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Kyle Bass on China’s reckless credit system

Kyle Bass who manages the $1.8 billion hedge fund Hayman Capital has a bearish view on the Chinese banking system. “China’s banking system has been recklessly built,” said Bass in an interview on Bloomberg Markets. Bass believes that China (FXI) (ASHR) (MCHI) has haphazardly built a system that is going to need a re-structure. In recent years, China’s credit system has multiplied at twice the rate of its GDP growth. Furthermore, over the last 6 years, credit in China has grown $6.5 trillion, while deposits have growth by $3 trillion. “China is running to stand still,” exclaimed Bass.

The country has reached the point where we may see the need for a restructure as inevitable. China has long been in line to get reserve currency status. On 1 October last year, the Chinese yuan was finally able to join the International Monetary Fund’s basket of reserve currencies. The milestone was a big achievement for the Chinese government’s attempt to be recognized as a global economic power. However, looking at the decisions that the authorities in China have taken in pursuit of this dream, China becoming an economic superpower is nothing short of a fallacy to Bass. He cites the example of the Chinese central bank’s decision of raising rates overnight to 120% annualized in an attempt to stop capital outflows from the economy. “Which other reserve currency would you see doing this?” questions Bass.

Confluence of events in China

Moreover, Donald Trump’s entry into the White House may have profound economic and geopolitical consequences for China. Amid all the speculation pertaining to who would win a trade war between U.S. and China, Bass believes that the China-US trade relation may end up somewhere between free trade and 45% tariffs. 2017 is a very interesting time for China as we’re soon going to see a confluence of three potential pivotal events happening at the same time:

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  1. President Xi Jinping attempting to consolidate his power at the 19th National Congress in the autumn of 2017
  2. Possibility of the US (SPY) embarking on a trade war with China
  3. China’s banking system forced into immediate re-structuring

China will soon be forced to make major decisions that have been sidelined for sometime now. With rampant credit growth in recent years, the economy will soon find itself at maximum leverage. It is then, that monetary policy tightening (raising interest rates) across developed markets(EFA) (VEA) would begin to hurt China.

Trading opportunity: Shorting the yuan?

As Kyle Bass sees it, China would soon have to recapitalize their banking system. And, when that happens, their currency is not going to be able to hold its value.

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