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Kyle Bass on the Next Big Crisis
By Robert Huebscher
November 20, 2012


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Kyle Bass

If economics could be studied in a laboratory, scientists might concoct something like the circumstances now unfolding in Japan – and policymakers should be paying close attention. According to Kyle Bass, Japan’s currency – and its bond market – are about to collapse under the weight of the country’s unsustainable fiscal deficit.

Bass is the founder of Hayman Capital, a Dallas-based hedge fund.  He was featured prominently in Michael Lewis’ book, The Big Short, for profiting from investments during the sub-prime crisis, which he accurately predicted.  Bass spoke last week at the University of Virginia’s Investment Conference.

Bass said Japan faces a “huge problem” that will lead to “a massive loss of purchasing power and default,” and US policymakers will have a front row seat to observe the debacle. He hopes Japan’s example will prompt the US to rethink its dependence on countercyclical spending measures, which have led to trillion-dollar deficits. Instead, Bass said, we should “embrace austerity.”

The market is assigning a remarkably small probability to the likelihood of a Japanese default, according to Bass, presenting investors with a tantalizing opportunity.  The market’s optimism is illogical, Bass said, and the only reason to think Japan will avoid catastrophe is that it hasn’t happened before.

Betting on a Japanese default has been the undoing of innumerable macro investors.  Let’s review why Bass believes this time will be different and what is at stake for the world markets.

A Potemkin village

Fiscal profligacy has been Japan’s undoing, Bass said, and monetary policy is the enabler that will lead to default.

Bass’ talk was titled “The Central Bankers’ Potemkin Village,” and he said that Japan will be the next developed nation to engage in unlimited quantitative easing – window dressing that obscures the underlying crisis.

For the US, Bass said that QE1 was a “desperate need for countercyclical spending,” and QE2 was another “anomalous one-time emergency printing.”  But with QE3, Bass said that easing is now the norm.

On December 16, Shinzo Abe will likely become Japan’s next prime minister, and Bass said his taking office will mark the beginning of Japan’s commitment to a similar regime of permanent easing.

On a global basis, that policy is unsustainable, and Bass expects that for Japan it will be particularly stressful.  Bass said that global credit market debt cannot grow by 11% per year and central bank balance sheets by 16.4%, as they have over the last decade, while real GDP has grown by only 3.9% annually and population by just 1.2%. 

“This is not going to work much longer, and, in fact, you are already seeing the diminishing marginal utility take its toll,” he said.  “More debt is not generating more GDP.”

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