"There are going to be consequences to central bank balance sheet expansion all over the world
," Kyle Bass tells Steven Drobny in his new book, The New House of Money
, adding "It’s a beggar-thy-neighbor policy, but everyone is beggaring thy neighbor." The Texan remains concerned at QE's effects on wealth inequality and worries that "at some point this is going to ignite and set cost pressures off
." While Gold-in-JPY is his recommended trade for non-clients, his hugely convex trades on Japan's eventual collapse remain as he explains the endgame for his thesis, "won't buy back until JPY is at 350," and fears "the logical conclusion is war.
Excerpted from Steven Drobny's The New House Of Money,
Drobny: You’re on the tape saying that dollar/yen is going to 200.
Bass: If I’m right, it will go much further than that.
I don’t think it will hit 500, but in crises, currencies swing too far. They can start discounting 15% or 20% rates out ad infinitum because they are in a full bond crisis. But once they flush the debt and have a reset, you’re not going to have 20% rates ad infinitum. We’ve committed more capital to the currency market, but all of the convexity is in the bond market.
Drobny: Recently we’ve seen the yen move your way and everyone is getting excited about “The Japan Trade” – is this the big move you’ve been looking for?
Bass: No, this is just the beginning. It’s not the real move. The real move happens when it runs away from the authorities and they lose control.
Drobny: At what point do you go the other way and buy Japan?
Bass: When the yen is 350 and they’ve wiped out their debts.
Drobny: Let’s play out your Japan scenario. If the yen goes to 350 and Japanese government bond yields go to 20% and they can no longer finance themselves such that it becomes a financial disaster, what are the implications for the rest of the world?
: Well, policymakers have been changing the rules, which is challenging for macro hedge funds. But that’s the beauty of this situation.
Drobny: What if they decide to just knock a few zeros off the debt?
: In the end, they may be forced to do so.
Drobny: What if they bought the whole debt stock at 1% yield?
Bass: That’s the St. Louis Fed’s school of thought, which contends that countries that have their own central banks can print their own currency and will never fall. For the world’s sake, I wish that were true. For the last 2000 years, it hasn’t been true, and I don’t believe it to be true. If it is true, I’ll lose 150 basis points a year and move on. Our core portfolio will be fine. Still, if it were true, then why even have fiscal policy? We don’t need a fiscal policy if that’s the case – we could just spend the money however we want. Policymakers don’t believe there are consequences to their actions, but the consequences will come. Economic gravity will actually set in.
Drobny: But you don’t suffer the consequences if you are out of office. That’s the next person’s problem.
Bass: The point is that no one will make those difficult decisions unless they’re forced to make them.
The politics of all these situations tell me how this is going to play out, and that’s through massive central bank balance sheet expansion and capital controls.
The Fed recently wrote a paper that actually endorsed capital controls if done concurrently with other nations. It’s hard for me to fathom that capital controls can ever be a great idea, but this is what you’re going to see.
We are in a period that will be characterized by enormous cross-border capital flows. How will it play out? Let’s assume that I’m right about Japan. What happens then? Nominal interest rates in the US and Germany go negative. The Pavlovian response is to fly to perceived safety; this is why we’re not betting against US rates.
In fact, we’re receiving rates in Europe and Australia right now because some sort of stagflation will play out first, before you start to see the real problems in Japan. If you look at history and try to understand what has created despotic rulers and wiped out populations financially in the past, and what happens next, the logical conclusion is war.
Drobny: Who is the war going to be between?
Bass: I’m not exactly sure, but it seems to me that the aggressor in Asia is China and they don’t get along with Japan.
Post-World War II, Japan has been constitutionally limited, such that they cannot declare war. But current Prime Minister Abe is talking about rewriting the constitution so that they can actually declare war again. That’s not stabilizing for the region. Nationalism is rearing its head as we speak.
A third of the population in Japan is over the age of 60, and a quarter is over the age of 65. To put this into context, in the broader developed world only about 8% of the population is over 65. At a point when these people need the money the most, they could lose 30-40% of their savings, maybe more in terms of purchasing power. The social repercussions bother us more than the financial repercussions because the social fabric of Japan will either be stretched or most likely torn, and we don’t know what’s going to happen next.
Drobny: Besides Japan, what bothers you?
Bass: There are going to be consequences to central bank balance sheet expansion all over the world.
Look at currency cross rates. If all central banks are expanding at the same rate, the cross rates aren’t moving, but your purchasing power, in terms of goods and services in the country where you live, is diminishing. You’re not focused on real returns, you’re preoccupied with the cross rates. It’s a beggar-thy-neighbor policy, but everyone is beggaring thy neighbor.
I really worry about the true cost of goods and services, but people are preoccupied by the dollar/euro exchange rate to gauge the relative strength of the European economy. You see this preconditioned response and even macro players say things like, “Oh, buy the Nikkei at week end.” They’re picking up a dime in front of a bulldozer.
Japanese industry has been hollowed out. The exchange rate may stop the decline for a certain period of time but it’s a secular decline. The people that own Japanese equities right now are tourists. But this creates opportunities in the marketplace.
Bass On inflation,
When you look at what’s going on from an inflation perspective, central banks have printed about $10 trillion dollars since the beginning of the crisis. The first $4-5 trillion went into re-equitizing heavily leveraged structures and bringing down rates. The second $4-5 trillion is making its way into the monetary base, and even though the multiplier is not working, at some point this is going to ignite and set cost pressures off. Again, it won’t be demand-pull, which is technically a good kind of inflation. Rather, it would result from too much money in the system.
Bass On QE's effects on wealth inequality,
It will show up in food in the early stages. Global QE is filtering its way into asset prices.
Those closest to the proverbial spigot are enjoying the printing the most with most in the middle and lower class not feeling the love at all. All you have to do is look at the gap between median income and mean income growing ever wider. This means the rich are getting richer while the rest stay stagnant or even decline.
Drobny: If you could do only one trade for the next ten years - non-risk-managed...
Bass: Actually, the answer to this one is easy – I would buy gold in yen.