The dollar as a carry-trade currency

There are a lot of speculations lately that the dollar is increasingly becoming the top choice for a carry-trade currency. Financial Times writes:

Analysts say negligible US interest rates, its quantitative easing measures and little sign that the country is set to withdraw from its ultra-loose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.

Or in other words, the investors find it advantageous to borrow dollars and invest them in high-yield currencies, in the same way they were doing with the Yen until the carry trade burst in the end of 2007. The FT article proceeds at giving equivocal evidence that the current decline of the dollar is caused by the dusting-off of the old vanilla borrow-exchange-deposit strategy, that was quite profitable before the current great recession. Their list is:

1. The dollar LIBOR is currently smaller than the Yens.
   
2. The dollar seems to be losing uniformly against all major traded currencies.
   

I have to agree. To these evidences, I can add the TIC long-term purchases which turned out well below estimates ($15.3B actual vs $65.0B expected). However, my opinion is that the dollar makes a pretty crappy carry-trade funding currency and these are the reasons.

1. The US has enormous current account deficit.
Economics 101 is that a country with a current account deficit is a net borrower. That is it imports more than it exports, and therefore needs somebody (read China) to finance this imbalance. The carry-trade will exacerbate this, i.e. people will be less likely to hold US debt, since they will want to get US loans. In the case of yen as a carry-trade funding currency, this wasn't an issue, since Japan is a net lender, and the carry trade was beneficial for its economy. Joe gives one dollar to Toyota, Toyota turns it into Yens, then Patric borrows it from Toyota turns it into Iceland crones, puts it in the bank and collects interest. Of course, this didn't turn out good for everybody.

2. Inflation is lurking around the corner.
You don't need much for inflation to catch you with your pants down. A sudden spike in commodity prices will be promptly distributed down the chain to both consumers and manufacturers, and bring high interest rates without having stable economic rebound. We've seen that the $150 oil is possible, and there are a lot of scenarios under which it can happen again (think about Iran.) If/when this happens the carry-trade game can easily turn into a game of musical chairs.

To summarize, I am suspicious about the current depreciation of the dollar. There may be a point in the future, that the dollar wins back in a matter of days what the euro has won in the last few months. I'll be looking for the signs ready to catch this fast train back south.