Consuming the Carry Trade

"Reagan proved that deficits don't matter." Dick Cheney, Jan 2004.

An urban legend claims that one has the protection of an angel when you drive your car at 100kph (about 63mph) or less. Accelerate and the angel gets out while the devil gets in. Exceed 200kph (about 125mph) and the devil also gets out. Long has the rule of thumb in economics been that a country should not exceed 3% of GDP as a Current Account deficit, a country's overdraft with the rest of the world so to speak. Exceed 3% and the devil gets in. However, some countries are now exceeding even 6% of GDP as a Current Account deficit and even the devil has deserted them. Surely driving your economy at a deficit of 6, 7 or 9% (or more) is an accident waiting to happen. Such deficits would normally have been punished severely in exchange rate depreciation. Carry trades and extreme provision of liquidity by Central Banks behind it, has facilitated a growth in deficit trading without the pain of sudden and severe exchange rate depreciations. Countries can and do live beyond their means while consuming the carry trade. Much like mortgage borrowers could consume fictional real estate values for a while. Who are these countries?

Chart 1

© Sarel Oberholster Data Source: International Monetary Fund - Current account balance; Percentage of GDP 2007. (*IMF 2007 Estimates)



In identifying the countries I have eliminated those countries with a GDP of less than US$100billion for the same period. Australia, South Africa, New Zealand, Portugal, Spain, Greece and Romania are driving their Current account deficits in serious crash territory. Poland, Ireland, UK, Pakistan, USA and Turkey are way beyond responsible Current account management. Moving on to the relative importance of each of these countries requires quantifying each deficit in a single currency.

Chart 2

© Sarel Oberholster Data Source: International Monetary Fund - GDP in USD Billions 2007 (may include IMF 2007 Estimates).


The relative size of the deficits in a single currency unit must be established to discern the relative importance of each country's deficit on a world economy scale.


Chart 3

© Sarel Oberholster Data Source: International Monetary Fund - 2007 GDP in USD Billions multiplied by the Current account balance; Percentage of GDP 2007 (may include IMF 2007 Estimates).


Chart 1 shows the extent to which these countries live beyond their means. Chart 2 shows the relative importance of each of the deficit countries in the global economy and Chart 3 shows the relative usage of current account deficits again in a global context. These charts do not deal with the compounding of deficits. They only deal with what happened last year. One further detail is required to complete the picture. How much are these countries paying? Countries pay in currency depreciation which shows up as imported inflation in their countries and more directly, they pay in interest.


Chart 4

© Sarel Oberholster Data Source: Central Bank benchmark rates have been obtained from the respective Central Bank websites.

Romania, South Africa, Pakistan and Turkey have to pay for the privilege of living beyond their means and to protect the relative exchange rates of their countries while they live the high life courtesy of the carry trade. The UK, Poland, Australia and New Zealand get an easier ride. Spain, Portugal, Ireland and Greece have the best of both worlds driving solid Current account deficits while under the protection of the EU. Nobody has a sweeter deal than the USA. It gets to drive a reckless 5.3% of GDP deficit and consumes 58% of the total share of the identified deficit living group (the rest get less than half!). Best of all it comes at a bargain basement price of 2%pa interest. Perhaps the world reserve currency status of the USD will continue to protect the USA. Perhaps I can drive my car at 600kph and not crash.

Somehow I think it is simply too good to be true and each of these countries will face the consequences, some sooner than they may expect. Do they also believe that Regan had proved deficits do not matter? I know I need a currency hedge, how about you?


Sarel Oberholster
BCom (Cum Laude), CAIB(SA).
August 2008

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Charts showing the trend in Current Account Deficit accumulation for each of the individual countries discussed in this article have been posted on my blog at http://sareloberholster.blogspot.com/ .


© Sarel Oberholster - 2008

Who is consuming the Carry Trade? (USA)

This is the last one on the alphabetical list:
Australia
Greece
Ireland
New Zealand
Pakistan
Poland
Portugal
Romania
South Africa
Spain
Turkey
United Kingdom
United States

The rest of the research into the Carry Trade will follow in my next post "Consuming the Carry Trade". Enjoy.

Who is consuming the Carry Trade? (UK)

More to follow.

Who is consuming the Carry Trade? (Turkey)

More to follow.

Who is consuming the Carry Trade? (Spain)

More to follow.

Who is consuming the Carry Trade? (South Africa)

More to follow.

Who is consuming the Carry Trade? (Romania)

More to follow.

Who is consuming the Carry Trade? (Portugal)

More to follow.

Who is consuming the Carry Trade? (Poland)

More to follow.

Who is consuming the Carry Trade? (Pakistan)

More to follow

Who is consuming the Carry Trade? (NZ)

More to follow.

Who is consuming the Carry Trade? (Ireland)

More to follow.

Who is consuming the Carry Trade? (Greece)

More to follow.

Who's consuming the Carry Trade? (AUS)

Here is the list in alphabetical order:

Australia
Greece
Ireland
New Zealand
Pakistan
Poland
Portugal
Romania
South Africa
Spain
Turkey
United Kingdom
United States

First up is Australia. More to follow.

Deflation, a thing of beauty

I have never been able to comprehend why deflation is a dark personification of economic evil to be avoided like the Black Death. Why? Is deflation not defined as a general fall in price levels? I certainly like the idea of falling price levels. Perhaps it’s also because I like to save a little for a rainy day. Not that it has done me any good in a world where inflation and indirect taxes suck the life out of my savings until the bank simply close the account for lack of a reasonable balance.

Do you believe in the innovative spirit of man? Do you believe in the rational of economic advancement through cooperation, mutually beneficial exchange, saving for an uncertain tomorrow, uncoerced willing participants to any economic exchange and investment in components for productivity enhancement?

Is it not an economic absolute that man would successfully strive to improve the product of his labour and gain from it? Is it not so that billions of humans contribute to this process every minute of every day to improve economic production? Are all these improvements not measured at a price level? It simply follows that it is in the general nature of economic man to promote deflation in the majority of his economic activities. How did this become an economic evil?

Somehow the deflation so diligently pursued and as we well know very effectively achieved seems to mostly vanish. The deflation is converted into inflation somewhere in the economic chain. Much has been written about the monetary processes of increasing money supply, artificial interest rate settings and encouragement of debt formation. I will not dwell on it here. Money supply growth has one supreme and ultimate beneficiary and that is the state and its vesting supporters. All other economic participants may seem temporary beneficiaries but will ultimately lose. Something is terribly wrong when the general tendency for prices to fall is converted to a general tendency for prices to increase.

It is the intent of State, one of many, to use a monetary stimulation to encourage a faster pace of deflation by making artificial savings available for investment at low interest rates. The logic is that the investment will generate a greater productivity effect than the negative implications of inflation which will surely follow such stimulatory monetary policy. It is at best a road to hell paved with good intentions, at worst, a self serving exploitation of the natural deflation engineered by billions and diverted away from economic man to gluttonous State. It is therefore very logical to expect State to actively propagate the virtues of “low inflation” and the horrors of deflation.

Deflation per se has no horrors. The propaganda of equating deflation with depression is the clever slight of hand used to smear deflation. The use of labels such as “recession” when an economic downswing happens in a low inflationary environment or “stagflation” to explain an economic downswing in the midst of high inflation all contributes to the perception that deflation is the ultimate economic horror. This is just not true. There is absolutely no reason or logic to equate deflation with depression. A general fall in prices may also imply that the price of labour would fall. It would be good for labour should labour’s price fall less than the general drop in prices, has no effect should labour’s price fall in the same relationship to general prices and would only be bad should labour’s price fall more then the general fall in prices. Same with all other items in the economy, it is the relative relationships that matters and the unhindered pricing mechanism of the market will take care of that as it always has.

What about employment you would ask? A general fall in price levels, more so when it is the result of human ingenuity, would not have any direct effect on employment. The increased productivity may mean less employment but that has absolutely nothing to do with deflation and it is not a foregone conclusion. Would we stop all human advancement because it inevitably has the potential to reduce employment? We know that such displacement is a natural consequence of advancement and that the economy will evolve and absorb the displaced in alternative employment. Temporary displacement as a result of human economic advancement is not a curse of deflation.

One group of economic participants who would do well to fear deflation would be the indebted. It would therefore be in the absolute interest of the inflating State to encourage broad based indebtedness in its voting constituents. That would guarantee acceptance and desirability of inflationary policies which as we have seen is immensely beneficial to the economic entity State and ultimately harmful to all other economic entities.

A most consistent example of this deflationary principle is captured by the development of the personal computer. Prices have been falling for twenty eight years, productivity increases have been fantastic, employment has increased tremendously in this industry, fortunes have been made, every economic activity in the world has been touched by the development in this industry and humanity has gained much from this economic advancement. It all happened in an industry perpetually in the grip of deflation.

Let’s page through some Personal Computer history. In 1981 you could have bought an IBM 5150 operating at 4.77MHz. It had no hard drive, working off a single 5.25 inch floppy drive. It would have cost you around $2000 with a limited number of software increasing to around $6000 for a full house system with colour graphics. That was 1981 dollars. A Datsun Stanza would have set you back $6680 and a Dodge Colt at $6194 cost close to the same as having a personal computer. Would you swap your PC for a new car today? Could you?

I remember those early PC’s well. My later version XT was so slow we had to run a spreadsheet overnight to calculate a relatively simple financial model. A branded desktop operating at 2.5 GHz with lots of memory and disk space, a huge 22 inch screen monitor included will cost you $1300 in today’s dollars (all software pre-installed). How much car can you buy for $1300 today? Look at it in another way. One paid $6000 for a 4.77MHz system at $1258 per MHz in 1981. The branded middle of the road PC system will today cost you only 52c per MHz. This is the deflation of human ingenuity. How is it possible to generalise deflation as an economic threat?

Let’s dare to have some deflation. It may just turn out to be a thing of beauty.

Sarel Oberholster


Car prices were obtained at this link http://www.gti.net/mocolib1/prices/1981.html How much did it cost in Morris County, New Jersey? a survey of retail prices advertised in the Daily Record, December 1-15, 1981