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How Kyle Bass and other bond vigilantes are wrong on Japan

JP Hochbaum

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Kyle Bass has been praised by some on this forum for making prediction that Japan will collapse. For accuracy sake here are his predictions:


"At 24 times central government tax revenues, cumulative Japanese government debt has reached a level which ensures financial collapse.

With the Abe/Aso government setting a 2% inflation target, the collapse will occur sooner—probably within the next 18 to 24 months.

The revelation will be that interest on the debt—currently 25% of national tax revenue—will double under higher interest rates.

The result will be massive JGB selling, a collapsing yen, and systematic financial crisis resulting from a collapse in yen asset prices."

Whither Japan Stocks and Bonds: Are Kyle Bass and Martin Feldstein Right? Is Market Collapse Ahead? - Forbes

Problem is that Bass and his ilk have no idea how things actually work:

"Rising interest rates would of course raise debt service costs for all borrowers, and especially the hugely indebted government. But they would enable lenders–including household depositors–to charge higher rates on new debt and raise returns on non-fixed rate debt. Since net stock of private savings is larger than the net stock of public sector liabilities, Koll reckons that the overall effect on the economy would be positive.

Rising interest rates would not spell large losses for Japanese financial institutions because these institutions’ bond–and especially JGB–portfolios are largely held to maturity, avoiding the requirement to be marked to market. The institutions would have no incentive to sell, and ample incentive to hold the JGBs [the weighted average duration of which they have in any event been shortening to well under five years--Harner].

As to who is or would buy JGBs, the answer for the present and foreseeable near term future is: the Bank of Japan. BOJ is already committed to buying the entire debt out to a maturity of three years and a new governing board to be installed in April may extend the range to three to five years. Interest rates will rise only as much as BOJ will allow. This is why foreigners and domestic institutions are still buying the bonds.

Whether or not significant inflation develops in Japan depends on productivity. Significant increases in productivity could fully mitigate inflationary pressures.
There is plenty of room in Japan’s economy for raising productivity. Agriculture, in particular, has absymal productivity that could easily be raised through deregulation. Land policy that affects housing is another. Health care is another. Indeed, deregulation is needed throughout the economy. “The Abe administration must implement real deregulation, so that private investors put their savings and capital to work, by building new factories, new hospitals, and so forth.”

Cooler Heads: The Rebuttal to Kyle Bass's Japan Market Meltdown Scenario from JPMorgan's Jesper Koll and Masaaki Kanno - Forbes
 

cpwill

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While I have recently come to the conclusion that Bass indeed oversells the case, I do not find the argument presented here to be particularly compelling. You would do better countering him by pointing out the actual amounts scheduled for roll-over in 2014/2015/2016.
 

Ahlevah

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While I have recently come to the conclusion that Bass indeed oversells the case, I do not find the argument presented here to be particularly compelling. You would do better countering him by pointing out the actual amounts scheduled for roll-over in 2014/2015/2016.
I just don't see how you can oversell this. Japan's interest expense is expected to rise from 8.4 trillion yen to 9.9 trillion for 2013. This is with the yield on the 10-year JGB currently running at .75% and tax revenues running at about where they were in 1987. So this non-linear relationship between Japan's interest expense and revenues that Bass has talked about is beginning to show up more clearly.

http://www.mof.go.jp/english/budget/budget/fy2013/02.pdf
 

cpwill

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I just don't see how you can oversell this. Japan's interest expense is expected to rise from 8.4 trillion yen to 9.9 trillion for 2013. This is with the yield on the 10-year JGB currently running at .75% and tax revenues running at about where they were in 1987. So this non-linear relationship between Japan's interest expense and revenues that Bass has talked about is beginning to show up more clearly.

http://www.mof.go.jp/english/budget/budget/fy2013/02.pdf
I have yet to see Bass publicly account for the fact that even as interest rates are (supposedly) set to double, the amount of debt being rolled over (in 2014 v 2012, when we are pulling the figures from) is set to be reduced to half. 200% of .5 = 1; and Japan is left paying the exact same amount to roll over its debt at before. That is why I think he oversells his case. The process isn't being driven at this point by interest rates payments, but rather by the withdrawal of Japanese workers and the turning of the populace from purchasers to sellers of JPY - that's a slower process. At some point it will become about interest rates, but if Abe is successful at boosting growth, then that tipping point is pushed further into the future due to higher government revenues and capital inflows. Now we are talking about 4-5 years years instead of 6-18 months.

But I'll take a look at the paper and get back to you. Between Japan and China, it's going to be an interesting time here in the Pacific in the next half decade.
 
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