Part 1 - Sayonara Japan
CNBC – Strategy Session
Guest: Kyle Bass – Part 1
Hosts: David Faber, Gary Kaminsky
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Part 1: Sayonara Japan
David Faber (2:45): Japan’s swoons, global defaults, the end of the world…If these are things that have you worried as an investor, well, you couldn’t have picked a better show to tune in to. That’s because our special guest today, Kyle Bass, Managing Partner at Hayman. It’s a hedge fund whose strategy involves, in part, occasionally, betting on so-called tail risks. You know, for Kyle, the unthinkable economic disaster is, of course, something that is quite thinkable. And something that he writes quite cogently about; it’s a strategy that worked quite well during the bursting of the housing bubble. And he is back in a Strategy Session exclusive. Always nice to have you.
Kyle Bass (3:18): Nice to see you again.
David Faber (3:19): Let’s start off on Japan if we can. We’ve talked to you about it before, and um, and you know my question is always, okay, when? You know, what ultimately brings the tell, if you will, that things are really starting to happen in Japan the way you expect them to?
Kyle Bass (3:33): Yeah, so, you prefaced your remarks with “the end of the world”, none of this is the end of the world, right. What we’re talking about is a restructuring that I think has to happen for the world to grow again. So, when you ask about doom and gloom, and talking about the end of the world, it’s not. Basically people lose money and you just don’t want to be one of the people that loses money when it happens. So, maybe you might want to make some money on the way down.
David Faber (3:57): It could involve a worldwide decline in living standards, could it not?
Kyle Bass (4:02): Yeah, it could have a worldwide decline in GDP. But, you know, it’s the way this works. So far, what we’ve seen, is total credit market debt in the world, in the last 10 years, has gone from $80 Trillion to $200 Trillion. Right, that’s an 11% growth rate in credit market debt globally, while GDP has grown at 4%.
David Faber (4:21): That’s the basic underpinning to a lot of your thesis at the end of the day, is it not?
Kyle Bass (4:24): Yeah, in the end, I guess, the question you have to ask yourself is: Does debt matter? If it doesn’t matter, then we’re in a cyclical upswing and everything’s going to be fine.
David Faber (4:31): Well, let’s start off with Japan. You know, Gary was, we were looking at the Nikkei there, you’ve been focused on it for some time. And again, the basic thesis there is simply, these guys have way too much debt, and ultimately are going to reach some Keynesian endpoint, as you like to say, where they can’t even service the interest on the debt.
Kyle Bass (4:47): Correct. So, when you look at the, it’s a math problem, and my assertion is that there is a fundamental availability of debt in each host country’s system. And we believe that Japan has sailed into the zone of insolvency many years ago, and that their only hope going forward is this kind of path of homeostasis that they’ve enjoyed for the last 10 years.
What sets this off? Well, there are a number of things that can set this off. It’s just a loss of confidence, right.
You have, if you look at Greece, Greece didn’t have a maturity default, Greece didn’t have a failed bond auction, you woke up one day and the rates went up. You woke up the next day and they went up a little more. And by the time you decided to pay some attention to Greece it was too late, their short rates were in the twenties.
In Japan, you had 20 years of pro-cyclical thought, working, that literally has built on itself and manifested itself into this scenario in which…who buys a 10 year, 1% bond?
David Faber (5:38): A lot of Japanese people did.
Kyle Bass (5:39): Right, right, but they expect persistent deflation, right. The whole argument over there is that they buy 1% nominal yield, they have 2 or 3% deflation, and they get 3 or 4% real yields, right, nominal yields plus deflation. Well, look at the world today, you’re starting to see, you know, inflation prints. Whether it’s food and energy, or ex-food and energy, around the globe, you’ve seen many of these prints recently in China and in India and the different places, everyone’s starting to feel some inflation.
Yes, U.S. housing isn’t moving yet, and that’s what, the Fed, I believe, is focused on. But, as you start to see inflation, and people need positive real yields, you’ll have moves in interest rates that will cause these collapses. And I just…you know, you’re asking me when, and, this is a 75 year secular cycle. You’re asking me to choose a day, a month, a year. I don’t know. The answer’s in the next few years. I can’t see how they can avoid it.
David Faber (6:29): What’s going to be the “tell”, I guess. What’s, if there’s something that I can at least be focused on as an investor. When I’m looking at those charts that Gary showed me, for example, something that will be the “tell” if you will, that your scenario is starting to play out?
Kyle Bass (6:41): Just watch 5 and 10 Year cash JGB rates. That’s all you have to watch.
Gary Kaminsky (6:46): You know Kyle, let’s go back to the U.S. for a second. I showed a chart of what’s happening with the S&P since August, you saw that chart, in terms of don’t fight the fed here, quantitative easing. Um, and then we took a look at what happened in Japan. Are you surprised at how the equity markets, the U.S. equity markets, since we visited with you in the early fall down in Texas, have been so resilient to all of the potential concerns. You turn on the national news last night, all about the deficit here, all about the problems with the budget, yet the U.S. equity markets don’t seem to care about the ballooning debt right now. Is that something that surprises you?
Kyle Bass (7:20): It’s not. And here’s why. What’s one of the top performing stock markets globally in the last decade? It’s Zimbabwe. In nominal terms, if you owned Zimbabwe in stocks you’ve done really well, but you’ve lost all your money. So, the fact that, the, the…
David Faber (7:33): But, we don’t have 2000% inflation.
Kyle Bass (7:36): No, I agree. The point I’m trying to make is that Bernanke is printing $2.3 million dollars a minute, he’s printing $3.3 billion dollars a day, right now. Okay. So, if you print, I guess you have to think of this more holistically, and I don’t know if we have enough time, we’ll walk through it quickly.
If you have a system, a banking system, that had a ($1) Trillion of equity, and ($15) Fifteen Trillion of assets, and you had a $1.8 Trillion of M1, and then you, the banking system lost 10%, right, we lost about a trillion-four, a trillion-five in the banking system. If you print enough money to re-capitalize that, in theory, the tree fell in the woods and did anybody hear it? All we did was replace what was lost.
David Faber (8:08): Yeah, but we’ve taken ultimately what was debt on the private balance sheet and put it on the public balance sheet.
Kyle Bass (8:12): All we’ve done is moved the systemic risk, Gary. We’ve moved it from the private balance sheet, and we’ve moved it, so now the real systemic risk in the world sits on the public balance sheet.
Gary Kaminsky (8:19): If I’m a retail investor, and I buy into this, and I say, I have to own stocks because I want to get the increase in the value of the equities, but I have to sell them correct. I have to get out of them at the right time. What are your other options? I mean, if you just, in that scenario, as we keep printing money, is holding cash, and just holding that cash, is that a viable strategy in an economy that continues to print money and try to grow through deficit funding?
Kyle Bass (8:44): Uh, I mean look, I don’t want to advise retail investors from that perspective…
David Faber (8:48): But there are people that who are, perhaps, who are going to agree with your viewpoint, and I am wondering…
Gary Kaminsky (8:53): Oh, we get the emails, we get emails in here everyday. We get people saying, I agree with what Kyle says…
David Faber (8:59): Right. What can I do though? What’s? Own gold? What can I do? What would you advise people to do?
Kyle Bass (9:03): So…I think in the meantime you have to earn some money, because this may take a few years to play out. So, in the meantime, you need to own productive assets. And, you see the productive assets like the MLPs and the apartments, anything with a yield that is a productive asset with a yield.
Gary Kaminsky (9:17): So, what distributions are being generated and being returned to shareholders in a form of a dividend distribution…
Kyle Bass (9:23): Even non-productive assets like gold, silver, platinum, and palladium have gone up far in excess of what the stock market has from the bottom. If say, if you use them collectively. So, you need to be balanced. You need to have some money in cash, some money in real estate, you need to have some money in productive assets…But, if this ever plays out, let’s assume that you say Kyle’s just this guy from Texas, that has a 1% chance of being right, 99% of the time he’s probably going to be wrong. So let’s file this under Plan B. What Plan B is, to the extent that I’m right, and you start to see sovereign dominos falling and the focus ends up on Japan very quickly, what do you do with your money? Well, if we go from plus 4 GDP to minus 3 or 4 on GDP, and we have an equity market contraction of 40 or 50%, you’re going to need some money to buy. That’s going to be the greatest time in the world to buy, once these restructurings happen.
Gary Kaminsky(10:11): Guess what, I don’t think there are a lot of people out there that think there’s only a 1% probability that he’s right…
David Faber (10:14): No, and obviously he doesn’t think he’s got a 1% probability of being right. Where would you put your probability?
Kyle Bass (10:21): I think it’s a little higher than that.
David Faber (10:22): Umm, you know what, you wrote a great shareholder letter which we want to get a bit more. Explain the Zero Lower Bound. We’re going to have a lot more with Kyle Bass when we get back.
End of Part 1.
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