Kyle Bass on the Fate of the World
If you're not already familiar with the hedge fund celebrity Kyle Bass, you should be. His first claim to fame came by investing millions on the collapse of the subprime mortgage market after warning many financial executives of the impending disaster. Their response: "I hope you're wrong". Since then his keen predictions of major market events and how they'll unfold has gained him a large cult following across the financial blogosphere, not to mention countless interviews on what'll happen next.
Here are two interviews (parts 1 and 2) he gave on BNN a few days ago on the U.S., China, Japan, and Europe. Oh, he also makes a brief positive mention on Canada, which after watching this interview you may want to move to afterwards. I've transcribed the most relevant portions below. (Click images to jump to video)
On why a coming Japan default will be greater than Greece:
“Their stock market is down 80% in nominal terms in the last 20 years; their real estate market is down 70% in the last 20 years. There has been only one thing that the Japanese people have bought domestically that hasn’t hurt them and it’s their bonds. So, again, think about the psychology of that kind of environment coupled with the fact that they now have an inexorable population decline—they have a secular population decline. So, if you have a scenario where you have a social benefits—social welfare program—that you as a government are committed to, that you’ve made promises that you know you can’t keep—by the way, Europe and America can’t keep theirs either—but, here’s the problem: Madoff failed when more people left his scheme than entering his scheme. In Japan we now have more people leaving the workforce than entering the workforce. Their population peaked a few years ago and they’ve lost about three and half million people in about four years; and, by their own accounting, they’re going to lose another twenty-seven million people in the next forty years. You have a scenario where the rubber is meeting the road. This is why more people will be dissaving than saving; and, one other point with Japan that’s very important, they spend half of their central government tax revenue on debt service alone. They spend a quarter of it on interest alone; and, to your point, their interest rates are zero and they’ve been a full zero really since 2001, and they really went to half of a percent in 1996. So when your debts are twenty times your revenue and your interest costs move at all, you have to restructure. So what’s not arguable is the fact that they have the worst on-balance sheet sovereign scenario in the world."
“So you basically think Japan is going to become Italy eventually?”
“No, I think Japan is going to be Japan and it’s going to be worse than Greece as far as the writedown is concerned. I think that if a kindergartener were to look at Japan’s balance sheet it wouldn’t take a genius to see that they have a position that is untenable—that they have a position they can’t move out of. It’s just a matter of time."
“We’re going to look back at this in two or three years from now and we’re going to say if you took the time to look at and understand their balance sheet and income statement as a country, it’s the single most obvious thing I’ve ever seen in my adult life. The reasoning I hear from the other side is we keep trying to find one or two reasons why they might be able to hang on for a while longer, and clearly that’s not an investable theme."
“When you look at Europe, you can’t look at it through the same prism that you look at Canada, the U.S., or other countries through because through the financial crisis of 2008-2009, the U.S. and the U.K. for all intents and purposes recapitalized their banks. Europe hasn’t had the money to recapitalize its banks and they haven’t done so yet. Interestingly enough, Europe’s banks have three times as much leverage from equity to assets that the U.S. has—and Canada for that matter. So, I think it’s really important to understand, Spain—by looking at a snap shot on a piece of paper today—it looks like they might have a manageable scenario. When they recap their banks they won’t have a manageable scenario; and they have to recap their banks, and so does the rest of Europe. So, as the dominos fall, clearly the peripheral countries that are in the news so much—the PIIGS, as we like to call them—all have to, we think, restructure their obligations; and I think that is coming much sooner than others would think. That is something you must prepare for in 2012.”
“And from that perspective then, what do you think Europe ends up looking like and what might that do to corporate debt?”
“This is something that’s not talked about very often. So, first of all, let’s talk about global banking assets. There about $87 trillion—if you were to dollarize all global banking assets—there’s about $87 trillion of global bank assets of which $40 trillion reside in the Euro area. And, what does Europe look like in a post-default world, your guess is as good as mine. I can tell you it doesn’t look as it looks today. I think, clearly, there’ll be a number of members that leave the EMU. I don’t know why the EMU exists if or when you have four or five members leave. In reality, once Germany recaps its banks—it has 82% on-balance sheet sovereign debt to GDP today—and in a post-recap world, Germany will be north of a hundred and we’ll also be [the U.S.] in a very difficult scenario. Europe will look very different than it looks today. The things we need to focus on are—if you look at deposit runs—if you were a Greek or a Spaniard or a Portuguese and you have money sitting in your host country’s banks, with capital mobility today, the question is why on earth would you leave it in those banks. Why wouldn’t you set up an account in Canada or Germany or Switzerland or Norway or somewhere that might be a safer jurisdiction for your capital? So what you’ve seen, if you follow it closely, is deposits leaving the country at an annualized rate of more than 20%. This is the final move—let’s call it the final precursor—before a sovereign default and it’s happening as we speak.”
“If the European Central Bank does, as many Keynesians want it to do—if it engages in quantitative easing, if it allows a higher inflation rate to be run within Europe—what does that do to your belief? Because, then, you start essentially using inflation to give haircuts to creditors and that benefits the debtors. Doesn’t that undermine the possibility of default?”
“So, this is a belief commonly held by most central bankers and academia who, as you know, unfortunately run many of these countries. They believe that when you get to this proverbial fork in the road that there are two options you believe you have. One is default and one is deflation; and you believe those two options are mutually exclusive to one another. When you sail into the zone of insolvency, when your debts become many multiples of your revenue—and this is something we spend a lot of time thinking about—when you attempt to inflate yourself out of this problem and your debts are already more than five, six, seven times your revenue, you put yourself in this position where the inflation causes the default. So, in many of these nations inflation is not an option; and I know your show isn’t long enough but when you talk about the ECB monetizing all these debts I think that doesn’t change any of the spending, number 1, and what you've seen coming out of the Bundesbank and many places in Germany, that doesn't change the behaviors of the participants whatsoever and, in fact, it may encourage their continuing behavior of the profligacy that's riddled throughout Southern Europe. I believe the ECB knows one thing: they have to print money—whether it's the ECB or one of the 17 various central banks at the periphery—they don't have the money to recap their banks. So the question—your question should be—do they print before they default or after they default. In my opinion, they have to just print afterward because the number that they're going to have to print is so large that they all know this going in.”
On why he’s not investing in China:
"China is an enigma to me. I don't know what numbers to believe and not believe. We don't maintain positions in China. One thing I do follow is their banking sector and in the last two years China has grown their banking sector—their banking assets—by 50% of GDP two years in a row. That's analogous to the U.S. lending $14.5 trillion into our economy in two years. One thing I’m fairly certain of, if we lent $14.5 trillion into our economy in the last two years, we would grow at more than 8%. So I think it’s very important to think about China’s FX [foreign exchange] reserves that everyone points to as being the piggy-bank for the world at now roughly $3.5 trillion, but it’s important to understand that Chinese non-performing loans in their banking sector are right around 1%. Historically, they’ve been 19%. So if you have $13.5-$14 trillion call it dollars’ worth of assets in your banks and your non-performing loans go back to what’s normal in China, you can do some quick math and realize that you’re going to end up losing almost $3 trillion; and that magical pot of money that sits in China goes away. I think it’s a tenuous scenario that as non-performing loans start to rise, as we’re starting to see in the property sector in China, it could be problematic. Counterbalancing that with the fact that Chinese banking assets are now only two times their GDP, could they go to three? Could they lend another $5 trillion into their banking sector and I think the answer’s yes. I sound like a weatherman. I don’t know what China does, but we’re not invested in China.”
On the U.S.:
“It’s a disaster in the United States. It’s a scary place and watching the fiscal scenario unfold on Capitol Hill is something I’ve recently begun to just turn my T.V. off. The best way I can analogize this scenario is the Republicans and Democrats each have—to use golf—each have 100 foot puts with 20 foot break in 30 mile-an-hour winds and they look at each other across the long green and say, 'Good, good?', and we move on. 'You don’t cut my entitlements and I won’t raise your taxes and we’ll move on'; and that’s how the U.S. has dealt with this problem so far—kind of the path of least resistance.”
“The good news of this show is that I’m a big fan of Canada and a country with no net-debt, massive natural resources, and a central banker whom I recently met that I like very much. The only thing that Canada is going to have trouble with, in my opinion, is—there are a few things that I think are facts and maybe this is presumptuous—the Eurozone is going to have recession next year. It’s already entering one now given the severe austerity that they’re having to impose on themselves. The U.S. is not going to be able to, in my opinion, grow through a European recession, therefore, commodity prices, asset prices may come down for a brief period of time [which will hurt Canada's economy].”
To read more about Kyle Bass' background and see where he's currently invested, click here for an article written about him at Gurufocus.com.