'Carry Trade' Reverse Shift Helped Drive Tuesday's Plunge
TOKYO -- One reason Tuesday's plunge in global stocks happened so fast involved money that helped fuel their recent rise: super-low-cost funds from Japan.</br></br>From 2001 until July 2006, Japan's central bank kept its benchmark short-term interest rate at zero, and even after a rate increase last week, the rate is only 0.5%. That compares with 5.25% in the U.S. and 3.5% in the euro zone. The difference has enabled investors to profit by borrowing money in yen to buy higher-yielding assets denominated in other currencies.</br></br>This technique is known as the carry trade -- because it takes advantage of the gap in returns, or "carry," from different assets. Once the preserve of sophisticated financial traders like hedge funds, its use now has spread to include mutual funds and others in countries where yen loans are available.</br></br>To execute a carry trade, investors have to sell the yen they borrow so they can buy assets in other currencies. With so many investors selling yen, the growth of the carry trade helped push down the yen in recent months to its lowest level in years against major currencies. That makes the carry trade more attractive because a falling yen makes profits earned in other currencies worth more in comparison.</br></br>When concerns about the U.S. economy and overheated stock markets around the world helped trigger market drops Tuesday, investors say the unwinding of yen loans accelerated the declines. Market participants say it is likely that when some investors grew nervous, they began to sell their holdings in everything from Indian stocks to the Australian dollar and used the proceeds to buy yen to pay back their loans.