Kye Bass Notes from the Vaue Investing Congress

I listened to Kyle Bass give an hour presentation this morning. Below are my notes from his talk. He had some incredible slides I hadn’t seen anywhere else. It was the scariest presentation I have ever heard. He is convinced the collapse of Japan is very very soon - within in the next 2 to 3 years. He sees no hope for Europe or the United States. Thinks it is almost impossible for the United States not to be in a recession by Q1 of next year. United States could still hypothetically fix the long term problems (think he was talking about from a math standpoint) but there is no way politicaly that is a possibility. Other thoughts talking to him after the presentation is that if China’s currency depegs from the dollar that China’s currency appreciates 25% and than plunges. Thinks the dollar needs to devalue 50%. However, thinks there is a high likelihood that the dollar surges at some point when things start to unwind. This will be the last gasp of the United States. I put huge emphasis on market history and talking to him I have honestly never heard anyone spout off economic history and historical facts as quickly as he did. I was in awe. He talked as if he lived during those times.

Starting with the United States.
- He put up the very familiar graph of consumer debt going back to 1900. It showed a small downtick recently but still massively above any long term historical perspective. Household debt has fallen from 104% to 98% of GDP. This drop is almost exclusively foreclosures. Consumers still aren’t choosing to delever.
- The next graph showed how the marginal benefit of debt has plummeted. According to Kyle each dollar of debt only produces $.07 of GDP currently. We can create all the debt we want at this point and it won’t help.
- He than showed a graph of unemployment duration and how headline unemployment massively understates actual unemployment. He made the point that the recent Nobel Prize winner won based on his study showing how increasing unemployment duration and unemployment benefits increases unemployment. Thought it was interesting that is who they decided to give it to considering what is happening today.
- He than showed the labor participation rate graph and how it has collapsed. He referred to the prior graphs on employment and made the point that the United States have been losing jobs for years and will continue to lose jobs overseas. Either you need wage deflation which will not happen or the dollar needs to lose 50% of its value.
- He shifted to the CBO projections for the next 8 years highlighting specifically 2013 and 2014. He titled the slide The Anatomy of a Utopian Economy. He pointed to the assumptions and said they are not possible. Humanly mathematically impossible.
- His next slide was titled what can $1 trillion can buy. He hosted a conference at a ranch the week prior where he posed this question and talked a lot about it with various people. You could implement the entire Pickens plan transferring every car and metropolitan center for natural gas usage. Making the transportation system the envy of the world and much more competitive. You could transfer every coal plant to a nuclear facility lowering the cost of energy to a fraction of what it is and make this country much more competitive. One could pay every unemployed person $67,000. A trillion dollars could buy a lot of things instead of what we are focusing on. By early next year the Fed will be the biggest holder of treasuries in the world surpassing China and Japan. Another trillion simply to extend unemployment benefits is absurd.

Europe
- He showed a lot of graphs in this series not directly related to Europe and most of them were really busy. The first one was that world wide governments need to issue 4.5 trillion.
- He than started talking about Iceland and mentioned some book (couldn’t get the name and t was written decades ago) talking about global crises and cultural epicenters and how Iceland and some country in the South Pacific would never default. Well Iceland at the time of the banking crises had 35% debt to GDP. Icelandic people were shocked at what happened and how the banking assets completely devastated the country. Ireland is in the same situation. In his mind there is no way they don’t default. The banking assets are huge. All of Europe could step in but mathematically it would not be easy even for that to occur.
- He than showed a graph of banking assets (I think it was specifically MFI) to GDP across countries. Said he was visiting a Harvard professor (again – couldn’t get the name) who specialized in sovereign problems. Kyle asked him how these countries could possibly get out of this. Kyle said the professor took off his glasses, leaned back, and said “Oh my God – I had no idea it was this bad.” Kyle’s point was that if someone who focused on it didn’t see this how in the world can someone like Trichet or Bernanke have seen it or doing anything to prepare for it. His point is that no one is looking at what is going on. It never mattered to look at this stuff.
- He also showed government debt compared to government revenue. Said investors should care about this and it shows the same picture.
- He showed balance sheets of several countries. He talked about how Ireland has cut 10% of government expenditures but government revenue has dropped 15%. The deficit may be up 40%. There is no way out.
- He spent along time talking about the IMF and how it works. I was unfamiliar with all of it and need to listen to it again to understand it. Basically the IMF is an optical backstop. It was created by the U.S. based in Washington but run by Europe. The backstops are never meant to be spent. Kyle had a meeting with Barney Frank a few weeks ago. When talking about the IMF Barney leaned over and said (paraphrased) – C’mon Kyle, it’s not real money. It is just a journal entry.” Kyle said after almost coming out of his chair he collected himself and his retort was if it isn’t money than why not make the number 15 trillion.
- The IMF is made up of nations who pay into it. This is supposed to cover drawing rights over time. Hungary was the first to draw on these rights. They drew 800%. Greece would need to draw 3000%. This is money the IMF knows it will never get paid back.
- The next graph was showing sovereign defaults over the last 200 years. Every 50 to 70 years have sovereign restructurings. In the past it was all about war. To the victor went the spoils and to the loser came restructurings. We have no war and yet we have more debt compared to any war period in the last 200 years.

3) Japan Will Default Not If.
- The government has 2.5 quadrillion in debt (think that was the number). Showed a graph and said this is what happens when a government steps in and tries to hide previous mistakes.
- Every 1% move on interest rates increase Japan government interest expense to 10 trillion. Inflation isn’t possible for Japan.
- Showed the Japan’s balance sheet and showed how the interest expense now exceeds government revenue. He said this is when Keynesiasm runs out.
- Some of this can work for a long time but last year more people exited the work force than entering it. It will continue. This is like a ponzi end game when more investors leave the ponzi than come in.
- What the big macro funds have missed over the last 20 yeas was the huge trade surplus. It switched in 2008. It is the game changer and will be the catalyst for what changes Japan’s situation. It is like taking Japan’s biggest asset and switching it to a liability overnight.
- If thesis is right - the largest buyers of government debt become net sellers. Than showed articles pulled from Japanese papers showing how the two biggest buyers have to start selling.
- Thinks the yen is intrinsically worth 250 to 1 compared to the dollar.
- He has a series of bets on Japan that pay 50 to 100x. No one believes what is going on. The tail risk you can buy is extraordinarily cheap. Cost less than one basis point in some instances. No way for retail investors to buy it. Need a couple of hundred million dollars.