Kyle Bass - RACE TO THE BOTTOM AND CURRENCY WAR

Kyle Bass

Tuesday, 15 Sep 2015

BASS: I THINK THAT WHEN YOU LOOK AT WHAT'S HAPPENED FOR THE LAST DECADE, AS YOU'VE SEEN FLOWS INTO EMERGING MARKETS, YOU HAVE SEEN DEVELOPED NATIONS RUN BIG CURRENT ACCOUNT DEFICITS, AND YOU'VE HAD A SEA OF NATIONS ESSENTIALLY RUN GIANT CURRENT ACCOUNT SURPLUSES AND THAT HAS BUILT FX RESERVE PILES IN THE EMERGING MARKETS. WHAT WE'RE SEEING NOW, FOR THE FIRST TIME IN A LONG TIME, IS A HUGE FX RESERVE DRAIN. I THINK YOU HAVE TO THINK ABOUT THIS CONCEPTUALLY FROM THE TOP. IN 2009, WHEN THE GLOBAL FINANCIAL CRISIS WAS AT ITS PEAK, KIND OF Q1 OF '09, WHAT YOU SAW IS THE CHINESE BANKING SECTOR GREW EXPONENTIALLY. IT ADDED 50% OF GDP IN '09, 50% OF GDP IN 2010. IN FACT, CHINESE BANK ASSETS SINCE 2007 ARE UP 400%. LET'S TALK DOLLARS. THEY'RE AT $31 TRILLION AGAINST AN ECONOMY THAT'S GOT 10 TRILLION OF GDP. SO THE CHINESE BANKING SECTOR IS 310% OF GDP OF ASSETS. WHEN YOU RUN A BANK EXPANSION THAT AGGRESSIVELY, THAT QUICKLY, YOU ARE GOING TO HAVE SOME LOSSES. AND OUR ASSERTION IS THAT YOU'RE JUST ENTERING THE NONPERFORMING LOANS CYCLE IN ASIA. AND THE SCARY THING ABOUT THAT IS, LET'S FORGET ABOUT CHINESE STOCKS FOR A MINUTE. IF YOU HAVE 30 TRILLION IN YOUR BANKING SECTOR AND YOU LOSE LET'S SAY 10% OF ASSETS, WHICH WE THINK IS LIKELY, YOU ARE GOING TO LOSE $3 TRILLION. WELL, WHEN YOU BREAK DOWN THE FX RESERVE PILE, IT'S KIND OF A ELUSORY THAT THEY ARE GOING TO HAVE TO USE A LOT OF THAT MONEY, THEY WILL HAVE TO SELL SOME MORE BONDS AND RAISE SOME MORE DEBT TO RECAP THEIR BANKING SYSTEM. AND THAT HOLDS TRUE PAN ASIA. SO IF YOU LOOK AT NON JAPAN ASIA, YOU LOOK AT COUNTRIES LIKE MALAYSIA, THAT HAVE ALMOST 700% OF GDP IN THEIR BANKING SYSTEM AND IT'S RUN BY SOMEONE THAT HAS MAGICALLY FOUND ALMOST A BILLION DOLLARS OF MONEY FROM HIS SOVEREIGN WEALTH FUND SITTING IN HIS PERSONAL ACCOUNT, AND HE IS ARRESTING PEOPLE – JOURNALISTS THAT ACTUALLY COVER THIS STORY – IT'S BECOMING PROBLEMATIC ALL OVER ASIA WITH FX RESERVE DRAINS AND THE SIZE OF HOST COUNTRIES' BANKING SYSTEMS TO THIS PROBLEM. THE COMMODITY COLLAPSE IS CAUSING THESE BANKING SYSTEMS TO HAVE STRESS. AND NOW YOU ARE SEEING INDUSTRIAL PRODUCTION LOOKING LOWER ALL ACROSS ASIA. YOU ARE SEEING DOUBLE DIGIT DECLINES IN INDUSTRIAL PRODUCTION. SO I THINK THOSE THAT ARE WATCHING WHETHER CHINESE STOCKS GO UP OR DOWN AREN'T PAYING ATTENTION, IN MY OPINION, TO WHAT IS THE REAL PROBLEM. AND THE PROBLEM IS THE LOANS THROUGH IN THIS BANKING SECTOR.

I THINK WITH EMERGING MARKETS BEING 42% OF GLOBAL GDP, WHAT I'M TELLING YOU IS GLOBAL GDP IS GOING TO SLOW DOWN MORE THAN PEOPLE THINK IT IS. NOW, THAT DOESN'T MEAN THAT THE U.S. MARKET IS AT SERIOUS RISK. I THINK THE U.S. MARKET AND THE U.S. MAY GROW INSTEAD OF A ONE TO TWO, IT MAY GROW – OR INSTEAD OF TWO TO THREE, IT MAY GROW ONE TO TWO. BUT IN EMERGING ECONOMIES LIKE THE ONES I AM TALKING ABOUT, THINK ABOUT SOUTH AFRICA FOR EXAMPLE. SOUTH AFRICA RUNS A 4.5% CURRENT ACCOUNT DEFICIT OF 4.5% FISCAL DEFICIT AND THEY HAVE 34 BILLION OF FX RESERVES. JUST A COUPLE OF MONTHS OF IMPORTS. SOUTH AFRICA IS COMPLETELY BROKE, AND WHEN YOU TALK TO THE RATINGS AGENCIES' ANALYSTS ABOUT SOUTH AFRICA, THEY SAY, WELL BECAUSE IT IS A LARGE PART OF EMERGING – EM – THEY HOPE THAT PORTFOLIO FLOWS PLUG THESE HOLES BECAUSE THEY HAVE FOR THE LAST 20 YEARS. WELL, THAT'S NOT – HOPE IS NOT THE PROPER INVESTMENT STRATEGY. FOR THOSE THAT ARE RESERVE MANAGERS AND THOSE PEOPLE THAT INVEST IN EMERGING MARKETS, YOU BETTER PAY ATTENTION TO THE SIZE OF THEIR BANKING SYSTEMS, AND YOU BETTER THINK ABOUT WHAT THE LOSSES ARE GOING TO BE WHEN THEY RUN A REGULAR NONPERFORMING LOAN CYCLE THROUGH THEIR BANK. SO, WHAT WE'RE LOOKING AT ARE THE COUNTRIES AROUND THE WORLD THAT RUN TWIN DEFICITS. THE COUNTRIES AROUND THE WORLD THAT HAVE TO DEVALUE THEIR CURRENCY IN ORDER TO COME BACK TO SOME LEVEL OF COMPETITIVENESS WITH THE REST OF THE WORLD. AGAIN, WE TALK ABOUT THIS RACE TO THE BOTTOM AND THIS CURRENCY WAR. WELL, IT'S HAPPENING AS WE SPEAK AND CHINA JUST LITEREALLY JUST STARTED WITH ITS DEVALUATION PROCESS. WAIT UNTIL YOU SEE WHERE THAT GOES.

IN CHINA, LOANS GREATER THAN 90 DAYS PAST DUE GREW 167% IN THE FIRST HALF OF 2015. IT IS HAPPENING AND WE ARE ALREADY HERE. SO NONPERFORMING LOAN CYCLES TAKE ROUGHLY 10 TO 12 QUARTERS TO HIT THEIR PEAK. I THINK WE ARE KIND OF ONE OR TWO QUARTERS IN AND THE NEXT TWO YEARS ARE GOING TO BE TOUGH. BUT, THAT DOESN'T MEAN THE END OF THE WORLD. THAT JUST MEANS YOU BETTER PAY ATTENTION IF YOU HAVE A BIG EM PORTFOLIO.