13 November 2021

Trey Lockerbie brings on a very special guest and that is Mr. Kyle Bass, the Founder, and Principal of Hayman Capital Management. Hayman’s first major success came from effectively shorting the housing market in 2008 and Kyle was profiled in Michael Lewis’ book The Big Short. More recently, Kyle has been heavily focused on China and has been sounding alarm bells from everything from their accounting protocols, military initiatives, and central bank digital currency development.

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  • The early days of Hayman Capital.
  • Why Kyle thinks our inflation rate is closer to 12%.
  • Why Kyle is protecting his capital by buying farmland.
  • Chinese real estate, demographics, accounting concerns.
  • Bitcoin, gold, and central bank digital currencies.
  • Oil and natural gas and why Kyle thinks we’ll soon be seeing unprecedented prices.
  • And a whole lot more!


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Trey Lockerbie (00:03):
In today’s episode, we have a very special guest for you and that is Mr. Kyle Bass, the founder, and principal of Hayman Capital Management. Hayman’s first major success came from effectively shorting the housing market in 2008, and Kyle was profiled in Michael Lewis’s book The Big Short.

Trey Lockerbie (00:19):
More recently, Kyle has been heavily focused on China and has been sounding alarm bells from everything from their accounting protocols, military initiatives, and central bank digital currency development. In this episode, we discuss the early days of Hayman Capital, why Kyle thinks our inflation rate is closer to 12%, why Kyle is protecting his capital by buying farmland, Chinese real estate, demographics, accounting concerns, cold wars, et cetera. Bitcoin, gold, central bank digital currencies, oil, natural gas, and why Kyle thinks we’ll be seeing unprecedented prices and a whole lot more.

Trey Lockerbie (00:53):
I’ve been a longtime admirer of Kyle’s, ever since I read The Big Short and it’s always great to meet folks like Kyle who are incredibly gracious and generous with their knowledge. This one is jam-packed. So, let’s get into all of it with the hyper-intelligent, Kyle Bass.

Intro (01:11):
You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Trey Lockerbie (01:31):
Welcome to The Investor’s Podcast. I’m your host, Trey Lockerbie, and man oh man, today we have an extremely special guest, and that is Mr. Kyle Bass. Kyle, welcome to the show.

Kyle Bass (01:43):
Glad to be here, Trey.

Trey Lockerbie (01:44):
I’m so excited to have you on. I’ve been following you ever since the Michael Lewis book and reading about The Big Short and that early success you had with Hayman Capital. I am really curious to start out here and learn a little bit more about how you developed this passion for investing in these macroeconomic themes and theories. How did you find that that was your niche or that was going to be your approach to investing?

Kyle Bass (02:12):
It was actually more of a logical process. When I launched the firm in 2006, we were actually very interested in long Asian equities and was looking, if you remember back then, that’s when housing prices had moved parabolically in the US, that’s when they were getting to be rough, seven times annual income and they’d always hung around four and a half times.

Kyle Bass (02:35):
We were looking at the housing market, knowing it was a bubble, trying to figure out how to basically asymmetrically be short housing. You do want to be necessarily short a home builder because a lot of them were being acquired, a lot of their mortgage origination businesses were being acquired, and there were a lot of risks there. In doing the work, trying to figure out how to really cap our downside, we got short some mortgage bonds, instead of mortgage originators.

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Kyle Bass (03:02):
That was a moment that came through due diligence and research and searching for something to get short. Then to hedge, being long Asia. I think, when you think back to the crisis, what central banks did and governments did is they took the bad private assets onto the public balance sheets. They started guaranteeing banks, they started investing in equity, they started taking on the risk of the bad assets of the market.

Kyle Bass (03:27):
Something that started as micro ended up being macro. The sovereigns were taking the bad private assets on the public balance sheets. That happened here, it happened in Europe, we studied Europe, we studied Europe’s banking system and the size of the call it, 20 biggest banks in Europe. The world moved, in my opinion, or at least in my mind, from micro-investing to macro investing, and now macro really drives sentiment and investing market-wide.

Kyle Bass (03:55):
I realized there are the idiosyncrasies of companies like Google and Facebook and the others, but the excess liquidity in the markets is what drives things. If all of a sudden the Fed were to really aggressively taper today, I don’t care what company you are, what stock you are, you’re probably not going to go up for a while. It just took me into a place where things were more, I think, for me more logical, it was just my own view.

Trey Lockerbie (04:19):
I recently heard Stan Druckenmiller talking about how the common theme with these very successful investors is that they always seem to have this concentrated position early on, this high conviction bet, basically. As I understand it, your fund, Hayman, was relatively new. I think you had around 33 million in assets under management if I’m not mistaken. I’m curious, at what point… How high was your conviction? Did you go all-in on this bet with the first fund of yours or was it a smaller allocation?

Kyle Bass (04:49):
Look, our big year was 2007, primarily, we were short mortgage bonds at par, and our negative carry was 1.5%, 2%. My downside scenario was when you think about all in, my downside scenario was I lost 2% a year in the position. My upside scenario is we made 80%, 90%, 100%. It’s hard to say that we went all in, but we had a meaningful position there.

Kyle Bass (05:39):
Then when we also launched our mortgage funds and our mortgage funds back then, at the end of ’06 is when we launched. I designed it so that it had about 10 times implicit leverage, and our negative carry was about 11% a year. Think about the proposition to investors was, I’m going to lose about a third of your money over a three-year period, or we’re going to make 10 times your money. It was a pretty good value proposition. You could say that was all in, but we ended up making about 6X, and it was a great transaction.

Trey Lockerbie (06:11):
That 2008 period, that’s when the Fed really broke the seal, so to speak, of all of this currency printing that they’ve been doing as of late. Is anything they’re doing today give you any kind of deja vu from that time in 2008?

Kyle Bass (06:26):
No. That’s a good question. I don’t believe we’re in a bubble today, as far as ratios are concerned and leverage in the system is a concern. We’re in a bubble today that I don’t think will pop because the Fed, regardless of how many mortgages they’re buying, I think it’s closer to 40 billion right now a month. But I think it’s important to note that we have 40% more cash abroad, money in our system than we had two years ago, or 18 months ago, when the virus first emanated from Wuhan.

Kyle Bass (06:58):
That’s never happened in the history of the United States, to have 40% more money in the system. I’m a monetarist at heart. I believe, if you increase the money supply by 40%, you’re going to have a 40% depreciation in purchasing power, roughly thereabouts.

Kyle Bass (07:14):
You and I both know inflation is running, call it mid-teens, if not higher, and interest rates are still at zero. The insidious negative real rates of return are hitting our savings in a major way, and that’s what’s going on. When you think about mortgages, and housing availability, who knew that when the virus plagued the world, that the first thing that would happen is people would just go… When rates went to zero and mortgage rates collapsed even further, that everybody just bought every house they could find. I wouldn’t have bet that actually. But that’s what happened.

Kyle Bass (07:47):
Now, we’re in a scenario where the price of everything has gone up, including residential housing, including commercial real estate. While it’s much higher than it once was, I don’t believe we’re in a bubble because of the amount of liquidity in the system.

Trey Lockerbie (08:02):
That raises the question for me around real estate, how much longer do you think this whole run is before you consider it to be a bubble?

Kyle Bass (08:12):
I will agree that I think the amount of appreciation of real estate in the last two years, it’s unprecedented. It’s never moved this far this fast. But I think that for it to be a bubble, it’s going to have to get to many multiples of people’s income. We have more job openings today than we have jobless people, which is a really strange phenomenon as well. We’re seeing the price levels of wages move.

Kyle Bass (08:40):
My answer to you is, I think assets, including real estate, are going to continue to move much higher over the next decade because I think the central banks can’t raise rates more than 100 basis points. We’re not going to move the front end very much, and it’s going to flatten the curve when they do. I think if we started aggressively raising rates in ’22, I think you’re going to see the curve flatten and maybe even invert almost immediately. That’s a real difficult scenario for the central banks.

Trey Lockerbie (09:07):
I’ve heard this opinion, to some degree, before, about this expectation that the Fed can’t raise rates upwards of say, 2%. What is that based on exactly? I know that the interest on our debt, at some point becomes untenable. Is that the theory, and is there a certain number that you’re basing that on?

Kyle Bass (09:24):
Well, it’s not only that, it’s the expectations of the participants. When you look at corporate America, you look at individuals in America, everyone has reset their expectations to borrowing around these low rates. You have to think about the rate moves as a percentage of the base and not as an absolute. If rates dropped from 8% to 5%, and then we raise them 5% to 6% or 6% to 7%, you’re moving two off of five, or you’re moving down three off of eight. When you’re moving from five to zero, and then you try to go from zero to one, the rate increases almost infinitesimal meaning as a percentage of the base.

Kyle Bass (10:04):
That’s what’s more functionally relevant than the nominal change in rates. That’s number one. Number two, everyone is, including the sovereign, including the US Central Government balance sheet, if we move short rates, almost everything’s financed on the front end or the short end. So, if we raise rates from zero to one, and then one to two, all of a sudden interest on our national debt starts costing us more than 10% of GDP and things start to collapse. The government can’t afford that.

Kyle Bass (10:35):
This is not like the period of time in which Paul Volcker can ride in on a white horse and raise rates to snuff out inflation. Think about this, we won World War II, we deficit spent going into World War II. So, our national debt in 1946 was about 106% of GDP, and we won, we eliminated the productive capacity of about two continents, and we helped rebuild, with the Marshall Plan, Japan and part of continental Europe. We ran a trade surplus with every single trading partner in 1946.

Kyle Bass (11:10):
We were able to pay off our debt from 106% of GDP, down to the low 30s By the mid-1970s. When we had the embargo, and oil price spike of ’79, and then runaway inflation in 1980, where Volcker showed up, we could afford to briefly raise rates.

Kyle Bass (11:32):
It’s important to think about where we were in late 1970 when you look at our sovereign balance sheet and corporate balance sheets, and where we are today. Again, Volcker cannot ride in today and fix this. You can’t arrest inflation by raising short rates, you’ll bankrupt the nation, you’ll bankrupt corporate America, you’ll bankrupt everything. I’m of the opinion that a move from zero to 1% is about all we can do on the short end.

Trey Lockerbie (12:00):
You mentioned inflation earlier, and I’ve heard you use a term that honestly, I hadn’t come across before, which is chain-weighted inflation. Talk to us about the difference between chain-weighted and non-chain weighted inflation metrics and what that means for investors and their discount rates.

Kyle Bass (12:16):
It means that the government rigs inflation. Let me give you a perfect example. 30 years ago, the average price of an average car in America was about $13,000 a car. Today, that number is just over $40,000. It’s up over 300% in 30 years. When you think about the construct of the Consumer Price Index, or the CPI, there is an auto component to that construct. I’m just picking one out just because it’s easy for us to remember how much cars used to cost and how much they cost now.

Kyle Bass (12:54):
Of that 300 and so percent increase, what percentage of that do you think is made into the CPI? Of a plus 300 number, what do you think has been calculated into the CPI over that time frame?

Trey Lockerbie (13:08):

Kyle Bass (13:10):
Yeah, five and a half. Here’s what chain weighting means. They say, “Trey, we realize that your bank account just went down by $41,000 because you wrote a check for a new car. But we, the government, well, we must compare apples to apples. In your new car, you have a digital speedometer, in your old car, it was an analog speedometer, that was just driven by more mechanical means. If you were to replace your digital speedometer with that analog speedometer from 1990, then your speedometer wouldn’t cost $900, it would only cost $70.”

Kyle Bass (13:47):
The chain weight every part of the car. You have electric windows, well, maybe in 1990, you had the roll-up windows. You have to subtract the cost of electric windows, you have to subtract the cost of your GPS navigator, you have to subtract the cost of everything, to try to compare an apple to an apple, when in reality, your bank account still went down $40,000, and you wrote the check.

Kyle Bass (14:10):
But you have to realize that so many things are tied to the CPI, especially government pension payments and there is the cost of living adjustments tied to that number. When you look at, let’s say Germany, for example, they don’t chain weight their inflation data. Germany just printed year over year numbers of 11.7% inflation. Sounds about right to me.

Kyle Bass (14:34):
It’s so fascinating when you peel back the layers of the onion to try to understand what the incentives are behind the people putting these numbers together and then what real life is. Real-life is your bank account. Real-life is what things actually cost you, not what they used to cost 30 years ago because you had analog this and roll up that, it’s what can you buy today? How much does your bank account decline? They’re playing fantasy football with the numbers, they’re not giving you real numbers.

Kyle Bass (15:01):
It’s really important to think about, they always talk about also CPI of food and energy. They’re like, “Wait a minute, if you don’t drive or eat, your bank account would have been okay.” It’s just crazy. I try to look at things in real terms, and how they affect the population and what your wallet’s really feeling when you go fill your car up and what your wallet’s feeling when you take your wife out to dinner, and you get the bill and think it’s in pesos, but it’s in dollars. It’s insane what’s been happening.

Trey Lockerbie (15:30):
I’m trying to understand, how is the Fed getting away with this, for lack of a better way to frame it? It seems so obvious when you have other resources to look into and compare to. How are they getting away with this? Why is it not more-

Kyle Bass (15:43):
I think the alternative was to have a much deeper recession in 2008-2009, to have a calamitous recession in 2020 on the outset of the virus. With those recessions would come more difficult hardships, maybe more physical violence, i.e. societal friction, that would be difficult to get under control. What they choose here is smoothing, and the smoothing is just printing the money.

Kyle Bass (16:11):
The unintended consequences of money printing are the rich get richer because they own the assets, and they have leverage on those assets. The middle class, their ability to trade up, do better is taken away from them. So, the negative real rates of return really hit the middle class, and the poor, they hit the poor the worst.

Kyle Bass (16:32):
I think the very people that they’re trying to protect are the people they end up hurting the most. But it’s insidious because it’s hard for you and me to say, well, even though you and I have retirement savings, we know it’s going to buy less stuff than it would have bought two years ago, but we don’t know how much less and they’re not actually telling us how much less. You and I just have to figure out what the new cost of living is going to be in the new paradigm. Again, I say it’s insidious, because it’s not black and white, and it’s very difficult for people to measure.

Trey Lockerbie (17:01):
What are your thoughts on something like a Bitcoin and the value it could bring to the market in this kind of environment, not having Paul Volcker around?

Kyle Bass (17:09):
I know Millennials love private crypto, and I know you’re probably a millennial, but I know that people like to think it’s a perfect substitute or a great substitute for gold and/or an inflation protector. I tend to think that you’re going to see authoritarian governments and Western democracies alike, start to really clamp down on Bitcoin.

Kyle Bass (17:30):
I know China’s first kicked the miners out and then banned private crypto. They did that a year earlier than I expected them to do it. I think next year, you’re going to see intense regulation come from the US Treasury and the IRS.

Kyle Bass (17:43):
When I think about how to think about discount rates, and I think where you’re going with that question is, how do I protect myself from this insidious inflation? I think there are much better inflation hedges. I know Bitcoin has done well, I know that the returns have literally been off the charts for many, and there are many newly minted billionaires out there in Bitcoin land. I think the easy money has been made, is what I’m telling you. I think from here on out, it’s going to be really difficult to make money there.

Kyle Bass (18:14):
What I look to are things like real assets like even rural land. Rural land, you can do a lot of interesting things with. You can actually put a judicious amount of leverage on it, call it 50% leverage, and stay way ahead of this insidious degradation of your savings. I actually launched a private equity firm a couple of months ago, to engage and not only an acquisition of rural land, because that’s where I want my money and my family’s money, but it’s also to engage in mitigating environmental impacts from big industrial and commercial users of the land.

Kyle Bass (18:49):
I’m actually a tree hugger at heart. I love the environment. I love the outdoors, and, that’s where I think the best place to go is to mitigate this. I know that’s not where you wanted me to go on Bitcoin, but it’s how I feel now.

Kyle Bass (19:05):
I own a couple of private positions in big firms that are trading, lending against, and developing bitcoins and NFTs and all of the digital universe of alphabet soup things that are out there. I think that the blockchain, I think that NFTs, those things are all very much here to stay. Private crypto, I put a question mark by over the long run. I’d be careful with that now.

Trey Lockerbie (19:30):
When you say rural land, is that different from something like farmland? Because I recently heard or saw a headline about Bill Gates, for example, owning like 100 million-plus dollars of farmland and making a statement, the same thing.

Kyle Bass (19:43):
What I’m talking about is when I think about the macro movements of the population today in the United States, you have a high cost, high tax jurisdictions like New York, New Jersey, Connecticut, and then you have the entire west coast of California, those people are all moving to places like Texas, like Tennessee, like Florida, because they’re pro-business, they’re low to no tax at the state level.

Kyle Bass (20:06):
I know rich people can move to Aspen and Utah and everywhere that super-rich people are moving, but you can’t move entire fortune 500 companies to places like those enclaves. When you think about where the pro-business environment is, who’s going to win over the next decade, 10 to 15 years, it’s going to be places like Texas, Tennessee, and Florida. With that nonlinear population growth, comes big movements inland within call it to two and a half hours of major MSAs, whatever you do on the weekend, where you live there, you probably have a second home, or your parents did or your friends do. That’s what you do, you go to a lake or you go to a ranch, you go to a farm.

Kyle Bass (20:45):
I believe you’re going to see those prices move faster than… Especially in front of those population demographic moves, I think those are going to move faster than inflation will.

Trey Lockerbie (20:57):
Interesting that, inflation being where it is, I didn’t hear you say something like gold. You went to farmland. Talk to us, what’s your position or your opinion on gold, and has it changed at all over the years?

Kyle Bass (21:10):
When private crypto came about… What’s private crypto’s market capitalization today? Is it north of 2 trillion? If you think back to 2009, the amount of gold ever mined in 2009 was 7 trillion, and a lot of that had been, let’s just say, stored, lost in dowries, this and that. When you think about that marketplace and how much money has basically never made it into that marketplace and gone into things like private crypto.

Kyle Bass (21:40):
I think these people that are selling some private crypto to buy real assets are actually not buying gold, they are going to buy more real estate, more land. When I think about gold versus rural land, again, I have the population demographic in my tailwind, and I also have something that I can drive to, I can fish there. I’m not a hunter, but if you wanted to hunt, you can hunt there, you can take your kids swimming, hiking outdoors, you can’t do that on a piece of gold.

Kyle Bass (22:09):
I think about the tangible benefits and both physical and mental benefits of being outside. I think that’s likely to move a lot faster than gold does. I’d much rather own that kind of land.

Trey Lockerbie (22:23):
Interesting. You did talk about China’s ban on crypto, and we’re going to talk a lot about China and the different aspects of it. The first point related to crypto here is the idea of China developing its own digital currency. What is the incentive for them to do that, besides, giving it yet another surveillance tool? How would that change their position in the world, at least in their minds?

Kyle Bass (22:48):
That would radically change China’s geopolitical, call it belligerence. When you think about how offensive they’ve been, in the last few years, first of all, in their complete botched review and allowance of scientists into Wuhan to figure out where patient zero is, and where this thing came from, they’re not a responsible global actor. They are a completely irresponsible global actor, they have a grand strategy, they’re executing it well.

Kyle Bass (23:19):
We are now trying to understand, in a much larger picture, what it means for them to have a CBDC of their own, a central bank digital currency of their own. Again, it’s antithetical to even private crypto. Private crypto is decentralized. The idea is, call it, not being under the purview of watchful eyes of centralized governments. I understand all of the libertarian ideals of private crypto, but when you think about central bank digital currency is the opposite, it’s run by the government, for the government in a centralized manner. They know exactly who has it, they know your spending proclivities, they would know Trey Lockerbie’s Social Security number and where you like to spend it, how you spend it, how much you have.

Kyle Bass (24:01):
It would enable them, not only to be you adopting the Chinese tech stack, you’re not just putting some digital currency in your wallet, you’re adopting the entire Chinese digital tech stack, and you’re giving them the ability to export their digital authoritarianism to you. The Chinese government could bribe you directly without being under the watchful eye of regulators or law enforcement.

Kyle Bass (24:21):
Imagine if the Chinese government has the ability to bribe, cajole, coerce anyone anywhere in the world if you’re holding on to their money. Imagine that world, that world would be a much worse place to live in. I believe the rollout of their CBDC next year is the biggest risk to the rules-based order in the West that we’ve faced in the last several decades.

Trey Lockerbie (24:46):
What would the incentive be for people to opt into a digital currency with China? Is it just that our US dollar is inflating away?

Kyle Bass (24:53):
No, I think what people maybe don’t realize and maybe some do is China can make two moves on the chessboard on the launch. They can say, anyone that imports and exports, i.e. engages in trade with us, China Inc, you have to settle on our currency. If you don’t like it, that’s okay, find somewhere else to trade. They literally could force you into their digital currency, and then they could say, oh, by the way, anyone that invests in China or has investments here, from now on, it all has to settle on CBDC.

Kyle Bass (25:24):
You say, “No, I kind of like the dollar. I like my dollars being invested there.” They say, “Sorry, it’s illegal, you have to buy our currency with your dollars.” What that would do is that would bring in trillions, literally trillions of dollars into their coffers at the central bank. Then they would not only have more dollars to exercise their global belligerence with, economically militaristically, but then they would also have a stranglehold over you. Because if you came out, and let’s say, you transacted a lot with China, and let’s say they screwed you on a transaction, and they were supposed to pay you a million dollars worth of their CBDC, and only paid you $800,000. And you said, “No, no, our deal was a million.” They would say, “Sorry, tough.”

Kyle Bass (26:09):
Then you go and make a public comment on Twitter and say, they just screwed me out of $200,000. Then they turn the rest of your central bank digital currency off because you said something negative about the regime. Just think about that world. I don’t think people have thought that all the way through. I know, the National Security Council, our intelligence agencies, DoD, we as a country have thought about this deeply. I don’t think the press has written about it much at all, and I don’t think there’s been a lot of a proper dialectic here, and hopefully, hopefully, we will have a meaningful dialectic about this rollout sometime very soon.

Kyle Bass (26:47):
I believe it should be banned, outlawed, and illegal for any US corporation or individual to hold. That sounds hyperbolic, but you either have cancer or you don’t have cancer is how I view this.

Trey Lockerbie (26:59):
What do you think happens to oil and how does it settle?

Kyle Bass (27:03):
They’ve tried really hard to get people like MBZ and MBS to settle in RMB. It’s been a tough, again, the road to hoe. But I think with the outset of a Chinese CBDC, that becomes fungible and tradable and transactable, and also is potentially freely tradable in and out of dollars. It gives them so much more to stand on. Today… Let me give you a hypothetical, if they attack Taiwan, today; bombers, fighter jets, and an amphibious assault, we have an economic nuclear button today, their entire world depends upon dollar settlement.

Kyle Bass (27:43):
If we sanction the Chinese banks, the joint-stock banks, and the SOE banks, we take China off the SWIFT system and their economy collapses overnight. We have that button today. We don’t have to send sailors into the South China Sea or the Taiwan Straits and risk our brave men and women’s lives. We simply press a button. If their rollout of their CBDC is successful, that changes the calculus of their entire geopolitical risk game. If we lose that button, then imagine how belligerent China can be if they’re not relying on us. I think, again, that calculus is something that we all need to be thinking about.

Trey Lockerbie (28:21):
You brought up Taiwan, I’d like to touch on that because there’s that speculation there, and probably with a good reason that there’s a potential takeover of Taiwan, maybe sometimes even after the 2022 Olympics. How should investors think about that, position themselves for? If that’s a concern and a risk, how do we factor it into our investment approach?

Kyle Bass (28:43):
They’re not thinking about it. There’s a Taiwan ETF that’s at an all-time high today. Either people don’t believe it, they don’t believe China will do it. If they listen carefully to X Jinping’s October 9th speech, he basically raised the bar on Taiwan. He said that he is trying to achieve the great rejuvenation of the “Chinese race,” and he is intent on achieving the “Chinese dream.”

Kyle Bass (29:14):
Those are two really important phrases because what he is saying is… He says that peaceful reunification of Taiwan is a foregone conclusion, it’s inevitable. In fact, they reiterated it again with their foreign ministry spokesperson yesterday, Wang Yi said that yesterday. But back to October 9, today is November 4th, call it back a little bit less than a month ago. What Xi said in that speech was, if you don’t surrender peacefully, we’re going to take you forcefully.

Kyle Bass (29:45):
His success as Premier and an Emperor for life is contingent upon that reunification. If he doesn’t achieve the Chinese dream of the great rejuvenation of the Chinese people, then he has failed and he’ll no longer run China. That’s literally what he said, October 9, if you read carefully what he said. He’s banging the war drums a little harder. I don’t know if you’ve seen just today, Trey, but for the first time in Chinese media, what I’m seeing all over China is they’re talking about how they’re fortifying positions in the region in which they’re going to attack Taiwan from.

Kyle Bass (30:24):
There are propaganda videos showing missile silos getting carried down the streets of China, that are all camoed up, and trains with tanks on them headed to the region, military planes landing there, and they’re pushing these videos all over China for the people of China to prepare for battle. I haven’t seen that level of rhetoric in China to date, but it seems to me like things are speeding up at a quantum speed, at an incredible pace.

Kyle Bass (30:57):
Whether they wait for the Olympics or not, I can tell you the conversations that President Biden has had with Xi surrounding Taiwan. We have a big national security problem with Taiwan. Taiwan Semi is very, very, very important to the US, to the US military, to our well being and it’s literally 100 miles from the Chinese border.

Kyle Bass (31:21):
The problem is, it normally takes about five years to build a wafer fab, we’re about a year and a half into the Taiwan Semi fabs being built in Arizona, and let’s say it takes three or four years instead of five, we still have a duration mismatch if they move now. If you’re thinking about their calculus, moving sooner, rather than later is in their best interest. However, they haven’t rolled out their CBDC yet.

Kyle Bass (31:44):
Again, this is my calculus and who am I, I’m some financial guy in Dallas. But if I were to bet when something’s likely to happen, I would bet the second half of next year or sooner.

Trey Lockerbie (31:56):
You brought up Taiwan Semiconductor, and I’m curious about that one, especially. Because if you’re someone who’s like me, and bullish on semiconductors long term, and it’s a seemingly great company in the space, it’s a $600 billion market cap. Does a Chinese takeover of Taiwan affect that company or at least the prospect of it as a good business? Or does it change your outlook on the business at all?

Kyle Bass (32:22):
Well, it changes my opinion of Taiwan Semi’s business overnight. Yeah, absolutely. If it’s under the centralized control of the Chinese Communist Party, then you have an entire myriad of new problems to think about. Immediately if the Chinese are running Taiwan Semi, our government… And then they take it forcefully, they take Taiwan forcibly, our government’s likely to ban all products from China.

Kyle Bass (32:47):
We’re going to have to alternatively source, we’re going to have to go to a different supplier. We, as a country realized what kind of position we were in, and that we had let the frog boil without our knowledge. It was actually under the Trump administration’s last two years, the Security Council tasked a former Naval Intelligence Director to help usher in and get these deals done for Taiwan Semi to build these… Imagine spending $17 billion on one building, Trey. Imagine what that building is going to look like. Those are being built today.

Kyle Bass (33:31):
We have Samsung about to break ground in Taylor, Texas. We have Taiwan Semi building its first and I think its second wafer fabs in Arizona, broken ground. But again, those periods of time and the capital it takes to build those are enormous.

Trey Lockerbie (33:47):
Speaking of buildings, I’m curious about the real estate in China. You have this theory around Xi’s intent. I’ve heard you say, especially around Evergrande, I’ve heard you express that he’s intentionally detonating the real estate market. What do you mean by that?

Kyle Bass (34:02):
I think that an unintended consequence of central bank largesse has been asset prices have gotten out of hand. In China, when we talk about how housing is priced here at call it five to seven times our annual income, four and a half to seven times our annual income. In China in tier-one cities, housing is now at 30 times the average annual income. It’s at a level that’s so high that when you look at the birth rate of the average Chinese woman, it’s 1.2 children per woman. To just sustain a population, that number has to be 2.1. It’s 1.2.

Kyle Bass (34:39):
You’re having a major population decline starting in China and the reason being is the Chinese men can’t afford once they get to be adult age, they can’t afford to have a job and buy a house. So, they’re living with their parents in their basement. None of the men want to marry a woman because the woman won’t marry him and live in the parent’s basement.

Kyle Bass (35:01):
They’re not getting married, they’re not procreating. They’re not having children. Xi realized this is a structural nightmare for him as a central planner. So, they eliminated the one-child policy and said, “How about three?” Well, guess what, it didn’t work, people aren’t having three, because they can’t afford to have three.

Kyle Bass (35:20):
Real estate is a third of China’s economy. In the US, it’s about 18% of our economy. The real estate prices are so high and so out of reach, and the average Chinese person owns 2.3 apartments. It’s where they’ve just been plowing their money in a speculative fervor. Now, what Xi’s doing is introducing property taxes, which [inaudible 00:35:40] didn’t exist. Imagine if you didn’t have a negative carry, well, you could go speculate in real estate. Imagine if you had to pay 2% a year, you wouldn’t speculate that much in real estate, right?

Kyle Bass (35:51):
In a speech just a few days ago, he talked about further moving property taxes higher in the midst of a real estate crunch. He is going to bring down real estate prices, and they’re going to stay down. That is the common prosperity of the people, that’s his goal and companies. There are eight developers now in default, Evergrande is… All these bonds are going to get wiped out, that’s the bottom line.

Kyle Bass (36:13):
Westerners are going to do a lot poorer than domestic Chinese, they’ll give domestic Chinese a few pennies on the dollar, and they’ll tell Westerners, “Sorry, thanks for playing.” If you’ve noticed the Chinese high yield bond market, at its worst, two months, ever, in the last two months, basically dropped from par to way below 70 in the entire high yield marketplace has probably gone a lot lower.

Kyle Bass (36:33):
You’ve got a scenario, you’re going to see real estate come down and stay down because it’s driven by Xi Jinping. It’s not just going to bounce back and everything’s going back to puppies and rainbows at some point in time. He realized that he made a major mistake in letting the central bank print as much Chinese money as they did and allow the rampant speculation that he allowed.

Kyle Bass (36:54):
This crackdown is not because Jack Ma is super-rich, it’s not because the property developers are too flashy with their jets and cars and things like that. That might have something to do with it, but it’s really core to the central planning of the Chinese Communist Party.

Trey Lockerbie (37:10):
Does that have any systemic risk? If there was speculation that Evergrande was the next Lehman there for a minute, it doesn’t sound like you share that opinion. But these bonds getting wiped out, does it have a rippling effect across the globe?

Kyle Bass (37:24):
I don’t think so. Well, let me rephrase that. I believe that if you’ve seen Goldman Sach’s most recent report and expectations for Chinese GDP, they’ve taken it to zero. That’s a pretty big statement. But if a third of your economy is going to go pretty significantly negative, and the other two-thirds of your economy is slightly positive, you could get to a zero number. God forbid, China only grows at zero.

Kyle Bass (37:45):
But I think if China has a 0% growth in GDP for a year or two, that just means global GDP won’t grow anywhere near where anyone’s expecting. So, the globe will slow down a bit. When you think about the systemic nature of what’s going on, we all know Evergrande has about 300 billion in debt. 200 billion, call it internal Chinese debt and 100 billion external maybe dollar bonds. Those bonds are not levered 10 to one in foreign financial institutions.

Kyle Bass (38:15):
Lehman was interconnected to both the US banks and the European banks with massive derivatives risk. No one signed is their agreements with Chinese banks, because Chinese banks demanded to have the jurisdiction be Beijing law, and of course, there’s no such thing as Beijing law. None of the either domestic US or European banks have major counterparty risk there.

Kyle Bass (38:38):
The question becomes internal. Are the Chinese banks going to get wiped out? For sure, they will. They’ll have huge holes in their balance sheets. But will the Chinese government back depositors? Without a doubt. I think that tree is going to fall in the woods, I don’t think many are going to hear it. I think there’ll be some people that are super-wealthy over there that end up losing everything.

Kyle Bass (39:00):
But I don’t think a default crisis will go global here, I think that they will take real estate down, hold it down. The Chinese property developers are all going to be massacred, and because there will be no bounce, and they’re all hyper-levered to price. Then the banks are all going to have huge holes in their balance sheets and their banking system’s three and a half times their GDP. They will print enough RMB internally to save the Chinese people from jumping off a cliff, but I don’t see a global contingent into western banks.

Trey Lockerbie (39:33):
Got it. You mentioned Jack Ma a little bit ago, and Alibaba is down around 50% or so from where it was a year ago. Your typical value investor might take a look at that and say, that looks interesting. I can gauge that you’re probably not investing in many Chinese stocks. But I’m curious, does something like Alibaba at its current price level intrigue you at all or is there some kind of just Chinese accounting suspicion that keeps you away?

Kyle Bass (40:00):
Have you really peeled back the layers of the onion and looked at Alibaba’s earnings? Alibaba’s earnings come from markups of their private investment positions, and they run it through their income statement. Alibaba is the biggest house of cards I’ve ever seen. I have no idea what their real financials are, and neither do you and neither does Charlie Munger, for that matter.

Kyle Bass (40:23):
They have never submitted themselves to a real Western audit. Now, you have Xi Jinping risk. Trey, what discount rate do you put on a company that doesn’t submit itself to real audits and has Xi Jinping risk? I think, if you’re a fiduciary, whether you’re a fiduciary to your household, your kids, or as a real market fiduciary, you should lose your job if you buy Chinese stocks that are unaudited, which are all of them right now.

Trey Lockerbie (40:49):
That markup aspect is interesting. Give us one example of their accounting issues, I guess, is for lack of a better word that comes up with something like Alibaba and how they’re putting it in the stock.

Kyle Bass (40:59):
You look at their markup of Ant Financial in their own income statement, and it was representing like a third of their earnings for 2020. When Ant Financial goes away or gets revalued lower, they don’t run it through the income statement. You know what, I don’t know. Think about how Ant Financial happened. Imagine if you and I were running Alibaba, and we’re like, hey, let’s start this consumer finance platform. How about you and I and 15 other people, we split it off. How about we take 50% of the company and let the shareholders of Alibaba have the other half? Does that sound like a good deal? Oh, yeah, that sounds great.

Kyle Bass (41:36):
They literally stole half the company. Imagine if that happened here, you’d be behind bars in 10 seconds. But we just nod our head and say, well, I guess that’s the way the Chinese do it. Because they’re running the company, they get to keep half of it. But that’s not the way it goes.

Kyle Bass (41:54):
People just look the other way, because they have FOMO, they have Chinese FOMO. They can’t wait to get to the end of that 1.4 billion person rainbow of riches in Eldorado and somehow leveraging the Chinese people when in the end, the Westerners never make the money.

Trey Lockerbie (42:11):
I want to shift gears a little bit and talk about oil because I’ve heard the theory of yours that I found fascinating around our lack of investment of hydrocarbons, and how that might actually lead to even inflation or higher inflation in food prices and others. What’s your current take on oil and walk us through that theory, a little bit.

Kyle Bass (42:31):
Yeah, it’s oil and gas. Seven years ago, the public markets, when we had the fracking decline, and we became energy independent, six or seven years ago when we were fracking and drilling at such a high rate when oil was $120 a barrel, call it 2014. Then we had an abundance of oil, and we’re the Saudi Arabia of natural gas, and we had a ton of natural gas. So, oil prices dropped in the low 30s, and natural gas prices went below $2 an M.

Kyle Bass (43:03):
Then we started virtue signaling. We said you know what, it’s time. It’s time to go to alternative energy, we have global warming happening and climate change, and it’s all well-intentioned. Don’t get me wrong, I believe that global warming is here, and the numbers suggest it’s here. Whether it’s secular or cyclical, it’ll be left to science over the decades.

Kyle Bass (43:24):
I’m a big believer in saving the environment and doing what we can to be responsible stewards of both the environment and our lands. But you have to take a major step towards sustainable power, meaning we blew it when we stopped engaging in nuclear power plant building. We could have solved this many, many, many years ago, we could have solved global warming. The same people screaming global warming and climate problems today are the same protesters that protested nuclear power after Three Mile Island, after Chernobyl, and then maybe even after Fukushima.

Kyle Bass (44:01):
Imagine if we just stopped flying airplanes after two of them crashed? The technologies are so much better, it’s so sustainable, it’s the cleanest, it’s the best way to power things. But what we did is we stopped spending on hydrocarbon seven years ago. Public market analysts said you can’t spend outside of your EBITDA anymore on the hydrocarbon industry. Then you started seeing over-the-top virtue signaling from corporate investors and corporate boards.

Kyle Bass (44:30):
You’ve seen a mass exodus of funding in the capital markets for anything hydrocarbon-based, it takes decades, many decades to move from one fuel source to another. It did for coal, it did for natural gas, and it’s going to for alternative power, but even with alternative power, we need a much better storage matrix. Right now, it’s just a great idea. Wind and solar are amazing, but they’re not powering any kind of major percentage of the grid, and they can’t be baseload power.

Kyle Bass (44:59):
If we mothballed the coal plants, we won’t lend to natural gas, and we won’t lend to oil. In fact, now private equity is having trouble raising money in hydrocarbons. Now, we have a scenario where demand is inelastic. Do you know how many cars are in the world, driving around? Cars and trucks? They’re 1.2 billion cars and trucks driving around. How many electric vehicles are on the road today? I think it’s around 30 million. 1.2 billion combustion engines, 30 million, it’s amazing, they’re 30 million electric cars.

Kyle Bass (45:34):
When you think about it in the grand scheme of things, we still, the world still use 100 million barrels of oil every single day. If we stopped spending seven years ago, and we’re not drilling for more now, and there’s the long-rated decline curve of production is about 7%. So, we lose 7% of production every year if we’re not drilling. In the next 20 years, we’ll have one and a half billion cars on the road that are combustion engines, and we’ll have 100 million electric vehicles. 100 million, amazing, out of one and a half billion combustion engines.

Kyle Bass (46:13):
Demand for hydrocarbons is inelastic, it’s going to keep growing, and we’re not spending the money to find it. What I believe is going to happen, if we have a cold winter, this winter, you’re going to see numbers you’ve never seen before. Because remember when oil went below zero?

Trey Lockerbie (46:28):

Kyle Bass (46:29):
In the front end, there was a problem, there was nowhere to put it. The exact opposite is about to happen. On the front end, demand might tick up from 100 million barrels a day to 105, as the world opens, and there isn’t 105 of production. By the way, for seven years, we’ve been under CapExed production, we can’t just flip the switch. You see Biden at OPEC, begging them for more production.

Kyle Bass (46:53):
At the same time, he’s saying, no more interstate pipelines, no more drilling federal lands. I get what he’s saying, and the people that are running Biden’s energy and climate team are actually good friends of mine, believe that or not, but you can’t turn something off in an absolutist fashion overnight, and flip a switch and think you can change energy sources, because you believe it’s a good idea. It is a good idea, but the incrementalist approach, over decades, it’s what it’s going to take.

Kyle Bass (47:20):
What’s going to end up happening is, I’m going to predict something, you’re going to see prices you’ve never seen before, for hydrocarbons in the next six months, and maybe six months to two years. Those prices will unseat the current leadership because you’re going to see energy prices and food prices ripping because of underinvestment and because of excess capital in the system.

Kyle Bass (47:45):
I think that’s the grave mistake that virtue signaling is going to… That’s what’s going to happen, you’re going to see these things happen. By the way, the front end, at the immediate delivery month of crude and natural gas, can go anywhere. Whatever that marginal cost is, our marginal barrel, what someone’s willing to pay for it, someone’s going to pay it.

Kyle Bass (48:08):
I’m not saying the whole curve out of 30 years is going to move to 150 or 200. But what I’m saying is, the front end of crude oil and the front end of natural gas, you could see numbers you’re going to need a slide rule to calculate if I’m right about this.

Trey Lockerbie (48:20):
Do you have a gallon of gas prediction in Dallas?

Kyle Bass (48:25):
Yeah, you could easily see all-time highs for gallons of gas. You could see $6 gasoline, easily.

Trey Lockerbie (48:34):
Do you think that then creates more demand for the electric vehicle market and maybe accelerates that adoption a bit more?

Kyle Bass (48:42):
Trey, how do we produce the electricity to plug the gosh damn vehicles in? We burn natural gas, we burn natural gas. That’s our alternative power source. You can’t spin enough windmills and have enough solar to power the additional electric cars, you have to put electricity into the grid. People just haven’t thought this all the way through.

Trey Lockerbie (49:05):
China is making a big move into nuclear in the near term. Do you think that will give us any more confidence in doing the same?

Kyle Bass (49:15):
There are places like France that have 70% of their grid is nuclear. There are some people that have it figured out. China is currently building more coal-fired power plants today than the entire coal-fired installed base of Europe. They’re building that much this year. They want to say they’re building nuclear, they’re building coal, they’re building whatever they can build because their entire system is so broke and their grid is massively underserved.

Kyle Bass (49:43):
They’re telling their bread and butter manufacturers that they can only manufacture every other week now because they have rolling brownouts. They’re having a real problem. Hydrocarbon demand is inelastic, and it’s growing at an ever-increasing pace. Whether China’s building nuclear or coal, when you think about Chinese electric cars, the way you need to think about them is they’re coal-burning cars, because the entire Chinese grid is powered by coal.

Kyle Bass (50:08):
When you’re feeling good about seeing electric cars on the road, just remember that coal is what made the electricity that’s in the car. The entire idea of getting Earth to a better place is really dependent upon only about eight countries, and China’s the number one country. Whatever they do with their emissions, so goes the world. Clearly, they’re not even engaging in emissions conversation, they’re telling us oh, they’ll be carbon neutral by 2050. Give me a break, you and I could say whatever you want to say about 2050. It’s a joke.

Kyle Bass (50:36):
But in the meantime, they are massively increasing their carbon footprint, and they’re doing it with coal. When we think about hydrocarbon pricing, going forward, I think you’re going to see prices that really shock people, and I think that’s actually going to empower some regime change in a number of countries, potentially, including China.

Kyle Bass (50:57):
The worst thing an authoritarian leader can see is skyrocketing food and energy prices because it hits the billion or so Chinese that are already dirt poor. That’s my prediction, much higher hydrocarbon prices.

Trey Lockerbie (51:11):
Circling back to what we spoke about a little bit earlier around inflation, and if we’re predicting that it’s 12%, and without tapering, it seems like it’s not going to be very transitory. For the retail investor, who can probably only expect, on average, historically 7%, 8% from the S&P, which, in my opinion, has become the default savings account for the retail investor, is that the best they can do, if they can’t afford rural land, or whatever, if their dollar-cost averaging into their IRAs, 401(k)s is that the best they’ve got?

Kyle Bass (51:47):
I guess our conversation today has been on the fact that we’re entering a stagflationary period. We’re going to see nominal numbers continue to move higher, we’re going to see real rates of return negative because the difference between nominal and real is inflation. Stocks typically keep up with about 80% to 85% of that move. You’ll feel kind of good about it, but you’ll still be losing purchasing power, I think over time.

Kyle Bass (52:14):
Again, I started this private equity firm called Conservation Equity Management to do exactly what I would do, which I’m doing, to try to stay ahead of that insidious, negative real rates of return. If people want to talk about it, they should call me.

Trey Lockerbie (52:30):
Summing up, given the fact that the Fed can’t taper, what is the endgame, in your opinion to right the ship and keep US dominance as per the US dollar?

Kyle Bass (52:43):
I think they will taper. I’m not saying they can’t. What I’m saying is, when they do, and if they start raising short rates, you’re going to see a curve flattening, and it’ll be recessionary. It’ll snuff out economic growth in the United States. For us to maintain our global hegemonic position, we should outlaw the Chinese Central Bank Digital Currency, we should make it illegal. We should enforce the rules-based order within our own borders, we should try to become less partisan, and have the centrist run things and not the progressives and the radicals on either side.

Kyle Bass (53:18):
The problem is, I’m not hopeful about that. I think we’re more divisive than we’ve ever been, and that’s largely due to the gap between the haves and have nots widening. I think that continues to widen. I think you and I when we think about protecting what we’ve worked so hard to save, you’ve got to be thinking in ways that people that are alive today, most people that are alive today didn’t really live through, invest through the late ’70s and early ’80s, when you think about the core of the investment corpus today in America, and that was a period of time in which the government could do something about it. Here, I think they’re going to be walking a tightrope of raising short rates, flattening the curve, trying to figure out how to stimulate again, they’ll have to come back and inject more capital in the markets and, again, grow the central bank balance sheets.

Kyle Bass (54:10):
Look, you’ve seen Japan do it, you’ve seen Europe do it. We’re just behind the… If you think about it on a timeline, we’re third in time, but everybody’s doing it, whether you’re the UK, whether you’re the Bank of England, the PBOC, the BOJ, the Fed, everyone’s doing it, and they’ll keep doing it. I think it’s important to just think about how to defend yourselves from that.

Trey Lockerbie (54:30):
Kyle Bass, this has been an incredible honor to have you on our show. I really enjoyed it, I learned a ton. I would like to before I let you go, give you the opportunity to hand off to our listeners, any other resources you want to share.

Kyle Bass (54:43):
No, I don’t have any other resources. But I appreciate it, Trey. Thanks for your time.

Trey Lockerbie (54:47):
I hope we can do it again soon.

Kyle Bass (54:49):
Yeah, it’s a pleasure meeting you.

Trey Lockerbie (54:51):
All right, I hope you guys really enjoyed that one because I sure did. If you’re loving the show, please don’t forget to follow us on your favorite podcast app and definitely leave us a review, we love to hear from you. You can always find me on Twitter @TreyLockerbie, and if you haven’t already done so, what are you waiting for? Go to theinvestorspodcast.com or simply Google, TIP Finance. You don’t want to miss all the amazing resources we have for you there. With that, we’ll see you again next time.

Outro (55:18):
Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s Podcast Network, and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


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