Kyle Bass says short Australia

Advertisement
imgres

From Advisor Perspectives:

China’s economy isn’t just slowing down, according to Bass: It’ contracting. While China’s published rates for annual growth are still positive, Bass said the nation’s economic growth was negative from the fourth quarter of 2013 to the first quarter of 2014.

That is a result of excessive government spending on unproductive sectors of the economy. Bass said the People’s Bank of China (PBoC) has been more aggressive in its quantitative easing (QE) that the Federal Reserve has, but much of that money has gone into unproductive credit expansion.

China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.

China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.

“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.” He said it is impossible to believe China could “manipulate” the inputs of its financial system without losing control of the outcomes.

Deflation is also threatening China. Bass said that its GDP deflator is now below zero. He expects the PBoC to engineer a devaluation of the renminbi as a way to stimulate exports and avert further deflation.

Bass said that if non-performing loans go from 1% to historical norms “somewhere in the teens” with loss severities of 100% for the worst loans, then China would delete its $4 trillion of foreign exchange reserves. Bass implied that China would need those reserves to stabilize its banking system, though he did not say so.

China’s leaders are fully aware of the dangers its economy faces, Bass said, and they hope to slow growth in a measured fashion, including through the restructuring of its banking system. “The jury’s out whether or not they can do it,” he said. “We actually believe they might be able to do that and that GDP [growth] is just going to slow down a lot more than people expect.”

“I’m not saying it is a calamity, a disaster or it’s going to end badly for the world,” Bass said. “All I’m saying is China is slowing down a lot faster than people think, and you need to think about how to position your portfolio for this.”

Bass advised against shorting Chinese equity as a way to capitalize on his forecast. Instead, he said, investors should look at China’s trading partners – Australia, New Zealand and Brazil. Those countries will be forced to loosen their monetary policy, raising rates and creating carry-trade opportunities.

I don’t think Mr Bass has done himself any favours at all with his Japan short of recent years, and some of the rhetoric about Chinese contraction is loopy, but the rest of it makes sense and Bass certainly still has his followers.

Advertisement
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.