The authors do not make this distinction sufficiently clear, defining carry as a trade with ‘short exposure to volatility’. This is correct for short volatility trading, but not for FX carry where only volatility in the wrong direction is problematic. But perhaps I am being too pedantic. Higher yielding currencies are usually emerging markets. These get hurt when risk levels are elevated, whilst lower yielding currencies are normally ‘safe havens’ like the US and Japan. the markets triggers central bank action to stabilize markets, reduce volatility, and ultimately truncate losses for some carry traders who would otherwise have been bankrupted (p. 37, LL&C).

The financial crash in February-March does not need coronavirus to explain it. It was predictable based on an understanding of the carry regime. But unlike in previous carry crashes, extreme central bank (and government) action has seemed able to rescue the financial markets but this time not necessarily the economy. The carry regime tends to increase inequality and the much more extreme situation we find ourselves in now raises a question mark as to its sustainability. What comes next is uncertain but there are pointers that can provide strong clues to the bigger picture. Implications of the book are interesting, but the writing is unconscionably bad. Yes, it’s a book about carry, you should have one cohesive definition and explanation of what it is, you don’t need to repeat at the beginning of every chapter what carry is. In this book we define all carry trades to share certain critical features : leverage, liquidity provision, short exposure to volatility, and a “sawtooth” return pattern of small, steady profits punctuated by occasional large losses (p. 3, LL&C). Recall how a liquidity provision is a critical feature of carry trades, therefore, we should have a net increase in liquidity right? Well, yes, markets are flooded with liquidity during periods of calm, or rather, markets are flooded with an expectation of liquidity:

Because there exists an risk-of-ruin, and the manifestation of which on a large scale in unacceptable to the central bank:

Of course, “solvent but illiquid” is exactly the situation SVB was said to be in. Expect to hear this messaging a lot more in the coming years. The line between market support and QE will become increasingly blurry and, as it does, the risk of much higher inflation will increase. This stems the immediate crises but, below the surface, also serves to truncate losses for carry traders. By truncating losses, central banks encourage further growth in carry trades, requiring larger central bank intervention during the next crisis. The book only briefly mentions the accumulation of moral hazard. However, in my opinion, this is where the main problem lies. In the institutions that run the society, the proportion of idiots has been steadily increasing for many decades. It is now close to 100%.If you think easing and tightening at the same time sounds like a contradiction, sounds like a loss of control, I’m with you. Holding a short position in volatility, by contrast, produces steady profits at the expense of occasional large losses. In the event of higher volatility, those who provide insurance against such an increase have a high risk of going bankrupt—a risk that is amplified if, as seems most often to be the case, they are leveraged. Thus a rise in volatility has the potential to set off a vicious cycle: when volatility rises, the cost of insuring against both gamma and vega risks will likewise rise; as a result of this increased cost, the market will become less liquid, and the decline in liquidity is itself likely to enhance volatility.