Washington, DC -- (ReleaseWire) -- 07/30/2015 --DAWN BENNETT: Tres Knippa is a trader, broker and member of the Chicago Mercantile Exchange. He's been trading futures in currency markets for over 17 years and because of this expertise he appears almost weekly on CNBC and Bloomberg, as well as other networks around the world. Tres recently wrote about Japanese debt, saying: "It is my opinion that long term there is a significant likelihood Japan will experience a sovereign debt crisis and a notably weaker currency. As a result, I believe there is opportunity in being net short the Japanese Government Bond market and the yen." Tres, welcome to Financial Myth Busting.
TRES KNIPPA: Thank you very much for having me. I really appreciate it.
BENNETT: Last month Japanese Prime Minister Abe's approval ratings plunged by something like 39 percent. This weekend, thousands of Japanese are in downtown Tokyo, demanding his resignation. Because of this, do you believe there's a rising risk that the Bank of Japan will be pressured to ease policy further in the fall, when the Japanese government struggles to find more funding sources for its budgets?
KNIPPA: So, let's back up a second. We're assuming that the Bank of Japan is making the decisions that they're making as some sort of an offensive maneuver to try to generate growth.. It's actually exactly the opposite of that. They are buying Japanese government bonds, which naturally weakens the yen, because you increase money supply in order to buy more bonds. They're doing it because they have to. They are doing it because there is no market for this garbage. The chance that the Japanese government could ever pay back its debt is zero. Right now, if you look at a financial statement of the government, you've got taxes, you've got some borrowing, and then you've got expenditures on the other side, right?
KNIPPA: Right now, Japan spends twice what it makes in tax revenue. That's like you make $50,000, but you spend $100,000. How can you ever reduce debt if you spend twice what you make? So the Bank of Japan is the last resort. The 10 year bond in Japan yields about 0.39 percent. Does that entice a U.S. investor? Our rates are much higher. Why in the world would I ever buy that low a yielding bond? The notion is nonsense. Some people would suggest, 'Wow, that is an awfully safe investment. Those bonds are priced very high and the yield is low, so risk is clearly not there.' Nothing could be further from the truth. So they're buying them because they have to. And so all this business about, 'Oh, they're going to try to help...' If increasing the money supply grew economy, then right now the world should be absolutely booming, because every central bank in the world is increasing money supply. But it isn't. You increase GDP two ways, and there's only two ways. This is not that hard to figure out. You increase GDP by an increase in population and/or an increase in productivity. Which one does increasing that money supply do? Neither. So Japan needs to print babies, not more yen.
BENNETT: That is the problem, they have an aging demographic there. The Bank of Japan, which is Japan's central bank, they've got to book losses when the bond prices or even the stock prices suffer extraordinarily sharp drops, since they own a lot of equity, too, in the market.
KNIPPA: Isn't that perverse that a central bank prints money and buys equities?
BENNETT: Yes, it is. If they suffer these extraordinarily sharp losses, since its financial health could hurt confidence in the Japanese currency, isn't that the reason why they have no choice but to support both the bond and the stock markets over there, because the central bank itself would be in jeopardy then?
KNIPPA: I don't know about the central bank being in jeopardy. They're going to continue to do what they do. This is what passes for economics now, and what's sad is that these are some bright people. The head of the Bank of Japan is a bright guy. This is Kuroda; he's an MIT guy, just like me. However, his models are wrong, and they're being sold this idea that if they continue down this path, they support the bond market, but really he's doing it because he is trapped. Japan has no ability to pay back this debt, and I believe that as we hear, Janet Yellen is the exact same way. She is literally dropping the knife and expecting the knife to get lodged into the ceiling, rather than the floor. She's a very, very smart person. However, her models are just completely wrong, and we are in uncharted territory now, globally. Now, a lot of your listeners, they may scratch their head and say, 'You've got this guest and he's here talking about Japan. Why does that matter to me?' It matters to the individual investor and your listeners because Japan has a 16 year head start on the United States. They had a real estate bubble that popped, then when the real estate bubble popped, the government bailed out the banks, immediately they dropped interest rates to zero. I mean, it is an exact playbook out of what's happened in the United States. They've got underfunded pensions, etc., etc. They've got all these problems, and they have tried to solve that problem by increasing government spending, which is the massive Keynesian idea that we have to borrow money and increase government spending, and that will make the economy grow. Obviously, we are doing a good bit of that there too. Politicians love to spend in Japan and everywhere else, because it gets them re-elected. So if we start from that point of economics, that, 'Oh, the government has to step in,' well, guess what? For all the debt Japan has, and Japan right now is sitting at about 240 percent debt to GDP, so the chance that the government pays it back is zero. It'll never happen. So the idea that if the government increases spending, it will generate growth, well the Japanese economy is the same size today that it was in 1992. Why are we not learning from that? Why are we not saying, 'Hmm'? All this increasing government spending has got to be paid for one of two ways, and one of those ways is increasing taxes, which obviously we have seen from the Left in the United States. So why is that entire economic thesis not completely being thrown out? Because clearly it does not work. It is absolute nonsense. It never has worked. But government wants to continue to spend, because it buys votes. Once you spend, you can't take it back. Look at the people in Greece.
BENNETT: That's right. I think that Americans need to know that it's become the new normal; politicians' favorite and only means of holding power is quantitative easing. If ratings plunge, print. If they continue plunging, print some more. Let me ask you something. By the time Prime Minister Abe is finally booted out of power, peacefully or otherwise, the yen may well be at 200, which in turn could be the catalyst that finally destroys the already weakening Japanese economy. Do you agree with that?
KNIPPA: No, no. Let's back up. The Bank of Japan has said that they are trying to weaken the yen. By the way, this is also nonsense. I just told you that the yield on a 10 year bond is 0.39. The Bank of Japan said, 'We need to generate inflation at 2%.' I don't know who inflation hired to be their PR firm, but I want to hire them, because whoever's representing inflation is doing a great job. Aren't they? Be careful what you wish for. You want 2 percent inflation, but your bond yield is 0.39? Who's going to hold that? Inflation happens when a government has borrowed some money and they have to print more money, and they're devaluing the value of their currency. They flat out said, 'We want to generate inflation,' so their target is to weaken the yen. There's a natural sort of knee-jerk reaction that says, 'I've got to own equities.' And I would be very, very careful trying to buy Japanese equities, simply because they're weakening the yen, and guess what? My target on the yen is a lot more extreme than yours. The way this is going to go down, and by the way, there's a graph of this on my website, www.shortjapandebt.com, the way this is going to happen, when their currency just completely breaks free and they lose confidence in it, is this. A bond is an IOU, so as you weaken the currency, the bond holder's sitting there saying, 'Wait a second. I lent you yen. You're going to pay me back in yen, but you're going to pay me back my yen in 10 years from now?' As the yen weakens, sharper and sharper, then the bond holders say, 'Yuck, I don't want to hold this thing to duration,' and they start selling those bonds. Whenever they start selling those bonds, what is the natural policy response of the Bank of Japan? 'Oh, no, we've got to print more and buy more of these bonds,' which thus causes more yen weakness. That's a feedback loop and when that trade sets fire to itself, it will start with the currency, the bond holders will get nervous, then that will make the currency accelerate, and I see the yen going to 400, 500, 600, or even 700 to the dollar. At some point, when you lose confidence in that currency, and that day is coming, it'll start with the yen, it'll jump over to the bonds, and then both with accelerate at the same time.
BENNETT: Tres, when is that day coming? Honestly, we've been kicking the can down the road for six years. It's just ridiculous. When do you figure you're going to be cashing out your short?
KNIPPA: When I cash out my short, clearly there will be some big, seminal moment when this happens. You do realize that this is the largest accumulation of peace time debt in the history of the world? So for me to pinpoint it with any degree of accuracy would foolhardy, to say the least. All I know is that the mass is stacking up against them, and guess what? It may not happen literally overnight, and there's a whole variety of ways that you could execute this; there's ETFs that short the yen; there's leveraged ETFs which you could short. I do mine with futures; some people do it other ways. There's a variety of ways to do this, but one clever way that I've done it is that I've bought a rental house in Houston, Texas, and I have the mortgage in yen. So I take rent in dollars, but then pay my mortgage in yen to the bank, and so as the yen weakens, it takes me less dollars to make that monthly payment. So you want to borrow in a currency that you think is going to get pounded on. Guess what? There's a pretty smart guy that's done this. Did you know that all the debt of the Dallas Mavericks is in yen, because Mark Cuban converted the debt of the Mavericks to the yen? There's a big money manager here in Dallas by the name of Kyle Bass, and maybe those guys were sitting in their luxury box one time at a ball game, and he explained to Mark Cuban why the yen is in deep, deep trouble, he should have his borrowing in yen, and Mark Cuban said, 'Oh, I think that's a pretty good idea,' and he did it. Just a hunch. I wasn't there, but I would imagine how that went down and how he got that idea.
BENNETT: ou're long on gold yourself, I understand. I'm going to change tracks here. What will it take before the current bear market breaks on gold?
KNIPPA: Right now, gold is getting caught in a wash of commodity prices. Gold's a commodity, so it's going to go down too. That is coming, obviously, from China. You're seeing a slowdown of their growth and their infrastructure spending and all that jazz, and clearly people were diverting money into stocks, and now they've gotten pounded on, owning those Chinese stocks. You know, isn't that odd, when you see information about what the Chinese government's responsibility is, to support stocks? And everybody always wondered why I've always been skeptical of everything going on in China. There's a very public guy who's written books on the subject, which is Peter Schiff. Peter Schiff and I are on the exact opposite side of this coin. I think that the yuan has a very, very good chance of getting completely pounded on versus the dollar. Why? Because the Chinese want to devalue the yuan to generate export again. So this business of, 'The Chinese, they want the yuan to be a core currency,' and all this kind of stuff, and nothing could be further from the truth. The Chinese want to sell our consumers stuff, and in order to sell us stuff, they would rather the dollar be stronger and the yen be weaker. So them trying to create a bunch of yuan strength is nonsense. Peter Schiff and I could not disagree more. But that's what's coming. They'll try to weaken the yuan, and I think it will probably go into the double digits. I think that they'll weaken the yuan and it goes to 12 or 13 to the dollar, to try to generate exports again.
BENNETT: China just announced a gold stockpile, and it's a bit smaller than some analysts expected, but it's still a lot. What do you think is going on there, and what do you think that China might be trying to do with gold?
KNIPPA: I was a floor trader for 18 years. If they're buying so much of it, how come to darn price is going down?
BENNETT: That's a good question. Is it possible that it's getting rigged down, it's getting suppressed down by the central banks that don't like it when gold is too strong, because it makes our own currency, let's say, the U.S. dollar, look weaker?
KNIPPA: For sure. I mean, I'm not going to speak in hyperbole and talk about central banks manipulating the price down. I know that when you're short a currency, like I have the yen, you have to be short the yen versus something.
BENNETT: Tres, you were saying that you own gold in yen terms, why is that better than buying gold with dollars?
KNIPPA: This has more to do with my yen short, rather than being long gold. So if you go down to the pawn shop and want to buy gold - you want to buy some gold coins, or whatever you buy - you take your dollars that are in your checking account, or in cash or whatever, and you give the pawn shop, or whoever's selling you the gold, you give them dollars and they give you gold. You have shorted the U.S. dollar when you've done that, because you've sold U.S. dollars to buy gold, right?
KNIPPA: Now, in my case, I want to be short the yen, for obvious reasons; they're loaded in debt, the Bank of Japan's going to destroy the yen, it'll just happen, right? So when I'm short the yen, I have to be long something against it, okay? So often times, these are referred to as currency pairs; the yen versus the Swiss franc, the yen versus the euro, the yen versus whatever. I've chosen to make my long leg of that trade gold, rather than being long the dollar, or the euro, or whatever. And the reason I've done that is to try to neutralize having to outguess the other central banks. Now, right now, the dollar has been firm, gold has been weak, I look wrong. In the case of the euro, if I had been short the yen versus the euro, I would look really wrong, because the euro has dropped faster than the yen over the course of the last six, seven months, for obvious reasons. So I've chosen to try to neutralize my position outguessing other central banks, by being short the yen in gold terms. Now, I told you before that I own a piece of real estate in Texas that's rental real estate. I'm short the yen versus the real estate; that is my long leg of that trade. I've gone to obviously a lot of money manager meetings and dinners, things like that, and what gets frustrating when you talk to these strategists and economists and all that stuff is they'll talk in their large thesis and their macro stuff, and oftentimes I want actionable ideas. So for your guests, let's talk about an actionable idea, and that's what I mentioned before; there's ETFs that are out there. You can do it in a very, very moderate way, you can do it with a small position, but find a way to get yourself short the yen as a starter. That is an actionable idea, it's easy to execute, there's plenty of ways to do it. But for your listeners, in my opinion, that's a good trade. Put it on and hold it, and it'll work out for you in 10 years.
BENNETT: All right. Tres, I still want to ask you about China. My understanding is that they dumped a record $143 billion in U.S. treasuries in three months, via Belgium. Why hasn't this extremely important topic received broader attention by the media and by our markets?
KNIPPA: Number one, it didn't move to markets, so then naturally you have to ask, then who bought it all? So is it possible that the Fed is still doing QE? Is it possible that the ECB is over there buying them? So if the Chinese have gone and sold all these bonds and the market didn't move, then you have to wonder, okay, well, where's all that demand coming from? In my opinion, I think it has to do with capital flows, and the other thing that has a major support to it is that if they can manage to keep our rates up, and Janet Yellen has also been talking about raising rates. You don't want to be long bonds in a rising rate environment. So this could literally be something as easy as a change in asset allocation. You know, the Chinese are long massive amounts of dollars because of the trade balance. We buy their stuff, we give them dollars to buy stuff, and they end up long US dollars. We don't buy it in yuan, we buy it in dollars. So all those dollars have to go somewhere. Often times, they have gone into out treasury market. That's a perfect example. You also mentioned before that the Chinese have been buying gold. A lot of that comes from that trade surplus. Where does that cash have to go? But in addition to that, the People's Bank of China, and you want to see a manipulative central bank? The People's Bank of China makes the Fed look like a free market operation. I mean, they have gone to such great lengths to keep the yuan weak. And my guess is that they're about to start doing it again, and they'll lift that tag and then try to weaken it even further, because, the Chinese leaders, the only way that they get thrown out on their rear end is because of hunger. You've got all these Chinese people, and if they don't have jobs and they're hungry and they're poor, that's how those politicians get thrown out. Clearly it's not because of a popularity contest. So if they create hunger and if they create economic downturn and this, that, and the other, that's how their jobs are at risk. So they started it with exports, then they went and they had massive infrastructure build-up, and now I think they'll go back and try to generate exports again, and that will come from a weakening yuan.
BENNETT: You can get more from Tres Knippa at his website, www.shortjapandebt.com. Thank you, Tres.
All data sourced through Bloomberg
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
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