Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Global Macro Investing And Geoeconomics With Hedge Fund Investor Kyle Bass | Hoover Institution

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Global Macro Investing And Geoeconomics With Hedge Fund Investor Kyle Bass | Hoover Institution · The Capitalism and Freedom in the Twenty-First Century Podcast

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[MUSIC]
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>> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast,
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an official podcast of the Hoover Institution Economic Policy Working Group,
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where we talk about economics, markets, and public policy.
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I'm John Hartley, your host.
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Today. My guest is Kyle Bass, who's a legendary
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investor who famously predicted and bet on the housing collapse of 2008.
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He's the founder and principal of Hayman Capital Management, a Dallas-based hedge
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fund focused on global events, and the founder of Conservation Equity Management,
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a Texas-based private equity firm focused on environmental sustainability.
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Welcome, Kyle.
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>> Kyle Bass: Glad to be here, John.
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>> Jon Hartley: Cal, I wanna just start by getting into your early life.
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You were born in Florida.
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Your dad was a career tourism executive who helped manage the Fountain Blue in,
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in Miami Beach.
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It's actually one of my favorite hotels, as well as the Dallas Convention and
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Visitors Bureau.
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You went to TCU where you studied finance and real estate.
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You worked at Bear Stearns, the Dallas Office.
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In the 90s, you started the Legg Mason office in Texas.
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How did you first get interested investing, global macro and geopolitics?
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>> Kyle Bass: Boy, look on the investing side.
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I was a chemistry major.
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Going in, I thought I wanted to be pre med and
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then I ended up taking a non major elective in options and futures.
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And I read the entire course book in a week and changed my major that week.
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It hit me that that was clearly what I wanted to do.
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It was just a moment in time.
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My junior year in undergrad,
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I grew up in a family where I had a great mom and dad.
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They didn't save any capital for retirement or for school.
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We were kind of call it lower middle class.
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We were on a hotel manager salary and when we moved to Dallas,
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we worked at the convention business bureau.
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So I had a good life.
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It wasn't a silver spoon, that's for sure.
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And so, you know, right, right out of school, I,
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I was just enthralled with financial markets.
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I was always a math and science guy.
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There are those two, I guess you're probably all of them, John.
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You probably have the, the, the, the ability to assimilate language and
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reading and, and math and science.
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I was always a math and science person.
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So it was a natural progression.
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>> Jon Hartley: Well, it's, it's amazing.
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And I know you're in my mind having followed and your thinking for
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a long time.
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I think you're a real icon of the Dallas finance community, which is something
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that has grown a lot in just the past few decades and even just recent years.
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I mean there's all these firms now that are moving from, say,
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New York or California to Dallas, I think Toyota and so forth.
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But also all these banks are setting up their second headquarters there,
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Ian Goldman Sachs is building a big office there.
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But you were there at the beginning of all this and
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all these early shifts and moves to Dallas early on.
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So I commend you for being a staple of Dallas finance and for
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not having left as well, like many people might.
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I want to talk about the financial crisis because I feel like
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the financial crisis was just a defining moment for many careers in finance and
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perhaps including yours in terms of, I think, your skyrocket to fame.
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I mean, you made these bets against the subprime mortgage market through Hayman,
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and later you testified to the Financial Crisis Inquiry Commission.
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I mean, how did you first come to start thinking that there was trouble with
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the housing market in the US in the 2000s and
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that it might end up in some sort of catastrophic state?
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>> Kyle Bass: Yeah, I think that.
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First of all, back to your question,
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the prior question about what got you into the financial markets?
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What do you care about?
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When I was at Bear Stearns, I worked on Bear, had a risk arbitrage department,
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you know, where I think they were one of the best and
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call it institutional risk with mergers and acquisitions and things like that.
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I was always a special situations analyst, meaning, you know, I was,
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I was kind of a technology.
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There was no vertical where I was an expert.
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It was just trying to dig into each M&A situation, each spin off,
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each bankruptcy, try to understand the operative parts, I.
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Just whiteboarding these things.
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So, you know, when you whiteboard something and you dig in,
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you just have to have a deep intellectual curiosity, which I also know you have.
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And you can't teach that in the kids into employees.
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I believe they have it or they don't.
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And having that deep curiosity for how things work,
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what are the proclivities of the players?
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And then how do you handicap, you know, the potential outcomes?
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I think again, on Wall street you only need to get like 55% of those,
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right, John?
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So I think that as.
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As we got into the launch of our firm.
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So I launched my firm in January of 2006.
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And at that time, you know, Asia was exploding,
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that China just entered the WTO in 2002.
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It was a big moment in time when,
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when money was really flying into Southeast Asia.
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At the same time, we all knew that our housing markets, I mean,
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everyone knew the housing market was overcooked.
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Everyone knew that it was really easy to borrow money.
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And as you know, you didn't even have to have a job.
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Bartenders could have two or three loans.
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I went to Abs west out in Las Vegas, and I was sitting in a Bellagio bar waiting for
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friends to go out to dinner, and it was just me and the bartender.
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And I said, how's it going?
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She said, well, you know, it's going fine, but, you know, my,
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My houses are killing me.
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And I said, what do you mean, your houses?
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And she said, you know, I have three homes that I've been able to buy here in
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Las Vegas, and I rent them out.
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But, you know, my, my tenants are giving me trouble, and they.
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They turn over too fast, and I'm like, whoa, wait, how do you buy three houses?
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And she said, well, they just ask for a loan and they just give you one.
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And literally that happened while I was sitting at the bar.
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And it's much deeper than that.
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But that was just an anecdotal, you know, confirmation of what, why I was there.
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I'm thinking, you know, it's crazy that a bartender can have three loans.
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And so the intellectual curiosity was, okay, how big is this?
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How much capital is out there in a disassociated risk paradigm?
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Because that's basically what it was.
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And then you have to figure out, well, how does that play into leverage structures?
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You know, levered hedge funds just blow up.
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Well, that's fine.
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That's not a really systemic problem for the, for our.
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For the US Financial system, but.
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And what does it do to the banks?
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And then once.
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Once you started.
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Once I started going down that rabbit hole, you realize that, you know, Lehman
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was 36 times levered, and they had a huge amount of this stuff on their books.
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Merrill had, you know, 50, 60 billion of this in a warehousing facility.
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You know, Bear Stearns was, Was.
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Was again, you know, 29 times levered.
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But you lever yourself 30x and you end up owning assets that lose,
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you know, 40% of their value.
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And you can do.
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It's just a math problem.
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And so, you know, it.
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I came to the conclusion that the whole financial system was in real trouble and
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went to meet with people at the Fed, went to meet with people like Professor Rogoff
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at Harvard, who at that time hadn't written his famous book, but as you know,
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he was kind of the father of sovereign balance sheet analysis.
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So again, I'd go out and meet with people and say, talk me off the cliff.
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I would say explain to me how I'm wrong, please.
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I need to know this because if you remember once, once everyone became
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aware of the situation, we were all wondering where money was safe.
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We were actually wondering where our savings were going to be safe.
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If it was GONNA be safe in JP Morgan or Morgan Stanley.
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Well, I guess Morgan Stanley wasn't a bank yet, but they had to become one.
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It was just this moment in time where intellectual curiosity and
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the ability to analyze special situations came together.
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>> Jon Hartley: That's amazing.
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And I guess you've also made some successful bets too against Japan and
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Greece.
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Speaking of sovereign debt crises, how did your thinking around those come about?
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That's sort of around roughly the same time period.
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>> Kyle Bass: Think about this.
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What precipitated the crisis in Europe was of course the financial crisis in America.
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And if you followed when the US decided to bail out its banking system,
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you had to follow the bad private assets to public balance sheets.
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So then the analysis was which public balance sheets can handle that kind of
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movement of that many bad assets.
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So the US could handle it.
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We lost about 800 billion.
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So our banking system had a trillion of Equity back in 2006 we had 17 trillion
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of on balance sheet assets.
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If you just, just look at banking assets, not the non banks.
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So we are about 1 times GDP in our banks, we had a trillion of equity.
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We lost about $800 billion.
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So we recapped our entire banking system through common and
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preferred equity injections.
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So we actually did it right and recapped the system and got going.
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Europe couldn't recap the system and
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they had a worse problem than we did some of their banking systems.
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Because of the EU, Iceland and Ireland both had 10 times their system,
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10 times their GDP in their banking system.
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So it's the same problem that the levered hedge funds and
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Lehman and Bear had as a country.
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They took on way too many banking assets because
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they were chasing deposits all over Europe.
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And so Iceland and Ireland fell in pure succession and then Greece.
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And so it was kind of a logical analysis of a balance sheet that just went from
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corporate balance sheets to sovereign balance sheets and then from there.
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How many things have you ever read in your economic career that say so and
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so ex Japan, so and so, you know, Asia ex Japan, ex Japan, ex Japan.
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Because Japan blows every Gaussian distribution you've ever seen, right?
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They're like they're so far out there and they're so far that they,
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that if you include them in any mean it ruins the whole mean.
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So they just exclude Japan.
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Well, I started looking at Japan, I said, well how do they do this?
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How do they, hang on,
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how do they take at that time 200% sovereign debt to GDP on balance sheet?
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Well, the answer was they had to take their rates to zero and negative and
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they have to leave them there.
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And so today Japan still has rates pegged out to 10 years and
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they're letting the 30 year kind of flap in the wind.
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But the real answer is now they're 265% sovereign debt to GDP.
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They can never let rates move.
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They can't.
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So what does that mean?
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That means the currency is the escape valve.
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So when you characterize where we launched a fund quote against Japan,
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it's not the case.
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That's kind of folklore.
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What we did is I said one of two things has to happen here in this analysis.
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Either Abenomics has to come about and
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Japan's got to inflate their way out of this problem and try to get some growth or
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they're going to be crushed under the weight of their debt in their own system.
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That's really, they hit a fork in the road.
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And so we took two thirds of the money in the fund and
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we bought bond market optionality right in the, in JGBs.
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I took one third of the money and I bet with the bank of Japan on their ability
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to weaken their currency because they had to do that.
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So when we launched that the yen was 85 to the dollar.
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Their bond market was where it was.
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And then Abenomics happened, when Abenomics happened,
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it took the yen from 85 to 120.
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You could have done the back of the envelope math.
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So we lost 2/3 of the money and
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on the other third of the money we made many multiples of that capital.
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The fund ended up making, you know, 250%.
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So you know, was a bet with the bank of Japan on one side and it was a bet against
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their ability to hang on in the bond market if they would ever let it go.
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So it was just the right economic bet at the end.
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>> Jon Hartley: It's amazing, yeah,
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I mean the whole story of Japan is I think a super interesting one.
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You just, when you think about it, and it's something I've been reading a lot
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about and saying a lot, I feel like Japan is kind of strangely ahead of the US and
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the western world maybe by a few decades or so.
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Think about.
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>> Kyle Bass: Exactly right.
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>> Jon Hartley: The sort of asset, you know, bubble some people call it, but
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really Just the collapse and flat GDP per capita there that began in the 90s.
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And you look at most of the Western world except for
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the US now it's had flat GDP per capita since the early 2010s.
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But even other topics, things like industrial policy,
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that was something that Japan is perhaps famous for.
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>> Kyle Bass: In the 80s they were doing so much lending that the Basel 1 accords
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had all to do with containing the Japanese banking system and
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constraining their equity ratios at that time.
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>> Jon Hartley: So it's a fascinating.
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They were first at quantitative easing.
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They're I think still the only central bank that's actually bought up stocks.
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So they're very interesting and instructive I think for a lot of reasons.
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First company to really go crazy on debt to GDP in sort of recent times.
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First advanced economy and 250% debt to GDP and
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now their bond yields have been skyrocketing just recently up to the 30,
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40 year bonds have been jumping in yields.
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And I guess there is, I guess you could call it
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this financial repression sort of issue.
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Or you could call it fiscal dominance really,
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where there's this challenge where they can't let
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interest rates rise because their net interest costs will just totally balloon.
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I mean, do you have any thoughts on Japan and like if there is some sort of
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a sovereign debt crisis looming, is Japan the first to go?
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And does that end up being some sort of a domino in your mind?
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>> Kyle Bass: You know, I, I don't, I think Japan's got it under control.
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And I mean in a way where you have a,
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if you have a population that has a significant, you know, the.
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Japan has one of the oldest populations in the world, Japan and Italy.
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And they've got a demographic crisis, right?
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They've got a crisis where it's really difficult to grow your sovereign.
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If your population, your call it endemic population is not growing.
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And so they're not.
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There's a fascinating, there's a fascinating thought to have here and
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it's one that I haven't really discussed that much.
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But when you think about fractional reserve central banking,
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which is the way we all operate and Japan is a poster child here.
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I have a theory on why the demographic curves are hooking down in
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the US in Europe and in China and Japan.
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So if you think about the way these systems work is they typically,
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by the way, almost no sovereign ever defaults, John.
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They get into a crisis, they print and print money, expand a balance sheet,
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but they always pay.
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They rarely if ever stopped paying.
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So we get into a situation where you look at where Japan is, and
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if you engage in this type of central banking activity and
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you kind of lose your fiscal moral compass to where you just run huge deficits and
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you print the balance and you suffer inflation.
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If the men in your economy, when they graduate university,
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can't afford to buy a home, they live with their parents, they're not having sex,
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they're not having kids, they're not marrying.
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So when you look at the marriage rates and you look at the fertility rates of
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the average women across not only the developed world, in China,
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when real estate prices rip and wages don't go with them,
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you create yourself an endemic problem in your economy.
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And so Xi Jinping has figured this out.
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He figured it out when he said financial security is national security.
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Note, he has not stimulated his real estate market.
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When home prices in China got to be 26 times median income,
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the men couldn't afford homes.
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So the demographers had this arc of the demographics of China,
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Japan, the U.S. you know, arcing out to 2050 and heading down around 2050.
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And now they're all collapsing.
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The reason they're collapsing is we just injected 50% inflation in
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dollar terms into the world.
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And that's our demographic curve here is hooking down.
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Europe's was already hooking down, Japan's was already hooking down, and China,
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China's demographic curve collapsed.
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So the way that we operate our central banks and the way that we kind of
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financially engineer, I, I heard you almost say financial repression in Japan.
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The way that we financially engineer our economies has consequences.
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And those consequences are we, we both know that asset prices far exceed wages.
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And so real wages have been massively negative,
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even though the Fed is not saying that.
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The reason the Fed's not saying that is because they chain weight inflation.
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So if you look at it in reality,
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asset prices have extended themselves to where it's not,
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it's not conducive to procreation and families.
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It's just fascinating.
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>> Jon Hartley: And yeah, and you think about zoning too, and, and you know,
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90s regulations, which is sort of pervasive in, in most countries.
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I mean, Japan being one exception, some Eastern European countries, some,
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some exceptions.
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But, you know, real estate has become so expensive,
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prohibitively expensive around the world.
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And I think, you know, that to some degree is causing, you know,
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there's some empirical evidence that that has negative effects on fertility.
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I mean, that's not a surprise, people can't buy their own homes.
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They can', really get married and have children.
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So, you know, it's, it's amazing how quickly all this land use regulation and
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how quickly real housing costs.
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If you think about home prices over the past 150 years,
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if you look at like the case Shiller index and you net out inflation,
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that trend is like basically flat from like the late 19th century,
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late 1800s up until like the 1970s and 80s.
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And it's just on a total upward trajectory and zoning,
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some people say it's other things, but you know, regardless of the cause,
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it's hugely prohibitive, especially, you know, for young people.
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So.
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>> Kyle Bass: Well, and then there's another natural progression,
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if you're intellectually curious, if, if in fact that's the case.
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And you look at FHFA zone index, the US government's own unchained weighted
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housing index was up 50% between 2020 and 2024, 50.
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So wages certainly are not 50 between 2020 and 2024.
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If you follow that naturally to the,
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to call it the next node on the, on the timeline.
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All that does is it tears the social fabric of both our country and the world.
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So the poor state, the poor were already poor.
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They didn't have any discretionary income.
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So it, it makes them much poorer on anything they have to acquire to just
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stay alive.
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Call it food, rent, inflation, or gas, whatever, whatever you're doing.
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And then it prices the middle class out of being mobile.
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So it immobilizes the middle class.
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What does that do?
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Well, it creates tension because it ends up in the richest hands.
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And so that gap widens.
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And what does that do?
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Creates tension and in some places it tears.
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And that's why we're having more wars.
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So, you know, you have,
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you have a scenario where the central bankers believe that it's the answer.
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The answer is just, let's just keep growing these
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balance sheets and kind of just not focusing on being
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more fiscally responsible because they can.
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And then what that does, though,
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is the follow on effects of what's happening here.
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Our inflation, our tearing at social fabrics,
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our fertility rates collapsing, and then war.
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It's actually what happens and that's what's happening now.
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And we should expect more and more war because there is no answer for
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this equation at the moment.
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>> Jon Hartley: So I want to shift just to China now because you're very outspoken
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on this.
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You served on a lot of defense boards, you're very involved in the military
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community, your lifetime Council on Foreign Relations member.
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And I think it's fair to say that some people would call China hawk and
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have been critical of the Communist Party of China for quite a while now.
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And in particular what it's doing with respect to Hong Kong and Taiwan.
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I'm curious, what's your sort of overall thesis on China,
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US decoupling and your thoughts on the role that say,
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defense tech and investors play in this?
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Because I know you're, you're involved in this space as well,
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not just as a policy expert and thinker, but also as an investor.
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>> Kyle Bass: Yeah. Well, thanks.
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Look, some call it China Hawk, some call it China Realist, you know,
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going to the lengths of understanding how the architecture of their system works and
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that we went from Japan to China between 2012 and 2015.
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I put my whole team on China.
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And this starts empirically with me calling all the Wall street firms and
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saying, someone send me your primer on the Chinese banking system.
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I want to understand how their domestic, since they have a closed capital account,
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I want to understand how the Chinese RMB or offshore CNH and the USD interact.
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I want to understand the architecture of their system.
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And no Wall street firm had a bank primer for Chinese banking system.
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No one had done it.
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They were selling stocks, everybody was buying and selling stocks and
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vie structures and whatever they were doing, but no one had actually sat down to
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do the work to understand how is the system built.
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And so that's how I got deeply involved in understanding not only the architecture of
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their system, but
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invariably what that does is it takes you into cultural preferences,
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cultural norms, then that invariably takes you down the history route.
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And like, how did they get there?
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What are the incentives of the players?
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Why does Xi Jinping care to just have the iron fist and
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the five tools of Democrats dictatorship in one hand?
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And then, then you understand what their grand strategy is.
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And when you understand what their grand strategy is,
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it is completely incompatible with ours.
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And so in 2016, I came to the conclusion that we
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were certainly going to be in conflict with China at some point in time.
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So it's actually easy to see if you apply yourself.
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And you understand.
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So on the defense side, you know, we're talking today, and I know this isn't just
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for today, but this is the day that Israel attacked Iran's nuclear facilities.
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You and I, John, have talked about that.
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That event was going to happen.
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Iran was not going to let everyone into their new centrifuges and
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all of a sudden become compliant with the rest of the world.
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They're the largest state sponsor of terrorism in the world.
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So this attack was obvious that it was coming.
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China has told us since 2017 that they are certainly going to take Taiwan by force,
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if not, if necessary.
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They continue to send more delegations over to the US to tell us this.
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They continue their air defense zone incursions into the Taiwanese air defense.
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And if you chart it, you can see that every year it's more belligerent.
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So it's coming.
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And then how do we think about our relationship with China?
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Well, you know, I was just recently in a, in an interview where someone said,
25:01
well, the CEO of Ford says if they don't release these, these very specific
25:06
rare earth magnets, then we can't put our EV engines in our cars.
25:10
We're just going have to shut down, my God, the sky's falling.
25:13
And I say, well, it's obvious since 2017, it's been written on the Great Wall, what,
25:17
what's coming.
25:19
And you as a CEO should have seen that.
25:21
And it should be obvious to you that you shouldn't rely on China for
25:24
your supply chain.
25:26
So I have no sympathy for these people.
25:27
But when the question you're asking is what happens?
25:31
I think you're going to see China invade Taiwan and
25:34
forever change the makeup of the economic relationship between the west and China.
25:42
>> Jon Hartley: How do you see them doing that in the sense that there's some,
25:48
I think at least maybe a couple hundred US military personnel that are there.
25:56
They're, do you see them sort of cutting off Taiwan with some
26:01
sort of a blockade and trying to starve them out?
26:04
Do you see it being some sort of a land or some sort of an incursion,
26:09
amphibious incursion, all at once,
26:13
that sort of overwhelming attempts to overwhelm Taiwan?
26:17
What do you think the US response would be in that kind of scenario?
26:21
Do you, what do you think that would all look like?
26:23
>> Kyle Bass: So I think there are three paths.
26:25
The first path is the soft path.
26:27
That is like the way that they took Hong Kong is, you know, this is going
26:32
to sound tin, tinfoil hat like, but let me, let me give you just a hypothetical.
26:38
So the Chinese Communist Party before they took, before they took Hong Kong.
26:43
The Hong Kong protests were at their peak and December 2019, the Chinese
26:49
current account, call it their net income account, was headed towards zero there.
26:55
They still had a positive trade balance, but
26:57
they had a lot of external capital flows and we're going to get into that later.
27:01
But, and so they had this existential crisis with Hong Kong and
27:05
the legitimacy of the Chinese Communist Party having to fight an uprising
27:10
in Hong Kong at the same time, a current account headed towards zero.
27:15
And what happened magically Covid happened,
27:17
it came at the exact perfect time for the Chinese Communist Party.
27:21
It took their current account plus 250 billion because they shut off
27:25
international travel for their population and they dialed back the school expenses.
27:30
All of those are in dollars.
27:32
And they were able to take over Hong Kong without firing a shot.
27:35
Everybody went home.
27:37
So the soft side of the Taiwanese situation is, you know,
27:41
the KMT is funded by China.
27:44
China is hoping they can get the KMT in there.
27:47
They really hoped this last time, but William Lai won.
27:51
So the question is, what happens in 2028?
27:54
Does the KMT win and does Xi jinping Wait until 2028?
27:58
I believe he can't.
28:00
There are those in the US that believe he's going to wait to see if they can take
28:04
it over with soft power as opposed to hard power.
28:07
So the three options are soft with the KMT winning in 28,
28:12
the two other options are blockade, as you mentioned, or all out assault.
28:19
One would think that a blockade would, would actually force the US to
28:24
block the bl to unblock the blockade so that China could claim to be the victim.
28:30
Right? They are.
28:31
They, they have a PhD in victimology in the Chinese Communist Party and
28:34
they're the best in the world at being the aggressor and claiming to be the victim.
28:39
So in a blockade scenario they would just blockade the west coast of Taiwan.
28:45
And as you know, Taiwan's very much like Japan was in World War II.
28:49
They have no natural resources, so they've got two weeks of energy on island.
28:54
They have to import their energy and their food every day.
28:57
So they're very dependent upon those ports and especially the southernmost port.
29:02
So a blockade is not going to be that difficult.
29:06
It's going to require us to unblock it.
29:09
And I think we will unblock it.
29:11
And then, then we're in, then we're in a kinetic conflict.
29:14
The question is, and then again, option three is just the all out
29:19
assault of the Taiwanese island with an aerosol amphibious assault.
29:23
And it's it's difficult.
29:24
You know they're, I'm sure you know the terrain.
29:28
There are, there are 22 foot tidal surges in the Taiwan Straits 110 miles wide,
29:33
the largest amphibious assault in the history of the world was D Day,
29:38
which we just had the 81st anniversary of about what seven days ago or so.
29:42
So this is a much, this is a much more difficult amphibious situation.
29:49
The tides being 22ft and changing title surges in that Taiwan,
29:53
Taiwan straight lends that lends it only to be somewhat amenable to an amphibious
29:57
invasion three months out of the year.
30:01
And so there'd have to be precision and timing as to when they go.
30:06
There would have to be precision and timing on their on island position, but
30:09
then on island, as you probably know there are two giant mountain passes, there's
30:13
a thermopylae problem and so there's all kinds of problems with an assault.
30:17
So I think they'd rather take it on the soft side or
30:20
through a blockade instead of an all out assault.
30:23
But the US we have plans for all of that.
30:27
We don't have a great plan for
30:29
the soft power takeover the either of the hard options.
30:32
We have the most capable and best kinetic military in the world to this day and
30:37
we have plans.
30:38
So you know, it's, let's hope it doesn't get there, but
30:41
it sure looks like it's going to get there.
30:44
>> Jon Hartley: I want to talk I guess just a little
30:47
bit about US China relations and how it's evolving,
30:52
particularly with respect to economics, trade, finance.
30:58
And when I think about like say go back 10 years ago,
31:02
the mid 2010s, you know, we had on the trade side all the western
31:07
powers in Japan were I think trying to get China into the TPP.
31:12
This is prior to the 2016 election cycle where
31:17
Hillary Clinton was forced to recant her support for the tpp.
31:23
This trade, Asia Pacific trade deal, multilateral trade deal and
31:28
those largely brought on by Bernie Sanders,
31:32
his candidacy obviously Donald Trump is president.
31:36
Trump has totally changed thinking on trade in the Republican Party.
31:40
Both parties have really shifted on trade broadly speaking.
31:44
But I think there's been also just this massive shift
31:48
in thinking about China in general.
31:51
And I think a lot of this had to do with in the mid-20s.
31:55
I remember sort of my wake up call to China, or
31:58
at least a big part of it was seeing these videos of the Uyghurs and
32:03
how they were being treated and these very, very serious human rights abuses.
32:09
And I think that really,
32:12
I think woke a lot of people up to what was going on in China,
32:18
that it wasn't this sort of peaceful, friendly,
32:23
inconveniently dictatorial kind of nation with archaic communist system,
32:31
but was very friendly economics wise.
32:35
And then Xi Jinping was transformational in that shift as well,
32:40
taking things on a very different track from Huintao,
32:44
who's in power in most of the 2000s.
32:47
But now we've seen China's really backing off on the one China,
32:52
two systems idea to sign a British joint declaration where China agreed to allow
32:57
Hong Kong to keep its executive judicial legislative autonomy until at least 2047.
33:04
As you mentioned, China moved on Hong Kong during COVID I'm
33:09
curious what your view is on all this in the sense that I remember
33:14
in the 2010s in the BRIC economies, that was really one of
33:18
the biggest investment themes in emerging markets and the.
33:23
And China was a huge part of that, I think if you're investing today, if you invest
33:28
in China from that time to today, we'd be maybe flat or something like that.
33:32
Certainly in Hong Kong, there are all these things that China connect and
33:37
all these things, all these things trying to get people to invest in China.
33:42
I'm curious, in your mind now,
33:44
there's issues around rare earth metals and so forth.
33:46
Where do you see all the sort of U.S. china economic relations going?
33:51
Obviously tariffs have been a, a very big story in the past few years as well.
33:56
But I'm curious, where do you see the U.S. economic, U.S.
34:00
china economic relations going on all these sorts of avenues?
34:04
>> Kyle Bass: Yeah, I look, our systems are fundamentally incompatible.
34:09
Our values, we, we don't share the same values as the Chinese Communist Party.
34:13
In fact, ours are diametrically opposed.
34:15
We want to empower the individual.
34:17
We have basic property rights.
34:18
We have free.
34:20
There's a joke in free in China.
34:22
There's free speech in China, but after you freely speak,
34:25
you won't be free any longer.
34:26
Right. So there's the,
34:28
there's the value system that has a complete lack of compatibility.
34:31
And we all want to say, well, they'll learn, they'll learn to open up.
34:35
They'll learn that when you look at the bright shining star of Taiwan,
34:39
think about Taiwan just ideologically, why does it bother Xi Jinping so much?
34:44
Taiwan is like a Chinese democracy that's embraced western capitalism.
34:50
Taiwan's GDP per capita is 300% what China's is.
34:55
So Taiwan is what China could be if it embraced Western values and
34:59
Western capitalism.
35:02
You and I both know you want to see meteoric growth.
35:05
You get China to open up and you get China to have an open capital account and
35:09
embrace Western values and, and stop lying,
35:12
cheating, stealing, cajoling your way through the world.
35:16
That's just, that's the way they operate.
35:18
So you, you said you kind of had your, your Sputnik moment on China was,
35:22
you know, it sounds like the images of the Uyghurs and
35:25
understanding what was happening over there in East Turkestan.
35:29
That was one part of, of my awakening in 2015, 2016.
35:34
But the other one that really, you know,
35:36
I don't know if you've read Unrestricted Warfare, once that got printed in English,
35:42
you know, that was written by two Chinese generals, that was written for
35:47
the Chinese military and it made its way into the popular,
35:50
not really popular, but into the policy circles and think tanks.
35:55
People got a hold of that book.
35:57
But Diu wrote a piece in 2016, the Defense Innovation Unit, and
36:01
it was written by Mike Brown.
36:03
And for me, that was my holy shit moment, pardon me,
36:06
I don't know if you're allowed to do that on your podcast, but you read this,
36:11
you read this 2016 Diu report and you're thinking, I like, I knew it was bad.
36:15
I didn't realize it was that bad.
36:17
It talks about how they steal 300 billion ish of IP from us every year and
36:22
earn a return on it.
36:24
It shows you how they infiltrate the venture capital companies in Palo Alto and
36:29
on Sand Hill Road and how they intentionally make investments in
36:33
information technology companies that hope to sell their
36:37
wares to the largest information buyer in the world, which is the CIA.
36:42
But if they're Chinese investors in there, it basically takes them off the map.
36:47
So if you, I don't know if you've read that report, it's a phenomenal report.
36:51
Then there's a follow up report from DIU but it's a very comprehensive,
36:56
specific analysis of Chinese economic statecraft in America.
37:01
And that did it for me.
37:03
Trying to, after understanding their system, after understanding
37:08
their basic complete refusal to, to embrace human rights of any kind.
37:14
And then you understand the way that they're operating their economic
37:17
statecraft.
37:18
And they are our mortal enemy, John.
37:20
They are not a competitor, they are not a trading partner.
37:23
These most recent negotiations that we just had, how many times did you hear,
37:28
well, they have these rare earth metals that we really need and
37:31
they have these rare earth magnets that are needed in every single ev.
37:35
And I mean, we kind of have to deal with them.
37:38
And I kind of jokingly said a couple of days ago,
37:40
I said this is not a trade negotiation, this is a hostage negotiation.
37:44
We need to bring in hostage negotiators because that's what we're negotiating
37:48
with China.
37:49
And that is not a positive economic relationship.
37:51
We're not talking about, hey,
37:53
you charge us this tariff on agriculture and we charge this on cars,
37:57
why don't we just like find a great place to be and, and move forward?
38:01
That's a trade negotiation.
38:03
What we just had was a hostage negotiation.
38:05
And how can that be positive going forward?
38:08
So I think we're going to see Xi Jinping move in the next two or
38:12
three years on Taiwan.
38:14
I think we're going to be kinetically involved.
38:17
I hope it doesn't involve nuclear, a nuclear transition transaction with
38:21
either tactical nukes or something like that.
38:25
We're two nuclear powers, the world seems to believe that we could just fight in
38:29
the Taiwan Strait and not take it to the Chinese mainland.
38:32
I think that is, I think that's short term thinking.
38:36
I think that you and I both know out of Fujan they're going to launch surface to
38:40
air missiles, surface to surface missiles, and then we're going to have to attack
38:44
military installations in Fujan if it happens.
38:46
So if you believe that that's even a possibility.
38:50
And you asked about investing, first of all,
38:52
investing in communism has never worked in the long run ever.
38:57
Number two, if you believe that China is our enemy and
39:01
that we might be at a kinetic conflict with China in the coming years,
39:06
why on earth would you invest dollars in anything Chinese?
39:13
>> Jon Hartley: You know, it's, it's, it's fascinating.
39:15
Just, you know, when I was in my time working at Goldman Sachs in China was
39:20
still a theme and you know, things like China a share and you know,
39:24
each year, all this, all these sort of vehicles to get exposure to China and
39:29
all this excitement about it in that sort of 2000s, even early 2010s period.
39:35
>> Kyle Bass: It was a good, it was a good bet back then, John,
39:38
because teaching them that Westernization and embracing some of these
39:43
values would grow their productivity and their GDP per capita.
39:48
It was a great bet back then.
39:49
At some point in time it became a bad bet and we must admit it.
39:52
And now we must explain to the world that they are our mortal enemy.
39:56
>> Jon Hartley: I mean, Milton Friedman, I think, famously made,
40:01
in part it was a prediction, and he recanted it later on.
40:06
But those that countries with economic freedom will inevitably develop political
40:11
freedom.
40:12
And yeah, I think it's fair to say that since Dong Xiaoping,
40:16
China's certainly become more of a capitalist economy now.
40:20
There's a lot of caveats to that and there's a lot of state control in all
40:25
over, all over its economy, its banking system elsewhere.
40:30
But I guess in your mind, do you think there's any way that somehow there's
40:35
political uprisings in China in our lifetimes that we see, and obviously this
40:40
is something that's always on the minds of the Communist Party of China,
40:45
but it's such a large country, it's a fairly decentralized government.
40:51
There's lots of different regions and lots of different peoples as well,
40:56
and some various ethnicities as well.
41:00
I'm curious, see, in our lifetimes could there be some sort of an uprising in
41:05
China or some sort of regime change in your mind?
41:08
>> Kyle Bass: Yeah, I think it's likely to happen.
41:10
And I think again, logically, if you understand their grand strategy,
41:16
understand the composition, architecture of their system.
41:22
They built their system.
41:24
Their system was flawed from day one.
41:26
Their banking system is 320% of their GDP.
41:30
There are two Chinese banks that have more assets than JP Morgan.
41:34
You know, the US economy is 26% of the world economy, the Chinese economy,
41:38
so we run about a $30 trillion economy.
41:41
They say theirs is around 18 trillion.
41:43
It's about a little bit more than half of ours.
41:46
And yet they have two banks larger than the biggest, best bank in the world.
41:50
I find that to be interesting.
41:52
So I think you get to a point where if, if the architecture is flawed,
41:57
if their leadership is hell bent on staying with a closed capital account and
42:02
being belligerent with the rest of the world and
42:05
partnering with the axis of authoritarians, right?
42:08
You've got China with a limitless partnership with the war criminal in
42:12
Russia.
42:13
You have China, China partnering with Iran,
42:16
you have China partnering with North Korea.
42:18
So all four of the big authoritarian governments called the axis of
42:23
evil are all working together this time.
42:26
So at some point in time, what's going to happen is when they go kinetic, John,
42:30
we hold all of the cards.
42:33
We have their ticket into the world financial system.
42:37
They have four joint stock, they have four SOE banks, 12 joint stock banks.
42:42
They have an Achilles heel or two, and we know exactly where they are.
42:46
And I can tell you when they move on Taiwan,
42:48
sending carrier strike groups in the Taiwan Strait is one thing we may do, but
42:53
we will certainly hobble them financially.
42:56
And when we hobble them financially, it's going to be hard for Xi to hang on.
43:01
>> Jon Hartley: So- >> Kyle Bass: So back to your regime
43:03
change question.
43:04
Like that's, that's likely the progression of that regime's exit when, if and
43:08
when he goes kinetic.
43:11
>> Jon Hartley: Yes, so I guess speaking of other sort of non-democracies and
43:18
forming alliances with some of them.
43:22
I think the Middle East and some of the recent foreign
43:28
policy positioning certainly with the US and
43:33
growing closer to various Sunni nations,
43:37
thinking Saudi Arabia, UAE.
43:41
And thinking about the Abraham Accords and
43:44
building bridges between Israel and some of these Sunni nations.
43:50
And just recently Israel began this campaign against Iran,
43:55
taking out many of its nuclear facilities.
43:59
I think you and I are both surprised that they didn't do this earlier.
44:05
In your mind, I guess should one of the primary goals of Western allied powers be
44:09
to stop other countries, especially poorly behaved ones,
44:13
from obtaining nuclear weapons?
44:15
I feel like this was sort of something that was talked a lot about
44:19
North Korea for a long time, long ago, and now that ship has sailed and
44:24
obviously China plays a sort of a critical role there.
44:28
But I imagine that's always been the reasoning in my mind why
44:34
there's this ultimate danger of Iran obtaining nuclear weapons.
44:40
Something that, you know, they were doing, you know, spinning centrifuges,
44:43
you know, attempting to do for a long time,
44:45
all these sort of failed attempts at various deals and so forth.
44:49
I'm curious what you think about that.
44:52
And also just really the changing role or relationship between the US and
44:56
various countries in the Middle East.
44:59
The sort of warmth, I guess, in the US relations with UAE and Saudi, I think.
45:06
Something that kind of almost wasn't even necessarily imaginable 20 years ago.
45:11
And certainly Israel making friends with the Sunni nations as well,
45:18
trying to find partners that are also sort of allied against Iran as well.
45:25
I'm curious what you think about.
45:27
The Middle east has kind of evolved and the US's role in that.
45:30
And obviously there's an economic component of that as well.
45:32
You know, Saudi, Saudi Aramco being ipo,
45:36
there's the UAE is trying to attract a lot of investment.
45:40
They've developed common law courts, you know, and basically imported Western
45:45
judges from Hong Kong and Australia and elsewhere because they want business
45:49
courts, because they want to do business like the rest of the Western world does.
45:54
I think Saudi to some degree wants this as well.
45:57
I'm curious how in your mind the Middle east is, is,
46:00
is being transformed in that sense too.
46:02
>> Kyle Bass: Yeah, I think.
46:03
That'S a great question.
46:04
Look, we made a, the Biden administration made a,
46:07
a huge blunder with the turning our back on Saudi Arabia and embracing Iran.
46:12
I mean that was one of the craziest policy moves I've ever seen, right?
46:18
Whether it was Jamal Khashoggi and the botched,
46:23
call it kidnapping, which turned into a murder by the Saudis.
46:29
You know, look, no, no, sovereign's perfect.
46:32
I don't think they set out to kill him.
46:34
I think he got over sedated and died.
46:36
But that is also not one, one life is not the reason to turn your back on
46:41
your number one ally in the region.
46:44
And so Saudi has been aligned with us for a very long time and
46:49
they are our principal ally over there.
46:51
And now the UAE as you know, had embraced China.
46:55
They were dancing both sides like the Qataris were, or are.
47:01
And as of Q1 of 2024, you saw the UAE decide to
47:06
align themselves with the US and walk away from China.
47:12
And you can look back to Sheikh Tanun, who's NBC's brother and he's in
47:17
charge of all the sovereign wealth and all the AI and hit their AI conglomerate G42.
47:23
And they said, you know what, we're just going to rip Huawei out and
47:26
we're going to go with America on this one.
47:28
Hopefully we see that follow through in the uae.
47:31
So imagine if we have our allies in the UAE who as you said,
47:35
are Westernizing to the extent that they can.
47:41
They have a, they do have a very religious community.
47:44
So does Saudi.
47:46
And the strange bedfellows with the Abraham Accords, you know, the Jews and
47:50
the Arabs getting together, the Jews and the Sunnis coming together for
47:54
these accords.
47:55
That's a very positive development in the Middle East, let's hope it continues.
47:59
Of course, Iran and their proxies, they don't want the Abrahamic courts.
48:04
My view on October 7th is that was to disrupt the Abraham Accords
48:08
from moving forward.
48:10
I still think the Abraham Accords will move forward.
48:14
But you have a scenario where poor, you said poor nations, but poor crazy,
48:19
rogue, insane nations should certainly not have nuclear weapons.
48:23
You know how we contain rocket man, Kim Jong Un?
48:27
I, I'm not sure.
48:28
I think China contains him.
48:31
You know, he's like, he's like a, a rabid rottweiler in a cage, right.
48:35
They just kind of feed him every now and then and keep him hungry.
48:38
And, and so as we move forward, now that Israel has, has acted on Iran's
48:43
nuclear capabilities, I think the Middle east can be a much better place.
48:49
That is all with the caveat though of saying the world's
48:53
architecture of the financial system is broken.
48:57
And especially in many of those Middle Eastern nations.
49:00
The world's priced in dollars, John.
49:02
We just pushed 50% dollar inflation to the world in a four year period and
49:06
they have a negative convexity to us.
49:08
They meaning any country that's not self sustaining.
49:11
So I don't think there's gonna be any detent or any denouement anytime soon.
49:16
I think that things are going to escalate before they de escalate and
49:20
unfortunately I just think there's a lot more kinetic conflict coming because of
49:24
the architecture of the world being broken.
49:27
But in the Middle east, focusing on our relationship with the uae,
49:31
our relationship with Saudi is a very, very good thing in my opinion.
49:36
>> Jon Hartley: I just want to close,
49:38
I guess one last question on sort of legacy and investing, long term investing.
49:43
And I think for a long time we think the US has been sort of the only game in town.
49:50
If you just look at sort of world equity markets,
49:53
the US is the one place that continues to really just crush it.
49:57
And a lot of this has to do with the tech sector, A lot of it now has to do with AI.
50:03
But you have these major tech companies that just don't exist in Europe or
50:08
Canada or Japan.
50:09
And it's a big part of why GDP per capita and
50:12
the US keeps growing while it remains flat in the rest of the Western world in Japan.
50:18
And you know, for many years, you know, you were on the board of directors
50:23
of the University of Texas and Texas A and M investment management company utimco.
50:30
Endowments have very long horizons.
50:32
I'm just curious like what your thoughts are and
50:36
what you would tell sort of endowments and very long term investors?
50:40
Are you sort of in from sort of a global macro perspective in your mind,
50:45
is the US still the only game in town in terms of long run, very positive expected
50:50
returns, the place where innovation happens for the foreseeable future?
50:56
Or do you see other countries starting to participate with this more in the future?
51:01
Obviously the EU I think steps on its own toes with a lot of this tech regulation,
51:07
making it very difficult for tech companies to exist there.
51:12
But I think if you were to strip out all these tech companies from the us,
51:15
the US would probably look pretty much like the rest of the West.
51:18
But that's the one thing that I think makes the US economy so unique.
51:22
I'm curious what you think about the US as a long term asset
51:27
class in general on the equity side of things?
51:31
>> Kyle Bass: You've set it up perfectly.
51:33
My short answer is yes.
51:35
I think the US is the best place for your capital allocation.
51:38
We are 4% of the world's population.
51:40
We're 26% of the world's GDP.
51:43
We are 60% of the world's capital markets, so why?
51:48
Because people vote with their money.
51:50
We have the most liquid, best, deepest capital markets in the world.
51:55
We have American exceptionalism in our schooling and in our entrepreneurship.
52:00
To your point on Europe with GDPR and some of the foot their own goals that Europe
52:05
scores on themselves, you know, and then they continue to like double down on
52:10
the instant replay after they just watch the bad movie.
52:13
You know, like after they see the play and they know how it's going to play out,
52:17
they just do more of it.
52:18
It makes no sense at all to me what Europe's doing.
52:22
And then, you know, we are the place to be.
52:26
I have looked and studied the history of the world and
52:29
I can't find an economy that was bigger than 26% of the world economy.
52:33
Maybe there was one in the past, it just wasn't recorded properly.
52:38
But we, we are still the best economy in the world with the best prospects,
52:43
with the best system.
52:45
Now we have our, we have our challenges and the frictions are growing and
52:49
that that gap between the wealthy, the middle class and the poor continues to
52:53
grow because we're going to keep running $1.8 trillion deficits going forward.
52:57
So that's the caveat, John.
52:59
But if you're investing your money,
53:01
I can't imagine anywhere better than the US to invest.
53:05
And I'll give you one one last thought here.
53:08
If, if I told you as a very smart young economist and I said,
53:13
John, I know today I have a crystal ball 20 years from today,
53:18
I know of an economy that will grow its GDP 500% over 20 years and
53:23
they will become the world's second largest economy.
53:28
And they have a public index.
53:31
How much of your money would you put in that index?
53:33
You'd say, well, I don't want to put words in your mouth, but would you say,
53:36
I'll invest some in that index?
53:38
>> Jon Hartley: Absolutely.
53:40
>> Kyle Bass: So if you invested in the Shenzhen Shanghai 320 years ago and
53:44
China has reportedly grown their GDP now 505%, it's actually 18 years ago.
53:50
Let's just go 18.
53:52
You've lost a third of your money and they've grown their economy 505%.
53:59
What else do you need to know?
54:01
The, you're the patsy.
54:03
The Westerner is not going to make the money.
54:05
The Westerner is gonna get left holding the bag in a communistic economy.
54:10
Now, could you have traded and made money along the way?
54:12
Of course you could.
54:13
But I'm not interested in picking up dimes in front of bulldozers.
54:17
I'm interested in making longer term investments in companies that we know can
54:21
succeed.
54:22
And the US is always going to be that place.
54:25
Europe again.
54:26
If you parachuted a capable person into managing the eu,
54:30
you would get rid of gdpr, you would encourage entrepreneurship, you would
54:36
give tax incentives to move companies over there and you could revive Europe.
54:42
If you think about the architecture, you mentioned Milton Friedman and
54:45
you know what he said right before he passed away?
54:48
When the world hits a speed bump,
54:49
it's going to kill Europe because they don't have a real union.
54:53
They have, think about this.
54:54
They still have, they have no fiscal union,
54:56
they have no central taxing authority.
54:59
They have, they don't have a unified fighting force.
55:01
There's still a French navy, there's still a German army, there's still a Spanish air
55:06
force, and there's no deposit guarantee scheme across Europe.
55:09
Europe's not actually a union, it's just an idea.
55:13
And so if I'm thinking about investing capital,
55:16
are there some interesting European companies here and there Maybe.
55:20
Mean they make great leather goods, right.
55:22
LMDH is worth a trillion bucks.
55:24
But you know, branded luxury is what Europe's good at.
55:28
Europe is a retirement community for the world.
55:30
It's where the world's rich go to hang out because it's beautiful and
55:33
has a lot of history.
55:34
But the US is the place where all of the growth is going to be and
55:37
it's where all the other innovation is.
55:40
>> Jon Hartley: Absolutely and it's amazing too when you think about over
55:44
time, all these forecast premonitions, you know, the, the all these people that
55:49
have predicted that, you know, the USSR was going to eclipse the US in growth,
55:54
and then it was Japan in the 1980s and then China in the 2000s.
55:59
And it's amazing how all those predictions have failed.
56:04
Paul Samuelson famously had, I think it was in his 1960s textbook that the USSR
56:09
would eventually eclipse the US and, yeah, all those predictions have failed.
56:14
So it's amazing how it's such a terrible strategy to bet
56:19
against the US in many ways.
56:21
Kyle, I really want to thank you for coming on.
56:23
This has been a really amazing conversation.
56:25
>> Kyle Bass: It's a pleasure, thanks, John.
56:27
>> Jon Hartley: This is the Capitalism and Freedom the 21st Century podcast,
56:30
an official podcast of the Hoover Economic Policy Working Group,
56:33
where we talk about economics, markets and public policy.
56:36
I'm Jon Hartley, your host, thanks so much for joining us.