A thought is bubbling up. Supposedly, Kyle Bass' hedgefund (and we assume a host of others) are shorting JGB's, egged on by the likes of ZeroHedge. While we don't begrudge (almost) anyone to make a profit, this is one of these cases where success for the hedgefunds could possibly contribute significantly to economic distress in Japan, and by extention the world. If they contribute to a crash in the JGB markets, public finances in Japan become untenable, capital of Japanese banks disappears, pension funds will go bust, and this is the third biggest economy in the world we're talking about.
We've seen in the mid 1990s what havoc an implosion of a rather small economy (Thailand) could cause in terms of ripple effects, we've seen what Greece could do, an implosion of Japan is a disaster of unmitigated proportions, especially coming after such a fragile state of the world financial system and the world economy in general.
We're well aware that there are some who abhor what Abe and the BoJ are trying to do. What we haven't heard from those people (or from anyone else, for that matter) is what alternative they have. Don't hold your breath, that's basically because there isn't one.
Adam Smith set out a great case for free markets, they usually create benefits for all concerned (called the static and dynamic gains from trade). We've already argued that much financial activities create little in terms of gains from trade but are essentially zero-sum activities (my loss is your win, and vice versa), and some can be even considered negative-sum games.
We have a feeling that taking on (probably highly leveraged) bets against JGB's falls distinctly into the latter category. What if he succeeds, what does he accomplish (apart from making a really big profit)? Consider this:
According to the BoJ, a 100 basis-point increase in interest rates would lead to mark-to-market losses equivalent to 20 per cent of tier-one capital for regional banks – and 10 per cent for the major banks. [FT]
if JGB interest rates rise 2% in Japan, then the government must pay almost 80% of its revenues (as currently received) just to cover the interest on its debt.
We'll spare you what happens to their pension funds (simply because we don't have data on that), but it can't be pretty. Financial markets do have useful functions, we're the last to deny that. They allocate capital, they price risk, they provide liquidity and funds where needed, but in this case, we're hard pressed to see any benefit of shorting JGB's.
If Kyle Bass succeeds, he'll significantly contribute to wrecking the third biggest economy in the world. Do we really want him to succeed? The outcome of that is that a few men will get astronomical amounts of money, while Japan will be plunged into misery and it's very plausible that the whole world economy will suffer.
Is that a rational outcome? Is that how capitalism is supposed to work?
Standing in his way is the BoJ, the Bank of Japan, the one big buyer of JGB's at the moment. We better hope it succeeds..