Kyle Bass: Why the Chinese Economy is Going to Collapse

I know many companies that are us companies that have had billions of dollars in earnings sitting in Chinese Banks and they can't get it out Kyle bass is the founder and chief investment officer of hman Capital Management he's known for his preent bets on major global economic events in this episode we dive into why he views China's economy as actually collapsing and what he believes the big economic and financial priorities of the incoming us Administration should be this is American thought leaders and I'm Yan Kell Kyle bass such a pleasure to have you back on American thought leaders great to be here Yan so let's talk about the Chinese economy I think you're you know you're one of the people uh who you know understands this whole realm best you've said that you believe right now the Chinese economy is collapsing um you know that's also something that you know numerous people that are dubbed China Hawks have said in in the past while but somehow they managed to pull through you know the property sector you know absolutely collapsing I think unquestionably but somehow they seem to be pulling through and so you know why is it different now or is it different now yeah I think that um when you think about China you have to think about it in two spheres you have to think about domestic China and how they operate their own economy their own their own internal situation on call on the mainland and then you think about China Inc as they as they interface with the rest of the world and it's important to think about it in those two buckets and here's why um internally they have an R&B based economy and China can abandon moral hazard and they can I don't even know if they had a moral hazard but uh they know how to define it but they can do whatever they like there if their banking system isn't solv in an R&B they can print the R&B uh when you look at banking system it's about 350% of GDP the US banking system is one times GDP if you include the non-banks uh and and then the fanny and Freddy's of the world were about 1.7 times GDP in our banks so China's banking system is twice as large as ours in an economy um substantially smaller than ours in a world in which they've only been at call it Advanced banking since 2002 they've only been at this 20 years so they've got a lot of plat spinning and they've got a lot of Leverage and almost 40% of Bank Assets in China are lent to domestic real estate so if you're real estate Market's down 30 to 50 and your economy is three and a half times lever to your Banks and your banks are insolvent you have a real problem and their problem is larger than ours was during the global financial crisis now Yan they were NE they would never tell you this they can't tell you that they don't want to show that they're weak they control all of the data but it's easy to see the architecture of their economy what they did wrong and what they've done wrong and what's happening internally their dealings with the rest of the world is are are vital to them and what I mean by that is they import about 13 million barrels of crude oil every day that the world's largest importer of crude oil they import almost nine BCF of LNG every day they are the largest import of LG in the world they import 40% of their food every single day and all of those Imports they have to pay dollars for so where do they get the dollars is the question and they have to keep a robust trade relationship in dollars with us uh to be able to pay for their daily operations with the rest of the world because they have a closed capital account their R&B is not convertible into anything unless the Chinese party allows it to happen they control that escape valve so it's really an artificial exchange rate closed Capital account internal disaster but they've made a lot of money by being the world's Factory floor they've made it two ways right they've been the world's Factory floor uh since 2002 and then they started stealing IP and they they their IP if you think about this if you sto 200 to 300 billion dollars worth of Ip every year and you make a return on it by by employing it using it and even making it potentially better they've got a machine where they were Factory workers and stealing IP and the way you think about China Inc they've had a positive net income right so meaning if you and I were running a country we need to have more dollars coming in than leaving that's that's how you think about the current account and they've taken that money and they've spent it on modernizing the military so their capital investment has been make money while the sun is shining make some hay while the Sun's shining and then modernize your military and force project so that you can achieve your potential goal of global Primacy at at all costs and they're going to come up a daylight in a dollar short but it's going to be a potential kinetic situation if and when they take Taiwan and I think that's coming well so maybe just give me the the building block you mentioned a few different things there's this property sector and it's interesting how you divided on the internal and the external but but give me the pieces that make up the Chinese economy now well it's important to note that when you look at at the breakdown of their economy um real estate and its concentric circles were the driving force in the uh let's just say the in the uplift and lifting in lifting 400 million people from poverty into the lower middle class in China and and I'm going to tie the most important driver to maybe one of the biggest risks that's facing them real quick quick and it's happening in the developed world too we've seen all of these reports of birth rates collapsing whether we're talking about the US Europe or China and China's birth rate's collapsing faster than anyone else's and here's why Yan you just have to think about this intuitively um if you allow real estate prices or even encourage them to just move up and to the right and you know how loc local governments in China were selling land to developers and that's how they that's how they meet their local government budgets well as we all know that's not happening anymore because we're in a we're in a collapse but housing prices as a percentage so median housing prices in the numerator median income in the denominator uh in tier one cities in China that ratio got to be 25 times so imagine if you made $100,000 a year and you had a $2.5 million house could you afford it the answer is absolutely not right in the us at our subprime worst our median home price to median income got to 6.6 or almost seven times they got to 25 times so what happened in China with this call it um unrestricted speculation in real estate well the men when they graduate University they can't they don't have enough money to get an apartment and therefore they're not having sex and procreating and they're not getting married so if you look at the H the uh number of marriages in China it's collapsed the number of births has collapsed they've gone from you need 2.1 births per per woman to just sustain a population China's now down to 1.2 so what's happening they allowed real estate prices to get so high that no one can afford them coming out of University therefore their birth rates collapsed which becomes a real problem so the reason that China is not stimulating its domestic economy and turning real estate around and letting it letting it move back back up is Xi Jinping realized his folly and you remember when he came out uh in 2019 and he said uh U Financial Security is National Security and he realized that the the population demographic curve uh was was tanking and it was because they allowed this rampant speculation in real estate which basically was the Chinese Miracle the Chinese miracle was real estate and all the concentric circles around it move moving up into the right growing GDP exponentially and and basically becoming the growth engine for the world on paper but when you look at when you look at did that wealth in GDP creation end up in the pockets of investors imagine this 16 years ago if I told you that I knew that there was a country in the world that would become the world's second largest in GDP and it was going to grow its GDP 55 % over the next 17 years if you invested in their largest public index which is the shenzen Shanghai 300 index going into a 500% increase in GDP you would imagine you would have made more money than you could pull Vault over uh and instead what happened is you lost a third of your money so in the US we've grown our GDP over the same period about 75% and you're up about 4 40% if you invested in the S&P 500 so investing in communism has never worked in the long run it never will and they end up showing themselves and xingping has shown himself since roughly 2017 and so when you get into a scenario where you're trying to bet or Hope on a turn in the Chinese economy um and you realize that it's actually an architectural structural flaw in their economy it's just kind of a Fool's errand uh to I mean I'm not saying that you can't trade it I'm not saying that you can't get in front of a big government announcement and have stocks move up briefly which just happened uh but it's it's of my opinion that they have about two trillion dollar equivalent of equity in their banking system so I think about the first 14 trillion R&B that they print will only fill a hole you know it it's really interesting because there's aside from these uh the stock market in China which you know he said is is basically down a third there are actually quite a few Chinese companies that are through this you know very unusual mechanism listed on us exchanges I mean you know at least a thousand I don't know the exact number and you know and significantly invested in as well by Americans and others yeah it's actually crazy as you know if it's in the vi structure which is typically how all of them are not all of them the majority of them um then then you're only you only own a fantasy football warrant right vies have no ownership uh directly to the entity in China it's a tracking entity against their performance so there's actually no there there there's nothing underneath oh and by the way the vi aren't subject to us uh PC covered audits like every us company is um as you know in 2013 we entered into a memorandum memorandum of understanding between this China's Securities regulator the csrc and the US Securities accounting regulator under the SEC it's called the pcaob the public accounting oversight board so we said you know what even though every us company have subject to pcaob covered audits we just think China will be okay we'll just trust you guys uh and in fact you saw gendler did a spot audit of four Chinese companies and a spot audit means they just get to see the paperwork they don't get to call the banks they don't get to have interviews with these people in the companies they just get to read read some paperwork that's redacted and um they decided to give them another three years what's been happening Yan is insane uh we need to have uniform standards for listing in America period we should stop the shenanigans I would love to know how that happened do you know how that you know the exemption to actually having meaningful audits occurred in the first place and how this investment vehicle that you don't actually own any anything as you're telling me exists yeah if you own if you own a Chinese listed ADR in America it's a most likely call it 95% of them or call the variable interest entities vies uh and again they own nothing they don't have a claim they don't have any liquidation preference if the company liquidates in America there there are bank loans there are bonds they're stocks if a company gets sold or if a company get gets liquidated if things go poorly um there's a chain of a waterfall where you may you own this thing so you're going to get what you're deserved in China if it goes bankrupt and you own a viie you get absolutely nothing you have you have no claim on any assets and just imagine owning a fantasy football share in an economy run by a communist government who's our number one adversary um it's like it's actually hard to believe it's like antithetical to anyone's common sensibilities and yet we do it you know why because there's this 1.4 billion person rainbow over there and we can't wait to see sell something into them or see it perform so that we can make some money and in the end everyone's losing their money I mean in the end you're going to lose everything let's say most people that I've spoken with kind of an enthusiastic supporter of the Wall Street engagement that's been happening Scott missant you've been a huge supporter of his in fact to get for him getting the nomination which he has now um so what can we expect might be different from the past when it comes to treasury in your mind ear money does a lot of talking in DC and when you look at Scott Besson one thing you realize is a he doesn't need any more money he doesn't need to go raise money from the Chinese or the Saudis or anyone afterwards he is a pragmatist um he understands the plumbing of global Capital flows better than than anyone that was in the Running by far uh and he also has a gravitas amongst glob Central Bankers that is important he doesn't have to earn it he already has it uh so when he steps in there uh on January 20th or January 21st he has already has the world kind of mapped out and figured out and so when you say how is this going to change um we are not going to be taken advantage of the way we had been taken advantage of in the past we are going to use the Scott I believe will end up using the the the tip of the Spear of our economic power and we're going to start acting like we are the number one's the world's number one economic power we also need to know if you if you've listened to his growth plans you know you realize we're not going to be able to bring the national debt number down we're just going to have to grow the denominator we're going to have to get to three to four% growth we're going to have to get below 3% inflation and we're going to really energize our economy by unlock unlocking those kind of capitalistic animal spirits that were going to unlock because of the prior administration's just lockdown on many of these ideas uh in the interest of climate change and God knows what else and anti-competition um so I think when you think about this treasury versus whether it's yellen's treasury or minuchin's treasury um I mean I would bet all my money on this one and forget about the other two uh because Scott is is as talented as anyone has ever been in the position that he's in you know this Trump Administration is inheriting you know an an accelerating debt right and you know the debt payments becoming like an increasingly significant portion of the actual you know money that that's out there that's one side the other side is you know we have this Chinese economy per what you've been saying that's about to implode that's kind of insinuated itself into kind of everything the US economy for sure but all sort all all sorts of places right so the the the question is this seems to me to be an incredibly volatile situation that this Administration is inheriting how do you view that yeah I agree I think when you look at the time continuum of the United States and where where we've had our best years in in economic terms and financial terms you you have to go back to what makes this situation so unpredictable and so difficult to deal with is prior to 2009 the Federal Reserves balance sheet in in in the United States had never hit a trillion dollars so think about this 15 years ago we had never approached we had never broken a trillion dollars in fed balance sheet creation from 2009 to 2019 to call it the financial crisis up until the Wuhan uh um virus uh propagating itself around the world in a very small window 15 years we took the fed's balance sheet from below one below one all the way to 9 trillion dollar we created eight trillion of fed balance sheet in 15 years and the majority of it was created five trillion was created in a less than a 24mon period between 2020 and 2022 so we have huge imbalances they went berserk they cleared clearly overcooked it thank God Joe Mansion is alive or we'd have another trillion and a half or two trillion thrown into this so you have a scenario Yan where the macro forces acting on us and the rest of the world we just blew it we just pushed 40 to 50% dollar inflation to the world and the world has a negative convexity to our push meaning what we push them is only the beginning of what happens to them so if you look at the Middle Eastern economies surrounding let's just say Israel today um if you're not a monarchy um you have hyperinflated your currency it's it's just gone uh including turkey uh and if you look at the South American countries that struggle uh with populism we just push the same inflation to them because the way the world works is everything's priced in dollars so if we create dollar-based inflation that inflation affects the whole world um and you look at Japan Japan's 10-year bond is still at 1et of a percent you know why they can't move it so we push the inflation to them uh and what happens their currency depreciates 50 that's the that's the relief valve so it's vital it's desperately uh we must focus on the fed's balance sheet Capital Money creation and the deficits and I think there is a focus in this new Trump Administration through Elon Musk and Bak RIS Swami on Doge through Scott Besson at the treasury there is a focus on fiscal rectitude as much as we can do on on the cost cutting so we have a cost Cutting Crew and we have a growth crew and both of them need to be very successful and I'm I'm I'm very enthusiastic about that so Kyle you painted a picture here of you know basically a very fraud situation that kind of requires that the US be successful um where do you see kind of the biggest challenges that need to be overcome here or like the the key areas which need to be uh uh addressed in order to achieve this domestically uh I think the road map that the Trump Administration has um starting January 20th is exactly what's needed um I agree with the road map uh wholeheartedly in Scott besson's vision of of how the treasury will act and Elon musk's vision on on cost cutting boy I think all of those things together create such a beautiful uh menagerie of growth uh and and also fat cutting you know we need to be leaner meaner uh and we need to we need to we need to show our true economic potential and I think with those people in charge um along with President Trump I think we're gonna we're going to be able to achieve that that the the challenges that are Global are the inflation we just pushed to the world is very destabilizing from a um from a geopolitical perspective we we several countries around the world that are vital uh to their regions uh hyperinflated their currencies away uh to where now they're struggling with just operating on a day-to-day basis it's a real problem um China's economic collapse is a problem where you know they were they were a positive force on global GDP growth we know that they're having an economic collapse look at the Chinese bond market today the Chinese 10year is Comfortably below 2% around 1.75% the Chinese 30 years is below 2% think about that think about what what the Chinese bond market is telling you that the Chinese Communist Party won't tell you telling you that China is in a recession so that's a a enormous um let's just say speed bump uh in in the in the uh call it uh uh parland of global economic global economic growth GDP growth and what the US has to do to overcome that growth but remember it is vital to remember one thing people vote with their feet and their money the US is 4% of the world's population we are 25% of global GDP and we are 46% of global Capital markets so we are the economic superpower of the world and when the rest of the world falters and fumbles some of those people will buy Bitcoin which is why you see it above 106,000 because they can't stand us governance and values and everything that we've got uh going for us here uh and the rest of them will keep investing I think in US dollar denominated assets we still have the most innovator most Innovative population of of any population in the world we have the best education system in the world uh and we are uh we have the we have the greatest rule of law and uh I think human rights perspective of almost anywhere in the world so we kind of have it all going for us Y and I think that we need to remind ourselves that we are in the position that we're in and we need to do our best to move forward despite these Global situations but and you ask what the what the problems are there's a ground war in Europe between Russia and Ukraine that I don't see an off-ramp for I mean if we think we're just going to draw some arbitrary line and sign another Munich agreement you and I both know how that will turn out Israel Iran and Iran's proxies there's no real offramp for that war at all uh I think that is going to rage and again it's going to rage because we've had these built up animosities over time and long periods of prosperity have have allowed both sides to I guess build armaments and now you have a scenario where Iran and its proxies have the gloves off and um I again I don't see that stopping and invariably in the next few years during this Administration most likely you're going to see China take Taiwan and how do we react there so those are enormous geopolitical stumbling blocks to a beautiful growth story well and I I want to mention you know these values uh you know of Freedom democracy and so forth probably the best opportunity for America to enshrine these and and you know kind of live by EX ex Le yes I agree well Kyle bass uh it's such a pleasure to have had you on it's great to be here Yan thank you all for joining Kyle bass and me on this episode of American thought leaders I'm your host Yan Kell [Music]