Texan hedge fund supervisor J. Kyle Bass, the founder of Dallas-based Hayman Capital, sent a big letter to investors describing why he thinks China has an issue much bigger than the 2008 subprime crisis.
China has actually been burning through money of late as it manages the devaluation of its currency, and there is a big argument over precisely how much money it needs to burn.
Bass notes that lots of folks look at the foreign-exchange (FX) reserves of $3.2 trillion and believe that China will be simply fine.
Its truly insufficient, though, based upon Bass computations. According to Bass, the country is out of cash today. Simply puts, China no longer has enough liquid reserves.
The letter stated, with Bass emphasis:
Responses we receive when talking about the FX reserve levels of China are filled with reverence: No country in the world has actually ever accomplished $4 trillion in FX reserves by running such enormous trade surpluses with the remainder of the world. While true, this analysis fails to frame the correct context of the bigger situation. When a host country has a huge industrial base, massive money supply (M2), and huge import/export company, there is a certain amount of liquid reserves that are needed to run the everyday operations of the nation (think working capital). For many years, the IMF has fine-tuned the formula used to compute this ‘reserve-adequacy’ metric. It can be finest computed as follows:
Minimum FX Reserves = 10 % of Exports + 30 % of Short-term FX Debt + 10 % of M2 + 15 % of Other Liabilities
For China the formula is as follows: 10 % * $2.2 T + 30 % * $680B + 10 % * (RMB 139.3 T/ 6.6) + 15 % * $1.0 T = $2.7 trillion of needed minimum reserves
Hayman Capital approximates that Chinas FX reserves today are in a range of $2.1 trillion to $2.2 trillion if you take commitments to different bodies like Chinas sovereign wealth fund (CIC) into account.
According to Bass, Chinas reserves are already below an important level of minimum reserve adequacy.
Simply puts, China is CURRENTLY from the needed level of reserves required to safely run its monetary system, Bass wrote. The view that China has years of reserves to burn through is misguided. China’s back is completely up against the wall today, which is among the main factorsreasons the government is hypersensitive to any remarks regarding its reserve levels or a tough landing.
Bass is among a handful of hedge fund managers betting against Chinas currency, the yuan. Much of Hayman Capitals fund today is devoted to the yuan short.