Sunday, September 09, 2007

Monopoly, a game from the Depression

I remember as a kid playing a game of Monopoly. One particular time, we ended up with the bank running out of money. So someone grabbed a note pad and made up some $1000 bills for the bank and the game continued. Chance, Community Chest, the Utilities and Luxury Tax were also deeded out and sold. We were putting houses on everything including the Railroads. Soon we ran out of houses and hotels, so we used chess and checkers set pieces for Mega Resorts. The game pretty much ended when two players got wiped out on Park Place and Boardwalk.

It kind of sounds a little like what has been happening world wide financially, doesn’t it? Japan should have been out of the game 15 years ago, but since they pledged to take all of their savings and invest it outside the country, they were allowed to stay (that’s not really what they did, but that was the end result). Now you hear whispers that the Yen carry trade is winding down. This, from my understanding, was a massive migration of cash from Japan to foreign banks.

I’m guessing that it’s far more serious than that. If it comes to pass that the Japanese were heavy investors in CDO’s and Hedge funds, they have a serious problem. It brings to mind the German Weimar Republic collapse where to purchase a loaf of bread, you needed a bushel basket of deutschmarks (Their funds had been sucked out of the country by a repatriation agreement settling World War I).

We will just have to wait and see what plays out in Japan. Will they land on Park Place or Boardwalk? It's time to roll the dice.


Bruce Stewart said...

My parents - who grew up in the Great Depression, no less! - used to have house rules that allowed for credit in the game. You could borrow to buy property, to build houses, to pay debts. We also stretched our housing supply by requiring properties in a monopoly to be built evenly (no 4 houses on Boardwalk and 3 on Park Place). You got full value back instead of 50% when houses were torn down.

As with your game, ours was highly inflationary as well. It was not uncommon to win the game (eventually - they'd last longer than Monopoly "by the rules") with a net worth of about $1,000, because of all the accumulated debt. The bank absorbed all unpayable debt on player elimination.

Sounds an awful lot like the times we are living in, doesn't it?

In any event, in my house, we play by Parker Brothers' rules, with the sole exception of the lottery winnings on Free Parking (all taxes and chance/community chest penalties are paid into that square; to take the winnings you must have put $50 into that fund as you passed Go the last time before hitting Free Parking). This has taught our children to be a little more careful with money and simulates the possibility of a windfall. They quickly learned that paying 25% of their Go income for a chance to collect if the dice co-operated was a bad deal!

Jim in San Marcos said...

Hi Bruce

I agree changing the rules is the name of the game, it sure made it more interesting.

This link gives some history on how the inventor of the game couldn't sell it to Parker Brothers to begin with. An interesting piece on how to go from being unemployed to a millionaire during the depression.

Kevin said...

I think the Yen Carry Trade is not *quite* what you think (and worse than you think). Here's the way Investopedia describes it:

Here's an example of a "yen carry trade": let's say a trader borrows 1,000 yen from a Japanese bank, converts the funds into U.S. dollars and buys a bond for the equivalent amount. Let's assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% (4.5% - 0%), as long as the exchange rate between the countries does not change. Many professional traders use this trade because the gains can become very large when leverage is taken into consideration. If the trader in our example uses a common leverage factor of 10:1, then she can stand to make a profit of 45%.

The big risk in a carry trade is the uncertainty of exchange rates. Using the example above, if the U.S. dollar were to fall in value relative to the Japanese yen, then the trader would run the risk of losing money. Also, these transactions are generally done with a lot of leverage, so a small movement in exchange rates can result in huge losses unless hedged appropriately.

Here's why this is really ugly:

1 - Traders (including plenty of Americans) have to convert dollars back to yen. The further increases the value of the yen and lowers the value of the dollar.

2 - The market for T-bills necessary to continue funding the US debt shrinks as the carry trade unwinds. US interest rates have to rise to compensate.

3 - The drop in the dollar makes T-bills a less and less lucrative (or even safe) investment for foreign investors. If foreign investors sense diminishing returns due to a falling dollar it can (a) drive the dollar down further and (b) push T-bill rates even higher (making it very difficult to continue our spending levels.

Unwinding the carry trade is a big problem for us!

Jim in San Marcos said...

Hi Kevin

I agree with you.

A lot of what I am saying, you have to read between the lines. There are no real solid facts to back up my case it is mostly conjecture.

I am suggesting that the Japanese currency is extremely overvalued. As the carry trade unwinds, they will drown in Yen. The worst case scenario would be the Weimar Republic where the currency dropped to zero, the end result of hyper-inflation.

That would explain the current gold buying while everyone is liquidating to raise cash.

Thanks for the pointer to Investopedia

Anonymous said...

Why would yen be overvalued now? Putting on the carry trade tends to depreciate the yen. Current ABCP woes will tend to strengthen the dollar (dollars needed to fund margin calls). Also looks undervalued on a PPP basis, e.g. the Economist's Big Mac index has it as 33% undervalued.

A massive unwinding of carry trade would strengthen yen, not weaken it.

Jim in San Marcos said...

Hi Anon 7:24

The Japanese have been playing games ever since their banking system collapsed in the 1990’s. They went with zero interest which started the Yen carry trade. So figure that all of the banks in Japan are using the Yen carry trade. It should still be working AOK even if you need to purchase a forward trade for insurance but it isn’t.

I think their problem is the need for cash at home, and that is what is crimping the carry trade. If you follow a trade from start to end, figure that the Japanese bank converts yen to dollars and buys treasuries, everything is ok. The change in currency values is the only concern. But what if the bank doesn’t go for treasuries and instead goes for CDO’s or hedge funds? They are not very liquid. If their investment is only worth 30 cents on the dollar, they can’t even wind down the carry trade properly. At this point, the Japanese bank has to go to the BOJ discount window to borrow to unwind the trade. This is what we did in the monopoly game; print money.

This is an oversimplification, but I ‘m suggesting that the banks in Japan never really fixed their solvency problems from the past, they have gotten worse, a lot worse.

Anonymous said...

Jim, it`s 3:59 CST, the dollar tanked today and oil hit a new record (well, cnbc said it hit $80 at one time today). My question is why didn`t gold go up today? It seems like it would have went up like oil did, but, alas it did not. Any opinion on this? Thanks.

Jim in San Marcos said...

Hi Anon 2:04

On a daily basis its impossible to tell what the market is really doing.

Month over month, gold and oil appear to be increasing in price. What could be happening is that the dollar won't buy as much gold and oil as it did yesterday.

If you picture our total currency in circulation as a big lake and Gold is a ruler indicating the depth of the lake, then by adding more currency to the lake, you raise the value read on the gold ruler.

You really can't feel $1,000 in the bank losing $100 in buying power, but you can see the rise in the price of gold.

Anonymous said...

If the U.S. stock market crashes, do you think that the Chinese market will crash also?

Jim in San Marcos said...

Hi Anon 5:05

The Chinese stock market has only been around 17 years. The country is still a communist dictatorship. Socialism doesn't mix well with capitalism.

The Shanghai market has gone ballistic in the last 20 months, and is unsustainable.

China's financial institutions evolved from socialist principles, so to say that they have no idea what they are doing is a pretty good summary of what is going on.

Their market will crash. A better choice of words would be "crater." The irony of the situation when it happens, will demonstrate that capitalism is flawed. We will be blamed for the whole mess.

Anonymous said...

Anon 5:05 saying, thanks Mr. Jim!