] Our concern is that derivatives in general, and interest
] rate swaps and total return swaps in particular, have
] helped make the economy and financial markets
] hypersensitive to short-term interest rates, much less
] the insanity of valuing long-term assets based on over-night
] interest rates. Nevertheless, the markets of late are
] reacting dramatically to the mere discussion of when a
] quarter-point increase in rates might occur. Liquidity
] and short-term rates have always been a factor in
] markets; however, the old rule of thumb was it took three
] increases by the Federal Reserve before markets took a
] hit. We believe that multiple factors have made the
] markets hypersensitive to short-term rates. The above
] mentioned derivatives, the emergence of the
] financed-based economy, the pervasiveness of the
] carry-trade, the leverage in hedge funds and margin
] accounts, and last but not least the debt-to-GDP of the
] U.S. economy. Even if we accept the low reported rates of
] inflation (which we question), real rates of interest are
] currently negative. A return to a more normal
] relationship between inflation and interest rates is too
] painful to contemplate.

Interesting emphasis on the Carry Trade, which does seem particularly vulnerable. And, of course, more questions on the hyper-derivitive financial environment (looming disaster?). In my Finance course, it is hard to maintain cognitive dissonance between the power and worship of derivitives, and the understanding and fear I've personally picked up from watching from the Berkshire side.

FNM, the Carry Trade, & other thoughts