Hedge fund manager Kyle Bass made a fortune shorting housing during the financial crisis, and over the last few years we’ve been watching him try to bag another huge score in the form of a bet that Japan would experience a financial crisis.
But so far his Japan fund—which has bet against Japan government debt via various instruments—has been a disaster for investors.
Kyle Bass would argue that like all “Tail Risk” bets, you’d presume it would lose money up until the point when it flips, at which point you make ridiculous boatloads of money in a short period.
But as we argued in a long and detailed post back in May, it’s unlikely to work out. Because Japan controls its own currency, it’s pretty much impossible for it to have a Greece-like debt crisis, which is what he envisions.
To step back a second, Bass argues that Japan can handle a debt-to-GDP ratio of about 200% because Japan finances all of its debt internally. Its citizens are famously savey. Bass predicts that as its population ages, people will start saving less, and that will leave the people with less money to buy Japanese Government Bonds. And that when that happens, Japan will have to look outside its borders for cash, and when that happens, the country will have to offer more money to borrow, and then the debt crisis happens soon thereafter.
On the surface it’s compelling. ZeroHedge recently even had a piece titled: Kyle Bass Vindication Imminent? Largest Japanese Pension Fund Begins To Sell JGBs. It argued just that, that the end of domestic debt financing was at hand.
But a new note by Bank of America’s Shogo Fujita blasts that conventional wisom out of the water.
Photo: Bank of America
First of all, he does grant the fact that as the population gets older, the savings rate declines. See the chart — >But! That’s only part of the story.
The other part of the story is that as people age, they shift their money out of risk assets (like stocks) and long-term savings assets (like pension funds) and into short-term cash-based deposits. And when they do that, and cash deposits swell at banks, that gives banks more funds to buy… you guessed it, Japanese Government Bonds.
Household financial assets, most of which are held by persons aged 60 or older, recently totaled ¥1,513trn(as of March 2012). Cash and deposits account for 55.2% of that total, and when including insurance and pension assets, that share rises to 83% of the total. Japan stands apart in that only a small portion of its household financial assets are invested in stocks and other risk assets, contrary to other developed economies.
We expect this characteristic to become more pronounced as the population gets older. Demographic ageing results in a decline in unneeded risk assets and long- term assets like pensions and insurance, leading to a structural shift into cash, deposits, and other liquid assets. Given that the savings rate is negative, this seems only natural. There is a rational need to convert savings into cash in preparation for future use. Cash and deposits held by households headed by a person 60 or older have turned to a rising trend, and there has been particularly sharp growth in more liquid, demand-type deposits. We expect the percentage of assets held in cash and deposits to rise further as the population ages.
As you can see from these two charts, cash deposits continue to grow among Japanese households (despite the low savings rate) and the ratio of short-term deposits to long-term savings has jumped in recent years.
Photo: Bank of America
Again, the crucial idea here is that although the savings rate is declining, people are building up their short term cash, and that cash goes to banks which can buy government bonds.
So the core of Kyle Bass’s argument blows up. There’s no demographic reason why Japan should no longer be able to self finance.
SEE ALSO: Why Japan is never going to default >