Doom Heralded at Hayman Capital by Widening Trade Deficit: Japan Credit

Japan’s worsening trade gap will make it harder to service the world’s largest debt, fulfilling part of the doomsday scenario that Hayman Capital Management LP is betting on.

The nation’s 10-year note yield may rise toward 10 percent from the world’s third-lowest of 0.79 percent, while the yen weakens, said Richard Howard, who oversees Dallas, Texas-based Hayman’s Japan-focused fund with J. Kyle Bass. That would represent the developed world’s second-highest borrowing costs after Greece, and a surge to that level by the end of 2013 would cause losses of 42 percent for investors purchasing the securities now, data compiled by Bloomberg show.

Data yesterday showed Japan had its biggest half-year trade deficit on record. Hayman, which manages about $1 billion, made $500 million by predicting the U.S. housing market collapse, and Bass has said since at least 2010 that Japan’s $12 trillion bond market is heading for a crash. So far, the debt has returned 3.1 percent in the past two years, Bank of America Merrill Lynch data show, while yields touched nine-year lows.

“It all came down to this idea that there was an internal self-funding mechanism in Japan, that essentially the Japanese economy and interest-rate environment could exist separate to the rest of the world,” Howard, 32, said in an Oct. 18 interview in Singapore. “It wasn’t going to last forever, and in fact it is rapidly approaching a turning point.”

Japan’s imports exceeded exports by 3.22 trillion yen ($40 billion) in the six months ended Sept. 30, the biggest trade deficit for a fiscal half-year period, according to Ministry of Finance data going back to 1979. The nation posted a shortfall in September for a third-consecutive month.

Current Account

The country has public debt equivalent to 237 percent of gross domestic product this year, the biggest debt-to-GDP ratio globally, estimates by the International Monetary Fund show. The ratio for the U.S. is 107 percent.

Ten-year Japanese government bond yields are less than half that of similar-maturity Treasuries and reached 0.72 percent in July, the least since June 2003. Japan’s current account, the broadest measure of trade, has been in the black on an annual basis since at least 1985, according to government figures, helping the country finance a budget deficit domestically for lower borrowing costs.

When Japan’s current account turns to deficit, “the marketplace is going to realize that it requires international capital, either repatriated Japanese capital or fresh new international capital, to buy Japanese government debt in order to keep funding the government,” said Howard. “That is the beginning of a cycle to put upward pressure on yields.”

RBC Samurais

On a monthly level, Japan reported a record deficit in its current account in January, showing the impact of rising energy imports following last year’s record earthquake that triggered the shuttering of nuclear plants.

Elsewhere in Japan’s credit markets, Kanagawa Prefecture plans to sell 20 billion yen of 20-year bonds next month, according to a statement yesterday by Daiwa Securities Group Inc., which will manage the offering with Mizuho Financial Group Inc.

Japanese municipal notes and the debt of government- affiliated organizations have handed investors a 0.02 percent loss this month as of yesterday, compared with a 0.08 percent decline for sovereign securities, according to Bank of America Merrill Lynch data. Global government bonds have also lost 0.17 percent in the period, the data show.

Royal Bank of Canada registered to sell as much as 600 billion yen of Samurai notes, according to a filing yesterday with Japan’s Ministry of Finance. Samurais are yen-denominated notes issued in Japan by overseas borrowers.

Yen Effect

The yen strengthened against most of its 16 major peers in the past six months as the euro region’s debt crisis boosted demand for the currency as a refuge. It touched 80.01 per dollar today, the weakest since July 6, before trading at 79.96 as of 9:51 a.m. in Tokyo, compared with its record high of 75.35 reached Oct. 31.

The stronger yen makes Japanese products costlier overseas and weighs on exports while encouraging domestic companies to acquire assets abroad. Softbank Corp., the country’s No. 3 mobile-phone career, agreed this month to buy a 70 percent stake in Kansas-based Sprint Nextel Corp. for $20.1 billion.

Proceeds from overseas investments have grown ninefold since 1985 through last year, helping alleviate a slump in exports. Japan had its first annual trade deficit last year in at least 27 years, Ministry of Finance data showed.

Household Wealth

Slower growth and more than a decade of deflation have prompted Japan’s banks to channel deposits into JGBs rather than loans. Domestic investors account for 91 percent of the total ownership of the nation’s debt, according to data from the Bank of Japan.

Japanese households held a total of 1,515 trillion yen of assets at the end of June, more than half of which were bank deposits, central bank figures showed. That’s bigger than the U.S.’s annual economic output in dollar terms and compares with 1,124 trillion yen of general Japanese government debt.

Standard & Poor’s said in a report yesterday that Japan’s deficits are likely to remain high for several years, and it runs the risk of a credit downgrade if its “debt trajectory were to remain on its current course.” S&P rates the sovereign AA- with a “negative” outlook.

The IMF said in its Fiscal Monitor report released this month that the Japanese government’s plan to double the 5 percent sales tax by 2015 won’t be sufficient to “put Japan’s record-high debt ratio on a downward path.”

‘Lot Higher’

A tumble in JGBs may happen in two steps, where a sell-off pushes yields a couple hundred basis points higher, triggering concerns about the government’s ability to refinance its debt, said Howard. That could push yields “a lot, lot higher” toward double digits, he said.

As to what may trigger the surge, “something very interesting” is likely to happen within the next 18 months, Howard said, declining to be more specific or to say how the fund is executing its Japan strategy. The risk to Hayman’s scenario is that concern about the rest of the world will sustain demand for Japanese assets as a haven, he said.

So far, financial markets are signaling little concern that Japan will fail to pay off its debts. The cost to insure JGBs against nonpayment for five years has fallen 67 basis points this year to 76 basis points yesterday, set for the biggest annual slide in data going back to 2005, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

Investment Surplus

Tomoya Masanao, head of portfolio management for Japan at Pacific Investment Management Co., said on Oct. 10 that the nation’s debt is the “cleanest dirty shirt.” Pimco, which runs the world’s biggest bond fund, has been adding to its holdings of JGBs over the past two to three months, he said.

Ten-year JGB yields may hold in a range of 0.8 percent to 1 percent in the next 18 months, said Akio Kato, team leader for Japanese debt in Tokyo at Kokusai Asset Management Co. That compares with the five-year average of 1.2 percent.

“I don’t foresee a situation where the trade deficit offsets the investment surplus, driving the current account into the red,” said Kato, whose company runs Japan’s biggest mutual fund with $42 billion in assets. “It’s reasonable to assume that Japan’s bond market can still continue to retain investor confidence.”

Source: Bloomberg

Kyle Bass, an American hedge fund manager, is the Founder of Hayman Capital. He received extensive coverage in the financial press for profiting $590 million by short selling the sub-prime mortgage bond market, before that market crashed. In 2011, Bass initiated a huge position in Greek sovereign debt through CDSs. Media reports were that he could profit up to 650 times his investment should Greece default on its debt obligations.

Kyle Bass: Buy Guns and Gold

Kyle Bass is one of the chosen 15 people who have made use of the subprime trade of CDS. He has been interviewed a couple of times recently and had very interesting ideas to share. Bass recently bought a record number of 20 million nickels for a price of 1 million US dollars. Bass says that the worth of each metallic coin is around 6.8 cents. Ken Rogoff reports his shock on the numbers that have been shared by Kyle Bass. The new investment thesis that Bass has come up with stats that the crisis caused by subprime mortgage was not the cause of the problem, buts it affect. The main reason for the problem is that there is just too much debt and this is never a good sign because after the crisis, this debt is transferred to the balance sheets of the public.

"Our biggest positions now are Japan and France. If and when the dominoes fall, the worst, by far, is France. I just hope the U.S. doesn’t collapse first. All my money is bet that it won’t. That’s my biggest fear. That I’m wrong about the chronology of events. But I’m convinced what the ultimate outcome is.”

“If Japan had to borrow at France’s rates, the interest burden alone would bankrupt the government.”

By the time the next crisis came our way, the gold market was most probably going to collapse as more pending future contracts were on hold than the total available gold.

“We’ve never had this kind of accumulation of debt in world history,” Bass said.

An important point to remember here is that the banks that invested huge amounts of money were being started to be treated as much more than just private financial institutions. They were considered as a symbol of their local governments and it was assumed that they would be bailed out in the time of crisis. The public debt of all the rich countries appeared to be at a dangerously high level and as a result of the crisis, this level increased further. As a fact, the official public debt was no longer considered to be the public debt and it actually contained the different debts of a country's banking system. Bass goes on to say,

“I believe that Germany and the balance of the Eurocrats will attempt to default Greece within the euro zone first. The frictions associated with such an event will prove to be problematic and the usual benefits of a substantially weakening currency that would historically accrue to the country in default will not be available to Greece. Greece will therefore be forced to go back to the drachma at some point in the near future.”

Continuing with his discussion he states that

“In the end, it is most likely that after Greece and the next peripheral country begin to hard default, Germany will exit the [European Monetary Union] and recapitalize their own banks. After recently conducting a population study on the German people, we have determined that the overwhelming majority of the people of Germany think that they would be better off never having formed the euro in the first place. Two thirds of the people do not think that they have any obligation to bail out profligate members of the EMU. The market’s hopes rest upon Germany and the [European Central Bank] going ‘all-in’ at some point in the future. I don’t think that is likely at all.”

“There is no playbook for how the world will most likely deal with a cluster of sovereign defaults…I believe it will all read like fiction from here. The organizers and members of the EMU are desperate and have nowhere to turn. The circular references of the optical backstops [International Monetary Fund and European Union] are showing in broad daylight.”

Kyle Bass, an American hedge fund manager, is the Founder of Hayman Capital. He received extensive coverage in the financial press for profiting $590 million by short selling the sub-prime mortgage bond market, before that market crashed. In 2011, Bass initiated a huge position in Greek sovereign debt through CDSs. Media reports were that he could profit up to 650 times his investment should Greece default on its debt obligations.

Kyle Bass - News on Debt and Other Issues

Transkscript
Inspire our students. let's solve this. . our own david faber is in larue, texas. investors are convening to discuss all kinds of issues. david, i see the jacket is on. take it away. reporter: jack ket is on because it's so bright out and i had a white shirt on. it's a magnificent day here. one of our hosts is kyle bass. thank you for having us, as always. sure. and you and i are going to start off where we start many of our interviews, mainly talking about debt balances throughout the world. deleveraging has been taking place around the world. in fact, you hear about it, the deleveraging the economy. that's not the case, right? we try to look at the world in its totality and when you look at on balance sheet corporate debt, they've grown from $80 trillion, 11% growth rate when you have a population growth of 1.2, realty gdp growth of 3.8 and debt growth of about 11. central bank balance sheet of 16. you can't just do this for very long. what you're seeing is leveraging on the government side. you're seeing central banks that are starting to do open-ended money printing. so it makes it difficult. you're looking now at the sort of further end of this chart. we didn't have it all in on global oh population, real gdp, 10% global credit increase in that and then central bank is printing money. everybody printing money. you and i have been having this conversation for years and it doesn't appear that things have gone off the rails yet. even europe is somehow staying together. i guess it's perceived to be saying together. 90% of your money and now you have owning the greek debt. that's going to have to get wiped out as well. you will still see what they need to do because certainly german economy benefits from the europe. extended family? maybe not. so imagine 17 nations that have basically been fighting for the last 200 years agreeing to seed their sovereignty to a higher power. it boils down to something more simple that it can't happen. when you look at global debt balances, the world and interesting adjective and historically what has happened, when you get to 250%, credit market debt, historically two sides of deficit spending going to a war and winner goes the spoils and losers go to defeat and default. the reason it's so difficult for us to understand what the playbook looks like going forward, we never did hear before. we're starting to see debt inflation. think about it, we had a hyper-levered economy and world going into the financial crisis. we lost trillions and trillions of dollars because of that leverage. the first trillion were replacing what was lost. and the subsequent printing and when you think about what we're seeing in southern europe, much higher than expected and gdp prints much lower than expected so you're seeing this cost push type of inflation push-up. debasing their own buying power at the end of the day? it takes time. it certainly does take time. you and i are going to be sitting here next year and the year after that having the same conversation? i hope so. i hope things are not going to fall off the rails as much as they could. do you think they could? yeah. i've spent enough time in d.c. they all shake their heads when you talk about debt sustainability and you leave and nothing happens. nothing changes. this fiscal cliff is not going to happen. they are going to vote it down the road another year. sequestration never works. it's fairly easy to see what is going to happen. how do you invest around that? what do you do? they don't want any parts of equity. they know that you've made coaching arguments and have been largely right directionally with what is going on but they wonder, where do i put my money? what do you tell them? we have more than half of our portfolio in bonds, believe it or not. the things that created and made your name, let's face it, in terms of being short that market. so now you're long a lot of residential mortgage-backed securities? right. we own about 1% of the market. we have a large investment in that marketplace. basically i think the u.s. housing markets played out. it's about 6.25 years and we're 6.50 years in our cycle. i think housing is going to flatten out. that makes housing affordable as it can possibly be. we don't think housing is going to go up at any point in time in the near future. you don't? it's not going to go down anymore. why won't it go up? there seems to be signs that prices are starting to creep up, affordability is definitely there. it is. but anyone who has already thought about buying is house has already bought a house. you have household formation rate in the u.s. about 1.2 million people, population growth of about1.5%. so it's going to take a few years to absorb the shadow inventory. everything just tells me that when yo income and home prices, they should be parallel. you and i have had many conversations about this macro world you're describing, way too much debt. what are you doing to play that or are you not even playing that? in our portfolio, we actually own what we call event-driven situations in either credit or equity and the way that we hedge our kind of the corpus of our portfolio is th dramatically misprices option ality. so there is enormous convexity in various areas of the world. and we can spend just a small amount of capital and have enormous convex positions. and i believe it's all in japan. but at the end of the day, i think many people would say this has not been -- even if you were right on this crisis as it's moved along, in europe for example, you have not been in position to profit from it the way you were from having seen subprime coming. it's just not the same. right. the opportunity is --s as a fiduciary, if i sit on a public.

Kyle Bass, an American hedge fund manager, is the Founder of Hayman Capital. He received extensive coverage in the financial press for profiting $590 million by short selling the sub-prime mortgage bond market, before that market crashed. In 2011, Bass initiated a huge position in Greek sovereign debt through CDSs. Media reports were that he could profit up to 650 times his investment should Greece default on its debt obligations.