STAY CALM: This investor looks like he could have done with a tranquilliser when Chinese stocks went on a roller-coaster ride. Shanghai's Composite index initially rebounded then dipped to a five-month low before ending the day higher. At the close it had gained 143.29 points, or 3.1%, to 4 703.05, after going as low as 4 510.50. Pic: EUGENE HOSHIKO. 23/01/2008. © AP. A Chinese investor looks at the stock price monitor at a private security company in Shanghai, China. Chinese stocks bounced in volatile trading Wednesday, with Shanghai's benchmark rebounding and then dipping to a five-month low before ending the day higher. The Shanghai Composite Index gained 143.29 points, or 3.1 percent, to 4703.05. The index dipped to as low as 4,510.50 during the day.

US Federal Reserve's low interest rate fuelling dangerous investment bubble

Nouriel Roubini, one of the few prominent economists to call last year's bursting of the financial bubble, is shouting from the rooftops that an imminent bursting of the current carry trade can lead to a major market crash that will make last year's fall seem like a hiccup.

He predicts a 25% strengthening of the dollar against other currencies. When or how quickly is another matter. Roubini's analysis seems to exclude the structural difficulties of the dollar.

Still, even the International Monetary Fund, rarely the first to spot a trend, warned the G20 meeting in St Andrews, Scotland, that the US Federal Reserve's low interest rate is now fuelling a dangerous investment bubble and is looking for an orderly means for central banks to exit the current interest rate regime.

Locally, Rob Dower, chief operating officer of fund manager Allan Gray, foresees more selling than buying opportunities in today's market. In other words, South African equities and fixed-interest securities are too expensive for long-term fund managers to pull into their portfolios.

So, is it time for investors to convert everything into cash - dollars rather than anything else - or is there still a profitable ride to be had on the investment roundabout?

The carry trade? At its simplest, investors borrow convertible currency in countries with low interest rates and invest in currencies and financial instruments in countries where interest rates and yields are higher.

There's nothing intrinsically bad about the carry trade except that as the trade has grown, what Roubini describes as a wall of investment funds has pushed the US dollar down and helped lift the euro, the rand and the Australian dollar, as well as gold and other commodities. Worse, investors have leveraged their dollar positions by shorting the dollar, effectively giving themselves sub-zero interest rates - for the present. And, looking for even greater returns, these carry traders have been turning to increasingly risky investments.

The trick will be to get out before the US Federal Reserve starts to increase interest rates. And that, Roubini warns, could lead to a mad panic as tardy investors seek to unwind their positions with the prospect that only a safe-haven dollar will benefit as foreign investments, commodities and currencies are dumped and markets crash.

But the Federal Reserve has said that it will continue with near-zero interest rates for some time and the G20 finance ministers have promised stimulatory rates. But the Fed is not happy that its loose money policies have not entirely encouraged banks to lend to consumers and businesses but has also helped fuel the speculative bubble that is today's carry trade.

As for South Africa, measuring the effect of the carry trade is highly speculative. But the effect of investment flows on the rand's external worth has been spectacular these past 12 months. From a low of R11.80 to the dollar at the bottom last October, the rand is now in the region of R7.40. That is the effect of the reversal in investment flows.

This year so far, net equity purchases by foreigners have run at R459-billion and sales at R388-billion, a net inflow of R71- billion. In bonds, purchases have run at R388-billion and sales at R370-billion, a net inflow of R18- billion. In very round figures, between the two, that adds up to 80% of this year's estimated current account deficit, and its effect on the rand is not hard to see.

If there's a reversal, look for another downward exchange rate swoop. But if you believe the likes of Roubini are talking through their hats and that there is money to be made in the carry trade, how does one get into it?

The simplest are probably the carry trade ETFs (exchange traded funds) that cater for all sorts of risk aversion and greed. Three of the better-known ones were recently suggested by CNBC.

Deutsche Bank's PowerShares DB G10 Currency Harvest is perhaps the least speculative and best diversified. The unleveraged fund plays both ends of the market.

At the other end of the spectrum, iShares MSCI Emerging Markets is into emerging market currencies on the basis that emerging markets will lead the world's economic recovery. And if you want something in between that doesn't expose you to the risks of smaller currencies, there's CurrencyShares Euro Trust that plays the carry trade between the dollar and the euro, where interest rate differentials are a narrowish 1%.