Hayman Capital's Kyle Bass Writes About The Cognitive Dissonance Of It All

Hayman Capital's Kyle Bass writes about "The Cognitive Dissonance of it All" - the fact that an increase in the unsustainable policies and economic structure of the past forty years that led to the recent financial crisis is being offered as the cure to the ills the very same policies caused. Sovereign defaults, debt accumulation, the Keynesian endpoint, Japan's coming X-Day, the future of the euro/EMU, fiat money, gold and other topics are all discussed.

Enjoy.

48881153 Kyle Bass Hayman Investor Letter February 2011[1]

Hayman Advisor's Kyle Bass: The Pattern Is Set

As we've said many times, we hate us some dollar and we hate us some yen even more than the dollar. The euro is an enigma. Other fiat currencies are subject - long-term - to the same issues. That leaves us with gold. Apparently Hayman's Kyle Bass agrees with us. This should come as no surprise to long-time TILB readers as we've highlighted Kyle's work/talks several times.

Below is the text of Hayman's most recent letter to its clients following the European debacle this weekend. TILB's immediate reaction was "holy shit, I don't want to own the euro", in spite of most Wall Street participants claiming this was a great showing of support for the euro. Our view was this "show of support" was more akin to a roadmap for self destruction. The euro's rally than recent retrenchment seems to support our initial take.

We lifted the below text it from First Adaptor's blog (click here for First Adaptor). Make sure to follow First Adaptor on Twitter.

The Pattern is Set - Betting the Bank on a Keynesian Free Lunch by Kyle Bass

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Dear Investors:

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. Meanwhile, I guess that Trichet must have decided on the lesser of two disastrous outcomes for fear that the very existence of their European Union was being called into question. He must have believed this to be the case as it would be the only rational reason to agree to such drastic measures – despite his blanket opposition to such policies just days ago and against the explicit wishes of the Bundesbank, Germany’s central bank.

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.

Attached is a Bank of International Settlements working paper that I highly suggest you read [TILB - link to referenced working paper here]. Please pay particular attention to the chart on the top of page 11 and remember the numbers you are seeing are as a percentage of GDP and NOT government revenue. This paper takes a very conservative view of interest rates (it essentially assumes they stay flat from the low levels of a few months ago – regardless of changes to debt levels or savings rates) and extrapolates current fiscal projections and even assumes pretty robust global growth. 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 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. It is no wonder that Bretton Woods failed so miserably in prohibiting “cheating” via currency weakening. It is also no wonder that the IMF and World Bank were created at that very same meeting in 1944.

We have also attached a chart showing total IMF commitments to member countries as a percentage of each respective country’s IMF quota. The magnitude of the initial EUR 30 billion commitment to Greece trumps all other commitments made throughout this crisis by multiples. This does not even include the EUR 250 billion announced for the broader Eurozone this weekend. By granting Greece more than 30x their quota, they are making a mockery of their own rulebook.

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. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well.

Sincerely,

J. Kyle Bass
Managing Partner

Kyle is clearly cut from the Austrian cloth.

Hayman Capital's Kyle Bass Gives Interview On CNBC

Kyle Bass of Hayman Capital (enjoy a past letter of his here) will be testifying in front of the Congressional Financial Crisis Inquiry Commission (FCIC) today as a market participant playing counterpunch to a bunch of big name bankers that are there to defend the role of banks in the crisis. Hopefully Lloyd talks more about how Goldman is doing "God's work."

Bass talks to David Faber in this video about capital adequacy of banks, Freddie and Fannie, and the looming meltdown of Japan (further proof of The Singularity risk).

Enjoy.

Hayman Capital's Kyle Bass Waxes Philosophical On The Debacle That Is U.S. Macro

Kyle made his name for crushing it hard on the subprime short trade. If you're a fiat currency fan and you don't like dissent, do not read below.

Bass Provides Sleep Demons

Hat Tip: Wild West