I have received the following letter from a reader of my column: I have been reading your work for a number of years and always look forward to your thoughts, particularly when they run counter to conventional wisdom. In your latest piece you suggest that the falling dollar (or rising yen) actually strengthens the yen carry trade. My chartwork argues otherwise, and your logic escapes me. I would welcome clarification of one particular paragraph of yours, especially on the last sentence that, I believe, is central to your analysis. You wrote: „This is where I take issue with conventional wisdom … What they miss is the fact that the bear market in the dollar actually helps rather than hurts the yencarry. The terms of trade for those who sell yens to buy dollars is improved immensely by the fall of the dollar. The yen carry trade can be described as arbitrage with short leg in the yen bond market and long leg in the dollar bond market. Profits on the long leg increase faster than losses on the short as a result of dollar devaluation.” I don’t follow this. Yes, borrow yen at 1 percent and go long dollar bonds at 4 percent. But over the holding period you lose on the dollar’s depreciation. I agree that a falling dollar means that over time you can buy more and more dollars with borrowed yens. But for borrowers, who short the yen, the ever more ’favorable ’ terms of trade work the opposite way in the end. It costs you more and more dollars ─ and then some ─ to buy those yens back and repay the loans (assuming that finally you do close the trade). Concerning the last sentence quoted, it is true that as long as the US longer term rates stay low or, better still, fall further, there are capital gains that might override forex losses. You don’t explain it that way, though, so I am not sure that this is what you mean. If so, it is not the falling dollar that assists the carry, but the falling US interest rate. And I question whether long rates are are as closely tied to forex rates as short rates sometimes are
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