The raising of Japanese interest rates and the cutting of the amount their bank pumps into the global banking system could have severely negative effects on the global economy and lead to dollar meltdown..................
How 'stoozing' could bring down the global economy
You may or may not have heard of 'stoozing'. The word is thought to have been named after a user called "Stooz" on the Motley Fool finance website, who was one of the earliest proponents of the technique.
A 'stoozer' borrows money on a 0% interest-rate credit card, and then puts the cash in a high interest savings account. Once the 0% period is over, the 'stoozer' pays the original capital back and keeps the interest earned on the savings. Or better still, they roll the original loan over to a new 0% card, and keep accumulating interest.
But as regular readers will know, Money Morning isn't about personal finance. So what does stoozing have to do with the world of international investment? Bear with me and I'll explain...
Over the years, if they're careful and have a decent credit rating, stoozers can build up several thousand pounds in interest. The key is to be well organised. You have to plan ahead to pay back the original loan or switch credit card providers before the 0% period ends. And of course, you must never spend the original capital, or be tempted to put it in an investment that's anything less than 100% secure and instantly accessible.
That's not usually a problem. The kind of people who can be bothered to make the effort to stooze are pretty financially savvy. They're not the type to stick the borrowed money on the 300-1 at Doncaster and end up losing it all.
But what if everyone was stoozing? And what if everyone started to believe that it would always be possible to find another 0% interest rate deal to switch to?
People would almost certainly start taking more risks with their money. After all, even if they lost the initial sum, they could simply put back the payback date indefinitely by continually switching between providers.
So people would start using all the 'free' money more adventurously. They would use it to put deposits on houses or buy stocks. House and stock prices would then rise. And so, inevitably, investors seeking even better value for money would then search for more exotic climes to invest in, pushing up the prices of emerging market stocks to unheard of levels.
Everything would tick along perfectly well - until the credit card companies realised they weren't making any money, and called a halt to the 0% interest rate deals. Then everyone would have to pay back the money they borrowed in the first place. The property market would collapse as people sold houses to pay back loans. Stock markets would plunge. It would be a financial disaster.
It's a good thing that only a few financially savvy people are actually stoozing then, isn't it?
Well, unfortunately, this is where the world of international investment comes in. Because banks and hedge funds around the world have basically been stoozing on a global scale.
When big institutions do it, it's called the "carry trade", but it amounts to the same thing. They borrow money in a currency, such as yen, where interest rates are low, and then invest it somewhere that offers higher yields, such as US government bonds.
But as everyone realises what a good trick this is and starts doing it, it pushes yields lower. And as yields on safe investments get lower, investors start putting their money into riskier prospects - like lending someone seven times their salary to buy a studio flat, or deciding that Iraqi government bonds paying 7% look good value.
As Morgan Stanley's Stephen Roach says: "The lure of the carry trade is so compelling, it creates artificial demand for 'carryable' assets that has the potential to turn normal asset price appreciation into bubble-like proportions."
The trouble is that the 0% lender in this case is Japan. But with the Japanese economy finally recovering after decades of decline, the Bank of Japan's 0% interest rate offer is about to end.
And as Ambrose Evans-Pritchard points out in The Telegraph, no one else is available to take its place. "Almost every bank other than the Bank of England is now tightening in unison."
Stephen Lewis at Monument Securities tells The Telegraph: "There are several hundred billion dollars of positions in the carry trade that will be unwound as soon as they become unprofitable. When the Bank of Japan starts tightening we may see some spectacular effects. The world has never been through this before, so there is a high risk of mistakes."
So Ben Bernanke may have inherited the title of Federal Reserve chairman from Alan Greenspan. But "the Maestro's" other title, "Most powerful man in the world" looks like it has now passed to his Japanese counterpart.
If Japan raises interest rates, the carry trade will become less attractive, and eventually end. Currencies like the dollar will no longer be propped up solely by the fact that they offer a higher interest rate. Attention will turn once again to the fundamentals - like the massive twin deficits in the US. And once that happens, a slide in the dollar looks a very likely prospect. You can read more about the woes facing the dollar on our website by clicking here: Why the US economy is on borrowed time
And what about all the other massively inflated asset bubbles around the world? David Bloom, HSBC currency strategist tells The Telegraph: "The carry trade has pervaded every single instrument imaginable, credit spreads, bonds spreads: everything is poisoned.
"It's going to come to an end later this year and it's going to be ugly."
So you can be sure we'll be keeping a close eye on Japan over the coming months. This is a story that will run and run...