After nailing it with a big bet against subprime, Kyle Bass is making another big bet. This time the brash hedge fund manager, who runs Hayman Capital, is making a massive bet against a bubble that he sees forming in Japan. Japan has one of the highest debt to GDP ratios in the developed world and Bass believes that eventually rates will explode and the yen will collapse due to the massive amounts of debt that Japan has taken on.
Joe Weisenthal of BusinessInsider thinks that Kyle Bass is wrong, that Japan will not implode. He makes the following points in his article:
The problem is that the analysis is totally simplistic and incorrect.
To start, debt-to-GDP (which is the number that in Bass’ mind really damns Japan) is a lousy measure of anything. It’s flawed right from the get-go, given that it’s measuring a stock (total debt) to a flow (a country’s national income for the year).
But beyond that, debt-to-GDP just doesn’t tell you anything about interest rate risk or credit risk.
And he has a point, as long as Japan’s debt is denominated in Yen and it can print yen, then Japan can keep rates where ever it chooses and it has no credit risk because it can always print more Yen to pay it back.
He goes on to say:
This is the key idea that Bass is missing, and why his trade is never going to pay off. For a country that borrows in its own currency, government spending finances borrowing! If Japan spends 100 billion yen on something, that’s 100 billion yen out there in the world that will eventually wind up in a financial institution, where ultimately 100 billion yen worth of JGB will be purchased. It’s the same with the US of course, and it’s this idea that Bill Gross didn’t get when he famously asked: Who will buy our debt after QE2 runs out? It caused him to get crushed on the Treasury boom of 2011.
But what he seems to miss is that a country that can pay off its debts by printing its currency can control interest rates and default risk, but at the expense of losing control of its currency.
So let’s say that Japan does go along this route. It suppresses rates on JGBs at the expense of the Yen. Since Japan imports virtually all of its energy a falling Yen means that energy costs go up and the cost of living goes up. In a nation aging as rapidly as Japan pensioners will eventually revolt politically against this policy. Low returns on JGBs are fine as long as living expenses are falling faster than interest rates. But when this ceases to be the case, there will be hell to pay. Thus Japan cannot exercise complete control over interest rates on it’s debt by continuing to print Yen as Weisenthal suggests. And though Kyle Bass is getting crushed right now, I suspect in the long run he will be proven right.