Way back in early March, as the market was suffering an 8% decline, I mentioned to my subscribers that part of the problem appeared to be an "unwinding" of a phenomenon known as the yen carry trade. For those of you who might not be familiar with this term, a carry trade involves borrowing money cheaply in a country that has very low interest rates and then investing it either in a country that has high interest rates, or in any asset class in which it can earn a high rate of return.

This was a massively popular trade for many years among U.S. and European hedge funds. They borrowed at close to 0% interest in Japan, and then invested the money in emerging markets and the West. This was the financial equivalent of running with scissors, because everyone knew that at some point it would get very dangerous if Japan ever lifted interest rates. And that is exactly what happened back in the late February, when Tokyo banking authorities signaled that they planned to raise rates. Hedge fund managers tumbled over each other trying to undo their carry trades, and a widespread sell-off of risky assets around the world was the result.

Before too long, however, the selling was over and calm crept back into the market. What happened? Well, it seems that Tokyo central banking authorities never actually followed through on their threat for a variety of reasons relating to Japanese politics. And just as confirmation, I saw a headline at the English language site of the Nikkei financial newspaper this week which said, "Record 22 Trillion Yen Sent Overseas by Foreign Banks in Japan." The article reported: "Foreign banks sent a record 21.92 trillion yen overseas through their Japanese branches as of March 31, 2007, as they acquired yen at low interest rates and took the funds offshore for investment and other purposes." A senior Finance Ministry official told the newspaper that he estimates the yen carry trade totals several tens of trillion yen a day.

Now you know where all the liquidity is coming from.