Kyle Bass: China's $40 Trillion Banking System Has "Largest Imbalances I've Ever Seen"

Kyle Bass’s Hayman Capital has been having a rough year thanks to its widely publicized bet against China’s currency, which has more than reversed its 2016 decline – its largest annual drop since 1994 - as the People’s Bank of China has cracked down on potentially destabilizing capital outflows.

However, Bass – unlike a handful of other former China bears who’ve been forced to scale back, or even reverse, their positions – has said that he is standing by his belief that China’s corporate sector is massively overleveraged, and overdue for a collapse that could destabilize the global economy. Chinese banks, according to Bass, have more than $40 trillion in assets held against $2 trillion in equity.

The dollar’s bull run against the yuan last year helped spark capital outflows as wealthy Chinese worried about the depreciation of their currency. In response, the PBOC tightened restrictions on foreign-exchange transactions for individuals, local companies – quashing a roaring international M&A boom – and even foreign companies, which in some cases have struggled to pull their money out of the world’s second-largest economy.

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Courtesy of RealVision, here are some of his latest thoughts:

“So what's going on right now? Let's get the elephant out of the room. Let's talk about China.

Kyle Bass: OK, how much time do we have?

RP: As long as you need. Where are we? What the hell's going on?

KB: We're in the such late stages of a game that is the largest global imbalance I've ever seen in my life. When you look at on balance sheet and off balance sheets, you look at on balance sheet in the banks, you look in the shadow banks. The number of total credit in the system, China is right at $40 trillion. Think about the number I just said. $40 trillion. And that's using an exchange rate of call it 6.7 to the dollar, right? So it's grown 1,000% in a decade. And we're on a $40 trillion credit system on $2 trillion of equity on maybe $1 trillion of liquid reserves.

RP: Where do you get the equity and liquid reserves from?

KB: Well, it's the amount of equity in the banks of China. It's right at about $2 trillion. So that's kind of a stated number. The reserves is my own calculation, right? The Chinese magically have leveled their reserves out around $3 trillion, which happens to be the minimum level of IMF reserve adequacy as defined by the IMF rule.

RP: So what have they been doing now? So, they were under pressure, and then everything kind of eased off, I guess, as the dollar started weakening a bit.

KB: Yeah. Actually, they've done three things. Well, so four things have caused this, quote, easing off that you refer to. Three have been driven by SAFE and the PBOC, one that's been driven by our illustrious Trump. So the first three are, number one, they essentially halted all cross-border M&A. So if you look at the parabola of M&A coming out of China from 2012 to 2016, it reached dizzying heights in 2016. In 2017, it's like 15% of the 2016 number and no new deals being announced. Now, they'll always be some outbound M&A that's driven by really policy at the Communist Party level, right?

They'll always buy copper mines in Uganda. They'll always invest in ports in Greece. They'll always do things that are from a strategic perspective and a policy perspective. The things that the Communist Party needs to procure resources for its people over the long-term. But when you look at the rampant M&A of money leaving China, they just put a halt to it in November of 2016.

And the second thing they did was they made it impossible for multinational corporations to get their profits and or working capital out of China. And that's something that has been a problem for a lot of the multinationals that do business in China.”

When asked how he intends to trade China’s inevitable unraveling, Bass said he believes the “ultimate” arbiter of China’s “entire macro situation” is its currency. He intends to remain short, with a target date between November 2017 and June 2018.

“RP: Somebody's going to be holding that baby in the end, and China's got the biggest basket in the short dollar issue.

KB: Yeah, but just think, just since January, the dollar index has gone roughly 103 to 92 and change. It's come in 10% in less than a year. That is an enormous move. And it's actually pretty beneficial to the US from a trade perspective, right?

RP: Yeah.

KB: Trump figured out very quickly that making America great again doesn't mean a big, strong dollar. But I think the fourth thing that's really affected the exchange relationship has been Trump's inability to get anything done on the Affordable Care Act repeal and replace. Therefore, nothing's being done on comprehensive tax reform. All we're hearing now is there's going to be a tax cut. Well, that's not going to balance anything. And so his kind of inability to get anything done has also forced the dollar much lower.

RP: So, give us some timings how this plays out. What kind of ways are you looking at? Are you just looking at a currency trade here? Is that the most efficient way of doing this?

KB: That's it. The ultimate arbiter of the entire macro situation I just described to you is the currency. So that's where we stay.

RP: And what about a time horizon? I know it's difficult. I don't want to pin you down.

KB: Well, no, it actually requires you to pin me down because our investors pin us down.

RP: OK, so when the f***'s this going to happen?

KB: So my best guess is between November and call it June. November 2017, June 2018.”

Foreign multinationals have continued to do business in China despite an array of obstacles, including the Chinese economy’s implicit bias toward state-controlled companies. But now that the Chinese have erected all these barriers preventing multinationals from repatriating profits, Bass expects companies will eventually give up on the “carrot” that is the unrivaled growth potential of the world’s second-largest economy.

“RP: It sounds like they've got a temporary fix in place. So what changes the dynamic of that then forces those reserves lower? Because if we're looking for this whole situation to kind of, you know, the apple carts get upset, how does that happen?

KB: Yeah. What's interesting to me is, so -  the answer is I'm not sure. I know that in an effort to maintain economic and political stability for the 19th Party Congress, which happens this November 2017, Xi, and Wang, and the ruling elite of China wanted to maintain the stability, needed to maintain it at all costs. And so they've tied a knot at the end of their proverbial rope and they've been hanging on. But imagine if you're Qualcomm, Ford, GM, Visa and you can't get money out of China, you have a US auditor. And so you go through the end of the year, and they're going to have to rethink how those profits are classified and maybe even how the working capital is classified.
And so it's my view that they can't do this forever. And to the extent that a multinational doing business in China is really having severe restrictions on their capital, they'll just move to Cambodia, or Vietnam, or they'll move somewhere in the region and start doing business elsewhere.

China wields this economic sword so beautifully. The carrot is so large. The delusion of riches is so great that companies and even investors are willing to suspend disbelief to chase that carrot, and the Chinese know it. And they do a masterful job.”

After highlighting the fact that the real risks to the Chinese economy involve financial stability, President Xi Jinping has begun a crackdown on shady WMP issuance and risky lending in the banks. But as Bass says, “it doesn’t matter who you parachute in to pilot the Titanic after it hit the iceberg.”

“So I think they're kind of focused on getting through the NPC, and we'll see what happens.

RP: When is that?

KB: So the way the Chinese electoral system works, it's every five years. And so that's this November. So they have kind of a presidential cycle every five years.

RP: And so, I've heard this before, is that seems to be a significant date that they just want things to go smoothly, and then they can take some harder measures to try and rectify the economy afterwards.

KB: That's correct.

RP: And do you get any sense of that within China itself when you talk to people?

KB: You know, they've spent a lot of time on trying to get banks to do debt for equity swaps. Xi himself has said the real risk in the economy is financial stability. And really, he's trying to crack down on excessive WMP issuance and risky lending in the banks. But it's like, it doesn't matter who you parachute in to pilot the Titanic after it hit the iceberg. It almost doesn't matter.

My point is they have some brilliant people at the PBOC. They have some brilliant people in the Communist Party. But we had a lot of brilliant people in the United States that have been running capital markets for over 100 years, and you know how bad we screwed it up. And we only had $17 trillion on balance sheet in the banks, maybe another $5 trillion off balance sheet in an economy $17.5 trillion, and we detonated our banking system. They've got four times what we had."

In summary, China’s crackdown on outflows and bad debt were meant to ensure stability ahead of the Communist Party’s quinquennial leadership elections in November. Afterward, Bass expects a certain degree of complacency to develop regarding the economy. The country’s banking system has become too sprawling to control.

The collapse will arrive, Bass assures his listeners. Profiting from it is a matter of getting the timing right – something that’s incredibly difficult for short sellers.

 

Comments

Escrava Isaura Duc888 Sun, 09/17/2017 - 20:24 Permalink

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Kyle Bass? Talking about an orthodoxy fatigue? Kyle Bass reminds me a sinner that keep repeating the same mistake over and over.  

In reply to by Duc888

Escrava Isaura Five Star Sun, 09/17/2017 - 21:00 Permalink

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The same can be said about any industrial civilization: It’s completely unsustainable.  

In reply to by Five Star

strannick Escrava Isaura Mon, 09/18/2017 - 00:44 Permalink

Bass' Translation;''China, plz capitulate, before I do''These grave, hand-wrining exposes are never public serve announcements coming from guys like Bass.China makes stuff, we make dollars. Chinese Universities educate engineers, we subsidize Social Justice Warriors while indoctrinating our kids to legalize pot and get sex change operations. Who ya gonna bet on?

In reply to by Escrava Isaura

fx strannick Mon, 09/18/2017 - 03:32 Permalink

I don't get it how so brilliant people (who Bass undoubtedly is) can fall for such poisened , ultra-hard trades/investments.The US banking system wasn't saved by pumping a few hundred billion $ into TBTF banks. It was essentially saved by suspending some key accounting rules (indefinitely!). So I read this stuff with multinationals getting heat from their accountants and the auditors and I ask myself WTF? Since neither the US nor China have any interest in China blowing up here, they will do whatever it takes. And if all that it takes right now is playing a bit loose with some accounting rules, then I don't see any major problem yet. Yes, some multinationals  can't get their money out, but so what? It's still there on their balance sheets, they still can report profits, can raise more debt to buy back stock - where's the fucking katalyst, kyle? I sense that it may take years, if not another decade or tow, to play out like you expect. That said, the Chinese' crackdown on bitcoin exchanges is certainly related to the 19th party congress and possible measures adopted there (or shortly afterwards). I am sure they wanted to close any escape routes, before that, even if they were rather tiny.So maybe we will get something big happening this winter in China, but I would not bet too hard on a yuan collapse. Not against the greenback anyway.

In reply to by strannick

Quantum Bunk Five Star Sun, 09/17/2017 - 22:51 Permalink

Doesn't matter. Unlike the US, who imports 50 billion per month worth of goods and then imports 50 billion in money to pay for it, plus more money to pay for govt, China actualy has an economy, An economy that produces more than it consumes. And saves the differnece. 3 trillion in reserves.I honestly dont understand how we can call what happens in the US, an economy. Its not an economy. Its money and goods consumer.

In reply to by Five Star

jaxville Five Star Mon, 09/18/2017 - 01:57 Permalink

Unsustainable for sure.  Betting on when it will all roll over is gambling.  Leverage can grow without being an issue until some outside event creates a move to liquidity.  It's only when people want/need to take their chips off the table that leverage causes grief.  We often overlook that Red China is essentially a Stalinist regime.  It is fully within the governments power to stop people from taking their chips off the table. Mass arrests and executions can occur there when it becomes expedient to do so. Another issue is that so many of Red China's trading partners have a huge vested interest in maintaining stability there.   Kyle is right but it won't be easy money for his fund on this call.

In reply to by Five Star

monk27 Conscious Reviver Sun, 09/17/2017 - 20:29 Permalink

He's bitter, but it's only his fault. Unlike US, the Chinese government controls their Central Bank 100%. They can order it to do whatever the heck they want, overnight. They can issue a gazillion of yuans in credits, and just CANCEL the whole debt next month if they so desire. Try that over here, and you'll end up dead (with some help from the debt owners...)

In reply to by Conscious Reviver

ZIRPdiggler Dewey Cheatum … Mon, 09/18/2017 - 00:54 Permalink

Tru-dat. How in the hell can you make a long term trade of any kind in a world where central planners can do whatever nonsense is expedient at that moment?  In his defense, when he came up with this thesis, the world was very different than it is today.  Today we are seeing central banks doing things that no one ever imagined they would do.  Kyle is saying "because of "X", then "Y"". That makes perfect sense when you are talking about physics.  'Economic rules', Austrian or otherwise, no longer apply. There is no price discovery and no true markets. Precious metals and cryto-currencies will provide the needed liquidity when our paper world gets carried away on the winds of carelessness and manipulation.  Until the true crisis reaches critical mass (which is the worldwide loss of confidence in the banking system), governments and central banks will continue to do whatever crazy s*** they need to do in order to maintain the present system.

In reply to by Dewey Cheatum …

Seasmoke Sun, 09/17/2017 - 20:31 Permalink

Chinese have most of the manufacturing. Enough of Gold and boatloads of USD to flood this cesspool with. I just don't see how they lose when they decide it's time.

mkkby Seasmoke Mon, 09/18/2017 - 05:03 Permalink

Read again. There is full blown capital flight from China. They are having to jail/shoot people to prevent losing that trillion in reserves.

This is no different from a bank run. Kyle is right. If corps aren't allowed to take their profits out, the china "miracle" is done. (Of course, he cannot time this and may lose his investment.)

I only make this comment to show fellow hedgers how silly it is to think china is ready for reserve status. Floating their currency and allowing investment outflow cannot be tolerated any time soon.

It amazes me that hedgers love liberty but think china is somehow their savior. What a hoot.

In reply to by Seasmoke

shovelhead Sun, 09/17/2017 - 20:31 Permalink

That's the beauty of China.Their economy is large enough to handle trillions more of shady loans on shady collateral.Wait until they take the Foxconn nets down and start putting them on the banks. That's the tell to go short.

TeethVillage88s Sun, 09/17/2017 - 20:34 Permalink

"Kyle Bass: China's $40 Trillion Banking System Has "Largest Imbalances I've Ever Seen"
- "We're in the such late stages of a game that is the largest global imbalance I've ever seen in my life..."

Well that is like very "Zerohedge of you man"

WTF?

- Anyone have total of Economically Significant Derivatives $700 Trillion?
- What is the total of USD Dervivatives World Wide... $2 Quadrillion or $4 Quadrillion?
- US Stock Markets at all time Highs
- US Whores on the Streets of USA in Record Numbers, Escort Numbers doubled
- Heroin Use and Over-Dose 4 times record high in USA
- Coke & Whores on Wall Street... just has Initial Coin Offering, after secondary offering of 1 Million Shares of Stock and IPO of 1 Million Share just 2 years ago

ThrowAwayYourTV Sun, 09/17/2017 - 20:47 Permalink

China is about as crooked as one can get. I would believe a word out of them.You're dealing with a people who think an ordianary man with an army is a God for Christ sakes.

new game Sun, 09/17/2017 - 20:46 Permalink

all I know is stay local. to dable in China is the forbidden fruit. what would bother me is their ability to pull the gold option out and back all their gov debt and back stop any slide into an abis. now they are rolling out gold backed oil trade for yuan. Kyle, minimize your looses soooon. dollar is going down due to this certainty. ask russia, iran and china themselves. dolla toast faster than the yuan. and kyle, what is at fort knox? see that is your trade, gold backed yuan oil trade. what do they say? never fight the fed, something is simulair here...

PGR88 Sun, 09/17/2017 - 20:44 Permalink

Bass and others just don't get it.  The Chinese Communist Party has total control over every major business, every market, every bank and investment firm.  There will be no crash, and they will be bailed out as needed, or shot for corruption if bad enough.Yes, economic reality will come to even China but in different ways - slow grinding decline, increasing wealth inequality, forced movement of people, etc... but it won't crash as you think. 

Mongoose HRH Feant2 Mon, 09/18/2017 - 01:10 Permalink

They fear "luan" (chaos).The public knows their government lies to them. Yet, at the same time they depend on their government quite a bit. Years ago I asked a Chinese co-worker if he was worried about a real estate crash similar to what we experienced (he owned three apartments and shopped for more). His answer was that the government controls the banks and the financial system and would never let that happen. It's an interesting aspect of their modern culture. They know governemnt lies, don't really trust government, but since gov. has been in charge of every aspect of their lives for the last few generations, it is expected that they (gov) will keep it all under control.  Back to killin' snakes 

In reply to by HRH Feant2

HRH Feant2 Sun, 09/17/2017 - 20:52 Permalink

"And the second thing they did was they made it impossible for multinational corporations to get their profits and or working capital out of China. And that's something that has been a problem for a lot of the multinationals that do business in China.”

This ^^^ was a fatal error.

francis scott … Sun, 09/17/2017 - 21:02 Permalink

Kyle, old pal.If the yuan is going to be the next petrodollar or share that distinction with the current one,there will be a lot of demand for it.  We know that demand increases value and not the opposite. Don't you want to think about covering your shorts?  Or are you just looking for 'greater fools'?

yogibear francis scott … Sun, 09/17/2017 - 21:23 Permalink

Kyle is to be slapped silly by people like William Dudley of the NY fed that has people watching the overnight markets/currencies.Ever notice the magical elevation last few years when things looked like they were turning to crap.Price Discovery has been taken out  markets. The central banksters now pick the winners and losers.Sorry Kyle, your about to be taught a lesson. 

In reply to by francis scott …

yogibear Sun, 09/17/2017 - 21:18 Permalink

Hey Kyle boy, your about to lean the lesson in how central banksters can manipulate economies/stocks beyond anyone's wildest dreams.Keep wishing. They have infinite fiat to make you look like a fool.

Robinhood Sun, 09/17/2017 - 21:35 Permalink

I use to hold Kyle in the highest regard. I still hold Jim Sinclair in the highest regard.IMHO Bass makes a mistake in not understanding the critical supply lines that China provides to ? The world. And they know this!All of these money pusher hedge fund managers just move fluff by blowing smoke up asses.When you are in the business of making real product and understand supply lines and purchasing "DIRECTLY" from China and how much they have to offer? well Kyle I think you are a fool!!!!!!!!!!!!! 

TheCentralScru… Robinhood Mon, 09/18/2017 - 11:18 Permalink

Yes, China provides much of the global "supply lines", but a financial crash there isn't likely to just dry those supply lines up..   If anything, IMO, it would just put their goods on a major sale as they struggle to raise hard currency to prop up their financial system.. I hardly see their factories shutting down, unless they are unable to obtain credit to operate..   And the PBOC will do whatever is necessary to offer these credit lines, for the very same reasons.. They need hard currency..Scrutinizer

In reply to by Robinhood

Let it Go Sun, 09/17/2017 - 21:41 Permalink

Whether you like Kyle Bass or not is not the issue. China is no small underdeveloped backwater with an insignificant economy and it is important to remember that "what happens in China does not stay in China." The financial missteps in China have continued and it will only be when their economy falters that we will learn to what extent or hear more stories about how they have masked their problems.The Chinese economy has "been very reliant" on government stimulus, rapid credit growth and the flow of newly created money from a loose monetary policy. We should remember China is far from transparent and the risk remains out of sight. The simple fact is we have become complacent over China's current problems and because it has yet to develop into a catastrophe doesn't mean it won't. More on this subject in the article below.http://brucewilds.blogspot.com/2017/07/chinas-financial-missteps-continue.html