The Japan Bubble: How One Country Is Holding Up The Entire World

Summary

The video script explores the concept of the 'carry trade', illustrating how a small interest rate change by the Bank of Japan can have global financial impacts. Using magic as an analogy, the narrator explains how misdirection in economics can lead to significant market reactions. The script delves into historical context, the mechanics of the carry trade, and its potential to trigger market crashes. It also discusses current economic indicators, suggesting a possible recession, and shares the narrator's personal investment strategies amidst uncertainty.

Takeaways

• 😎 The concept of misdirection in magic is likened to macroeconomics, where small changes can have large, seemingly unrelated effects.
• 🌐 A 0.25% interest rate increase by the Bank of Japan can have a significant impact on global markets, illustrating the interconnectedness of economies.
• 💡 The 'carry trade' is a financial strategy where investors borrow in a country with low-interest rates and invest in higher-yield assets elsewhere, which can lead to substantial profits or losses.
• 📉 The Japanese stock market's drop of 12.4% was its worst single-day decline since 1987, and it affected global markets, including the US and the NASDAQ index.
• 🏛️ Andrey J uses the analogy of a card castle to represent the foundations of the carry trade, including low-interest rates and a declining yen, and how changes can lead to instability.
• 📈 The carry trade has been a significant factor in global finance for decades, with various countries participating and experiencing both benefits and risks.
• 📊 The size of the carry trade is difficult to measure accurately, with estimates ranging from hundreds of billions to trillions of dollars, indicating its potential impact on the global economy.
• 🚫 The carry trade can lead to 'flash crashes' in the market when there are unexpected changes, such as an interest rate increase by a central bank.
• 💼 Warren Buffett's company, Berkshire Hathaway, is holding a large amount of cash, which some interpret as a sign of economic caution or preparation for a downturn.
• 🛑 Indicators such as luxury item sales, unemployment rates, and small business struggles suggest potential economic slowdowns or a possible recession.
• 💰 Andrey J shares his personal investment strategy, which includes dollar-cost averaging into Bitcoin and the S&P 500, and reinvesting dividends to build wealth over time.

Q & A

What is the concept of misdirection in magic and how is it related to macroeconomics?

Misdirection in magic is a technique where a magician creates a small action to draw attention away from the real trick. In macroeconomics, this is akin to how a small change, like a slight interest rate increase, can have a significant impact on the global economy by drawing attention and causing reactions in financial markets.

What is the carry trade and how does it work?

The carry trade is a strategy where investors borrow money in a country with low-interest rates and invest it in another country or asset with a higher return. As long as the return on investment exceeds the borrowing cost and the borrowed currency is weakening, the strategy can be profitable.

Why did the Japanese stock market drop 12.4% in a single day?

The Japanese stock market experienced its worst single-day decline since 1987 due to the Bank of Japan's unexpected decision to raise interest rates for the first time in 17 years. This small increase scared investors and led to forced liquidations.

What is the significance of the VIX index in the financial markets?

The VIX index, or the 'fear index,' measures market volatility and investor fear. A high VIX indicates significant market stress and is often associated with market downturns, such as during the 2008 financial crisis and the pandemic.

How does the carry trade affect global financial markets?

The carry trade can inject significant liquidity into global markets when investors borrow cheaply to invest in higher-yielding assets. However, when conditions change, such as an increase in interest rates, it can lead to a rapid unwinding of these trades, causing market volatility and potential crashes.

What historical event is the carry trade's origin often linked to?

The carry trade's origin is often linked to Japan's economic collapse in 1989. In response, Japan slashed interest rates to nearly zero, creating an opportunity for speculators from other countries to borrow cheaply and invest in higher-yielding assets.

How did the carry trade influence the Australian dollar in the 1990s?

In the 1990s, Australia had a high-interest rate and a strong currency due to an influx of money from around the world. Investors would borrow in Japanese Yen and invest in Australian treasury bonds, profiting from the difference in interest rates.

What is the current estimate of the size of yen-denominated loans outstanding globally?

According to the Bank for International Settlements, the loans outstanding from one country to another denominated in yen are valued at 41 trillion yen, or a little over $400 billion.

Why is it difficult to determine the exact size of carry trades worldwide?

The exact size of carry trades is difficult to determine because foreign exchange borrowing is not included or counted on a bank's balance sheet. Instead, it's hidden within foreign exchange swaps, which are not recorded as debt.

What are some signs that suggest a potential recession?

Signs of a potential recession include wealthy individuals holding more cash, a decline in luxury item sales, rising unemployment, and small businesses struggling to get loans. Additionally, the market may predict a decrease in interest rates by the Federal Reserve, which is often a sign of a slowing economy.

Outlines

00:00

🔮 Economic Illusions and the Power of Misdirection

This paragraph introduces the video with an analogy of a magic trick involving a spoon, demonstrating the concept of misdirection. The presenter, Andrey J, compares this to macroeconomics, where small actions can have significant impacts elsewhere. The example given is how a 0.25% interest rate increase by the Bank of Japan affected global markets, leading to massive financial losses. The paragraph sets the stage for a discussion on the carry trade, its effects on the world economy, and the potential for such small changes to cause large-scale economic shifts.

05:01

🌐 The Global Impact of Japan's Monetary Policy

The second paragraph delves into the historical context of Japan's economic rise and fall, and how its policies inadvertently created opportunities for the carry trade. It explains that Japan's low-interest rates and deflation led to a situation where speculators from other countries borrowed Japanese yen to invest in higher-yield assets globally. The paragraph outlines how this practice has been used by various countries, including Australia and others, to profit from the difference in interest rates. It also touches on the 2008 financial crisis and the subsequent revival of the carry trade under Shinzo Abe's policies, highlighting the potential risks of this practice, such as market crashes when conditions change.

10:03

📉 The Unintended Consequences of Monetary Policy Shifts

This paragraph discusses the potential triggers for a carry trade collapse, using the example of the Bank of Japan's unexpected interest rate hike in 2022, which led to market corrections and investor liquidations. It draws a parallel to the European Central Bank's rate hike and its impact on the Vanguard International Market ETF. The paragraph emphasizes the uncertainty surrounding the size of carry trades and their potential to cause significant market disruptions, as well as the difficulty in predicting the severity of a potential crash due to the lack of transparency in the size of these trades.

15:04

💼 Economic Indicators and Personal Financial Strategies

The final paragraph shifts focus to the current economic indicators and the presenter's personal financial strategies amidst uncertainty. It notes trends such as wealthy individuals holding more cash, a decline in luxury goods sales, rising unemployment, and the potential implications of these trends on the economy. The presenter shares his approach to investing, which includes dollar-cost averaging into Bitcoin and the S&P 500 ETF, as well as reinvesting dividends. He emphasizes the importance of saving and having an emergency fund, while also acknowledging the unpredictability of economic conditions and the potential for a recession. The paragraph concludes with an invitation for viewers to share their thoughts and strategies.

Keywords

💡Carry Trade

The carry trade is an investment strategy where an investor borrows money at a low interest rate in one currency and invests it in another asset that is expected to generate a higher return. In the video, it is mentioned as a mechanism that allowed Japan to prop up the world economy by borrowing at near-zero interest rates and investing in higher-yield assets globally, which could lead to significant market reactions when conditions change.

💡Macroeconomics

Macroeconomics is the study of the economy as a whole, including topics like inflation, unemployment, and economic growth. The video uses the concept of misdirection in magic to illustrate how small changes in macroeconomic policies, such as interest rate adjustments, can have large-scale impacts on the global economy, as seen with the Bank of Japan's actions.

💡Interest Rate

An interest rate is the percentage of an amount loaned that a lender charges for its use, typically expressed as an annual percentage. In the script, the increase of 0.25% in the interest rate by the Bank of Japan is highlighted as a catalyst for significant global financial market reactions, demonstrating the sensitivity of financial markets to central bank policies.

💡Misdirection

Misdirection, in the context of the video, refers to the concept in magic where the magician's actions are designed to draw the audience's attention away from the method of the trick. The video compares misdirection in magic to the way small changes in economic policies can be overlooked but have significant effects, such as the impact of the Bank of Japan's interest rate adjustments.

💡Deflation

Deflation is an economic phenomenon where the general price level of goods and services in an economy falls over time. The video discusses how Japan experienced deflation, leading to the central bank setting interest rates to nearly zero to encourage spending, which inadvertently fueled the carry trade by making Japanese Yen an attractive currency to borrow.

💡Flash Crash

A flash crash refers to a sudden, dramatic decline in the prices of assets, typically within a short period. The video mentions a flash crash in the context of the carry trade, where an unexpected rise in interest rates by the Bank of Japan led to a rapid sell-off in financial markets, illustrating the volatility that can be triggered by shifts in monetary policy.

💡Yen

The yen is the official currency of Japan. In the video, the yen is highlighted as the currency that was borrowed in large amounts due to Japan's low-interest rates, which facilitated the carry trade. The script also discusses how changes in the value of the yen and Japanese monetary policy have had significant global financial implications.

💡Unwinding

In financial terms, unwinding refers to the process of closing or reversing a position in an investment or trade. The video discusses the potential for large-scale unwinding of carry trade positions if interest rates were to rise, which could lead to significant market corrections and financial instability.

💡Recession

A recession is a period of negative economic growth that lasts for at least two consecutive quarters, indicating a decline in economic activity. The video raises the question of whether the current economic conditions might lead to a recession, citing factors such as rising unemployment and changes in consumer behavior as potential indicators.

💡Dollar-Cost Averaging

Dollar-cost averaging is an investment strategy where an investor consistently buys a fixed dollar amount of a particular investment, regardless of its price. In the video, the creator discusses using dollar-cost averaging in the stock market and Bitcoin, as a way to mitigate risk and invest systematically over time.

💡Portfolio

A portfolio refers to a collection of financial assets such as stocks, bonds, and cash equivalents held by an investor. The video creator shares insights into their personal investment portfolio, discussing strategies like reinvesting dividends and dollar-cost averaging as methods to grow and manage their investments.

Highlights

The concept of misdirection in magic is analogous to macroeconomics, where small actions in one area can cause significant reactions elsewhere.

A 0.25% increase in the Bank of Japan's interest rate had a global impact, causing billions of dollars to be lost.

The carry trade mechanism involves borrowing from countries with low interest rates and investing in higher-yield assets.

The Japanese stock market dropped 12.4%, the worst single-day decline since 1987, affecting global markets.

Markets reacted with fear to the potential end of the carry trade, with the VIX index reaching levels seen only during the 2008 financial crisis and the pandemic.

The carry trade has been a significant factor in global finance for decades, influenced by Japan's economic policies.

The collapse of Japan's economy in the late 1980s set the stage for the carry trade, as Japan introduced near-zero and negative interest rates.

Countries borrowed cheap Japanese Yen to invest in high-yield assets, creating a global financial dependency on Japan's low-interest rates.

An unexpected interest rate hike by the Bank of Japan can trigger market crashes and force investors to liquidate positions.

The size of the carry trade is difficult to measure, with estimates ranging from hundreds of billions to trillions of dollars.

The potential for a recession is increasing, with indicators such as high cash reserves among the wealthy and a decline in luxury goods sales.

Unemployment rates are rising, which historically has been a sign of an economy slowing down and potentially entering a recession.

Market predictions suggest a high likelihood of the Federal Reserve lowering interest rates, signaling a possible economic slowdown.

The speaker is personally building a cash position and investing through dollar-cost averaging, despite market uncertainties.

Diversification and consistent investing, even without perfect timing or stock-picking skills, can lead to significant wealth accumulation over time.

The speaker emphasizes the importance of saving and having an emergency fund, as well as the benefits of reinvesting dividends.

Investors should be cautious of relying on market timing and instead focus on consistent investment strategies.

Transcripts

so I want to show you how one country's

currency was able to prop up the entire

world using just a spoon sounds weird

but if I place the spoon on my hand like

this and I start to slowly rub it it's

going to start to look like the spoon is

bending watch you see that tail end of

it Rising just by rubbing it the metal

is bending just like that with the power

of my mind it's fully bent okay not

really that was just a magic trick but

within magic there's this really

interesting concept called misdirection

and the way misdirection works is not

that different from macroeconomics

because by creating One Small hidden

action in one place I can cause a much

bigger reaction in another by lowering

my fingers on one end of my hand I can

create the illusion of the metal bending

on the other but where you look is where

all the action happens and that's

exactly how a tiny increase of just

0.25% of another country's Central

bank's interest rate the bank of Japan

could cause the world to lose hundreds

of billions of dollars imagine one small

country one currency did all that how

and this is where it gets really

interesting because the mechanism that

caused this to happen is something

called the carry trade imagine borrowing

a million million dollar at 0% interest

which right now you can't do because

interest rates are just too high but

it's possible to borrow from a country

where interest rates are close to zero

like Japan and then using that loan to

invest in anything stocks real estate

treasury bonds gold Bitcoin doesn't

matter as long as the return on

investment is higher than the interest

rate of your loan and the currency that

you borrowed is on the decline then this

could work until it doesn't that's why

the Japanese stock market dropped

12.4% and that was the worst single day

decline since the Black Monday of 1987

and the US the stock market lost 3% and

the tech heavy NASDAQ index fell

3.4% even the vix which is what people

like to use to measure people's fear

went up to 65 and that's a level seen

only two other times before the 2008

financial crisis and the pandemic so the

markets got really scared and they sold

off and of course right now they've

recovered but I still have a lot of

questions like was that the end of it

did we fully unwind or is there more

left to go how big are these trades how

did Japan cause US Stocks to fall and

are we in a recession already there's a

lot of questions I don't know the

answers to but I want to try to

understand so with that said let's get

into it hi my name is Andrey J hope

you're doing well well come for the

finance and stay for macroeconomic magic

let me just show you a visual analogy of

what I think is happening all around the

world as I'm building this little card

Castle I just want you to imagine that

each and every one of these pillars

represents what allowed the Japanese

carry trade to sort of exist like for

example Japan's low interest rate and

the declining yen in the 1990s combined

to make this little Foundation that

everything was built on top of because

on top of that we built some interesting

things like we added some investor

confidence and then we added some Global

Financial liquidity so as you'll see

there we go and on top of that we added

another

Foundation which represented all the

countries in the world that wanted to

get yields from their cheap

loans so it looks like that creates a

beautiful little pyramid but here's

where it gets interesting because as

things start to change like for example

interest rates are no longer zero or

negative we get this very interesting

effect to happen then we start to remove

other things like investor confidence

for example kind of interesting and then

of course we remove other things like

Global

liquidity and we get something that

makes no sense at all and that's a

visual analogy of the stock market as it

is today the only thing that's holding

up this sculpture is the invisible force

of Central Banking now in Magic I like

to call this fake it until you make it

but in economics it's called fake it

until you break it and break it we did

because on August

5th we broke it because that's when

Japan introduced the force of gravity my

first question is would you please

subscribe cuz that took me way too long

to do and the second question is how did

we get to a point in time where one

country raising its interest by a tiny

amount could affect someone on the other

side of the world to wake up and say

what just happened to my stons so let me

give you a big picture historical

context of how we actually got here but

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this segment of the video and now let's

get back to it it turns out what made

all of this possible was Japan trying to

save itself by the height of the 1980s

Japan became one of the most powerful

countries in the world Japan's stock

market alone was estimated to be worth

four times more than the entire value of

us real estate and times were so good

and Japan made so much money it started

buying huge portions of the United

States people in the US thought Japan

would become the world's dominant

superpower but then it all reached a

peak in 1989 and Japan

collapsed now that's a completely

separate video not related to the carry

trade but it was Japan's rise and fall

that created the opportunity for the

carry trade because Japan started to

experience deflation and prices started

to fall so to save itself Japan slashed

its interest rate to nearly zero and

then eventually to negative to encourage

people to go out borrow money and spend

it but the Japanese people just

experienced the worst economic crash of

their lifetime they didn't want to

borrow money instead the borrowers

became speculators from other countries

and that's what created the carry trade

that turned Japan into the biggest

creditor Nation in the world where

countries go to borrow cheap money let

me just show you some examples of how

Japan has propped up the entire world

for decades now because countries with a

high interest rate have also done this

throughout history like Australia for

example in the 1990s Australia like the

us today had money pouring into itself

from all over the world which made the

Australian dollar extremely strong and

Australia had a high interest rate so

what countries would do is they would

borrow Japanese Yen they would park that

money into Australian treasury bonds

collect the high interest rate pay off

the loan and they would pocket the

difference that was the infinite money

glitch it was a way to virtually

risk-free make a return on their money

and this has been happening all around

the world for decades with other

countries and their currencies including

the Mexican peso which spoiler alert

didn't have a good ending the Turkish

lead ER the Hungarian forign the South

African rand the Indonesian rupia and

the Russian rubble and then 2008

happened and the carry trade was

reset at least until 2013 and the Cary

Trade was revived under Shinzo ab's

policies which kept Japanese interest

rates low and then eventually negative

in 2016 while the United States and the

rest of the world started to increase

their interest rates and that once again

creat created this opportunity for the

carry trade and once again the cycle

started to repeat money could once again

be cheaply borrowed and invested into

high yield assets like the US Stock

Market and treasury bond market for a

guaranteed return so it works when

things are working but when things go

bad it can lead to a flash crash and

that's how you can get someone to wake

up one week halfway on the other side of

the world and wonder why their portfolio

is crashing all right so if the carry

trade has been around since the 1990s

the next question question I had is

could something trigger it to happen

again and how bad would it be it turns

out yes it can and here's how all that

happened was the bank of Japan

unexpectedly raised interest rates for

the first time in 17 years and just a

small increase of 0.25% of the key

interest rate was enough to scare

investors and force their liquidations

when interest rates go from negative to

positive really bad things could happen

to the market in fact the same thing

happened to Europe in July July of 2022

that's when the European Central Bank

the ECB started to raise rates for the

first time in 11 years and watch what

happens to the Vanguard international

Market ETF ticker symbol vxus right

around that same time frame the market

corrected 15% between the end of July to

Mid October and some of that can be

attributed to the unwinding of their

carry trade thanks to Europe ending its

negative interest rate policy so yes all

of this can happen happen at any time if

Japan decides to raise their interest

rate now unfortunately because I'm not a

smart Economist I couldn't figure out

how bad a crash could get but the truth

is no one really knows because we don't

know the size of these carry trades

around the world but what we do know is

they are really really big in fact

according to bis the bank of

international settlements which is sort

of like a group of banks that report on

information they say that the loans out

standing from one country to another

denominated in yen is valued at 41

trillion yen or a little over A4

trillion but economists also say that's

not an accurate measure of how big carry

trades actually are and that's because

foreign exchange borrowing is not

actually included or counted on A bank's

balance sheet instead it's hidden within

what's called foreign exchange swaps and

the swap Market including the Yen totals

wait for it

14.2 trillion us that money is not

counted as debt it goes completely

unrecorded because there is no spoon

that's why no one can agree how big this

thing really is it could be in the

hundreds of billions or in the trillions

of dollars analysts at UBS for example

say that it's 500 billion so half of it

just got Unwound but JB Morgan says it's

$4 trillion so we're nowhere near it

being over but no one knows all we

really know is that we got really lucky

this time around because Japan

backtracked and was like we're not going

to raise interest rates anymore just

kidding but no one really knows the full

size of the mother of all carry trades

and how bad this could really get so all

of this sort of leads me to ask the

ultimate questions are we in a recession

session or are we going to be in one

soon and of course the answer is no one

knows for sure so I looked at a bunch of

different things and here are some of

the trends that I've noticed I might put

you to sleep for the next minute or two

but I promise I'm going to tie it all

together and show you what I think and

how I'm investing through all of this

but the first thing that I noticed is

that rich people are holding a lot of

cash right now take Warren Buffett for

example his company Berkshire Hathaway's

cash position relative to total assets

spiked to 25% in Q2 2024 the highest

level in 24 years he sold off so many

stocks that is Cash has now doubled in

Just 2 years and it's not just investors

raising cash I've also noticed that

luxury items are not selling as much and

the prices have significantly dropped

especially luxury cars which I know is

anecdotal and it's only a small part of

the economy but hear me out if you've

ever looked at auction sites like cars

and bids or bring a trailer luxury cars

are not meeting their reserves and in

general the used car market is

significantly declined and cars are

usually the first to go there's also

Rising unemployment the latest jobs

market report showed that unemployment

is now at a three-year high and this is

a classic sign that the economy could be

slowing down it's happened a lot of

times before we get a recession and a

part of what leads to higher

unemployment are small businesses and

right now small businesses are going

through a recession of their own because

because it's really hard for them to get

a loan from the banks right now and the

harder it is for them to get a loan the

less people they tend to hire and the

more they tend to let go and that

affects unemployment and that's exactly

what we're seeing in this chart also

economists say that it takes on average

roughly 10 quarters after the first rate

increase to put economies into a

recession and right now we're on that

10th quarter which means the likelihood

of us being in a recession is

statistically higher and that's why when

you add everything up together everyone

is sort of waiting to see what the most

important Bank of all will do of course

the Federal Reserve the central bank and

no one knows what they're going to do

until September but right now the market

is predicting a 74% chance that they're

going to lower interest rates by at

least a qu% in September now this

doesn't always happen but when the FED

starts to Pivot and lower interest rates

that usually means the sign of a slowing

economy and a potential recession ahead

that's not to say that we are in a

recession or we're going to be in one

but those are just some of the things

I've noticed now if you made it this far

into the video here's what I'm

personally doing please understand this

is not supposed to be Financial advice

and I don't want anyone to confuse the

view counts of my video or the

subscriber count of my channel as me

having any knowledge about how to

actually invest I share these numbers

with you because I think transparency is

really cool that's what it got me me

into saving and investing and so I try

to return the favor and I hope that

inspires you or it informs you but the

way that I'm looking at everything is

this year we're in an election year so

all the numbers that I'm seeing reported

by the government I tend to think the

real numbers are probably not as good as

what I'm seeing maybe I'm wrong but

that's the way I look at it now when I

ask people what they're doing with their

finances they're saving are you

investing are you just waiting to buy a

lot of times I I hear people say I'm

going to wait until interest rates come

down until house prices car prices all

come down and I can finance and buy when

it's cheaper and that's fine but I think

what most people forget is that when

interest rates come down it's because

the economy is slowing down and when

asset prices come down it's not because

interest rates are cheaper it's because

people lose their incomes now I hope

that doesn't end up happening but when

it happens people lose their purchasing

power that's why things go down that's

also why I've been building a cash

position just in case life throws a

lemon in my face I think it's really

important to save at least 3 to 6 months

worth of an emergency fund just in case

but when it comes to investing I'm also

dollar cost averaging right now for

example when the market flash crashed I

was buying a little bit of Bitcoin

unfortunately I missed it below 50,000

but that's okay because I'm putting in

about $100 a day into Bitcoin sometimes

more sometimes less but that's about my

pace when it comes to the stock market

the S&P 500 I'm also dollar cost

averaging at the exact same rate of $100

a day and that's into an ETF ticker

symbol vti which is basically the broad

stock market that's made up of thousands

and thousands of different stocks now

I'm also reinvesting all my dividends

and right now I'm buying a dividend ETF

ticker symbol jeq or Jep Q to

supercharge my dividends at the rate of

$200 a day and my goal is to get to

about $1 $1,000 in that position which I

also realize all these numbers are

completely unrelatable to most people so

I don't want anyone to look at all this

money that I'm investing in thinking wow

Andre is really confident and knows what

he's doing that is not the case and to

prove to you that I'm no genius stock

picker I will show you that so far my

year-to-date returns are only 11%

compared to vti's 177% so if you want to

make more money than me just focus on

the broader stock market and then of

course I'm also reinvesting all of my

dividend income back into my portfolio

which right now is generating about

$2,000 a month but I will say I wish I

could just time travel back to my

younger self and thank that kid for

putting myself on this path today I wish

I could show him my portfolio right now

and say look you're still no genius but

even though you made only 11% this year

that's more than six figures it's more

than what you're making now and it's

more than what most people are making

from their day job and here you are

doing nothing and these stocks and all

the people on Wall Street are making you

wealthier every single year just because

you had the foresight to know that

someday you will be at this point in

your life and all it took was just being

consistent and not particularly smart

which I think is pretty cool I'll leave

a link down to the course below just

kidding I don't have any courses but

someday in the future if there's any

interest I will definitely make one and

if you'd like me to do a more detailed

breakdown of my portfolio just let me

know down in the comments below and I'll

see what I can do but in the meantime

I'd love to hear your thoughts about

where you think the world is going and

what you're doing about it I hope you

have a wonderful rest of your day smash

the like button subscribe if you haven't

already don't forget to grab your free

stocks links are down below go track

them automatically with a spreadsheet

link Down Below in my patreon I'd love

to see you back here next week I'll see

you soon bye-bye