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Kyle Bass: China’s $34 trillion banking sector set to collapse 30-40%
(TRUNEWS) The Head of Dallas based hedge fund Hayman Capital Management, L.P., Kyle Bass, says China’s banking sector valued at $34 trillion is set to collapse 30-40%.
In his 12 page thesis titled “The $34 Trillion Experiment: China’s Banking System and the World’s Largest Macro Imbalance” Bass noted that China has an enormous debt problem from their non-performing loans (NPL), one which won’t be solvable by money printing or quantitative easing stimulus schemes. Bass emphasized that to survive this China must eliminate their over capacity problem, which has greatly contributed to the global deflationary supply glut, and allow the market to purge misallocated capital. This means waves of defaults and bankruptcies.
In an interview with CNBC on the subject last week Bass said “banking system losses – which could exceed 400% of the US banking losses incurred during the subprime crisis – are starting to accelerate,” adding “our research suggests that China does not have the financial arsenal to continue on without restructuring many of its banks and undergoing a large devaluation of its currency.”
Bass believes this “restructing” will force the Chinese to recap their banks by expanding the Peoples Bank of China (PBoC) balance sheet by “trillions and trillions of dollars.” He believes this will cause a devaluation of 30-40% because China’s Forex (FX) reserves are woefully small in comparison to the value of their financial sector.
From his paper, Bass offered four policy options for China:
1. Cut interest rates to zero and let the banks “extend and pretend” bad loans – lower interest rates will force more capital abroad putting downward pressure on reserves and the currency.
2. Use reserves to recapitalize its banks – this will reset the banking sector, but wipe out the limited reserve cushion that China has built up, and put downward pressure on the currency.
3. Print money to recapitalize its banks – this will reset the banking sector, but the expansion of the PBOC’s balance sheet will lead to downward pressure of the exchange rate.
4. Fiscal stimulus to revive the economy – this will help some chosen sectors of the real economy, but at the expense of higher domestic interest rates (if not done in conjunction with Chinese QE). The 2009 fiscal stimulus was primarily executed through the banking sector so a similar program would require a properly capitalized banking sector. Also, any increase in Chinese investment would reduce China’s trade surplus and ultimately pressure the currency.
Bass ended the paper by saying “once we drew this conclusion in the middle of last year, we decided to liquidate the majority of our risk assets and position ourselves for the various events that are likely to transpire along this long road to a Chinese credit and currency reset.”
Bass also predicted that “the next 18 months will be fraught with false-starts, risk rallies, and second-guessing.”