If you ever wanted to get a look inside the mind of Kyle Bass, founder and CIO of Hayman Capital Management, here is your chance. In a wide-ranging discussion with Grant Williams, author of Things that Make You Go Hmm and co-founder of Real Vision TV, he shared his thoughts on position-sizing, China, the appeal of holding gold, central banking, interest rates – and much, much more.
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.
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