The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis.

• Author: Malz, Allan M.

The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis

Tim Lee, Jamie Lee, and Kevin Goldiron

New York: McGraw-Hill Education, 2019, 240 pages

Over the past quarter-century or so, the United States and the world have experienced a relatively new and puzzling, yet old and well-understood, phenomenon. Generally, accommodative monetary policies by major central banks have been punctuated by financial crises large and small rather than by spasms of inflation. The era has been characterized by declining productivity, growth and overall economic vibrancy in spite of an explosion of new ideas and technologies. The Rise of Carry looks at the financial mechanisms underpinning these maladies from a new and unusual angle. It identifies at their core an approach to trading heavily reliant on leverage, the use of borrowed funds. Public policy, particularly monetary, encourages leverage and enables it to become excessive, undermining financial stability and ultimately leading to a decline in financial stability and economic dynamism.

The book's new angle is from the point of view of the carry trade, a trading strategy that serves as a technical description and a metaphor for the incentive system built by the policy prescriptions that keep the financial system leveraged and fragile. The term "carry trade" was originally applied to a set of foreign exchange transactions in which a sum is obtained, largely by borrowing, in a currency with low money market interest rates, and exchanged for one in which rates are materially higher. If the purchased higher-rate currency appreciates, or at least doesn't depreciate too much and too fast against the borrowed currency, the trader stands to net some interest income. The difference between the cost of funds and the interest on the purchased currency is called the "carry," and capturing that gap is the primary aim of the trade. Credit expansion is fostered in the countries issuing both the funding and purchased currencies.

Three features are emblematic of this trading strategy. First, if the carry-trade transactions are not hedging an existing offsetting foreign exchange exposure, then it is an outright bet the purchased currency will retain or even gain in value. Typically, that purchased currency is that of an emerging-markets or export-dependent economy susceptible to infrequent but sharp and sudden depreciations. Second, it can...