This Rally Still Has Plenty of Room to Run

The big hose of global cash flow is Japan. Japanese interest rates are stuck now at 0.25%, when interest rates are 5.25% in the U.S. and 4.5% in Europe. The gap is even larger between Japan and countries such as New Zealand, where interest rates are 7%.

So what do you do if you're a sophisticated global investor? You borrow in Japan at 0.25% and invest just about anywhere else in the world. Because you're using mostly borrowed money, your return on the small amount of your own capital that you commit to an investment is quite a bit higher than the gap between interest rates.

Buy U.S. Treasury notes and have the dollar strengthen against the yen, and whammo: leveraged profits. Buy U.S. stocks in the midst of a stock market rally, and whammo: leveraged profits. Buy an entire U.S. company, take it private and then flip it back to public buyers, and whammo: leveraged profits.

But what is known as the carry trade, the process of borrowing cheaply in Japan and then investing where returns are higher, isn't just for sophisticated investors anymore. Homebuyers in Latvia and Romania, to take just two examples, are taking out yen-based mortgages with interest rates as much as 5 percentage points below prevailing rates in the local market, the Financial Times reports.

A Safe Harbor

As you'd expect, this flood of cash drives up asset prices. The U.S. dollar is stronger than you'd expect for a country that in 2006 recorded another record trade deficit: $764 billion, up 6.5% from 2005. In fact, 2006 was the fifth year in a row that U.S. trade deficit produced a record.