🔴 Will a Currency Crisis Bring Down China? (w/ Kyle Bass & Raoul Pal)

RAOUL PAL: Kyle, fantastic to have you back again It’s been a while End of last year, you created quite a sensation with a series of interviews started with Grant interviewing you about your views on China and some other views That led us into a series of interviews that were sensational, I think, to say the least KYLE BASS: They were a lot of fun RAOUL PAL: Yeah, and that was everyone from Graham Allison through to Miles Kwok, and Steve Bannon I think it was an eye opening experience for so many people You know, I’m just pleased to get you back You reached out recently, said, listen, you want to go through really, the full China thesis, so we can really dig into that, and have a look at it Because it looks like there’s a lot of interesting things going on right now And you’ve alluded to something that may come in due course, which is kind of a knock on ancillary to this, that is a really big story That we won’t talk about this time around, but just we’ll allude to, that there’s something bigger out of this that has never really been talked about on Real Vision I think that’s going to be interesting KYLE BASS: Right That’ll be a lot of fun You know, four or five months from now, you and I will break a new idea that– it has its own idiosyncrasies You know, it is a Southeast Asian idea But it’s one that has reached a quiet panic, and has yet to reach a newspaper And so that will be a fun one But we’re not quite ready yet RAOUL PAL: So let’s take stock of where we are in the China story, because I know you’ve been making some presentations on this recently And you’ve now got a really fully fleshed out thesis So talk me through what the thesis is now, and what’s going on win March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Sure When Grant and I spoke– again, the way that we look at China, the way that I think the world must look at China is again, you know, we have the presentation here where we have two worlds You have China’s world and you have the rest of the world And that’s how China looks at it, too They have a domestic world that they control They control everything They control the price level, and the narrative, and the printing press, and the police And they can do whatever they want to do And they can do that ad infinitum, especially if they don’t interact with the rest of the world But unfortunately for China, they actually have to interact with the rest of the world because what– they’re desperately short resources Desperately short energy, desperately short food, desperately short base materials They have all these things that they must go acquire, and no one accepts RMB as payment because it’s just funny money RAOUL PAL: But people– there was an argument that a lot of people making is, oh, they’re doing these RMB, and they’re opening up these lines so they can trade with Brazil and Argentina in RMB KYLE BASS: How’s that going for Argentina? I’m not quite sure yet And Brazil You know, like, come on And I know that the Chinese have spent a lot of time in the Middle East trying to convince MBC to accept RMB for oil It’s like Popeye asking you know, to buy the hamburger today– or Wimpy trying to buy the hamburger today, and pay someone on Tuesday In the end, everyone has to be able to convert back to something that’s actually usable If you look at BIS, and you look at you look at Swift, China purports to be the second largest March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff economy in the world that 15% of global GDP at today’s exchange rates And yet, when you look at cross-border settlements, less than 1% of cross-border settlements in the world settle in RMB RAOUL PAL: So there’s nothing they can do about it, really They are trapped in dollars KYLE BASS: Well, there’s something they could do, right? They could just open their capital account But we know what would happen then RAOUL PAL: Well, don’t they have to do that? And this is what I want to get into Because having talked to you and having looked at it myself, I can’t see how they can keep it closed, and still get the dollars that they need KYLE BASS: So that’s key You’re heading right on the key point I think they could have their world of make believe, and their world of printing RMB, and running their economy, and convincing economists like Krugman and others that their purchasing power parity is higher than anyone’s in the world But the denominators are inflation And they massively underreport inflation That’s just a fallacy But I think that can go on for a long period of time as long as what– as long as they’re growing their reserve balance As long as they’re growing their working capital, which is imports and exports As long as they’re growing that number, FX reserves, they can keep playing with their domestic economy, and playing with the printing press RAOUL PAL: But when I look at global imports and exports– this is an odd thing going on, happened in 2016, ’15 to ’15– is that they’re kind of shrinking So it doesn’t look to me like China is growing either side of that equation March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: No I mean, if you look at industrial activity– we’re going to skip forward in the presentation– But if you look at your subcomponents of China’s industrial production, this is using NBS and one of our consultants– their five seven components– energy is the only one that’s above zero So you have infrastructure, transport, consumer goods, and property Look at the consumer goods no printing down 10% year over year RAOUL PAL: Collapsing We’re seeing the car sales there, all sorts of stuff KYLE BASS: Car sales just printed down 18% That’s the most they’ve ever been down year over year

And then think about in nominal terms, what volumes have been, right? So if you think about car sales in percentage terms, then think about in number of cars, 18% of the largest SAAR China’s ever seen So think about how many cars that is RAOUL PAL: Yeah KYLE BASS: Right? So the point being is they’ve been contracting their economy They contracted their fiscal impulse beginning Q1 of 2016, when the money was really running So Xi came out and said, national security is financial security And that’s when they started contracting their fiscal impulse They were running 15% of GDP fiscal deficit at the end of 2015 RAOUL PAL: That’s ludicrous KYLE BASS: I mean, it’s as large or larger than any country in the world And the way they can do it is they’ve printed a lot of RMB domestically But what has helped them are enabled them to March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff keep doing this is they’ve been growing the reserve balance– i.e They were the world’s factory floor, their labor was cheap And the way that China really subverts WTO rules is they give free property and free electricity to national champions And that’s how they grow big companies– RAOUL PAL: Quickly KYLE BASS: Quickly And they actually don’t lose money until they get much bigger But they have all the basic inputs for free And so that also can– as a state, if you and I were doing that, and we said, we want to go to, Europe and ruin the European aluminum smelting business– you and I could do that if we had free electricity and get free property Because one of the biggest inputs to aluminum smelting is energy So they did that to the US, right? They dismantled our aluminum business They were starting to dismantle our steel business until we started putting tariffs on them RAOUL PAL: But they didn’t just do it to the US They did it globally KYLE BASS: Globally, yeah RAOUL PAL: They just holed everybody KYLE BASS: That’s correct So the point I’m trying to make is, again, when you look at this page here, you see that there augmented fiscal deficit reached 15% of GDP And look back to 2008, ’09, when they went to the gas pedal to save the world from the global financial crisis Their fiscal impulse was almost three times that by 2015 And now, it’s starting to contract And it’s March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff contracting 5% or 6% of GDP RAOUL PAL: It feels that something happened in 2015 when the dollar rallied, that China never recovered from KYLE BASS: Correct RAOUL PAL: And something happened It was the capital outflows that were happening at the time– and we’ll talk about capital outflows later– but something changed The whole global demand supply situation– if I look at world trade volume globally, it fell And it never really recovered It’s kind of flatlined Something broke in the world at that point I don’t really know what it is And I think it was probably China KYLE BASS: I think you’re right If you think back to the timeline, the 3%, the mini deval in China happened in August 2015 And from August 2015, basically a year later, they lost what, a trillion worth of reserves Trillion They had 14 and they had 3.2 There are a couple of really interesting observations that we make about this, and we’ll start with this chart here The red line, if you have a closed capital account, the amount of foreign currency or your offshore currency that should trade each night is just the sum total of exports plus imports if you have a closed capital account That’s the red line on chart on page six The yellow line is actual CNY turnover, which is reported every night by the Bank of China, Hong Kong The difference between those two lines– notice those lines stayed in perfect unison until just before the mini deval RAOUL PAL: Which, if it’s closed, it should be, right? March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Should be run on top of each other right There might be some noise, but let’s just say on average, if you’re to smooth it out two to three months, six month running averages, they should be right on top of each other And these things diverged going into the mini deval And they continue to diverge Once again, during the Trump election Once again, now, and into the trade RAOUL PAL: But this is the largest divergence in history, right? This is the period where we’ve just seen the currency strengthen a little bit Everybody is saying it’s fine, there’s no problem KYLE BASS: And you’re not seeing any ammunition in the aggregate balance reported FX reserves, either RAOUL PAL: So where are these outflows? What’s going on? KYLE BASS: These are illicit capital flows that are just going unreported RAOUL PAL: So then what are their reserves? KYLE BASS: We believe the reserves– so a few Nobel laureates went in and explain to China in early 2016, maybe late 2015, that there’s a certain reserve adequacy formula that a heavy exporting, importing country must have And they call it minimum levels of working capital for your machine to operate And a lot of those inputs are, how much short term debt do you have, how much long term debt What your imports, where are your exports, what are your near-term maturities

There’s a formulaic set of inputs that gives you an output And the output for China in early 2016 was $3.2 trillion So imagine when they lost a trillion, and got to 3.2– it’s flatlined, magically at 3.2 RAOUL PAL: Like all the other statistics out of China, right? KYLE BASS: Just because you see the capital flows continuing to diverge RAOUL PAL: But meanwhile, we know they’ve trapped foreign corporations capital in China KYLE BASS: Correct RAOUL PAL: So it’s not that money going out Money is going out somewhere They’ve stamped on a lot of the billionaires exporting capital, hiding capital So where is this capital? Whose capital is it? KYLE BASS: So there’s a really fun chart of something that happened recently RAOUL PAL: It’s like a detective game, this whole thing, right? March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Well, I mean, it’s exciting when you start to see things that are kind of corroborating your ideas You’re going to love this one, Raoul, you of all people, Mr. Chart himself RAOUL PAL: I love a good chart KYLE BASS: In November, precious stones– so diamonds, sapphires, opals, and the like– so November 2018– they accounted for 53% of China’s total imports from Hong Kong, up from 2.9% in Q1 So they went to 53% But at the same time, sales of jewelry dropped 4% So this is a fascinating chart When you look here, notice that this line of precious stone imports just went straight to the moon before the devaluation RAOUL PAL: Strangely March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Strangely So I showed you on the other chart where prior to August 2015, there was a huge spike of outflows? RAOUL PAL: Yeah KYLE BASS: So those that were in the know, those in the Chinese Communist Party that this deval was coming, ran They got as much money out as they could They bought as many precious stones as they could at the old exchange rate, at the stronger exchange rate And then post deval, it doubled again And then when Bitcoin became big, it collapsed So the wealthy Chinese figured, there’s a better way to get money out, and that was true And if you look at the bank for national settlements chart on Bitcoin– it didn’t print so well here, but I can show you 95% of Bitcoin settlement was CNY based until January 2017 When did Bitcoin collapse? At the same time China closed the door on Bitcoin, Bitcoin collapsed And then you know what happens? RAOUL PAL: But Bitcoin collapsed in 2018 KYLE BASS: At the beginning of 2018, right? Or the end of ’17 March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff It was the end of ’17 China closed the door here, and then and then it ended up collapsing towards the end of the year RAOUL PAL: Yeah KYLE BASS: So I guess what I’m showing is all the different avenues of being able to go out, and get your money out of China– like, how do you get it out You get it out by over-invoicing if you run an import export company You get it out by going to a bank like Minsheng Bank, and saying, I’ve got a billion RMB over here How many dollars will you lend me against my billion RMB? And then you just don’t repay the dollar-based loan Those are the ways you do it But they charge you 30% to do that, so it’s kind of an exit tax That’s how the billionaires get their money out, but the way the masses get their money out is they have to buy things They can go to Hong Kong, because, as you know, CNH and CNY, there’s no limit to the exchange in Hong Kong And so they buy watches, they buy jewelry, but more importantly, to get real money out, you buy really nice gemstones and bitcoins RAOUL PAL: Yeah But they also have– from what I’ve seen, is you’ve got an ability that you get a buy-back guarantee So what you do is you buy the gemstone in Shanghai– KYLE BASS: The guarantee is 90% of your original price March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: Exactly KYLE BASS: So again, there’s a vig RAOUL PAL: Yeah KYLE BASS: It’s the price you pay to get money out RAOUL PAL: That’s right But how are they doing it in such– KYLE BASS: But what’s interesting about that, Raoul, since rates have converged, Chinese and US rates are now equal to one another So the one year forward cost of, let’s say, selling CNH short is now at parity with the dollar It used to be as high as 5%, 6% of negative carry So now, it’s at parity, so why would you pay a 10% to 30% vig to get your money out? Because you know it’s coming RAOUL PAL: Yeah And the behavior reminds me, before Argentina devalued in 2003 or 2, whenever it was– the big deval– all the elites got their money out KYLE BASS: Yeah Think about the tequila crisis in Mexico in ’95 What happened? The elites got their money out Think about Thailand in ’97 RAOUL PAL: Yeah, same thing KYLE BASS: The IMF was urging the Thai government to devalue, and they wouldn’t, because all the military leaders hadn’t gotten their money out So the central bank held the peg until the military leadership got their money out

In the tequila crisis in Mexico, the finance minister of Mexico, the day before the devaluation, made an affirmative determination on TV that Mexico will never devalue And the very next day, what happened? They devalued RAOUL PAL: So what’s interesting to me is we’ve seen a similar situation going on in Russia, Saudi, and China, where anybody against the regime is– or, in Russia’s case, did get into trouble They allowed some people to take huge sums of money out That was public Abramovich being a great example But then there’s a whole bunch of others who disappeared There’s been a lot of killing, there’s been a lot of people being sent back to Russia We’ve seen China, the same thing going on And we’ve seen it in Saudi, this huge shift of taking all the money What are they doing here? Are they taking some of the money back to support the reserves, and allowing the right people– that they perceive the right people– to take money out? What the hell is going– because it’s all related to this, obviously, somewhere KYLE BASS: I have opinions on those three that actually differ But there’s one thing that is March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff homogeneous throughout, or at least the common denominator throughout, and it’s power And so when people like Jack Ma take pictures with the Queen of England, that is potentially usurping the power of the Almighty Xi And that’s probably bad for your net worth and your ability to travel with your family RAOUL PAL: But did she want Jack Ma to take so much money out of the country, or is this part of the crackdown of saying, you’ve taken too much money out? Or she is only saying to some people, you can take money out, but you better not We want your money back KYLE BASS: No, I think ostentatious displays of wealth are not good for China’s leadership And I think power, or perceived global power is not good for China’s leadership So as you’ve seen, Jack Ma gave up his VIE structure ownership to five unnamed individuals in a nanosecond, and the world has kept moving on RAOUL PAL: That came up in the interview– I think it was with Steve Bannon– that you did And you and I have talked about, I cannot fathom– imagine if that happened to Apple That’s the equivalent KYLE BASS: It is RAOUL PAL: That Apple suddenly loses its leadership, and four or five unknown people take ownership of the firm KYLE BASS: Right And the world’s OK with five unknown individuals taking over ownership It’s just like when the HNA chairman, air quotes, “fell off the wall.” He was clearly murdered His bodyguards murdered him And the bodyguards don’t work for him, they work for the for the Communist Party So when Jack Ma travels around the world now, he’s got bodyguards with him But they’re there to look at him, and not after him We’ve been told that he can’t even travel with his family It’s either him alone, or his family, but they can’t travel together, i.e. they can’t all leave China at the same time So this is the world we live in And I think what you’re seeing is both a power and a money grab get back to, call it the leadership Whether you want to call it the despotic leadership, the dictatorial leadership I don’t know what you want to call it Saudi was a little different I think that, in the case of MBS, you know he rounded up about a little more than 100 people, and he took half their money You don’t cattle prod billionaires and only take half their money I think you have to go all the way, or you don’t do it at all And I think he got a lot of blowback for that But we hear that he took about $120 billion RAOUL PAL: That’s right March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: That was a big number for Saudi reserves, when you think about the predicament they were in when oil collapsed, and they were running negative fiscal balances $100 billion bought them a lot of runway And so with Russia, it was a– Russia’s Russia We knows what goes on there Who knows what goes there? RAOUL PAL: So let’s go back to that chart, because that’s a shocking chart to me It’s assuming that there’s enormous amounts capital flight going on KYLE BASS: Yes RAOUL PAL: And it’s not showing up in the currency market KYLE BASS: The one that shows illicit capital RAOUL PAL: That’s right KYLE BASS: Yeah RAOUL PAL: The diamonds obviously corroborates it KYLE BASS: Yes And then we’ll show you also, one of the things that when you think about how China operates, when you understand that they’ve now gone to current account negativity for the first time in the first half of 2018, what is important to China going forward? It’s capital flows March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff And so we put together this chart from SAFE and CEIC’s database When you look at the green bars there, the green bars are the current account building that reserve balance that enables China to just keep printing money on the other side of their balance sheet, running their domestic economy they want to do That turned negative in the first half of 2018 So you see the green bars went negative The blue bars here are quote, “net errors and omissions,” which is Chinese for illicit capital flows So the only thing holding China up right now— March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: This hasn’t changed trend We still think that this is negative now, going into 2019?

KYLE BASS: Well, I’ll say that– think about what happened in December Crude oil dropped from $75 a barrel to, what did it hit, like $43 a barrel? RAOUL PAL: Yep KYLE BASS: That’s one of China’s biggest imports, is crude oil So that will give them a brief reprieve on the current account side of things But again, the question with that, is that a secular or is that a cyclical phenomenon? RAOUL PAL: That’s right KYLE BASS: This is key to understand You see you see the dotted line? RAOUL PAL: Yeah March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: That’s volume of crude importation by China, using the right y-axis And this is the dollar value of imports So back in the end of 2014, early 2015, when crude collapsed from 100 to 30, they got a massive reprieve in their current account But if you look at the volume, does that line look like equals y equals mx plus b? It doesn’t look very cyclical RAOUL PAL: No It’s not KYLE BASS: The thing about this, they were importing just under 300 million tons the beginning of 2015 The most recent number is 462 million tons Think about this They’re now importing 50% more crude in only four years ago 50% more today than they were importing four years ago RAOUL PAL: That’s staggering KYLE BASS: Right So is this a secular or a cyclical phenomenon? It is clearly secular, when you look at this line RAOUL PAL: Yep KYLE BASS: And now, energy prices will stabilize So you say, well, are they going to have a positive current account or negative, this quarter? And the fourth quarter’s probably positive, because oil collapsed But in the long run, smoothed They have a secular problem where they, from now on, will have a negative current account RAOUL PAL: Right March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: They’re starting to look more and more like Argentina, and Turkey, and the other twin deficit countries Because what are they doing? They’re running a negative current account, they’re running a negative fiscal balance of roughly 9% of GDP So they’re running twin deficits, their FX reserves are dwindling, and they’re starting to borrow a lot of dollars RAOUL PAL: So how much of the FX reserves is liquid, out of what’s left? What’s the composition of that, now? KYLE BASS: Well, first of all, if you remember when they were led into the IMF SDR basket, they said they would disclose the composition of their reserves within two years That was a long time ago, and we haven’t seen it So again, look at what they do, not what they say in China And clearly, they lied to everyone with that statement But more importantly, I think, getting back to your question, what does that composition of reserves look like? One thing we know for a fact is US treasury tick data shows that they own a little bit less than $1.2 trillion in treasuries So we think that their only liquidity that they have any size of is our treasuries So they own a little bit of, call it yen, euros, pounds But they mostly own treasuries We think the number is closer to $2 trillion, instead of $3.2 trillion Which is dangerously below adequate levels RAOUL PAL: Because it sounds like a huge sum, but for the signs the economy and the potential capital flows, that can go super quick KYLE BASS: So if we’re going to play large numbers here, the broad measure of credit in the Chinese financial system’s $48 trillion worth of RMB They only of $2 trillion of reserves Think about these numbers In their last banking crisis, which was between ’98 and 2002, the loss given defaults were 80% of loans that defaulted And at one point in time, they had 35% of their entire system was non-paying RAOUL PAL: But the counterargument always, for everybody, is, it doesn’t matter KYLE BASS: But it’s China RAOUL PAL: That’s always the thing It’s China They’ll smooth it Kyle’s being an alarmist Everyone’s being an alarmist You’re wrong, Raoul It’s not a trade through seven against the RMB All of this KYLE BASS: And those people sleep well at night, until they don’t RAOUL PAL: That’s the nickels in front of a steamroller approach KYLE BASS: Yeah I think what brings this to a head is the current account When the current account goes negative, and the reserve balance is going the other way, that the rubber meets the March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff road then As long as that balance is increasing annually, along with GDP, in RMB terms, they can keep going But as soon as those balances go– now, their fiscal balance is negative 10, negative 9.5 Their current account balance goes negative, and it’s a secular negativity, then they have more money leaving than coming in They have to desperately borrow And now, they’re changing their laws They say, you know what? Now, Westerners can own more than half of our banks, not a problem RAOUL PAL: That’s right KYLE BASS: Please invest more in Chinese equity RAOUL PAL: They have to get rid of all the shit they can KYLE BASS: Right So please invest more in Chinese equities So when you look at capital flows, this is a really important chart This is from CEIC and SAFE The red bar and the striped bar is just portfolio investment and FDI So without Western capital flowing into China, China can’t hold this all together Literally, we are providing them– RAOUL PAL: Which is Turkey and Argentina, right?

That’s the only way that– KYLE BASS: That’s right March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: –they were supported KYLE BASS: But what’s interesting about China is this gives them– first of all, their economy has given them the confidence globally to be more geopolitically assertive in their dealings It’s given their military the ability to be much more assertive in the South China Sea And it’s given Xi an aura that he’s made the West think that, somehow, his economy, his economic model is superior to that of Western capitalism And it’s all a facade The whole thing is a mirage The whole thing is made up with the printing press, keeping a closed capital account, and hoping the world doesn’t notice it RAOUL PAL: But can they get away with it? Can they do a smooth, Japanese-style decline, 20, 30 years of below-trend growth or growth of trends lower, and just kind of work out the bad debt? Because Japan’s surprised everybody of how they actually managed it Now, it’s a different economy, because they have a bunch of surpluses KYLE BASS: Yep RAOUL PAL: But, can they do it? KYLE BASS: I don’t have the chart in here I didn’t bring it with me But the other thing that Japan has, that China doesn’t, if you look at the net international FX reserve position abroad– so it’s the investments of Japan, Inc. abroad, both from a sovereign perspective and from a savings perspective of the population Japan’s net international effects position is 250% percent of their GDP China’s is 18% of GDP And most of China’s are the state It’s the left side of the PBOC’s balance sheet Lending to ports in Sri Lanka, buying the port in Greece, owning a Ugandan copper mine in Congo, for lithium, and things like that Those are things they are not going to monetize and bring home So China doesn’t have that net international FX position that Japan can really rely upon, to keep its dream alive Now, Japan still runs a positive current account And Japan has a quadrillion yen of debt, right? RAOUL PAL: Yeah KYLE BASS: They also have a quadrillion yen of net international savings, where China doesn’t So Japan is a completely different animal RAOUL PAL: So there’s two things I want to put into this One of the things that I’ve been talking about, I think the probability of a global recession is reasonably high, at this point KYLE BASS: What do you think it is? March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: 80% KYLE BASS: 80 RAOUL PAL: Yeah KYLE BASS: Yeah, I agree with you RAOUL PAL: It’s very high, and all the data I look at looks like it’s coming Could it be 2016 again? Well, we kind of avoid it, because the Chinese got us out of it I don’t think that’s coming We saw that a fiscal stimulus in the US lost two quarters It’s not going to help So we’re running out of something We’re running out of ability to get around this Looks like Australia is about to go into the recession All of this is starting to happen So let’s assume ceteris paribus in China, they don’t anything different, but the world goes into recession They’re screwed, right? KYLE BASS: Yeah RAOUL PAL: Because they can’t sell goods And then so their current account– KYLE BASS: Goes more negative RAOUL PAL: Exactly Because that offsets the oil thing, because the fact is– because we saw a similar kind of thing happened when oil fell last time It’s because world trade fell, as well KYLE BASS: That’s right RAOUL PAL: And if Chinese cannot sell enough goods, then that’s the end of the game KYLE BASS: I think the writing’s on the wall, when you look at– everything that you look at You look at Australia, you look at Southeast Asia But look at Italy just entered a recession a week ago If you look at the subcomponents of Germany’s industrial production, it’s actually tracking, right this minute, as bad as it was when Lehman came down RAOUL PAL: And you know what it’s highly correlated to? China KYLE BASS: But that’s my point Germany’s headed into recession The US numbers look really good right now It’s because we just stimulated at full employment RAOUL PAL: That’s right KYLE BASS: That’s stimulus– I think peak stimulus is February 27 That’s peak tax return day, and everything after that is just going to slowly head the way the rest of the world’s heading So the US looks good We will be the last economy to roll But Europe looks like it’s heading into a full March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff recession now Australia’s housing market and numbers look like they’re already in a recession Germany, Germany’s bond yields are trading at Brexit lows It’s crazy RAOUL PAL: Yeah, and the European banks, you and I have talked about before, that looks a mess KYLE BASS: The thing that I think is lost on some folks is this idea that the IMF and the ECB can just– the troika can, again, give Europe another save Well, think about what they did with Greece The IMF never designed to lend to even a small developed nation They’re supposed to lend to African nations, and other tiny nations that run into small balance of payments problems They’re kind of the last money in and first money out DIP lender to help people fix balance and payments problems They’re not meant to be a lender of last resort, like they were in the Greek situation But in Greece, pre-crisis, the IMF could lend two times your rainy day fund, if you were a member And with the stroke of a pen, Geithner got that to four times your rainy day fund during

the financial crisis They agreed to lend to Greece 32 times their rainy day fund They knew, that day, that they wouldn’t be repaid I’ve asked both sides I’ve asked the guy that actually made the loan, and I’ve had the guy that borrowed the money, and they both agreed So this is a fact That was about $220 billion euros Italy has $4 trillion euros of debt So I can’t see a case where, if Europe has a proper recession, I don’t know how to get out They’re already at negative rates, Germany’s already trading at Brexit lows, Germany is headed into recession, Italy’s in one If we have a proper recession in Europe, I don’t know how the euro survives RAOUL PAL: No, I don’t I don’t know how the euro survives, I don’t know how the European banking system survives And in that situation, I don’t know how China can survive, particularly with Europe bad, as well It’s a big part of the world Europe’s no small thing KYLE BASS: Right RAOUL PAL: And we can see it in leading indicators I think Australia is a leading indicator, in this example The Aussie dollar’s basically led this whole thing lower all the way through Something in the bond market’s telling us this It’s writ large, as far as I can see it, everywhere And for me, look, there’s numerous things I think the US bond market, the corporate bond market is one of the issues that may blow up in this one but China is the obvious one, to me, that something may happen So talk to me a bit about the other thing that I think exacerbates it Talk to me about trade and tariffs, and what your perspective is Because we’ve talked about it And you’ve been around DC, you kind of know what people’s intentions are But I’m not sure whose intention is what, and what the outcome people want is March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: I think, whether you’re looking through the National Security Council or the US Trade Reps office, or the Department of Commerce, or the US intelligence agencies, or the president and his own views, I think everyone has finally come to a conclusion independently, and yet, collectively, that a global reset of our relationship with China has to be had It’s not this simple, oh, we run a $400 billion a year trade deficit with China Let’s get the Chinese to buy some soybeans and some crude oil, maybe some LNG, and we’ll work this thing out That’s not it They steal $300 billion worth of IP from us every year, according to the Defense Department and the US Trade Reps reports to the president And they earn a nice return on that every year That has to stop, because that’s the one thing we have in this country RAOUL PAL: How do you stop that? It’s such an intangible How do you stop IP– KYLE BASS: There are a number of things– RAOUL PAL: –because the court system is the usual way, and they don’t have a court system KYLE BASS: But our court system, it’s not written correctly You have these– we can get into legal nuances– but the kind of adverse inference rules And the rules that, let’s just say, if the PLA steals technology from the US, and then a Chinese private company launches with that stolen technology, we don’t have any recourse to the company that’s launching with stolen technology, but their government took it If we start changing the presumptions with the theft, and making the burden of proof be on the other side that’s using the technology, in the US court system, that would be a real problem for China, because we could start attaching lawsuit winnings to some of their assets here Which would be a game-changer RAOUL PAL: Right KYLE BASS: And there are some basic policy prescriptions that we could change, let’s say banking-wise, legal-wise, and at the SEC, that would just level the playing field If we could do a few of those things, we could really make some quantum leaps in our relationships with China RAOUL PAL: But the US– KYLE BASS: And that doesn’t require their buy-in, either RAOUL PAL: No, but the US has not been particularly good at clamping down on China Even the launching of all the companies, all the fraudulent vehicles in the US, and stuff like that The US is pretty slow actually changing legislation to do stuff KYLE BASS: What China’s so good at is using money The Achilles heel to a democratic system based on capitalism is money They buy everyone They buy senior politicians in the US Just March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff recently, the Washington Post puts China Daily inserts in the Washington Post, as if it’s news It is pure Communist Party propaganda, and they pay the Washington Post to put it in there And it’s like it’s the New York Magazine and the New York Times It’s not You go to Berkeley, California, and the China Daily and Global Times is being delivered for free They have this incredible propaganda machine that’s disguised as news They’re foreign agents acting on our soil, and they’re using money to distribute the propaganda And they’re good at it And we, as a country– we’d rather earn the money You and I were talking off camera about friends of ours that do business in China

And they go to China, and they get paid to give speeches RAOUL PAL: They weren’t saying anything bad about them KYLE BASS: They would never say anything bad about them And there are people at think tanks, whose wives teach the Chinese Communist Party members English, and their family members English They’ve never said a one bad thing about China in any of their think tank reports China plays such a beautiful game of coercion through money that, you say, how does it stop? Well, maybe we just need some thick disclosure requirements, if Chinese money is coming in the country RAOUL PAL: My issue is it’s so pervasive, and it’s so deeply entwined with the political and economic system of the US and elsewhere, that nobody stops it It’s like how it’s like with the pharma companies, and all of the others This is not a world you want to get into, because– KYLE BASS: But that’s the Achilles heel of a– RAOUL PAL: It’s so rotting KYLE BASS: –democratic, capitalist-based system RAOUL PAL: It is But let’s say we can’t change that bit yet, because it’s not a quick fix So we’re going into a deadline that Trump put out KYLE BASS: The March 1st deadline RAOUL PAL: The March 1st deadline We were talking off camera that sounds like it’s softening a bit But there is, I think, zero chance that the Chinese can agree anything about intellectual property and technology within two years This is a complex, difficult negotiation, because there isn’t a rule of law that’s applicable and easily enforced So you have to figure out some way of a trust-based system that will work So I don’t see that happening If the US administration really is after the IP stuff, which you say that’s the real game– March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Well, I think that’s just part of the real game It’s the militaristic aggression in the South China Sea It’s their industrial policy, that circumvents WTO rules It’s espionage, and theft, and the lying, cheating, and stealing that the Chinese do We have to figure out how to stop it RAOUL PAL: So therefore, if that’s the case, it’s a really big game to play Then this March deadline’s meaningless, and the markets going to sniff this out pretty soon KYLE BASS: Right And if you and I were the Chinese, we would do exactly what the Chinese did in their first overture to our negotiating team All they said was, we will eliminate our trade imbalance with you over a six-year period It was brilliant a number of ways It looks like it gives Trump a win They only have potentially two more years of Trump anyway, so they’re just trying to wait him out We’ve been in these trade negotiations for a long time If you think about when we first started engaging in trade negotiations with China, when Xi was at Mar a Lago What’s happened since that day? Not a damn thing They’re just playing the waiting game, which they’re really good at RAOUL PAL: But then all I’m trying to think of this, does this increase the probability now that 7 goes in the RMB, and it starts trading 8, 8 and 1/2, 9? Because there is no conclusion, so the US has to play hardball And global growth and Chinese exports are going to suffer KYLE BASS: This will not be determined by our government or theirs Again, if all the training wheels came off the bikes, we’d already be at 8 or 9 on the RMB What you’re asking is, will a trade impasse accelerate the move? RAOUL PAL: Yeah KYLE BASS: Absolutely Will we have a trade impasse? Is there some sort of hybrid, where they agree to some agreement on trade, and then they agree to a timetable, a longer discussion on industrial policy and intellectual property theft? Maybe Maybe Trump could call that a win I actually think it’s going to be somewhere in the middle I don’t think it’s going to come to blows or pencils down, and walking away from one another I think China is desperate to get something done, because the trade talks, while they’re small– we’re talking about $50 or $100 billion a year We’re talking about 10% or 25% tariffs on a total number of $500 billion So we’re talking about $50 to $125 billion On an economy of 13 over there, an economy of 20 here– $20 trillion– this shouldn’t matter But we were just talking about, their reserve number might only be $2 trillion RAOUL PAL: That’s right KYLE BASS: So if they’re going to lose another $100 billion a year in tariffs, that’s a real problem for them March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: And what I’ve noticed is the decline in the value of the RMB pretty much offsets the tariffs So if they were to increase the tariffs by 25%, to me, it’s got 8 written all over it It’s just another way that I look at it, I just think that they offset it as fast as they can Now, what’s weird is the RMB it’s a currency basket, essentially But it seems the knock-on effect through the lack of trade, as the Euro falls, the Aussie falls, all of these things fall, it’s highly correlated, as we know

That’s why, for me, I’m just sensing that– and I know you don’t really want to go necessarily to a catalyst point– but I’m feeling like there’s a catalyst point racing towards us, which is a deadline that’s not going mean anything KYLE BASS: I agree RAOUL PAL: It’s going to be a half answer, because nobody can actually create an answer It’s impossible to get an answer done You said, OK, peak fiscal stimulus, February 23rd Well, then, by the time we get to March, and April, and May, what we’ve got is fading I think the US economy’s slightly weaker than that, anyway We’re seeing the global economy fading We’re seeing the bond market telling us something So to me, it’s like, OK, we’re rushing toward something And the capital numbers look like there’s money leaving China right now, and that there is something going on KYLE BASS: You’ve set it up properly, Raoul I don’t want to be a near-term catalyst Armageddon person RAOUL PAL: No, I get that KYLE BASS: But look at what’s out there today It’s everything you just described And you left out just a few things We have the March 1st deadline for trade RAOUL PAL: Yep KYLE BASS: We have the mid-may European parliamentary elections, where you’re going to see, let’s say, populism raise its ugly head once again You’re going to see early elections in Greece, you’re going to see the Italians go crazy, again, on the budget RAOUL PAL: Yep You see what’s going on in Spain? They’re voting the Catalans have got– KYLE BASS: We’re talking about a potential hard Brexit coming, what, in March? Literally, there are so many things going on right now, and each, in their own right, is an enormous contributor to the global economy RAOUL PAL: And the market is actually choosing to ignore them, and hoping we get through every one of those speed bumps and don’t fall over March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff KYLE BASS: Not fall over, I think the market’s priced as if we’re going to walk through their squeaky clean It’s a fascinating time to be alive, because I think the machines are running the ball game here And it’s really human interaction and human intuition that’s going to determine the outcomes in many of these situations, in the next four or five months RAOUL PAL: So if people can’t trade the RMB, what are the other obvious knock-on effects? As you know, I just say, well, if the world is going to shit, the US bond market’s going to be the best place in the world KYLE BASS: And by the way, you rightly called– you basically said, all you need to own– I can’t remember It was bonds and diamonds And that was like six months ago And you called it just right You get an A plus– RAOUL PAL: Thank you KYLE BASS: –for that call But it’s just the beginning RAOUL PAL: Yeah, and it feels to me, I’m looking at the currency market again, it looks like the dollar wants to break higher again KYLE BASS: Wait, I thought when US rates go lower, the dollar’s going to get killed RAOUL PAL: That’s the argument that everyone– KYLE BASS: And the dollar’s going to lose its reserve status And all of these things I’m hearing from all these people– RAOUL PAL: Exactly right KYLE BASS: I think they’re all dead wrong RAOUL PAL: I think they’re dead wrong I think the world has a problem, and there’s not enough dollars KYLE BASS: I knew I liked you RAOUL PAL: I think the world doesn’t have enough dollars I think China is the biggest problem with the shortage of dollars The dollar will go higher in any slowdown, I think, regardless of what rates do And looks like it’s starting to happen now The DXY broke 97 today Well, yesterday And I look at things like the Aussie And the Aussie, for me, is a great one, because that’s at the epicenter of all of this KYLE BASS: It is March 1st, 2019 – www.realvision.com The Interview: China’s Currency Cliff RAOUL PAL: If I’m looking at one thing, it’s bonds And I think the Aussie dollar is one of them And the Euro just seems– KYLE BASS: If the US dollar’s going to lose its reserve status, which currency are you going to own? You’re going to own the pound? Because if there’s a hard Brexit, it’s going to go to parity Are you going to own the euro? Because if they have a recession, that’s going below parity Are you going to own the RMB? No, you can’t really spend it You might as well just go buy another Monopoly game RAOUL PAL: That’s the problem KYLE BASS: What are you going to own? RAOUL PAL: What you own Yeah KYLE BASS: Well, you’re going to own dollars It’s what you’re going to own RAOUL PAL: Yeah So let’s see what happens with the Chinese thing I think the story’s building And I’m waiting eagerly for the second part of the story, because we talk about knock-on effects, and we’re talking about the Aussie dollar, and the US dollar, and the US bond market There’s potentially another huge knock-on effect that everybody’s missing, which– KYLE BASS: That’s right RAOUL PAL: –I know you’re putting together a thesis KYLE BASS: It’s the most asymmetric trade ever seen in my entire life And it’s staring us right in the face And we will pick up on that the next time we get together RAOUL PAL: Excellent, Kyle Thank you ever so much for coming in KYLE BASS: Raoul, thank you RAOUL PAL: I look forward to it