Want to make some serious money? Buy yen now.

Yoshikazu Tsuno/AFP/Getty Thousands of investors have cashed in on Japan’s low interest rates—the lowest in the world—and the Bank of Japan’s reluctance to raise them for fear of deflation. These investors, many of them ordinary Japanese housewives, have managed this through what is known as the “yen-carry trade“. Here’s an example of how it works. ...

Yoshikazu Tsuno/AFP/Getty

Thousands of investors have cashed in on Japan's low interest rates—the lowest in the world—and the Bank of Japan's reluctance to raise them for fear of deflation. These investors, many of them ordinary Japanese housewives, have managed this through what is known as the "yen-carry trade".

Here's an example of how it works. A Japanese investor—let's call her Mrs. Nakamura—borrows yen to buy U.S. treasury bonds. Since the cost of borrowing in Japan is so low, she can make money merely due to the difference between the T-bills' interest rate, somewhere just north of 4.5 percent depending on the maturity date, and the almost negligible rate of interest she pays on her yen loan. Even better, because the yen keeps sliding in value against the dollar, Mrs. Nakamura can sell her T-bills for dollars, buy more yen with them than the amount she orginally borrowed, and pocket the difference. Yatta! (as the Japanese often say when they're celebrating.) For now, it's a win-win investment. But is it sustainable?

Yoshikazu Tsuno/AFP/Getty

Thousands of investors have cashed in on Japan’s low interest rates—the lowest in the world—and the Bank of Japan’s reluctance to raise them for fear of deflation. These investors, many of them ordinary Japanese housewives, have managed this through what is known as the “yen-carry trade“.

Here’s an example of how it works. A Japanese investor—let’s call her Mrs. Nakamura—borrows yen to buy U.S. treasury bonds. Since the cost of borrowing in Japan is so low, she can make money merely due to the difference between the T-bills’ interest rate, somewhere just north of 4.5 percent depending on the maturity date, and the almost negligible rate of interest she pays on her yen loan. Even better, because the yen keeps sliding in value against the dollar, Mrs. Nakamura can sell her T-bills for dollars, buy more yen with them than the amount she orginally borrowed, and pocket the difference. Yatta! (as the Japanese often say when they’re celebrating.) For now, it’s a win-win investment. But is it sustainable?

According to Randall Forsyth of Barron’s Online, the answer is no:

In today’s markets, the ultimate contrarian bet would [be] to buy yen. Were these yen-carry trades… to be reversed, these effective yen short sales would have to be covered, meaning yen would have to be bought.”

All it would take, Forsyth says, is a “flight from risk” as investors try to move their money out of an unfavorably changing investment climate such as a stock market drop, currency crash, or the bursting of a housing bubble. Alternatively, Japan’s central bank could begin raising interest rates, making the carry trade far less profitable. For those who buy yen now, any of these future scenarios would be good news. As yen-carry traders scrambled to pay back their loans in Japan, the value of yen would continue to rise. Those smart enough to buy yen early would make a killing. With the size of the global carry trade standing at no less than $1,500 billion, there’s a lot of money to be made—and with the yen at an all time low against the euro, there seems to be only one direction for Japan’s currency to go. As Forsyth concludes, “[W]ith sentiment so overwhelmingly bearish on the currency, and fundamentals such as a record Japanese current-account surplus bullish, it’s hard to see the yen going much lower.” We’ll see if he’s right.

Prerna Mankad is a researcher at Foreign Policy.

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