Wednesday, January 20, 2010

No Way Out for Japan: an Ominous Preview of the Ramifications of the Democrats' Massive Deficit Spending

Global Economic Analysis provides a fascinating interview with Kyle Bass, founder of hedge fund Hayman Capital. Bass, you may recall, made billions betting that housing was headed for a meltdown... in 2006.

Bass concisely explains the kind of trouble Japan is in and what it means for the massive deficit trajectory that the U.S. is on -- courtesy the free-spending Obama-Pelosi-Reid Democrats.

Kyle Bass: .... China and Japan own a lot of Fannie and Freddie Debt. I think we are more sensitive to them losing money than we are to the US taxpayer losing money and I think that has to change. ... Fannie and Freddie have paid $200 million into campaigns of 354 politicians over the last 10 years. This is an organization created by the lawmakers. Why are they paying the lawmakers? Let's get rid of this structure and just have the government make mortgage loans. ...

David Faber: Let's talk briefly about some other things you are doing at Hayman. ... We saw the mini-blowup in Dubai, we have heard a lot about Greece, when you look at the totality of sovereign risk, where are you focused?

Kyle Bass: I think the big canary in the coalmine is Japan. When you see how Japan has lost 20 years of their prosperity from 1990 to today, you see what happens when a government steps in and runs giant deficits to make up for the private market place pulling back and attempting to deleverage.

So what we've seen around the globe in the developed world, bad private assets are moving onto public balance sheets. Sovereign balance sheets have expanded 86% from pre-crisis levels of debt. If you extrapolate that from the beginning levels of debt, many of these countries around the world won't be able to service their debt. So I think in the next 2-3-4 years you start to see significant defaults.

David Faber: Do you believe Japan is in a position where it might default and/or devalue its currency as well, in the next 3-4 years?

Kyle Bass: I do not think Japan has a way out of this.

David Faber: Why Not?

Kyle Bass: You have a secular decline in population, and you have a huge funding structure at below market rates. So Japan's weighted cost of capital is only 1.4% and their sovereign balance sheet is much worse than the rest of the developed world. If their cost of capital goes up 250 basis points, their interest expenses of the government will exceed their total government revenue, and it can't even get there [that high].

David Faber: Now their debt is held there as opposed to us where our debt is held by foreigners, in Japan it's mostly citizens.

Kyle Bass: That's right. In the United States about 57% of our debt is held externally. In Japan 6% of their debt is held externally. 94% is held by the people, the pensions, and the life [insurance] companies. What's happening now with the population decline, all the buyers of their debt are turning to sellers. And the largest pension fund in the world in Japan told the Ministry of Finance in May that they are going to be a net seller from now on. So their buyer's base is disappearing and if they have to go to the international capital markets to raise money, they can't exist. It's an awful social problem for Japan.

David Faber: These things always seem to be years away and they never seem to happen.

Kyle Bass: If you put pen to paper, and you understand the problems that some of the larger nations have, the good news is the United States is a good 10 to 12 years away from this. The silver lining is, we can see what happens when a country decides to spend its way into a huge deficit and have nowhere to turn.

Unfortunately, as long as ideologues like Barack Obama and Nancy Pelosi are in power, facts, logic and reason will always play second fiddle to a Marxist agenda.

Our only hope is to continue to educate the citizenry -- because an informed electorate is a conservative electorate.

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