Global Macro Investing and Geoeconomics with Hedge Fund Investor Kyle Bass

>> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast, an official podcast of the Hoover Institution Economic Policy Working Group, where we talk about economics, markets, and public policy. I'm John Hartley, your host. Today. My guest is Kyle Bass, who's a legendary investor who famously predicted and bet on the housing collapse of 2008.

 

He's the founder and principal of Hayman Capital Management, a Dallas-based hedge fund focused on global events, and the founder of Conservation Equity Management, a Texas-based private equity firm focused on environmental sustainability. Welcome, Kyle.

>> Kyle Bass: Glad to be here, John.

>> Jon Hartley: Cal, I wanna just start by getting into your early life.

 

You were born in Florida. Your dad was a career tourism executive who helped manage the Fountain Blue in, in Miami Beach. It's actually one of my favorite hotels, as well as the Dallas Convention and Visitors Bureau. You went to TCU where you studied finance and real estate. You worked at Bear Stearns, the Dallas Office.

 

In the 90s, you started the Legg Mason office in Texas. How did you first get interested investing, global macro and geopolitics?

>> Kyle Bass: Boy, look on the investing side. I was a chemistry major. Going in, I thought I wanted to be pre med and then I ended up taking a non major elective in options and futures.

 

And I read the entire course book in a week and changed my major that week. It hit me that that was clearly what I wanted to do. It was just a moment in time. My junior year in undergrad, I grew up in a family where I had a great mom and dad.

 

They didn't save any capital for retirement or for school. We were kind of call it lower middle class. We were on a hotel manager salary and when we moved to Dallas, we worked at the convention business bureau. So I had a good life. It wasn't a silver spoon, that's for sure.

 

And so, you know, right, right out of school, I, I was just enthralled with financial markets. I was always a math and science guy. There are those two, I guess you're probably all of them, John. You probably have the, the, the, the ability to assimilate language and reading and, and math and science.

 

I was always a math and science person. So it was a natural progression.

>> Jon Hartley: Well, it's, it's amazing. And I know you're in my mind having followed and your thinking for a long time. I think you're a real icon of the Dallas finance community, which is something that has grown a lot in just the past few decades and even just recent years.

 

I mean there's all these firms now that are moving from, say, New York or California to Dallas, I think Toyota and so forth. But also all these banks are setting up their second headquarters there, Ian Goldman Sachs is building a big office there. But you were there at the beginning of all this and all these early shifts and moves to Dallas early on.

 

So I commend you for being a staple of Dallas finance and for not having left as well, like many people might. I want to talk about the financial crisis because I feel like the financial crisis was just a defining moment for many careers in finance and perhaps including yours in terms of, I think, your skyrocket to fame.

 

I mean, you made these bets against the subprime mortgage market through Hayman, and later you testified to the Financial Crisis Inquiry Commission. I mean, how did you first come to start thinking that there was trouble with the housing market in the US in the 2000s and that it might end up in some sort of catastrophic state?

 

 

>> Kyle Bass: Yeah, I think that. First of all, back to your question, the prior question about what got you into the financial markets? What do you care about? When I was at Bear Stearns, I worked on Bear, had a risk arbitrage department, you know, where I think they were one of the best and call it institutional risk with mergers and acquisitions and things like that.

 

I was always a special situations analyst, meaning, you know, I was, I was kind of a technology. There was no vertical where I was an expert. It was just trying to dig into each M&A situation, each spin off, each bankruptcy, try to understand the operative parts, I. Just whiteboarding these things.

 

So, you know, when you whiteboard something and you dig in, you just have to have a deep intellectual curiosity, which I also know you have. And you can't teach that in the kids into employees. I believe they have it or they don't. And having that deep curiosity for how things work, what are the proclivities of the players?

 

And then how do you handicap, you know, the potential outcomes? I think again, on Wall street you only need to get like 55% of those, right, John? So I think that as. As we got into the launch of our firm. So I launched my firm in January of 2006.

 

And at that time, you know, Asia was exploding, that China just entered the WTO in 2002. It was a big moment in time when, when money was really flying into Southeast Asia. At the same time, we all knew that our housing markets, I mean, everyone knew the housing market was overcooked.

 

Everyone knew that it was really easy to borrow money. And as you know, you didn't even have to have a job. Bartenders could have two or three loans. I went to Abs west out in Las Vegas, and I was sitting in a Bellagio bar waiting for friends to go out to dinner, and it was just me and the bartender.

 

And I said, how's it going? She said, well, you know, it's going fine, but, you know, my, My houses are killing me. And I said, what do you mean, your houses? And she said, you know, I have three homes that I've been able to buy here in Las Vegas, and I rent them out.

 

But, you know, my, my tenants are giving me trouble, and they. They turn over too fast, and I'm like, whoa, wait, how do you buy three houses? And she said, well, they just ask for a loan and they just give you one. And literally that happened while I was sitting at the bar.

 

And it's much deeper than that. But that was just an anecdotal, you know, confirmation of what, why I was there. I'm thinking, you know, it's crazy that a bartender can have three loans. And so the intellectual curiosity was, okay, how big is this? How much capital is out there in a disassociated risk paradigm?

 

Because that's basically what it was. And then you have to figure out, well, how does that play into leverage structures? You know, levered hedge funds just blow up. Well, that's fine. That's not a really systemic problem for the, for our. For the US Financial system, but. And what does it do to the banks?

 

And then once. Once you started. Once I started going down that rabbit hole, you realize that, you know, Lehman was 36 times levered, and they had a huge amount of this stuff on their books. Merrill had, you know, 50, 60 billion of this in a warehousing facility. You know, Bear Stearns was, Was.

 

Was again, you know, 29 times levered. But you lever yourself 30x and you end up owning assets that lose, you know, 40% of their value. And you can do. It's just a math problem. And so, you know, it. I came to the conclusion that the whole financial system was in real trouble and went to meet with people at the Fed, went to meet with people like Professor Rogoff at Harvard, who at that time hadn't written his famous book, but as you know, he was kind of the father of sovereign balance sheet analysis.

 

So again, I'd go out and meet with people and say, talk me off the cliff. I would say explain to me how I'm wrong, please. I need to know this because if you remember once, once everyone became aware of the situation, we were all wondering where money was safe.

 

We were actually wondering where our savings were going to be safe. If it was GONNA be safe in JP Morgan or Morgan Stanley. Well, I guess Morgan Stanley wasn't a bank yet, but they had to become one. It was just this moment in time where intellectual curiosity and the ability to analyze special situations came together.

 

 

>> Jon Hartley: That's amazing. And I guess you've also made some successful bets too against Japan and Greece. Speaking of sovereign debt crises, how did your thinking around those come about? That's sort of around roughly the same time period.

>> Kyle Bass: Think about this. What precipitated the crisis in Europe was of course the financial crisis in America.

 

And if you followed when the US decided to bail out its banking system, you had to follow the bad private assets to public balance sheets. So then the analysis was which public balance sheets can handle that kind of movement of that many bad assets. So the US could handle it.

 

We lost about 800 billion. So our banking system had a trillion of Equity back in 2006 we had 17 trillion of on balance sheet assets. If you just, just look at banking assets, not the non banks. So we are about 1 times GDP in our banks, we had a trillion of equity.

 

We lost about $800 billion. So we recapped our entire banking system through common and preferred equity injections. So we actually did it right and recapped the system and got going. Europe couldn't recap the system and they had a worse problem than we did some of their banking systems.

 

Because of the EU, Iceland and Ireland both had 10 times their system, 10 times their GDP in their banking system. So it's the same problem that the levered hedge funds and Lehman and Bear had as a country. They took on way too many banking assets because they were chasing deposits all over Europe.

 

And so Iceland and Ireland fell in pure succession and then Greece. And so it was kind of a logical analysis of a balance sheet that just went from corporate balance sheets to sovereign balance sheets and then from there. How many things have you ever read in your economic career that say so and so ex Japan, so and so, you know, Asia ex Japan, ex Japan, ex Japan.

 

Because Japan blows every Gaussian distribution you've ever seen, right? They're like they're so far out there and they're so far that they, that if you include them in any mean it ruins the whole mean. So they just exclude Japan. Well, I started looking at Japan, I said, well how do they do this?

 

How do they, hang on, how do they take at that time 200% sovereign debt to GDP on balance sheet? Well, the answer was they had to take their rates to zero and negative and they have to leave them there. And so today Japan still has rates pegged out to 10 years and they're letting the 30 year kind of flap in the wind.

 

But the real answer is now they're 265% sovereign debt to GDP. They can never let rates move. They can't. So what does that mean? That means the currency is the escape valve. So when you characterize where we launched a fund quote against Japan, it's not the case. That's kind of folklore.

 

What we did is I said one of two things has to happen here in this analysis. Either Abenomics has to come about and Japan's got to inflate their way out of this problem and try to get some growth or they're going to be crushed under the weight of their debt in their own system.

 

That's really, they hit a fork in the road. And so we took two thirds of the money in the fund and we bought bond market optionality right in the, in JGBs. I took one third of the money and I bet with the bank of Japan on their ability to weaken their currency because they had to do that.

 

So when we launched that the yen was 85 to the dollar. Their bond market was where it was. And then Abenomics happened, when Abenomics happened, it took the yen from 85 to 120. You could have done the back of the envelope math. So we lost 2/3 of the money and on the other third of the money we made many multiples of that capital.

 

The fund ended up making, you know, 250%. So you know, was a bet with the bank of Japan on one side and it was a bet against their ability to hang on in the bond market if they would ever let it go. So it was just the right economic bet at the end.

 

 

>> Jon Hartley: It's amazing, yeah, I mean the whole story of Japan is I think a super interesting one. You just, when you think about it, and it's something I've been reading a lot about and saying a lot, I feel like Japan is kind of strangely ahead of the US and the western world maybe by a few decades or so.

 

Think about.

>> Kyle Bass: Exactly right.

>> Jon Hartley: The sort of asset, you know, bubble some people call it, but really Just the collapse and flat GDP per capita there that began in the 90s. And you look at most of the Western world except for the US now it's had flat GDP per capita since the early 2010s.

 

But even other topics, things like industrial policy, that was something that Japan is perhaps famous for.

>> Kyle Bass: In the 80s they were doing so much lending that the Basel 1 accords had all to do with containing the Japanese banking system and constraining their equity ratios at that time.

 

 

>> Jon Hartley: So it's a fascinating. They were first at quantitative easing. They're I think still the only central bank that's actually bought up stocks. So they're very interesting and instructive I think for a lot of reasons. First company to really go crazy on debt to GDP in sort of recent times.

 

First advanced economy and 250% debt to GDP and now their bond yields have been skyrocketing just recently up to the 30, 40 year bonds have been jumping in yields. And I guess there is, I guess you could call it this financial repression sort of issue. Or you could call it fiscal dominance really, where there's this challenge where they can't let interest rates rise because their net interest costs will just totally balloon.

 

I mean, do you have any thoughts on Japan and like if there is some sort of a sovereign debt crisis looming, is Japan the first to go? And does that end up being some sort of a domino in your mind?

>> Kyle Bass: You know, I, I don't, I think Japan's got it under control.

 

And I mean in a way where you have a, if you have a population that has a significant, you know, the. Japan has one of the oldest populations in the world, Japan and Italy. And they've got a demographic crisis, right? They've got a crisis where it's really difficult to grow your sovereign.

 

If your population, your call it endemic population is not growing. And so they're not. There's a fascinating, there's a fascinating thought to have here and it's one that I haven't really discussed that much. But when you think about fractional reserve central banking, which is the way we all operate and Japan is a poster child here.

 

I have a theory on why the demographic curves are hooking down in the US in Europe and in China and Japan. So if you think about the way these systems work is they typically, by the way, almost no sovereign ever defaults, John. They get into a crisis, they print and print money, expand a balance sheet, but they always pay.

 

They rarely if ever stopped paying. So we get into a situation where you look at where Japan is, and if you engage in this type of central banking activity and you kind of lose your fiscal moral compass to where you just run huge deficits and you print the balance and you suffer inflation.

 

If the men in your economy, when they graduate university, can't afford to buy a home, they live with their parents, they're not having sex, they're not having kids, they're not marrying. So when you look at the marriage rates and you look at the fertility rates of the average women across not only the developed world, in China, when real estate prices rip and wages don't go with them, you create yourself an endemic problem in your economy.

 

And so Xi Jinping has figured this out. He figured it out when he said financial security is national security. Note, he has not stimulated his real estate market. When home prices in China got to be 26 times median income, the men couldn't afford homes. So the demographers had this arc of the demographics of China, Japan, the U.S. you know, arcing out to 2050 and heading down around 2050.

 

And now they're all collapsing. The reason they're collapsing is we just injected 50% inflation in dollar terms into the world. And that's our demographic curve here is hooking down. Europe's was already hooking down, Japan's was already hooking down, and China, China's demographic curve collapsed. So the way that we operate our central banks and the way that we kind of financially engineer, I, I heard you almost say financial repression in Japan.

 

The way that we financially engineer our economies has consequences. And those consequences are we, we both know that asset prices far exceed wages. And so real wages have been massively negative, even though the Fed is not saying that. The reason the Fed's not saying that is because they chain weight inflation.

 

So if you look at it in reality, asset prices have extended themselves to where it's not, it's not conducive to procreation and families. It's just fascinating.

>> Jon Hartley: And yeah, and you think about zoning too, and, and you know, 90s regulations, which is sort of pervasive in, in most countries.

 

I mean, Japan being one exception, some Eastern European countries, some, some exceptions. But, you know, real estate has become so expensive, prohibitively expensive around the world. And I think, you know, that to some degree is causing, you know, there's some empirical evidence that that has negative effects on fertility.

 

I mean, that's not a surprise, people can't buy their own homes. They can', really get married and have children. So, you know, it's, it's amazing how quickly all this land use regulation and how quickly real housing costs. If you think about home prices over the past 150 years, if you look at like the case Shiller index and you net out inflation, that trend is like basically flat from like the late 19th century, late 1800s up until like the 1970s and 80s.

 

And it's just on a total upward trajectory and zoning, some people say it's other things, but you know, regardless of the cause, it's hugely prohibitive, especially, you know, for young people. So.

>> Kyle Bass: Well, and then there's another natural progression, if you're intellectually curious, if, if in fact that's the case.

 

And you look at FHFA zone index, the US government's own unchained weighted housing index was up 50% between 2020 and 2024, 50. So wages certainly are not 50 between 2020 and 2024. If you follow that naturally to the, to call it the next node on the, on the timeline.

 

All that does is it tears the social fabric of both our country and the world. So the poor state, the poor were already poor. They didn't have any discretionary income. So it, it makes them much poorer on anything they have to acquire to just stay alive. Call it food, rent, inflation, or gas, whatever, whatever you're doing.

 

And then it prices the middle class out of being mobile. So it immobilizes the middle class. What does that do? Well, it creates tension because it ends up in the richest hands. And so that gap widens. And what does that do? Creates tension and in some places it tears.

 

And that's why we're having more wars. So, you know, you have, you have a scenario where the central bankers believe that it's the answer. The answer is just, let's just keep growing these balance sheets and kind of just not focusing on being more fiscally responsible because they can.

 

And then what that does, though, is the follow on effects of what's happening here. Our inflation, our tearing at social fabrics, our fertility rates collapsing, and then war. It's actually what happens and that's what's happening now. And we should expect more and more war because there is no answer for this equation at the moment.

 

 

>> Jon Hartley: So I want to shift just to China now because you're very outspoken on this. You served on a lot of defense boards, you're very involved in the military community, your lifetime Council on Foreign Relations member. And I think it's fair to say that some people would call China hawk and have been critical of the Communist Party of China for quite a while now.

 

And in particular what it's doing with respect to Hong Kong and Taiwan. I'm curious, what's your sort of overall thesis on China, US decoupling and your thoughts on the role that say, defense tech and investors play in this? Because I know you're, you're involved in this space as well, not just as a policy expert and thinker, but also as an investor.

 

 

>> Kyle Bass: Yeah. Well, thanks. Look, some call it China Hawk, some call it China Realist, you know, going to the lengths of understanding how the architecture of their system works and that we went from Japan to China between 2012 and 2015. I put my whole team on China. And this starts empirically with me calling all the Wall street firms and saying, someone send me your primer on the Chinese banking system.

 

I want to understand how their domestic, since they have a closed capital account, I want to understand how the Chinese RMB or offshore CNH and the USD interact. I want to understand the architecture of their system. And no Wall street firm had a bank primer for Chinese banking system.

 

No one had done it. They were selling stocks, everybody was buying and selling stocks and vie structures and whatever they were doing, but no one had actually sat down to do the work to understand how is the system built. And so that's how I got deeply involved in understanding not only the architecture of their system, but invariably what that does is it takes you into cultural preferences, cultural norms, then that invariably takes you down the history route.

 

And like, how did they get there? What are the incentives of the players? Why does Xi Jinping care to just have the iron fist and the five tools of Democrats dictatorship in one hand? And then, then you understand what their grand strategy is. And when you understand what their grand strategy is, it is completely incompatible with ours.

 

And so in 2016, I came to the conclusion that we were certainly going to be in conflict with China at some point in time. So it's actually easy to see if you apply yourself. And you understand. So on the defense side, you know, we're talking today, and I know this isn't just for today, but this is the day that Israel attacked Iran's nuclear facilities.

 

You and I, John, have talked about that. That event was going to happen. Iran was not going to let everyone into their new centrifuges and all of a sudden become compliant with the rest of the world. They're the largest state sponsor of terrorism in the world. So this attack was obvious that it was coming.

 

China has told us since 2017 that they are certainly going to take Taiwan by force, if not, if necessary. They continue to send more delegations over to the US to tell us this. They continue their air defense zone incursions into the Taiwanese air defense. And if you chart it, you can see that every year it's more belligerent.

 

So it's coming. And then how do we think about our relationship with China? Well, you know, I was just recently in a, in an interview where someone said, well, the CEO of Ford says if they don't release these, these very specific rare earth magnets, then we can't put our EV engines in our cars.

 

We're just going have to shut down, my God, the sky's falling. And I say, well, it's obvious since 2017, it's been written on the Great Wall, what, what's coming. And you as a CEO should have seen that. And it should be obvious to you that you shouldn't rely on China for your supply chain.

 

So I have no sympathy for these people. But when the question you're asking is what happens? I think you're going to see China invade Taiwan and forever change the makeup of the economic relationship between the west and China.

>> Jon Hartley: How do you see them doing that in the sense that there's some, I think at least maybe a couple hundred US military personnel that are there.

 

They're, do you see them sort of cutting off Taiwan with some sort of a blockade and trying to starve them out? Do you see it being some sort of a land or some sort of an incursion, amphibious incursion, all at once, that sort of overwhelming attempts to overwhelm Taiwan?

 

What do you think the US response would be in that kind of scenario? Do you, what do you think that would all look like?

>> Kyle Bass: So I think there are three paths. The first path is the soft path. That is like the way that they took Hong Kong is, you know, this is going to sound tin, tinfoil hat like, but let me, let me give you just a hypothetical.

 

So the Chinese Communist Party before they took, before they took Hong Kong. The Hong Kong protests were at their peak and December 2019, the Chinese current account, call it their net income account, was headed towards zero there. They still had a positive trade balance, but they had a lot of external capital flows and we're going to get into that later.

 

But, and so they had this existential crisis with Hong Kong and the legitimacy of the Chinese Communist Party having to fight an uprising in Hong Kong at the same time, a current account headed towards zero. And what happened magically Covid happened, it came at the exact perfect time for the Chinese Communist Party.

 

It took their current account plus 250 billion because they shut off international travel for their population and they dialed back the school expenses. All of those are in dollars. And they were able to take over Hong Kong without firing a shot. Everybody went home. So the soft side of the Taiwanese situation is, you know, the KMT is funded by China.

 

China is hoping they can get the KMT in there. They really hoped this last time, but William Lai won. So the question is, what happens in 2028? Does the KMT win and does Xi jinping Wait until 2028? I believe he can't. There are those in the US that believe he's going to wait to see if they can take it over with soft power as opposed to hard power.

 

So the three options are soft with the KMT winning in 28, the two other options are blockade, as you mentioned, or all out assault. One would think that a blockade would, would actually force the US to block the bl to unblock the blockade so that China could claim to be the victim.

 

Right? They are. They, they have a PhD in victimology in the Chinese Communist Party and they're the best in the world at being the aggressor and claiming to be the victim. So in a blockade scenario they would just blockade the west coast of Taiwan. And as you know, Taiwan's very much like Japan was in World War II.

 

They have no natural resources, so they've got two weeks of energy on island. They have to import their energy and their food every day. So they're very dependent upon those ports and especially the southernmost port. So a blockade is not going to be that difficult. It's going to require us to unblock it.

 

And I think we will unblock it. And then, then we're in, then we're in a kinetic conflict. The question is, and then again, option three is just the all out assault of the Taiwanese island with an aerosol amphibious assault. And it's it's difficult. You know they're, I'm sure you know the terrain.

 

There are, there are 22 foot tidal surges in the Taiwan Straits 110 miles wide, the largest amphibious assault in the history of the world was D Day, which we just had the 81st anniversary of about what seven days ago or so. So this is a much, this is a much more difficult amphibious situation.

 

The tides being 22ft and changing title surges in that Taiwan, Taiwan straight lends that lends it only to be somewhat amenable to an amphibious invasion three months out of the year. And so there'd have to be precision and timing as to when they go. There would have to be precision and timing on their on island position, but then on island, as you probably know there are two giant mountain passes, there's a thermopylae problem and so there's all kinds of problems with an assault.

 

So I think they'd rather take it on the soft side or through a blockade instead of an all out assault. But the US we have plans for all of that. We don't have a great plan for the soft power takeover the either of the hard options. We have the most capable and best kinetic military in the world to this day and we have plans.

 

So you know, it's, let's hope it doesn't get there, but it sure looks like it's going to get there.

>> Jon Hartley: I want to talk I guess just a little bit about US China relations and how it's evolving, particularly with respect to economics, trade, finance. And when I think about like say go back 10 years ago, the mid 2010s, you know, we had on the trade side all the western powers in Japan were I think trying to get China into the TPP.

 

This is prior to the 2016 election cycle where Hillary Clinton was forced to recant her support for the tpp. This trade, Asia Pacific trade deal, multilateral trade deal and those largely brought on by Bernie Sanders, his candidacy obviously Donald Trump is president. Trump has totally changed thinking on trade in the Republican Party.

 

Both parties have really shifted on trade broadly speaking. But I think there's been also just this massive shift in thinking about China in general. And I think a lot of this had to do with in the mid-20s. I remember sort of my wake up call to China, or at least a big part of it was seeing these videos of the Uyghurs and how they were being treated and these very, very serious human rights abuses.

 

And I think that really, I think woke a lot of people up to what was going on in China, that it wasn't this sort of peaceful, friendly, inconveniently dictatorial kind of nation with archaic communist system, but was very friendly economics wise. And then Xi Jinping was transformational in that shift as well, taking things on a very different track from Huintao, who's in power in most of the 2000s.

 

But now we've seen China's really backing off on the one China, two systems idea to sign a British joint declaration where China agreed to allow Hong Kong to keep its executive judicial legislative autonomy until at least 2047. As you mentioned, China moved on Hong Kong during COVID I'm curious what your view is on all this in the sense that I remember in the 2010s in the BRIC economies, that was really one of the biggest investment themes in emerging markets and the.

 

And China was a huge part of that, I think if you're investing today, if you invest in China from that time to today, we'd be maybe flat or something like that. Certainly in Hong Kong, there are all these things that China connect and all these things, all these things trying to get people to invest in China.

 

I'm curious, in your mind now, there's issues around rare earth metals and so forth. Where do you see all the sort of U.S. china economic relations going? Obviously tariffs have been a, a very big story in the past few years as well. But I'm curious, where do you see the U.S. economic, U.S. china economic relations going on all these sorts of avenues?

 

 

>> Kyle Bass: Yeah, I look, our systems are fundamentally incompatible. Our values, we, we don't share the same values as the Chinese Communist Party. In fact, ours are diametrically opposed. We want to empower the individual. We have basic property rights. We have free. There's a joke in free in China.

 

There's free speech in China, but after you freely speak, you won't be free any longer. Right. So there's the, there's the value system that has a complete lack of compatibility. And we all want to say, well, they'll learn, they'll learn to open up. They'll learn that when you look at the bright shining star of Taiwan, think about Taiwan just ideologically, why does it bother Xi Jinping so much?

 

Taiwan is like a Chinese democracy that's embraced western capitalism. Taiwan's GDP per capita is 300% what China's is. So Taiwan is what China could be if it embraced Western values and Western capitalism. You and I both know you want to see meteoric growth. You get China to open up and you get China to have an open capital account and embrace Western values and, and stop lying, cheating, stealing, cajoling your way through the world.

 

That's just, that's the way they operate. So you, you said you kind of had your, your Sputnik moment on China was, you know, it sounds like the images of the Uyghurs and understanding what was happening over there in East Turkestan. That was one part of, of my awakening in 2015, 2016.

 

But the other one that really, you know, I don't know if you've read Unrestricted Warfare, once that got printed in English, you know, that was written by two Chinese generals, that was written for the Chinese military and it made its way into the popular, not really popular, but into the policy circles and think tanks.

 

People got a hold of that book. But Diu wrote a piece in 2016, the Defense Innovation Unit, and it was written by Mike Brown. And for me, that was my holy shit moment, pardon me, I don't know if you're allowed to do that on your podcast, but you read this, you read this 2016 Diu report and you're thinking, I like, I knew it was bad.

 

I didn't realize it was that bad. It talks about how they steal 300 billion ish of IP from us every year and earn a return on it. It shows you how they infiltrate the venture capital companies in Palo Alto and on Sand Hill Road and how they intentionally make investments in information technology companies that hope to sell their wares to the largest information buyer in the world, which is the CIA.

 

But if they're Chinese investors in there, it basically takes them off the map. So if you, I don't know if you've read that report, it's a phenomenal report. Then there's a follow up report from DIU but it's a very comprehensive, specific analysis of Chinese economic statecraft in America.

 

And that did it for me. Trying to, after understanding their system, after understanding their basic complete refusal to, to embrace human rights of any kind. And then you understand the way that they're operating their economic statecraft. And they are our mortal enemy, John. They are not a competitor, they are not a trading partner.

 

These most recent negotiations that we just had, how many times did you hear, well, they have these rare earth metals that we really need and they have these rare earth magnets that are needed in every single ev. And I mean, we kind of have to deal with them.

 

And I kind of jokingly said a couple of days ago, I said this is not a trade negotiation, this is a hostage negotiation. We need to bring in hostage negotiators because that's what we're negotiating with China. And that is not a positive economic relationship. We're not talking about, hey, you charge us this tariff on agriculture and we charge this on cars, why don't we just like find a great place to be and, and move forward?

 

That's a trade negotiation. What we just had was a hostage negotiation. And how can that be positive going forward? So I think we're going to see Xi Jinping move in the next two or three years on Taiwan. I think we're going to be kinetically involved. I hope it doesn't involve nuclear, a nuclear transition transaction with either tactical nukes or something like that.

 

We're two nuclear powers, the world seems to believe that we could just fight in the Taiwan Strait and not take it to the Chinese mainland. I think that is, I think that's short term thinking. I think that you and I both know out of Fujan they're going to launch surface to air missiles, surface to surface missiles, and then we're going to have to attack military installations in Fujan if it happens.

 

So if you believe that that's even a possibility. And you asked about investing, first of all, investing in communism has never worked in the long run ever. Number two, if you believe that China is our enemy and that we might be at a kinetic conflict with China in the coming years, why on earth would you invest dollars in anything Chinese?

 

 

>> Jon Hartley: You know, it's, it's, it's fascinating. Just, you know, when I was in my time working at Goldman Sachs in China was still a theme and you know, things like China a share and you know, each year, all this, all these sort of vehicles to get exposure to China and all this excitement about it in that sort of 2000s, even early 2010s period.

 

 

>> Kyle Bass: It was a good, it was a good bet back then, John, because teaching them that Westernization and embracing some of these values would grow their productivity and their GDP per capita. It was a great bet back then. At some point in time it became a bad bet and we must admit it.

 

And now we must explain to the world that they are our mortal enemy.

>> Jon Hartley: I mean, Milton Friedman, I think, famously made, in part it was a prediction, and he recanted it later on. But those that countries with economic freedom will inevitably develop political freedom. And yeah, I think it's fair to say that since Dong Xiaoping, China's certainly become more of a capitalist economy now.

 

There's a lot of caveats to that and there's a lot of state control in all over, all over its economy, its banking system elsewhere. But I guess in your mind, do you think there's any way that somehow there's political uprisings in China in our lifetimes that we see, and obviously this is something that's always on the minds of the Communist Party of China, but it's such a large country, it's a fairly decentralized government.

 

There's lots of different regions and lots of different peoples as well, and some various ethnicities as well. I'm curious, see, in our lifetimes could there be some sort of an uprising in China or some sort of regime change in your mind?

>> Kyle Bass: Yeah, I think it's likely to happen.

 

And I think again, logically, if you understand their grand strategy, understand the composition, architecture of their system. They built their system. Their system was flawed from day one. Their banking system is 320% of their GDP. There are two Chinese banks that have more assets than JP Morgan. You know, the US economy is 26% of the world economy, the Chinese economy, so we run about a $30 trillion economy.

 

They say theirs is around 18 trillion. It's about a little bit more than half of ours. And yet they have two banks larger than the biggest, best bank in the world. I find that to be interesting. So I think you get to a point where if, if the architecture is flawed, if their leadership is hell bent on staying with a closed capital account and being belligerent with the rest of the world and partnering with the axis of authoritarians, right?

 

You've got China with a limitless partnership with the war criminal in Russia. You have China, China partnering with Iran, you have China partnering with North Korea. So all four of the big authoritarian governments called the axis of evil are all working together this time. So at some point in time, what's going to happen is when they go kinetic, John, we hold all of the cards.

 

We have their ticket into the world financial system. They have four joint stock, they have four SOE banks, 12 joint stock banks. They have an Achilles heel or two, and we know exactly where they are. And I can tell you when they move on Taiwan, sending carrier strike groups in the Taiwan Strait is one thing we may do, but we will certainly hobble them financially.

 

And when we hobble them financially, it's going to be hard for Xi to hang on.

>> Jon Hartley: So-

>> Kyle Bass: So back to your regime change question. Like that's, that's likely the progression of that regime's exit when, if and when he goes kinetic.

>> Jon Hartley: Yes, so I guess speaking of other sort of non-democracies and forming alliances with some of them.

 

I think the Middle East and some of the recent foreign policy positioning certainly with the US and growing closer to various Sunni nations, thinking Saudi Arabia, UAE. And thinking about the Abraham Accords and building bridges between Israel and some of these Sunni nations. And just recently Israel began this campaign against Iran, taking out many of its nuclear facilities.

 

I think you and I are both surprised that they didn't do this earlier. In your mind, I guess should one of the primary goals of Western allied powers be to stop other countries, especially poorly behaved ones, from obtaining nuclear weapons? I feel like this was sort of something that was talked a lot about North Korea for a long time, long ago, and now that ship has sailed and obviously China plays a sort of a critical role there.

 

But I imagine that's always been the reasoning in my mind why there's this ultimate danger of Iran obtaining nuclear weapons. Something that, you know, they were doing, you know, spinning centrifuges, you know, attempting to do for a long time, all these sort of failed attempts at various deals and so forth.

 

I'm curious what you think about that. And also just really the changing role or relationship between the US and various countries in the Middle East. The sort of warmth, I guess, in the US relations with UAE and Saudi, I think. Something that kind of almost wasn't even necessarily imaginable 20 years ago.

 

And certainly Israel making friends with the Sunni nations as well, trying to find partners that are also sort of allied against Iran as well. I'm curious what you think about. The Middle east has kind of evolved and the US's role in that. And obviously there's an economic component of that as well.

 

You know, Saudi, Saudi Aramco being ipo, there's the UAE is trying to attract a lot of investment. They've developed common law courts, you know, and basically imported Western judges from Hong Kong and Australia and elsewhere because they want business courts, because they want to do business like the rest of the Western world does.

 

I think Saudi to some degree wants this as well. I'm curious how in your mind the Middle east is, is, is being transformed in that sense too.

>> Kyle Bass: Yeah, I think. That'S a great question. Look, we made a, the Biden administration made a, a huge blunder with the turning our back on Saudi Arabia and embracing Iran.

 

I mean that was one of the craziest policy moves I've ever seen, right? Whether it was Jamal Khashoggi and the botched, call it kidnapping, which turned into a murder by the Saudis. You know, look, no, no, sovereign's perfect. I don't think they set out to kill him. I think he got over sedated and died.

 

But that is also not one, one life is not the reason to turn your back on your number one ally in the region. And so Saudi has been aligned with us for a very long time and they are our principal ally over there. And now the UAE as you know, had embraced China.

 

They were dancing both sides like the Qataris were, or are. And as of Q1 of 2024, you saw the UAE decide to align themselves with the US and walk away from China. And you can look back to Sheikh Tanun, who's NBC's brother and he's in charge of all the sovereign wealth and all the AI and hit their AI conglomerate G42.

 

And they said, you know what, we're just going to rip Huawei out and we're going to go with America on this one. Hopefully we see that follow through in the uae. So imagine if we have our allies in the UAE who as you said, are Westernizing to the extent that they can.

 

They have a, they do have a very religious community. So does Saudi. And the strange bedfellows with the Abraham Accords, you know, the Jews and the Arabs getting together, the Jews and the Sunnis coming together for these accords. That's a very positive development in the Middle East, let's hope it continues.

 

Of course, Iran and their proxies, they don't want the Abrahamic courts. My view on October 7th is that was to disrupt the Abraham Accords from moving forward. I still think the Abraham Accords will move forward. But you have a scenario where poor, you said poor nations, but poor crazy, rogue, insane nations should certainly not have nuclear weapons.

 

You know how we contain rocket man, Kim Jong Un? I, I'm not sure. I think China contains him. You know, he's like, he's like a, a rabid rottweiler in a cage, right. They just kind of feed him every now and then and keep him hungry. And, and so as we move forward, now that Israel has, has acted on Iran's nuclear capabilities, I think the Middle east can be a much better place.

 

That is all with the caveat though of saying the world's architecture of the financial system is broken. And especially in many of those Middle Eastern nations. The world's priced in dollars, John. We just pushed 50% dollar inflation to the world in a four year period and they have a negative convexity to us.

 

They meaning any country that's not self sustaining. So I don't think there's gonna be any detent or any denouement anytime soon. I think that things are going to escalate before they de escalate and unfortunately I just think there's a lot more kinetic conflict coming because of the architecture of the world being broken.

 

But in the Middle east, focusing on our relationship with the uae, our relationship with Saudi is a very, very good thing in my opinion.

>> Jon Hartley: I just want to close, I guess one last question on sort of legacy and investing, long term investing. And I think for a long time we think the US has been sort of the only game in town.

 

If you just look at sort of world equity markets, the US is the one place that continues to really just crush it. And a lot of this has to do with the tech sector, A lot of it now has to do with AI. But you have these major tech companies that just don't exist in Europe or Canada or Japan.

 

And it's a big part of why GDP per capita and the US keeps growing while it remains flat in the rest of the Western world in Japan. And you know, for many years, you know, you were on the board of directors of the University of Texas and Texas A and M investment management company utimco.

 

Endowments have very long horizons. I'm just curious like what your thoughts are and what you would tell sort of endowments and very long term investors? Are you sort of in from sort of a global macro perspective in your mind, is the US still the only game in town in terms of long run, very positive expected returns, the place where innovation happens for the foreseeable future?

 

Or do you see other countries starting to participate with this more in the future? Obviously the EU I think steps on its own toes with a lot of this tech regulation, making it very difficult for tech companies to exist there. But I think if you were to strip out all these tech companies from the us, the US would probably look pretty much like the rest of the West.

 

But that's the one thing that I think makes the US economy so unique. I'm curious what you think about the US as a long term asset class in general on the equity side of things?

>> Kyle Bass: You've set it up perfectly. My short answer is yes. I think the US is the best place for your capital allocation.

 

We are 4% of the world's population. We're 26% of the world's GDP. We are 60% of the world's capital markets, so why? Because people vote with their money. We have the most liquid, best, deepest capital markets in the world. We have American exceptionalism in our schooling and in our entrepreneurship.

 

To your point on Europe with GDPR and some of the foot their own goals that Europe scores on themselves, you know, and then they continue to like double down on the instant replay after they just watch the bad movie. You know, like after they see the play and they know how it's going to play out, they just do more of it.

 

It makes no sense at all to me what Europe's doing. And then, you know, we are the place to be. I have looked and studied the history of the world and I can't find an economy that was bigger than 26% of the world economy. Maybe there was one in the past, it just wasn't recorded properly.

 

But we, we are still the best economy in the world with the best prospects, with the best system. Now we have our, we have our challenges and the frictions are growing and that that gap between the wealthy, the middle class and the poor continues to grow because we're going to keep running $1.8 trillion deficits going forward.

 

So that's the caveat, John. But if you're investing your money, I can't imagine anywhere better than the US to invest. And I'll give you one one last thought here. If, if I told you as a very smart young economist and I said, John, I know today I have a crystal ball 20 years from today, I know of an economy that will grow its GDP 500% over 20 years and they will become the world's second largest economy.

 

And they have a public index. How much of your money would you put in that index? You'd say, well, I don't want to put words in your mouth, but would you say, I'll invest some in that index?

>> Jon Hartley: Absolutely.

>> Kyle Bass: So if you invested in the Shenzhen Shanghai 320 years ago and China has reportedly grown their GDP now 505%, it's actually 18 years ago.

 

Let's just go 18. You've lost a third of your money and they've grown their economy 505%. What else do you need to know? The, you're the patsy. The Westerner is not going to make the money. The Westerner is gonna get left holding the bag in a communistic economy.

 

Now, could you have traded and made money along the way? Of course you could. But I'm not interested in picking up dimes in front of bulldozers. I'm interested in making longer term investments in companies that we know can succeed. And the US is always going to be that place.

 

Europe again. If you parachuted a capable person into managing the eu, you would get rid of gdpr, you would encourage entrepreneurship, you would give tax incentives to move companies over there and you could revive Europe. If you think about the architecture, you mentioned Milton Friedman and you know what he said right before he passed away?

 

When the world hits a speed bump, it's going to kill Europe because they don't have a real union. They have, think about this. They still have, they have no fiscal union, they have no central taxing authority. They have, they don't have a unified fighting force. There's still a French navy, there's still a German army, there's still a Spanish air force, and there's no deposit guarantee scheme across Europe.

 

Europe's not actually a union, it's just an idea. And so if I'm thinking about investing capital, are there some interesting European companies here and there Maybe. Mean they make great leather goods, right. LMDH is worth a trillion bucks. But you know, branded luxury is what Europe's good at.

 

Europe is a retirement community for the world. It's where the world's rich go to hang out because it's beautiful and has a lot of history. But the US is the place where all of the growth is going to be and it's where all the other innovation is.

>> Jon Hartley: Absolutely and it's amazing too when you think about over time, all these forecast premonitions, you know, the, the all these people that have predicted that, you know, the USSR was going to eclipse the US in growth, and then it was Japan in the 1980s and then China in the 2000s.

 

And it's amazing how all those predictions have failed. Paul Samuelson famously had, I think it was in his 1960s textbook that the USSR would eventually eclipse the US and, yeah, all those predictions have failed. So it's amazing how it's such a terrible strategy to bet against the US in many ways.

 

Kyle, I really want to thank you for coming on. This has been a really amazing conversation.

>> Kyle Bass: It's a pleasure, thanks, John.

>> Jon Hartley: This is the Capitalism and Freedom the 21st Century podcast, an official podcast of the Hoover Economic Policy Working Group, where we talk about economics, markets, and public policy.

 

I'm Jon Hartley, your host. Thanks so much for joining us.