One Country at the Tipping Point

03/14/2012 12:03 pm EST

Focus: GLOBAL

John Thomas

Author, Diary of a Mad Hedge Fund Trader

The Mad Hedge Fund Trader, John Thomas, thinks that this country is reaching an important crossroads, after which the nation’s currency could drop 50% in value.

I’m talking with John Thomas about Japan. John, what do you think about investment opportunities in Japan these days?

I think they’re terrible. I think we’re on the verge of a collapse of the Japanese economy, the Japanese bond market, and the Japanese yen.

Do you think that there’s going to be any more carry trade at all in the next couple of years?

Not really. What’s happening is we’re approaching a tipping point where the government with the world’s largest debt-to-GDP ratio will no longer be able to adequately borrow from the local population. That will force them to go overseas, and they’ll have to pay much higher interest rates.

And do you think there will be interested investors? What interest rate might investors be interested in?

Well, the real play for the investor here would be to take out a short position in the yen, and make a bet that the Japanese yen is going to fall against the US dollar. It could fall by as much as 50% over the next five years.

The ideal instrument to play that move would be an inverse ETF, the ProShares UltraShort Yen (YCS). That is an ETF that goes up when the value of the yen goes down against the dollar.

Is that one that’s like two times or three times…

That’s a double-leveraged one, yes.

OK, can you just bring us back a little bit to what really happened in Japan? I remember working in a brokerage firm back in the 1990s, and they were just the rage—everybody was buying Japanese stocks.

People thought Japan was going to take over the world, and in fact the Japanese stock market did rise from 3,000 to 39,000 in a ten-year period—that’s when I lived in Japan.

But the country lost its way. It was no good at creative destruction…they took sick companies and kept them on life support for 20 years. The end result was that you had no real economic growth for 20 years.

Now they have a big demographic problem, where the birth rate has collapsed, and they are running out of workers to support a rapidly aging population.

Are there any sectors over there? I mean, I think about the electronics industry, for instance. They have some of the largest companies in the world, are headquartered in Japan.

Well, there are great world-class companies in Japan, and I’m thinking of companies like Nissan (NSANF), Toyota (TM), Honda (HMC). Those stocks will rise because these companies benefit from a falling yen.

But you want to hedge out your yen exposure by simultaneously betting that the yen goes down. Otherwise, you end up making money in one pocket and taking it out of the other.

And losing it. Right. Not a good idea.

If you strip out your yen exposure by buying Japanese companies, you’ll do really well over time, because they’re basically taking over our market.

Sure, sure. But if you were just an average, individual investor who did not have a major portfolio, would you just stay away from Japan, or…

Yeah, just stay away from Japanese equities. Just do the yen play I mentioned, and keep it simple.

So, do you have any kind of forecast? Will Japan rebound, do you think?

It won’t. It won’t.

It sounds pretty dismal.

It won’t. There are no signs they are dealing with the debt problem, corporate managements are still weak, debts are still piling up, and they’re just not making Japanese anymore. A shortage of workers always leads to a great slowdown in economic growth.

Well, and it doesn’t seem that. You hear about problems in Japan, you read about them, but it doesn’t seem like it has much impact on us over here, such as what’s happening with the Greek default crisis.

It doesn’t, really. The only way the Japanese will affect us sometime in the future is if they start to sell off their Treasury bond holdings to finance their own debt problems. They own about $800 billion of our Treasury bonds.

That’s considerable.

So that could impact the bond market here by making interest rates go up. That’s probably a couple of years off…but it is out there on the horizon.

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