Practice English Speaking&Listening with: Kyle Bass on China's Major Risks & Opportunities (w/ Grant Williams)

Difficulty: 0

GRANT WILLIAMS: Kyle, welcome back.

KYLE BASS: Thanks.

GW: It's been way too long since you and I had the chance to sit down and talk about

the world.

It's great to have you back.

And the subject today is China.

We're going to talk about China.

You and I had lunch in Dallas a little while ago, and we were talking about China.

I know it's something that you've done a lot of reading about.

And every time you've done a little reading, I want to hear your thoughts are.

They're always so well organized and so well structured.

So let's talk about how this all kind of coalesced as an idea for you.

KB: Yeah, I think what we try to understand is the capital flows.

When you think about capital flows, what do we learn 10 years ago, almost to the week,

was that flows mattered more than the stock.

And as soon as the flows became meaningful, the stock became important.

And so this idea of what happened to Lehman, what happened to Bear Stearns, what almost

happened to Goldman and Morgan Stanley actually applies in the context of the sovereign realm.

There are many more variables to the equation, but when you think about how China operates

and how it operates globally, you have to bifurcate your thought into two buckets.

One bucket is how China operates domestically.

They have a renminbi-based economy that they essentially control.

And I think global investors understand that they can control their internal accounts of

RMB, basically however they wish.

They can print more.

They can recap banks.

They can make losses go away.

They can make people go away.

They can do all kinds of things internally that we really aren't privy to and probably

won't ever be privy to.

But the kind of the barometer, or let's say the arbitrator of China's cake and eat it

too strategy is the exchange rate vis-a-vis the rest of the world.

Now as you know, they're a massive net importer of goods, of call it raw materials, whether

that is iron ore or crude oil or derivatives thereof.

They need foreign currency to continue to grow China Inc's working capital.

You think about it as working capital.

The way that that works is they need positive capital flows annually on a net basis.

So their current account has to be positive.

They have to be growing their wealth, and they have to be growing it in foreign currency

terms, not just in RMB terms.

And so what we've studied are those capital flows, and we've studied their use of dollars,

euros, and yen, and really, it's mostly all dollars.

The euros and yen are negligible.

When we think about dollars, China's brought roughly 400 million people out of abject poverty

into the middle class, and they've taken the middle class to the upper class and the upper

class to the elite, well, what's the first right the wealthy Chinese and middle class

Chinese want to exercise, and it's their right to travel.

GW: Right, sure.

KB: Because the PRC said, we want you to travel.

When they travel and spend abroad, they spend dollars.

They don't spend RMB, because Jamba Juice won't take RMB, and the hotels in London won't

take RMB, and the hotels here won't either.

We're a long way from that.

And when you think about, you look at the Swift global settlement system, if you look

at the most recent report that Swift has put out, Chinese GDP is around-- if you dollarize

the RMB at the current exchange rate is about 15% of global GDP.

They're the second largest economy in the world behind us.

But it's Swift settlement terms, the RMB doesn't even amount to 1% of Swift settlements.

So they kind of have this-- they have this world that's of their own conjuring, right,

and so, again, when we think about flows, these Chinese that travel and spend abroad,

they actually have this data series between CEIC and Safe.

We use their numbers.

So the travel services deficit in China is almost $80 billion a month-- a quarter, sorry.

A quarter So they're $320 billion a year.

And that number, if you look at this chart it just keeps going down and down and down,

because what's happening more and more Chinese are traveling and spending abroad.

They're not really investing abroad yet en masse, because the government won't allow


So the Bank of England wrote a great paper on the expectation of Chinese investment abroad,

being upwards of $25 trillion by the end of 2025.

We all know that can't happen.

A, they don't have that many dollars, and B, that's just too quick of a move.

So you have the travel service deficit costing them, and the most interesting thing, when

you really look down at the numbers is their current account's gone negative for the first

time since 2001.

All right, so it's really 17 years since it's been negative, and the first half of this

year, it's negative.

And there are a few reasons why, the travel services deficit, getting the $320 billion,

and the second thing when you look at their current account is they're such a massive

net importer of energy.

GW: Sure.

KB: So you look at energy.

If you remember end of 2014 when crude oil collapsed from 100 down to 35, and iron ore

the base metals went with it, that gave China a huge reprieve.

Their current account was right at 0 at the end of 2014, and that it bounced back up into

the low single digits, because all of a sudden their raw materials costs collapse.

So what's interesting is the net volume of crude oil that they import has gone up 45%

in four years.

And now what's the price doing?

It's turning.

GW: Yeah.

KB: So the price of crude has gone from mid 30s to call it 70, and the same for our base

metals, iron ore, and lot of the inputs that they have.

So when you look at their current account, this is not an aberration, right, and the

reason they're fighting so hard on trade is while they run a big trade surplus with the

US, they run trade deficits with everyone else everywhere else.

And so they run a $400 billion trade surplus with the US, and their current account's negative.

GW: Yeah.

KB: Right?

And what we're doing is putting some tariffs and trying to at least level the playing field

on unfair trade practices.

And that's why they're really pushing back so hard, because they're out of dollars.

So they are desperately short dollars, and now their current account's negative.

And so when you think about this fallacy of China can have its cake and eat it too forever,

I think we all know that that can't happen.

And what we're seeing now is all the preconditions are set forth for pretty material devaluation.

GW: Well, let's talk-- The devaluation story has been something that you and Mark Hart

and people have spoken incredibly eloquently about, and every time I've read those theories,

and you lay out the steps, they're all very plausible, and they will make perfect sense.

But I think what's probably confused a lot of people is this idea that China can't have

his cake and eat it, too, makes sense, but they've had their cake, and they've been throwing

it down their faces for a long, long time.

And so people kind of think, well, maybe this can go on like everything these days.

Can this go on forever?

What's going to be the tipping point for this, and are we there with this the current account

going negative?

KB: Yeah, I think, again, the flows really matter.

And when we studied their banking system, their banking system is called-- if you dollarize

it just for argument's sake, if you use current exchange rates, it's almost $50 trillion if

you include the shadow banks, and they only have $12 trillion of GDP.

We're talking about 400% of GDP in their banks, and even the IMF that NPLs, publicly they've

said they think non-performing loans in the Chinese banking system are 7%.

Well, if 4 times your GDP is in your banks, and you have 7% losses, you lose a lot of

money, and they only have $2 trillion of equity in their banking system.

And so our view all along has been that we all know that the rolling loan gathers no


GW: Right.

KB: And the Chinese are experts at rolling loans, because basically they just grow the

loan balance, right, they just term it out.

And so no cash is coming in.

This is almost a non-sequitur, but you'll love this story.

When I wrote an investor letter a couple of years ago, one of the charts that we found

in the Chinese data, it was losses by loss making enterprises.



And that was actually cash flow losses.

Right, it wasn't rolling loans and no interest being paid.

It was losses.

Those numbers approached 2% of GDP.

Well, the total Chinese banking system profitability was 1.8% of GDP.


KB: So they were losing money the entire banking system was actually reporting its profits.

But mind you, they weren't getting the interest payments.

And once we put that in a, letter the very next day, the data series disappeared...

GW: Is that right?

KB: From the Chinese, and they've never shown it again.

GW: interesting KB: So again, this idea of flow is very functionally relevant to this

answer to your question about when.

When we were saying the Chinese banking system had grown 1000%, while their GDP had only

grown 500%, we know that that can't last for long.

Right, but you don't know what turns it.

And what turns it is this a desperate shortage of dollars.

And so running a positive current account, you can keep growing your working capital,

and you can keep this charade going, but now that you have a negative current account and

a desperate need for dollars, and the US is pushing back on trade, you're really put it

into a predicament.

GW: What you said that beginning was very interesting, because I've pondered this a

long time is I once said if there's a crash in China, would we even know about it, because

they can pay for this stuff over, and they can keep-- there's so much opacity there.

And in this kind of don't ask, don't tell world that we're in because everything is

kind of floating higher, and we all kind of know that it's not real, but everybody's making

money, and so we kind of play along with it.

Now, with China, there's an awful lot of, yeah, these numbers don't make sense, and

they kind of carry on, and we all kind of understand that.

But everybody's kind of states-- it's the Chuck Prince.

The music's playing.

We're all going to dance.

And we're all going to carry on with this.

Do you sense that when we're approaching a point now where it may not be the end, but

we can start to bring it into focus from here?

Because it feels, when this happens, it's going to happen quickly.

KB: I don't know if you feel it or if you see it in even the press's writing, you're

starting to feel the tides turning in the last, call it, six months, with regard to

everyone who leaves and understands and now knows that the Chinese steal 2 to $300 billion

a year from us, whether it's the trade rep's report to the White House or whether it's

the Defense Department's DIUx report that they wrote two years ago, they go in and they

show you that the state actors are stealing from us.

And what is the US?

What is our number one export in the world or say where's our EV?

It's in our intellectual property.

GW: Sure.

KB: And so they've stolen $2 or $3 trillion from us over the years, and we really haven't

pushed back, because to your point, they use economic coercion with us.

Right, they hang that golden carrot out in front of us, and we chase that carrot, regardless,

I think, of ethical or moral behavior.

Like we were just talking with another person here in the studio beforehand.

You know, they've taken a million people against their will and put them in concentration camps,

re-education camps, and yet the rest of the world still buys Chinese government bonds.

We are funding the Chinese government's internment of a million people against their will.

There's actually no logic behind it other than oh well, their bond's yield 100 basis

points more than ours.

GW: Right.

KB: And you think, what has this world come to?

Right, so I think the world is finally realizing a couple of things.

Number one, that they don't act as a global actor.

They act in their own best interests, and when their interest turns out watch.

And if you're a Westerner that owns a Chinese equity, or God forbid, you own a Chinese bond,

and something restructures, good luck in the Chinese bankruptcy court.

GW: Yeah.

And I think we all understand that.

And I think people have been making money in China.

This golden carrot idea is so important, because everyone says it's the future.

China is the future and it's the only economy that's growing.

We don't know what the real numbers are, but there's real growth, real growth that you

can invest in.

But let's talk about ethical capital, because that's essentially what a lot of this comes

down to.

If real ethical capital flows start to make a difference, that's just another push of

this snowball down the hill to come pick things up quickly.

KB: It's hard to get to a place where ethical capital becomes-- I think where it becomes

mandatory, or even to become commonplace.

But I do think that with sanctions-- today we have sanctions on all three countries in

the US, right, so we have Sudan.

We have Syria.

We have Cuba.

They don't mean much globally as far as investment's concerned, especially Western investors in

those economies, but when you add Iran to the mix, which happens, what, November 4th--

today's September, mid September.

I think we're going to see capital flows change globally.

And I think that they should change globally.

We should start adhering to the US law.

And I think that's coming literally in the next few months.

So again, that's another added twist to how global capital flows work.

And I had sent something to you beforehand, you know, again almost a non-sequitur.

But in February of 2018 BNP Paribas CLSA reached a billion dollars for a debt issuance for

an entity called Poseidon Finance.

And if you read the prospectus, Poseidon Finance was newly formed November 2017 in the Caymans,

but the sole owner of Poseidon Finances is China Ship Building Industry, CSIC.

CSIC is wholly owned by the PRC and run by the state council of China.

And they build the military apparatus for the Chinese Navy.

So somehow in some way, Western capital is giving the dollars, not the RMB, the dollars,

for the Chinese military to build their ships and their weapons systems to basically oppose

us in the South China Sea or to oppose order around the nine dotted line.

Again, it's just another example of holy shit, did that really happen?

Did someone really buy those bonds?

GW: But this wasn't hidden.

I mean this is all there.

The prospectus-- KB: But Grant,How many people you know that read prospectus?

GW: That's my point.

That's exactly it.

I mean, we're all complicit in this, because people don't read prospectus.

KB: They say, oh, it's-- you'll love this.

It was fully collateralized by China post shares.

So you had an entity that fully collateralized with shares that share trading, and they just

needed a billion dollars.

GW: Yep.

KB: So again, further evidence.

If you look at the Bank of International Settlements report, Chinese corporate borrowing in dollars

has spiked over a trillion dollars.

They borrowed $250 billion last year alone.

So when you think about dollars, they're fungible.

So if a company in a foreign nation borrows dollars, those dollars hit that central bank,

and they can use it as their own working capital, if they need to.

GW: Sure.

KB: And they do.

And so this fascinating capital flow is enabling some of the global actors to become more assertive


It crosses the Rubicon of here we're talking about well, which should we buy or sell, how

should we invest, how do we make better returns.

Importantly enough, it's allowing this geopolitical assertiveness to continue.

GW: Yeah.

KB: And whether you like the current administration or not actually doesn't matter.

You need to look at what they're doing, right?

Not what they're saying, what they're doing.

Our administration.

Whether you voted for President Trump or not-- I didn't vote for him.

I don't like the guy.

I think he's got some real personal issues, just like everyone does.

But if you look at what he's done with NAFTA, with China, with Canada and Mexico, he's done

more than the last 15 presidents combined in kind of trying to push back and level the

playing field.

GW: But it's interesting that that is couched as Trump getting tough on trade.

Do you think-- I know you speak to the higher ups in government.

You have good lines of communication open with those guys.

Do they get this, or is this-- are they sleepwalked into a really crucial area here?

KB: No, they get it.

It's the prior administration's, all the way back to Kissinger and Nixon.

Kissinger and Nixon pivoted to China to counterbalance Russia's influence around the world.

That was a strategic . Decision and we basically opened the kimono to China and prostrated

ourselves, and we've never looked back, and we've never readjusted that relationship,

and we allowed China to ascend in the WTO in 2001.

We lost 4 million jobs in literally a nanosecond, as far as geopolitical time is concerned.

And interestingly enough, that's what gave rise to President Trump.

The Rust Belt flipped from blue to red, and that's why he got elected.

GW: Yeah.

KB: And it's interesting but the inaction with China is actually what produced this

kind of president that I don't think many of us approve of.

However, the people say Trump's starting a trade war.

It's laughable, because there's been a trade war since 2001, and we haven't been fighting.

GW: Yeah, right.

KB: We've just the losing.

And so the fact that he's leveling the playing field is the right thing to do.

GW: As an investor, you're like me, you have to take these emotions out.

You have to take any feelings about positive or negative about someone like President Trump,

you have to put those aside, right?

And that's so difficult to do, because he makes it so difficult to do.

And so when you talk about what he's trying to do, his agenda, if you want to call it

that, there are a lot of positives in it, but people just can't see through that to

the base issues, because of the smoke and the clouds around it all that come from his


How do we get through that and talk about the issues here, as opposed to the political


KB: Yeah, it's the hardest thing that I can do.

When you go meet with-- you know, as you know, I live in two places.

I live in Dallas and San Francisco, and I come to New York a lot.

The hardest thing for people to do is to force their hatred for the man running the show

and think about things objectively.

Think about this.

When you think about the stock market this year, the two biggest down days in the stock

market this year, I believe, and I don't know this is an absolutism, but knowing-- I was

participating in them.

So in my memory, they're the two biggest down days in the market this year.

They were 4 and 500 point down days, were the days that he announced the 232 decision

in tariffs and the 301.

And for some reason, no one believed that he was going to do it.

He told you he was going to do it when he campaigned.

He initiated the investigation.

The investigation had a finite timeline, and it had an announcement day, and he called

a press conference, and then the market dropped 450 points.

And we looked at each other and said, well, he told you he was going to do it.

GW: He's that unique thing.

He's a politician that does what he says he's going to do.

And I know it's flipped.

You're right.

We don't know how to handle it, because it's real.

KB: But it's really hard to divorce your-- whether you are an ideologue or whether you're

someone that just hates him, it's really hard to be objective in your analysis, because

that-- my mom was a flight attendant before she met my dad, and she was at American Airlines

in the good old days, and there are only three things you are not allowed to talk about on

those flights.

And you know what they are? GW: Well, I'm guessing one of them was politics.

KB: So religion, politics, and money.

Everything else was free game.

You would not-- literally, the company wouldn't allow you to talk about those three with people

on the plane, because those are the things that elicit such a visceral response from


And of course, religion and politics, I think are much greater than money, I guess because

we talk about investing all the time.

I'm passionate about it, but it doesn't bring me to arguments across the dinner table.

GW: Well, you learn to divorce emotion from it.

That's it.

KB: So I think that, being objective and your analysis is really difficult.

It's hard for me to see the way some of these government actors work, for me to think that

we can engage with them once again.

I mean, there are reports, just recent reports that show that when the Chinese found 12 of

our State Department employees sending information back to the US, they pulled them out of their

workplace and executed them on the same day in front of their coworkers.

Like me, if I were working in the State Department, I don't know how I would engage my interlocutor

the next day.

GW: Right.

KB: Yeah, what did you guys do that for?

You're thinking I thought we were friends.

GW: Yeah.

KB: You know, so I don't know how you engage with people like Kim Jong-un or like the Chinese

after they execute 12 of your people.

GW: Well, it's different.

I've lived in Asia for much of my life, and I understand things are different over there,

and there is definitely a kind of never the twain shall meet.

But we've been forced into this bipolar world now by the rise of China, where to your point,

you have to try and engage-- you know, I don't want to use the term enemy pejoratively, but

you have to engage someone who is actively seeking to do things that are in their best

interest, which have to be against yours.

And there's a certain degree, I think in the West of fair play and laissez faire, and we

need to do the right thing.

And in the East, they're not at that level yet.

Society hasn't reached the point where we are trying to make it fair for everyone.

We are trying to maintain 1.7 billion people, and there's 9 guys in charge, and they know

where we live, and we have to be really careful that everything is good for them.

And so screw everybody else.

It's domestic first.

So any time that you tell me you've been doing analysis, I love it, because I know the depth

and the thoroughness of the work you do.

So let's talk about where that analysis has led you to think this goes and how it plays

out, because it's happening now, and it's going to be slow, slow, quick, quick, slow,

so to talk about the roadmap as you see it.

KB: Sure.

So one comment you made about how we tend to be in our kind of academic institutions

and our media want to be laissez faire.

We want to be a globalists, and free trade is good for everyone, but unfortunately, that's

just not the case.

And if you run a country, you realize that if you allow someone else to subsidize power

and give away land and sell something to you at prices that are so far below what you could

possibly produce it here, they can actually put your whole industry out of business, and

then it becomes a real problem.

That free trade, you just lost your whole aluminum industry.

Well, you might need to lose aluminum strategically.

So a lot of times, these aren't economic arguments.

GW: No.

In fact, they rarely are.

KB: These are national security arguments, and I think that the communications department

of the Trump organization is terrible, because it's really easy to describe or elucidate

that narrative to the people.

GW: Well, they did it in the campaign.

KB: They do it, but they do it so poorly.

You know, Trump will tweet, you know, trade wars are good.

That's the worst thing you could possibly say.

How about say we need to keep our aluminum industry for strategic reasons.

GW: Yeah.

KB: That would have actually played a little better in the press.

GW: Yeah, for sure.

KB: So anyway, again, you asked where were all of this work takes us to.

GW: Yeah, the road...

KB: You know, we're having a little bit of an EM crisis, as we speak.

The dollar has appreciated.

More importantly, various EM nations that run twin deficits have fallen apart and continue

to fall apart, whether you're Turkey or whether you're Brazil.

There are a number of these, Romania, that have just fallen apart, because they've run

out of dollar reserves, they've borrowed a lot in dollars, and they run twin deficits.

It's like a redo of 1998.

So when you look at what's happened in the world in the last decade, there's this anomalous

scenario in Hong Kong, a place you know pretty well.

GW: Yeah, I do.

KB: But a lot of people aren't paying attention to what's really happening in Hong Kong, so

in the financial crisis, you know, Hong Kong-- let's go back 36 years.

They pegged the US dollar to create a hub of stability in Asia, and they pegged because

they were, as you probably know, this was when Thatcher was negotiating with the Chinese

to return Hong Kong back to Chinese rule from the British.

And another fun fact, you know, Thailand devalued the day after the handover.

So money was leaving Asia because of that.

So they pegged at the dollar, and here we are today.

And we are in a scenario where Hong Kong's economy used to move with the US economy.

The US led the world.

So as the US did better, Hong Kong did better, and as the US did poorly, Hong Kong would

do poorly.

They were essentially the Southern export hub for Southern China itself.

They were a massive US dollar based goods exporter, and they ran a huge current account


Fast forward to the financial crisis, China's relative importance to Hong Kong kept growing

and growing and growing, and China was also building out their own Southern port infrastructure.

And so to have a currency peg, you have to have approximately the same interest rates.

GW: Sure.

KB: So in a financial crisis, US took rates to 0.

Hong Kong imported US monetary policy.

They took their rates to 0.

At the same time, their biggest trading partner, China, went to the gas pedal.

So the last 10 years have been the best 10 years in Hong Kong's history, bar none.

Well, the exact opposite is happening now.

If you look at the IMF's Article IV review, the last review of this special administrative

region in Hong Kong, one of the key risks they say is the fact that almost every loan

in the Hong Kong banking system is now floating, and it floats at 1 month HIBOR plus a spread,

and it resets monthly.

So factor in the Asian crisis, the exact opposite was true.

Almost 95% of their loans were fixed.

GW: Fixed, that's right.

KB: So they could actually move rates around and not grenade their banking system.

Now you have a scenario where their rates are tied to ours.

Our monetary policy, we've emerged from our crisis, and inflation is starting to show,

we're raising rates, we're raising in September, we're raising again in December.

We've already raised a few times before now.

And in just the last couple of months, three month HIBOR in Hong Kong's gone from 1% to


Well, interest costs have almost doubled in Hong Kong this year.

And the most expensive real estate market in the world and Hong Kong's banking system

is 900% of their GDP.

GW: Yeah.

And you'll see it.

KB: It's probably higher than it was before '98 when they had a complete collapse.

So one of the interesting or most interesting casualties of this EM crisis, dollar resurgence,

US rates going higher, and Hong Kong's golden period, one of the most interesting, I think,

problems that the world is going to see is going to be in Hong Kong.

GW: Well, it's somewhere-- I mean, there's been a lot of people who've talked about the

Hong Kong XE being vulnerable, and people have attacked it periodically over the last

10 years a number of times.

KB: But which way?

Were they saying it needed to re-evaluate stronger?


KB: Because the RMB was growing stronger.

GW: Exactly right.

And now things have flipped around.

But it's still-- you're right.

It's a pressure point that has kind of been flagged so many times, I think now people

are looking past it and saying, well, we're past the problems.

It won't happen.

KB: So I'll say look at the flows.

Flows are super important.

And so when you look at the flows, people look at Hong Kong and say they have an FX

reserve number of hundreds of billions of dollars.

GW: That's exactly what they say.

KB: They're fine.

GW: Yep.

KB: But what's lost in that dialectic is when you have a currency peg, for every US dollar,

you have to have a Hong Kong dollar.

For every Hong Kong dollar, you to have a US dollar if you're going to keep a peg.

GW: Sure.

KB: So what you have to look at is what they call excess reserves.

The excess reserves is kind of their war chest that they have to defend their peg.

How much of their war chest do you think they've spent defending their peg since June 1st of

this year?

We're in September.

GW: Yeah, significant.

KB: 70%.

GW: That much?

KB: 70% of their war chest is gone.


KB: Today it sits about 82 billion Hong Kong dollars, so at an exchange rate of 7.75.

GW: 7.75, yeah.

KB: About $11 billion.

GW: Yeah.

KB: That's all that got left.

GW: Yeah, that's not a big cushion.

KB: So guess what.

They're six innings into a baseball game that they don't want to see the end of.

GW: Yeah.

I mean, is that something that when you look for an end game, because presumably if that

starts to go, what do the Chinese do?

Because the Chinese, it feels like they'll have to get involved somehow because-- KB:

So why does Xi's little colony still peg to the dollar?

GW: No, it's a great question.

KB: It makes no sense to me.

GW: You're absolutely right.

KB: And 90% of their GDP faces China.

When you look at Hong Kong today, Hong Kong 10 years ago was 25% of China's GDP, 25%.

GW: Yeah.

KB: Today, it's less than 2.

Their current account's headed to 0.

Hong Kong is a net goods importer, believe it or not.

GW: I struggle to believe that.

KB: Net goods importer in a pretty big way.

They're a services exporter, net goods importer.

So the entire complexion of their economy flipped in 2009, and to untrained eye, one

would say, oh the financial crisis did something to Hong Kong.

Had nothing to do with that.

It was the Southern port-- GW: Yeah, yeah.

KB: --and Southern China that just took the business away from Hong Kong.

So now, when you look at Hong Kong, it's a giant question mark.

It's not on the front page of any newspaper.

But I promise you, it will be.

GW: So let's talk about why that matters, then, because if all that's gone away, obviously

you have got arguably the expensive property market in the world, which is coming apart


If you look into the South China Morning Post, for example, there's all kinds of stories

about how quickly that's unraveling.

KB: Yeah.

GW: Why does Hong Kong matter so much now?

KB: So that's a great question, and I don't know if our hour of allotted time is-- GW:

That's right.

KB: This goes back to Admiral Liu's-- kind of when you think about the first island chain,

the second island chain, and Chinese kind of primacy in the Naval powers in the South

China Sea.

You have Hong Kong and Taiwan that China really wants to essentially annex and get back.

And when Hong Kong has a real problem financially, when you think about the mechanism to re-peg

the RMB, first of all need a pretty meaningful devaluation.

We believe it should be as much as 30%, maybe more.

That will allow you to peg your overnight-- and we're getting more technical.

But it will you to pay your overnight rate to the Chinese overnight, because again, if

you're going to have a peg, your rates have to be close to the same.

But China could effectuate that change in literally the time it took for them to buy

the US dollar reserves of Hong Kong with RMB at the current exchange rate.

GW: Right, right.

KB: So one day.

They could literally re-peg the time it took to settle that trade.

GW: how would that ripple?

If they did that, how does that ripple through the global economy?

Is it just-- KB: Well, I don't think it does.

I think-- think about when Switzerland did its revaluation, of course, the other way.

It was a shock.

It caught some people with their pants down and closed a few businesses, but did it really


GW: But this is slightly different.

KB: This is geopolitically more important.

GW: That's my point.

This ripples because it's a sign that there are things-- things are becoming unstable.

There's a sense of a loss of control.

There's a sense of having to step in, not necessarily wanting to step in, and make what

would be a pretty drastic move on the part of the Chinese.

So how does that kind of fold into your roadmap for how those destressors manifest themselves?

KB: I think there's been a big protest globally about how much money has been printed, whether

you're the BOJ, the BOE, the ECB, or the Fed, you've printed more money than you ever printed



And so when you look at global M2 as the numerator and global GDP is the denominator, we're now

at 110%.

Never been there before in world history.

And we normally vacillate somewhere between 30 and 50, and now we're at 110.

And so when I think about the financial crisis, and how do we solve a debt crisis, well, we

issued some more debt.

GW: You're exactly right.


KB: When we get to kind of these points of global instability, it's interesting to me

that there's almost a coincidental, but it's not a coincidence, but a coincidental uptick

in geopolitical rhetoric from, call it, the physical side or the kinetic side at the same

time that it's happening on the economic side.

And I believe throughout history, that those two things are one and the same, or one is


I think the economics cause the kinetics throughout world history.

And so I think we're at another historical point.

But again, as we sit here today in the business that we're in or that I'm in and that we talk

about a lot, it's really difficult or naive to think that you can call a global turn with

any kind of accuracy.

GW: Of course.

KB: Given the continuum of time, what's 1, 2, 3?

What's even 5 years?

It's nothing.

So it just takes a while for these things to happen.

And then they happen all at once.

GW: Well, that's exactly it, and that leads to my next question, because you know, our

mutual friend Mark Hart had several funds that were looking to make money from a Chinese


The logic was incredibly sound, and you know, Mark eventually in his own words, found religion,

and said, I just can't fight this trade anymore.

So how do you position yourself to kind of figure OK, how do I put a trade on here that

will give me the maximum time, because I may need 5 years in this trade.

Is it too early to do that yet, or are there stresses such that you have to kind of have

something on the table in case it does happen really quickly?

KB: I think you have to be there now with everything you have at this point in time.

What we miss, what Mark missed early was when they're running a giant positive current account,

and they're willing to put another turn or two of GDP on their banking system, they can

push this off 3 to 5 years.

In our business, every month, every day-- GW: It's a lifetime.

KB: Every day, every week, every month, every quarter is an eon in terms of the investment

time continuum.

So there's a duration mismatch between the investment time continuum and kind of geopolitics.

GW: Well, and expectations, which have compressed now.

I mean, for you running and having to deal with investors, if you're not making money

yesterday for me, why not, right?

So that's a really tricky position for you to be in.

KB: I'll give you a great anecdote.

I met with someone in the Russian finance ministry.

And we became-- we shared information.

This isn't a collusion thing.

We were talking very specifically about this the geopolitical economic situation and our

work in Asia.

And they were keen to understand a few of the points that I had made at a conference.

At the conclusion of the call, and I'd never really spoken at length with these people

before, but I know exactly who they are.

And I think they were brilliant in understanding flows.

They're the best I've ever spoken with, which is really interesting.

And at the end of the call, they said, well, you may be right, but we're Russia.

We'll be here when it happens.

We don't know if you'll be there when it happens.

We had this great information exchange and what I thought was a very productive call,

something that's going to be the beginning of a two-way flow that I was going to enjoy.

And at the end, he just made sure to let me know that I'm in a business that is a fickle

business and that they run the Russian Finance Ministry, and they'll be around.

GW: I mean, it is interesting, but it's a valid point.

But when you say you've got to be in now, how do you do that?

Because obviously, you've got currency strains, you've got the bond strains.

But you've also got this ability that the Chinese have to pull levers that we don't

even think about, and you've got that tailwind for them and that people will sit and believe

any number that comes out of China, because it's generally accretive to their own investment


If the Chinese say our GDP is 8%, no one's going to argue.

They don't want to cause bullshit.

People say well, you can't prove it.

So how do you position yourself to have skin in the game that is manageable?

KB: You just have to try to time it.

I mean, that's the best answer I can give you is you have to try to time it.

GW: But is it currency?

Is it the bond market?

Is it equities?

KB: It's currency.

Again, the only arbiter of the Chinese position is going to be their currency.

Right, if you're in the Chinese stock market, or if you're the Chinese bond market, they

can manipulate that market.

They're big enough, they're smart enough.

You think about Hong Kong and the financial crisis, you remember the HKMA bought funds.

GW: The tracker fund.

Absolutely right.

KB: And they bought a lot of them.

And so if you are short equities, they can ban short selling.

They can manipulate.

They can purchase.

They can do anything they want to do.

But again, the ultimate arbiter is what is the world willing to exchange an RMB for $1


GW: Sure.

KB: Because in the end, even though it's less than 1% of the Swift settlements, there is

still a number.

And if all of these things play out the way we think they're going to play out, then that

number's going to be dramatically different than it is today, and it's going to be a lot


Here's an interesting thought.

Back when China did its mini devaluation, and a trillion dollars left their reserves,

quickly, if they were to have devalued at that point in time, it would have looked like

a major moment of weakness, a move of weakness by Xi and his regime.

Interestingly enough, given our trade conflict, today we've served up an interesting plate

to President Xi or Emperor Xi, whatever you want to call him, Winnie the Pooh.

The way you look at it now is we've put him in a position where if he were to do, if he

were to weaponize the currency, and that's how the world would see it, it would look

like a move of strength, and we all know he has to do it at some point in time.

He wants to be the one controlling it, not some hedge fund guy in the US, or not some

other government.

He wants to be the one that makes that decision and he wants it to look like a move of strength.

By the way, the people in China, they'll barely feel it.

GW: That's right.

KB: It doesn't matter.


Look at what Russia when Ural's crude collapsed.

They masterfully made that adjustment in their currency, and it moved a huge-- it moved massively,


From 20 or 30 to 80.

And basically, the Russian people took that deval.

And I think the Chinese people are going to take their deval.

GW: When you think through what the Chinese need to do to manage this, because it feels

like it's something-- I think we all know this that some point, they are going to lose

control of this thing.

It's too big for them to be able to maintain this iron grip over it forever.

At some point, the real world is going to have an effect on it.

And that's when I think it starts to happen quickly.

How do they think about that?

How do they think, OK, here is how we are going to manage this problem?

Because they must see it.

KB: I think the number two guy in China, as we all know, is Wang Qishan.

Wang Qushan is an economic historian.

He's a very capable economic leader, and he's the one who essentially orchestrated the whole

restructuring of the Chinese banking system.

From '98 to 2002, he recapped all the banks.

And he knows how to put Humpty Dumpty back on the wall with the duct tape.

He knows how to get it done once he falls off.

But I think if you look back then, it cost them 30% of GDP in 2002, the BIS concluded.

Well, 30% of GDP today would be $3 1/2 trillion.

They only have $2 trillion of equity.

So they lose 1 1/2 times their equity in their banking system.

That's worse than we did in our financial crisis.

Again, orders of magnitude, you have just think about the constructor that market.

And so will they be able to do it?


Will they be trade competitive once again if they devalue enough?

They will.

Will it cost US consumers money?


Will the price of the US dollar based goods go up because China devalues?


That's where the press has it wrong.

GW: Why do they have it wrong?

Because this is not a complicated thing to understand.

Once you understand what the problem is, the dominoes fall in a pretty linear fashion.

There's no kind of quirky-- why is that people have it wrong?

KB: I'm going to sound conspiratorial, but I'll tell you there are a lot of reports out

there on Chinese influence and our think tanks.

I know of a few instances personally where the Chinese either pay the think tanks, or

more importantly, they pay a think tank writer's spouse to teach Chinese elite English.


KB: And they pay that spouse way more than the person that the think tank earns in a


GW: Right.

KB: And so they have a lot of influence, both in the media.

They have a lot of influence in the think tanks and in the universities of the US, and

so when the narrative comes that US trade spats with China are going to increase the

price of goods here, it just doesn't happen, and it won't happen, because the devaluation

of the Chinese currency will spread that tariff out amongst the Chinese people.

I can't imagine any goods here moving up in value.

GW: But it's interesting.

You think that the perception will be you're being conspiratorial, which in many ways is

a victory, because we all know this stuff goes on.

Of course, it does.

But it goes in both directions.

The West has less influence in China, because it obviously is much harder to get in there.

It's not an open economy.

But this idea that thinking about this stuff makes you conspiratorial is a massive win.

KB: It is.

GW: Because it shouldn't be that way.

This is-- KB: It's becoming better though.

I mean-- GW: It is a little bit.

KB: Take the press narrative in the last six months.

GW: Yes, that's true, but again, that's almost-- the pendulum didn't swing.

The pendulum's just gone from all over here to all over there suddenly.

And now, it's OK to think that everything is a conspiracy, and everything is influenced


I mean, there's no middle ground anywhere at the moment.

But in something like this, where it's a case of either making money or losing money, that's

not necessarily the worst thing.

Having that clarity is probably a good thing.

When you look at the currency positions and trying to actually capture this, obviously,

we've seen these long term trades get exhausted and the times run out.

Is there a way to do this effectively?

You know, is it forwards?

Is it currency options?

How are you looking into it-- without giving away the secret sauce obviously, but how are

you thinking of positioning yourself so that you have some time?

KB: So one of the things we use in our firm is you know what the definition of a long

term trade is?

A short term trade that went bad.

GW: Right.

You're not the only one, I'm sure.

KB: But you know, look at the convergence.

One of the other things that's really working against this currency pair, and we keep focusing

on China, is you look at SHIBOR as it approaches dollar LIBOR, you know that SHIBOR used to

be 400 basis points higher than dollar LIBOR.

Now it's only 100 basis points.

You've had rates convergence.

So when you look at the forwards, the implied forward rate in that marketplace in the offshore,

CNH, so you look at the 12 month forwards, the negative carry costs have come down to

literally some peanuts.

And in the past, you had a significant negative carry.

So you have this confluence of events where the carries have come down to be negligible

at a time in which the current account's going negative over there, and the world has been

lulled sleep thinking that this currency pair is going to be fairly solid, and now this

is when things happen, right, when these flows.

I'm not saying it's tomorrow.

I'm just saying that their current account's in a bad shape, we're imposing tariffs, and

we haven't even started to discuss the bill that we're going to put in front of them for

all the IP theft.

GW: Well, let's start about that, because I know you and I spoke about this before,

and I know it's something you've done a lot of work on.

But let's talk about that bill, because again, it's something that's kind of sailed under

the radar, surprisingly to me, because it is such an important aspect of this whole

dynamic, and yet, you barely read anything about it.

KB: I think they wanted to get somewhere on trade first.

I think they tried to get to NAFTA first, because we have this wild man-- you know,

Lopez Obrador is probably a bigger wildcard than Trump is, given his prior rhetoric.

So I think they were trying to get things done with NAFTA.

I think they're trying to get things done with trade.

And then when we start talking about intellectual property, I found the Defense Authorization

bill that just passed in the US, which was a little bit of a rejigging of CFIUS and then

changing maybe a little bit of the way that that foreign investment is being viewed here

in the US.

That bill passed like 407 to 8.

It passed in the biggest bipartisan way I've seen since September 11th.

So you're starting to see this idea of reparations almost for intellectual property theft and

trade, happens to be a nonpartisan idea, which is something that is fascinating to me.

GW: Is that-- I wonder whether that's an understanding of the depth of the problem, or I mean, it

doesn't matter which way it is.

Or is it convenient, OK, look over here, here's a guy we can both have enmity towards?

We don't have to fight each other.

Here's a guy over here that we can rally around and come together on.

KB: It's hard for me to say, because since it's something that I spend a lot of time

on, the people I meet in DC, whether at the Defense Department, the Treasury, or State,

they all fully understand.

In fact, they understand so much more than has been put in the press, as to what's really

going on.

And so I feel like there's cohesion.

I haven't met with a lot of the politicians, right, meaning in the House or the Senate.

I stick with the agencies, and the agencies get it.

GW: Yeah.

And when you have those conversations, are you are you talking the same language, or

are you having to educate, and then they understand it, or are they on the same page as you and

it's like-- KB: Again, it depends who the audience is.

If it's someone that is deeply in the weeds with financial flows, they actually know them

better than we do.

We're just trying to give them rationale for why they're happening that way, and the converse

is also true.

If it's someone that is a state actor that doesn't spend a lot of time looking at the

flows, then you're educating on flows, and they're telling you why the flows are happening.

GW: Yeah, you're right.

KB: We don't believe that we have more expertise than anyone in DC.

I just believe there are certain pockets in which we may know a little bit more, because

we've studied it for such a long time.

But I think in the bigger picture, I think they know more about the bigger picture than

we'll ever know.

GW: I find that interesting because you can't help but feel as though not just DC, but in

the UK, anywhere you get around government, there's so much chaos and so much noise and

so many distractions that I struggle to get a sense that anyone really understands what's

going on, because how can you?

It's like how can Jamie Dimon know what the hell is going on JP Morgan?

It's such a gigantic institution with so many moving parts.

So you know, to hear you talk that when you meet with these people individually, they

really do get it, you then have to hope well, OK, but when they escalate this thing to who

knows where, can that person process all these different strands of information in a way

that you can, because that's your training, that's how you've built a successful career

is on processing information into a solution to it.

Can they synthesize this, or are they going to need help doing that?

KB: The better question-- that's a great question.

There's actually a better one.

GW: I'm always up for a better question.

KB: The second derivative of that question is when you talk to the people that, let's

call them the rank and file, the people that aren't the leaders of these departments, that

have things really figured out and have them really dialed in, and they understand all

the inner workings of what's happening, and they go to their superior, who let's say,

the president appointed and said, I'm going to anoint you to run this department, and

that superior might have completely ulterior motives.

That person might have been financing films his whole life, and the Chinese might be the

ones financing them.

And so it doesn't matter what you say to him.

Can tell him exactly what's happening, and there might be a motive that once that person

is out of that seat, they just hope they can finance some more films.

GW: Yeah, sure.

KB: You see what I'm saying?

GW: Absolutely.

KB: So I think the variables that come into play aren't necessarily logical.

They aren't necessarily financial, and they can be not only purely political.

They can be purely personal.

They can actually be greed and avarice over everything else, which is exactly the way

some of the state actors that are non US understand that that's how we think.

And that's why they're so effective in implementing their strategies against us.

It's like your Neo in The Matrix and you start to see you start to see how the whole matrix

is put together, and then you just want to do what your friend did and go to New Zealand

and-- GW: Right.

KB: And realize that this is an equation-- you know, it's not the Pythagorean Theorem

that has an answer.

It's more of a Mandelbrot set that you never get to the end of.

GW: Greed and avarice around the circles of hell.

Who would have ever thought such a thing could exist, right?

Karl, it's been a fascinating hour.

I've got to let you go.

I know that otherwise you and I would end up talking all day.

I can't thank you enough for taking time out of a crazy schedule to come and talk to us.

KB: Thank you.

GW: I really enjoyed it.

Thank you.

KB: Enjoyed it.

The Description of Kyle Bass on China's Major Risks & Opportunities (w/ Grant Williams)