Folding the Yen; It seemed so easy: use cheap yen to make big bucks outside Japan. Some gambled it all, and now the bets are unraveling.

Byline: Akiko Kashiwagi

The subprime debacle has exposed many dicey deals in recent weeks. One of the most worrisome is the yen carry trade, a perfectly legal, highly profitable and hugely popular trick that involves borrowing cheap yen at low Japanese interest rates, and using them to invest in countries with higher interest rates and more valuable currencies. When it worked, it was like shooting greenbacks in a barrel. Some investors have gambled as much as 10 times their own worth on what looked like a sure thing. But now that these deals are unraveling, they show just how interconnected and vulnerable to contagion modern financial markets have become.

Yen carry traders are mainly institutions, hedge funds and other big-time players, but in recent years Japanese retail investors have also gotten in on the game. Some of the most popular yen carry trades have involved the purchase of New Zealand dollars or Australian bonds, emerging-market debt and various U.S. dollar-denominated investments. While there's no clear tally of the trade, estimates of its total size go as high as $1 trillion.

For some time now, central bankers have worried about the destructive potential of the carry trade--the more investors sell yen, the weaker it gets, and while that may be good news for Japanese exporters, it also distorts the global economy by increasing liquidity and encouraging bubbles.

Now, worried about growing currency volatility in unsettled markets, yen investors have begun unwinding their trades. In the past four weeks, the yen has risen 6 percent against the U.S. dollar, and over 20 percent against the New Zealand dollar. While it's unclear how much of this is due to the unwinding of the carry trade, the result is a snowball effect. As the ...