How 'stoozing' could bring down the global economy
Big banks and hedge funds have been 'stoozing' on a global scale, inflating asset bubbles across the world. But now the party is about to end.
This feature is part of our daily Money Morning email. If you'd like to sign up, please click here: sign up for Money Morning.
***Why 'stoozing' could bring down the global economy
***Does the most powerful man in the world now live in Japan?
Try 6 free issues of MoneyWeek today
Get unparalleled financial insight, analysis and expert opinion you can profit from.
Sign up for MoneyWeek’s free twice-daily newsletter.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
***RECOMMENDED ARTICLES: How to profit from the world's most important resource... Is the euro set to collapse?...
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
Turning to the stock markets
The FTSE 100 gained 24 points to 5,860. Advertising giant WPP was the main gainer, up 8% to 668p as full-year profit jumped 36% in 2005, helped by its acquisition of US group Grey Global. Meanwhile, banking group Lloyds TSB gained 5% to 566.5p as annual pre-tax profit rose 10%. Miners were among the main fallers as mid-cap Lonmin ended takeover talks. For a full market report, see: London market close.
Over in continental Europe, the Paris Cac 40 closed 33 points higher at 5,073, while the German Dax gained 12 to close at 5,870.
Across the Atlantic, US stocks were mixed, as an attempted attack on a Saudi oil refinery hung on sentiment. The Dow Jones fell 7 to 11,061. But the S&P 500 gained 1 point to 1,289 and the tech-heavy Nasdaq rose 7 to 2,287.
In Asian trading hours, oil was mixed. In New York, a barrel of crude traded lower at around $62.10. But Brent crude was higher, trading at around $60.80. Meanwhile, spot gold headed lower to trade at around $557 an ounce.
In Asian stock markets, the Nikkei 225 gained 91 points to 16,192. Steelmakers were among the main risers as newspaper reports suggested that Nippon Steel Corp will beat its own forecasts for full-year profits.
And here in the UK, shares in mobile phone giant Vodafone have plunged as the group cut its growth forecasts and said it will write down overseas assets by as much as £28bn.
And our two recommended articles for today...
How to profit from the world's most important resource
- What liquid is the most important to the global economy? Oil? Close, but not quite right. We could survive without oil, says MoneyWeek editor Merryn Somerset Webb, albeit with difficulty. To find out the one resource we couldn't live without - and the best way to profit from its increasing scarcity, click here: How to profit from the world's most important resource
Is the euro set to collapse?
- The five criteria set for countries wanting to join the euro were extremely strict - so strict that only one country actually qualified in 1997. But in the end, anyone who wanted to join the club was admitted - and this will ultimately be the downfall of the currency, says Brian Durrant in the Fleet Street Letter. To find out why the euro will face a 'dramatic test' in the next decade, click here: Is the euro set to collapse?
Join more than 165,000 subscribers and keep yourself informed with the latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
