Is the Dollar Carry Trade a Myth?

Nouriel Robini has been talking a lot of smack lately about the great global dollar carry traden that is supposedly ongoing. The players are borrowing in cheap dollars and investing in securities with higher yield currencies. I have been suspicious of this actually being the case, largely because the money supply isn't growing. If such a trade is being put on, it has to be hedge funds, and the like, sucking the money out of other areas.

Maybe Goldman Sachs is putting all the money that the government has shoveled into it, into carry trades, but this wouldn't be enough to roil the global markets. It would have to be Goldman AND the hedge funds. But, if it isn't mostly hedge funds sucking form other sectors, , it isn't happening. Now a trader is calling Roubini on his theory. The Mad Hedge Fund Trader writes:

Nouriel Roubini is wrong. He has embarked on a global campaign to warn the world, Cassandra-like, of the “mother of all highly leveraged asset bubbles” now in progress. Shorts in the US dollar are being built up to unprecedented levels, and are being used to finance the purchase of every asset class, especially in energy, commodities, and precious metals. This bubble will be pricked by a huge snap back rally in the greenback, the exhaustion of Fed support measures, a growth surprise in the US leading to an early Fed tightening, or a real double dip recession. The inevitable collapse will make the last financial crisis look like a cake walk, and take all markets, especially equities, down to new lows. The flaw in the Turkish New York University economic professor’s logic is lurking in his own arguments. The basis for his “U” shaped recession (described by others as “bathtub” or “toilet bowl” shaped), is the absence of credit, especially at the regional and small business level. But I can tell you from my own experience that credit is also absent, or severely diminished, in the hedge fund community too. Terms have been tightened across the board. Collateral requirements are much stricter. Margin requirements on the futures markets are vastly heavier than they were two years ago, especially for the most volatile contracts, like crude. You can forget about financing for any kind of instrument that is illiquid or trading over-the-counter. Prime brokers really play hard ball. The days when big hedge funds borrowed stock and shorted them with no money down are a distant memory. The last time I checked, Lehman, Bear Stearns, and AIG weren’t doing any new lending. Many credit markets, such as those for certain CDO’s, are still completely closed, and are never coming back. So where is all this leverage? The net net is that speculative positions are but a fraction of those seen at the 2007 peak. To get a real crash with new lows, someone has to sell, and there just isn’t that much around to be sold these days. I think Nouriel is one of those Mount Olympus guys who can only give a very broad, general overviews of what we mere mortals are doing. Never having worked on a trading desk, he doesn't realize that what he is proposing can't actually be executed. When the current trends reverse, there will be much volatility, pain, hand wringing, and gnashing of teeth, for sure. But it is much more likely that we are going to die from ice, not fire, and of boredom, not from cardiac arrest.

So Roubini could be all wet on his carry trade call. This, however, doesn't mean the markets won't move in the direction Roubini expects. The dollar may rebound and commodities may crash, but not because too much credit is chasing commodities, but because this is the end of a major dead cat bounce and their isn't enough credit around to support the current structure of prices.