(snip)"In fact, the main trigger for an unwinding of carry trades is likely to be not Japanese interest rates, but an upsurge in currency volatility. That is what happened in 1998, when enormous yen carry trades had built up. After Russia's default in August and the subsequent near collapse of Long-Term Capital Management, hedge funds reduced their leveraged positions and the yen started to rise. Then in October the Japanese government announced a plan to recapitalise its crippled banks, which further bolstered the currency, forcing those who had bet against it to cover their positions. The yen jumped by 13% within three days.

Nouriel Roubini, at Roubini Global Economics, says that the lesson of 1998 is that it takes only a small piece of positive news to unravel such trades. Suppose there is suddenly some good news about the Japanese economy at the same time as America's appears to be stalling. An initial rise in the yen could cause today's carry trades to unwind just as rapidly, causing the currency to soar, American interest rates to rise and risk spreads to widen. The volume of yen-related leverage is probably greater now than in 1998. (here is the full dose from roubini / hier die volle dosis roubini )

The G7 should be concerned about carry trades not just because they could suddenly unwind and trigger financial turmoil but also because the yen's misalignment is distorting the world economy. The yen carry trade has amplified global liquidity (see article), further inflating asset-price bubbles across the world. The trade has also prolonged global imbalances by making it easier for countries such as America, Britain and Australia to finance their large current-account deficits."(snip)