Betting Against Japan: The Straddle Of The Century
Japan has accumulated an enormous and growing debt load. The Japanese Central Bank’s bond buying may prevent a crisis. The yen is likely to continue weakening. Investors can profit from the JCB’s moves. Japan emerged from the ashes of World War II to becoming one of the largest economic powers in the world by the 1980s. By creating high quality products and making highly publicized corporate purchases, Japan was both respected and feared by competing economic powers. Japan’s economic advancement came to an abrupt end when the Japanese market crashed in the late 1980s and never truly recovered. The once mighty power is now heavily indebted and dealing with a declining population and a declining economy. A crisis is possible, but like with crises of the past, a major Japanese economic event can become a great opportunity, particularly with the right investments. The debt load of the Japanese government stands at just under 1.2 quadrillion yen ($10.1 trillion), greatly exceeding their 484 trillion yen ($4.07 trillion) economy and the 96 trillion yen budget ($812 billion), with projected revenue at only 54.5 trillion yen. This is a precarious financial position, and at a 4.5% interest rate, the projected revenues would only cover debt service. But because the Japanese Central Bank (JCB) is such a large buyer of Japanese government bonds, the interest rate for a 10-year bond stands at under 0.5% as of the time of this writing. Given that this 1.2 quadrillion yen is a debt level unlikely to be paid off, hyperinflation or default would appear to be the only realistic options for addressing the debt. To counter a possible collapse, the JCB started buying larger amounts of bonds than the Japanese government was creating. It’s likely the JCB plans to buy up a large percentage of the outstanding bonds ( it owns about 16% now ) and simply write off the bonds, and hence, that portion of Japanese government debt. If this were to work without destroying the economy, the Japanese government strengthens its financial position by returning to sustainable debt levels. If it fails and Japanese bonds rise to double or even triple digit interest rates, default becomes a possibility. Another possible scenario involves weakening the yen. This has been seen in earnest since 2012 and born of the JCB’s larger levels of aggressive stimulus. The JCB created more yen and pumped the currency into the economy, sending the Nikkei to highs not seen since the 1990s. The price of this stimulus has been a greatly devalued yen falling from 76 to the dollar in early 2012 to the low 120s in early 2015 . Experts such as Kyle Bass predict the yen will fall beyond 140 to the dollar by year-end and further beyond this year. The potential danger of this approach is that more yen chasing the same amount of goods will devalue the yen to the point that investors lose confidence in the currency. In addition to making Japanese consumers poorer, the devalued currency could also lead to higher interest rates that also make the government debt load untenable. Investors can protect themselves from this horrifying yet plausible scenario with a different take on the straddle bet, one based on different vehicles instead of up or down bets on the same investment. In this case, it would be a position betting against Japanese government bonds (the JGBS ETF is the easiest way to accomplish this) coupled with a second bet against the value of the Japanese yen (versus a precious metal or a currency such as the US Dollar). If the JCB can successfully write off a large amount of government debt, investors can still profit from what’s likely to be substantial yen devaluation. If the worst case bond crash occurs, investors can profit or at least protect themselves from what would be a devastating economic event. The once-mighty Japanese economy now finds itself in a situation where the JCB struggles to maintain economic strength. An economic collapse would be the most devastating occurrence to hit Japan since their loss in World War II, and a catastrophic blow to a world economy where Japan exerts wide influence. However, this situation also presents a great opportunity for the prepared investor. Whether the high debt resolves itself through a dramatic collapse or by the JCB engineering a large-scale debt write off, bets on a weaker yen and higher interest rates will likely bring investors outsized returns and possibly protection in a crisis. Disclosure: The author is long JGBS, GYEN. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.