May 27, 2014
by Robert Huebscher

Kyle Bass
Kyle Bass

For the last several years, nobody has been more outspokenly bearish on Japan than Kyle Bass. In a recent talk, Bass reiterated his doubts about Japan’s chances of averting a debt crisis. What’s more, he also said China’s economy will fall below expectations.

Bass changed one aspect of his outlook on Japan. Instead of predicting a collapse of the Japanese bond market, he focused on a severe weakening of the yen – without predicting when that might happen.
His predictions for China were equally distressing. He said that its banks will be saddled with non-performing loans and that its economy is actually contracting.

“I don’t think the markets are discounting what’s really happening in China,” he said.

Bass is the founder of Hayman Capital, a Dallas-based hedge fund. He was featured prominently in Michael Lewis’ recent book, The Big Short, for profiting from investments during the sub-prime crisis, which he accurately predicted.

He spoke on May 19 at in San Diego at the Strategic Investment Conference, which was sponsored by Altegris and John Mauldin.

I’ll look at Bass’ predictions for Asia’s two biggest economies – and how Bass believes investors can profit from their plights.

China

China’s economy isn’t just slowing down, according to Bass: It’ contracting. While China’s published rates for annual growth are still positive, Bass said the nation’s economic growth was negative from the fourth quarter of 2013 to the first quarter of 2014.

That is a result of excessive government spending on unproductive sectors of the economy. Bass said the People’s Bank of China (PBoC) has been more aggressive in its quantitative easing (QE) that the Federal Reserve has, but much of that money has gone into unproductive credit expansion.

China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.

China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.