Back in April, Kyle Bass, head of Dallas-based hedge fund Hayman Advisors LP, outlined to CNBC (above) why he is shorting the Yen and Japanese Government Bonds:
Kyle Bass: I think it’s really important to understand the magnitude of what they’re embarking on. It’s essentially doubling the monetary base. It is a giant experiment. Doubling the monetary base in two years is extremely experimental. But when you’re backed into a corner, and your debts are more than 20 times your central government tax revenue, you’re already insolvent. It’s to the point that they have to do something. They have to do something big. Because they are about to implode under the weight of their debt. What is interesting to me is they also abandoned the bank note rule. They had a handshake with them. They would not monetize the debt. They got to a goal post, and they removed it. When you think about the magnitude of what they’re doing on a nominal basis, the goal will be buying assets at 70% of the rate of the US Fed on an economy that’s one-third the size of the US, just to put things in perspective.
Interviewer: Well, to the extent that you have said for some time that japan is already in the zone of unsolvency. Is this going to change the dynamic or the trajectory?
Kyle Bass: Yeah, I think what they have done is formalize the announcement that a new sheriff is in town. It’s important to follow the bond markets. There are economic zealouts running the central bank. They only know one thing. In this case the trajectory is set. What they’re trying to do is materially devalue the currency in order to become slightly more trade competitive while attempting to hold their rates marketplace flat.The economists believe they can live in that nirvana, and that is not the case. You also play that in part by belief that the value of the currency would go down. It’s going down more than it has since October of 2011.
Interviewer: Do you continue to approach this in the same way and tell the viewers how you go about trying to benefit from the series of events that are trying to occur?
Kyle Bass: If you’re Japanese, you need to spend the yen that you have. You’re not going to suffer a massive depreciation in your purchasing power. If you’re non-Japanese, go borrow yen and buy assets in other countries not as fiscally stretched as yours is. There is really no great prescription here. I think it’s really important to not be long yen and long Japanese assets. There are people that own equities and in this response to weaker yen buy equities. You have to remember the Japanese industry has been hallowed out over the last 20 years. So I think it’s going to be very disappointing for the equities. I think they’re macro tourists.…
When you have the declining population and the death rate across the birthrate and a hollow out of industry, you may get a bump in nominal GDP and with the looming tax inkroes in april2014, they’ll pull forward some consumption this year. But it’s important to focus on the fact that this is not the panacea that everybody hopes it will be… I can’t imagine when we look at – let’s say they’re trying to get to 2% nominal inflation, 16% of GDP is imports. They have to get the yen to the dollar by the end of next year. So that’s our target. But if they lose control it’s going to be much weaker than that. We are in unchartered territory, are we not? We are. The central banks around the world are creating tents and villages that are very difficult to invest around.
Overnight, the Financial Times ran an article further elaborating on why Bass is betting on a full-blown Japanese crisis:
“They will have a bond crisis in the next couple of years. A bond crisis doesn’t mean spread widening. It means they lose control of rates and their currency”…
For Japan, that turning point is approaching, and to explain why he turns to Bernard Madoff, the US mega-fraudster. “As long as you have more people entering than exiting, you can maintain any kind of fraud, lie, or non-payment of obligations.”
What previous Japan bears missed, he says, was the mechanisms funding Japan. Current account surpluses ran at 3 per cent to 6 per cent, and fiscal deficits used to be only 3 per cent of economic output. Meanwhile, Japanese savers reliably bought JGBs.
However, the population has peaked and spenders now outweigh savers, the current account surplus has almost gone, and the budget deficit has ballooned to 11 per cent of gross domestic product. “The entire mechanism by which they fund themselves has literally changed overnight,” he says…
He is equally sceptical on the patriotic fervour of Japan’s savers: “Don’t conflate or confuse their love for their country with their love for their government.”
Mr Bass says he commissioned a poll of 1,009 Japanese investors that asked: were your country to have a bond crisis and appeal to you to buy more JGBs, would you be likely to buy more or not?
He says 8 per cent would buy, while 83 per cent responded that they would “run, not walk”.
That choice is likely within two years, he says, though adds that “it’s naive for anyone to say that they can predict with any kind of accuracy the end of a 70-year debt supercycle”.
…if he is right, well, “if there’s a quadrillion yen that is long the cash debt, they’re all on the wrong side”, and there might be another couple of trillion dollars worth of interest rate swaps outstanding, he says. “So, when you think about who’s where and who’s on the wrong side, the answer is: everyone is on the wrong side.”
Watch this space, I guess.
