How Yen Carry Trade Benefits Japan

(I was asked about the unwinding of the Yen Carry Trade on another forum, so I wrote up this quick summary.)

Hedge funds playing with other people's money borrow Yen, which they'll eventually have to pay back with interest. As they buy dollars and other currencies with the Yen it drives the Yen down for now and helps Japanese manufacturers sell their goods.

It also creates profits for Japanese banks who normally have trouble finding enough Japanese to borrow money and keep the money supply growing. I estimate around $50 Trillion Yen have been created out of thin air by Japanese banks for Yen Carry Trade related borrowing. Interest on this new money is pure profit for japanese banks. Call it $10 Billion in profits annually for Japanese banks with other economic benefits as long as the carry trade continues.

The YCT is a Ponzi scheme with the BoJ acting as chief schemester. To keep the yen suppressed requires ever more borrowing of Yen to be sold for other currencies, which in turn leads to greater profits for the Japanese banks. Also, most of the trades entered into by hedge funds playing the YCT accept very high long term risk in order to maximize short term gain. Eventually, however, long term realities coupled with the weight of the Yen denominated debt and the will bring the majority of hedge funds playing the trade back down to earth. As the trade unwinds, the Yen rises and carry traders will lose out on the conversion back to Yen, resulting in a very large gain for Yen holders (i.e. the entire Japanese economy).

The BoJ tends to go for extreme economic interventions to benefit the Japanese banks. It pumped a huge amount of liquidity into the Japanese economy during the recession years, then drained it out during big carry trade years. The Yen created by the YCT sit in Japanese accounts waiting to be converted in to foreign assets when the trade unwinds. The BoJ can create as much new liquidity as it likes to offset the conversion of those Yen into foreign assets when the YCT unwinds.

There will likely be a very large economic shift when the trade does unwind. Japanese manufacturers will be at a huge disadvantage, but Japan will be sitting on monstrous amounts of foreign reserves. The Japanese consumer sector will likely take off as Japan adjusts to a much higher standard of living.

In answer to your question about the Japanese stock market, I'd expect the Japanese manufacturers with enough overseas production to do well, while those will all their production in Japan should have trouble. I'd also expect Japanese retailers and service providers to do well. For now, however, the YTC continues stronger than ever and the Japanese consumer sector has been weak.