Tuesday, November 17, 2009

Currency Carry Trade

I have and a friend who some years ago spent a year and a half and a day in Saudi Arabia. The time is important because it made his income tax free. For the first few years I knew him (and perhaps to this day) he made his living essentially by changing that money back and forth into other currencies (generally the Swiss Franc) picking up a little gain on the changes in the relative values of the two currencies. Apparently he did it pretty well, because he rarely sought employment and lived relatively well.

Currency carry trade is a lot like that but on steroids, and involves the arbitrage on the interest differences as well as the relative value. One borrows money somewhere where the interest is arbitrarily low (like the US right now) and parks the money in bonds somewhere else with a higher return. In some cases, like George Soros, where your wealth and credit support it you even short the money - you invest money you don't even have yet!

Aside from the magnitude of the process (read too big to fail), there are examples with common sense failures in our ordinary experiences with this. I have two examples from the period of time I was in college many years ago. It was a time before computers when the velocity of money was not the speed-of-light, and we mere mortals could play too. It was just as illegal then, but time worked for us not against us. And we were too little not to fail.

In the first mea culpa, I lived in Pennsylvania, and went to college in Illinois. I had bank accounts in both states. When I didn't have enough money in Illinois, I drew upon my account in Pennsylvania and deposited it in my bank in Illinois. Ultimately, my money in Pennsylvania from my Summer job and allowances were running down, I did what the big boys do now ... I wrote a check on the Illinois bank and mailed to Pennsylvania. And then I could deposit a Pennsylvania check into my Illinois bank to cover it. I managed to do this for quite a while. Eventually It all fell apart. I was lucky, the small town bank in Illinois let me have a loan and I paid it off by working a small job in a woodworking factory before they caught on. But it didn't have to turn out well ... I quit while I was still ahead. Beats prison.

My other mea culpa is a he-a culpa. My college classmate Alan had a small business going buying old cars at auto auctions with a bad check. Tow-barring them home two at a time, cleaning them up and taking them to another auto auction where he would sell them at a profit, cover his check and pull a little out for himself. This one did not come to a good end though. One snowy night while coming home, he skidded on ice and wrapped his investment around a tree. Alan had to go hat-in-hand to his father who ran a savings-and-loan in a nearby small town to bail him out.

Right now, there are many 'Alans' and many 'me's. It is said they are too big to fail. I think the full statement has been truncated. They are too big to fail without taking the current currency system down with them, just as Alan and I took our wealth down with us. Morgan Stanley, and George Soros have the United States Government as their daddies to bail them out, but who it the United States Government's Daddy? I guess it will need to get a part-time job.

As my daughter would say "No good can come from this."

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