY from appreciating, hedgers simply bought barrier call options and other capping devices on the JPY for a relatively cheap hedge. The yen carry trade was a form of vendor financing: By financing Japan’s customers, the Bank of Japan was able to support Japan’s export industries in the face of the Chinese onslaught.

There are several ways to illustrate the extent of the yen carry trade. One is to compare the annualized growth of Japan’s monetary base (its currency circulation plus reserve deposits at central banks) against M2 plus certificates of deposit. The former can grow by central bank action; the latter grows by extension of credit domestically. Once quantitative easing began, monetary base grew as rapidly as 31 percent on a year-over-year basis. M2 growth never exceeded 4 percent over this period. Someone other than Japanese banks had to be taking advantage of the cheap JPY.