[00:02:01] Clay Finck: So one of the hot topics of the past few years, especially has been China. And I thought there was no better person to invite on the show to chat about this than you.

[00:02:10] Clay Finck: China’s major indices over the past year are down north of 20 percent and down over 40 percent in the past five years. And additionally, many people are concerned about the potential spillover effects of the downfall of Evergrande back in 2021 and a potential collapse of their real estate market.

[00:02:27] Clay Finck: But I wanted to start with the potential of a Chinese invasion of Taiwan. You recently gave this presentation that I found to be quite fascinating, but also pretty alarming. So how about we get started with what is the primary motivation for China to want to invade Taiwan in the first place? 

[00:02:46] Kyle Bass: It’s a great question.

[00:02:47] Kyle Bass: I think when you look at the world today, the prognosticators, and especially Wall Street, like to think about everything in terms of logic, efficient market analysis the random walk, all of the things that you and I’ve grown up on, framing how we think about investment, how we think about rational actors, and that rational actors will always choose the most positive economic outcome.

[00:03:09] Kyle Bass: While Putin’s invasion of Ukraine was anything but a rational economic decision. And so I think number 1, the point we must make before we even dive in here is there are leaders in this world of totalitarian, genocidal killers that are running some of the largest, most dangerous countries in the world.

[00:03:30] Kyle Bass: They are not acting under a set of rational expectations or rational thought as they move forward. And I think that’s important to just identify right on, on the outset here, if Putin were a rational actor and he was a rational economic actor, he would have never invaded Ukraine in 2022. So when we think about what the rationale is for Xi Jinping and his intense desire to, as he puts it, reunify Taiwan, or actually he says to create, or I guess, put together the rejuvenation of the great Chinese race.

[00:04:05] Kyle Bass: Which is another way of saying we’d like Taiwan back when you understand what his motivations are and you listen to his speeches or read his speeches from, I’ve carefully looked at him from 2017 on he tells you in every speech that they will take Taiwan, whether it’s peacefully. Or not so peacefully that they will get this wayward province back in line.

[00:04:29] Kyle Bass: And that is not the way the people of Taiwan have thought about things since 1949. And in fact, the new election that they just had, essentially everyone in Taiwan is ethnic Chinese. And Xi Jinping claims sovereignty over anyone that’s ethnic Chinese, and they just shun Xi Jinping and voted for William Lai, who is their candidate, and not China’s favorite candidate, even though William Lai only won by seven points.

[00:04:56] Kyle Bass: He still won. And China has spent billions of dollars and has so many operatives in Taiwan trying to make that a reality for China. He actually failed and was shunned. So when you think about what he cares about with Taiwan, Taiwan isn’t actually the prize. Taiwan secures the first island chain. And if you’ve read the book, Unrestricted Warfare written by a couple of Chinese generals, you think about their long term goal is global primacy.

[00:05:24] Kyle Bass: They are tired of being the world’s number two economy, or the world’s number three, or wherever you think they are. Xi Jinping’s goal is global primacy at any cost, and securing the first island chain is something that they’ve talked about for decades. And that secures the first island chain. Taiwan is but a stepping stone to Southeast Asia and Oceania and to this goal of global primacy.

[00:05:47] Kyle Bass: And so whether you think that’s rational, whether you think that’s a positive economic outcome, it actually doesn’t matter to him. What matters to him is that he achieves this. And he said in a speech during the 20th party Congress, just. A couple of years ago, he said his life goal is the reunification of Taiwan.

[00:06:06] Kyle Bass: If he doesn’t achieve that life goal, his life has been an abject failure. So when you think about hearing him in his own words, that’s a pretty scary statement. And so I think it’s very important to take him for his word, which obviously we didn’t take Putin for his word, but let me read to you a quote from the speech he gave.

[00:06:28] Kyle Bass: He said, we must strengthen our sense of worry, adhere to bottom line thinking, which of course means party thought or Xi Jinping thought, prepare for danger in times of peace. And prepare to undergo high winds and waves. And even for the stormy seas of a major test. He said that in the last couple of years.

[00:06:48] Kyle Bass: He’s telling you what’s happening is he’s going to move and it could create a situation where. The world has to take sides, and I think that will likely happen. 

[00:06:59] Clay Finck: One of the things that sort of struck me in preparing for this conversation is that much of the information that various institutions have used to gather on what’s happening in China has actually been cut off by the CCP and it’s no longer available.

[00:07:14] Clay Finck: So why have such moves? been made by the CCP. We know they like to control data and information flow. And how are you able to get accurate information on what’s happening in China and really make sense of it? 

[00:07:28] Kyle Bass: No one has accurate data on China except the Chinese Communist Party. They do and used to, they began to adhere to Western standards and they put together data aggregators that collected both micro macro level data.

[00:07:40] Kyle Bass: And so they had a Bloomberg of China called wind and there were four or five others. And they were actually pretty good, but if you dug into the data, if you looked at the Chinese Customs Bureau for import and export, and you looked at the customs data that was in the wind database 1 year until they recently cut it off, it was off by 200 billion dollars.

[00:08:02] Kyle Bass: Not 2 billion dollars, 200 billion dollars. Then you think about trade with the US is what? 650 billion. So to be off by 200 billion, that just means someone’s really cooking the books. We all knew that Chinese data had low fidelity, and now there just isn’t Chinese data anymore. As of March of 2023, they severed all of those links to U.

[00:08:22] Kyle Bass: S. research universities, to the Fed, to Wall Street writ large, and that data is only allowed out of the mainland. To mainland data, call it readers, and they’re not allowed to share it unless the party approves it. So do you think you’re getting the truth? Probably not. And, they were reporting youth unemployment until they actually reported that it was over 20%.

[00:08:47] Kyle Bass: And then they say, we’re not going to report that anymore. If you read some Chinese scholars while that was going on, 1 of the top scholars at 1 of the top universities in China said. It looks like it’s 46 percent and then they silenced him. So all of the indicators point one way, Clay, and therefore, if you understand the architecture of their financial system and their banking system, you can make educated guesses on how much risk there is or how bad it’s going to get.

[00:09:14] Kyle Bass: And that’s where I end up. 

[00:09:16] Clay Finck: In a recent presentation you gave, you outlined a compelling argument supporting the idea that China is preparing for an invasion of Taiwan. Can you please outline what moves China has made from a military standpoint to support your thesis? 

[00:09:31] Kyle Bass: Again, I’m not a military expert, but I work closely with military experts and actually the U.

[00:09:36] Kyle Bass: S. military on these. And so I know enough really to be dangerous, but I’ve also been briefed by, let’s just say the people that know what’s really happening. So if you look at what China’s done in August of 22, they engaged in an operation called joint fire strike in April of 23. They engage in an operation called Operation Joint Sword, and the joints mean they’re moving PLA Army, PLA Navy, PLA Air Force, they’re moving jointly together at high speed and interacting properly.

[00:10:10] Kyle Bass: Now, as China’s never been in a major war in the modern era. And so the fact that they really need to coordinate all their forces, they need to show leadership that they’re ready for an invasion. And so we believe. That they must go through an amphibious assault as well. When you think about the 100 miles between the mainland and Taiwan, it’s a really difficult strait to navigate.

[00:10:37] Kyle Bass: And just when you think about what has to be pulled off here, the tidal surges in the strait are at least 22 feet between high tide and low tide. You’ve got at least three miles of mud bogs, so when you think about the Normandy invasion, if you remember, that had to happen at a very specific tidal moment to get the tanks and the heavy equipment on the beach and roll it up.

[00:10:59] Kyle Bass: And we actually, you probably know this, we sent people over even beforehand to test the sands, to make sure that our equipment could roll in that sand and that it was firm enough to allow that invasion to happen. And in Taiwan, the distance traveled is about three times what it was in Normandy. The tidal surges are much, they have much greater amplitude.

[00:11:19] Kyle Bass: There’s even a thermopylae problem there. There are a couple of choke points that are amphibious. troops are going to have to go through what are called choke points and mountain ranges that presents a problem for the Chinese. I guess the point I’m trying to make is they’ve already engaged in 2 of the 3 necessary exercises.

[00:11:35] Kyle Bass: They’re building the biggest hospital they’ve ever built right there on the coast in Fujian, which is the province that is right across the strait from Taiwan. They’re building bomb shelters all along the coast. They actually released it on some of their local government websites before the Chinese Communist Party killed the releases.

[00:11:53] Kyle Bass: We all caught it. So this isn’t supposition. This isn’t us guessing. We know this is happening. And they even admitted it was happening. They just didn’t have a strategy that was buttoned up enough for us to not see it. But when you think about the data being severed, it’s because all of the data is so bad that leadership doesn’t want to talk about how bad things are.

[00:12:13] Kyle Bass: They’d rather pretend. Those things aren’t bad. And I’ll take you to an October 2023 Reuters release where the People’s Bank of China, which is the regulator or the call it the Chinese Fed that regulates their banking system issued an edict in October 23 and it said, The local government financing bonds that exist in the marketplace in China, it’s a 13 trillion dollar equivalent market, a monster market in China.

[00:12:39] Kyle Bass: It’s all about how the local governments fund themselves by selling real estate. They sell real estate to pay their debts. They issue debt and to gather even more funding. And that 13 trillion dollar market is in default. 80 percent of those bonds are not paying. Those local governments can’t pay because there’s no real estate bid because every public developer in China is in default.

[00:13:00] Kyle Bass: When you think about what the PBOC said in October of 23, they said to the banks, if you own the debt or you own those bonds, you can just say they’re current and it won’t affect your ratings in our annual reviews of the banks. We’re just going to pretend that the market’s paying. Just think about that for a second.

[00:13:17] Kyle Bass: Clay, a 13 trillion market. is in a complete state of default, and we’re just not going to talk about it. 

[00:13:26] Clay Finck: And they’ve also been doing some other things on mainland China. You mentioned the hospitals they’ve been building, but talk more about the legal structure and the sort of laws they’ve been putting in place over the past few years.

[00:13:39] Kyle Bass: Yeah, I think if you were Xi Jinping and you knew that you were going to be subject to foreign sanctions, look, the sanctions we put on Russia. We’re a nothing burger. When you’re a leader in the United States and you’re going to sanction a foreign sovereign for their belligerence, sanctioning 10 percent of the oligarchs and leaving all of the banks on the Western system and able to move money around the world because you’re afraid of the price of oil and gas moving up is really again, it’s a, it’s not even a half measure.

[00:14:11] Kyle Bass: It was like a, not even a quarter measure. For what we should have done. We should have simply shut all travel off to Russians, to the West, no Russian passports in or out. Because right now Russians travel freely as long as they go through Istanbul, they can fly all over the world. The Russians really don’t care.

[00:14:29] Kyle Bass: I see a Russian woman every now and then who is a sister of one of my good friends’ wives, and she goes wherever she wants. And I say, how’s the war going? What’s going on inside Russia? She says, no, there’s just a few fewer men in the coffee shops, but it’s all fine. No one talks about it. Again, think about that.

[00:14:44] Kyle Bass: We really haven’t sanctioned anything or anyone when you really look at this. I know we’re going to try to get serious, but going back to what they’re doing in their legal system, in January of 2020, China updated its foreign investment law, giving Beijing the power and the ability to nationalize foreign assets or investments.

[00:15:03] Kyle Bass: Under special circumstances, which include war, that’s their words, not mine that began in January of 2020. That’s super interesting because that’s when a covid emanated from the city of Wuhan. So that’s when they began their legal movements in the system. In June of 2021, they issued a new counter foreign sanctions law.

[00:15:24] Kyle Bass: Foreign sovereigns that were sanctioning anyone in China, they were saying if Chinese. Corporate interests or international corporate interests that have business in China are adhering to foreign sanctions that are punitive on China. That China can just nationalize their interests, imprison the expats that live there, and basically turn their companies off.

[00:15:49] Kyle Bass: Basically they were countering foreign sanctions by saying we’ll just shut off all of your business here in China and we’ll take everything that you’ve got. That happened on June 21. In April of 23, Chinese lawmakers passed a new update to their anti espionage legislation. If you remember, that’s when they were raiding U.

[00:16:06] Kyle Bass: S. due diligence firms. They raided 3 or 4 firms, they arrested everyone, they took all of the computers, and due diligence firms were just doing due diligence, business due diligence. On potential acquisitions management teams, they’re everything that companies like Bain or McKenzie or these others do when they get hired to do due diligence, that became illegal and that had a chilling effect.

[00:16:33] Kyle Bass: On capital movement and or corporate interests in China. And again, if what you’re trying to do is attract investment dollars and become more Westernized or more capital markets focused, that was the plan for the last 20 years. And that’s what they told everyone. The plan was, but in the last few years, every single move that Xi Jinping has made legally or financially.

[00:16:56] Kyle Bass: Has been a head scratcher because it is not, again, logical. If you were trying to achieve the outcome that you and I were thinking they were trying to achieve in growing their economy, growing their capital markets and becoming the Asian financial hub. It is the counter foreign sanctions law, the counter espionage law requires every single Chinese citizen to spy on their neighbors and tell them if they think they’re doing anything that might counter national interests.

[00:17:20] Kyle Bass: And it just, again, put an enormous chilling effect on investment, but even abroad, that’s how they extend their authoritarianism to even in the United States. Imagine if you are a Chinese national, and you’re in school here, or you already have a job here at a tech company, and let’s say you have your green card, but your parents still live in Beijing, and your grandparents live in Beijing, or your family still lives there.

[00:17:45] Kyle Bass: If Beijing activates you and tells you, you need to give us data on that company, or the US government, or anyone you interface with, you’re forced to give it to them. There is, it’s difficult to draw a line. And again, this is not xenophobic. This is ours. Known for an adversary as defined by the director of national intelligence in this threat assessment report to Congress every year.

[00:18:08] Kyle Bass: Now, every single person that has any relatives in China can actually be coerced to break US law and forced to spy for China and these moves in their legal system have really had a chilling effect on the world. But if you were to write them all on a wall, this is what’s important in our offices and our firm is we just get out a whiteboard and we say, let’s just write the facts on the wall.

[00:18:34] Kyle Bass: Let’s forget about any kind of reporting slant, any kind of media bias, any of this, any of these things, let’s just look at the facts. And when you put all the facts out there on a whiteboard. They all point in one direction, and unfortunately, that means towards the acquisition of Taiwan and towards a militaristic belligerence that maybe, you know, Clay, maybe the world’s starting to believe that’s who they are.

[00:19:00] Kyle Bass: I made that determination in 2016, and you just have to spend enough time to just do the reading and understand what he’s saying and what the Communist Party is doing. Now, if you look at his purge of the missile force, his purge of the military, his purge of the He’s taken anyone out that had any prior allegiance to Jiang Zemin, to any prior ruler, and you probably saw what happened to Hu Jintao in the Party Congress when he was humiliatingly removed from the Congress.

[00:19:30] Kyle Bass: That was Xi Jinping sending a message. Everyone knows their life to me now. We won’t accept any dissenting views. And it is now the reincarnate of our generation that is now running China. And he’s not logical, but he’s driven and he’s driven to achieve these changes to the legal system to the financial system too.

[00:19:51] Kyle Bass: They’re the military that scare me. 

[00:19:55] Clay Finck: In light of those laws that you mentioned that were passed around COVID and ever since COVID, I actually ran across this chart that showed data from the administration of foreign exchange. It showed that China’s inbound foreign direct investment has just essentially collapsed.

[00:20:10] Clay Finck: It was, this data shows it was north of 300 billion just prior to COVID. And then in 2023 it is around 33 billion. Does that data sound accurate to you? 

[00:20:19] Kyle Bass: That’s right. And there’s a caveat to that data where they don’t asterisk and don’t tell you this, but it’s actually wildly negative. And let me explain to you how.

[00:20:27] Kyle Bass: If you are a corporate interest in the U. S. and, or a multinational and you have business in China Tesla’s got business in China, there are plenty of multinationals that have business there. Chevron has business there. The profits they make in China get put in a Chinese bank and China never lets them out.

[00:20:45] Kyle Bass: So I know many multinational companies that have hired friends of mine to try to get their money out. And China just, pardon the pun, gives them a bunch of red tape and won’t allow the money out. Every dollar that’s made by a multinational in China, if it stays in the bank through the end of the year, it’s counted as foreign direct investment into China.

[00:21:06] Kyle Bass: When you look at the FDI numbers, they’ll always be until they nationalize everything, right? Multinational profits in China are automatically FDI. And I think that’s also a lens that we need to be thinking about looking at things through. What is a complete collapse of FDI, by the way, Clay.

[00:21:23] Kyle Bass: Given all of the legal changes we’ve spoken about and given Xi Jinping’s publicly declared limitless partnership with the world’s number one war criminal, he’s not only declared it, he’s ratified it. They’ve met multiple times and they say things publicly, like we’re changing the world in a way that people haven’t changed the world in a hundred years.

[00:21:44] Kyle Bass: What on earth does that mean, Clay? So you have to realize that this is a very precarious time that we live in. 

[00:21:53] Clay Finck: You had mentioned sanctions. So if China were to end up invading Taiwan, they would need to be prepared for severe actions taken by the U. S., including things like sanctions. So what sort of sanctions might the U. S. implement and how is the CCP potentially working to protect themselves on this front? 

[00:22:12] Kyle Bass: Yeah. I know your podcast is intended to be timeless and I appreciate that about your podcast. It’s not a newsy podcast, but. I think that if you notice just in the last few days, and here we sit, call it end of February of 24 in the last few days, you’ve seen, actually, articles written about potentially, potential secondary sanctions for Chinese interests, helping the Russians acquire technology for the battlefield and for the military, very specific, targeted, potential secondary sanctions.

[00:22:42] Kyle Bass: Again, the Russian sanctions were really disappointing and not even half hearted. So when I think about China invading Taiwan and the fact that we will have, the world will be in a very different place if they do because you’ve had Japan publicly announce that the moment any kinetic action happens, they will defend Taiwan with everything they have.

[00:23:04] Kyle Bass: And as we have Article 5 protections. With Japan, so by deductive logic, we will be in that fight the moment it happens in theory. When I think about sanctions, if you were the President of the United States, and you had 2 buttons to press. 1 is to send carrier strike groups in to fight a kinetic war in the Taiwan Strait, knowing that you’re sending tens of thousands of our men and women into certain death.

[00:23:31] Kyle Bass: Now, would we prevail? I think we would prevail. I still think we have the most advanced military, the best military in the world. Has China had a big military buildup? Yes. Would it be an awful, ugly battle? Of course it would. War is the last thing that I want. Or there’s this other button. The other button is the sanctions button.

[00:23:48] Kyle Bass: It’s the financial tip of the spear. If you remove China’s ability to transfer dollars around the world, China still imports 40 percent of its food every day in dollars. They still import 12 million barrels a day of crude. They’re the largest importer of energy in the world, and they have to pay for it in dollars.

[00:24:08] Kyle Bass: They’re the largest importer of LNG in the world, every single day, and they have to pay for it in dollars. If I’m president, I press that button. And that button collapses the Chinese economy, and I’ll give you a great historical analogy, the wall in Russia didn’t fall because the Russian leadership woke up one day and said, you know what?

[00:24:30] Kyle Bass: I think you’re right. I think your value system is better than ours. I think your organizational system is better. You know what? Democracy is just better than communism and we agree. That’s not what happened. If you remember what happened, oil was taken down to 10 or 11 bucks a barrel in the Middle East and was overproducing.

[00:24:51] Kyle Bass: And Ural’s crude represented over 60 percent of Russian GDP, and we broke them. That’s what happened. We broke the Russians, and that’s how we dismantled the USSR. We can do it again with China now. Will a bunch of American business interests lose huge amounts of money? Yes. Do they deserve to lose it? Of course they do.

[00:25:13] Kyle Bass: They invested in a communist country. Investing in communism. You started this podcast with major averages down, 40 percent over a number of years and 20 percent this year. Think about this. Since the day that China took over Hong Kong in 2020, when COVID magically appeared at the height of the Hong Kong protests.

[00:25:33] Kyle Bass: Hong Kong’s markets are down 50, 5 0 percent. They’ve dropped every year since China took over. They’ve dropped every year for the last four years. This is the beginning of the fifth year that we’re in today. And this year they were already down 12 percent. So you’ve lost half your money. The beatings will continue until you actually figure out that investing in communism never works.

[00:25:54] Kyle Bass: It never works. Now, it might work for a short period of time because they’re trying to juice this market or stop short selling or this or that. But you made this point over a 15 year period. If you invested in China 15 years ago in their biggest index, the Shanghai Shenzhen 300. GDP is up 500 percent and you’ve lost a third of your money.

[00:26:13] Kyle Bass: Why would you ever do that? Imagine if I told you, Clay, that I know for a fact of a major economy that’s going to increase its GDP 500 percent over the next 15 years. And I know it for sure. You might have gone all in with your money. And you’d have lost a third of your money over a 15 year period. In the U.

[00:26:33] Kyle Bass: S., we’ve grown our GDP about 72 percent over the same time frame, and the S&P is up over 340%, and we have a rule of law, and we have the world’s most liquid deepest capital markets. If you just, again, write everything up on the walls and you say I need to be diversified. No, you don’t need to diversify into communism.

[00:26:53] Kyle Bass: You lose every time. You might have a good year. But you’ll never win in the long run. And so I think that’s important to be thinking about for investors. 

[00:27:02] Clay Finck: I want to get to talking more about China’s economy, but I think another important point related to the sanctions is what China is doing with their U.

[00:27:12] Clay Finck: S. treasury holdings. One would think, with interest rates where they’re at and all the imports China gets from the world that they would be continuing to build their U. S. treasury. Balance, but if they need to worry about sanctions, then they might not head that direction. So is that the primary motivation for them selling off treasuries instead of buying them?

[00:27:31] Clay Finck: And I’m also curious, what would they be diversifying into if it’s not treasuries? 

[00:27:37] Kyle Bass: If you were running very large, positive dollar trade balances, when you think about your net income as a sovereign, if it were positive each year in dollars. And the U. S. has the most liquid, deepest capital markets, and by the way, the highest short term interest rates in the world.

[00:27:52] Kyle Bass: You’d be piling in the treasury bills. You might buy one year’s, you might buy two years, you might buy six months. But your economic return and your liquidity happen to be in the same place, the highest. And instead, all is a continued liquidation of Chinese ownership of treasuries. If you actually weren’t running a dollar surplus And your economy was doing much worse than you’re admitting to.

[00:28:15] Kyle Bass: And you were trying to prop up your currency by selling dollars to buy your currency, which is what’s been happening for the last few years. Then what you’re projecting and telling the world is one thing and what you’re doing is another. For instance, South Korea did this in 97 and 98 until they ran out of dollars.

[00:28:32] Kyle Bass: And they actually lied to the world. I don’t know if you followed what happened in the Asian financial crisis, but China itself is forced to sell treasuries because they are actually running a negative current account negative net income account. So they propagate the narrative of we have this sort of Damocles holding over your head and we will show you, we will sell your treasuries in an offensive maneuver.

[00:28:55] Kyle Bass: When what they’re really doing is reeling from an economic collapse defensively and they’re forced to sell their treasuries because they have to pay for dollars. They have to pay for everything they import every day in dollars. You wonder where it’s going? They’re going to spend on a daily basis what they have to buy in dollars.

[00:29:12] Kyle Bass: There is no magical pile of dollars that China has. They’ve been lying all along about the size of their reserves. 

[00:29:20] Clay Finck: So in addition to what’s happening here, in relation to Taiwan, China definitely seems to be going through a financial crisis of their own, which you’ve touched on plenty here. And a lot of data has pointed towards an economic contraction, but they actually reported GDP growth of 5.

[00:29:38] Clay Finck: 3 percent in 2023. And real estate is definitely a big part of China’s economy. So What are you seeing in their real estate market and how this plays into the bigger picture? 

[00:29:50] Kyle Bass: The data that’s actually being released, again, whether there’s proper fidelity in the data, nobody knows. Clearly it’s suspect, but Hong Kong’s real estate is down over 25%.

[00:30:01] Kyle Bass: Again, since China took over, that’s the largest decline ever. And that’s just a harbinger of more to come. And by the way, that’s probably that’s the reported number. We know the real numbers are much worse and we have a couple of anecdotes from people that we know that have traded in that market and been forced to trade in the real estate market there.

[00:30:22] Kyle Bass: And it’s much worse than people think it is. But when you think about the Chinese, you mentioned that Chinese real estate is vital to their GDP. It’s somewhere between 33 percent and 40 percent of their GDP. It’s 70 percent of their net worth. And it is, it was the primary driver of the Chinese miracle of their GDP growth.

[00:30:41] Kyle Bass: And imagine if you allowed reckless speculation in your real estate markets. Your GDP grows, all the ancillary services grow. Everyone technically gets wealthier and wealthier. The banks lend into it. The bank, their banking system is three and a half times the size of its GDP. The U. S. going into a financial crisis was one time our GDP.

[00:31:02] Kyle Bass: And you know how bad we screwed this up back in 2008. And if you include non banks like Fannie and Freddie and other financials, we’re about 1. 7 times. They’re three and a half times levered to their GDP. They’ve only been at the capital markets for about 20 years, ever since they ascended to the WTO. Are there a bunch of smart technocrats in China?

[00:31:20] Kyle Bass: Yeah, they’re smart. We were smart too. And you know where we got. Their leverage is instantly more than ours was going into 08. Their system is brand new and they have multiple plates spinning and the plates are starting to fall. So in the real estate market, if real estate starts to drop. What happens?

[00:31:38] Kyle Bass: Local government debt financing vehicles can’t pay their debts. That’s a real problem because that’s a 13 trillion market. Every public developer in China is in bankruptcy. Between China, Evergrande and Country Garden, two companies have 500 billion worth of debt that trade in like single pennies.

[00:32:00] Kyle Bass: And if you think about the U. S. financial crisis, we lost about 880 billion of equity in our system. There’s two companies that have 500 billion that’s been wiped out and all the rest of them in bankruptcy and all the municipalities. can’t pay their debts. Like the order of magnitude of what’s happening there are multiples of what it was here, and they have a close capital account.

[00:32:24] Kyle Bass: They’re in real trouble, right? They can’t just fix things. Now, Xi Jinping, on the R&B side, meaning internally in their economy, could he print a huge amount of R&B, abandon moral hazard, and just plug these holes? Yes, and it’s likely what he will do. He will create internal inflation, which is again, 

[00:32:43] Kyle Bass: I have a theory, a thesis that looks to be true. It’s hard to prove, but if you know what the demographers were saying about China’s population, Crowning and heading down in between, call it a couple of years ago in 2050, we knew it was going to come down a little bit way out to 2050 and now that number is collapsing and the average fertility rate of the Chinese woman is 1.

[00:33:09] Kyle Bass: 2 and you need 2. 1 to sustain a population. My view on this is if you allow real estate to reach the heights that it reached in China, again, if you look at median home price in the U. S. to median income at the peak of our subprime folly, it was about six and a half times. In China today, it’s around 17 times and it got as high as 25 times in tier 1 cities.

[00:33:33] Kyle Bass: So completely unaffordable. No way. Can you buy these things? So what happens to the men graduating university? They can’t afford to buy an apartment, so they go live with mom and dad. They live with mom and dad in the basement or another room. They’re not having kids, they’re not marrying. So you see the Chinese marriage rate collapse, you see the birth rate collapse.

[00:33:53] Kyle Bass: That’s the unintended consequence of allowing a market to grow unregulated, unabated, in a speculative frenzy, which was a real estate market. When Xi Jinping said, Financial security is national security. Two years ago, and he said, no more speculating in real estate. Have you noticed? It hasn’t bounced.

[00:34:10] Kyle Bass: It can’t bounce. It actually needs to come back down to a level that allows his economy to operate properly. What does that do? Wipes out the banks. What does that do? It takes every Western investor that invested a penny in their real estate markets to be completely wiped out.

[00:34:27] Kyle Bass: And their GDP is going to be reset and their GDP is much lower minus that rampant speculation than anyone thinks it is. And so all of those things are also a real problem. If you’re thinking about geopolitics, you’re thinking about Xi Jinping’s consolidation of power and what he wants and what he wants to achieve.

[00:34:47] Kyle Bass: And what’s happening to his economy right now is a complete collapse in his real estate markets and the architecture of his system. If that’s the case. Clay, do you think that means that he is more or less likely to move kinetically on Taiwan? He can change the narrative pretty quickly and generate some national fervor because he controls all of the tools of dictatorship in his hand today.

[00:35:10] Kyle Bass: He has all of it. And so he controls the narrative. He controls the military, controls the Politburo. He can actually create a narrative to the people in China. Propagate it and go fight. And so I know that doesn’t sound logical to any economic actor, but it’s very logical if you get in the head of Xi Jinping.

[00:35:29] Kyle Bass: That’s why I think this war over Taiwan is coming 

[00:35:33] Clay Finck: Now, you were ahead of the curve on the great financial crisis, and that just shook the whole world economy. So I’m curious if you see the crisis in China affecting other major economies globally in the coming years. 

[00:35:47] Kyle Bass: Look, I hope I’m wrong about this. It’s obvious that I’m some percentage of right because it’s happening.

[00:35:52] Kyle Bass: I hope I’m wrong about the war part, and I don’t have any great history of predicting a geopolitical disaster on the war side, on the kinetic side. But if you just, I’m trying to look at all the cards as they lie and decide what’s likely to happen. So when you look at the global financial crisis.

[00:36:12] Kyle Bass: China actually became the engine that pulled the world out of the global financial crisis. That’s when they became. A believer in themselves that they were now the prime of power and you heard everyone say there’s almost this Ipse Dixit statement or edict that, East is rising in the West is declining, that was the narrative they wanted out there.

[00:36:33] Kyle Bass: They thought they pulled the world out of the financial crisis and they did it by increasing the size of their money supply and allowing their real estate market to grow unabated and attracting capital. Now the capital is going the other way. If China has a real problem like they’re having now, will global GDP take a hit?

[00:36:54] Kyle Bass: It will. Will we have depression? Probably not. What the U. S. and Europe are so good at is, besides the fact that we are the entrepreneurial leaders of the world, and we have the best companies in the world, we have the best governance system in the world, we have the deepest capital markets in the world.

[00:37:10] Kyle Bass: We will adapt. If we can’t buy something in China, we’ll buy it somewhere else. And yes, it might be a little bit more expensive, might be difficult to get, but we will adapt. If all of a sudden there was a forced decoupling today, would that be difficult? Yes, it would be difficult. Are there national security problems?

[00:37:28] Kyle Bass: Yes. Chips, rare earth metals processing, we all know these things, right? And pharmaceuticals, basic APIs for antibiotics. Those are all problems. Is it rocket science kind of problems, or is it just focus and capital, just focus and capital. Now chips, 2 nanometer chips, are really hard to make. No one can make them except TSMC, and they’re only made in Taiwan.

[00:37:49] Kyle Bass: Be a problem. But if we had to all of a sudden revert back to. two generations ago of iPhones. Would the world stop? Wouldn’t stop, right? So again, I’m not trying to say the world’s coming to an end. If this happens, it’ll be difficult. And you’re asking if there’ll be a global hiccup in economic prosperity.

[00:38:07] Kyle Bass: And the answer is yes, there would be. We’ve had so many decades of prosperity in the global financial crisis. What? It was a bad 18 months in the market. Things turned around February of 09. We expanded the Fed’s balance sheet and voila, we were back to profits and rich people got richer and very few people lost money in the long run.

[00:38:27] Kyle Bass: So long periods of time of prosperity create weak leadership. They create the, let’s just say the wrong incentives to grow a really strong economy and strong nation. And that’s where we are right now. We’re after many periods of pure economic prosperity, and we’re at a point in time in which, unfortunately, we have a ground war in Europe with Russia, Ukraine, Hamas, and Israel.

[00:38:52] Kyle Bass: We even have basically the Shias willing to bind together, even with the other world’s malign actors, like China and Russia, and act in concert and share information. That’s really scary. The world’s kind of bifurcating into good guys and bad guys. And unfortunately, that’s where we stand today.

[00:39:10] Clay Finck: Before we get to how you invest in this environment, I wanted to mention that during your previous chat with us on the show, you were pretty adamant that the U. S. wouldn’t be able to afford increasing interest rates to the degree that they have to tackle inflation. Recently, you also said that the Fed is just totally out of touch with reality.

[00:39:31] Clay Finck: So presumably you think it’s a big mistake that they have taken the actions that they have with regards to interest rates. I’m curious to get your take on why that is, however else you want to take that. 

[00:39:42] Kyle Bass: In the circles of the DC elite, the academic elite, it’s a very self congratulatory circle. They’re not critical of each other.

[00:39:50] Kyle Bass: I’ve been invited into several of these meetings with the key people. And I am taken back when I hear them debating the Phillips Curve and I know this is a, this is not a pure economics podcast, but Phillips Curve is basically the relationship between unemployment and wages and it’s a historical relationship and talking about the Phillips Curve.

[00:40:12] Kyle Bass: And they’re today, they’re talking about do you think the service sector workers like the bartenders or waitresses, do you think that their future expectations of inflation are driving their wage demands? And you sit in a room with them. 15 of these people. And I say, have any of you spoken with a bartender or a waitress lately?

[00:40:30] Kyle Bass: I said, you guys just created 40 percent more broad money in 18 months and you created 45 percent inflation. That’s about what happened. Now they’ve only admitted to about 17 percent inflation because they chain weight things and they, the way that it’s calculated by the BLS and the Fed are, we didn’t want to go there.

[00:40:49] Kyle Bass: Bottom line is, they’re not admitting to the inflation that they just created. Now you and I in our wallets know exactly what we pay for. Food and energy and goods and buildings and houses. And we know what those things cost today. In fact, the NAHB, the government’s own index, is up 47 percent in three years.

[00:41:10] Kyle Bass: Right now that’s not chain weighted. That’s actually a price. So when you think about that and you think about the Fed created 40 percent more broad money in an 18 month period. and generated massive inflation and now they’ve raised rates 600 bps, And it slowed a few things down, but at the same time, the Fed and the Treasury, look, you want to believe they’re apolitical, but people like the vice chair write checks to people like Hillary Clinton, and again, I’m not being political, Democrat or Republican, I’m just stating a fact.

[00:41:44] Kyle Bass: That those people don’t want someone like Donald Trump ever being president and I’m not a Trump voter just to be clear, but I’m telling you that if you look at what they’re doing now, since November of last year, they realized we remember when the 10 year got above 5 percent and everyone was talking about the 10 year.

[00:42:04] Kyle Bass: Cracking 5% and that it was a real problem. Janet Yellen flipped and started funding 80% on the front end, 20% on the back end. If you and I had the backend a hundred percent, a hundred base points lower than the front end, we’d be funding ourselves at the cheaper rate, not the more expensive rate.

[00:42:20] Kyle Bass: And then there’s, there are a bunch of things that Yellen and Powell can do and think about it as. Funding slush markets. I call it a slush fund market. They’ve got about a trillion five between them today and they’re spending it. They’re flooding the market with liquidity to make the economy feel like it’s growing and everything’s fine.

[00:42:39] Kyle Bass: It’s important to know that interest expense is, if it were reset today at these rates, it far exceeds that of defense spending, right? We’re talking about almost a trillion dollars of interest expense. When the U. The S. government can’t really afford a 550-600 basis point increase, it’s true.

[00:42:56] Kyle Bass: Last year, the U. S. government spent 6. 1 trillion dollars. We brought in 4. 4 trillion in tax receipts. We ran one of the largest deficits. in the history of our country in peacetime at full employment. So is that sound policy? That is absolutely crazy. And yet here we are. And when was the last time you heard the Tea Party out of the Republicans?

[00:43:21] Kyle Bass: No one’s what the Fed and the treasury taught everyone is just spend, do whatever you want to do. We’ve got it. We will run monster deficits and we will create inflation in America. And we’ll just keep running with it and we’ll just keep underreporting it. And that’s literally where they are today. So they think they saved the world from the virus that emanated from Wuhan in 2019, 2020, and now they think they’ve gotten rid of inflation.

[00:43:50] Kyle Bass: Dragging under control. And Clay, when you hear terms like transitory, if the price level, let’s just do a quick exercise. The price level was 100 in January of 2020 and it’s 145 today. And let’s say for 1 year’s time, it stays at 145, which means there’s 0 inflation reported because it’s a year over year number.

[00:44:10] Kyle Bass: It was transitory. They won, but you and I are still paying 145 as a price level, as opposed to 100 3 years ago. It’s an abject disaster for our checkbooks. And yet they have won. They’ve tamed the inflation dragon. It’s just silly the way you think, the way that things are reported as opposed to your wallet and my wallet.

[00:44:30] Kyle Bass: I can’t spend a chain weighted dollar. I spend a real dollar and a real dollar pays real prices. They don’t pay the price. If you chain weight a car back to what it was 30 years ago with the same components, I actually have to buy today’s car with today’s dollar. And so they’re disconnected from reality in many ways, and their self congratulatory circles are actually pretty scary if you actually get to go behind the curtain and listen to them.

[00:44:57] Kyle Bass: So that’s what I mean. Can the U. S. afford 6 percent rates? Absolutely not. We just, again, we spent 6. 1 trillion on 4. 4 trillion receipts. People talk about deficits as a percentage of GDP. I think of this percentage of what we earned, we spent almost 40 percent more than we earned last year.

[00:45:16] Kyle Bass: 40, 4 0, whether it’s 4 percent of GDP or 5 or 6 the average American has no idea what that means. And it’s by design. If you say we spent 6. 1 and we only made 4. 4 trillion. That’s really bad. And so I think it’s important. To have, I’m getting on a soapbox, but there are 18 unelected people that control monetary policy for the whole world.

[00:45:39] Kyle Bass: That’s pretty interesting. They have no oversight. They have to go to Congress every now and then do Humphrey Hawkins testimony. And that’s about it. And they use economic speak and they move on and then they go high five themselves on saving the world from COVID and taming the inflation dragon. And here we are with a 145 price level.

[00:45:56] Kyle Bass: And by the way, that disproportionately affects the poor and the middle class, right? The rich own the assets and are levered to the assets that have gone up in price. How many rich people do you know that are less rich today than they were in 2020? I don’t know 1. I don’t know one. So how many poor people do you know?

[00:46:14] Kyle Bass: Or let’s just say economically disadvantaged folks that are doing better today than they were back then. It’s so much worse because they didn’t even have disposable income back then. And now the price of everything has moved up 40, 45%. So this is a disaster for those people. And so that’s the insidious nature of inflation and underreporting inflation and self congratulatory circles in DC.

[00:46:42] Kyle Bass: It’s obvious to you and I and to our wallets. It’s just hard to. 

[00:46:48] Clay Finck: One thing I really like about you is your contrarian view, and especially contrarian views when it comes to investing in the markets, for example, you capitalize on the great financial crisis back in 08. I remember during your last chat, you discussed farmland.

[00:47:04] Clay Finck: Has your positioning as an investor changed much at all over the past year or two? 

[00:47:09] Kyle Bass: No, thank you for saying so. I believe the Fed will stop. Shrinking its balance sheet. I believe we’re going to have a permanent 7 trillion Fed balance sheet. Again, think about this. From 1972 to 2008, the Fed only expanded its balance sheet by about 900 billion dollars.

[00:47:27] Kyle Bass: From 2008 to 2019, it expanded from 900 billion to about 4. 5 trillion. And then in 18 months, it hit 9 trillion. It’s a parabola. Once you put the money in the system, you can’t take it out. So when I think about what’s going to happen next and how I need to, how you and I and everyone listening needs to defend themselves from What’s inevitably coming our way.

[00:47:51] Kyle Bass: I want to be invested in real assets, real productive assets and assets. Also, that’s a broad statement, but assets that are productive assets that have some sort of income, but also I want to find assets where. Population migrations are happening in the best markets in the world, which happens to be in the US.

[00:48:11] Kyle Bass: So when you think about the US, you look at the coastal region, the West Coast and the Northeast being very high cost, very high tax, one could say mismanaged jurisdictions and where are the population movements happening in America? They’re moving to pro business, lower cost, lower or no tax jurisdictions.

[00:48:31] Kyle Bass: So you see movements, massive population movements. to places like Florida, Tennessee and Texas. And I say, rich people can go to Coeur d’Alene, Idaho and Aspid and this and that. You can’t move real companies to places like that. You have to move real companies where there’s affordability, where there’s expansive activity, where there are natural resources to accommodate those movements.

[00:48:53] Kyle Bass: So I want to buy real estate in front of that macro movement. And I actually want to be levered to that real estate. And I want to use a prudent amount of leverage. And then if you care about the environment, you care about, and not in a sense of just buying carbon credits and feeling good in a sense of actually fixing environmental impacts. I’m layering those on top of owning the real estate.

[00:49:18] Kyle Bass: To protect myself and build wetlands and rebuild streams, creeks and rivers and charge the people that are impacting those markets huge amounts of money for their impacts by selling them actual federally regulated credits. It’s a great business. It is super fun. You put on your snake boots, your waterproof snake boots, and you go.

[00:49:39] Kyle Bass: Out in the wetlands and out into timber forests, and you do the things that I know over the next 10 years, we’ll definitely maintain and grow the wealth and we’ll also have all of the macro tailwinds that are back. Now, if there’s a China-Taiwan war, will the rates go to zero? They’ll go to zero right away.

[00:50:01] Kyle Bass: The Fed will expand its balance sheet. Asset prices will continue to go up. I want to own what’s going to continue to go up. That also means stocks, stocks are up. I would rather own something tangible and productive that has even better macro tailwinds. And now I say that the people that own NVIDIA are much smarter than I.

[00:50:21] Kyle Bass: I don’t know how to value things like that into the future. I know the AI chip revolution is unbelievable. I know every 10, 000 new chips cost 500 million. I know NVIDIA is the best in the world at what they do. I’m not a tech investor, I’m not truly a biotech investor, so I’m just telling you what I know.

[00:50:40] Kyle Bass: And when you think about generational wealth over time, how many big generational wealthy families do you know that own a lot of land in interesting areas? Just about all of them, right? So I’m thinking about preserving and growing that wealth more carefully, and that’s what we’re doing at our firm.

[00:50:58] Kyle Bass: Conservation equity management is something I started 2. 5 years ago, and I’m having a ball doing it. And it was a major change in my life after being stuck to a screen since I was 21 years old and it’s redemptive. It’s fun. I know that we’re going to win. I just don’t know how much we’re going to win.

[00:51:17] Kyle Bass: And I know that I’ll be able to counter whatever the Fed’s doing because of what we’re doing. When I think about allocating family capital, I think things like apartment complexes, things like. Land and what we’re doing ahead of major population migrations. I think there’s so many ways to skin a cat, and I’ve chosen one that’s just a lot of fun for us.

[00:51:39] Kyle Bass: I think, and also there’s this intense desire. ESGs became a bad word because some of these things were greenwashed and were proven to be ridiculous. Get this the largest investment. And the biggest ESG fund on Wall Street was Alibaba. You can’t even make that up. How Alibaba fits the ESG fund is some tomfoolery that I actually never figured out.

[00:52:01] Clay Finck: Now, once you study financial markets long enough, and you read about some of these investors that short things or bet against markets, eventually they get to a point where they get burned for doing so. And with all your knowledge around China and how their bubble is much bigger than what day. The Great financial crisis was presumably because you aren’t long for anything in China.

[00:52:23] Clay Finck: So given your knowledge, I’m curious to hear if your position is to benefit from falling prices in any markets related to that. 

[00:52:33] Kyle Bass: There is a setup today in the world that I have never seen before and I actually don’t think it’ll ever happen again. So the linkage between the US dollar and the Chinese r and b is the Hong Kong dollar and the Hong Kong dollars.

[00:52:47] Kyle Bass: freely interchangeable with U. S. dollars at a very narrow band, call it seven spot seven five to seven spot eight five, a really narrow band. And if I’m right about all of the financial troubles I was just telling you about, it’s a little bit of a complex situation, but we have an organization in our asset management firm where we have a giant position in one thing, and this is it.

[00:53:09] Kyle Bass: We can buy U. S. treasuries, post them as collateral for selling the Hong Kong dollar forward. That’s super interesting because if nothing happens, I still make three and a half, 4%. Because of the positive carry. So they’re paying me to put myself in a levered position that allows me to invest around the views I’ve just given you for the last hour.

[00:53:32] Kyle Bass: And if I’m wrong, I still make money. That’s really interesting. If I’m right we will make multiples of our capital. So that is an endeavor that I will continue to Invest around and I think it’s inevitable. It will happen. I don’t know when the peg was put on the US dollar peg in Hong Kong 1983 because the Hong Kong dollar was collapsing 50 percent versus Western currencies when the world found out that Britain was negotiating to give.

[00:54:03] Kyle Bass: Hong Kong back to the Chinese. And again, here’s a fun historical anecdote. The day that they handed Hong Kong back to China was July 1st, 1997. Do you know when the Asian financial crisis began? July 2nd, 1997 is when the Thai bot broke its peg to the dollar. Some might say it’s a coincidence. Clearly it’s not.

[00:54:23] Kyle Bass: And now here we are again. with China absolutely walking away from the Sino British Joint Declaration in 1983 and the US Hong Kong Policy Act of 92. They just took over the legal system and the whole system of Hong Kong really early. They promised to leave it alone for 50 years and they took it early.

[00:54:42] Kyle Bass: Again, you ask how you position yourself around that. It is an institutional issue because you have to have, is the agreement, you have to be able to sell things forward and it’s not as easy as just buying an ETF, but building that mousetrap, once you’ve built it, you might as well keep it.

[00:54:57] Kyle Bass: And we have a great, big bet there and it’s for me, a lot of fun and one day that will happen. 

[00:55:03] Clay Finck: Kyle, I really appreciate you joining me. It’s an honor having you back on the show for a final handoff here. I just want to give you a chance to give a handoff to the audience and how they can learn more about you and any other resources you’d like to share and potentially anything else we needed to cover today.

[00:55:18] Kyle Bass: Yeah, sure. Again, we focus on investors in the private markets at our firm and it’s our firm, we have Hayman Capital that handles the Hong Kong situation. And then we have. We have Conservation Equity Management, which is our private equity firm, where we’re buying huge amounts of real estate in front of big macro population movements and doing environmental work.

[00:55:40] Kyle Bass: And all of those are based in Dallas and Nacogdoches, Texas, which is probably a place you’ve never heard of before. One of the best forestry schools in the country is there. And so if you want to reach out to us, look up. Conservation Equity Management’s website or Heyman’s website and go through Steele Schottenheimer.

[00:55:56] Kyle Bass: And we’d be happy to talk. Thanks for saying so Clay. 

[00:55:59] Clay Finck: Amazing. I’ll be sure to get all that linked in the show notes for those interested. 

[00:56:03] Kyle Bass: Great. 

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