The Tipping Point for China's Economy (w/ Kyle Bass and Raoul Pal)
RAOUL PAL: So Kyle, good to get you back. You're one of the most requested ever people on Real Vision. Everyone always says, I get messages all time, what does Kyle think? What does Kyle think? So now we're trying to find out what you're thinking. So what's going on right now? Let's get the elephant out of the room. Let's talk about China. KYLE BASS: OK, how much time do we have? RP: As long as you need. Where are we? What the hell's going on? KB: We're in the such late stages of a game that is the largest global imbalance I've ever seen in my life. When you look at on balance sheet and off balance sheets, you look at on balance sheet in the banks, you look in the shadow banks. The number of total credit in the system, China is right at $40 trillion. Think about the number I just said. $40 trillion. And that's using an exchange rate of call it 6.7 to the dollar, right? So it's grown 1,000% in a decade. And we're on a $40 trillion credit system on $2 trillion of equity on maybe $1 trillion of liquid reserves. RP: Where do you get the equity and liquid reserves from? KB: Well, it's the amount of equity in the banks of China. It's right at about $2 trillion. So that's kind of a stated number. The reserves is my own calculation, right? The Chinese magically have leveled their reserves out around $3 trillion, which happens to be the minimum level of IMF reserve adequacy as defined by the IMF rule. RP: Oh, really? KB: And what you saw in November last year when they were hemorrhaging $50 to $60 billion a month, they sold down their US treasury position from $1.2 trillion to $1 trillion. It's our view at Hayman that the Chinese' only liquid reserves is their US treasury position. And so we think that they really have about $1 trillion of liquid reserves. They might have another $1 trillion, $1.5 trillion of illiquid reserves. But just remember that two years ago, they said they would kind of deconstruct and become more transparent on what their reserve balances are and how they are constructed. Of course, we've seen nothing in two years. But when they were hemorrhaging back in November, the amount they were losing monthly was the amount they were selling in the US treasury market. So it's our view that that's where the liquidity is. RP: So what have they been doing now? So they were under pressure, and then everything kind of eased off, I guess, as the dollar started weakening a bit. KB: Yeah. Actually, they've done three things. Well, so four things have caused this, quote, easing off that you refer to. Three have been driven by SAFE and the PBOC, one that's been driven by our illustrious Trump. So the first three are, number one, they essentially halted all cross-border M&A. So if you look at the parabola of M&A coming out of China from 2012 to 2016, it reached dizzying heights in 2016. In 2017, it's like 15% of the 2016 number and no new deals being announced. Now, they'll always be some outbound M&A that's driven by really policy at the Communist Party level, right? They'll always buy copper mines in Uganda. They'll always invest in ports in Greece. They'll always do things that are from a strategic perspective and a policy perspective. The things that the Communist Party needs to procure resources for its people over the long-term. But when you look at the rampant M&A of money leaving China, they just put a halt to it in November of 2016. And the second thing they did was they made it impossible for multinational corporations to get their profits and or working capital out of China. And that's something that has been a problem for a lot of the multinationals that do business in China. RP: And that's interesting because it's not really public. I know we've talked about it before, but you don't really see a lot about that. KB: There have been a few meetings with SAFE where they quietly say, please let our money out. And SAFE says, well, it must be a problem with your bank or the forms you're filing. Here's an email at SAFE. Send us an email and we'll help you get your money out. This is really, pardon the pun, this is the red tape that the Chinese put together where it's an internal policy that's not explicit externally. They just basically throw more bureaucracy at you and make it impossible for your money to come out. And so I'm close to a few consultants that have been hired in the US by these multinationals to get their money out, and it still hasn't come out. So that's the second thing they did. Now, remember, multinational's profits in China amount to almost 2% of Chinese GDP. Right at the current account surplus number. So this is meaningful as far as profitability is concerned and capital flows are concerned. The third thing, which is kind of on the individual level, an additional edict came out of SAFE about two weeks ago where they said that any cash withdrawals or overseas purchases with Chinese credit cards are to be reported to SAFE weekly at levels that exceed, any transactions that exceed 1,000 RMB. That's $150. Imagine how big that data file is going to be. And so what happens in an economy where people come out of poverty into the middle class and the upper class is, naturally, they travel. Naturally, they spend. And so the services deficit today is running $30 billion a month negative in China. And that's been growing ever since they've elevated the people from poverty to the middle class. And that will constantly grow. And so that number will constantly get larger. RP: It sounds like they've got a temporary fix in place. So what changes the dynamic of that then forces those reserves lower? Because if we're looking for this whole situation to kind of, you know, the apple carts get upset, how does that happen? KB: Yeah. What's interesting to me is, so-- the answer is I'm not sure. I know that in an effort to maintain economic and political stability for the 19th Party Congress, which happens this November 2017, Xi, and Wang, and the ruling elite of China wanted to maintain the stability, needed to maintain it at all costs. And so they've tied a knot at the end of their proverbial rope and they've been hanging on. But imagine if you're Qualcomm, Ford, GM, Visa and you can't get money out of China, you have a US auditor. And so you go through the end of the year, and they're going to have to rethink how those profits are classified and maybe even how the working capital is classified. And so it's my view that they can't do this forever. And to the extent that a multinational doing business in China is really having severe restrictions on their capital, they'll just move to Cambodia, or Vietnam, or they'll move somewhere in the region and start doing business elsewhere. China wields this economic sword so beautifully. The carrot is so large. The delusion of riches is so great that companies and even investors are willing to suspend disbelief to chase that carrot, and the Chinese know it. And they do a masterful job. RP: One of the things I'm thinking is that with the Chinese currency basket, the weakening of the US dollar came just at the right time because they were hanging on, they were plastering over the cracks and hoping the whole thing didn't fall apart, and then the dollar started weakening. Now, for me, again, I'm still a dollar bull, although it feels slightly tenuous and scary at this point. But if the dollar turns up again, then it starts adding real pressure. KB: Yeah. When you think about if you were running China or I were running China, we want a weaker currency. Even though we magically flipped a switch that we all of a sudden went from an export based economy to an internal consumption based economy and all was fine, they still rely on exports from more than 40% of their economy. And so there's a little bit of cutting off your nose to spite your face in strengthening their currency, call it 5% this year. China wants a gradually weakening currency, the US wants a gradually weakening dollar, and Europe wants the euro to weaken. Everyone wants their currency weaker. The yen is supposed to be weaker, the dollar, the euro, and the RMB. They just don't want it to go in a discontinuous fashion, right? They don't want the euro to go from 120 to 1 in a day because then, all of a sudden, that instability begets additional outflows. So I think that to your point, the dollar at this speculative short position on the US dollar has never been larger in the history of the dollar. I think our economy is moving along at a decent and a nice pace right now, both nominally and real. We haven't seen wages start to move yet. Maybe they will. But I think the dollar is likely to move higher, and I think we're likely to see somewhat of a financial crisis in China where they need to recap their banks. So I think those people jumping onto this genius Sharpe ratio trade where they go long CNH and short VOL, and do all of these things that have great Sharpe ratios. That will work until it doesn't, and I think we're pretty close to that point. RP: There's a lot of murky stuff going on in China, which I know you've spent a lot of time trying to pick apart what the hell's going on. What's going on with commodities? I mean, I wish I knew. There's a lot of-- I mean, it seems to be disconnected from the real world. And it's obviously something to do with currency deval fears or collateral and lending. What do you think? KB: Well, my own view on commodities is they're all idiosyncratic for different reasons. But whether you're talking about copper, iron ore, gold, gold's starting to move a lot higher now. But I think on the commodity side, a lot of people got excited about additional capacity reductions that are announced in coal, and iron ore, and steel. And now we have the One Belt, One Road initiative where they're going to spend $1 trillion over 10 years on infrastructure. You look at the Chinese infrastructure spend, they're spending 15% on real estate. 15% of GDP on real estate. And call it 16% on other infrastructure spending within China. They're spending like 30% of their economy building things. RP: But I thought the accepted thing was they'd already overbuilt. So what the hell are they building? KB: It's difficult if you're going to bring that many people out of poverty into the middle class, you have to-- imagine if you and I were central planners. And if we said that our population of city XYZ is going to double in the next 10 years, you have to start building right now. So you have to be way ahead of the building curve, and that's the challenge they've had. You and I both know they've built cities to nowhere, and they've built malls to nowhere. Don't RP: And also because it employs people. It's a self-fulfilling prophecy because what they do is they bring people out the villages, give them jobs and construction to build a city that nobody ever lives in. KB: Yeah. Well, I mean, look, if you have an economy of $11.5 trillion and you're at $40 trillion worth of credit, you can bet that you've extended credit to places that you're not going to see it come back from. And really, that's our view. And the IMF article IV review that was just released this month. I don't know how many people actually read, them but when those come out, we tend to read them all. And the actual document that comes is a collaborative agreement between the article IV a reviewed country in the IMF, but then the supplemental material is not collaborative, and it's just where the IMF can actually say their piece. Look at the supplemental material to the IMF article IV review that just came out in China. They talk about the dangerous credit expansion. And that in the 43 credit expansions that the IMF reviewed that, say, expanded with the rapidity at which China did, or somewhere at the level of where China did, said, you know, 38 of them ended in a financial crisis immediately thereafter. And the five that didn't, don't give them any solace. And they said any of them that began with credit over 100% of GDP all ended in crisis immediately. And so the IMF is basically taking the gloves off and saying what they're doing-- if you saw, there were a couple of headlines. Said what China's doing in the short term is going to cost them in the short to medium term immediately. So I think they're kind of focused on getting through the NPC, and we'll see what happens. RP: When is that? KB: So the way the Chinese electoral system works, it's every five years. And so that's this November. So they have kind of a presidential cycle every five years. RP: And so, I've heard this before, is that seems to be a significant date that they just want things to go smoothly, and then they can take some harder measures to try and rectify the economy afterwards. KB: That's correct. RP: And do you get any sense of that within China itself when you talk to people? KB: You know, they've spent a lot of time on trying to get banks to do debt for equity swaps. Xi himself has said the real risk in the economy is financial stability. And really, he's trying to crack down on excessive WMP issuance and risky lending in the banks. But it's like, it doesn't matter who you parachute in to pilot the Titanic after it hit the iceberg. It almost doesn't matter. My point is they have some brilliant people at the PBOC. They have some brilliant people in the Communist Party. But we had a lot of brilliant people in the United States that have been running capital markets for over 100 years, and you know how bad we screwed it up. And we only had $17 trillion on balance sheet in the banks, maybe another $5 trillion off balance sheet in an economy $17.5 trillion, and we detonated our banking system. They've got four times what we had. RP: So the argument goes when people hear this, and when I talk about this kind of thing, people just go, yeah, but it's China. KB: I hear that all the time. RP: So what's your answer? KB: I mean, if command and control economies worked, we'd all be speaking Russian. Command economies haven't worked throughout history. And they can work, you know, the place where I actually see greatness in command economies is if they want to build a high speed rail between two cities, they just build it. And if people live there, they move them out, they give them some renumeration, and they move on. If we want to build high speed rail between LA and San Francisco, it's going to cost $40 billion. It's going to take 15 years. And you're going to have every single greenie and every single pissed off person that you're moving out filing lawsuits against you. That doesn't exist in China. That's why they can build things so quickly. And they can do things, I think, in a much better fashion than the United States can. I will give you that there are positives to command economies. But I think also that the laws of economic gravity in a credit system will catch you every single time. RP: So I've never found an example in history where it hasn't. KB: I haven't either. RP: And that's my argument. When people come to me, I'm like, OK. Maybe they can elongate it, which they have done longer than I ever expected. I first started looking at this issue back in 2004. So they've elongated quite a long period of time. Probably longer than the Japanese did, probably longer than the tiger economies did in the '80s and '90s. KB: Right. RP: I've never, ever found an example, ever where you have a financial system that can survive this. KB: Right. If China didn't trade with the rest of the world and it was a closed system, they could expand their central bank balance sheet, recap their banks, and move on. Because what's China's objective? It's to stay in power. When you look at what Russia did, Russia took the adjustment all through their currency all at once. It was brilliant. Right The Ural price of crude today is very close to where it was in 2014. They lowered their call it break even of the Russian economy in rubles from call it $90 a barrel to $40 a barrel. And they took the adjustment 100% through the currency, and they did it knowingly. Their finance ministry is really talented at what they do. China trades with the rest of the world. There is an exchange rate between RMB, euro, and dollar, and whatever other currencies they settle in that don't really matter other than the euro and the dollar. Mostly dollar. And so if you have a system that has to print $2 to $3 trillion, so call it $15 to $25 trillion RMB, then what's the exchange rate going to be? I'm not saying it's the end of the world, I'm just saying that they're going to have to recap their system. They have to recap their system, what is the exchange rate of that currency vis-a-vis the dollar going to be? It's just going to be a lot lower. RP: So another argument people say is that China's starting to trade with other people-- their trade counterparts in different currency, in yuan. And the cross currency swaps, and that kind of stuff. What do you think about that? KB: I mean, it's de minimis. When you think about the enormity of trade settlement in dollars, and dollars CNY, it's the whole shooting match. RP: Yeah, and I think we've had a bit of a reprieve in the dollar funding markets. But if that tightness comes back and you can see it in the Japanese basis swaps. They're starting to go wildly negative again. KB: Yeah. RP: If that comes back, then there is no dollars. On If there's a shortage of dollars, then all you're doing is passing around the shortage. KB: Right. RP: And if that comes back into the system, which it hasn't gone away and the BIS keep telling everybody that this is not going away and nothing's been resolved. KB: Right. RP: Somebody's going to be holding that baby in the end, and China's got the biggest basket in the short dollar issue. KB: Yeah, but just think, just since January, the dollar index has gone roughly 103 to 92 and change. It's come in 10% in less than a year. That is an enormous move. And it's actually pretty beneficial to the US from a trade perspective, right? RP: Yeah. KB: Trump figured out very quickly that making America great again doesn't mean a big, strong dollar. But I think the fourth thing that's really affected the exchange relationship has been Trump's inability to get anything done on the Affordable Care Act repeal and replace. Therefore, nothing's being done on comprehensive tax reform. All we're hearing now is there's going to be a tax cut. Well, that's not going to balance anything. And so his kind of inability to get anything done has also forced the dollar much lower. RP: So give us some timings how this plays out. What kind of ways are you looking at? Are you just looking at a currency trade here? Is that the most efficient way of doing this? KB: That's it. The ultimate arbiter of the entire macro situation I just described to you is the currency. So that's where we stay. RP: And what about a time horizon? I know it's difficult. I don't want to pin you down. KB: Well, no, it actually requires you to pin me down because our investors pin us down. RP: OK, so when the fuck's this going to happen? KB: So my best guess is between November and call it June. November 2017, June 2018. RP: Right. Now the other thing that I think about is I don't see how China survives the next global recession. One will come. But I don't see how this situation, actually, I don't see how Japan survives, or Europe either. Because in this world where things are growing just about, everybody is OK. KB: Right. RP: This dollar funding shortage keeps moving around and there's a few things, but it's OK. But the moment that the global business cycle turns lower, which at some point it will because it always does, then all of this stops. KB: Yeah. The point you make is a good one, unless we get rates higher first so that we have some rates to cut. And I think what you see happening in the G4 central banks, ex Europe, but I think you'll see Draghi’s painted into a corner. But look, why is Japan talking exit? They set a 2% inflation target. They're not even at 1% and they're headed lower, and for some reason they're talking exit. Makes no sense at all, right? All central banks have is their credibility, and they've completely lost theirs. And so I think that whether it's the US, Japan, Europe, or even China, I really think you need to see rates higher to buy them a little bit of a rainy day fund going forward. I think you and I both know-- RP: Could China take higher rates? Could Japan take higher rates? Could the US take higher rates? Could Europe take higher rates? KB: I think the US could take higher rates. Not a problem. RP: US, possibly. Although, you notice how the curve flattens every time they raise, but that's normal. KB: Look, if we raised rates 100 basis points, it's not going to kill anybody. It's just not. We're still at emergency levels of monetary accommodation eight years in. RP: And what about Japan or China then if they were to raise rates? KB: You know, Japan won't be able to raise rates much at all because of their fiscal issue. They're so hyper-levered to their debt stack. But Japan's weight average maturity has actually been pushed out to about 7.5 years now. So I think they could still move the front end a little higher in Japan, Europe still has, what, the discount rate is negative? And so they could bring that up to positive, and you move it up 150 BIPS. And that would bring NIMS back into the European banks. That would bring money back into savers. So I am of the opinion that globally we need to move rates higher. And maybe we need to move them higher all together. And that might be why Japan is talking exit when they haven't achieved anything that they set out to achieve. RP: Yeah, I think definitely right. With higher rates it changes a lot. Particularly the aging population. You're actually injecting money into the economy by raising rates, which is almost the opposite of how it used to work. KB: That's right. RP: Right now the more you cut rates, the more people stop spending. The circulation of money collapses. KB: Exactly right. RP: But I don't think the central banks-- KB: They've figured out that negative rates don't work. RP: Right. Well, that's a good thing. But I don't think they have an understanding of how it's possible to normalize rates again. KB: They're too afraid. RP: So what happens when the Fed starts to shrink the balance sheet? Do you think they will? How does that work? KB: I do. I mean, I think I think the Fed shrinks the balance sheet, and I think Draghi has to turn QE around. I mean, you can't have the ECB owning every boon in existence by next June. So I think balance sheets have to start shrinking. And I think that steepens curves. And we've talked about this. Whether it's a bear steepener or a bull steepener, you're going to see curves steepen in the initial move. And you think about the G4, the way that we think about it, our firm, you have sovereign bond issuance in the G4 and then you have QE. And so there's this kind of, forget about the stock. Let's look at the flow. When you look at the flow of sovereign bond issuance in 2016, there was a net accommodation. So net of maturities and issuance. There was still a $500 billion injection in the G4 economies from QE. Net of issuance. So net of any new sovereign issuance. This year, it's kind of an injection of about $100 billion. And next year based upon our view of ECB beginning to taper next year and kind of getting to a final tapering by the end of next year, it's going to be a net $1 trillion issuance. So it's going to go from an injection to-- an injection of half a billion-- sorry, half a trillion dollars last year to a demand for an extra trillion in 2018. RP: $1.5 trillion-- KB: So $1.5 trillion swing and flow. And that's going to come from somewhere. And you know, money's fungible, so we all know that QE didn't buy stocks, but the net result was people bought a lot more stocks, because there were a lot more money out there-- there was a lot more money out there. So again, there's no direct causal link that's hard to-- or sorry-- that's easy to explain. But when you have a net injection of half a trillion to a draw of a trillion, it's just going to make conditions a little tighter in the G4. Which, the G4, I think, is all that really matters. And so when you say, what happens when they run off balance sheets? Well, I think this kind of world of low vol and the perpetuity is going to come to an end. And I think that rates are going to start to move a little higher. Now rates moving higher too quickly might cause a problem and the curve might flatten out, to your point. In the beginning, I think it steepens. RP: Yeah. When I look at the steepening, I'm expecting a steepening based on a slightly different premise, but it could be the same in the end, is that I think whatever's going on now with the rates and everything else ends up slowing the economy. And that's basically what the yield curve flattening tells you. KB: OK. RP: The next phase is always a steepening. KB: Yeah. RP: Now you could be right, and it steepens as a bear steepening. So I just think that curve steepener, the 2/10 steepener is probably becoming one of the better trades out there, because you kind of get it right either way. KB: Yep. Now the risk, right? The risk in the steepener is, you know, Kim Jong Fatty III throws another missile somewhere, and it actually land somewhere that it upsets people. Like last night as you and I were meeting, you know, they flew an ICBM over Japan. So when I think about the risk to putting on a big steepener-- --you have this risk of something geopolitically happening that, sure, it feels to me, like when you look back at all of the geopolitical dislocations that we've seen in the world in the last- - call it 200 years, they all actually are pretty well rooted in economic malaise. RP: Always. KB: Right? And there's this confluence of events that one almost feels today, where you see that this global world order that the globalists have promoted for so long feels to be fraying. And it's fraying in the developed economies, in the lesser developed economies. The economics of the situation, whether it's China has the largest imbalance of credit I've ever seen in my life, percolating to the top at the same time that the imbalances between the haves and have nots continue to grow. And geopolitically, we're having so much trouble with North Korea. But more importantly, I think the larger problem-- I know North Korea is a big problem-- but the larger problem is the rising power and the ruling power having friction, right? is this a classic Thucydides trap between the US and China? And all of these things are boiling at the same time. I mean, it feels to me like all of these things are happening concurrently. RP: So you speak to a lot of people in government, and not only that, but within agencies and various people. Do they get a sense that this is a different point in history? KB: Yeah, it feels that way. Whether you're talking with the US military or whether you're talking with the US intelligence apparatus or the institutions of the reserve banks of the world, they all feel like-- yeah, it all sounds different. And now look, I can't tell you in my lifetime, which has been pretty short, as has yours, in the terms of kind of historical parlance, right? We haven't lived that long. But in the last several decades, I've never seen a higher level of alert and worry in many of these different verticals that we just discussed, which is pretty fascinating to me. RP: So here's a thought I was thinking when you were talking about China, if I were the president of the United States, I would push China to the brink. If you want to win the game, whatever that game is, and you know they're this fragile, well, why not do something about that? I mean, if the US were to force the dollar higher, for example, it would probably hold back China's growth potential and spending potential, military potential, all these things by probably a decade. KB: So that is clearly our view, my view, is that China's newfound strength is rooted in their belief that they are the economic engine of the world. And so as they project their economic power alongside projecting their newly found militaristic power, it's all rooted in this belief of having the strongest foundation of economics in the world. And I believe that it's kind of built on sand, right? Because their credit has grown, as the IMF calls it, dangerously, and I call it recklessly. Whichever adverb you want to use, it's grown entirely too quickly. And so I think that your point's perfect. If one were thinking strategically-- and we don't want to give-- --too much credit to that kind of strategy-- but if one were thinking strategically, you might want to change tact and start calling them out for having $15 trillion RMB of non-paying loans in their banking system, as China just admitted in a public press conference. Which, by the way, came and went and no one wrote about. But it's on china.org's website. We might want to be thinking down the road that you just went down, more strategically about calling them out on their kind of economic weakness instead of bowing to their economic sword. RP: That's right. Because saying we're going to raise tariffs almost tells you that you're a threat to us. When I find-- KB: Well, I think whether you look at South Korea, Japan, or China, they have all traded circles around the United States. Believe it or not, I agree with the Trump administration's stance, whether it's Leitheiser, Navarro. You look at the differing trade agreements that we have with Japan, for example. It's a one-way agreement. Japan trades all over us. And they're able to put restrictions and tariffs on us on many of our exports, and we can't touch theirs. Same with South Korea, and China's in the same boat. So I think that-- so back to your question. I think you have to look at it in dumbed down terms. And in dumbed down terms, Trump been a fail-- has failed at the Affordable Care Act, right? Because he couldn't get Republicans on board. And he has been unable to get comprehensive tax reform done, and that was largely, you know, the border adjustment tax was a tax that I think was an elegant tax to basically tax our trading partners. And the Koch brothers, who own a lot of refineries, spent a lot of money very quickly to try to quash the border adjustment tax, because it would really hurt domestic refineries that procure oil from non-domestic sources. And then the retailers didn't want that to happen either. So the retailers got together with the Koch brothers and killed border adjustment tax. So you think-- if you're Trump today, what one lever can you throw unilaterally? You can throw a tariff lever unilaterally, right? Leitheiser's 301 and the investigation into overcapacity and steel and others, Trump can, under the Trade Act of 1974, unilaterally impose tariffs up to 15% at any time with an executive order. So to change the option trade here would energize his base. So again, not thinking too strategically, but basically, which lever can he throw? RP: Yeah, because there was the recent press report of him saying in a recent meeting, I don't care. Just get me some tariffs to raise. KB: Yeah. Now I'm actually not sure if his advisors are telling him, but he has the authority to throw that lever today. I'm pretty sure that he doesn't know that. Because he would do it. RP: Yeah. For sure. OK, let's move tack. What else in the world is interesting to you right now? What are you looking at? What are the opportunities that people should be focusing on? KB: You know, my own view is I think the Greek banks are interesting. I think that Greece has gone through one of the worst recessions ever to be recorded in a developed economy, right? Their GDP, peak to trough, dropped 30%. 30-- imagine GDP dropping 30%. Imagine unemployment going up into the high 20s, right? Imagine the disaster that Greece has gone through. If they-- again, if they had the ability to devalue their currency and make the adjustment the easy way, their currency would have devalued 60% or 70%. They would have become competitive again. They would have restructured their banks, and they'd already be off to the races. And they've been a prisoner of the euro and the eurozone, and so they have really, really, really had a difficult time. And the Greek people have unfortunately had to suffer the hard way. But through the legislated austerity and the cuts that have been made at the request of the ECB and the IMF, I think now kind of eight years in, Greece is starting to turn. If you look at new vehicle registrations, you look at real estate prices, you look at Greek industrial production, all of those charts are starting to head higher for the first time in eight years, and the Greek banks have been recapitalized three separate times, right? Once in 2013, once in 2014, once after Tsipras won in 2015. And I believe now that they're likely to be over-resourced for the amount of losses that are left in the system. And they've also legislated change on foreclosure and the bankruptcy process, which streamlined dramatically the manner in which they can restructure assets. And that literally just went into effect in August. RP: So do you think after all of this tremendous pain that the Greeks will end up building a stronger foundation for an economy? KB: So I think cyclically, the answer is yes. I'm not willing to tell you that the proclivities of the Greek people will change, because as you know, they're the largest serial defaulters known to man. It's in their DNA to spend recklessly and then restructure, and spend recklessly and restructure. So that's likely to happen again. But I still think we have a good 10-year runway of an upswing cyclically. RP: What about emerging markets? What's your views on emerging markets here? Any particular views? KB: I really don't other than I think that the-- so I think there are 100-- there are a little over 180 recognized nations in the United Nations, and China is the largest trading partner of more than 100 of the 180. So when I think about China moving through a difficult period of time, I can't imagine that that'd be positive for EM. And when you look at EM, EM vol is underneath US NASDAQ vol for the first time ever. And just-- we kind of live in the twilight zone, right? I mean, we live in an environment where we have-- RP: European junks lower than treasuries. KB: We have European junk lower than 10-year treasuries. We have EM vol inside of NASDAQ vol. We have crazy people lobbing missiles in different places. We have a rising power threatening a ruling power. All of these things are happening all at the same time. I wake up each day and say, I don't even realize which world I'm living in anymore. And yet, equities march higher, vol continues to come lower, and the world is moving from active to passive like there isn't a bump in the road right in front of us. And I feel like there's a pretty material bump in the road. There could be a pothole that we might fall in in the near term, and yet we're speeding along at 100 miles an hour. And so there are these-- yeah. There's a dissonance in the world today that I actually have a hard time putting my finger on. RP: So that makes you-- that's making you more risk averse than you would be. KB: Yeah. I think as you probably know me, you know, maybe I'm cursed, but I'm skeptical by nature. RP: I think all good macro people have to be, because that's the game. KB: But when you think kind of eight years into one of the biggest bull markets in the history of time, it is not the time to be adding risk. It's not the time to be going from active to passive. It's not the time to be piling onto what's been working. Because I think, you know, inevitably-- again, not the end of the world. But inevitably, we could see some really big gaps, right? We could see some air pockets if all of the sudden everyone thinks they can reduce exposure so quickly, and they can't. So I think in the next 12 months, we're going to see pretty elevated vol levels. I think vol's the cheapest asset class in the world. RP: Vol in what? Equity? Fixed income? Currency? KB: Everything. RP: Everything. KB: Yeah. RP: And how do you hold onto a vol position, because you just bleed cash? I mean, you know, there was the story of the guy, the Target manager, the Target-- did you see this? I didn't. So this is a guy who was the manager of a Target store, and he had, like, half a million bucks to his name. And he developed his short vol strategies, and he's now worth $12 million. And all he does is go to the cash machine-- he's the VIX short position. And ca-ching! He's now a millionaire. KB: Oh, God. RP: But the problem is, that trade, it's painful to be long vol. KB: Oh, I agree. But you remember Niederhoffer? You remember Victor Niederhoffer, though, right? He spectacularly blew up three times, but he raised money every time. And if you remember, his strategy was just selling puts on the S&P, right? He just sold vol on the S&P. And it was a great Sharpe Ratio trade until it wasn't. And when it wasn't, he lost everything. And so these people selling vol at 9%, you know, vol can go to 20% in a nanosecond. It can go to 25%. And we saw in the financial crisis, it can go to 80% and 100%, right? Realized. So selling vol at the historic lows is not a great idea. There's just too much that can go wrong. And the markets won't ignore geopolitical risk indefinitely. RP: Got any views on gold? KB: I really-- I know where this is going to go. My view on gold is it's just another currency, right? RP: I mean, I noticed right now it's outperforming versus the US dollar, because the dollar is full length. So it's not doing much against other currencies. Just wondered whether you had a-- KB: I just-- I view it-- I view it as another currency. I always have. The thing that we've come to conclude on gold in the last couple of years is it is the relic that people say it is. Because as the new asset class of digital currencies has emerged on the scene, you know, it's much easier to have a jump drive in your pocket with $100 million on it than it is-- in a cold storage wallet than it is to have $100 million worth of gold in your briefcase. You couldn't get on the plane. So I think that the asset class of digital currencies is real. There are going to be big winners and there are going to be massive losers. There are going to be many zeros and many frauds, as there are in any kind of gold rush. But I don't know how much of the capital's going to run to the hard yellow metal and how much of it's going to run to the digital currencies. And I think a lot of the problems in the fiat world have kind of funneled themselves to the digital world. RP: Yeah. I mean, the digital world is a whole ‘nother-- you know, we had this conversation yesterday. I mean, there's so much to think about, because it's really not clear. It is the Wild West. KB: It is. RP: The ICOs, I mean, look. The problem is, it's kind of like the gold market where people are vociferous lovers of it, and you cannot question it. You cannot ask a sensible question like, does that make sense? Or you'll have your hands ripped off and your head ripped off. But you know, we have to ask questions about the ICOs. We have to ask the questions of, what does that fork-- you know, what did the fork for Bitcoin actually mean, as you and I talked about yesterday? Was that, like, a rights issue? Was that actually doing exactly what fiat currency does, which is printing new ? KB: Yeah. So what the fork does that mean, or what did you say? I've spent a lot of time reading what I can read and meeting the people that are the key players in that marketplace, and I believe that it is a viable asset class, the digital currencies. On the ICOs, you know, when you look at the sources and uses of the capital, it's all based upon some trust. But to say that on day 1, you know, 80% of the money goes to the people that came up with the scheme and 20% goes into working capital to develop the scheme even more, and there's the coins themselves aren't worth anything unless someone thinks they're worth something-- I don't know if you saw in the USA Today this morning-- and I never read that paper, but it was at my doorstep here at this hotel. Burger King just announced that they're coming up with their own cryptocurrency in Russia. So when you buy Big Macs, you get the burger coin, Burger King coins. RP: What? KB: But this is-- yeah. It's in today's paper. Point being is anyone can come up with a cryptocurrency. Anyone can come up with an ICO if they have an idea. So some of them will be robust and thoughtful, and some of them will have value. But the fact that this market was the Wild West, unregulated, and there's so much hype and so many millennials willing to plop down capital, that I just think that you and I both know there'll be a lot of winners and losers. They all won't be winners. RP: No. And I just think from everything I've ever understood about markets, this is speculative mania. KB: Yes. RP: That doesn't mean, like almost all bubbles, that in the end, the premise is not right. But the price is just wrong for now. KB: The thing that we think about from the macro perspective is we think global M2 we think is around $80 trillion, right? All the gold ever mined in the history of gold is about $7 trillion, and there's about a trillion dollars' worth of what we call investible gold. The cryptocurrency market collectively I think today is around $110, $120 billion in total value. So if it's a viable asset class and the institutions aren't there yet-- and they're not, because there's no bona fide custodial edifice that allow institutional capital to come in-- then I believe there's going to be a once-in-a-lifetime move of some number, but then it's not going to grow from there. So you have to be there in that kind of step function change in an asset class. And so is $100 billion the number? That's probably low if it's going to be a real asset class. But you and I functionally say, well, this asset class has gone up so much so quickly and there really is only some belief there. It's hard to buy into that. RP: You see, because I think of it in terms of being around in '96, '97, '98, '99 and watching the internet bubble, and I see a similar thing. Almost every premise of the internet bubble was right. It was going to be one of the biggest changing technological events any of us had ever witnessed in our lifetime. Just got way ahead of itself. KB: Yeah. RP: And yet, a load of shit went to the wall. In the end of it, Facebook, Amazon. You know, all of this stuff came out of it and the real wealth got built. I kind of still think it's that with this, with the cryptocurrencies. KB: I'm with you. I think we're going to see hard, big pullbacks, and we have seen them. RP: Do you own any? KB: I don't. I'll tell you that I tried to open an account before the fork, and it took four weeks and me getting someone else involved that got the CEO to put me to the front of the queue, and it got open. But in the four weeks that it took my account to get open, Bitcoin went from $2,400 to $4,000. And so therefore, you know, I'm not buying in at the moment. And I was going to buy in with a nominal amount of capital, just so that I can see how it works. I can see how it goes from the private key being kind of in the street name to the private key being in the cold wallet, what a cold wallet looks like. I'm in the exploratory phase. I'm not in the, let's commit real capital phase. But that phase should come. RP: Yeah. So to sum up, anything else that we should be looking at? Anything that you think is-- people aren't looking at that you're starting to dig into now? Because-- so China is the key thing for you. You know, the opportunity in China, the asymmetry of that whole situation. You know, you've got a massively indebted economy. You've got virtually no reserves versus the amount of debts outstanding. So that's super interesting. KB: Right. RP: We've talked a bit about rates and the potential for rates to rise. How do you think that manifests itself in Europe? We didn't flesh that out fully. Because Europe's probably where the weakest link in that thing is. KB: Yeah, I think that Draghi has tried to even jawbone the euro down. And as we sit here today, it's north of 120. It was 104 at the beginning of this year. The euro's had a massive move, and Draghi still has yet to tell us how he's going to taper. And so we think that-- you know, when you think about the way that the European QE began, it began as QE. Then they took deposit rates negative. One would imagine that they would take deposit rates back up before they would taper QE, and that was our thought. But now we're hearing they're just going to be talking about tapering QE and leave deposit rates where they are. I think getting European deposit-- the discount rate positive again would be very positive for the European banks, just like US rates moving higher was a boon for US financial institutions, finally getting some NIMS back. I think it's a very positive thing if they do it. The question is, where will the euro go, right? If I call it on purchasing power parity it has the euro at, like, 125. It's almost there. But will it overshoot if Draghi has to-- RP: But don't forget, the Fed raised rates. The dollar fell. KB: Hmm. RP: You know, be careful. You know, I think a lot of people-- if the expectation has been for this in Europe, and I know that's a theme within the market, well, maybe that's in the price. KB: Yeah. That's what all the trading desks think. But they've said that since 112, right? So now it's kind of 120, and I'm hearing the same thing. So we'll see. We'll see what Draghi has to do. But he's got to do something quickly. RP: Yeah. So I guess if we're talking about low volatility and the potential for the open rate market to move, then what puts on bunds? KB: I just-- I think what's more important is thinking about something going from an extreme level of accommodation to a draw. Just think about-- we think about it in a larger macro sense than exactly where we're going to go with it. I just think about $500 billion of accommodation going to a trillion dollar draw in just the G4 in two years, what happens when that happens? Well, financial conditions tighten. Well, what does that mean? What does that mean for rates? What does that mean for equities? And my guess is rates don't stay low and equities don't go much higher, right? And that's less than a year away. So how do you position yourself from here? You just can't keep-- you can't just keep plowing away the way you have been for the last eight years. RP: No, and I think you're right. It comes down to one trade, which you said was the best trade in the world right now, which is long volatility. KB: Yeah. I think so. RP: Kyle, thank you ever so much. It was fascinating. KB: Thank you. RP: You’ve covered lot in the world. Good to see you. We'll catch up with you again soon. KB: Good seeing you too.