Professor Elam

At left on Friday the dollar in center rallied. This reflects the practice of borrowing dollars at zero interest cost courtesy of Mr. Bernake. Then take the money and speculate on oil at top or gold at bottom. One can see that both those were sold to finance covering or buying back the dollar short. One shorts the dollar by borrowing at zero interest rates. One is betting he or she can buy the dollars back for less than the borrowed cost, and indeed so far, the traders exiting friday did just that. The ones this next week may not be so lucky.  We have been studying derivatives in class, hopefully this real world example makes the case why this topic is so important to understand. 

Steve Kaplan, http://www.truecontrarian.com explains this next. 

For the past several trading days, the U.S. dollar index has been forming a bullish pattern of higher lows, and currently (75.8) stands above its low (74.940) of October 21, 2009. This indicates that a small number of hedge funds or others have concluded that the recent downtrend in the greenback has probably ended, and are therefore positioning themselves for a reversal. As this reversal has intensified, those who were borrowing U.S. dollars have been forced to begin to pay back some of their loans. Since nearly all of these carry-trade participants are using margin–in some cases, incredibly thin margin–in order to raise the cash necessary to repay their U.S. dollar debts, they have been forced to sell their other assets. This is primarily why the price of gold suddenly plummeted today, as speculators have had to scramble to repay their U.S. dollar borrowings. Later in the day, the price of crude oil also reversed lower, as carry-trade participants decided they didn't want to sell gold so far below its recent peak, and decided to go after crude as an alternative. Sooner or later, they'll be selling their emerging-market equities, and eventually closing out most of their positions either to meet margin calls or else to lock in whatever profits still remain before it's too late. Since everyone will be rushing to unwind the carry trade ahead of everyone else, there will be a cascade of unloading positions. It will not likely happen immediately, but eventually this will result in a massive rally for the U.S. dollar and gains for U.S. Treasuries, along with a plunge for gold, crude oil, and emerging-market largecaps.