He foresaw the mortgage mess; now, he sees an inflation wreck

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Investors who are convinced that serious inflation looms -- but who’ve been putting off buying gold or some other potential hedge -- will want to read the latest client letter from Kyle Bass, the hedge fund manager who made a fortune betting against mortgage-backed securities in 2007.

Count him as convinced about inflation, too, even in the face of the deflationary forces now bearing down on the economy.


Bass, who heads Hayman Advisors in Dallas, writes:

Western democracies, communistic capitalists and Japanese deflationists are concurrently engaging in what may be the largest, global financial experiment in history. Everywhere you turn, governments are running enormous fiscal deficits financed by printing money. The greatest risk of these policies is that the quantitative easing will persist until the value of the currency equals the actual cost of printing the currency (which is just slightly above zero).

Get out the wheelbarrows!

Bass’ March client letter carried a warning about looming inflation, too. But back then, he declared the U.S. to be ‘in relatively better shape than the rest of the world,’ and thought that the dollar would be ‘a safer currency than any other.’

The dollar, however, has been dropping since then, a downtrend that made headlines again on Tuesday.

In the latest letter, Bass seems much more concerned about the U.S.:

There have been 28 episodes of hyperinflation in national economies in the 20th century, with 20 occurring after 1980. Peter Bernholz, professor emeritus of economics . . . at the University of Basel, has spent his career examining the intertwined worlds of politics and economics with special attention given to money. In his most recent book, ‘Monetary Regimes and Inflation: History, Economic and Political Relationships,’ Bernholz analyzes the 12 largest episodes of hyperinflation -- all of which were caused by financing huge public deficits through monetary creation. His conclusion: The tipping point for hyperinflation occurs when the government’s deficit exceeds 40% of its expenditures.

Uh-oh. Office of Management and Budget projections, Bass says, ‘imply that the U.S. will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. One has to ask whether the U.S. reached the critical tipping point? . . . In fact, the recent price action in metals, the dollar and commodities suggests that the market is already anticipating the future.’

But maybe the dollar still has a chance to be the best of a bad bunch: Bass goes on at length in the latest letter about the extreme risks that China and Japan face given their own free-money economic policies.

Where is Bass’ money now? Once short mortgage securities, he now has 50% of his portfolio in them, lured by the plunge in prices. He also has been buying what he believes is bargain-priced corporate debt.

And, given his inflation outlook, Bass says he owns precious metals, though he doesn’t say which ones or in what form.

-- Tom Petruno