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Japan collapse


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I think this deserves its own thread. I wonder what the best asymetrical way is to bet on a collapse here.

 

This video explains it well

 

And Kyle bass, the guy betting against housing before the crisis is betting against Japan as well. To give a synposis of the numbers (in link below):

 

Gov budget:

~95 trillion yen

of which 22 trilion yen is debt service, and rest expenditures

 

Tax revenue

~45 trillion yen (was little over 60 trillion at all time high)

 

part of 95 trilllion that is funded by debt:

 

about 50 trillion yen.

 

 

 

Now how much debt is outstanding?

 

780 trillion yen (!!) So that is over 15x tax revenue! And increasing 50 trillion a year to fill up the hole in the gov budget.

 

http://www.mof.go.jp/english/budget/budget/fy2014/02.pdf

 

Now what can happen? They currently print money, but because of inflation interest would go up. The central bank hopes that they can stimulate the economy by money printing without monetary inflation (which would cause rates to go up) and this would then hopefully bring in enough tax revenue to fill the gap and slowly shrink debt.

 

22 trillion of interest on 780 is roughly 2.7%? Let's say it goes to 4%, that would now be another 10 trillion yen that goes of the gov budget. Which would be significant and could easily cause a downward spiral.

 

The only way to close this gap without some crazy hyperinflation scenario would be to raise tax revenue and/or lower government expenditures. The problem is if you raise taxes on a levered private sector, you might not get more taxes as spending goes down. If you lower government expenditures, due to the already high leverage, the economy would go down and tax revenue would go down. Anything you do that causes GDP to go down will cause a decrease in tax revenue.

 

So if you get inflation by turning up the printing presses, rates would go up a bit, and government budget would be wiped out. The only way out of this is if GDP would suddenly turn up and tax revenue would go up while inflation stays very very low, and they magically get their way out of this while printing money without inflation causing rates to go up 1-2%. But GDP is actually DOWN this year...

 

If Japan was a company it woudl look really horrible. This not going wrong for Japan is basicly a 30 feet hurdle. And they only have one leg and are overweight. So thoughts on this? Is there a way out of this that is not very ugly?

 

Video of Bass going in dept explaining it.

 

Another thing to reconsider would be japanese net nets wher eyou invest based on cash on the balance sheets. I would not want to be in japanese net nets right now. Hyperinflation would be a likely scenarion and that would be very bad?

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It is just as likely bass was just lucky with the timing on housing. Like the Japan thesis it was hardly novel.

 

The Japan is done macro call had been around forever, and all that's happened is lots of lost premiums.  Some day it'll probably happen but who knows when.  A tremendous amount of that crazy debt is satisfying endogenous demand.  As long as demand stays high the situation will persist. And when it no longer does that macro tourist du jour will look like a genius.

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so basicly when the music stops it all collapses? This has to end badly someday, and it will end in large inflation numbers right? The debt just has to dissapear at some point, and that can only be through inflation. You  have a 23%+ population of 65 years and older that see their pension wiped out?

 

I think his call is that they are running out of people to sell the bonds to. So Endogenous demand is running out due to graying of the population. He mentioned that in the video. This means old people cashing in their bonds to spend that money in their old age. Population has been shrinking since 2007.

 

Basicly as soon as they sold the last possible bond at this rate, they got problems. Then you see a rate hike, and then it can go fast with a lot of panic. I can not see this go another for another 5-6 years?

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all those things have been said multiple times since at least the mid-90s.

 

Nothing has changed we're just closer to the end but no one knows when the end is. Or maybe it won't end? If it does though it won't be smooth.

 

In the context of owning net-nets it's an interesting question though.  It would tell you to own cheap things with lots of book in non-financial assets.

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all those things have been said multiple times since at least the mid-90s.

 

Nothing has changed we're just closer to the end but no one knows when the end is. Or maybe it won't end? If it does though it won't be smooth.

 

In the context of owning net-nets it's an interesting question though.  It would tell you to own cheap things with lots of book in non-financial assets.

Yea agree should not be too important. Just thought i should warn the jap net net investors here.

 

The thing that changed is shrinking population and speeding growth of retirees. So gov expense go up while people who could buy gov debt is shrinking. And odds for tax revenue going up aren't good either. Deleveraging has to end in hyperinflation though.

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I remember when Bass was talking about this a few years ago and it worried me, but then someone else pointed out that it was an extremely small position for him, and that perhaps it was more valuable to him as a hype generator to grow AUM than anything else.  Also, around the same time I remember someone posting a video of Buffett with the japan company handbook on his desk, which made me wonder if he was buying Japanese stocks in his personal portfolio.

 

I don't know anything about economics but the numbers certainly sound scary enough to my uneducated mind.  I have no interest in macro bets.  The question I would like to ask people who are interested in this trade is if they have looked at japanese stocks and if so whether they think those valuations are justified.  I think even the bears would agree japanese equities are still a good bet at some price, so the question is how big of a discount is big enough?  If you can put together a portfolio that is 5x earnings and 1/2 book is it enough to compensate?  Maybe you'd only buy at 10% of book and 1x earnings?

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I think you need to avoid companies that import and sell in japan. The ones that export and sell mostly to outside japan could be good bets. Especially if their costs are in yen..

 

I think it is best to use macro to avoid bad situations, not so much to make bets I guess.

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I remember when Bass was talking about this a few years ago and it worried me, but then someone else pointed out that it was an extremely small position for him, and that perhaps it was more valuable to him as a hype generator to grow AUM than anything else.  Also, around the same time I remember someone posting a video of Buffett with the japan company handbook on his desk, which made me wonder if he was buying Japanese stocks in his personal portfolio.

 

 

That's my understanding as well.

 

I remember him saying that this is part of his tail hedge.

 

An asymmetric bet that pays off hugely when bad things happen.

 

Don't remember how he does it but it would be an option like instrument (maybe CDS on country or so).

 

;)

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I think you need to avoid companies that import and sell in japan. The ones that export and sell mostly to outside japan could be good bets. Especially if their costs are in yen..

 

I think it is best to use macro to avoid bad situations, not so much to make bets I guess.

 

I hedge out the currency in these situations and i think Japan is a good bet because a lot of japanese investors/pension funds are underweight in equities. So when inflation picks up its natural to shift to foreign investments, domestic equities and real estate. Any company with hard assets and producing things the people/world need are a good idea. But i would avoid companies that are only cash proxies, too. Think about how much money Toyota can earn when their costs go down because they pay Japanese wages and sell their cars in harder currencies. (or any other exporting company, perhaps Toyota is even a bad example. A business that produces only in Japan and sells everything abroad would probably be perfect.)

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yeah problem is, how do you find them. Those AR's barely contain any info and are in japanese. If they sell in japan, half their market cap is in cash, and PE is 6x, it might look cheap. Untill costs go up, and that cash stash is suddenly only worth half.

 

I think ill be on the sidelines, and go in after it collapses. It will be very interesting to watch this play out. I think if any country could get out of this somewhat alive, it is japan.

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In a hyperinflation scenario Japanese equities skyrocket. You just have to make sure you hedge out the currency risk since JPY will hugely decline. But you have to do this anyways because we know that the Japanese plan on monetary easing which will negatively effect their currency. So even if there is no hyperinflation it makes sense to currency hedge Japan.

 

I am not sure about the Japanese thesis. I understand the argument but there are a few things I would point out:

 

1. You can increase taxes which Japan is doing with the increase in consumption taxes.

 

2. Inflation will not wipe out the government budget. I don't understand where this idea comes from. Inflation will increase interest rates only on new debt. The existing debt will actually be easier to service because nominal revenues will increase due to inflation. The effect of inflation depends critically on the duration of Japanse debt. If most of the Japanese debt has long duration than inflation will be a reduce debt burden. On the other hand of it has short duration then that is a different story. Critical to knowing the effect of inflation is the duration of Japanese government debt.

 

3. Half of Japans debt is intragovernmental. Its debt that one agency owes another agency.

 

4. Japan has assets it can sell including Japan Post, Toll roads etc. These assets have value and can be used to reduce debt.

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@rukawa:

 

I don't think they will skyrocket in actual value. If they sell stuff in Japan, that means they will now sell less stuff. So actual $ or EUR value will go down.

 

1. they did already, and it is not working. GDP goes down when they do that. Plus they would have to double taxes to actually fill that hole

2. that is a problem if they need to borrow 50 trillion a year. That would increase debt servicing costs by about 2-4 trillion a year? And when they need to roll over debt, it becomes a huge problem because a lot of debt has a maturity of a few years

 

Your last 2 points are good. I wonder what value those assets have? 780 trillion in debt is 7 trillion US$. Im not sure if those assets are that valuable? They are maybe worth in the tens, maybe hundreds of billions?

 

I think part of their problem is that more then half of taxes need to be paid out in social security. And then the rest to debt servicing.

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I guess it had been a year or so since someone flogged this horse, so maybe it was time to drag it out again?

 

People have been saying this since the 1990s, it hasn't happened yet.  Bass made the same prediction a few years ago when I started to invest in Japan.

 

Here's my question, what model predicted what's happening?  If you go back in history and look at the predictions things about Japan have been wrong, so why will it change suddenly?

 

There are tailwinds, about 4% of Japan is invested in equities.  Even a slight change in attitude could provide a huge boost to the market.

 

Think of second order effects, so if Japan suddenly needs to raise money they might dump their $1T in US Treasuries, what happens to the Treasury market when that happens?  Could it be that the US might be hurt more?  If there's a sudden run to the exit in Treasuries do you think China would sit on the sidelines as well?

 

Japan is a modern country, yes something will eventually go bump, but if it goes bump there then I'd expect the US to go bump eventually as well.  We're on the same path as them.  The Japanese are fairly resilient.  It wasn't even 70 years ago that the country was mostly wiped out and they've not only recovered, but become a world power.  Something to ponder.

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Because unlike the 90's the population is now srhinking in the past years. And this is basicly a ponzi scheme. Find more people to sell debt to so it can keep going. And the last guy who is still standing loses.

 

In the 90's there were more people every year who would pay taxes and who they could sell debt to. But now it is the opposite, the tax paying population is shrinking and the number of people cashing in those bonds is rising. And they cannot sell these bonds for such a low rate outside of japan.

 

I do agree with you that long term Japan will be fine. But short term it could become very rocky. And i you invest based on  a 10 year horizon, the odds do not look good at all. At some point they run out of people to sell bonds to at such low rate, and old bonds need to be refinanced, and it will either end in default or in hyperinflation. I mean if they let a girl band sell those bonds to their fans, that kind of signals how desperate they are getting. Maybe it will go well for another few years. I doubt it can go on for another 10. If you think that, it would mean they will have to borrow trillions of dollars more, where will they get that money from ? Not within Japan.

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People have been saying this since the 1990s, it hasn't happened yet.  Bass made the same prediction a few years ago when I started to invest in Japan.

 

Here's my question, what model predicted what's happening?  If you go back in history and look at the predictions things about Japan have been wrong, so why will it change suddenly?

 

But this is exactly the type of logic that people made about housing or about stocks during the tech bubble. The point about all these bubbles is that you can't predict when something happens only that it will happen and so past experience is a poor forward-looking guide. Also the catalyst for these events is often extremely unpredictable.

 

I don't think they will skyrocket in actual value. If they sell stuff in Japan, that means they will now sell less stuff. So actual $ or EUR value will go down.

 

If there is substantial inflation, Japanese pensions and institutional investors will have to switch out of bonds and if they do where exactly do they invest? There is a high probability it is equities. Plus institutional investors in Japan have already indicated they want to make this switch. I work for an institutional investor and I can tell you that there home bias is extremely strong. The same will be true for other Japanese companies and individuals. I would predict that equity markets would become hugely overvalued.

 

Bass named one case where equities did not skyrocket and that is Mexico. But the Mexican situation is different than Japan. Mexico had a peg and they removed the peg allowing the currency to devalue. Japan has no peg. Also Mexico has substantial hot money flows from foreign investors. Japan doesn't.

 

In Argentina, inflation has led to equities going up in value. In Germany during their hyperinflation the same thing happened. The reason is simple, companies can increase their prices and so become the safe place for domestic investors to put their money. Equities become the "safe" assets for domestic investors.

 

There a few things I take away from all this:

 

1) hedge your currency risk if you are investing in Japan

2) Don't invest in banks or insurance or any large bond holders

3) Stick to companies which will do well when there is inflation

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People have been saying this since the 1990s, it hasn't happened yet.  Bass made the same prediction a few years ago when I started to invest in Japan.

 

Here's my question, what model predicted what's happening?  If you go back in history and look at the predictions things about Japan have been wrong, so why will it change suddenly?

 

But this is exactly the type of logic that people made about housing or about stocks during the tech bubble. The point about all these bubbles is that you can't predict when something happens only that it will happen and so past experience is a poor forward-looking guide. Also the catalyst for these events is often extremely unpredictable.

 

I don't think they will skyrocket in actual value. If they sell stuff in Japan, that means they will now sell less stuff. So actual $ or EUR value will go down.

 

If there is substantial inflation, Japanese pensions and institutional investors will have to switch out of bonds and if they do where exactly do they invest? There is a high probability it is equities. Plus institutional investors in Japan have already indicated they want to make this switch. I work for an institutional investor and I can tell you that there home bias is extremely strong. The same will be true for other Japanese companies and individuals. I would predict that equity markets would become hugely overvalued.

 

Bass named one case where equities did not skyrocket and that is Mexico. But the Mexican situation is different than Japan. Mexico had a peg and they removed the peg allowing the currency to devalue. Japan has no peg. Also Mexico has substantial hot money flows from foreign investors. Japan doesn't.

 

 

 

Well said, the Yen is almost like a reserve currency, so Japan does not need to attract foreign capital. The current account is positive for 2014 despite the nuclear reactors being shutdown. And now with oil prices plumetting they'll use up even less foreign capital!

 

 

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For those of you who are buying japanese stocks, how are you hedging if you are doing so?

 

I buy with a margin account at IB, so i am short the same amount of Yen that the stocks are worth at the time of the purchase. I am still thinking about the idea of readjusting that amount from time to time.

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