Recently, I read about how the Bank of Japan surprised the entire market in July 2024, and that made me think of a strategy that many don’t understand well: the financial bicycle.

Look, what happened was quite interesting. For years, investors around the world were borrowing Japanese yen almost for free (interest rates close to 0%) to then convert that money and invest it in U.S. assets that paid much more. It was like finding cheap money on one side and putting it where it yields well. They earned the difference, known as carry. It seemed like a foolproof business as long as things remained stable.

But then, when the Japanese central bank unexpectedly raised rates, everything changed. The yen skyrocketed in value and suddenly all those investors were losing money like crazy. It was a massive panic sell-off. This is exactly what can happen with the financial bicycle when things go wrong.

Now, how does this strategy actually work? It’s relatively simple in theory. You borrow money in a currency with low rates, convert it to a currency with higher rates, and invest in something that gives you a return. If you borrow at 0% and put it into a product paying 5.5%, you earn that 5.5% minus fees. Some use leverage to amplify those gains, but that also multiplies losses if everything goes wrong.

What many don’t consider is that the financial bicycle depends on two things: that the exchange rate remains favorable and that interest rates don’t change unexpectedly. In 2008, we saw how this doesn’t always hold true. When the market panicked, many of these operations collapsed. Investors had to close positions quickly, causing extreme volatility in currency markets.

The reality is that this strategy works well when the market is calm and optimistic. Everyone is willing to take risks, currencies don’t fluctuate too much. But when there’s economic uncertainty or central banks make unexpected moves, the financial bicycle can turn into a disaster. And if there’s a lot of leverage involved, problems escalate quickly.

Emerging markets are another example where this is constantly seen. Investors borrow in currencies with low rates and invest in bonds or assets from countries with higher yields. It sounds good on paper, but these markets are sensitive to changes in global sentiment. If investors panic and start selling, everything collapses.

The truth is that the financial bicycle isn’t for everyone. You need to deeply understand how global markets work, currency movements, and central bank decisions. Hedge funds and large institutions have the resources and knowledge to try it. For an average investor, exchange rate and interest rate risks are too much to handle.

What we learn from cases like 2024 is that although the financial bicycle can offer consistent gains, the risk is always there. An unexpected change in monetary policies, sudden volatility, and everything that seemed like a good operation turns into losses. That’s why it’s crucial for anyone considering these strategies to thoroughly understand what they’re getting into and be prepared for the worst.