"Fasten Your Seatbelts": Kyle Bass Previews The Collapse Of China's $34 Trillion Banking Sector

Tyler Durden's picture

Earlier this month, Kyle Bass asked a funny question in a discussion with CNBC’s David Faber. To wit: “If some fund manager in Texas is saying that your currency is dramatically overvalued, you shouldn’t care on a $10 trillion economy with $34 trillion in your banks. I have, call it a billion -  it’s so small it should be irrelevant and yet somehow it’s really relevant.”

Bass was referring to China’s penchant for firing off hilariously absurd “Op-Eds” in response to anyone who suggests that the country may indeed be experiencing the dreaded “hard landing” or that a much larger yuan devaluation is a virtual certainty. The People’s Daily literally laughed at George Soros when the aging billionaire said he was short Asian currencies in Davos. “Declaring war on China’s currency? Ha ha,” PD wrote. Chinese media also called Soros a “crocodile,” a “predator,” and said his yuan gambit “cannot possibly succeed.”

That’s what Bass means when he says the Chinese seem to be quite ornery for a country that claims to be unabashedly confident about the prospects for their economy. Bass, like Soros, is betting on a steep devaluation of the yuan. In fact, he thinks a one-way bet on RMB weakness is "the greatest investment opportunity right now." The thesis is simple. Here’s some of our commentary from last week followed by key excerpts from the CNBC interview which should serve as a nice recap of why Bass thinks the yuan is set to fall by 30-40%:

China’s banking system, Bass told CNBC, is a $34 trillion ticking time bomb, and when it explodes, Beijing will need to plug the holes. $3.3 trillion in FX reserves will be woefully inadequate, he contends.

 

“Very few people have looked at what the cause of the problem is,” Bass begins. “They’ve let their banking system grow 1000% in 10 years. It’s now $34.5 trillion.”

 

Bass then goes on to note that special mention loans (which we’ve discussed on any number of occasions) are around 3% of total assets. “If they lose 3%, that’s a trillion dollars,” Bass exclaims. Ultimately, Bass's argument is that when China is forced to rescue the banking system by expanding the PBoC's balance sheet, the yuan will for all intents and purposes collapse. This is of course exacerbated by persistent capital flight.

 

Below, find some other soundbites from the interview. Notably, towards the end, Bass says that if China is right and speculation around a much larger devaluation is indeed unfounded, then it’s curious why China seems to care so much about what “one fund manager in Texas thinks.”

 

From Kyle Bass:

 

“The IMF says they need $2.7 trillion in FX reserves to operate the economy. They’ll hit that number in the next five months. Those who think they can burn it to zero and they have a few years ahead of them, they really only have a few months ahead of them.”

 

When they lose money in their banks they’re going to have to recap their banks. They’ll have to expand the PBoC balance sheet by trillions and trillions of dollars.”

 

“No one’s focused on the banking system. Focus will swing to it this year.”

 

“A Chinese devaluation of 10% is a pipe dream. It will be 30-40% by the end.”

 

“If some fund manager in Texas is saying that your currency is dramatically overvalued, you shouldn’t care on a $10 trillion economy with $34 trillion in your banks. I have, call it a billion -  it’s so small it should be irrelevant and yet somehow it’s really relevant.”

 

If 4% of the population takes out their $50,000 quota, the FX reserves are gone. We lose ourselves in the numbers. $3.3 trillion is a big number, but the reserves to bank assets number is one of the worst in the world.”

On Wednesday, Hayman is out with a 12-page letter to investors in which Bass explains why he's making such an outsized bet against China. Most of what Bass says has been covered in these pages extensively for years.

Put simply: China has an enormous debt problem and the rapidly decelerating economy means that the country's banks will only be able to paper over the soaring NPLs for so long. If Beijing wants to eliminate the acute overcapacity problem that's contributed mightily to the global deflationary supply glut, it will mean allowing the market to purge misallocated capital. And that means bankruptcies and a wave of defaults. "The unwavering faith that the Chinese will somehow be able to successfully avoid anything more severe than a moderate economic slowdown by continuing to rely on the perpetual expansion of credit reminds us of the belief in 2006 that US home prices would never decline," Bass begins.

"Banking system losses - which could exceed 400% of the US banking losses incurred during the subprime crisis - are starting to accelerate," Bass adds. "Our research suggests that China does not have the financial arsenal to continue on without restructuring many of its banks and undergoing a large devaluation of its currency." 

He goes on to recap the entire thesis, including the idea that WMPs are a big, big problem (something we've said on dozens of occasions including here when we called WMPs an "8 trillion black swan") and you can read the full letter below, but excerpted is the "what happens next" portion, in which Bass explains how things are likely to play out in the not-so-distant future for the engine of global growth and trade. 

*  *  * 

From Hayman Capital

What Happens Next? – Fasten Your Seatbelts

The troubles in China are much larger than market participants believe. Everyone (including Chinese citizens) knows something is wrong, but few, if any, can put their finger on exactly what it is. The narrative to date has been focused on the symptoms of the problem (i.e. capital outflows and low commodity prices) as opposed to the problem itself. We believe the epicenter of the problem is the Chinese banking system and its coming losses. Once analysts, politicians, and investors alike realize the sheer size of the impending losses and how they compare to the current levels of reserves, all focus will swing to the banking system.

As it is obvious that China’s economy is slowing and loan losses are mounting, the primary question is what are China’s policy options to fix the current situation? We believe that a spike in unemployment, accelerated banking losses / a credit contraction, an old-fashioned bank run, or more likely the fear of one or all of these events, will force Chinese authorities to act decisively. The policy options that China has then are limited to:

1. Cut interest rates to zero and let the banks “extend and pretend” bad loans – lower interest rates will force more capital abroad putting downward pressure on reserves and the currency.

2. Use reserves to recapitalize its banks – this will reset the banking sector, but wipe out the limited reserve cushion that China has built up, and put downward pressure on the currency.

3. Print money to recapitalize its banks – this will reset the banking sector, but the expansion of the PBOC’s balance sheet will lead to downward pressure of the exchange rate.

4. Fiscal stimulus to revive the economy – this will help some chosen sectors of the real economy, but at the expense of higher domestic interest rates (if not done in conjunction with Chinese QE). The 2009 fiscal stimulus was primarily executed through the banking sector so a similar program would require a properly capitalized banking sector. Also, any increase in Chinese investment would reduce China’s trade surplus and ultimately pressure the currency.

The playbook from policy makers to deal with China’s challenges will likely combine several of the above measures, but ultimately a large devaluation will be a centerpiece of the response. This will allow the Chinese economy to regain the competitiveness it has lost over the past few years.

Chinese officials will realize that a meaningful devaluation is exactly what China needs to help rectify the imbalances that have built over time. Look to Japan, Russia, Brazil, Mexico, and Europe as examples of countries (or a monetary union in the case of Europe) that have allowed their currencies to depreciate in order to correct the imbalances in their economies. This begs the question of whether governments are going to engage in a full-on currency war. In our view, this has already begun. One only has to look at what BOJ Governor Kuroda said to the Chinese during a panel at Davos last month. He told them to impose stricter capital controls to stem the flow of hot money out of China and to stabilize their currency. Just one week later, he moved the BOJ to negative rates and devalued the yen 2% versus the renminbi overnight. There is one thing central bankers loathe, and it happens to be free advice.

Once China realizes that it must save its banks (China only has a newly established deposit insurance system with limited coverage and little pre-funding, which could make bank runs very problematic), it will do so. The Chinese government has the capacity and the willingness to do what it needs to do to prevent a banking system collapse. China will save its banks, and the renminbi will be the valve for normalization. It is what any and every government would do if put into a similar situation.China should stop listening to Kuroda, Lagarde, Stiglitz, and Lew and start thinking about how to save itself from the impending disaster in its banking system.

Remember, Bernanke had the subprime crisis wrong when he said it was “contained,” Lagarde and Sarkozy had it completely wrong when they said speculators were the cause of Greece’s problems, and now they all have it wrong when they say China’s problems are due to a simple “communication problem” regarding its FX policy. The problems China faces have no precedent. They are so large that it will take every ounce of commitment by the Chinese government to rectify the imbalances. Risk assets will not be the place to be while all of this is happening. 

Once we drew this conclusion in the middle of last year, we decided to liquidate the majority of our risk assets and position ourselves for the various events that are likely to transpire along this long road to a Chinese credit and currency reset. The next 18 months will be fraught with false-starts, risk rallies, and second-guessing. Until China experiences a significant devaluation, it will not be able to cope with the build-up of credit that has helped fuel its rise, but may, in the short-term, be its undoing.

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pitz's picture

Yet this guy is claiming that the Yuan should be shorted.  Wow, guess he missed the Deflation lession from 2008/2009 in the USA and what it did to the USD$.  And is obviously not a student of history, ie: the 1930s, to figure out what a private sector debt implosion does to the value of a currency.

PhoThus's picture

His short yen worked and then it didn't. His short japanese bonds worked and now is not. So what

Goliath Slayer's picture

Why do they see the Collapse in China but not the coming Financial CATACLYSM in America >> http://bit.ly/1KogtGi

Cognitive Dissonance's picture

The problem with being an old(er) man is that reading doom porn after 8
pm tends to put me to sleep. Best I save this for my morning
constitution. :-)

Save_America1st's picture

34 Trillion????  LOL

That's chump change, bitchez!

Signed,

Deutsche Bank's imploding 73 Trillion derivatives exposure

cheka's picture

umm kyle

are you chinese or japanese?

stupid redneck, i laotian!

uh huh, are you chinese or japanese?

asteroids's picture

What if the Chinese start dumping all the US debt to purchase things like gold and silver. Then they turn around and start packaging their stinking debt and sell it back to the West.

Harlequin001's picture

Or, alternatively they can revalue the only asset they have on their balance sheet that has no 'monetary value' upwards by so many multiples that these losses pale into insignificance and globally, the entire banking sector becomes solvent again, overnight.

That's multiples of 'many thousands', and the asset is gold.

That's 'overnight', read 'bank holiday', bail in and revalue gold and silver. All done, and very quickly.

Mintcoin's picture

That is exactly what a devaluation is.  What would they "revalue" gold against? Their currency? That would be a massive devaluation ...of their currency.

Harlequin001's picture

No, a devaluation is usually a repegging of a currency against another currency or currencies.

I'm talking about all currencies, in all banks. in all countries, everywhere, all at the same time being revalued not against other currencies, but to to such an extent as to make exploding bad debts so manageable as to make the bank solvent again .

Which is a bit different from your average 'devaluation'. But yes it would also devalue the currency in the process.

This is where the theft is realised, is it not?

franzpick's picture

Hey Cog: Enjoy yourself while you're still old.

Cognitive Dissonance's picture

Dup

ZH is having issues tonight with its servers. A DDOS attack?

stant's picture

Forget who posted from the last air strike , " when it gets serious you have to take out zero hedge" kudos

Donald J. Trump's picture

WHAT HAPOENS NEXT

5 - Lie like hell. Fudge the numbers. Pretend none of it exists.

MayIMommaDogFace2theBananaPatch's picture

No problems myself tonight, but it was mentioned by a couple of folks in the last thread I was in.

franzpick's picture

Maybe a billion man Chicoms on DDOS vacation March.

Hulk's picture

Sorry CD, that was me, speed reading through the articles again !!!

KingTut's picture

First Kyle has probably forgotten more than you will ever know, not to mention having made a shit load more money.

However I digress.  This is NOT 1930's.  In those days CB printing presses were still steam powered.  We now live in the age of thermonuclear printing presses. For craps' sake negative interest rates?!?!  Who put PCP in the water cooler? Do you really think there are any central bankers on earth who are going sit by let their currency appreciate due to deleveraing?  

Actually, I wish they were smart enough to flush the system of malinvestment, but it ain't gonna happen.

As for China they are probably worse off than Kyle is willing to say in public.  There are so many layers of shadow debt, with collateral chains longer than the great wall.  When this beings to implode, the deleveraging will be brutal, but the money printing leave it in the dust.  They just can't let it happen.

monk27's picture

China can let the debtors default, and make the banks take the loss. It might even shut down a few of the worst offenders, while paying back the depositors up to a limit. Then it could come back and recapitalize the remaining banks with fresh capital. Voila, fresh banking system with no bad loans ! Rinse and repeat as necessary...

That's how it used to be, before our bankers captured out esteemed politicians. Incidentally, it's also the only way to solve a banking problem caused by too many bad loans and malinvestments...

in4mayshun's picture

So I have a question: what keeps the Government from bailing out these banks with covert recapitalization, thus keeping it off balance sheet? I mean, if it's all 1's and 0's, really, what keeps them from waving the magic money creation wand and poof! Problem solved. They simply tell the public that the banks were in better shape than previously thought.

Seriously, if someone could explain why this isn't possible, I would appreciate it.

Motasaurus's picture

It is possible. Of course it's possible. The only way any of this collapses is if someone wants it to collapse. And the only reason anyone would want it to collapse is so that they can get wealth from the collapse. 

It's theft on a grand scale. 

monk27's picture

They could but they won't. They'll let them crash, save the deponents, and beat the bankers into submission. That's a peaceful way of showing who's in control of the country. Otherwise, if they keep bailing out the bankers without penalties, those guys would become too powerful, and China will end up like America, where it's not possible to let a bank fail anymore... The "art of war", applied to a practical case. By the way, a Chinese wrote the "Art of War", not an American...

pitz's picture

"Do you really think there are any central bankers on earth who are going sit by let their currency appreciate due to deleveraing?  "

 

What do you think Yellen is doing at the moment?  And with so much debt in China, its not like China will succeed at QE any more so than the US succeeded at it.  Devaluation is extra difficult when one is a chronic net producer. 

Lady Jessica's picture

I've known some hot Texans.  Kyle is not one of them, alas.

new game's picture

you arn't a gold digger for nickels?

new game's picture

you aint a gold digger for nickels?

Lady Jessica's picture

Only precious gems for me, sir.

Kirk2NCC1701's picture

If China doesn't back their CNY with Gold, they are screwed 69 ways till Sunday.

They won't.  So they're forked.  And let's stop depressing PM, which allows China to buy it as subsidized discounts.  Make 'em pay for it.

jaxville's picture

  What the heck....  The four points are all things going on in America through the Fed.  As the Remnimbi falls won't other central banks buffer it through competitive devaluations of their own? Calling out Red China for economic propaganda?  What country does Kyle live in?

  The most important point is the one about printing.  Red China operates a fractional reserve banking scheme and like America, massive printing is meaningless if there is no one to borrow or the velocity of cash drops dramatically.

  Red China has experienced an unsustainable growth rate and substantial malinvestment.  They have some hard times coming.  If they let the malinvestments collapse rather than propping them up with bailouts, subsidies and NIRP, they will be well on the road to recovery well before the depression winds down in America.

  They have a lot more cards in their hands to play than the Fed and most Western central banks.  

MSimon's picture

It is not the cards. It is the willingness to play them.

 

Militaries have the same "Paper Tiger" problem.

Escapeclaws's picture

"Red China"

Haven't heard that one since Jack Benny was a big star.

ebworthen's picture

China just copied Japan, the U.S., and Europe model, just happening faster there.

It's been a race to the bottom for some time with this lunacy; just wait until the Dollar isn't the reserve currency anymore.

All those years of Wall Street pimps and fluffers poking fun at the Renminbi and the Ruble will come back to haunt them.

nmewn's picture

My own personal Go-Fund-Me account ;-)

Lady Jessica's picture

DB has just been absorbed into the CB Borg system.  Risk as a crucial economic agent has been nullified.  It is no more.  The Chinese have a money system - a state money system - wherein this can be replicated ad infinitum without any discernible impact on their ability to export to us.

Linus's picture

I think Bass is right because China built all those ghost cities with personal savings and borrowed money. But now that those ghost cities are just sitting there earning "0" all those investers are similarly earning "0" on their investment and/or cannot make payments toward all those loans. China will, IS, going to suffer a severe financial crisis probably worse than the 2007 one in the west. And, the contagion will spread worldwide. Here we go again.

Lady Jessica's picture

Contagion exists only for those investors who do not have the PBOC as their backstop.

Witness the brazen attitude of the "abstemious" ECB as they swallow up DB.

The PBOC will heal all Chinese wounds.

matermaker's picture

The ECB can't afford Deutsche.  It's not just a matter of them running a little low on capital.  All of their meth'd out bets are going south, a good amount of 55 or more trillion.  Credit Suisse is in just as bad shape or worse.  The Swiss sure as hell can't give that much reach around.  Stock buy backs for DB will work about as well as they will for AMZN.  Somebody to buy your turds at any price.   Is the ECB going to step in after DB runs out of the little cash they have left and insure to buy everyone's monkey flinging and THEN backstop greatly more than the entire Eurozone GDP?  Okay, let us assume they do.  It still doesn't negate the 55+ trillion of stupid bets they made.  Nor does that negate the stupid bets any of the other EU banks made... Or the stupid bets the Wall Street banks made.  Even the squid was down close to 10% for the month, at close.

China ain't no innocent in all this racket, but I'm pretty sure they are either at par or less than what the Western banks have burning in their bean pot.  I rather like Bass.  However at this point, all those boys figure China blowing up and by some miracle the rest of the world not doing so is about the only infinitely slim chance for any of them  having fiat currency they don't just wipe their asses with.

Hence all the hype about banning cash,bail ins,  NIRP yada yada... It was obviously a "dude...." moment at Davos.   They can't possibly morph the entire planet into electronic fiat currency in the prescious little time they have.  NOW, wishful thinking on their part was surely, "make all money electronic, go NIRP globably... take everyone's savings on bail ins....print boatloads of new electronic currency... and voila!  we're back to normal!"      Ain't going to happen.

matermaker's picture

"Trouble with mice is you always gott'a kill'em." Steinbeck

blue51's picture

MM .. Quite the synopsis! I hope you are correct, about the "dude" moment.

vincent's picture

And many of those Special Mentions (although not yet NPL's) will be pushed off the books just like an unknown amount have been already.

This is a portion of the thesis and it is what they can't see that probably scares them but provides some confidence in the position. Then again, it's China. Risk on

 

CTG_Sweden's picture

Linus:

"[- - -] But now that those ghost cities are just sitting there earning '0' all those investers are similarly earning '0' on their investment and/or cannot make payments toward all those loans. [- - -]"

 

My comments:

A building with no tenants gives no returns. But if it´s likely that it will have tenants some time in the future it is not worthless. So the question is how bad the the bad loans in China really are.

The solution to the bad loans problem in China seems to be to increase wages as fast as possible. That´s probably the only way to create tenants for the empty apartment buildings. And I think that could be accomplished fairly easy in a country which has such a gargantuan domestic market. All they have to do is print money and see to that this money is invested in capacity to produce consumer goods. They also have to substitute imports like passenger aircraft with domestically produced goods. More electric cars which need no imported oil is probably also a smart move. So improving the electric grid is probably important. They can´t continue to depend on exporting cheap junk and buy passenger aircraft for these export revenues. They got to build their own aircraft so that they don´t have to export cheap junk which takes low wages that are not sufficient to pay for all those apartments which have no tenants currently.

Furthermore, empty shopping malls can also be converted to apartments even if that takes some additional investment.

Escapeclaws's picture

Why can't they just do forced marches and force people into those cities? The state could offer to move their stuff free of charge and give them the first 6 mo free rent on their new digs. Forced marches seem like such an east Asian thing.

logicalman's picture

Should be interesting when China comes back on-line.

A lot can happen behind closed doors.

 

Son of Captain Nemo's picture


"Fasten Your Seatbelts": Kyle Bass Previews The Collapse Of China's $34 Trillion Banking Sector

Then Kyle will preview the "collapse" of his own ... Starting with his firm!!!

No worries Kyle!...

There's a Margarita with your name on it anda  pool party waiting for you on "Cloud 9" after you blow your own brains out with the autographed picture and .45 Caliber Chris Kyle gave you before he checked out!

Save one in the chamber for your pal George Soros!!!

logicalman's picture

Should be interesting when China comes back on-line.

A lot can happen behind closed doors.

 

reader2010's picture

That says how little he understands China.

TheReplacement's picture

It is hard to argue with you when you make no point at all.

CHoward's picture

It's only a matter of time (very short time I'm afraid) that the entire world will be involved in the largest and longest shit show in mankind's history. 

CTG_Sweden's picture

 

Article:

"3. Print money to recapitalize its banks – this will reset the banking sector, but the expansion of the PBOC’s balance sheet will lead to downward pressure of the exchange rate."

 

My comments:

Should be the best option. They should probably also convert lots of debt to equity. I don´t see why this should lead to significant downward pressure of the exchange rate. And if that would happen, I can´t see why they shouldn´t just let the Yuan depreciate a little bit more. That is probably what they already should have done.

I they want to avoid downward pressure on the Yuan they can also stop building railroads on the Balkans and motorways in Africa. They should also make investments in China more attractive to domestic investors. More foreign retail investors could probably be attracted by offering mutual funds with low ongoing fees that invest in Chinese IPO:s. If they could offer retail investors something like that with an expense ratio lower than 0.5 % I think that they would have an attractive financial product for retail investors, provided that the funds invest in good companies.

 

pitz's picture

If the banking system implodes, so does Chinese domestic consumption and borrowing.  Extremely deflationary, hence, the Yuan surges to incredible heights. 

Bass has it ass-backwards.  Banking collapses are almost always deflationary, not inflationary.  And there is no shortage of physical supply of goods and services in the Chinese economy, so an inflationary/devaluation outcome is practically impossible.