Kyle Bass Sticks To Guns On China At SALT: “It Will Happen Sooner Rather Than Later”

“I suppose I need someone to define hard landing for me.”

That’s from Kyle Bass who has taken it upon himself to go to war with China’s central bank.

Back in January, Bass began to lay out his thesis in earnest. “China is going to have to dramatically devalue its currency,” he said.

Of course China has already devalued their currency. Last August, the PBoC transitioned to a new FX regime wherein the central bank effectively manages the daily spot in order to manipulate the next day’s fix. In the old system, the situation worked the other way around. That is, they manipulated the fix (essentially) to control the spot.

In short, the dollar peg was causing the yuan to appreciate against the currencies of China’s trading partners. Clearly, that’s not desirable for an economy that relies on exports. By the end of last summer, China simply couldn’t take the pain any longer.

Things went haywire after that, as the market began betting that a deeper devaluation was likely in the cards. The pressure on the yuan forced the PBoC to drawdown its FX reserves in order to prop up the CNY spot and before long, the central bank was intervening everywhere (onshore and offshore) and began resorting to forwards to stop the reserve bleed.

Fast forward to December and China spooked the market again by adopting a trade-weighted reference index for the yuan which seemed to telegraph the central bank’s intention to weaken the currency further.

Mercifully, the dollar hit the skids this year, ushering in a (relative) period of calm for the PBoC as outflows slowed.

So that’s the backstory in a nutshell. Now back to Bass.

Bass’s thesis hinges on the notion that China’s elephantine banking system is lying about its NPLs which officially stand at 1.75%. Here’s a look at the trajectory of the official numbers via PWC:

At 1.75%, NPLs are at their highest in 11 years, but Bass - and nearly every other China watcher who’s predisposed to incredulity - thinks the real number is far, far larger.

For starters, the Politburo encourages (and by “encourages” I mean “demands”) that banks roll some of their sour loans rather than dumping them in the non-performing or special mention (i.e. doubtful) buckets. This is the same type of fudging that likely goes on with China’s notoriously dubious GDP prints.

But beyond that, Chinese banks carry an enormous amount of credit risk outside of traditional loans. It’s an exceptionally convoluted methodology, but in essence, the banks have an array of vehicles they use to channel credit to borrowers. These vehicles are sometimes classified as “investment receivables” and thus don’t show up on the NPL line even if they’re bad. If you want to know how big of an issue this practice truly is, consider that at just one mid-tier bank (Industrial Bank) the “investment receivables” book is larger than the entire Philippine banking system.

The math here is actually pretty simple. As Bass told CNBC in February, “they’ve let their banking system grow 1,000% in 10 years. It’s now $34.5 trillion.” Special mention loans sit at about, let’s call it 3% to be conservative. That would be a trillion dollar hit to the banking system. If the PBoC only has $3 trillion in reserves and it takes, by the IMF’s estimates, $2.7 trillion to manage the economy, they simply won’t have any money left to recapitalize the banks - especially considering the capital flight that’s been bleeding reserves for most of the last eight months. “They’ll have to expand the PBoC balance sheet by trillions and trillions of dollars,” Bass contends. When they do, look out below. Bass sees a 30-40% deval in the cards.

So why bring this up today? Because Bass was at the SkyBridge Alternatives Conference (SALT) yesterday reiterating his views amid a veritable cacophony of China banter. Here’s what he had to say via a transcript on ValueWalk:

“One of the biggest macro imbalances is the Chinese credit system…things are going to happen sooner rather than later.

When you start thinking about how levered China actually is, their asset liability mismatches are 10% of the system vs the US at 2-3% prior to our crisis. SOE’s are going bankrupt. The currency is an afterthought – just a product of the credit system.

We’ve seen credit declines in their partners – Hong Kong and Singapore. HK real estate is collapsing. As if the Chinese government is omnipotent enough to decide when this will happen! Look at credit growth at Malaysian banks. All these emerging markets have grown credit relentlessly. China may be able to fudge numbers for a while but their trading partners are telling the truth – they can’t lie. China just had the lowest GDP print in the last 41 years. Reverse migration for the first time in years. I suppose I need someone to define hard landing for me. Banking cycles take 12 quarters to reach peak and we’re two quarters in. So you need duration in your vehicle. It’s easy to maintain conviction. It’s harder to maintain investors.”

Bass was joined on the bear side by several others on the panel discussion at the Bellagio. But not everyone was gloomy. Unsurprisingly, China Investment Corp.’s Roslyn Zhang came to the country’s defense. “They really don’t know much about China but they just spend two seconds and put on the trade,” she said. “Should we pay 2 and 20 for treatment like this?”

Well Ms. Zhang, I suppose that depends. If Bass turns out to be right, he’ll make a fortune for himself and his investors on a bet that in hindsight will seem like a no brainer. Don’t forget, this is all set against an economic backdrop that includes rising bankruptcies and an acute overcapacity problem which makes it difficult for the sprawling industrial complex to service its debt.

But I’ll give Zhang one thing: if recent history is any guide, investors shouldn’t pay 2 and 20 for anything.

Spread the love

Comments are closed.