KYLE BASS, FOUNDER, HAYMAN CAPITAL: If you basically consider this a big chess game, Japan moved into Checkmate a long time ago. You won't see this coming. It will literally happen overnight.
JAMES OATEN, REPORTER: Itís a grim warning of pending economic crisis from one of the few investors who predicted the Global Financial Crisis.
Kyle Bass made a fortune betting against the American sub prime market by calculating that the huge amounts of debt racked up by mortgage providers would be impossible to payback. Now he says the same principles are at work and Japan is the target.
KYLE BASS: Japan's reached a new milestone. They've reached a quadrillion yen of debt, thatís a one with 15 zeros after it. They're spending 50 per cent, they're spending half of central government tax revenues on debt service. They're spending 25 per cent of central government tax revenue on interest alone, and their interest costs are almost free.
They are in a Checkmate position. It is the most obvious thing I've ever seen in my entire life.
(Footage of Japanese stock market during the 1980s)
JAMES OATEN: By the 1980s, Japan's decades of post war economic growth had made it the world's second biggest economy. But the good times came to an abrupt halt in the 1990s when the Central Bank increased interest rates to cool an overstimulated property market.
The move burst the real estate bubble. With the Japanese economy stumbling, some firms hid their losses, while banks propped up unprofitable companies that were deemed too big to fail.
It was a bandaid solution, and by 1997 some of the country's biggest firms were collapsing.
Japan has never recovered from the so called Ďlost decade.í Stagnation, budget deficits and deflation continuing and corporations paralysed by fear of a repeat of the 1990s.
RICHARD KOO, CHIEF ECONOMIST NOMURA: This is basically a trauma. Fifteen years of debt repayment, companies are saying Ďnever again. I never want to borrow money againí. That's completely natural.
JAMES OATEN: With private investment low it has been left to the government to stimulate growth. It's done that by going into debt, financed by selling bonds.
Prime minister Yoshihiko Noda is now warning that Japan could follow in the footsteps of Greece or Spain if its massive debt isn't tackled. His first major financial reform is to double the nation's consumption tax from 5 per cent to 10 per cent in three years.
Itís a move the International Monetary Fund supports.
DAVID LIPTON, INTERNATIONAL MONETARY FUND: Japan must tackle its deep rooted fiscal problems. Passage of the current tax and social security reforms is thus crucial to demonstrate commitment to fiscal reform and, thus, to sustain investor confidence.
JAMES OATEN: But not everyone is convinced that the IMF prescription is the right medicine for Japan.
RICHARD KOO: Every time we tried to cut budget deficit, the actual result was far worse than when we started out with. For example, in 1997 OECD (Organisation of Economic Co-operation and Development) and IMF told Japan to cut deficit, you're building roads and bridges to nowhere, population declining, why don't you cut your deficit? Well prime minister Hashimoto listened to those guys, cut the deficit and guess what happened? The economy collapsed, five quarters of negative growth, budget deficit increased by 68 per cent. And it took Japan 10 years to climb out of that one.
JAMES OATEN: Peter Tasker is one of Japan's most highly regarded financial analysts. Rather than tax hikes, he wants investment guarantees and stimulus to encourage corporations to spend and borrow again.
PETER TASKER, ARCUS RESEARCH: So Japan unfortunately has taken completely, in my view, completely the wrong message; thinking that itís got too much debt, therefore, it must tighten its fiscal stance, raise taxes to try to close the public deficit. But I think that's actually a very mistaken approach and what will happen is you'll get less consumption, less growth, and probably less tax revenues and, therefore, a higher deficit at the end of it.
JAMES OATEN: 20 years of slow growth means Japan is running out of options to prop up the economy. The number of people in casual work doubling in the past 20 years, more and more people are falling below the bottom income tax bracket, meaning less revenue for the government. Japan also has more people exiting the workforce than entering, with the number of people over the age of 65 substantially higher than the OECD average. And a drop in demand for Japanese goods, plus a need for non-nuclear energy means the country may soon be importing more than it's exporting.
Takatoshi Ito says the economy may eventually snap but not for another 10 years, due to large corporate savings.
PROFESSOR TAKATOHSI ITO, UNIVERSITY OF TOKYO: The current course of fiscal situation is unsustainable. Something has to be done before the collapse happens. We have time and we have to hurry, but we have time.
JAMES OATEN: But Kyle Bass says the crisis will hit within three years.
KYLE BASS: You look at Japan, 92 per cent of the debt is held internally. Ninety-five of the 92 per cent is held institutionally. Itís held by literally a few handfuls of chief investment officers in Japan. So they all know that a bond crisis is coming.
JAMES OATEN: He says this means demand for government bonds will start to drop, forcing the government to issue new bonds with higher interest rates. And that could back Japan into a corner where more than half the government's tax revenue will be spent on servicing debt.
KYLE BASS: The two largest owners of Japanese debt are the largest pension fund in the world,, which is the GPIF (Government Pension Investment Fund, Japan), and the largest banking institution in the world which is Japan Post Bank. both of their CIOs have made public statements in the past 12 months that say not only can they buy more JGBís (Japanese Government Bonds)this year they actually have to sell some because they have more benefits they owe than they have benefits coming in or people contributing.
JAMES OATEN: Some have accused Kyle Bass of talking down economies to create a self fulfilling prophecy. Itís a charge he denies.
KYLE BASS: I get paid to be a realist. I don't get paid to be an optimist. I don't get paid to be a pessimist. This is really an atonement for the sins of all the deficits that we've run and spent.