G7 lets Japan off hook; ECB’s Trichet: Carry trade poses risk

February 11, 2007
By Ken Worsley

On Friday, US Treasury Secretary Henry Paulson said that Japanese Finance Minister Koji Omi provided other G7 finance ministers and central bankers with a ‘favourable’ report on the Japanese economy.� Paulson essentially said that the yen’s value is in line with Japan’s economic fundamentals, dissipating any possibility that Japan would be pressured to take measures that would help boost the value of the yen against the dollar and euro.

Paulson expressed the opinion that it would be more prudent at this time to keep an eye on China, and to continue urging it to allow its currency to float freely. Mr Paulson summarized the main items that were discussed at the meeting by saying:

over the last two days, we discussed ways to keep the global economy growing in a balanced way, including stimulating domestic demand in Japan and Europe and pressing for greater exchange-rate flexibility in China.

Hedge funds, of course, are the main culprits behind the practice of ‘carry trade,’ which involves assuming debt in a currency such as yen with a low interest rate, and using that debt-bearing capital to buy assets in more lucrative markets with higher returns. European Central Bank President Jean-Claude Trichet said, “We want the market to be aware of the risk in one-way bets, in particular on the foreign-exchange markets.”

Does this mean that hedge funds really should be careful, on the lookout for a rise in the yen and a raise in interest rates in Japan? This observer still doesn’t think they have much to worry about.

Filed Under China, Finance