Volatility Suppression Turned The Entire Economy Into One Big Carry Trade
Oct 1, 2020
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In this discussion, Tim Lee, the founder of Pi Economics known for his insights on financial markets, and Kevin Coldiron, a financial engineering lecturer at UC Berkeley, dive into the concept of carry trades. They explain how policymakers' suppression of volatility has turned the economy into a massive carry trade, distorting asset prices and intensifying income inequality. The conversation touches on the implications for liquidity and market behavior amidst rising risks, and questions the future of fiat money in a world increasingly influenced by cryptocurrencies.
The central banks' suppression of volatility has led to the growth of carry trades, which disconnect asset prices from the real economy and exacerbate inequality.
Carry trades, such as currency carry trades and property investment, contribute to liquidity in financial markets but also create imbalances and the risk of rapid crashes.
Deep dives
The rise of the carry regime and its impact on markets
The podcast episode discusses the concept of the carry regime and its implications for financial markets. The carry regime refers to a period where financial structures and trades that involve short volatility and leverage dominate the market, driving asset prices and disconnecting them from the real economy. The regime is perpetuated by central banks' suppression of volatility, which encourages the growth of carry trades and exacerbates inequality. The discussants also touch on how the carry regime has changed the way investors think and behave, with buying the dip becoming a common strategy. They suggest that breaking out of the carry regime may be difficult, potentially leading to a cycle of recurring crises and highlighting cryptocurrencies as a potential alternative form of money.
The relation between carry trades and liquidity provision
The episode explores how carry trades, such as currency carry trades and property investment, provide liquidity in financial markets. Carry trades involve borrowing at low interest rates to provide funds in higher-yielding investments, contributing to liquidity in these markets. The discussants highlight the role of leveraged carry trades in generating consistent income in low volatility periods. They also discuss how carry trades can create imbalances and the risk of rapid crashes when leverage and liquidity become unsustainable. The interconnectedness between carry trades, asset prices, and the real economy is examined, emphasizing the impact of liquidity evaporation during market crashes.
Central banks and the carry regime
The podcast delves into the role of central banks in the carry regime. Central banks, through their intervention and suppression of volatility, have inadvertently contributed to the growth of carry trades and the disconnect between asset prices and the real economy. The discussants argue that central banks act as agents of the wealthy and powerful, reinforcing income inequality. They also address the potential effects of the carry regime on social instability and discontent, as financial asset prices become increasingly important to people's livelihoods. The discussion touches on how the carry regime has shifted the perception of central banks and their ability to influence markets.
Challenges and potential solutions
The challenges of breaking out of the carry regime are examined in this episode. The discussants express pessimism regarding finding a solution within the current framework. They suggest that the regime's persistence may lead to the demise of central banking systems or the emergence of alternative forms of money, such as cryptocurrencies. The discussion touches on the impact of carry trades on volatility, investor behavior, and economic cycles. The episode concludes with a consideration of the broader implications of the carry regime on society and the need for a more holistic approach to addressing its consequences.
In a carry trade, an investor borrows money cheaply to buy an asset that yields more. As long as nothing changes overall, the investors get to pocket the spread. In our latest episode, our guests argue that more and more aspects of the economy resemble this trade, and that the culprit is the policymaker suppression of volatility. We speak with Tim Lee, Jamie Lee, and Kevin Coldiron, the authors of the new book “The Rise Of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis”.
