Posted on June 14, 2013 by Richard Solomon
J. Kyle Bass thinks the government of Japan has mismanaged its finances to breaking point. He says the country will be the first developed nation to experience financial meltdown. In an exclusive interview with Beacon Reports, Kyle explains why Japan has moved into a position of ‘checkmate’.
Kyle Bass is Managing Partner at Hayman Capital Management, LP. He is credited with having correctly predicted the subprime mortgage crash of 2007, and in doing so earning $500 million for his firm. The Financial Times recently reported that Kyle’s $1.5bn hedge fund has averaged after-fee returns of 25% a year since 2006.
Beacon Reports: Kyle, what’s your latest thinking?
Kyle: I believe that 20 years of pro-cyclicality has manifested itself in a low volatility Japanese Government Bond (JGB) environment. In human psychology, beliefs become axiomatic through repetition. Investors are now conditioned to move their assets to the safety of JGBs when things go wrong. That’s now changing because of the size of Abe’s and Kuroda’s aggressive monetary easing plan.
That plan, one of the three arrows in Abe’s growth strategy (called ‘Abenomics’), has the BOJ buying just over ¥60 trillion of new bonds each year for the next two years. It effectively doubles Japan’s monetary base. Considering the likely fiscal deficit for this year and next is running about ¥50 trillion each year, or close to 11% of GDP, I think the BOJ can only buy another 10 or ¥12 trillion of JGBs. I don’t think that cushion is going to be enough to monetize the entire fiscal deficit if they are going to be the buyer of last resort.
The key question is, will the BOJ be able to hang on to rates? I think they can in the near-term and I think they can’t in the medium to long-term. If investors holding JGBs actually believe that ‘Abenomics’ will work, then it creates a problem – the ‘Rational Investor Paradox’ – where investors rationally sell some of their JGBs because they are being told to expect negative real rates of return if the administration achieves its 2% CPI target.
Whether that means they sell some or all of them is up to the individual sellers. One bank sold more than 20% of its JGB ownership in the first quarter. If 5% of owners sell, that’s another ¥50 trillion. The reason you’re seeing so much bond market volatility, even though the BOJ is actively trying to keep a lid on rates, is that the BOJ is being overwhelmed by selling despite its large purchase program.
We’re seeing the problem because average duration of JGBs held by the three biggest city banks in Japan is only about 1.2 years. I think the banks are going to let their portfolios expire on maturity. The BOJ must try to hold the yield curve down. It has responded by saying that they’re going to try to implement a Japanese style Long-Term Refinancing Operation (LTRO) in which they would buy all JGBs with a duration of up to two years at a yield of 1/10 of 1%. In essence this equals a policy of unlimited monetary easing.
Continue reading at Kyle Bass Tells Beacon Reports its ‘Checkmate’ for Japan | Beacon Reports.