Kyle Bass: This Ends in War

Kyle Bass is no stranger to provocative statements. Last year, in a

, Bass expounded on his short yen thesis, a trading idea he had held for some time, but one that has not, at least until now, appeared to have gone his way. With the yen continuing to plummet following the Christmas holiday, Kyle Bass' argument appears to be gaining some credibility once more. And yet, the weakening of the yen is only the first part in Bass' full prediction of what's about to unfold in the land of the rising sun. If the rest of Bass' line of reasoning proves true, the world is about to witness yet another financial crisis. Only this time, it won't center around a relatively tiny economy like Greece or a some southern European state, but rather the world's third largest economy. Many modern observers of monetary policy and government finance believe that a country with a printing press can avoid bankruptcy. In theory, if a country cannot pay its bills through tax revenue, it can simply print the currency to pay them. However, Bass believes that one begets the other. That, when a country turns to the printing press to avoid default, it only accelerates the defaulting process as investors demand higher rates of interest to purchase the bonds of the country. Earlier this month, the Japanese electorate voted Shinzo Abe back into power as prime minister. Abe laid out an aggressive view on the role of the Bank of Japan, urging the central bank to adopt an explicit, two percent inflation target. Thus far, the Bank has not yet acted on Abe's goal, although the market has traded as if the Bank will, selling the yen against the U.S. dollar. This is the first leg of Bass' predictions. The second is much more grim. If Bass is correct, this explicit inflation goal will drive investors to dump Japanese government bonds on the market. Although the bonds have long paid almost nothing in interest, investors have been able to earn real returns due to the ongoing deflation in the Japanese economy. Should this occur, Japanese interest rates will quickly overwhelm Japan's budget. At this point, the government will be forced to default or enter into full on hyperinflation. If this is the case, why would the Bank of Japan or the Japanese government want to pursue such an inflationary policy? Besides skepticism of Bass' views on how things will actually play out, much of Japan's debt is held by its own people, who may hold the bonds out of a sense of patriotism and therefore be unwilling to dump them. Of course, the most dire market cynics have long believed the U.S. was on a similar path. "You know how this ends, right? This ends through war. And I don't know between who and who, but when you think of war, it's just economic entropy played through to its conclusion...I'm fairly certain that, within the next few years, you will see wars erupt, and not just small ones," Bass remarked. If the Bank of Japan acts on Abe's promise of inflation, investors won't have to wait long to see if Bass' theories prove true.