Most investors are familiar with the concept of the yen carry trade. It is where a trader will borrow say 1,000,000 yen from a bank in Japan at about a 1% interest rate. The trader then converts these yen into say US dollars and uses the dollars to buy bonds yeilding say 5%. Therefore the trader is looking at making a profit of 4% on his trade (5% - 1% = 4%).

This works well so long as the yen doesn’t getter stronger against the dollar. Many professional currency traders would leverage their trade by say 10:1 and so make 40% profit instead of 4%.

For some time now, the yen has been this currency of choice for this trade, as interest rates in Japan have been as low as 0% in the era known as “free money”. However, now the yen is getting stronger against the dollar partly because the Japanese Central Bank has raised the interest rate above 0% but it is largely due to the decline in the value of the US dollar.

The dollar has been falling against most major currencies for some time and shows no sign of slowing down any time soon. Its collapse is being accelerated by the monetary policies of the Federal Reserve as every time they cut interest rates, the USD Index drops significantly.

We do not know for sure how far the Fed will go with their interest rate cuts, but it is possible that Bernanke could bring it all the way down to zero. Even if the Fed only cuts rates to say 1% and not to absolute zero, there is still a strong possibility that we will see the beginning of a “US Dollar Carry Trade. With interest rates at around 1% it becomes incredibly attractive to borrow US dollars and invest in other currencies or foreign government bonds. In countries such as New Zealand, savings accounts in NZ dollars are paying anywhere from 8% to 9.5% for fixed term deposits. Therefore by borrowing at 1%, investing at say 9% and using a leverage of 10:1, traders could make 80% a year on their money.

Of course these types of trades will become more and more risky as volatility in the financial markets continues but nonetheless the possibility is there to make the US Dollar the carry trade currency that the yen once was. This will weaken the US dollar even further, pushing the price of gold still higher.

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