Kyle Bass to CNBC “The Chinese are in the worst financial situation they’ve been” [Full Transcript]

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CNBC Exclusive: CNBC Transcript: Hayman Capital‘s Kyle Bass Speaks with CNBC’s David Faber Today

WHEN: Today, Tuesday, October 23, 2018

WHERE: CNBC’s “Squawk on the Street

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DAVID FABER: Well, an interesting time to talk to well-known hedge fund manager, Kyle Bass. On November 4th, by the way, the U.S. is going to begin its sanctions against Iran. While there’s much focus on the effect those sanctions are going to have on the oil market, a perhaps overlooked impact is on the investment management business, which must divest from sanctioned entities. Well what does that mean? You just saw him and you’ll see him again: hedge fund manager Kyle Bass. He chairs the risk committee for UTIMCO – that is the endowment for the University of Texas and Texas A&M. It is the second largest endowment in the country. Kyle, it’s good to have you. This is an important topic. Before we attack it, I do want to just get your reflection on this market move today. It’s been a while since we’ve seen a down 2% in the S&P. You have any thoughts about why we’re having this down move or what may be causing it?

KYLE BASS: You know, I mean, clearly, this is not a monocausal event, David. But I think that – look, on this day back in 1929 was the beginning of the stock market crash. And October 19, 1987. It seems to be bad days in October seem to happen regularly. But I think when you look at today, one of your other guests earlier this morning pointed to the fact that, you know, the ruling coalition in Italy is essentially a Donald Trump and a Bernie Sanders deciding to rule together, so they’re going to lower taxes and raise spending And clearly, that’s not going to work with the European Union. I think that’s having a lot to do with global markets in the last several months. A lot more than people think it has.

FABER: Interesting. Alright. We’re gonna come back as well to that and talk specifically about China, but first let’s get to this specific news that I want to discuss with you. Because The University of Texas, Texas A&M Investment Management Company, the Office of Foreign Asset Control Compliance Procedures. You guys are putting this out today, basically letting those you invest with understand what you are going to do as a result of the sanctions that are going to take effect on November 4th. What is it that you are going to do and that other investment managers, Kyle, need to be aware of?

BASS: I think it’s really important to understand that, you know, most of the institutional community in the U.S. adheres to U.S. law and when – whether it’s the Treasury, whether it’s the BIS at Commerce or whether it’s the State Department sanctioning entities that are foreign entities, those are divested. But that’s a legal standard. There’s a fiduciary standard that I don’t think institutional investors in the U.S. have paid attention to. And I think that is – those companies that continue to do business with entities that we sanction are still invested in by the U.S. institutional investor community. We at the University of Texas are going to lead the way in raising the fiduciary standard for investors in the U.S. by saying, “If you’re going to invest in companies that -- that basically continue to defy U.S. sanctions and break U.S. law, we’re going to divest of you and we’re not going to buy your stocks, your bonds, your derivatives. And we’re not going to or allow our external managers to do so.” It actually is completely logical and it adheres to the fiduciary standard that we all should be adhering to. And the good news is the University of Texas is going to lead the way here.

FABER: Alright, well, as one of the largest endowments in the country, I would think that has an impact. But how do you communicate then with your external managers? Can they continue to own stakes in some of these companies but not for you? Or are you going to argue that they need to divest across the board, regardless of whether those are funds that are UTIMCO funds?

BASS: That’s a -- look, it’s all going to be, on the front end there’s going to be a little bit of friction. And you know all of our capital is externally managed. We have 45 billion in total money invested around the world. And you know if these investments are in comingled funds, we would imagine that the investment manager has to make a decision whether or not they need to adhere to this fiduciary standard for all of their investors or just for some of them. And, you know, we’re willing to work with all our external managers on setting up separately managed accounts that might exclude these investments, or if they want to make more difficult decisions, our investment team, our investment staff at UTIMCO is one of the best in the world. And they’re the ones doing the communicating. The board and investment staff together decided to enact this plan. And the investment staff is working with our external managers on making sure they get into compliance with our new compliance plan.

FABER: So do you think other investment managers and, by that token as well, private equity firms, I mean any of these large entities that have investments in what I would assume is an objectively verifiable list of companies that do business with Iran, are they all going to have to stop those investments?

BASS: I’d imagine that every institutional compliance manager and general counsel is going to have to be thinking about their fiduciary responsibilities here, David. And it’s interesting that over time there’s been a schism between the investment community and let’s say the operating community, where the investment community keeps moving ahead and -- with investments and companies that directly defy U.S. laws. And I find that to be unconscionable and so does the rest of our board. And so I think it’s important for the rest of the institutional investor community to start paying attention here.

FABER: Alright, so if you find that there’s a U.S. government authorized -- or that one of the companies on the list -- you have, what, 180 days to wind down the position. Is that right, Kyle?

BASS: Yeah, I think, look, the time limits are not that -- as important as the direction of where we’re going. And, you know, we want to do things that are commercially practical and we also want to not harm the corpus. We don’t want to cause losses in our portfolio. What we want to is parse through the list on the front end and think about these as sanctions get enacted going forward, we just want to be ahead of the curve. And so today, you know, the U.S. has primary sanctions on Syria, on Cuba, South Sudan. We’re reimposing the Iranian petroleum sanctions November 4th, we’re probably going to impose Myanmar and we’ve got some Russian and North Korean sanctions. Most of those don’t matter but when you get into a situation like Iran, I think it’s going to matter pretty materially across Western Europe, across India, across China. As you know, David, two countries have come out and said they simply won’t adhere to our Iranian sanctions and that’s Turkey and China. And this is going to have, I think, some reverberations across the world.

FABER: Interesting. Well, we’re going to be following it closely, Kyle. You mentioned China. In the few minutes I have left with you this morning, let’s talk a bit about China. Of course, our deteriorating relationship, the performance of the Chinese stock market, concerns about the economy -- they are certainly spilling over here. You’ve been following it closely. You’ve talked to us previously about the current account deficit going negative, you’ve talked about the currency. What are you seeing on the ground now in China that may be concerning you?

BASS: You know, the Chinese are in the worst financial situation they’ve been in, in the last 17 years because they operated domestic economy where they control the printing press, they control the press narrative, they control the price level and they control their people as we’ve seen them detain over a million of them in Jingjang for their religious preference. So they can change a lot of things domestically, but their -- the arbiter of the Chinese plan is their cross rate or their exchange rate with the rest of the world. China Inc.’s working capital account is now going South because they’re running what we believe to be a structural and more permanent deficit on the current account. And so, i.e., their working capital, their dollar balance whether it’s dollars, euros, yen or pounds, it’s mostly dollars. And their dollar balances is headed south. And so, the U.S. is in a very particularly interesting negotiating position today. We are in the strongest negotiating position we’ve ever had against China. They’ve kind of leveled the playing field a little bit more with their, let’s say, subversion of WTO rules, their intellectual property theft and basically everything they’ve done to take advantage of the U.S. over the past 15, 17 years.

FABER: And you and I have discussed this in the last couple of interviews we’ve done specific to this topic of China. But it’s not clear, Kyle, that the Chinese are going to back down from the asks, so to speak, whether it be intellectual property, whether it be on removing tariffs on U.S. goods. And I’m curious as to whether you think economic pressures -- and if you could explain what those might be -- will move the regime to a more cooperative stance.

BASS: Yeah. Again, I know, this is a little bit of an Archean subject. But I do think the negative current account makes china desperately short dollars. So what China has been doing is forcing their companies, whether they’re state-owned enterprises or private enterprises in China, to borrow dollars. So dollars are refundable. They go into the Chinese Central Bank. And I think he more pressure you see, that a) they create for themselves by running big imbalances between their raw materials and whatever they can produce domestically, and also the U.S. pushing back on the enormous trade deficit, all it does is add to, let’s say, the intense economic negativity that China is facing today. And not to mention David, as you know, they’ve recklessly built their credit system; their banking system is now four times their GDP. And they’ve got, you know, $40 trillion worth of credit, somewhere between 40 and 50, no one knows, in a system with only a couple trillion dollars’ worth of equity. And so China is running the largest financial experiment the world has ever seen. And the economic tides have turned negative for them. If you notice the narrative amongst the United States, it’s actually a bipartisan narrative whereby you’re seeing both sides of the aisle pushing back on China taking advantage of the U.S. And I think the U.S. is in a great negotiating position and this administration needs to level the playing field a little more. And it looks like they’re doing so.

FABER: Well, right. So, I mean, according to you then, they’re going to have to I guess borrow more dollars or figure out how to get more investors to invest in China. They need to attract more capital, right? You don’t seem to think they’re going to be able to do that, certainly not in the near term.

BASS: That’s correct. And you know, David, back in November 2016, when they were trying to stop the outflows, the elicit capital outflows of China’s capital controls, they took multinational corporations, a lot of them U.S. corporations, haven’t been able to get their money out of China since November 2016. I would be willing to bet that the investment community that has enormous amounts of capital invested in China probably couldn’t get that money out of China if they tried today.

FABER: Yeah. But they always seem to figure out a way to sort of either grow out of their problems, Kyle, and/or just borrow even more money. I mean, by the way, we’ve seen that globally for how many years now, right? You and I could have had a conversation ten years ago that was worried about the growing number of cash and assets in the world and it’s only gone up – I don’t even know what fold, but a lot. Why is now the time where you really believe, I guess, that they’re on some sort of a precipes?

BASS: Yeah, they’ve always been able to grow their working capital account. They’ve always been able to grow their dollar reserves while they’re running a big surplus with us and the rest of the world. That surplus has now turned into a deficit. And you know, what happens when 4 million Chinese people move from abject poverty to the middle class? They start traveling and spending abroad. They’re spending 320 billion dollars a year in just their travel services deficit. And four years ago when crude oil collapsed, China was importing 40% less crude than they are today. And now crude prices have come up from 35 to 70 or 35 almost to 80. And so --

FABER: Yeah.

BASS: -- their current account negativity is structural, it’s not cyclical, in my opinion. And so therefore, their desperate need for dollars is ever increasing. And so you see them trying to open up their capital markets to investors from the West. In fact, as you know, just this year, they said global financial institutions are allowed to now own more than 50% of their financial institutions. So right after they wrecked their banking system, they’re now inviting us in to invest in their banks. It seems to me like it’s beautifully premeditated and they’re trying to desperately seek dollars. And the question is, should people begin investing?

FABER: I know but bringing the world’s second largest economy to its knees, if you’re correct, wouldn’t necessarily seem to me to be a great recipe for success over here as well and certainly wouldn’t seem to presage a particularly great time for our own equity markets.

BASS: Yeah. I mean, David, whether you look at the defense department or the U.S. trade reps reports, the reports are that they steal $200 to $300 billion a year in intellectual property from the U.S. So we’ve exported 5 million jobs since China ascended the WTO in 2001 with the hopes that they would one day they would open up their markets to us. They haven’t. They haven’t lived up to their promises to us while they’ve been stealing intellectual property from us every year. And so, I don’t know if the hollowing out of the U.S.’ number our resource, our intellectual property, is a great idea either. There’s no easy solution here, David.

FABER: So it’s worth taking the pain? That’s basically what you’re saying here? It would be worth taking the near-term pain for the long-term gain of reclaiming our intellectual property, reclaiming the rule of law, reclaiming jobs.

BASS: That’s right. And if you look at --

FABER: Okay.

BASS: Look at what the Chinese do and not what they say. When the wealthy Chinese get the chance, they invest over here. They love a rule of law. They love the fact that their money can’t be taken from them and they love, you know, there are 350,000 Chinese students in the U.S., there are only 10,000 U.S. students in China. So, you know, what just happened with Jack Ma as a great example. Jack Ma was forced to resign and then he had to sign over his ownership in Alibaba to five unnamed individuals just three weeks ago. And you know, this isn’t carried on the front pages of the news but I think the U.S. still has the best financial system in the world.

FABER: As do many of us as well, Kyle. Listen, thank you. Iran sanctions, China, our markets. We covered a lot. Kyle Bass from Hayman Capital, as always we appreciate your time.

BASS: Thank you, David.

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