Kyle Bass image

The Wall Street Journal in an article today, cited similarities between Japan and the European Sovereign debt crisis. The article goes on to mention how investors are now looking at Japan as the next place to bet against Government bonds.
The credit default swaps on Japanese Government bonds, have risen to higher levels than those reached in the immediate aftermath of the Japanese natural disasters, and nuclear reactor problems last March.

Kyle Bass is among those investors  who view at Japan as the next Europe.   Kyle Bass bet correctly against Europe several years ago, and became a celebrity after Michael Lewis published his recent book, Boomerang, which detailed Bass’ correct bets.

Bass and many others have a common thesis: Japan has debt to GDP of 200%, the population is aging, and the savings rate is falling. The Government will not be able to finance this debt like Europe and therefore betting against the bonds is almost a no brainer. Bass mentioned many of these issues as well in a recent Bloomberg interivew

Japan does face many problems, and aging demographics are a huge issue, which will haunt Japan and Europe in the near future.  However the comparison is dead wrong for one main reason: Japan has its own central bank.

As the European crisis intensified it was unable to get its act together because the European Central Bank (ECB) has its hands tied. Greece, Portugal, and even Germany cannot print their own money. They either have to borrow it, or raise capital. The ECB’s mandate is to control inflation, as opposed to the Federal Reserve, which has a dual mandate. The Federal Reserve to promote maximum employment and control inflation.

Germany has a lot of influence over the ECB as this FT article explains. We stated in a recent article:

In our opinion the best decision would be to let the ECB print money. This would help elevate inflation, devalue the euro, which would increase experts. Furthermore, euros could be used to recapitalize banks and countries, which are insolvent.

We think Germany has hesitated out of fears of hyperinflation and memories of 1923. So we can blame the treaty of Versailles or even the assassination of Archduke Franz Ferdinand.

Japan has its own Central bank. Japan cannot default unless it wants to. If Japan  needs money it can issue more money, unlike the case of European countries. Japan could also buy as much of that debt as the country desires. The only problem would be that it could cause inflation. In Japan this would be welcome, as the country has experienced almost non-stop deflation for the past 20 plus years as the chart below demonstrates. The Yen is also very strong, so weakening it would simultaneously help exporters and produce some inflation the country needs.

Historical Data Chart Japan cPI

Of course there is always the chance of hyperinflation, however, people have been arguing this possibility for 20 years. Many investors have been killed on this trade, whether its shorting Japanese bonds, buying credit default swaps, or others to bet against hyper-inflation and/or default in Japan.

Furthermore hyperinflation would actually help the Government ease its debt problem. Although inflation would kill bondholders, the Government would be able to pay back in cheaper currency.

In conclusion we think that any chance of either bond vigilantes causing the Japanese Government to default, or due to an increase in Government debt, has little backing in the actual facts. The rise in CDS prices on Japanese bonds is outside the Government’s control. However, the Government always can keep bond yields as low as it wants.