Richard Howard of Hayman capital believes that market re-pricing of Japan’s debt and a devaluation of the Yen could happen sooner rather than later.
“If you think of where the most interesting shift in dynamic has occurred for the last three month, it’s in Japan,” says Howard, managing director and global strategist for Hayman Capital.
“It’s important for people to understand how bad the economic environment has been in the last five years,” says Howard who points out that virtually all major developed economies have seen a rebound in economic activity from the troughs of the last financial crisis. Japan has not.
Previously, Japanese exports were relatively strong, which allowed the country to maintain a current account surplus and accumulate $1.1 trillion worth of U.S. treasuries as foreign exchange reserves. This has shifted since the financial crisis. “The Japanese absorbed an enormous amount of the world currency debasement and exported deflation over the last five years,” Howard says, and explains that the aggressive move by other central banks to ease monetary conditions after the crisis cheapened their currencies and made Japanese exports less competitive.
Korea, which devalued the won in response to the crisis is an example. “A lot of Japanese exporters and Korean exporters are now chasing the same customers,” he says, with Japanese firms being on the losing end of that competition. Indeed, according to the IMF, the Japanese current account balance shrank from 4.9 percent of GDP to a projected 1.6 percent of GDP in 2012.
The reversal of these supporting factors makes Howard believe that a final re-pricing of bad Japanese debts will finally happen in the near future. Despite a collapse in the value of equities and real estate over 20 years, debts accumulated during the credit bubble of the 1980s are still lurking on the balance sheets of banks and corporations. Despite the price drop in the value of collateral, they have not been written down.
“The value of the debt has already been crushed. The losses have already been incurred through the mal-investment of that capital. All that remains is to realize it. Either it gets realized through inflation or it gets realized through some sort of debt restructuring or write down,” says Howard.
RIchard also thinks that the government’s debt accumulated in a bid to prop up the banks and the economy is unsustainable and will lose in value. Major pension funds have announced that they will start selling Japanese Government Bonds (JGBs) in order to provide retirement income for an ageing Japanese population.
This leaves the Central Bank as a buyer of last resort.
“We’ve moved into a world that is more comfortable with the concept of truly aggressive monetary easing,” says Howard who thinks that the unlimited monetary easing that the Bank of Japan (BoJ) announced in January 2013 is a game changer.
“That is a sort of unorthodoxy and aggression that we haven’t seen previously. It’s a question of scale and scope,” he comments on the BoJ’s plans to buy $145 billion of government securities per months starting in January 2014 in order to reach a 2 percent inflation target.
While 2 percent inflation sounds relatively innocent, according to Howard, it will be enough to cause people to sell JGBs and the Japanese Yen in his opinion.
“You could see a big sell-off there as people migrate out of those assets because we don’t believe that there is a natural buyer out there in this new inflationary environment… with bonds at current yields were they are,” says Howard. Investors want to be compensated for inflation to earn a real return. In order to get that real return, nominal bond yields will have to rise.
“The problem with trying to create inflation is that debt is going to be harder to service. The hope is that the inflation creates enough nominal growth to enable the higher debt service costs. That makes sense for a portion of the economy that is not highly levered and can afford to service their debts,” explains Howard.
“The policy makers who are overseeing this process, they are convinced of the correctness of their views. Lots of experts out there will tell you that a government can never go bankrupt if you have a compliant central bank out there that can always buy your debt. As long as the BoJ cooperates there will never be a problem,” says Howard.
“We expect the Yen to devalue from here and we expect interest rate to rise in a sharp sudden fashion at some point over the next couple of years,” says Howard.
And this time Howard might prove right as Mr Abe, nominated Haruhiko Kuroda as Next Bank of Japan Governor.
Japanese Prime Minister Shinzo Abe nominated Asian Development Bank President Haruhiko Kuroda to lead the nation’s central bank, raising the likelihood of further monetary stimulus this year.
Kikuo Iwata, a professor at Tokyo’s Gakushuin University who advocates greater government oversight of the Bank of Japan (8301), and BOJ Executive Director Hiroshi Nakaso were nominated for the two deputy governor positions, the nation’s parliament said in a statement today. Current Governor Masaaki Shirakawa and his deputies will step down on March 19.
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.
