Thursday, May 13, 2010

Kyle Bass of Hayman Capital: The Pattern is Set - Betting the Bank on a Keynesian Free Lunch

As with many destructive events, it is one thing to forecast them and quite another to put a firm timeline of any sort on their occurrence. Anyone warning of the tech bubble in mid 99 was made a fool off... if one dared bet against it with actual money- they were wiped out. Rinse, wash, repeat with housing not half a decade later. Knowing when something will suddenly 'matter' is a very difficult endeavor. For example, no one was talking Greece 12 months ago - then suddenly it became the center of the universe. On the other hand, people have been forecasting Japan's demise for a decade now and they just keep ticking along. (obviously Greece relied much more on foreign capital than Japan does so it's a bit of apples to oranges comparison).

Prominent hedge fund manager Kyle Bass of Hayman Advisors is one person who has not been shy about posting timetables of 'doom' [Jan 13, 2010: Kyle Bass of Haman Capital - Japan Defaults on Debt or Devalues in 3-4 Years; US in 10-12] It will be interesting to see if his if his timetable is correct and let us not forget about the United Kingdom aka the mini U.S. Bass was apparently quite shocked by the nuclear option engaged by the ECB over the weekend, and posted a myriad of thoughts in an investment letter titled "The Pattern is Set - Betting the Bank on a Keynesian Free Lunch" sent out Tuesday.

Via Absolute Return-Alpha some excerpts:
  • With the avalanche of announcements over the weekend out of Europe and the IMF (and even the US Federal Reserve), I think it is important to communicate our views. The Lisbon Treaty explicitly prohibits direct monetization of fiscal deficits (i.e. printing money out of thin air in order to perpetuate deficit spending) because central bankers are (or I guess at least "were") aware it is the path to severe inflation or even hyperinflation.
  • Just as the Romans did time and time again, the EU has now decided to change from the rule of law to the rule of man when it suits them. With none of the sixteen members of the currency union forecasted to be in compliance with the Maastricht Treaty (the foundation on which the EMU is built) in 2010, today's actions further attempt to eliminate the natural policing role that markets play with respect to egregious economic behavior. It looks like there will be no consequences for fiscal profligacy... no negative implications for continuing to spend far beyond one’s means... there will be nothing but moral hazard for running massive deficits as member countries can now hold hostage the entire EU (as Greece has done).
  • The ECB’s monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to "solve" a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more "bail-outs" and debt financed spending.
  • This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future.
  • Germany weakened itself as it has now abandoned the core bargain of the Euro (which was that they would never be responsible for another country’s debt) by opting to be the largest guarantor of a new loan program that essentially makes European countries joint and severally liable for emergency funds for the worst fiscal offenders in the EU. It has begun a process of ceding its fiscal sovereignty to the over-indulgent countries. I still cannot believe Germany has done this. No wonder Merkel’s government is so unpopular.
  • We believe that there is a “Keynesian End” to the policy du jour that governments can solve all their fiscal and economic problems with more debt and more cross guarantees (aided and abetted by desperate central bankers). We at Hayman believe this theoretical endpoint is reached when debt service exceeds government revenues. Of course, any particular country has certain fixed expenses beyond debt service; therefore, the real endpoint occurs significantly in front of our definition.
  • Outside of Greece and “Club Med” countries, Japan will begin to grace the front pages of newspapers very shortly. Japan has already reached a point where its central government tax revenues are eclipsed by debt service and social security payments alone. Coupled with its debt and demography problems, the world's second largest economy is about to enter a real bond crisis.
  • Even in this somewhat utopian scenario, the Keynesian End arrives in many of the world's countries much sooner than is popularly believed.
  • The competitive devaluation will begin in full force (Mark's comment - it already has!) with Japan needing a weaker Yen to grow exports, the US needing a weaker dollar in order to double our exports (under the current Obama plan), and the EU really needing a weaker euro in order to grow their own exports.
  • This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors.
  • In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a “sea change” in public opinion towards government spending and deficits.
  • We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years.

[Oct 5, 2009: Kyle Bass Hayman Capital October Letter to Investors]

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