No Way Out For Japan

The Business Insider has a fantastic Interview With Hayman Capital Founder Kyle Bass. Bass testified at the crisis hearings in Washington, about Fannie Mae, Freddie Mac, bank capital, bank leverage and derivatives. He discussed those issues with CNBC's David Faber along with his forecast for Japan.




Here is a partial transcript.


Kyle Bass: .... China and Japan own a lot of Fannie and Freddie Debt. I think we are more sensitive to them losing money than we are to the US taxpayer losing money and I think that has to change. ... Fannie and Freddie have paid $200 million into campaigns of 354 politicians over the last 10 years. This is an organization created by the lawmakers. Why are they paying the lawmakers? Let's get rid of this structure and just have the government make mortgage loans. ...

David Faber: Let's talk briefly about some other things you are doing at Hayman. ... We saw the mini-blowup in Dubai, we have heard a lot about Greece, when you look at the totality of sovereign risk, where are you focused?

Kyle Bass: I think the big canary in the coalmine is Japan. When you see how Japan has lost 20 years of their prosperity from 1990 to today, you see what happens when a government steps in and runs giant deficits to make up for the private market place pulling back and attempting to deleverage.

So what we've seen around the globe in the developed world, bad private assets are moving onto public balance sheets. Sovereign balance sheets have expanded 86% from pre-crisis levels of debt. If you extrapolate that from the beginning levels of debt, many of these countries around the world won't be able to service their debt. So I think in the next 2-3-4 years you start to see
significant defaults.

David Faber: Do you believe Japan is in a position where it might default and/or devalue its currency as well, in the next 3-4 years?

Kyle Bass: I do not think Japan has a way out of this.

David Faber: Why Not?

Kyle Bass: You have a secular decline in population, and you have a huge funding structure at below market rates. So Japan's weighted cost of capital is only 1.4% and their sovereign balance sheet is much worse than the rest of the developed world. If their cost of capital goes up 250 basis points, their interest expenses of the government will exceed their total government revenue, and it can't even get there [that high].

David Faber: Now their debt is held there as opposed to us where our debt is held by foreigners, in Japan it's mostly citizens.

Kyle Bass: That's right. In the United States about 57% of our debt is held externally. In Japan 6% of their debt is held externally. 94% is held by the people, the pensions, and the life [insurance] companies. What's happening now with the population decline, all the buyers of their debt are turning to sellers. And the largest pension fund in the world in Japan told the Ministry of Finance in May that they are going to be a net seller from now on. So their buyer's base is disappearing and if they have to go to the international capital markets to raise money, they can't exist. It's an awful social problem for Japan.

David Faber: These things always seem to be years away and they never seem to happen.

Kyle Bass: If you put pen to paper, and you understand the problems that some of the larger nations have, the good news is the United States is a good 10 to 12 years away from this. The silver lining is, we can see what happens when a country decides to spend its way into a huge deficit and have nowhere to turn.

US On Path Of Japan

The US is on the same path as Japan (with a lag), something I have said repeatedly for years. However, Japan's path is about ready to veer, and Japanese government bonds will soon be in trouble.

Let me rephrase that. Japanese government bonds are in trouble.

Japan, the nation of savers is about to start drawing on those savings. And there is no way Japan will be able to finance its long-term debt at 1.4%. Indeed, Japanese government bonds are in much deeper trouble than US treasuries at this point.

Kyle Bass says the US has 10-12 years to right the ship; I think 5-10 years (but closer to 5 than 10). Even if it's only three years, it's not today's worry. See Worry Over the US$ and PIIGS for further discussion and comments from Marc Faber.

In the meantime, the pending collapse of Japanese government bonds will not be good for the carry trade, but should benefit the US dollar. In fact, there are many things good for the US$ here.

US Dollar Positives

• Japan demographics as noted above
• Greece bailout
  
• Spain property bubble
• Baltic state currency collapse
  
• Savings rate in US headed north
• Extreme bearish US dollar sentiment
• Pending implosion in the UK
• Canadian property bubble bursting
• Australian property bubble bursting
• Hard landing in China, collapse of the RMB
  

Most would argue against a hard landing in China, but I actually think that is the best China can look forward to after its rampant expansion of credit. All of the above are accidents in progress or accidents that will happen soon enough. The US dollar should benefit when they do.

Morepver, I would like to point out that the Massachusetts special election is likely to be US dollar positive. After the special election Democrat massacre, there will be little sentiment for more bailouts but there will be increasing calls for more fiscal prudence and less government spending. It will be much tougher to pass stimulus bills, or bills of any kind.

Health care may not even pass now, although it's likely the Obama administration will manage to slam it through in one last hurrah, possibly by the simple maneuver of the House accepting the Senate version straight up.

However, if the healthcare bill does not pass, that too would likely be US$ positive.

Finally, many US states are in deep, deep trouble. California and Illinois lead the list. The change in the senate is a huge message that states are going to have to go it alone and not rely on Washington for bailouts.

Add it all up and most of the possible surprises are likely to be US$ supportive. Thus, dollar bears should consider hibernating for a while. The stars are aligned for at least a modest dollar rally, and perhaps a lot more than that.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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