Bass are known to predict the true crisis in the market of mortgage securities in the United States, and well earned, buying insurance against default (CDS) on these securities. He also predicted the sovereign debt crisis of member countries of the European Union, as well as the problems in Japan and Argentina.
Now bass puts on the fall of China. Last week, he sent investors a letter explaining why the problems faced by China are much worse than the mortgage crisis in the US in 2008.
Bass talks about the upcoming loss of the Chinese banking system, which, according to his calculations, can exceed the losses of the American banks during the mortgage crisis by 400%. As soon as the government will understand that he will have to save the banks to avoid the collapse of the financial system, it will start to spend foreign exchange reserves. But now is not enough, writes bass. “The notion that the Chinese reserves will last for a year is a myth, China is already pinned to the wall, so the government is hypersensitive to any comments regarding the level of reserves and a hard landing of the economy,” the letter reads.
Record banking system
The Chinese economy shows the weakest growth rate since the 1970s, industrial production is falling rapidly, despite the decline in raw material prices, more and more companies become unprofitable. The unshakeable belief that China will be able to avoid more serious problems than a slight decline in GDP growth due to the further growth of lending to the economy, is reminiscent of 2006, when Americans were convinced that housing prices never go down, writes bass.
Since 2004, the Renminbi has appreciated by 60%, at this time, the Chinese government has invested heavily in infrastructure in order to achieve the specified policy of the party and government GDP growth rates. Bass illustrates the following data: in 2005 the share of exports accounted for 34% of GDP, the share of investment was 42% of GDP by 2014, the share of exports fell to 23% of GDP, the share of investments increased to 46% of GDP.
The situation in China is reminiscent of the crisis in Ireland and Spain, where in 2008 the construction, real estate and infrastructure investment accounted for a disproportionately high share of government spending and Bank lending.
Investment growth was financed by banks that led to the explosive growth of the banking system assets since 2006 has increased from $3 to $34 trillion. It’s 340% of China’s GDP. This was never in history, reminiscent of the bass. For comparison, before the mortgage crisis in the U.S. banking system assets was $16.5 trillion, or 100% of GDP. During the crisis, us banks lost about $650 billion, Chinese banks may lose about 10% of the assets, that is $3.5 trillion.
The myth of reserves
Investors, thinking about the problems of the Chinese economy and banking system, soothe yourself with thoughts of magic gold and foreign exchange reserves at $3.2 trillion (although the reserves declined by $100 billion a month). “We often hear the argument that no country in history has been accumulating such reserves,” says bass. However, the opinion that the Chinese reserves will last for a year — it’s just a myth, he said.
“When a country has such a large manufacturing base, a huge money supply (M2) and large volumes of imports and exports, it needs to have a certain level of highly liquid reserves to ensure that the daily work of the economy,” writes bass. The IMF developed a formula for calculating the appropriate level of reserves assumes that the minimum level of reserves shall not be less than 10% of exports + 30% of short-term foreign currency debt plus 10% of the money supply plus 15% of the remaining commitments. Under this formula, the Chinese reserves must be at least $2.7 trillion, bass estimated.
Fasten your seat belts
The surge in unemployment, increase in Bank costs lending squeeze, old-fashioned flight of depositors, or rather, just the fear of the development of events according to this scenario, will force the Chinese authorities to take decisive action.
The government may reduce its key interest rate to zero, banks were easier to deal with bad debts, but this will increase capital outflows and put further pressure on reserves and the exchange rate of the yuan. It can also put provisions for the recapitalization of banks, but the decline of reserves would also lead to the weakening of the yuan. Another variant of the actions of the Chinese authorities to print money to recapitalize banks that will also be negative for the yuan. In any case, the Chinese currency will weaken by 30%, sure bass.
Agree with him even a few managers of hedge funds. The Fund Manager Nexus, under the management of which is $500 million Brian McCarthy is confident that the Chinese economy will derail this year. Last year he predicted the decline of the yuan to the dollar, earning indicator of 16.5% per annum.
The founder of Odey Asset Management Fund, managing $12 billion Crispin Odei wrote in a letter to investors in October last year that “the Chinese authorities will not be able to cope with four bubbles in the property market, credit, stock and currency markets. This one is $29 trillion, and today’s policy of the Chinese authorities can only lead to further overproduction and falling prices. Eventually the yuan will fall by 30%,” said Odei. The return on its investment in January 2016 amounted to 14%.