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Kyle Bass: The ZIRP trap [W:108/221]

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The fiscal situation in Japan is of no concern when economic growth and inflation float around zero.

And when they aren't? Will investors tolerate negative real yields when the same securities have been earning 2-3% for 20 years and equity markets are skyrocketing?
 
And when they aren't? Will investors tolerate negative real yields when the same securities have been earning 2-3% for 20 years and equity markets are skyrocketing?

I believe deficits will naturally decrease when output growth and inflation increase. Even at current projected deficit levels, a 5% gain in production will be something like 12.6 times larger than the additional deficit financing of 5% annually.
 
So the points Unanswered/Deflected were:

1. Your selective/deceptive and NON-representative use of a Yen chart to Obscure the Fact the Yen is at 36 month LOW.
It wasn't selective. It was used to bring up a point that the value of the YEN was much worse 5 years ago and they never collapsed, defaulted, partial defaulted, or caused a paralell universe to explode.

2. Inability to deal with my Valid and Meaningful use of 'Partial/effective Default' for large restructuring or currency Collapse.
What is valid and meaning ful to you simply doesn't exist in the realm of reality, so no need to address it. It would be like addressing a theory of Santa Clause killing children, it is fake and made up.
 
It wasn't selective. It was used to bring up a point that the value of the YEN was much worse 5 years ago and they never collapsed, defaulted, partial defaulted, or caused a paralell universe to explode.

That is correct. Because 5 years ago Japanese borrowing was self-funded. That is increasingly not the case.

What is valid and meaning ful to you simply doesn't exist in the realm of reality, so no need to address it. It would be like addressing a theory of Santa Clause killing children, it is fake and made up.

No, he is correct. A deliberate devaluation of a currency in order to reduce real debts outstanding is indeed an effective default.
 
I believe deficits will naturally decrease when output growth and inflation increase. Even at current projected deficit levels, a 5% gain in production will be something like 12.6 times larger than the additional deficit financing of 5% annually.

Walk me through the math here because I'm having a hard time understanding what you're saying. A 5% gain in industrial production? Public investment? 12.6x what? Investment to revenue multiplier? Additional debt service cost to revenue multiplier?

Current projected 2013 deficit is 45.46 trillion yen - with 47.15 trillion in revenue, 29.12 trillion in social security costs, 22.24 trillion in debt service costs and 41.25 trillion in other government expenditures. Projected nominal GDP growth is 2.7% which gets them to 487 trillion yen in 2013. A very generous assumption of 5% nominal growth in 2014 (let's say 3% real and 2% inflation) would get them to 512 trillion yen. Now let's say they collect around 11% of GDP in tax revenue - right about where they were in pre-2008 - such that tax revenue would come in at 56.33 trillion. Given the aging demographics social security is projected to rise by 10.4% in 2013 which is a safe assumption for 2014 - giving us 32.14 trillion in social security expenses which added to a 5% increase in general government expenditures brings us to 75.46 trillion in primary government expenses. Now the rub lies in how the yield curve would react to 5% nominal growth with 2% inflation. Interest rates are already against the zero bound with an effective interest rate of 1.32% on 749.6 trillion in general JGBs outstanding - we know the nominal amount of our interest expense has already bottomed out. Given the front-loaded maturity schedule of the existing stock of debt - let's assume the effective interest expense rises to 2% due to the resurgence of growth and rising prices. This puts our 2014 interest expense at a measly 29.2 trillion*. If you have a calculator out you'll see this results in total government expenditures of 105.57 trillion which, subtracting for our generous tax year of 56.33 trillion, would result in a deficit of 49.24 trillion - 2.09 trillion higher than the projected 2013 deficit.

Now you could very reasonably claim that a rise in total effective interest rates to 2% is implausible given Japan's status as a sovereign currency issuer (and all that jazz), meaning that the BOJ would keep the short end of the curve at 0% and force the long end of the curve even lower by snatching up long-term JGBs. And you'd be right - as this is probably what is most likely to happen. The problem with recovering economic growth and inflation at 2% is that the 95% of domestic JGB holders will have to suffer negative real yields - at precisely the time they plan on selling anyway for retirement. If current forecasts about U.S., German, and Chinese growth are even reasonably met - you can fully expect treasuries, along with other safe haven assets, to revert back to positive real yields. The reversal of trends - from two decades of strong real yields in Japan and close to 5 years of negative real yields in the United States - combined with the other factors that don't need repeating (trade balance, pension funds becoming net sellers, etc.) results in a significant weakening of the yen. It doesn't have to be catastrophic but it will definitely be significant. Even Krugman's model of a "bond vigilante" attack on a sovereign currency issuer results in weakened currencies in spite of rising interest rates. It goes back to the famous trilemma of international finance.

In the end, that's why whether I consider myself a monetary realist, libertarian goldbug, or Krugman Keynesian - I don't understand why people react so strongly to Kyle Bass' arguments. If you watch the video he even states that he only watches this trade because he finds it to be the best hedge against his overall book. He even tells an audience member that the convexity isn't there in this trade for retail investors - only qualified institutional investors are able to see the trades he's seeing. I find it hard to believe anyone on this board would turn the opportunity to buy $5 billion of risk for 1bps.

*Note that more than half of the debt service costs are "Redemption Expenses" that are associated with intergovernmental transfers - I assume this remains at a fixed rate of 1.6% of total government bonds outstanding. (see here)
 
Walk me through the math here because I'm having a hard time understanding what you're saying. A 5% gain in industrial production? Public investment? 12.6x what? Investment to revenue multiplier? Additional debt service cost to revenue multiplier?
Yes, you've caught a 'point' that doesn't really have a point. Your bottom line analysis below is Much better/Deals with the issues at hand.
In my post at the top of the last page I tried to summarize the problem with a challenge.
There were no takers, there still aren't.
It's a quandary.
In fact, the best arguments against Bass I have heard are only time ones.
No one here, or outside this board for that matter, has really countered them from a mathematical viewpoint or Ultimate outcome.
I posted the Harvard Business School study previously. They thought it had so much merit, I believe it was the first case study, before the case, they ever published.

Rhapsody said:
Current projected 2013 deficit is 45.46 trillion yen - with 47.15 trillion in revenue, 29.12 trillion in social security costs, 22.24 trillion in debt service costs and 41.25 trillion in other government expenditures. Projected nominal GDP growth is 2.7% which gets them to 487 trillion yen in 2013. A very generous assumption of 5% nominal growth in 2014 (let's say 3% real and 2% inflation) would get them to 512 trillion yen. Now let's say they collect around 11% of GDP in tax revenue - right about where they were in pre-2008 - such that tax revenue would come in at 56.33 trillion. Given the aging demographics social security is projected to rise by 10.4% in 2013 which is a safe assumption for 2014 - giving us 32.14 trillion in social security expenses which added to a 5% increase in general government expenditures brings us to 75.46 trillion in primary government expenses. Now the rub lies in how the yield curve would react to 5% nominal growth with 2% inflation. Interest rates are already against the zero bound with an effective interest rate of 1.32% on 749.6 trillion in general JGBs outstanding - we know the nominal amount of our interest expense has already bottomed out. Given the front-loaded maturity schedule of the existing stock of debt - let's assume the effective interest expense rises to 2% due to the resurgence of growth and rising prices. This puts our 2014 interest expense at a measly 29.2 trillion*. If you have a calculator out you'll see this results in total government expenditures of 105.57 trillion which, subtracting for our generous tax year of 56.33 trillion, would result in a deficit of 49.24 trillion - 2.09 trillion higher than the projected 2013 deficit.

Now you could very reasonably claim that a rise in total effective interest rates to 2% is implausible given Japan's status as a sovereign currency issuer (and all that jazz), meaning that the BOJ would keep the short end of the curve at 0% and force the long end of the curve even lower by snatching up long-term JGBs. And you'd be right - as this is probably what is most likely to happen. The problem with recovering economic growth and inflation at 2% is that the 95% of domestic JGB holders will have to suffer negative real yields - at precisely the time they plan on selling anyway for retirement. If current forecasts about U.S., German, and Chinese growth are even reasonably met - you can fully expect treasuries, along with other safe haven assets, to revert back to positive real yields. The reversal of trends - from two decades of strong real yields in Japan and close to 5 years of negative real yields in the United States - combined with the other factors that don't need repeating (trade balance, pension funds becoming net sellers, etc.) results in a significant weakening of the yen. It doesn't have to be catastrophic but it will definitely be significant. Even Krugman's model of a "bond vigilante" attack on a sovereign currency issuer results in weakened currencies in spite of rising interest rates. It goes back to the famous trilemma of international finance. ....(see here)
Nicely done.
And you have been conservative in the numbers making your point.

In Kushinators's ?/5%/12.6x/? thing above he didn't make provision for the (or any) concomitant increase in debt service for the inflationary policy that allows these 5% growth projections. Because even using your conservative number for avg rate, going from 1.32% to 2% is a 50% increase in Debt service cost for a country with a perilously high Debt/GDP and debt/revenue Problem.

And let's not for get this New government threw away the fiscally responsible Doubling of the National sales tax in favor of a Stunning, all-out, print fest.
The Yen dropping significantly enough so that their last monthly trade deficit Increased even tho exports were up 5%; Imports were up more because of the weak currency. (My #198 http://www.debatepolitics.com/econo...-zirp-trap-w-108-221-a-20.html#post1061484806)
 
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Walk me through the math here because I'm having a hard time understanding what you're saying. A 5% gain in industrial production? Public investment? 12.6x what? Investment to revenue multiplier? Additional debt service cost to revenue multiplier?

Using more accurate data, a 5% gain in economic output will be 10.5x greater than additional debt service costs of 5%.

It is a matter of magnitude in regards to aggregate output, tax revenue, and debt service. According to FRED data, Japan's 2012 GDP was approximately ¥471,163 billion. Also, according to Japan's Ministry of Finance, Japan's 2012 budget, revenue, deficit, and debt service were: ¥90.3 trillion, ¥46.1 trillion, ¥44.2 trillion, and ¥21.94 trillion respectively. Using this data, we can obtain ratio values which will allow for more accurate assumptions because the variance for ratios are smaller (logarithmically) than variances of the raw data. The 2012 revenue to GDP ratio in Japan was 0.09782, while debt service to GDP was 0.04657.

Under the 5% growth, 5% effective future debt service cost assumptions (both highly unlikely yet trivial none the less), along with 2013 budget projections for guidance, GDP will grow by more than ¥23.6 trillion, revenue grows by ¥2.3 trillion, debt service grows by ¥2.2 trillion, and the deficit increases by ¥2.2 trillion. Of course we must hold a countless number of other variables constant as well.

Year20122013Change
JGDP (¥)471.163 trillion494.721 trillion23.558 trillion
Budget (¥)90.33094.8614.531
Revenue (¥)46.09048.3942.304
Deficit (¥)44.24046.4662.226
Debt Service (¥)21.944 trillion24.1932.249
Revenue % GDP9.7829.7820
Debt Service % GDP4.6574.8900.233
Total Debt (¥)942.000 trillion988.466 trillion46.466 trillion
Debt to GDP %199.931199.803-0.128

2013 GDP: (¥471.163 trillion*1.05)=¥494.721 trillion

2013 Revenue: (¥494.721 trillion*0.9782)=¥48.394 trillion

2013 Debt Service: ((¥494.721 trillion*0.0467)+((¥494.721 trillion*0.0467)*0.05))=¥24.193 trillion

2013 Budget: (¥926.115+¥2.249 trillion)=¥94.861 trillion
note: The current 2013 budget projection is ¥926.115. Additional debt services costs of 5% were then included to find the total.

It is interesting to note that total Japanese government debt to GDP falls even if we assume identical increases in both economic growth and financing costs. Interest rates will not climb in Japan without the requisite economic growth to foster said growth.

Now you could very reasonably claim that a rise in total effective interest rates to 2% is implausible given Japan's status as a sovereign currency issuer (and all that jazz), meaning that the BOJ would keep the short end of the curve at 0% and force the long end of the curve even lower by snatching up long-term JGBs. And you'd be right - as this is probably what is most likely to happen. The problem with recovering economic growth and inflation at 2% is that the 95% of domestic JGB holders will have to suffer negative real yields - at precisely the time they plan on selling anyway for retirement.

There will be interest rate risk in the event of strong economic growth. But will the loss of purchasing power exceed income gains in a stronger growth environment? IMO, no.

If current forecasts about U.S., German, and Chinese growth are even reasonably met - you can fully expect treasuries, along with other safe haven assets, to revert back to positive real yields. The reversal of trends - from two decades of strong real yields in Japan and close to 5 years of negative real yields in the United States - combined with the other factors that don't need repeating (trade balance, pension funds becoming net sellers, etc.) results in a significant weakening of the yen. It doesn't have to be catastrophic but it will definitely be significant. Even Krugman's model of a "bond vigilante" attack on a sovereign currency issuer results in weakened currencies in spite of rising interest rates. It goes back to the famous trilemma of international finance.

Agreed!
 
Missed a decimal place twice. It should read:

2013 Budget: (¥92.612+¥2.249 trillion)=¥94.861 trillion
note: The current 2013 budget projection is ¥92.612. Oops :3oops:
 
Japan has started the 'full monty' experiment.
Outa money {and outa Math and outa Finance ministers (10 in 6 years!)} they're just printing it and buying a large percent of their debt... And other stuff.
3 hrs ago
Kyle Bass 7 Minutes on CNBC
Bank of Japan Policy Is Huge, Risky Experiment: Fund Manager

"The Bank of Japan is buying assets at roughly 75% of the rate of the U.S. Fed, on an economy that's 1/3 the size of the U.S."
 
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Most agree on the Fundamentals it seems, only the timing in question.
Bass has gotten hurt alot on his JGB futures position til now, but I believe has done well in the short-Yen dept.
JGB rates though have ticked up off the bottom which I doubt they will hit again.
This author believes Japan has more time than Bass opines, but that Lava is going to flow.

Please excuse slightly longer than normal excerpt as this link is by subscription and wouldn't otherwise be seen.
I can email or post the rest on request. (cp, ahlevah, rhapsody, et al)

April 26, 2013
Japan's debt volcano rumbles on - FT.com
By John Dizard
John Dizard believes it is hard to predict whether the yen is a good long-term bet

"...The science of predicting volcanic eruptions is still in its early days. So, apparently, is the science of predicting the order in which central banks’ reflation strategies will blow up. For the past couple of years, macro speculators, or investors if you will, have lived off the sulphur dioxide releases of southern European governments and ECB policy. Then there were a few tremors early this year from the Fed’s deep quantitative easing channels. For the past month or so that’s been supplanted by interpretations of the Bank of Japan’s long-period seismicity. Perhaps it’s just a coincidence, but the three main centres of volcanology in the world are Japan, Italy and the US.

Everyone in the world agrees that Japan’s yen-denominated debt is Unsupportable over even the medium term, given the country’s Ageing population and the Decline of the workforce. The argument is over how long that “medium term” will be. Those who think it’s three or four years out, or even a bit longer, think there’s a lot of money to be made by owning some Japanese equities for a couple of performance-bonus years.
Those who think it’s sooner, believe the opportunistic long-equity investors will be caught in a steel-jawed value trap.

Most yen and Japan government bond bears are to be found, stuffed, in museums of natural history. However, they roamed the earth before the country’s household savings rate and current account turned negative.
[......]
The current star among the cross-asset-class Japan bears is Kyle Bass, principal of Hayman Capital Management in Dallas. Whether you agree with his analysis or not, Mr Bass has to be respected for having held on to his three-year-old short-Japan positions over months of mark to market losses reaching more than half their value. Now, he says, the Hayman Japan-short strategy has more than doubled from its inception.
[......]
A lot of people are inclined to agree with Mr Bass about the path the yen and Japanese interest rates will take, but believe the devaluation’s convexity will increase the value of Japanese exporters’ shares.
[......]
The demographic decline and net debt burden on Japan are Impossible to overcome without a significant reduction in the public’s standard of living. But that can be drawn out and ameliorated by the structural reforms that are the most problematic “arrow” of its government’s plan.
I am inclined to believe the positive story on exporters’ earnings, and Japan’s serious competitive challenge to Germany.
The question is the discount placed on those earnings by rising real rates, and when that discount goes up. There is probably more than a year’s worth of excess return to those positions.

You should take Mr Bass’s point that you can’t know exactly how long you have before those positions are run over by a Lava flow.
 
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OP 4/13/12 said:
.... For instance, Japan maintains central government debt approaching ¥1 quadrillion against revenues of roughly ¥48 trillion—a fatal 20 times debt to revenue. Minute increases in the weighted-average cost of capital for these governments will force them into what we have termed “the Keynesian endpoint”—where debt service alone exceeds revenue...
Two years and, of course, the Math is the same.
"Keynesian Endpoint"... or now... "Cul de Sac".
take your pick.

I think Japan does have to raise the sales tax to dramatically decrease debt with their shrinking work-age population and shrinking overall population..
And settle for an ongoing recession/downsizing, instead of trying to inflate their currency in some kind of false stimulus.
Unless they do (and even if they do to a lesser extent), they're left with less and less people to pay more and more debt/a Ponzi scheme.
Most of the industrialized world depends on a growing population to support social and retirement services, but no one has a demographic problem like Japan.

Barron's this evening:


Japan Reaches a Keynesian Cul-de-Sac
By RANDALL W. FORSYTH
APRIL 2, 2014
Japan Hurtles toward Fiscal Cliff as money Printing can't make up for an economy's Decrepitude.
Japan's April Fool's Tax Hike Shows Abenomics' Limits - Barrons.com

The calendar read April 1, but instead of a day of pranks, Tuesday was the day Japan goes over its own fiscal cliff. So says Carl Weinberg, chief economist at High Frequency Economics. That's because Japan imposed a massive increase its national sales tax, to 8% from 5%, on April 1, which is the first day of the fiscal year there. But instead of April Fool's Day, it might better be called the Japanese version of Groundhog Day.

As in the now-classic 1993 film by the late Harold Ramis, Japan seems determined to relive its massive blunder of 1997. That year, the nation also hiked the sales tax, to 5% from 3%, and turned an unsteady economic recovery back into recession. In a report colorfully entitled, "Japan's Sales Tax Hike: Anatomy of a Murder," Weinberg writes the nation's gross domestic product is set up to Crash in the current quarter -- after a spending spree to beat the sales-tax increase. Over time, he estimates real GDP will be lowered by 1% while consumer prices will be increased by 1% by the tax increase.

At the same time of the sales-tax hike, other fiscal stimuli under "Abenomics" will expire, exerting a further drag on the economy. Even so, the higher sales tax doesn't come close to curing Japan's fiscal problem.

"We estimate that this increase in the sales tax accomplishes less than 1/5 of the adjustment in public-sector finances necessary to stabilize the debt-to-GDP ratio, which is approaching 300%," Weinberg writes. "Even so, economic growth will take a big hit in the second quarter because of the tax hike, and at least some momentum gained from the massive fiscal stimulus of Abenomics will be lost."
Abenomics might be described as Keynes on steroids.
[........]
As a result, the Citi economists estimate a 10% depreciation in the yen worsens Japan's trade balance by 1.5 trillion yen ($14.4 billion.) Again, that's the opposite of the textbook prediction; that currency depreciation produces trade surpluses.

This suggests Japan is in danger of reaching a Keynesian cul-de-sac. Printing more money to depreciate the yen isn't having the positive effect of boosting exports but is reducing households' purchasing power. Accumulated government debt is forcing tax hikes on a weak economy and limits the scope of fiscal policy.

Underlying all this is Japan's well-known demographic plight of an aging and shrinking population. That means a falling workforce to produce income to support pensioners.

In the end, money printing and government borrowing cannot make up for a shrinking work force in an economy in which producers have moved offshore. That is the conundrum facing Abenomics.
 
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Something like 92% of Japans government
debt is held internally by households, governments, corporations, and various pension systems. If rates went up from near 0% to 2%, there would be an interest rate shock (which figures to be a negative on equities), but no... they would not go "broke". Please remember, Japan can (and has continued to) print as much Yen as required to meet their obligations. The risk of inflation in Japan is about as probable as the risk of deflation in China.

I agree Nation that has a sovereign Currency can not "go broke", but what benefit is it to have to float your currency as a final solution ?

How does thaf affect Japanese citizens ?
 
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Actually, with something like 20% of the roughly $55 trillion in sovereign debt providing a negative interest rate, revivifying this thread isn't a bad idea. Bass talked about Japan's debt issues and ZIRP for years, using the country's currency as a hedge against other holdings in his hedge fund. Obviously, the yen is still here and considered a high-quality currency. I wonder what might have been without all of the monkey motion going on between the Bank of Japan and foreign central banks as well as various cross-currency basis swaps arrangements between commercial banks. But I digress.

What we're seeing in countries with the long-term use of ZIRP, such as Jaoan and the EU, is weakening banking systems. Banks simply don't want to lend because they don't feel they're being adequately compensated for their risk. They'd rather lose money slowly by buying government debt. It's classical Debt Deflation Theory stuff. Look at Deutche Bank, for example. Talk about getting knocked off your pedestal. :doh And banks in Japan are selling for well below their presumed book value. I mean, who wants to own stock in a bank when there is virtually no yield spread and they're losing money? They absolutely suck as investments. Europe and Japan have been stuck in a slow-growth debt quagmire for years, and I'm afraid the United States is headed down the same dead end.
 
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