Of course, “solvent but illiquid” is exactly the situation SVB was said to be in. Expect to hear this messaging a lot more in the coming years. The line between market support and QE will become increasingly blurry and, as it does, the risk of much higher inflation will increase.

A thought-provoking, riveting read that shines much-needed light on an important, but neglected, topic. The Rise of Carry provides the red pill to a system whose grotesque reality will be unmasked through the forces of populism. It isn’t an easy read; the truth rarely is. For those of you perma-bulls questioning the basis of “bearish fundamentals:” If headlines such as:Beschrijving: X, 229 p. Bibliographie: Includes bibliographical references and index. Dewey: 332/.0415 23 Onderwerp: Business cycles. (source)lcsh The Rise of Carry provides foundational knowledge and expert insights you need to protect yourself from what have come to be common market upheavals—as well as the next major crisis. Simply put, carry trading is now the primary determinant of the global business cycle - a pattern of long, steady but unspectacular expansions punctuated by catastrophic crises.

The more ambitious parts of the book are those that discuss carry as a wider phenomenon that affects large parts of the economy; from international trade to domestic macroeconomics, and even as a possible cause of economic inequality. The section on international financial flows is both original and interesting. But this may be less relevant if the US dollar is no longer the go-to currency for financing carry trades. If you think easing and tightening at the same time sounds like a contradiction, sounds like a loss of control, I’m with you. These data show that daily price changes of U.S. equities followed a random walk when measured over the whole span from 1927 to 2020. The actual variance over periods of one to thirty-two days is almost exactly the same as that implied by the daily variance (vari­ance, the square of the standard deviation, is a measure of volatility). Price changes do not, however, show a consistent pattern when measured over shorter time periods: since 1945 there has been a sharp positive serial correlation for one-day changes measured over periods of one to eleven years, but steady negative serial correlation there­after. Yet the authors are correct in claiming that daily price changes have shown a negative serial correlation since 1987. Some might argue that the indicator is mis-specified because we have been coming off a huge jump in money supply and therefore there could still be an excess of money, in some sense.Over at least the past 30 years financial markets have become increasingly dominated by carry trades; markets can be said to be in a ‘carry regime’. Carry trades have in common four features: 1) Leverage; 2) They provide liquidity to markets; 3) Short volatility exposure; and 4) a ‘saw tooth’ return pattern. Particularly because of the liquidity provision feature, carry trades have always had a role in the financial system. But certain non-market developments, particularly the increasingly dominant role of the Federal Reserve and other central banks, have led to the evolution of the carry regime. However the world has changed. Currently the US dollar has an interest rate more than 2% higher than that of the Euro. A carry trade where US dollar deposits are funded by Euro loans would not necessarily do badly in a global market crash. He currently lives in Oakland, California with his wife Jody and their four children and has as a moderate-to-severe obsession with tennis. Kevin Coldiron is a Lecturer in the Financial Engineering program at U.C. Berkeley’s Haas Business School. From 2002-2014 he was co-owner and co-CIO at Algert Coldiron Investors, a San Francisco-based quantitative hedge fund. Prior to that, Kevin spent 11 years in the UK where he founded the hedge fund business for Barclays Global Investors after serving as Head of European Research.

The financial shelves are filled with books that explain how popular carry trading has become in recent years. But none has revealed just how significant a role it plays in the global economy—until now. What effect does a short volatility trader have on the market? The authors are not explicit here, but a simple thought experiment may help. Consider first the delta hedging trader. If the market rises, they are forced to buy. If it falls, they must sell. Their actions will increase market volatility. Interestingly, if they have sold their option to another delta hedged trader, then their actions will be exactly mirrored by the buyer. There is zero net effect on the market, since their trades will exactly offset (assuming the same hedging strategy is used). Traders do not especially care their strategies affect the operation of the market more generally, but the authors do explore this interesting facet of the carry story. I particular enjoyed their description of selling vol at short durations, then buying it at long durations. This nicely fits certain stylised facts of market behaviour: mean reversion at shorter horizons, and momentum at longer horizons.

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Financial instability has thus risen as the carry trade has grown. The Rise of Carry does not estimate the size of the market, for which reliable data do not seem to be available, but the authors argue convincingly that it is very large and has expanded greatly in recent years. They also point to the risk that volatility in different financial assets may be contagious: “There is also evidence of a growing correlation between currency and equity market carry, suggesting that a single global volatility risk factor may be a driver of all forms of carry in the future. If this is true, future carry crashes may impact on all asset classes at the same time.” 7 In this book we define all carry trades to share certain critical features : leverage, liquidity provision, short exposure to volatility, and a “sawtooth” return pattern of small, steady profits punctuated by occasional large losses (p. 3, LL&C). Worst of all, these idiots have become insolent because of years of impunity for their stupidity and theft. Central bank policies are largely to blame for that. After losing their fear, our dear leaders no longer see the need to strengthen the systems that keep them alive. Moreover, they are actively trying to destroy those systems. In Russian, we call it sawing the branch on which you are sitting. For most of the twentieth century, the neoclassical synthesis in economics was generally believed to provide a solid basis for public policy. There were, nonetheless, significant dissenters. Hyman Minsky, for instance, wrote that “modern orthodox economics is not and cannot be a basis for a serious approach to economic policy.” 1 In the wake of the financial crisis and the great recession of 2008, such questioning became even more vociferous, and criticisms like Min­sky’s are now increasingly accepted. money-printing presses went into overdrive. A myriad of emergency funding windows were opened to enable cash to be injected into the financial system, and from virtually any and all directions. Sovereign borrowing and credit guarantees were issued left, right, and center. Direct public funding was placed into all the major American banks and many of the smaller ones” This, “unprecedented deployment of liquidity and direct involvement in markets played a critical role in reconnecting the wires of the market system and restoring trust (p. 48, El-Erian)