Hard Landings

Hard Landings

Australians should have all eyes focused on China. China is the dog upon whose tail Australia is attached and our view, as you know, has been that the country would slow dramatically as it tries to rebalance from an economy heavily dependent on fixed asset formation to one reliant on the consumer.

Of course when stocks markets decline 30 or 40 per cent, commercial property prices fall 50 per cent, and residential property languishes under a three-year supply overhang, it isn’t easy for consumers to pull the country out of its malaise.

Kyle Bass is someone whose views are worth also heeding. As the founder of Hayman Capital Management he famously shorted the sub prime bubble and parlayed the billions he made for his clients into a short position against Greece.

In an interview with Laura Laughlin for Fortune, Bass says China’s impending banking crisis, though far bigger than the U.S. crisis in terms of the assets at risk, will have a smaller impact on the global economy.

The essence of his more sanguine view about China is this;

“When you are thinking about their [foreign-exchange] reserve pile, and investor solace that they have so much money – a $3.5 trillion rainy day fund that they can weather any storm – the point is that their banking system used to be 41 trillion RMB only eight years ago and now it’s 184 trillion RMB. They have $31 trillion of assets in their banking system. Their economy is $10 trillion.”

“What does that look like relative to the U.S. in 2008?”

“When the U.S. was entering the financial crisis, the US banking system was [equivalent to] 100% of GDP, with $16 trillion of assets on the balance sheet. We had $1 trillion of equity, meaning we were, in essence, levered 16 times. Loan losses then were about 7.6%. China has three times its GDP in bank assets.”

“When you look at emerging markets even back to the Asian financial crisis in 1998, emerging markets only represented 12% of global GDP. In U.S. dollar terms now, emerging markets make up 34% of global GDP.”

“If we are right about China, they are going to have credit contraction and a hard landing. It’s not the end of the world but it will be a hard landing. Asian GDP overall will be extremely challenged.”

And what are Bass’s views on the implications for the US economy?

“We don’t know. If a third of the globe that’s been driving GDP growth slows down or goes negative, it doesn’t mean we are going into a surefire recession, but there is no chance of 2.5% real growth in the U.S. We think it’s going to shave 1.5% off GDP growth: That means that U.S. GDP could be up 0.5% to 1%, which is not good. Again, it’s not the end of the world. The U.S. already recapped its banks so we won’t have any banking problems. But we will have problems with growth.”

The complete article can be read here.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

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