“It seems I have a yen to lose...”
- Carly Simon

Viva Recklessness! Long Live the Prom Queens!

Today, the significant news is that the European Central Bank has raised its key-lending rate to 3.75%, warning of growing inflation.

That puts exactly 325 basis points between the yen and the euro. A speculator can still borrow in yen, convert to euro, and lend the money out - pocketing 3.25% of gross margin yield. Using leverage unwisely he can leverage that return up to the point where he is almost sure to go broke.

The yen carry trade lives on!

But we are not high rolling international speculators here at the Daily Reckoning. We are low rolling, stay-at-home plodders more interested in the return on the local Laundromat than on yen carries.

Still, there are butterflies flapping their shiny little wings all over the world of finance. One of them is bound to send shirttails flying somewhere.

And thus begins some rambling reflections fit for a quiet Friday morning.

If investors think they can make money by investing in euro they should look at the New Zealand dollar. The Kiwis raised their rates too - citing the same zeal to declare preemptive war on inflation. The gap between a short yen position and a long New Zealand dollar position is precisely 700 basis points. That looks like easy money to us...as long as nothing goes wrong.

And nothing ever goes wrong...until something goes wrong. We had our eye on the yen, because we saw it as something that probably would go wrong. At some point - perhaps last week - investors were bound to get a little nervous. When they got nervous, we reasoned, they would make haste to exit their risky speculations. Since they are overwhelmingly short on yen, they would necessarily have to buy it back in order to unwind their positions. This would force the yen to rise.

And the yen has been going up. If it continues upward it will both signal the demise of the carry trade...and bring it about.

The math is elementary. Let’s say you have $1 million you want to put into this play. You leverage it up to borrow $10 million in yen. Then you invest the $10 million in NZ dollar bonds. If all goes well, in raw numbers, you make $700,000 in net yield - or 70% or your original investment.

But what if it is the yen that goes up 7%? Ai yi yi...that’s $700,000 more that you have to pay back. Now you’ve lost 70% of your original investment.

Yes, dear reader, it is a wicked, treacherous world, although no one else seems to notice. While we still fly our ‘Crash Alert’ flag...and while the world lost $2.5 trillion in equity value last week (before recovering some of it)...and while the yen rises ominously...we see few signs that investors have gotten the message. Most think that today’s gush of liquidity will gush on forever and that today’s investment sweethearts - stocks, bonds, art, property - will remain prom queens forever. Eternally young. Forever beautiful. Oh, dear reader...if only it worked that way!

And here we let you in on a little secret. Pssst...don’t tell anyone...but stocks are going to sag and fall. Especially those cute little Asian beauties. Bonds too. And art? Today’s belles will be yesterday’s news...rejected, ignored, neglected - like the prom queen’s mom!

Even housing will fade and fall out of fashion. It’s already happening. Quietly, prices are being cut...while mortgages go bad. It may not yet be the end, or even the beginning of the end, but it is surely the end of the beginning for America’s housing boom.

Our old friend Marc Faber says he’s lived through four MAJOR financial booms in his lifetime. There was the boom in commodities and precious metals in the ’70s...then the boom in Japanese assets in the ’80s...then the mania in emerging markets in the ’90-’98 period...and finally, the bubble in tech and telecoms in the ’90-2000 era. During each one of these booms, people thought the good times would last forever, ‘because there was so much new money coming in.’

Today, that is just what people say about China, art, and London property
- and stocks and bonds, generally. But each bubble popped...and its brightest stars - its alpha companies...its go-go market leaders...its prom queens...and its celebrity kings - all quickly vacated the headlines. When they reappeared in the news, it was in the fine print...that is, in the notices for workout, refinance and chapter 11.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.