Japan is a disaster waiting to happen, says Kyle Bass

By James McKeigue Feb 06, 2013

James McKeigue

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Japan is a country in crisis, says US money manager Kyle Bass. “Its GDP is falling, its exports are collapsing and its debt is about to explode”, he said in a recent CNBC interview. Moreover the new Japanese PM’s solution to those problems will just make things worse. “By aiming for a 2% inflation target they will detonate the timebomb of Japanese debt.”

43-year-old Bass is no stranger to dramatic calls. In 2006 he spotted a bubble in the US housing market and founded his own asset management firm to short it. Thanks to getting that, and subsequent moves, right, investors have flocked to the brash Texan’s firm. He now manages more than $1bn in assets, up from just $33m when he started out.

So far his Japanese call has taken longer to work out than his subprime move. He first started shorting Japanese debt two years ago and the collapse still hasn’t happened. Yet while he says it’s impossible to call the end of a “70-year debt super cycle with complete precision” he believes it is looking closer now. 

The primary problem, says Bass, is that Japan has too much debt. “The total debt is 24 times central government tax revenue. One you sail into that zone of insolvency nothing you can do will help.”

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The fact is, says Bass, Japan’s central government spends 50% of its revenue on servicing debt. If interest rates rose by 2% then all of Japan’s tax revenue would be spent on servicing debt, leaving it with no money for anything else.

For now, the severity of the situation is masked by the fact that Japan pays very low interest, but that won’t last forever, says Bass. “The only reason bondholders put up with this is because of the implicit promise of deflation. People think Japanese bonds are safe and that the yen does nothing but strengthen.” But all this will change now that the government is targeting inflation.

The only difficulty, says Bass, is predicting exactly when it will happen. One sign will be that elite members of society and corporations start moving their money out of the country. Another, more technical, sign will be when derivatives such as swaps start pricing in future inflation.

Pressed to give a guess Bass estimates that it might happen in 18 months time. And he has one piece of advice to investors who are buying Japanese equities in the meantime: “Be careful. You’re picking up dimes in front of a bulldozer.”

• As long-term fans of Japan, we don’t agree with Bass. For a different view of Japan’s debts, read my colleague Merryn Somerset Webb’s blog here: The 'awe-inspiring' financial strength of Japan .

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Published in Guru watch | More articles by James McKeigue

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  • 1. JREwing

    (06 February 2013, 06:40PM)  Complain about this comment

    Yep.

  • 2. CerroRico

    (07 February 2013, 10:08AM)  Complain about this comment

    I was just about to take Money Week advide to buy Japan Investment Trust Baillie Gifford Japan Trust (LSE: BGFD) - http://www.moneyweek.com/investments/currencies/avoid-a-pounding-in-the-currency-wars-62526.

    Confused...

  • 3. funkawaana

    (07 February 2013, 11:42AM)  Complain about this comment

    Yep, I've not been convinced on any of the articles on Japans upside. I can only think that the massive debts, huge money printing and the political stuff with China makes it sound very dodgy to me.

    Agree with the sentiment on Sterling, but I think it applies accross the board on currencies. Relative strength and weakness could turn out to be a timing issue

  • 4. Anal_yst

    (07 February 2013, 03:42PM)  Complain about this comment

    yeah no, the typical article written by a journalist instead of a financial professional. Given the inability to time a trade like this, the key is to limit your downside by using options. Kyle bass is playing this trade using three strategies. OTM yen options, Interest rate options on the JGB and I believe swaptions to achieve convexity (exponential payoff). AKA buy cheap otm options funded by his RMBS position which yield about 7-8% which could spike 100x - 200x if and when his prediction happens. This has nothing to do with going naked short on a position just because you think it can happen. It has everything to do with the mispriced options using the black-scholes model by market participants selling the options due to mistaking historical volatility for true risk. What makes a good money manager is not simply predicting things right, it is the executions and positioning that makes all the difference.

  • 5. James McKeigue

    (07 February 2013, 06:27PM)  Complain about this comment

    Ha! Typical comment written by a financial professional ☺

    Thanks for the feedback and technical analysis – it’s interesting. In my defence I don’t get paid to go into detail about trades that aren’t available to my readers (retail investors). Also, I didn’t say Bass had a naked short. I said he was short Japanese government debt. Which he is.

    You talk about ‘limited downside’ and ‘exponential payoffs’ (let me guess, you’re a derivative salesman) but the fact is Bass has taken a position where he profits if JGB falls and loses if it doesn’t. Therefore it is fair to say that he is “shorting Japanese debt”.

    Best,

    James

  • 6. Abe

    (07 February 2013, 09:34PM)  Complain about this comment

    @ 4

    I think you are being rather bit pedantic. You suggest the author said is incorrect in saying he has a "naked short". Few things seem off with that;

    i) puts on JGB is a short .
    ii) if he is long puts on the JGB and not at the same also long the underlying JGB bonds, then that is actually called a "naked short". If he is long the bonds as well as the puts then he is delta neutral and the trade becomes a skew/vol trade rather than an outright directional trade. Given the comments from Bass in the article I believe it is the former, so I'm rather confused by your comments on not being a naked short .

  • 7. Abe

    (07 February 2013, 09:36PM)  Complain about this comment

    For the rest, regards mispricing of fat tail risk completely agree with what your saying. He will be leveraging up a load so a strong downside move could mean massive profits eg like subprime cds. Though dont forget he is gonna be bleeding a whole heap of theta in the meantime, as you say, timing is the key, even more so with options where you lose 100% of your premium if they expire OTM.

    wow... writing a comment isnt easy here

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