Kyle Bass On China's "Contraction" And "The Fed's Worst Nightmare"

Tyler Durden's picture

Via Robert Huebscher, originally posted at Advisor Perspectives,

For the last several years, nobody has been more outspokenly bearish on Japan than Kyle Bass. In a recent talk, Bass reiterated his doubts about Japan’s chances of averting a debt crisis. What’s more, he also said China’s economy will fall below expectations.

Bass changed one aspect of his outlook on Japan. Instead of predicting a collapse of the Japanese bond market, he focused on a severe weakening of the yen – without predicting when that might happen.

His predictions for China were equally distressing. He said that its banks will be saddled with non-performing loans and that its economy is actually contracting.

“I don’t think the markets are discounting what’s really happening in China,” he said.

Bass is the founder of Hayman Capital, a Dallas-based hedge fund. He was featured prominently in Michael Lewis’ recent book, The Big Short, for profiting from investments during the sub-prime crisis, which he accurately predicted.

He spoke on May 19 at in San Diego at the Strategic Investment Conference, which was sponsored by Altegris and John Mauldin.

I’ll look at Bass’ predictions for Asia’s two biggest economies – and how Bass believes investors can profit from their plights.


China’s economy isn’t just slowing down, according to Bass: It’ contracting. While China’s published rates for annual growth are still positive, Bass said the nation’s economic growth was negative from the fourth quarter of 2013 to the first quarter of 2014.

That is a result of excessive government spending on unproductive sectors of the economy. Bass said the People’s Bank of China (PBoC) has been more aggressive in its quantitative easing (QE) that the Federal Reserve has, but much of that money has gone into unproductive credit expansion.

China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.

China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.
“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.” He said it is impossible to believe China could “manipulate” the inputs of its financial system without losing control of the outcomes.

Deflation is also threatening China. Bass said that its GDP deflator is now below zero. He expects the PBoC to engineer a devaluation of the renminbi as a way to stimulate exports and avert further deflation.

Bass said that if non-performing loans go from 1% to historical norms “somewhere in the teens” with loss severities of 100% for the worst loans, then China would delete its $4 trillion of foreign exchange reserves. Bass implied that China would need those reserves to stabilize its banking system, though he did not say so.

China’s leaders are fully aware of the dangers its economy faces, Bass said, and they hope to slow growth in a measured fashion, including through the restructuring of its banking system. “The jury’s out whether or not they can do it,” he said. “We actually believe they might be able to do that and that GDP [growth] is just going to slow down a lot more than people expect.”

“I’m not saying it is a calamity, a disaster or it’s going to end badly for the world,” Bass said. “All I’m saying is China is slowing down a lot faster than people think, and you need to think about how to position your portfolio for this.”

Bass advised against shorting Chinese equity as a way to capitalize on his forecast. Instead, he said, investors should look at China’s trading partners – Australia, New Zealand and Brazil. Those countries will be forced to loosen their monetary policy, raising rates and creating carry-trade opportunities.


For several years, Bass has maintained that Japan faces an imminent crisis in its bond markets – an uncontrollable upward spike in interest rates. He has been wrong. In this talk, however, he focused more on what will happen to the yen.

Bass expects Japan’s reform program to fail. That program is based on “three arrows”: aggressive fiscal policy, which is causing Japan to run a deficit that is 10% of its GDP; aggressive monetary policy, which is the “Abenomic” pursuit of QE that has doubled the monetary base in pursuit of 2% inflation; and structural reform, which Bass said hasn’t happened and isn’t likely.

None of those arrows, either individually or in combination, will be sufficient to normalize the Japanese economy, according to Bass.

Japan recently instituted a consumption tax, which Bass expects to push inflation up to 3%. But that will cause real yields to be negative, since Japan’s 10-year bond now yields approximately 60 basis points. Bass said that would lead to selling of Japanese government bonds.

The Bank of Japan (BoJ) might step in to buy those bonds, he said, effectively monetizing the debt through QE. Japan’s QE is enormous relative to that of the U.S. Bass said Japan’s is 140% of tax receipts, 170% of its fiscal deficit and 14% of GDP, versus 13% of tax receipts, 62% of fiscal deficit and 2% of GDP in the U.S.

But that QE, he contends, will cause the yen to depreciate.

“It’s my supposition that at some point in time, once the currency depreciates enough and capital flows leave Japan’s current account that you can’t hold the bond,” he said. “When this happens I don’t know. But I can tell you this: The yen is going to do nothing but weaken from here.”

Bass said the BoJ is already the primary source of liquidity for Japan’s bond market. When it recently stepped away from the market, not a single bond traded for a day and a half, according to Bass.

One way out of this predicament would be to allow interest rates to rise. But Japan can’t afford that. It already spends 25% of its tax revenue on interest expenses. A hundred-basis-point increase would cause the country to spend all of its revenue on interest.

Japan has been able to pursue QE because it ran a current account surplus for the last 31 years. Bass said that string has ended, and Japan’s balance of trade is continuing to worsen. This creates a paradox for Japan, he said. Either it must buy foreign bonds in order to weaken its currency, or it must invest in capital goods (machinery and equipment) to foster the “animal spirits” that would stimulate growth.

Either way, Bass said the money would have to come from the banks, as they sell their government bonds. That will force the yen to weaken.

Implications for the U.S.

With the Fed tapering and both China and Japan’s currencies likely to weaken, the net impact on the U.S. will be deflationary, Bass said. That trend will be accelerated by the improvement in the balance of trade for the U.S., which had its current account deficit shrink due to increased hydrocarbon production.

The crucial moment will come when the U.S. reports a sub-6% unemployment rate, meeting the target it has set for normalizing its monetary policy by ending QE and raising rates. He predicted that will come in July.

That will be the Fed’s “worst nightmare,” he said.

Raising rates would stifle growth and recreate unemployment problems, which would be disastrous politically, according to Bass.

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HUGE_Gamma's picture

like MH370.. it just doesn't add up

TeamDepends's picture

In both cases, simply ask Rolls-Royce what's going on.

DoChenRollingBearing's picture

I respect Kyle, and he may be proven right in the end, which may not be too far away.  But, gold and the Asian markets are not sweating anything (gold stable, Asian stocks are up).

Jim Rickards smells deflation coming too...

Dr. Richard Head's picture

His premise on his conclusion leaves me scratching my head. QE tapering would appear to be a misnomer, unless you of course believe Belgium is that hungry and has the wallet for that much US debt.

Vampyroteuthis infernalis's picture

Dear CBs, printing your way to prosperity does not work!

markmotive's picture

Kyle may get his wish after all.

Marc Faber: China's Colossal Credit Bubble Is Deflating

SafelyGraze's picture

kyle bass is always better when he youtubes than when he's in print

and hearing him say 'optical backstop' in person is to die for

the university of texas endowment 

Pinto Currency's picture


Prolonged low interest rates cripple an economy - research 'capital based macroeconomics' and 'time preference'.

There is no recovery from low interest rate policy as it mal-structures the economy such that it cannot function properly and eventually collapses.

There needs to be an orderly write-down of debt and shuttering of the too big to fail banks which will blow up when the write-down occurs.

Then the central bank debt-based money needs to be replaced.

SafelyGraze's picture

+1 for "mal-structures"

orderly write-downage and shutterfaction .. which will upblow ..

too big to fail seems due for an upgrade .. maybe "having already failed but still being inflated even bigger"

prains's picture

kyle's forehead is getting bigger or his hair is getting smaller, this can only mean one thing.......he's in finance of some description

Bay of Pigs's picture

"With the Fed tapering"

Fuck off...

Spitzer's picture

I've almost lost all my respect for Kyle Bass. He is a USA Inc bull. Even though its the US's creditors that he is so bearish on.

So Kyle, how does that work ? China and Japan are going to burn to the ground before they sell some US debt ? Yeah right

Yen Cross's picture

 You're a little housebroken Europeon. You just got what's left of your manhood handed to you this weekend.

 What are you going to do 'tough guy' ? You've got a 30% margin of dissent?  I hope you're Scottish.

Spitzer's picture

I am not a Eurpean you fool

Yen Cross's picture

 I thought you were Eurpeon?  My Mistake.

I MISS KUDLOW's picture

u guys r mising the end game scenerio

Ghordius's picture

Yen Cross, just one little thing: our electoral system allows dissent. all those dissenters get seats in the EU parliament, for example

we even have national parliaments where fistcuffs happen, often between dissenters from various sides. manly enough for you?

Yen Cross's picture

 Just let me play with him Ghordo.  I'm having some fun with the Eur/peon. :-)

GardenWeasel's picture

Uh, actually, it looks like your just being an ass.

DerdyBulls's picture

Does voting matter in Europe? Congratulations.

Ahmeexnal's picture

Yep. Kyle should worry more about the "contraction" of his hairline than that of China's economy.

Panafrican Funktron Robot's picture

"printing your way to prosperity does not work!"

Printing your way to nominal prosperity does work.  

Buck Johnson's picture

Yea and not the Fed giving Belgium money to buy our debt.  We are done.

Tabarnaque's picture
Interesting. Bass is indeed a smart guy. Although, humbly disagree with a few points:   First: I don't think that the US can raise interest rates in any meaningful way without collapsing the OTC derivative market, the US government budget (debt service) and collapsing the US economy (which lately looks like turning back into recession mode).   Second: There are founded suspicions that the Fed is in fact not tapering but expanding its QE through proxies such as Belgium.   Finally, we have to keep in mind that in the global picture both force of inflation and deflation are present everywhere all the time. We have clear evidence of inflation in; food, health, energy, tuition fees, rent, house prices etc, etc... If there is deflation it is in non performing loans write offs, businesses closing down, etc. So I bring again my point of a stagflation; general inflation with slowing down economy.    No matter what Blass says, I haven't come across any deflation where I live. Prices of everything are going up like crazy.
tarsubil's picture

In our magic money world, cheap credit will lead to a steady increase in prices. The subsequent credit implosion will lead to a sudden drop in prices. Schiff is right to say prices do not inflate or deflate. Credit inflates and deflates.

mkkby's picture

We had a credit implosion in 2008.  Did you see prices decrease?  No, you didn't.

Why?  Because businesses have gotten very good at matching supply with falling demand.  Hell, they've had the last 40 years to practice.  And those that couldn't react fast enough are gone. 

Sure, houses came down -- but not rent.  And the banks/fed have pulled out all the stops to ponzi that back up.

You'll lose a lot of money following Shiff.  He only half understands what's going on.  Fatal.

Panafrican Funktron Robot's picture

Yep, the idea that the Fed can meaningfully pull back from continuing to increase the money supply is just silly, unless the purpose is to intentionally re-crash everything in order to mop up more tangible assets.  

mkkby's picture

I have a lot of respect for "Nickels" Bass... but if he thinks the US fed will raise rates this July he is smoking some STRONG weed. 

Everyone knows higher rates kills off the fake recovery and probably forces every bank to need another bailout.  Therefore, they will print until forced to stop.  Forced to stop means some kind of monetary crisis.  That won't happen as long as every other large central bank is competing to devalue their currency at the same time.

Protect yourself with hard assets.  And stocks if you can stomach the risk.  They'll keep a bid under stocks as long as they can to keep the sheeple hoodwinked and quiet.

hungrydweller's picture

Sure, but why do these retards keep equating money printing with growth?

DoChenRollingBearing's picture

How dare you!  I am not an economist nor a bankster!

hungrydweller's picture

No disrespect DoChen!  I like your comments and know where you are coming from.  We are on the same page.  My comment is pointed toward Bass being right or wrong.  In my opinion he is already wrong and his article is meaningless once equates QE with the ablility to create growth.

DoChenRollingBearing's picture

I gotcha, I just like yankin' chains sometimes...  smile,,,

+ 1.618

TheRideNeverEnds's picture

makes sense, you know what they say about gold right?


ya can't eat and ya cant fuck it so what good is it?



BigJim's picture

Erm... cuz you can eat and fuck what it buys?

knukles's picture

Uh... The Fed said several weeks ago that the 6.5% U threshold is no longer active... with something about "em" or "un"employment, labor market conditions,and other nefarious garf becoming the indica of the modus operandi.
This is exactly the confusion I wrote about here on ZH, mere days after the Fed originally cited a hard economic statistic as a trigger for future policy.
And indeed, the waters have become murkier as opposed to more transparent, Fed and governmental credibility has deteriorated as opposed to improved.

And they ain't gonna tighten anywhere near yet.  The Economy is still suck-o to justify and major withdrawal of monetary stimulation

Moreover, I'd send you over to Paul Graig Robert's website wherein he does a magnificent job of reconciling the Belgian depository/custodial purchases of treasuries versus an "undefined" like increase on the Fed's balance sheet again,l as I'd suggested weeks ago.

No, there is no recovery, there is no withdrawal of money from the Liquidity Trap and rates, people, are going to continue to fall.

ZerOhead's picture

I expect they will soon spread the buy orders out amongst the "indirects" in the future to preserve the illusion of the taper actually working. People might start asking questions when Belgium owns over $1T of T's.

I think foreign CB liquidity swaps is the way the Fed will arrange it as it has in the past..

disabledvet's picture

I have no idea what knukles and you just said but because there are girls around i'm going to pretend like i know, nod approvingly and agree with everything. (shhhh, don't tell anybody.)

knukles's picture

Insightful, Zerohead....

BigJim's picture

I think the Western CB's will all start buying up each others' sovereign's debt, thereby in essence widening 'reserve currency status' from the US to include all its partner countries' currencies. We'll see every-day price inflation picking up (what is it now, 10% for the average person's cost of living?) but the MSM will keep telling the voters i) look, all our currencies are in the same trading range, and ii) official CPI is only 2%, so any talk about high inflation is conspiracy nonsense... and because all the Establishment pundits agree, the average schmoe will just tell himself he's imagining things and his belt is magically getting longer.

This will work so long as our OPEC satrapies keep demanding USD; so we can see more Western warmongering to remind the OPEC dictators who it is keeping their heads attached to their shoulders and their harems stocked. Eventually, it will all collapse but fuck knows when. Maybe they'll have destabilised China's periphery sufficiently that the Chinese will be embroiled there and the USD will stagger on.

China and Russia need to get a move on destabilising the West if they're not going to suffer the same fate at our hands. They need their own Al-Qaeda.

buyingsterling's picture

I think you're probably right, and also, the US will scrape along because there are other dominoes to be pushed over first. But lately I'm wondering if the last few years have been mostly about recapitalizing the banks, and takng the US the way of Greece, except harder and faster because we're too big to bail out. Fire sale on all US assets and then the reset. I don't know how to reconcile this with Belgium. But I think there's room for them to really push austerity while still leaving us as the last domino, so I wouldn't be surprised to see genuine tightening in the not too distant future (not due to any recovery, of course). 

JRobby's picture

What choice do they have? Keep the balls in the air at all cost is the mission. Until it isn't the mission anymore and they will all be in hiding then. Counting on them doing what they have been doing as the bubbles pop up here and there in the air mattress is what will occur.

Honey Badger's picture

The fed has said that their forecast of various metrics is what they are looking at...their forecast. Shitshow.

Frilton Miedman's picture

To add to Knukles point about the 6.5% U/E threshold, Yellen also more recently hinted that wage growth might be a new addition to Fed criteria.

This might 'splain Bernanke's recent "concert tour", stating to expect low rates for all eternity.

From a Fed policy angle, it would be insane to raise rates when median wages are $3K lower than 2007, participation rate is dismal and household debt to income ratio is still above 105%.

Kyle Bass was spot on seeing the oncoming CDO crisis, but I think that may have been his crowning moment.



Abitdodgie's picture

Kyle Bass the money behind G4S.

French Frog's picture

Come on....

The Fed will do exactly like the BoE did a few months back when the unemployment rate got within a whisker of its 'target': they decided that after much thought, the unemployment rate was 'too narrow' as an indicator and that the people would be best served with a combination of data including the CPI, the unemployment rate and others...therefore giving themselves as much room for manoeuvre as possible.

We all know that rising/raising rates will decimate the current house of cards but the general public had no objection to this change of stance by the BoE. Ignorance is bliss as they say...

QQQBall's picture

Think back - that was part of the spin for Yellen - that she did not hold UE rate as the holy grail. They will just shift the gaol line

NoDebt's picture

Being a stickler for details, I don't recall the "target UE" being 6% for the Fed.  I do believe the number was 6.5%.  In fact, I'm quite certain that was the number.  And we're basically there.  

I hate it when ANYONE changes the number and then pretends that was always the original number.  Even Kyle.

I do agree with the conclusion, though.  The US is going to face DEFLATION, at least of imported plastic consumer goods.  Food and energy- the REAL costs to the economy, will continue to rise.


DanDaley's picture

Like Rickards said of Fed-speak: a threshold is not a trigger. They can lie 'til the cows come home and then lie some more. People have short attention spans these days.

MATA HAIRY's picture

yes, bass is wrong on two counts--it was 6.5, not 6.0%, and also the Fed has already ditched the numerical unemployment threshold they gave of 6.5%....he is not really someone I would listen to, although he may be right for all I know...