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'China is a paper tiger,' says Kyle Bass, Hayman Capital Management

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By Silas Brown
09 Oct 2020

Kyle Bass, made famous by shorting the US housing market in the run up to the financial crisis, has told GlobalCapital that the Chinese state is a paper tiger on the road to collapse. The Texan, who has been on a fierce campaign against the Chinese Communist Party for years now, says that US politicians are finally catching up with his position.

Bass, who has run Hayman Capital from Dallas for 15 years, is known for predicting downfalls.

His greatest triumph was in 2007, with an enormous return from shorting subprime mortgages. He may not have featured in Michael Lewis’s book The Big Short, but he did show up in a later work of Lewis’s on the sovereign debt crisis, Boomerang: The Meltdown Tour. In the book, Lewis says Bass’s interest in sovereign debt stems from his childhood obsession with Risk, the board game with the tagline, "the game of global domination".

With China, Kyle Bass blurs the line between political activist and investor. One aspect that both character types hold is certainty of conviction, and Bass has that in spades. He has been a stern critic of the Chinese state for years, partly on investment grounds and partly on a broader, political basis.

Bass does not see his campaign against China as a mere investment, but a moral battle. This is fortunate, as Hayman Capital has not yet prospered from its views on China. 

Currently, the fund holds no investments against the Chinese economy, which Bass says is so he can present his strong views with a modicum of impartiality. However, he has his eyes fixed on Hong Kong, and has made an audacious bet against the currency’s peg to the dollar. Investors will cash out 64 times what they put in if the Hong Kong dollar falls 40% by the end of 2021. But if the peg holds firm, investors will lose everything.  

As tensions between China and the US rumble away over the summer, Bass doubled down on his public position. He believes industries like Hollywood and professional sport are laundering the reputation of the Chinese state. He defends trade tariffs and argues that the West needs to set up government departments that can wage economic war.

Bass lives with his wife Alexandra Suich, a senior correspondent at The Economist, in Dallas. 

GlobalCapital: Why is your view on China still a minority position in the US and in the West? What in the West provokes indifference to your perspective on the dangers of the Chinese state?

Kyle Bass: It’s a great question and there are two really simple answers to it.

The most simple answer is greed. Even in the UK, so many former MPs are on China's payroll, lobbying current MPs... actually, it's amazing to see [prime minister] Boris Johnson actually standing up to China as far as Huawei is concerned and a few other things.

China is so good at exploiting every nook, every cranny, every potential weakness of the human psyche, and of the Western legal system. They exploit the freedoms of the West by dangling the carrot, through overt bribery or bribing in other ways.

What I mean by that is opening your markets to select groups of people and keeping them closed to others, or giving business to specific companies and keeping business away from others. The Chinese state coerces with money, and money to a capitalist system is the best aphrodisiac.

The other answer is more structural. There are four manners of conflict a sovereign can enter into with another sovereign. There's the obvious one that has happened throughout the ages, physical conflict. Arguably, the US and the UK have two of the best physical war departments in the world. 

The second one is cyber warfare. Arguably, we’re among the top five in cyber war and we've been fighting that with China since the early 2000s. 

But the other two we struggle with. One is economic, which we have been handling on an ad hoc basis, in essence, defensively. Here, the US and the developed West must put together economic war departments. I know that might sound like warmongering, but just pragmatically and logically it's an absolute necessity.

The fourth one is a narrative/data war. China spends more on narrative and data than any country in the world and we need to match that. We have a sanctions department that punishes bad actors, but no narrative department telling the story. 

Data and narrative are the weapons of mass destruction of the future.

That is where the next battleground will be fought. It will be fought in a way that's coercive, controlling, and all knowing. He who has all the data wins.

Unfortunately, we have a leader in our country that is the single worst person to convey any kind of deeply thought strategic action against an adversary. He makes it sound like we're in kindergarten.

Purely regarding China and the interests of the US, who out of Joe Biden and Donald Trump would best serve those interests?

If you use history as your guide, there's no doubt the Trump administration is better at confronting China.

Bush Jr. and Obama ran the most passive administrations in relation to China in the US’s history. We basically prostrated ourselves to China. We hoped that enriching them and promoting proper Western rule of law, free and simple property ownership, open capital markets and an open capital account would show the Chinese a better way to prosperity. That plan didn't work out and in fact the Chinese went the other way. They exploited our openness.

Some of Biden's strategic advisers have been strong, though. Kurt Campbell wrote a piece in Foreign Policy a few weeks ago and Jake Sullivan gave speeches about how the Democratic Party won't be trading human rights issues for trade deals.

This was a good shot at the Trump administration. Trump wouldn't even speak the name Uighur. He would not talk about the crimes against humanity and cultural and ethnic genocide happening in China in the hopes of maintaining his beloved trade deal, which was somewhat of a joke in the first place.

In terms of practical policies, presumably trade tariffs aren’t the best response to China. What about a tax on capital flows?

I disagree with your assertion. Let me give an example — aluminium — and how SOEs [state-owned enterprises] and the Chinese state can change the balance of global production and how they violated World Trade Organisation rules.

Prior to us imposing the tariffs on China, our aluminium smelters were operating at 84% of capacity, and the supply/demand balance was good.

The number one input to aluminium smelting is electricity, so the Chinese state decided to give free electricity to their smelters. Then their smelters operate at a profit at any price. They took US capacity from 84% to 40% in a couple of years and at 40%, our aluminium business is out of business.

So, can the US government be dependent upon China for our strategic aluminium production, for military use or even auto manufacturing? Should we allow China to act in an uneconomic way and remove our ability to produce in a way that basically underpins US national security? The answer is no.

The only way to combat that is enormous tariffs on Chinese aluminium, as long as the state gives away free electricity. 

As a blanket statement, I wouldn’t say tariffs aren't a good thing. Tariffs are necessary if there are bad actors acting in a non-economic way.

All we need is a level playing field. We need to act with proper rule of law. 

We need not be punitive on the Chinese state, we just need their companies to adhere to US company listing standards if they want US money. If we follow proper English law and sanction bad actors around the world, like Pakistan or Venezuela, and Chinese banks decide to keep funding transactions with bad actors, well, then we need to sanction the Chinese banks too.

That's something the US hasn't been willing to do. But I'm telling you the US government has come around to this and you'll see these kinds of things in the next few months.

How much faith do you have in China’s economic reporting, and how do you debunk the data?

They report whatever they want to report. I literally don't even pay attention to their numbers.

The manner in which the Communist Party sets up the architecture of its financial system is very clever. I don't know if you know this but 95% of the chief economists in Asia are Communist Party members. When you have a Goldman Sachs partnership in China, they require joint venture partnerships. Nothing can be printed without someone in the Communist Party approving it being printed.

I know this because I know senior people at these firms and talk to them, sometimes on a daily basis. They'll tell me their thoughts and I'll say, ‘Well, why don't you print that?’ 

They’ll say ‘Oh, that would never get through editing or we would never get that through our chief economist — but this is really what’s going on’.

The Chinese state is able to control the data flow and the narrative in the financial sphere through Western firms, because Western firms agree to this architecture.

It's important to note how you debunk a Chinese number: it's really easy. China says for example their exports grew 8% in a quarter, yet you look at their top 10 exporting importers that are buying exports from China. Let's say all of them had a quarter that was down 4.6%, then China's plus eight is probably not the number — it's probably minus 4% or minus 5%.

It's our job to figure out what the truth is. And it's not by listening to their reporting.

You mentioned JVs. It looks like China is opening its capital account, with a bunch of high profile investors piling into the country. What’s your advice to them?

I'll correct something you said. China is not opening its capital account. 

You need to be thinking about the spider and the fly, right? The spider is going to let the fly come into the web, but it's not going to let him lead the way. What China has done so well is they get marquee investors and they allow them special access to enrich themselves.

Those people then become evangelical about the benefits of doing business in China. It's brilliant.

Allowing a few billionaires in to make a few more billion and then creating billionaire evangelical cheerleaders is a brilliant exploitation of the West.

But that’s a fool's game. Many less consequential to China who have invested on a smaller basis have fallen into difficulty. All of a sudden your Chinese partner writes you out of the shareholding universe and you spend eight years and $15m in court with them, which one of my friends just did and ended up with nothing.

Those things happen all the time but it won't happen to the marquee investors so China won't screw them.

What about institutions like the NBA or industries like Hollywood which have expanded heavily in China? Is your view that they’re going down a rabbit hole they’ll struggle to get out of?

It's all greed. I mean, do you think the ‘woke’ NBA would have a practice facility in Xinjiang? It boggles my mind. In a post-truth world whatever narratives are out there, people adhere to. If people can make more money by just closing their eyes, they will. 

Look at Disney's web page and look at their mission statement, then they film Mulan in Xinjiang and their lead actress is a very pro-Communist Party member. Like, it makes no sense to me other than greed.

I mean, how many movies have you seen in the last decade where the antagonist is some nefarious Chinese state actor? During the Cold War, the movies painted Russia in a negative light and Hollywood had a field day with them.

But now that Hollywood thinks they can make money syndicating their movies in China, they won't allow Chinese to be the bad actors. 

That's the laissez-faire attitude that has to change.

You don't have any positions in China, and what interests me is that you’re still prepared to do interviews on the subject. You have moved from being investor to being an activist on the subject. What’s in it for you?

My career has been focused on financial systems, studying flows and trying to understand where either opportunities or risks are in these systems. I started with the US system and then moved into the greater European systems, and then Japan, China and subsequently Hong Kong.

Going down that rabbit hole, spending time with consultants and advisers, reading books and talking to people and governments and understanding the manner in which they operate, led me to reading history books on China, which I never did in my university days.

I studied the closed capital system of China, trying to understand how the supposed second largest economy in the world has a closed capital account and still interacts with the rest of the world. It's taken me many, many years to understand the manner in which they operate.

I’m not alone in taking a stern view. Take Sir Geoffrey Nice’s report and ChinaTribunal.com. I mean, I applaud the UK for actually putting together a group run by one of the top QCs in England to talk about live organ harvesting by prisoners of conscience in northern China. I don't know how anyone can read Geoffrey Nice’s report and even engage one more day with China. 

I can't believe these kinds of ethnic genocides are happening in this day and age and yet, all of these various groups of people tend to just turn a blind eye because of money. 

There's certain things in your life that you decide to be passionate about.

I'm passionate about a number of other things, too. I love our environment, trees, flowers. As I get older, I become a little softer. But at the same time, given the wealth of knowledge I've accumulated through my years of study, I see the inner workings of the pure evil of the Chinese Communist Party and the self-righteous nature of this government. They prey on the poor governments of the world, from northern Africa to south America, to central America and southeast Asia. All of their Belt and Road programme is basically a rich, predatory nation taking advantage of poor nations for strategic reasons.

At the end of World War Two, we said never again. But we should have said never again and put an asterisk next to it. Never again, unless it can possibly make us some money.

On money, is it hard to make money as a China bear? Beyond your ethical case, is that also why you don’t hold positions in China?

Look it's hard to make money in basically anything today unless you own the five biggest stocks in America. The rest of the markets are down 7%-8% a year. The basic stock markets have done really poorly in the last couple of years.

I don’t use the term bear, I call it realism. If you're going to be realistic about China, and therefore not invest there, can you make money somewhere else? Yes, in US tech, in US biotech, but is it difficult? It's very difficult.

Your position on Hong Kong, its currency peg and its banking system; are you still confident a collapse will take place? 

Currency pegs are actually an old colonial tool from Great Britain. Whenever Great Britain was colonising areas, they would impose currency pegs, which made sense at the time.

But in modern economies having a rigid currency peg for 36 years, given the evolution of the economic and political forces in the region makes no sense, and actually it doesn't work.

Hong Kong is going through a pandemic depression on the back end of the protests that began in June 2019. By the third quarter of 2019 its economy had dropped 3%. Now, year-on-year Hong Kong has a real GDP decline of almost 10%, in a banking system that’s levered 850% to GDP.

So from the macro perspective, Hong Kong is going to have a full banking crisis, which will show itself in the third and fourth quarter of this year. 

On top of that, you have the political overlay here of China. You're going to see a number of people leaving Hong Kong because they're not going to submit themselves and their family to the arbitrary nature of the evil Chinese Communist Party. You wouldn't submit your own family to that.

I think around 10%-20% of depositors will leave Hong Kong. There's $3tr of deposits in Hong Kong, so that’s $300bn-$600bn leaving and their reserves are not really reserves.

Do you think we’re witnessing the end of Hong Kong as a financial centre of any global significance?

Correct. The reason Hong Kong was so important was there was English rule of law, and we could adjudicate our differences in a proper court system.

Now that's usurped by the Chinese Communist Party, people are going to move their business and their on-ramps to Singapore and other areas of influence in southeast Asia. Truthfully, some of it will move to Sydney, to London and New York. 

The big tycoons that have been in Hong Kong for their entire lives are moving their families out and that takes time. If you had grown an empire, you can't just turn the lights off and buy a house in London. It takes a while to move and those moves are happening as we speak.

There are two things one could infer from your views. One, that China could wreak a lot of damage but ultimately will collapse in and of itself. Or two, that China poses an existential threat to the West and that the concepts of the rule of law, democracy, habeas corpus, etc., could actually be no longer. 

China is still really an emerging economy, even though they claim to be the second largest economy in the world. It’s not a responsible global actor either.

China’s somewhat of a paper tiger, and I think they're going to collapse because they've played their political hands so poorly. Their financial architecture won’t allow them to be a foundational currency for the rest of the world.

China will have a real rough go of this, and I think the democratic West will actually coalesce together in combating all of the evil ways of China, despite the fact that China can continue to bribe everyone going forward. 

Their strength is only perceived strength.

Global economists that are all on China's payroll one way or the other say that they're the second largest economy at 15% of global GDP. But that is taking their renminbi-based economy and converting it back at a closed capital account exchange rate for the dollar. But if they opened their capital account, the renminbi would drop 40%-50%, and its economy would be just the third or the fourth largest economy in the world. 

The West gives China this status as the world's behemoth and that not dealing with China will have such negative consequences for the US and the developed West. 

If you're 15% of global GDP and yet only slightly over 1% of global transactions settle in your currency, the West holds all the cards and believe me when I say that Western governments have just figured this out.


By Silas Brown
09 Oct 2020