The global economy could be poised for the creation of a potentially explosive dollar carry trade, analysts said yesterday.
The trade allows investors to borrow dollars at near-zero interest rates, which they use to fund asset-buying sprees around the world, and has been possible since the collapse of Lehman Brothers last year and the extreme monetary response to its aftermath.
The warning was issued at the Apec summit of Asia Pacific leaders in Singapore and came after a variety of assets started to display bubble-like patterns of inflation: everything from gold and copper to fine wine and Hong Kong penthouses.
As the carry trade grows more popular it could add more downward pressure to the already falling dollar, particularly if the “carried” — borrowed — dollars are immediately sold to buy non-dollar denominated assets in China or Singapore.
Analysts believe that it was the sudden unwinding of the yen carry trade — immense pockets of investment funded by cheaply borrowed yen — that sent the destructive ripples of the Wall Street crisis around the world last autumn.
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Carry trades, which essentially mean borrowing at low rates to fund higher return assets, make sense until markets turn sour and exchange rates shift too violently. At that point, the rush for the exit wildly exacerbates any crash. A collapse of the dollar carry trade has the potential to be particularly harmful because of its scale.
While a few prominent financial figures have already warned of the threat of an emerging dollar carry trade, governments have steered clear of commenting on the issue until now.
But talking on the sidelines of the Asia Pacific summit, Donald Tsang, chief executive of Hong Kong, admitted openly that the dollar carry trade had started to spread and that the prospect “scared” him.
Washington’s response to the recession, he said, ran the risk of emulating the behaviour of Japan after its bubble collapsed in 1989 and allowing overly loose policy and a rock-bottom cost of money to inflate asset bubbles around the world. “Gyrations in financial markets and bubbles in asset markets remain ahead of us,” he added.
Hong Kong is perhaps closer to the new asset bubbles than others: house prices there have risen 28 per cent this year and new records for land price sales have landed with thudding regularity over recent weeks.
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Behind Mr Tsang’s concerns is the fixed relationship between the Hong Kong dollar and the “greenback” — the so-called dollar peg that is the cornerstone of Hong Kong financial policy but is forcing its interest rates to be much lower than the monetary authorities would like. Hong Kong’s property inflation is being driven by mortgages that are cheaper than they should be but the authorities are limited in how they can respond.
Observers who have warned of the emerging dollar carry trade include Nouriel Roubini, the American economist.
He believes that the prolonged ability to borrow dollars cheaply risks planting the seeds of the next financial catastrophe. Carry traders feel more comfortable with their positions because of the Federal Reserve’s promise to keep rates “exceptionally low” for an “extended period”, he said recently.
Also attending the Apec meeting in Hong Kong, Robert Zoellick, the World Bank president, noted the risk of allowing liquidity to flow into equity and property markets in the region.
“In East Asia, if you start to get a strong rebound in growth, and you’ve got a lot of liquidity, there is the question of whether one could start to face asset bubbles in particular markets,” he said.