By Kyle Bass
[UPDATE: This column is excerpted from an earlier draft of
Bass's October 2 investor letter, the full version of which is
The good news is the recession is officially over. And what a
recession it has been. Real GDP has dropped 4% peak-to-trough,
S&P 500 revenues have decreased 18%, and home prices have
lost 31.3% nationwide. Broad-based unemployment figures
(including numbers for the underemployed) reached 16.8%, which
translates into 17.2 million Americans out of work and another
9.1 million working part-time jobs insufficient to pay the
bills. After losing an average of 579,680 jobs every week since
October 2008, the headline unemployment figure improved in July
from 9.5% to 9.4%.
Never mind that in August the Bureau of Labor Statistics
revised its prior estimates, and a portion of the July
"improvement" was accomplished by adjusting the participation
rate-think increasing the denominator to reduce the
percentage-and unemployment increased its upward trajectory to
9.7% in August.
Bernanke and crew have done a masterful job of pulling out all
the stops-and then some-to save the U.S. and world banking
system from overall failure. Having gone from potential
systemwide failure to valuations well above 10-year averages,
the S&P 500 now trades at twice its book value and 23 times
its earnings per share, and credit spreads relative to
Treasuries are back to pre-Lehman levels.
If only the story could end on such a happy note.
Unfortunately, this is where the really bad news begins.
Western democracies, communist capitalists and Japanese
deflationists are concurrently engaged in what may be the
largest global financial experiment in history. Everywhere you
turn, governments are running enormous fiscal deficits fueled
by printing money. The greatest risk of these policies is that
the easing persists until the currency value equals the
printing costs, which are slightly above zero.
There have been 28 episodes of hyperinflation for national
economies in the 20th century, with 20 of them occurring after
1980. Peter Bernholz, a professor at the University of Basel in
Switzerland, has spent his career examining the intertwined
worlds of politics and economics with special attention to
In his most recent book, "Monetary Regimes and Inflation:
History, Economic and Political Relationships," he analyzes the
12 largest episodes of hyperinflation-all of which were caused
by financing huge public budget deficits through money
creation. Bernholz's conclusion: The tipping point for
hyperinflation occurs when deficits exceed 40% of government
According to recent Office of Management and Budget
projections, U.S. federal expenditures are projected to be
$3.653 trillion in FY 2009 and $3.766 trillion in FY 2010 with
unified deficits of $1.580 trillion and $1.502 trillion,
These projections imply that the U.S. will run deficits equal
to 43.3% and 39.9% of expenditures in 2009 and 2010,
respectively. History suggests that this is dangerous
Beyond the quantitative measurements associated with government
deficits and money creation, there exists a qualitative aspect
that may be far more important. Unfortunately, the qualitative
perceptions of fiscal and monetary policies are impossible to
control once confidence is lost. In fact, recent price activity
in metals, the dollar and commodities suggests that the market
is anticipating the future.
The greatest concern is that, with the exception of Japan, the
major global currencies have experienced money supply growth
between 15% and 55% in fewer than three years.
Imagine a game of Monopoly where the participants are playing
with one bank of money. Then, halfway through the game, the
banker decides that money is too tight and the game is slowing
down or a few players are about to go broke. In Godlike
fashion, the banker adds two more banks and distributes monies
to participants as he or she deems fit.
In this scenario, did the real value of anything change? Does
bartering for property increase or decrease prices? Did each
unit of money become worth more or less? How did the banker
allocate the extra money? Was the process fair? All things
being equal, quantitatively speaking, the players are no better
or worse; however, depending on how you were positioned prior
to the additional banks' injections, and how you play the rest
of the game, you'll either feel fortunate or cheated.
As a player in today's real-life game, how are you
Kyle Bass is the founder of Hayman
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