Meanwhile, in the United States, the world's richest country, the multibillion-dollar credit contagion expands from press release to press release. We would stop the presses if only it would halt the contagion. But the financial world is not so configured.

For the first time ever, therefore, investors consider Brazilian government bonds safer than Merrill Lynch (NYSE: MER) bonds. According to the relative pricing of credit default swaps (CDS) on Brazilian government debt versus Merrill Lynch debt, the reeling American brokerage firm is a riskier credit that the resurgent Latin American economy.

[Credit Default Swaps are a kind of insurance policy against a bond default. The greater the perceived risk of default, the more expensive the insurance - i.e. the Credit Default Swaps - would become. Declining CDS prices, therefore, would indicate declining anxiety about a potential default, whereas rising CDS prices would indicate rising anxiety about a potential default.]

Buying five years of protection against a Brazilian default used to cost much more than buying five years of protection against a Merrill Lynch default.

But now that Brazil has become as crisis-free as the U.S. financial sector has become crisis-prone, Credit Default Swap prices have flip-flopped. Merrill CDS prices have jumped above those for Brazilian government debt! In other words, CDS buyers consider a Merrill Lynch default more likely that a Brazilian default.

Maybe CDS investors have got it all wrong... or maybe the U.S. finance sector is in much deeper doo-doo than most investors believe. The "doo-doo" interpretation seems more plausible.

Credit Default Swap pricing is not necessarily indicative of future trends, but neither is it NOT indicative. For example, after presenting the following chart in the March 14, 2007 edition of the Rude Awakening ("Credit Default Swaps... and You"), we advised, "Sell the mortgage lenders... Finally, investors are beginning to recognize that the unfolding mortgage-lending crisis might be something more than a fleeting annoyance...

"Now that companies like New Century are perishing," we concluded, "and the nation's largest banks and brokerage firms are warning of possible ‘mortgage- related charge-offs' demand for Credit Default Swap protection is rife. Demand for put options on mortgage-lending stocks is also very robust. As a result, insurance ain't cheap. Then again, how often do you get the chance to buy fire insurance when you're house is already ablaze? If the bond market is as smart as she usually is, this inferno might blaze for a while longer still."

And indeed it has. The mortgage-lending conflagration has consumed hundreds of billions of dollars worth of asset values, both in the real estate market and in the mortgage-backed securities market. At the same time, the conflagration has scorched the careers of a few finance-company CEOs, torched the U.S. dollar and threatened the viability of numerous enterprises.

An updated version of Credit Default Swap pricing for Pulte Homes (NYSE: PHM), Washington Mutual and the Russian government shows that the market has become even more anxious about homebuilders and mortgage-lenders. Pulte Home Credit Default Swap cost five times more than Brazil Credit Default Swaps. A contrarian investor might infer from these pricing extremes that the time has come to buy Pulte and sell Brazil. Perhaps the contrarian would be correct.

But a chicken investor would conclude that the time has come to accept the verdict of the Credit Default Swap market and avoid stocks like Merrill Lynch and Pulte... even though they have already suffered mightily. A chicken would infer that the time has come to avoid obvious risks and play it safe.

Cluck... Cluck.

Eric Fry
for The Daily Reckoning Australia

• None Found

These four letters stand for Asset-Backed Commercial Paper. "Commercial paper" - or CP - refers to short-term corporate debt. Specifically, unsecured short-term promissory notes issued by corporations with maturities that typically range from 30 to 270 days. Asset-backed CP is that which is collateralised by an asset-backed entity - i.e. an entity that owns assets like mortgages or credit-card receivables.

The asset backed commercial paper market is struggling mightily at the moment. Almost no one will provide financing to an asset-backed entity, especially not an asset-backed entity like a "structured investment vehicle" (SIV) that is full of mortgage-backed securities (MBS).

In a perfect world, SIVs borrow short-term money in the commercial paper market, then invest the proceeds in debt instruments like mortgages, credit card receivables and collateralised debt obligations (CDOs). But as we observed in the September 24 edition of the Rude Awakening, "The borrowing part of this formula has dried up completely. The asset-backed issuers of commercial paper cannot find any lenders to finance their toxic cocktails of lousy mortgages and 'new math.'"

Since almost all the investors who comprise the free market refuse to purchase asset backed commercial paper, the Federal Reserve has stepped into the breach. In other words, the Fed is now financing the very same stuff that the world's private investors refuse to finance. What more do you need to know about the gravity of America's credit crisis?

The asset backed commercial paper market has nearly ceased functioning. In early August, ABCP outstanding totaled nearly US$1.2 trillion - representing about half of the entire commercial paper market. Since then, however, ABCP outstanding has tumbled by US$279 billion, while the other half of the CP market has remained exactly the same. In other words, traditional corporate borrowers like IBM may still tap the CP market, but not asset-backed entities.

This harsh reality becomes even more alarming when one considers that a complete CP cycle is 270 days...which means that the SIVs who effortlessly obtained 270-day commercial paper commitments last April, May or June have not yet attempted to roll over their CP in the now- hostile environment.

In all, another US$894 billion of asset backed commercial paper will mature over the next six or seven months. Who will provide that funding?...Maybe the same nameless "top tier" institution (the Fed is our guess) that just provided an US$80 billion credit line to Citigroup. Already, the Federal Reserve appears to have absorbed about US$25 billion in MBS securities via "temporary" repurchase agreements. (We realise that this stuff is as boring as heck, but that's also why it escapes scrutiny...and why it may be so important to investors, especially, dollar-based investors).

Repurchase Agreements, "repos" are also called Sale and Repurchase Agreements. Under these agreements, the seller (usually a bank) sells securities to a buyer (usually the Federal Reserve) for cash. But the seller (bank) agrees to re-purchase the securities from the buyer (Fed) at a later date. Typically the banks use Treasury bonds or Agency bonds as repo collateral. Lately, however, mortgage-backed securities (MBS) have become the collateral of choice.

In the early part of this year, the Fed rarely "repoed" an MBS. Weeks would pass between MBS repos. But as springtime arrived, MBS repos started popping up like so many daffodils. Just a few at first, then a few more, then eventually enough to absorb a money center bank's entire short-term liabilities...for example.

As the nearby chart clearly shows, the rolling 2-week total of "temporary" MBS repos soared from about zero in June to a whole bunch in August...and the repos are on the rise again, despite the "recovering" credit markets.

The Fed's newfound interest in MBS contrasts sharply with the utter disinterest of free market investors. The disinterest of real-world investors comes as no surprise. It is an open secret among many hedge fund managers that the institutional holders of mortgage-backed securities and derivatives have not even come close to marking their assets to market. It is also an open secret that two critical pieces of knowledge remain utterly unknown: How big is the total MBS risk? Who's holding the risk?

Until these questions receive credible (and quantifiable) answers, no one will provide financing to AB entities, except the Fed.

Could the Fed conjure up US$1 trillion worth of AB financing between now and President's Day, 2008? Maybe, but probably not without also conjuring up a dollar crisis, or a bond market crisis...or both at once. The only viable path toward recovery and normalcy requires a legitimate mark-to-market. But marking MBS and CDOs to real-world prices might clip tens of billions of dollars from bank balance sheets...and might kick a few dozen millionaire-bankers to the curb.

Unfortunately, because the millionaire-bankers still control the flow of information - and still hold meetings with the Treasury Secretary to concoct shell games - the "fantasy pricing" regime remains in effect. Merrill's US$8 billion write-down was at least a good start because it broke new ground: it acknowledged impairment of AAA-rated securities - "a level of detail that other banks have so far failed to give," analysts from the Royal Bank of Scotland politely observed.

To begin to illustrate the magnitude of the crisis, let's examine the unfolding SIV meltdown. According to professional estimates, 36 SIVs worldwide deploy about US$400 billion in capital. According to unofficial "whisper" estimates, these 36 SIVs have leveraged their capital to about US$2 trillion worth of actual exposure. [If the number is less than US$2 trillion, we'd love to hear about it. But the SIV operators are conspicuously mum on the topic. In fact, the SIV operators ain't sayin' nuthin' about nuthin'.]

And even when they do say something, they don't say anything useful. Late last week, Citigroup claimed to have "secured funding through year end for the US$80 billion in structured investment vehicles it manages..." But of course, the giant bank neglected to disclose the source of this astronomically large credit line. There aren't too many lending institutions with US$80 billion to toss around. In fact, there's only one we know of, and it's run by a guy named Ben Bernanke.

Citi also announced that its SIVs had succeeded in selling "many billions of dollars" of short-term commercial paper to "top-tier name institutions." Again, we wonder, what's the big secret? Why not just tell us which "top-tier institution" is in a position to purchase "many billions of dollars" of SIV commercial paper? Why not just tell us...unless that top-tier institution is also the one run by Ben Bernanke? We are also struck by the coincidence that US$80 billion happens to be the exact sum that the Citi-led syndicate of banks is supposed to be providing to the Super SIV.

Maybe we're way off base here, but we're not way off base in fearing non-disclosure. Any investor with more than two days of investment experience should know that non-disclosure is never good news.

Meanwhile, the SIVs that can't secure financing from the US Federal Reserve must liquidate their portfolios at "fire-sale" prices (i.e. real-world prices), or default on their debts...or both at the same time.

One week ago, the US$6.6 billion Cheyne Finance Plc became the first SIV to default on its commercial paper. A couple European SIVs are in the process of liquidating their US$15 billion portfolios. We predict others will follow in their footsteps. According to the Financial Times, "More than US$42 billion of assets in SIVs...are facing limits on their operations." But that still means about US$300 billion of SIV assets are struggling for survival. And they will likely continue to struggle, not merely because they cannot access funding, but also because their assets are deteriorating.

Just read the newspaper.

The housing bust is triggering a deepening mortgage bust, which is triggering a deepening MBS bust. And the evidence is everywhere. Last week, S&P downgraded US$23 billion worth of mortgage-backed securities that had been issued less than 9 months ago! 1,713 different securities in all; and each one from the class of 2007. Meanwhile, the housing market is trending from bad to worse. As the nearby chart clearly shows, home sales and home inventories are both heading in the wrong direction. The inventory of unsold homes nationwide totals more than 10 months worth of sales - a 23-year high.

Enter the US$80 billion Citi-Paulson "Frankenfund" - the Master Liquidity Enhancement Conduit, or MLEC - to finance the stuff no one else will touch. We are skeptical of this rescue attempt, as noted in the October 17 edition of the Rude Awakening, "Bail-Out Nation." The MLEC advances the cause of obfuscation, while preventing the price discovery that would enable the ABCP market to recover, and bring an end to the crisis.

Just yesterday, Former Chairman of the SEC, Arthur Levitt, described the Citi-Paulson MLEC scheme as "problematic."

"Transparency is the issue," said Levitt. "These [MBS] products are opaque. And our mechanism for overseeing the products, for regulating the process is virtually non existent."

Translation: Its time to clear the fogged mirror, not fog it up some more. The crisis will continue deepening until the market-improvers at Treasury and the Federal Reserve abandon their price-support schemes. The crisis will deepen until MBS securities fall to the real-world prices that will attract real-world investors.

The asset backed commercial paper market will probably provide an early clue as to when that moment has arrived.

Eric Fry
for The Daily Reckoning Australia

• None Found

America, the Land of the Free, is quickly becoming the "Land of the Freebie," especially for members of the millionaire corporate elite who make multi-billion dollar mistakes... with someone else's money. This unfortunate state of affairs is jeopardizing the dollar's value, as well as its hard-won reserve-currency status.

Once upon a time, American-style capitalism resembled a bare-knuckled fistfight – a continuous "Ultimate Fighting" match in which competitors would pummel one another until a victor emerged. But modern American-style capitalism is more like "arts and crafts" time in one of Manhattan's pricey nursery schools. Every coddled kiddy's "artistic" creation – no matter how inept or ghastly it may be – elicits praise from the nursery school instructors. Indeed, every grunt elicits praise...and every boo-boo finds a Band-aid.

Outside the walls of the nursery school, capitalism is just as brutal and Darwinian as it has always been, perhaps even more so. But on the inside, the privileged kiddies never shed a tear without receiving an immediate hug and a "There, there. It's okay. It wasn't your fault... and even if it was your fault, Uncle Ben will make it all better."

As for discipline; forget it. The coddled capitalists of America's high finance never receive a slap on the wrist for any misdeed whatsoever. That would be child-abuse. Nor do they ever even receive a time-out for bad behavior. Worst case, punishment arrives in the form of multi-million dollar severance packages.

Who are these "nursery school" capitalists? They are the folks who receive millions of dollars each year to preside over public corporations and/or to speculate with the shareholders' capital.

American corporations are crawling with these leeches. Using other people's money, they engage in moronic speculations, knowing that success will multiply their net worth dramatically and that failure will produce negligible negative consequences. And sometimes even failure produces success, thanks to the Federal Reserve's well-established penchant for bailing out speculators.

Because Wall Street's privileged speculators receive continuous coddling, they never really learn to behave themselves. Thus, when the multi- millionaire, Nobel-prize winning operators of Long Term Capital Management fell down and got an "owy" in 1998, Alan Greenspan's Federal Reserve rushed to their sides with Fed bailout Band-aids aplenty and emergency doses of financial Bactine. He slashed interest rates, while also cajoling Wall Street's leading banks to provide a multi-billion dollar bailout.

Everyone called it a rescue plan for the capital markets. But the capital markets of 1998 required no rescuing. They had worked flawlessy; they had separated fools from their money.

But because the fools in question hailed from leading Wall Street institutions, and because the Wall Street institutions, themselves, stood to lose billions of dollars, LTCM would not be allowed to fail. Thus, the Fed bailout of 1998 was nothing more than government-sponsored collusion to rescue speculators from the consequences of their ill-conceived speculations.

But the Fed bailout succeeded in sparking a robust year-end rally, which made lots of people very happy...and Alan Greenspan very popular. Few folks cared that the bailout would lead directly to the largest stock market bubble of the preceding 60 years – a bubble that would produce an epic bust and erase hundreds of billions of dollars from the savings accounts of unsuspecting individual investors.

During the early years of the 21st century, the Fed continued coddling Wall Street's privileged few, by slashing short-term interest rates to unnecessarily low levels. Who benefited? Lots of banks and lots of speculators...and lots of speculating bankers.

The speculators devised numerous ways to capitalize upon ultra-cheap short- term financing. The speculators become overnight investment geniuses by borrowing short-term and speculating long-term. But the sort of genius that relies on short-term financing often perishes at maturity. Only a complete moron would borrow short-term and invest long-term, without preparing an emergency back-up plan or exit strategy – only a complete moron...or a coddled capitalist.

Fast-forward to the summer of 2007 – the financial "Summer of Love" – and we find the same playpen of privileged kiddies making the same poopies in their diapers. All the biggest banks and brokers on Wall Street found themselves on the losing side of some kind of ill-conceived loan. They found themselves on the hook for billions of dollars worth of loans that no individual of moderate intelligence would have ever issued with his own money.

Not only did Wall Street's genius bankers issue billions of dollars worth of idiotic loans, they also packaged the loans into billions of dollars worth of idiotic mortgage-backed securities (MBS). The bankers then sliced, diced and reformulated various types of mortgages into various categories (tranches) of collaterized debt obligations CDOs and other asset-backed exotica.

Why did the whiz kids go to such great lengths to repackage mortgage loans? Because it was a great way to move these things off their own companies' balance sheets, and onto someone else's. By moving the loans elsewhere, the bankers could originate new idiotic loans, create new idiotic mortgage-backed securities for public consumption...and collect hefty fees along every step of the process.

When the Wall Street bankers couldn't find any real buyers for their idiotic mortgages and MBS, they would create non-real buyers called structured investment vehicles (SIVs). These SIVs would borrow money, just like a corporation, then use the money to buy mortgage-backed securities from the Wall Street bankers who created the SIVs. The process would be something like setting up a shell company to buy your house from you.

As long as the shell company could obtain financing, it could easily buy your house, and might not even quibble about the price (but that's a topic for another day). Unfortunately, if the shell company suddenly lost access to financing, it would have no choice but to sell the house it bought from you at whatever price it could obtain.

That's exactly where we are today.

Typically, SIVs borrowed short-term money in the commercial paper market, rolling over their obligations every few months. In essence, therefore, the SIVs financed their long-term mortgage assets with short-term CPO liabilities. The process worked brilliantly...until it didn't.

In mid-August, the asset-backed commercial paper (ABCP) market tumbled into a deep-freeze, thereby eliminating the SIVs' primary source of funding. What happens to an SIV that cannot borrow in the CP market, you may be wondering? Option A) It liquidates its portfolio of mortgage securities at fire-sale prices; Option B) It goes knocking on the door of its original underwriter for emergency funding.

Unfortunately, "Option A" includes the distasteful side-effect of putting real-world prices on the billions of dollars worth of illiquid securities that still carry Wall Street's fantasy prices. Replacing fantasy prices with real-world prices would force many American financial institutions to fess up to the billions of dollars of additional mark-to-market losses – losses that the institutions are pretending they have not already incurred. "Option B," therefore, seems like the lesser of two evils, but only in small doses. Large doses of "Option B" could cause serious indigestion on bank balance sheets.

Enter the beefy "Master Liquidity Enhancement Conduit," or M-LEC to save the day. This $80 billion fund-to-be, according to Bloomberg News, "will help SIVs, which own $320 billion of assets, avoid selling their holdings at fire- sale prices."

Here's how the whole thing is supposed to work: Citigroup, Bank of America, JP Morgan and a few lending institutions to be named later will kick $80 billion into a fund. The fund will buy AA- or AAA-rated SIVs. Once these SIVs become the M-LEC's property, they cease to require financing from the commercial paper market or, more importantly, from the lending institutions who are providing the $80 billion bailout. In effect, the banks are bailing out themselves.

To the skeptical observer, therefore, the M-LEC merely puts a happy face on a grim inevitability. These banks would be on the hook for billions of dollars worth of financing anyway. So while pretending to "provide liquidity to the SIV market," the M-LEC is merely a ruse...and not even a very good one.

For one thing, Goldman Sachs is conspicuously absent from the consortium of participating banks, even though former Goldman CEO, and current Treasury Secretary, Henry Paulson, brokered the deal. Presumably, Goldman demurred because it has no interest whatsoever in stepping into the SIV tar pit that has ensnared its competitors...and will continue to ensnare its competitors.

The second problem with the M-LEC ruse is that it will not commence operations for 90 days. That's an eternity in the commercial paper world where the SIVs are fighting for their survival. The 90-day lead-time reveals the insincerity – or incompetence – of the M-LEC proposal. Many, many SIVs could implode over the next 90 days - many more, in fact, than an $80 billion fund could hope to rescue.

The entire SIV market totals more than $320 billion in assets, most of which relies on financing of less than 270 days. Do the math.

The third glaring problem with the M-LEC ruse is that it will buy only AAA- or AA-rated SIVs, where the least of the problems reside. A genuine bailout fund would buy the most toxic securities first, and leave the highly rated stuff out in the marketplace to find real-world buyers. This curious aspect of the M-LEC, therefore, elicits the thought, "Gosh, maybe the banks are trying to support the prices of the highly rated stuff they haven't marked to market, rather than the lowly-rated stuff they don't own."

Net-net, the M-LEC is a joke – a very bad joke.

It is the kind of joke that attempts to rescue well-heeled speculators from the consequences of their recklessness...without providing any benefit whatsoever to the capital markets overall. The SIV world doesn't need a bailout; it needs a mark-to-market. If SIVs were reflecting their real-world pricing, instead of Wall Street's government-sponsored fantasy pricing, REAL capitalists would be lining up to purchase them or to provide financing.

The American capital markets do not need M-LECs, they do not need bailouts; they do not need rescuing...except from the "nursery school" capitalists who consider their wealth an entitlement, and who believe that their failures and their successes both deserve multi-million dollar paydays.

The "Bail-Out Nation" is costing us all dearly. Every Fed bailout undermines the dollar's value and international prestige. That's a very heavy price tag. If the "Bail-Out Nation" does not allow its coddled capitalists to fail, the U.S. dollar itself might fail.

Eric Fry
for The Daily Reckoning Australia

• None Found

Sometimes, the difference between a good boom and a bad boom is very subtle and subjective. A "bad boom," for example, might simply be a good boom that you failed to participate in. But usually, key fundamental differences differentiate the good from the bad. Bad booms tend to rely upon credit, for example, rather than earnings and savings. Therefore, when the inevitable bust occurs, credit becomes a four-letter word: Debt.

When a nation of debtors finally exhausts all its sources of additional credit, it chokes on debt. The nation of debtors can no longer sell a house to repay it creditors. Instead, the debtors must simply work to satisfy their creditors. And that's not all. Sometimes the debtors must work for cheapened money, but repay their creditors with expensive money.

Let's consider a simple illustration: A European creditor who loaned 100 euros to an American in 2001 will expect to receive 100 euros in repayment. He does not care that 100 euros will cost the American 65% more dollars than they did in 2001. But the American will care…especially if he loses access to easy credit.

Since bad booms rely upon ever-larger doses of credit to sustain themselves, what happens if credit creation lurches into reverse? Usually, the booms go bust…in a big way.

In fact, credit may be lurching into reverse right before our eyes.  The lenders are simply refusing to lend, which is why the commercial paper outstanding is plummeting. In a perfect world, asset-backed entities, known as "structured investment vehicles" (SIVs), borrow short-term money in the commercial paper market, then invest the proceeds in debt instruments like mortgages, credit card receivables and collateralised debt obligations (CDOs). But the borrowing part of this formula has dried up completely.

The asset-backed issuers of commercial paper cannot find any lenders to finance their toxic cocktails of lousy mortgages and "new math".

Over the last six weeks, the (formerly) US$1.2 trillion US asset-backed commercial paper market has contracted by a whopping US$245 billion dollars. In other words, one fifth of this market has simply disappeared. Unfortunately, the SIVs still need the US$245 billion that nobody will lend them. Without the money, they must liquidate their illiquid portfolios of subprime mortgages and credit derivatives. "We're dumping all our collateral into the market and it becomes a death spiral for the assets," moans Brian McManus, head of collateralised debt obligation research at Wachovia Corp.

To avoid dumping their collateral on the market, however, some SIVs will try to "move back home" like an unemployed college grad. Where is home exactly? On the balance sheets of the biggest banks and brokerages firms in the US (we're talking about the same folks who are already reeling from overexposure to various other piles of financial compost). According to the fine print in many SIV formation documents, the underwriters who issued the SIVs must provide the financing of last resort.

So far, the slow-motion crisis in the commercial paper market is unfolding behind the veil of institutionalised obfuscation. That's because all of Wall Street wishes to keep it that way. The cold, hard truth might hold some interest for short-sellers and academics, but not for the folks who are on the hook for billions of dollars worth of mortgage-backed securities. But even a very bad boom is not so bad if an individual prepares for the bust.

Preparing would include reducing debt and diversifying savings into foreign currencies and "hard assets". But the American financial system is not merely an "SIV problem", it is also - and more importantly - a financial system problem. In addition to the US$250 billion of short- term financing that has already disappeared form the asset-back CP market, another US$300 billion will come due before Thanksgiving. It will come due, and it will probably not find willing lenders. So where will this US$550 billion of credit and/or collateral end up?

Probably not in a place that will please stock-market investors, or bond investors or stock market investors…especially, dollar-holders. Here's the problem in a nutshell. Since homeowners are defaulting in record numbers, mortgage-backed securities of all types are tumbling in value. And since the prices of mortgage securities are tumbling - and since know one knows what these things are really worth - no one wants to provide financing. And since no one wants to provide financing, hundreds of billions of dollars worth of credit drops out under the asset-backed securities market.

You get the idea. As credit disappears, therefore, SIVs and other mortgage-loaded entities must either liquidate their portfolios or obtain new financing from some other channel…or dump their portfolio back on the underwriters. And the numbers involved are extremely large. The US$500 billion that might disappear from the commercial paper market before Thanksgiving could be a very big problem…for the mortgage market, for the banking system…and especially for the US dollar.

Bad booms produce bad results. That's just the way it is. Maybe it's time to prepare for the bust.

Eric Fry
for The Daily Reckoning Australia

• None Found

If the connection between falling stocks markets and a rising yen confuses you, don't be dismayed. You have a lot of company. But the connection is not as confusing or sophisticated as it might seem. The "yen carry trade," as it is known, only seems complicated. But it's actually so simple, it's moronic.

"Speculators borrow yen at preposterously low interest rates," explains Bill Bonner. "They trade the money for other currencies - notably those of English-speaking countries - in order to place the money in higher-yielding investments. They then pocket the difference and think they are geniuses. The game works beautifully. Nothing goes wrong. That is, until something goes wrong."

Two weeks ago, as global stock and bonds were tumbling, the "EXIT" door became jam-packed...and the yen's price soared. If assets prices worldwide continue to tumble, the yen carry trade will continue to unwind. And if the carry trade unwinds, the yen will soar. Buying yen, therefore, offers a back-door hedge against falling stock and bond prices.  One simple way to buy yen is to purchase the CurrencyShares Japanese Yen ETF (NYSE: FXY).

For several years, the yen carry trade has nurtured and facilitated risk-taking throughout the world's financial markets. It has provided a seductive source of low-cost liquidity that has emboldened speculators to borrow yen at dirt-cheap rates of interest and invest the proceeds in higher-yielding investments. As long as the "higher-yielding investments" obliged with high-yields, the process worked beautifully. And it had been working very beautifully... until about four weeks ago.

But now that stocks and bonds become very volatile - or simply falling - many yen carry trades are producing losses. As the losses mount, the pain is increasing. As the pain increases, the speculators begin to sell their "high-yield" assets and repay their borrowed yen.

Obviously, the process of repaying yen requires buying yen first, then giving them to the lender. That's why the yen appreciates during times of market distress.

For example, in mid-July the yen fell to a record low against the dollar on the very same day that the Dow reached its all-time high above 14,000.

But as stocks tumbled from their all-time highs, the yen's value rocketed higher. The more stocks fell, the more the yen rose; the more the yen rose, the more stocks fell. After a while, cause became indistinguishable from effect.

The yen's recent spike might be signalling that rampant risk-taking is winding down.

"People are taking risk off the table," one currency trader told Bloomberg News, "In this environment, the yen carry trade is suffering and is going to continue to suffer." The "suffering" of the carry trade does not move us to tears.

"The big carry trade beast has started to roar," says Albert Edwards, an investment strategist with Dresdner Kleinwort, "A complete meltdown of the Yen carry trade now beckons.

"So far," Edwards continues, "the 'Great Unwind' has not seen a major reversal of Yen-funded trades. Much else has happened, but this is the elephant that has been waiting to trample its way through the global financial village and squash the villagers already dying of thirst from a liquidity drought."

Avoid the stampede; buy some yen.

Eric Fry
for The Daily Reckoning Australia

• None Found