I suspect that we can add Mrs Watanabe to the list of those suffering from global financial turmoil.

The abrupt rise of the yen and the dollar against higher-yielding currencies seems to have been driven by hedge funds unwinding various forms of carry trade - borrowing in a low-yielding currency and investing in assets in higher-yield economies. This has caused havoc in financial markets in the past couple of weeks.

The yen fell somewhat this morning amid reports that Japan will intervene on currency markets to dampen the extreme volatility in its currency. But the yen is at multi-year highs against the dollar, let along higher-yielding currencies such as the Australian and New Zealand dollars, while the Japanese stock market has plunged.

Hedge funds that invested heavily the carry trade, using leverage, are obviously in trouble to judge by the rapid changes in exchange rates. But the individual Japanese investor, including the mythical Mrs Watanabe, is also suffering, to judge by a conversation I had a few months ago with one banker.

He recounted taking a look at the books of a Japanese retail stockbroker that was offering itself for sale, and being taken aback by the amount of buying on margin in which ordinary Japanese investors were indulging.

The accounts showed that it was common for Japanese retail investors to be offered leverage of 20 times or more for their cash. In other words, they could deposit the equivalent of $1,000 and take trading positions of $20,000. A lot of them had used the opportunity to buy higher-yielding foreign assets.

The trade worked fine for Japanese investors as long as currencies remained stable and they could in effect switch yen into higher-yielding assets denominated in other currencies. But the sharp rise in the yen - and comparative fall in the value of these foreign assets - is probably landing Mrs Watanabe and her friends with big losses.

Here, to expand the point, is a prescient piece from FT Alphaville a year ago.

October 28, 2008 5:55pm in Finance | Comment