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.”
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