Predictably, the one topic that got the most attention was China, where as widely known Bass has made his next "career" wager, expecting a substantial devaluation of the currency, a process which had stalled out in recent months but has once again picked up speed.
Looking at recent data, and specifically something we pointed out two weeks ago, Bass said the country’s $3 trillion corporate bond market is “freezing up” amid rising defaults and canceled debt sales. “We’re starting to see the beginning of the Chinese machine literally break down.”
Bass reiterated that China’s lending binge in recent years is unsustainable and it is only a matter of time before this bubble, bigger than the US bubble of 2005/2006 which brought Bass fame and fortune, bursts. He expects bank losses of $3 trillion to trigger a bailout, with the central bank slashing reserve requirements, cutting the deposit rate to zero and expanding its balance sheet - all of which will weigh on the yuan, and lead to a dramatic devaluation.
“They’re going to do everything the U.S. did in our crisis,” said Bass, who has gone public with his China views since at least October. “Every single thing the Chinese central bank and central planners have to do is currency negative for them.” He added that the Chinese government wants a devaluation, but “they just want to do it on their terms." By this he is of course referring to the vast exodus of domestic capital as the local population sees the endgame and is scrambling to park its funds offshore (mostly in UK, US and Canadian real estate as well as US M&A, and more recently, in bitcoin), something Beijing is terrified of and is doing all in its power to prevent.
An interesting theme here was Kyle Bass's devaluation thesis as a contrast to Hugh Hendry's recent Chinese optimistic euphoria. This is what Bass told Williams:
Williams: China is something else that you've been very vocal about recently. You and this gang of nefarious Texas hedge fund managers who are trying to take down the People's Bank of China. And again, it's another, in my reckoning, very well argued case for the devaluation of the yuan. And Hugh Hendry was on talking to Raoul, said, "It'll never happen. The world's over if it happens." And I can see where he's coming from, but it seems to me that the people that debate on the "they won't devalue" side are assuming it's going to be a voluntary devaluation, something that they choose to do, rather than they have to do.Kyle: That's a perfect point, perfect point.Grant: Because that seems to me, they're going to have to do it to recap the banks. There's going to be a reason for them to do it, not a choice.Kyle: Well, it's going to happen to them. And again, even in your soliloquy there, you say, "They're going to have to do it." They're going to have to allow it to happen. It's going to happen. I love Hugh, we've had a number of debates throughout history, and he's a fantastic individual and a brilliant mind. But if the reason that it's not going to happen is because "it can't happen, because the rest of the world's going to have so much trouble with it," that doesn't give me any solace whatsoever. In fact, you look back to the U.S. financial crisis when I would go meet with various heads of investment banks or investors, and I would say, "This is what's going to happen, and this is why, and this is how the structures are structured." And some would look at me and say, "Well, that means Fannie and Freddie will be out of business. And so therefore, the government will never let that happen." I said, "Well, the government doesn't have a choice here. It's too late." The credit excesses had already been built. And in China, the credit excesses are already built. They've got, we can go into numbers, but they have asset-liability mismatches in their system, in the wealth management products, that are more than 10% of their system. And our asset-liability mismatches were two and a half percent of our system, and you know what they did. So their excesses are already, they're already so far ahead of the world's excesses in prior crises that we're facing the largest macro imbalance in world history. And to this day, I can't figure out why people don't see it for what it is.
At this point Bass proceeds to discuss some interesting behavioral bises inherent in investing:
Bass: I think the behavioral psychology plays a huge part. And you've hit it right on the head. I give you an interesting anecdote. Again, back to the U.S. subprime crisis, I went all over the country raising money for a subprime, two subprime funds and some advisor relationships. And what was absolutely hilarious to me, looking back at the meetings that we had, is we would go to Chicago, and we would say...we'd lay out the thesis, and they would say, "You're exactly right, this is absolutely going to happen." It's not going to happen here in Chicago because of one, two, three and four these points. But that's because they live there, the NIMBY, the not in my back yard scenario or psychological profile of events, was not going to happen. But it was going to happen to everyone else but them. And then I'd go to Seattle and I'd lay that thesis out and they'd say, "Oh, you're absolutely right. Never going to happen here because Microsoft's here and Amazon's here, and but our houses are fine, but everybody else's homes, they're going to drop 35%, and we're going to invest with you." And then I'd go to Southern California and I'd go to Texas, and everywhere I went, not one organization or group of investors would agree that it would happen to them, but it was going to happen to everyone else. And that's again, I think the beginning of what you and I were just discussing with regard to the psychological profile, or more importantly, the behavioral psychology that plays into one's thought process. Because the first thing...I think the first inalienable right of human nature is self-preservation, and when you get into a thought of, okay, Hugh's position, is if it...if this were to happen, it would be so globally terrible that therefore, they're going to not let this happen. I understand that logic and I think you do too, but I believe it's flawed. And the reason it's flawed is again, it's just this...It's almost like the Kahneman's availability heuristic, where you only have this certain data set, and you only look at history back...I think the brevity of financial memory is only about three years.* * *What's fascinating to me, Grant, is outside of Hugh Hendry, behind the scenes, when you talk with some of the largest asset managers in the world and the largest investors in the world, and you lay out a hundred page PowerPoint of exactly how their banking system and credit system works, and how they are putting off the final day of just realizing a loss cycle. You mentioned Armageddon. It's not Armageddon. They're going to have a loss cycle. They'll recap their banks, their currency will depreciate, pretty materially. It will export deflation to the world one last time. And if you have any money left, it will be the best time in the world to invest, and we both know this.
Bass also sees the humor in shorting China:
Bass: I know there are permabears on China. But from my perspective, it's just a scenario that I see has come to a head. And one other point that you made...one of my good friends, Dan Loeb, says all the time to me that "there are no short sellers on the Forbes 400 list, so be careful." And a friend I think told you, don't invest in Armageddon, it only happens once in a blue moon. All of those things are absolutely true. But to check caution to the wind and hope the central banks get it right from here, I think is an outsized risky proposition.
Bass doesn't just limit himself to China: he also touches on arguably the most controversial asset of all time - gold.
Williams: What's your current thinking on gold? Because I know it's something you've had thoughts in the past, but it's not something I've heard you talk about for a while.Bass: Yeah. I look at Global M2, being just under a hundred trillion. And the total amount of mined gold in world history is somewhere around seven trillion. And there's about...and then gold that's kind of in circulation in use. We studied...we did a deep dive on gold a few years ago. They call it the yellow metal that has no yield, but with the entire world going to negative rates, then on a relative basis, it's probably one of the better currencies to own. I buy that wholeheartedly. And seeing which way the central banks are going, you're going to have to own something.
He also touches on the future of interest rates:
Bass: The spreads between U.S. 30 year treasuries and 10 year treasuries, and Japanese 30 years and 10 years, and European 30 years and 10 years, is as wide as it's ever been. And so what does that mean? That means that I think U.S. rates are coming down, regardless of what kind of inflationary pressures we have, which is something that we've never seen before. Again, a new paradigm given the global central banking conundrum. So when you ask me whether stocks have peaked or not in the U.S., look, if China has the comeuppance we think they're going to have, soon, then that's not going to be an equity positive environment.
Bass also discusses the recent collapse in central bank confidence:
Williams: When you talk about this handicapping the central banks, which we've all had to do, and it's essentially impossible. How do a group of free market capitalists handicap a group of academics?We speak different languages. So as we watch this thing move forwards, the guys in the markets assume to a cliff somewhere out yonder in the fog. What do you think tips this thing on? Because to me, it's purely confidence now. There's nothing left but confidence in these guys that they can do this. And you bring up the reaction to Kuroda-San going negative in January. And I think the instant reaction of the markets, people are going to look back on that, when the Nikkei fell a thousand points and the yen strengthened by a full bip. That, to me, was the start of people going, "You know, maybe these guys are just throwing things at the wall."Kyle: You're right. That was the first time I've seen investors show a disbelief in the markets, in central banks. And I agree with you. That was a watershed moment in our business, in attempting to see when there's a tectonic shift in the belief systems, because we all know that that one of the central banks' objectives is price stability, whatever that means. I think that means each relevant industry that they oversee trading higher and not lower, it equals price stability. And they didn't get it, Kuroda-San didn't get it then, and since then Japan struggled. And this concept of Ricardian equivalence, where you're issuing debt to quantitatively ease on the monetary policy side, and maybe even allowing, right, the fiscal authorities to continue to spend, it comes into play where people just start saving more. And this idea of negative interest rates realize...it's interesting, academically negative interest rates look like they work on paper. And in reality, what these central bank heads are realizing, whether you're in Denmark or Japan or any of these economies, is savers think, "Well, I just need to save more if I'm not going to earn anything on my savings."* * *We're already crossing the Rubicon of the helicopter money. And Japan's talking about a negative lending facility from the BOJ to the banks. So we're starting to see...the academics will never turn and say, "We were wrong." The academics will go "more," and they'll just go unsterilized. And in the end, we know where that gets all of us.
But the punchline is beyond gold, beyond China, beyond even investing, and has to do with something a central banker once told Bass in what the hedge fund manager describes as an "out of body" epiphany:
Grant: this idea of helicopter money, and the idea of banning cash, and all these things that, when you sit here in the cold like that, you can see exactly why they need to do these things. You watch the narrative unfold in the media, and then the trial balloons get floated. But you're right, they have to go to helicopter money, they're really not going to have a choice. And it seems to me that they are going to have to try to ban cash. Because, as you say, the U.S. savings rate has tripled since 2007, and that's literally the last thing they want or need. So is there any way out for these guys? Because that's the thesis that I keep checking. I can't see a way out, absent cold fusion.Kyle: Look, I had a fascinating out of body experience meeting with one of the world's top central bankers in a private meeting about three years ago. And he said, "You know Kyle, quantitative easing only works when you're the only country doing it." He would never say that publicly. And I'll protect his name, because it was a private meeting. But it was one of those moments where I...it was one of those epiphanies almost, where it's something you and I knew, but hearing him say it, call it one of the four top central bankers in the world, it was a jarring experience for me, because when I look around the world today, everyone's in the same boat. So we're all trying...we're attempting through our treasury and our Fed to get the rest of the world to not devalue against us, while we quietly attempt to devalue ourselves against them, and it's all this...it is the race to the bottom, it is the beggar thy neighbor policies that we all talk about. And I believe that there is no way out.
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