Yet another legacy bites the dust:

Japan Will Follow Europe With a Debt Crisis: Kyle Bass

By Jeff Cox

May 10 (CNBC) — Japan is about to join Europe in the debt crisis ranks, with the two regions offering the best opportunities for investors to bet against, hedge fund manager Kyle Bass said.

While the world’s attention has been focused on sovereign debt issues in Greece and elsewhere, Japan will emerge as a problem area as well as the European developments accelerate, Bass told attendees at the Skybridge Alternatives, or SALT, conference.

“Greece will circle the drain and be ungovernable in the next 30 to 60 days,” said Bass, founder of Heyman Capital and famous for presciently shorting subprime mortgage bonds before the industry collapsed. “Japan is in the crosshairs of the market…I’ve never seen more mispriced optionality in my entire life.”

The Bank of Japan, the nation’s equivalent of the U.S. Federal Reserve, is effectively monetizing the national debt by buying up 50 trillion yen-worth of Japanese Government Bonds, commonly referred to as JGBs in the marketplace, Bass said.

There are a number of perils commonly associated with the strategy of a central bank trying to print its way out of a debt crisis, not the least of which is inflation and lack of confidence in stability of debt, though Bass did not mention specific threats.

However, he said it’s easy to see a crisis coming.

“The fact of the matter is this is no longer an exercise in quantitative analysis,” he said. “It’s a question of when, not if.”

An aging Japanese population and entitlement culture are primary factors contributing to the national debt problem. Bass used disgraced money manager Bernie Madoff to make a point.

“Madoff taught us something,” Bass said. “You can make promises for a long time as long as you don’t have to live up to them.”

29 Responses

  1. Forgive my ignorance Warren, but what do u mean by “another legacy bites the dust”?

    Thx in advance

      1. @WARREN MOSLER,
        In a multi trillion dollar market …lucky streaks can make some a billion or two …
        But from the bottom up a man making a billion is almost always accorded genius status
        by those you can barely make ends meet , a status , with which the man in question will rarely contest!

  2. Maybe they’re both “choices”. Concentrated gain & distributed loss refers to time too.

  3. He has been saying this for quite some time now. There must be a limit to the patience of his clients.

      1. @roger erickson, My old chess tutor said the problem today is we have all these people clever enough to skirt the rules, without the wisdom to realize why they are there in the first place and should be followed.

        The cofounder of Facebook just renounced his US citizenship so he can beat those taxes like Warren! How does a fiat government do effective policy controlling aggregate demand when the players are clever enough to skirt the rules? Like Selise, I am removing my facebook account in protest to his tax-arbitrage strategy 😉

      2. @Save America, It can’t, unless an adequate sampling of the players themselves are active participants in updating of the rules.

        Rule 1 of neural & analog networks (& cultures, & markets).

        Even then, democracy can still be demos crazy. Organization has to keep up with demand to organize more members, faster.

        If the number & characteristics of the players are changing, and the game’s therefore also changing by default … then it gets harder every day. Only solution is ramping up player interactions & system analysis at a rate proportional to the net rate of expanding inter-player inter-dependencies. There’s always demand to find out how little is mission-critical, cheaper/faster/better.

  4. I don’t undestand a thin about Currency JPY :
    * if GDP growth High => currency appreciate because in-flow invest.
    * if Interest Rate Low => currency depreciate (may be carry trade)
    * if a nation is safe-heaven => during crisis currency apreciate

    but with Jpy => GDP low by decade, Interest 0% by decade (with QE)
    public debt 300% (even if great part hold by domestic savers or Boj)

    so.. if no-one of the 3 points is true => why is Jpy apreciating by years both agains Euro and $ ? … it’s only a mega-closure of carry trade because wester sotck market are dancing on the cliff?

      1. @Jan,

        so.. if the unwind of the last ten years is in progress..
        that means that in the future the apparently good stocks market
        will crash well below the 2009 minimum ?

  5. I stumbled upon this article and I thought you guys might appreciate it as he gets the accounting identities. I am not sure if I agree with his conclusion regarding April’s surplus BUT I am just sooooo glad that the discussion is on the issues and framed in the proper ways.

    http://jerrykhachoyan.com/is-the-treasurys-surplus-in-april-a-good-sign-for-the-economy/

    Quote from the article:

    if the Treasury (public sector) had surplus, someone had to have run a deficit. Presuming that the trade deficit (Foreign account) did not decrease significantly in April (We just got the data for March today and the trade deficit actually increased which likely means no jump in April), this must mean that the Private Sector as a whole, ran a net deficit. All that means is that the amount of Net Private Savings (Savings-Investment) went down.

    1. @Mario,
      You have to admire Jerry for seeking real world wisdom beyond what his professors at UCLA can provide. Luckily, he is not an economics major so he doesn’t need to argue.
      I for one contributed a great deal to the public sector surplus on April 15. My least favorite day of the year.

    2. @Mario,

      Thanks for that link. Payroll and personal income tax together increased by almost 230%, a rate far higher than the increases in household employment or income over the same period.

      Granted, taxes are a ‘below the line’ item, and you’d have to estimate the actual impact on the household sector’s “margins,” but I suspect they were compressed, which a falling saving rate would seem to support.

      Given our still subpar growth and employment, it certainly highlights the fact that taxes are too high for the govt we have, and perhaps a shortcoming of progressive taxation (though reasonable minds can differ on that last one).

      1. @Art Patten,

        “Payroll and personal income tax together increased by almost 230%…”

        Oops, sorry, those were month-over-month figures (Apr-Mar) that he showed, not year-over-year. YOY was ‘only’ around 10% for April and 14% for March. Still, a three handle on monthly receipts is notable, and is more than 60% above the prior 18 month average. Upside tax stabilizers are kicking in sooner than they ought to.

  6. Did James Turk have a legacy to bite?

    “James Turk gives his timeline on the Dollar’s Collapse and Gold’s role as the messenger!”

  7. “The Bank of Japan, the nation’s equivalent of the U.S. Federal Reserve, is effectively monetizing the national debt”

    As inevitably occurs under an inconvertible monetary system (and should be called something other than “monetizing”). And as long as JGBs are denominated in Yen, it just doesn’t matter, to quote Bill Murray, except for the impact on the BOJ’s interest rate target.

  8. After a lenghty discussion with a Daiwa strategist the only conclusion to be had, after using MMT logic to question the Japanese QE and consumption tax ,is that Japan is doing to avoid being the odd one out and risking a stronger currency !

    a classic ‘the blind leading the blind’ ..

    1. @walid M, Blinders do make it easier to see where you’re going. Less choices. Less confusion. Easier consensus. Less discussion. Less stress … until there isn’t, but at least the end change is quick.

      Many prefer it that way.

      Monkey hands inside a coconut supposedly won’t release when the rest want to leave.

      Humans brains grasping consensus are loathe to listen to those other little voices. (Unless they practice doing otherwise, & get comfortable with it. May be too late by age 10.)

  9. I believe the dollar value of Japanese government debt will decrease, which will take place as follows.

    0) Japan’s public sector debt relative to Japan’s GDP exceeds levels at which it is politically feasible for such levels to decrease without a discontinuity. There is no region of accessible economic phase space wherein Japan’s public sector debt grows more slowly in real terms than Japan’s overall economy. If Japan attempted to achieve elevated inflation rates while pinning interest rates near zero, it would lose control of prices and the economy would shrink. Therefore, it is a known fact that Japan’s public sector debt will continuously increase relative to Japan’s GDP until a discontinuity occurs.

    1) Due to demographics, declining export competitiveness, and the lack of feasible domestic energy production options, Japan is in the process of entering a chronic structural balance of payments deficit. Existing domestic reservoirs that have absorbed yen debt issuance, such as insurance companies, the postal savings system, high domestic rates of savings, etc., have been exhausted; retired savers are now liquidating their bonds in order to cover living expenses. Thus, either Japan would need to incur debt in non-yen currencies, or a growing fraction of new yen-denominated debt would need to be absorbed by non-Japanese.

    2) Foreign holders of Japanese debt must be either from the official sector (foreign central banks, IMF, sovereign wealth funds of countries with a current account surplus vs. Japan, such as oil exporters) or private foreign savers. In either case, the Bank of Japan will have lost the independent ability to simultaneously control domestic interest rates and manage the value of the yen relative to other currencies.

    a) There is a limit to the foreign demand for yen denominated debt, which is tied to global confidence in the yen as a sound currency, and thus ultimately tied to the global public goods that Japan can provide, and the perceived political capacity to manage Japanese fiscal policy. The willingness of foreign central banks, international monetary institutions and sovereign wealth funds to keep reserves denominated in yen would be limited by concern that Japan’s underlying economy had no growth prospects and Japan’s government had no control over future fiscal policy, causing excess yen reserves to have far less real value than exchange rates implied.

    b) Beyond this limit, ongoing creation of yen-denominated debt either would weakens the yen (due to low marginal demand for additional yen-denominated reserves) or forces yen interest rates upward (to attract foreign savers to choose yen). With interest rates kept at zero, a continuously weakening yen in an import dependent economy causes cost-push inflationary pressures, ultimately forcing the central bank to raise yen interest rates.

    3) Due to the immense leverage present in Japan, as soon as yen interest rates rise above the zero bound, the amount of excess new yen paid to JGB creditors as interest can no longer be controlled effectively by the political process. With debt levels at hundreds of percent of GDP, any positive real interest rate grows mathematically without bound. Theoretically, excess interest payments could be recaptured by taxation, but in practice, doing so would be politically impossible and interest rates would simply adjust upward to compensate.

    4) Confidence in the future purchasing power of the yen would collapses, because there would be no prospect that the future number of yen would have any relationship to the real value of underlying economic activity carried out in yen or the global public goods that could be provided by Japan. Foreign investors would flee, the value of the yen would collapse / yen-based interest rates would rise out of control. A discontinuity would occur.

    All of this can be anticipated in a very short period of time once market psychology turns. A lack of confidence in yen is a self-fulfilling prophecy.

    Therefore it is not stupid for Mr. Bass, an investor of US dollars, to short Japanese Government bonds denominated in yen, because unless the Federal Reserve prints dollars to buy up JGBs without limit, the real USD value of a fixed number of yen will fall drastically in the next decade.

    1. 1. funding the yen govt deficit is just a ‘reserve drain’- get over it, thanks!

      2. the boj has no choice but to set interest rates. yes, the currency might fall, but the level of the currency isn’t a function of rates with floating fx policy.

      3. yes, higher rates add to aggregate demand and weaken the currency. so why would the boj hike rates if it knew that?

      4. not if he’s thinking like you are. but he’s been losing a lot of money waiting for it to happen as it’s a negative carry bet.

Leave a Reply