Monday, October 19, 2009 3 comments ++[ CLICK TO COMMENT ]++

David Einhorn bets big on a currency crisis

It's hard to tell how good David Einhorn is with his macro calls. I don't give him the same respect as many others, when it comes to his macro views. In any case, it looks like Einhorn is making some bold calls. MarketWatch reports that he is expecting a major currency crisis (interestingly not in USA):

Greenlight Capital is betting on the possibility of a major currency collapse and a surge in interest rates, the hedge-fund firm's manager David Einhorn said Monday, citing ballooning government deficits in some of the world's most developed countries.


On Monday, he said Greenlight has added new trades to this investment theme, buying long-dated options on much higher interest rates in Japan and other developed regions -- effectively giving the firm the chance to make big profits from a jump in rates. The options, bought from major banks, are tied to interest rates four to five years out, Einhorn noted.

"Japan may already be past the point of no return," he said during a presentation at the Value Investing Congress in New York.


"When the market refuses to refinance at cheap rates, problems emerge," he said, adding that this could trigger a "currency death spiral."

Interest rates have been very stable in Japan for years, so the options on higher rates that Greenlight bought were relatively cheap. Einhorn said the "asymmetry" of that trade was interesting: If rates were to jump suddenly in Japan, Greenlight stands to make "multiples" on its positions.

So many people have been burned badly by Japan over the decades. It is very difficult to call—in any direction!

I personally don't share Einhorn's view of Japan. I can see bond yields rising but I don't forsee any currency crisis. Although the government of Japan, as well as the JCB, influence Japanese bond yields, it is largely the free market that is setting the long-term yields. They are very low because the market is willing to accept it. This makes sense given how earnings yields on stocks are very low in Japan, and the economy has continuously experienced mild-deflation/low-inflation.

Regardless of what happens, one thing is for certain: Japan cannot continue increasings its government debt. But I don't think there will be a currency crisis.

Rolf Winkler also covered the story—and also provides this link to his David Einhorn's speech—and he quoted Einhorn's thoughts on gold:

I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked...

I have been mistaken with Einhorn's bet on gold. I thought he was betting on inflation but it appears he is betting on fiscal policies being "poor." I'm not sure what that means but I'm curious to see what happens to gold.

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3 Response to David Einhorn bets big on a currency crisis

October 19, 2009 at 9:17 PM

I think one of the issues with the "market rate" for bonds in Japan that keep interest rates so low is a savings-hungry population. Once the demographic issues of the aging population kick in, those buyers of 1-2% long-term bonds will need to be net sellers of bonds. I don't have the stats in front of me but I believe that a good portion of the Debt issued in Japan is bought up by local investors and not foreign acquirers (a la the U.S.). I think that's the general macro call on Japan: it's ability to service the debt once the natural buyer of its bonds switches from net investor to net seller.

October 20, 2009 at 5:27 AM

It is hard to know, but Einhorn's trades may be attractive on a purely mathematical basis, without actually being very likely predictions of the future.

For instance, if the market is pricing in a 2% chance of a jump in interest rates, but there is actually a 10% chance of a jump in interest rates, then this would be an excellent trade, even though the probabilty of being right is pretty low.

Sivaram Velauthapillai
October 20, 2009 at 12:17 PM

David Einhorn is definitely trying to take advantage of the skewed potential. Low probability but potentially massive return. It's similar to those who bought CDS on mortgage bonds a few years ago.

I think one really needs to be confident with their macro call or else this strategy is nothing more than gambling. Such skewed outcome means that you better know what the guy on the other side of the trade is thinking and why they are taking such a position.

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