🔴 Kyle Bass Explains The Chinese Currency Crisis As An Investment Opportunity

KYLE BASS: The 10-year period from ’08 to 2018 were the best 10 years that Hong Kong will ever see, will never happen again The Hong Kong banking system is now almost nine times their GDP Call it today, it’s 850% of GDP 280% of GDP of the 850 is lent to Chinese property developers into China They’re the most levered nation in the world with the most expensive real estate in the world with an economic arrangement with a country that is no longer synchronized It is a recipe for disaster RAOUL PAL: If you remember a month ago, Kyle Bass was on Real Vision talking about China And he said he had one big trade for us The really big one, the one that he’s been doing all of his work on And he refused to unveil it until he told his investors and got himself set up and positioned. That moment’s now. Kyle’s back to come and tell us the next big trade The trade that he thinks is one of the greatest opportunities in financial markets It’s going to be super interesting for us all to sit back and watch Kyle Bass unveil this great idea So, Kyle, you come with a tie, I’ve got my collars up What you promised me a month ago is you’re going to come with the killer trade The big idea that you’ve been working on for a while ago and we alluded it on Real Vision to people And now you’re back, and you’re ready to unveil what is- you and I have spoken about it a little bit And it’s, for me, fascinating and almost incredible talking through it KYLE BASS: Very start at the beginning. So, for the last really three years, we’ve focused on as you know, I don’t know- six or seven years, we focused on China’s financial system. And that’s taken us to understanding the flows and the plumbing of capital and how it flows in and out of China, whether you’re looking at Hong Kong or China or you’re looking at listed market or the domestic market in China The majority of the capital flows through Hong Kong and when you look at Hong Kong as a sovereign- tell a little bit of a story as far as the existence of Hong Kong in its economic and financial state that they’re in today, you have to look back 36 years Really have to look back much further than that when the UK or Great Britain really fought a couple of wars, the first and second Opium Wars and then the balance for the new territories and took over Hong Kong Island, Kowloon and the new territories And they basically ruled those territories for a very long time And at some point in time, in the late 1970s, early 1980s Deng Xiaoping started I think some rhetoric back behind the scenes some conversations with Margaret Thatcher on handing Hong Kong over back to the Chinese as you know the British basically secured their rule over Hong Kong with a 99-year lease. The Chinese wanted that lease to end in 1997 and threatened I think the British in one way or another to get them to do it a little sooner And so, while these negotiations were going on, word got out that the Chinese were talking to the British about a handover And if you notice what happened then, the Hong Kong currency had about a 50% decline versus both the dollar and the pound going into 1983. And then, in late 1983- RAOUL PAL: So, it was a free-floating currency then? KYLE BASS: It was a free-floating currency then, yep So, but 50% devalued over just a handful of years. To the extent that the South China Morning Post was saying it’s becoming a banana republic The currency is in a “free fall”, and then they pegged it to the dollar, the US dollar Fascinating, right? It’s being controlled by the British and yet they’ve pegged it to the US dollar looking for more stability than I guess the British had RAOUL PAL: Nice dig KYLE BASS: And so, right now, we face Brexit and I don’t know what’s going to happen next, but I think that back then, they engaged in a peg to try to bring some sort of stability to calm the nerves and the psyches of investors in Southeast Asia and primarily Hong Kong, because as you know, investors were thinking with Great Britain, there’s a legislative democracy, there’s basically financial stability, there’s rule of law They’re all the things that capital needs to invest and make real investments in the sovereign of the territory And with the idea that China might take back over sooner rather than later, the money left

And that’s why they had to institute the peg So, the UK-Chinese agreement, this British agreement 1984 stipulated or set forth the rules by which Great Britain would engage with Hong Kong in the future And the handoff would be July 1st, 1997 Fast forward from ’84 to ’92 when the US entered its Hong Kong-US Policy Act, both Great Britain and the US treat Hong Kong as its own sovereign, as long as it maintains autonomy Autonomy in its economic affairs, and its legislative affairs and its rule of law RAOUL PAL: What does autonomy mean? KYLE BASS: That no one else is running the show This agreement stipulates that it is a special administrative region of China, but it’ll be treated as Hong Kong as long as those things are maintained Like, I’d love to cover that secondarily in our conversation- RAOUL PAL: That’s my question, what’s autonomy, but yeah- KYLE BASS: Yeah. The word’s very important So, when you look at today, if you just look at Hong Kong from a macro perspective, it’s really important to think about what happens when you peg your currency to another There’s the pegged currency, then there’s the anchor currency The anchor currency, in this case, is the dollar What you’re doing is you’re basically saying I will adopt their monetary policy I’ll adopt their yield curve I will basically let Jesus take the wheel and let the US run my economy Now, that works actually fairly well as long as there’s a synchronicity in economic outputs, right, i.e. if the economies are working together, if one grows, the other grows, if one goes into decline, the other goes into decline That kind of relationship actually works If one economy is growing, while the other one is declining, and you have to import monetary policy and i.e. the same rates curve, it’s a disaster for the one that’s declining And so, 36 years ago, the US was the engine for the world. And as the US economy went, the world economy went. There was synchronicity And if you fast forward to China’s ascension to WTO in 2001, China’s move into becoming the second largest economy in the world with roughly 15% of GDP And you look at the infrastructure build that China engaged in since 2001 in their southern ports, really southern and up the coast, what you see is Hong Kong used to be the biggest port in the world They were a dollar-based goods exporter and re-exporter of goods for Southern China They were essentially China’s southern port And they were very functionally relevant to China especially in the early 1990s They represented a quarter of China’s GDP, actually, almost 30% of China’s GDP Today, it’s 2.5%. So, they were ready relatively unimportant, important, very important, and now, unimportant again from an economic perspective, right? From a capital raising perspective, very important But from an economic output perspective, not that important I think if you look at how Hong Kong’s economy has changed over the last 36 years, they’ve gone from a goods exporter and services importer, and right in the financial crisis, that flipped and now, we have a chart in here, whereby you see the blue bars are goods, the red bars are services. So, it looks like the financial crisis flipped them But that’s just coincidental actually It was the southern port buildout that basically moved China’s, let’s say ownership of the top 10 ports in the world, from 9% in 2001 to 60% in 2015 So, that’s what happened in making- forcing Hong Kong to actually reinvent its economy Hong Kong today is a massive goods, net goods importer, it’s hard to believe that And they’re a services exporter and they face China, right, for travel, for financial services, real estate services, legal services, call it 80% plus their economy relies on China on the export side of services And they import dollar-based goods And so, there’s no lack of- there’s no synchronicity between the two RAOUL PAL: So, they coupled essentially from the US economy? KYLE BASS: Yeah. And so, when you and I were running Hong Kong today, and we said, how should we run our economy? We would say, pegging to the dollar would not be the right idea RAOUL PAL: X the R&D I guess, if you can do it KYLE BASS: Yeah. And so, their economic arrangement with the US is one that has changed dramatically over 36 years, but on the face of the world, that actually hasn’t changed at all yet. And then you look at the macro of Hong Kong, if you import US monetary policy, as they went into 2008, right? In 2008, US took rates to zero. So, historically, the anchor currency is the one that,

let’s say is the fiscally responsible one It’s the one that keeps inflation under control It’s the one that keeps rates where they should be, keeps a more stable economy and that’s why people anchor to them In this case, the inmates are now running the asylum, we just took rates to zero Imagine this, 2008, US takes rates to zero so Hong Kong rates go to zero And their largest trading partner, China, goes to the gas pedal So, the 10-year period from ’08 to 2018 were the best 10 years at Hong Kong will ever see, will never happen again. So, no wonder real estate went up five to 700% in a 10-year period Right? No wonder the price of Hong Kong real estate is $10,000 a square foot RAOUL PAL: And that’s why that chart of services because it all becomes finance because it all just goes to money. Right? KYLE BASS: Well, it’s free money. And your largest trading partners growing double digits And so, what happened, the Chinese came in with all the money they were making and bought all the real estate in Hong Kong So, now, it’s completely unaffordable, I think the most expensive real estate in the world. And what’s interesting is the Hong Kong banking system did exactly what Iceland, Ireland and Cyprus did The Hong Kong banking system is now almost nine times their GDP What was the common denominator the countries that fell apart in the European crisis? They fell like dominoes It was the size of their banking system when they hit a slight recession Broke the country, right, because the country has to go in and save the banks, save depositors And that means the sovereign has to lend into the banks and it breaks the sovereign because the banks are levered to the GDP RAOUL PAL: But what did they lend against in Hong Kong? Because this is going to be the key, right? The USA is the housing market- KYLE BASS: This is a fun one. Call it today, it’s 850% of GDP 280% of GDP of the 850 is lent to Chinese property developers into China The rest is lent to domestic SMEs and mortgages So, I hear a lot from the various sell side firms that we call, they say, oh, Hong Kong mortgages are only 50% loan to value, not a problem And I said really? How to how do they afford a 50% deposit on the most expensive real estate in the world? They said, that’s easy So, the bank lends 50. The property developers lend 35 in a second lien, and families- the families or friends lend them the other 15. I said, so how does that work? And they say, well, that’s easy, because housing goes up like 10% to 15% a year So, in the first year- this is a partner at one of the biggest firms in the world tells me this that runs a real estate business. In the first year, they re-fi their family home And in the next two years, they re-fi the developers out and then they have a 50% off of the loan I said, but what if prices go down? He said, oh, prices don’t go down Literally, I’m hearing this again RAOUL PAL: We’ve heard this before KYLE BASS: And so, there’s this belief that the loans in the banking system are safe because of their loan to value ratios. I think we all know that that’s not going to be true RAOUL PAL: So, of the Hong Kong money, the banking system, is most of that debt in China Chinese debt KYLE BASS: Yes RAOUL PAL: It’s nothing to do with the Hong Kong domestic so- KYLE BASS: Oh, no, no. So, 280- say of the 850, 280 is on to China The balances went to Hong Kong domestics RAOUL PAL: Right. What the hell do they do with it all? Because that many people in Hong Kong- KYLE BASS: Private sector financial credit is the highest of any developed nation in the world. 300% of GDP. Look at the US and Japan and look at where Hong Kong is So, you have the most levered banking system in the world- RAOUL PAL: [Inaudible] mechanism, that is flowing back into China just feels that you don’t look at the streets of Hong Kong and think everyone’s completely borrowed as much money as Libor’s. It feels like there’s another mechanism KYLE BASS: Well, they could have taken the money and invested in China, right? What I’m saying is domestic private sector credit to GDP is 300% banking assets to GDP are 850. So, they’re the most levered nation in the world with the most expensive real estate in the world with an economic arrangement with a country that is no longer synchronized It is a recipe for disaster RAOUL PAL: So, everyone’s kind of have in their head, yeah, heard this all before in ’98 And everyone got every hedge fund to try to take advantage of that peg breaking, didn’t break. What’s going on now that’s different? Because you’ve got- you’ve look at reserves and a whole number of different things [inaudible] KYLE BASS: Yeah, let’s talk about ’98 first I think it’s important to see the HK may have a decision to make, right, either revalue the peg or suffer a massive debt deflation

And now, their debt was nowhere near what it is today. But what they did- if you look at this chart here, from July 2nd, 1997, which is when the Thai baht broke the peg, interestingly enough, one day after the handoff from the Brits to the Chinese, July 1st, ’97 was day the handoff July 2nd was when the Thai baht broke. That is not coincidental So, from July 2nd of ’97 to the beginning of 2003, Hong Kong real estate dropped 70% in value Right? So, they elected to take a multiyear enormous, basically, deflation like depression So, the way that they made that election during the crisis of ’97-’98, is they spiked overnight rates up to 20%. So, US rates were 4.5%, 5%, right? So, they took rates from five to 20 on a spike to forge any currency from leaving, they were trying to keep currency there, right? Well, today, the fascinating thing about their banking system or their mortgages, their assets, their loans and their system, the substantial majority of all those loans indexes to one-month high bar, their overnight lending rate and they all reset every month. So, imagine taking an economy at max leverage and raising rates to keep currency from leaving RAOUL PAL: Impossible KYLE BASS: That arrow is out of the quiver They can’t do it this time So, if you look at the IMF’s article for review of Hong Kong, the number one risk is the fact that all the loans are floating an index to one-month high bar RAOUL PAL: It’s the same with the UK back in Sterling crisis All the UK properties borrowed at the short- term rate KYLE BASS: Right. Same with Hong Kong Now, they have a mechanism in their mortgage market that has a cap at prime minus A rate call it 250. Prime is at 5. And so, the Hong Kongers believe that even though their rates have gone from an effective 1.25% or 1.5% to 2.5%, that there’s a cap So, the most fascinating thing was in September of 2018- I think it’s September 29- was the day that Fed raised rates That night, Hong Kong raised the prime lending rate by 12.5 basis points. That’s it The next week, the South China Morning Post ran stories every day, talking about real estate dropping 6% to 10% in a week, because all of a sudden, the Hong Kongers figured out that the cap could move, right? You can’t just move based lending rate, you have to move prime if rates are going to move up So, 12.5 bip move on the prime lending rate scared the entirety of the Hong Kong real estate market That’s why you see that hook down there at the end of this chart That started at the end of September RAOUL PAL: So, then the other preconception is right now- same as it was back then- is Hong Kong has unlimited balance sheet, the HKMA- because even I’m burned by the HKMA because they even bought the equity market They killed everybody, every hedge fund. You can talk to Paul Tudor Jones and the whole lot I don’t fight these guys. So, Tudor and the HKMA, the options they’ve got in this situation KYLE BASS: Let’s talk about Norman Chan, right, the head of the HKMA He’s going to retire here in the next four or five months So, they’re going to look for new leadership As far as the HKMA and this idea that is- let’s say talked about by the sell side a lot with regard to they have a pile of dollar- based reserves. They have a what they call perfect currency board. For every seven point- call it 7.8 Hong Kong dollars in the system, there’s a dollar in the system And they’ve got more than their entire GDP in money in circulation, everything’s going to be fine When you think about that, if currency boards worked, then Argentina, which used to be one to one to the US dollar in 2001- if you just think about this- 2001, 17 years ago, 18 years ago now, I was wondering what- we know what it is today 43 to one, maybe 44. Who knows what it is? Right? When you look at a currency board, if you look at a currency peg, let’s say that identity is true For every 7.8 Hong Kong dollars in the system, there’s one US dollar in the system You can’t take it below that and run a fractional reserve peg, I guess you can, but you’d lose- confidence would be lost very quickly And so, the way we look at it, we look at it as currency in circulation, which you can’t really- let’s just say go into. You can’t go into that cookie jar You have to stay out with your excess reserves So, Hong Kong reports every night what their excess reserves are

They call it their aggregate balance And just two years ago, that was about HKD 170 billion, real money In the last year, they’ve spent 80% of that money defending the peg- 80. 8-0 They have HKD 50 billion left, call it USD 6 billion left, before all of a sudden, they’re going to have to make a decision Now, can they go find some other money in their economy somewhere somehow to keep defending the peg? This actually goes back to this concept of even sovereign default And if you and I are running a sovereign or you and I are running a peg, it’s actually similar. Do we think that it’s anomalous that this attack is speculators? Or is it the macro economy telling us that maybe the peg’s not pegged to the right thing? And maybe not the value is the right value? All right? Is it temporary or is it a secular problem? RAOUL PAL: So, in 98, what was different is everybody was under pressure KYLE BASS: Yes RAOUL PAL: It wasn’t Hong Kongers problem KYLE BASS: Exactly right RAOUL PAL: But nobody’s- KYLE BASS: And it wasn’t Hong Kong’s leverage either And it wasn’t Hong Kong’s [inaudible] market or banks It was people were running into dollars afraid of China taking over the region And so, now, you have this hyper levered system In the most expensive real estate market in the world, you have the natural moves So, right now, if these two- if the Hong Kong dollar and US dollar interchangeable, which freely interchangeable which they are at the peg, you can earn 83 basis points more on an overnight rate if you just have a dollar deposit So, if I asked you, Raoul, would you rather have 1% or 2% on your deposits? And it’s freely interchangeable. You don’t have to be a genius to figure that one out So, then, that’s why the pressure continues to mount and mount and mount People are just converting the dollar RAOUL PAL: So, I don’t think many people will be aware of what’s actually going on the Hong Kong currency. Explain a bit about the situation of what’s been going on how it’s been trading versus the peg KYLE BASS: So, it has a very narrow band. So, the peg was set in ’83 They adjusted it to a band, the band is 7.75 to 7.85 to the dollar It’s basically a little more than a 1% band And so, for the last few years, it’s traded at the strong side of the band And in the last one year, it’s traded to the weak side, the 7.85 to the dollar And so, what happens when- RAOUL PAL: But a flat line there, though KYLE BASS: But what happens is if you’re going to maintain a hard edge, like they have to maintain, they have to sell dollars and buy their own currency So, they have to sell their rainy-day fund, their excess dollars, they have to sell So, they’ve sold 80% of those dollars in a year’s time. Just think about that So, what happens when they sell the last 20%? So, two things happen Either they find more dollars by mortgaging or leveraging another asset or requisitioning funds from somewhere. It’s not the only money they have And we’ve done a very in-depth analysis, not in our letter, we can cover that another day But let’s just say they have a decision to make They can raise rates up to the level where they stopped the currency from running, i.e. converting the dollars, or they can find some more money to fight the peg with RAOUL PAL: Now, the other question is, is this is clearly tied into the Chinese story Is this also a capsule flight from China via Hong Kong? Because that’s always been my premise that this is a mechanism that’s part of a bigger story, and too difficult for the HKMA to stand in the way of KYLE BASS: I’ll say that your premise has been right for a few years, in the last few years But if you remember when China closed the door, really shut down and put their fingers in the holes of the dam or the money running out of China They did that really beginning of 2017. I’ll give you some anecdotes I have friends that are some of the biggest art dealers in the world and they do these Art Basel shows, right. And there’s an Art Basel in Miami There’s an Art Basel in Hong Kong And so, in the last couple of years, this year in particular, my friend that sells all the fancy paintings, not one Chinese buyer this year, not one And three years ago, they were selling them like hotcakes to the Chinese So, they can’t get their money out And they’re policing that very, very, very, very closely RAOUL PAL: But my guess is they can put the money, as you said earlier, into Hong Kong, right? So, their first step was put into Hong Kong real estate, right? You’re outside of China, because within China, then you’re free You liquidate the property or whatever you do- KYLE BASS: And in theory, there’s a rule of law on Hong Kong, right? It’s still a UK rule of law in theory RAOUL PAL: In theory, exactly. Which we’ll come a little bit on to in a sec But I just have a feeling that that money is flowing out So, let’s say they sell real estates. It’s mainland money that’s been there for 10 years It now finds its way out because they’re looking for more security So, it goes to Vancouver, it goes to Sydney or wherever

KYLE BASS: Imagine if you’re a Hong Kong family that has been there for generations And let’s say you’ve built wealth over time You would have to be foolish And in a freely convertible market, you’d have to be foolish to leave at Hong Kong dollars given the macro economic instability of Hong Kong. And what happens in a peg where 36 years, there’s no volatility, right, no volatility begets no volatility until it doesn’t But if you look at the macro, if you had your entire wealth invested in Hong Kong dollars, in Hong Kong stocks and bonds, and I sat and talk with you and explain to you how bad the macro is, and then you say, well, it’s probably going to be a political situation I don’t care. I’d rather own US dollars tomorrow, and not be on the hook or at risk of my home currency collapsing RAOUL PAL: So, let’s talk a little bit about risk in terms of the rest of the people in Hong Kong. Because we talked about autonomy, we both sniggered about autonomy in Hong Kong because it feels like and from friends of mine in Hong Kong as well and you’ve got friends in Hong Kong- that autonomy is going fast KYLE BASS: So, last night, I had dinner with a friend that just sold both pieces of real estate that he had there and he moved his family to London RAOUL PAL: Oh, really? KYLE BASS: Gone. He grew up in Hong Kong, generational Hong Kong family, the moment that China started actually floating a proposal to be able to extra judicially grab someone off the streets of Hong Kong and take them to China without any court proceeding, that’s scaring the Hong Kong- not only the Hong Kong elite, but 85,000 Americans that live there, right? In the past, we all know that the MSS from China grabbed booksellers that were writing books about President G that he didn’t like, and they came in the middle of the night, took him and ripped him, rip them back to China. That was a political grabbing And everyone was up in arms about it And there were four booksellers that went missing for a while, and then they resurfaced at some point in the future, never to sell another one of those books again This is a different thing. The proposal in the manner in which it is stated today, and Carrie Lamb’s government is the one making this proposal So, she’s not really democratically elected, right? She’s chosen by President G to be the CEO of Hong Kong and she’s proposing this, and her proposal is it states that there’ll be a judicial review, i.e. if the crime that is supposedly been committed by the “fugitive” is a crime also in Hong Kong. So, let’s choose murder, right? It’s a crime in both places If China calls the police station in Hong Kong, and says Raoul committed a murder in China, arrest him and send him over here The court says their judicial review is okay, is murder a crime here? Oh, yes, it’s a crime here, we’ve got- the presumption is guilt So, there is no court process to determine whether or not this is a political movement or not or whether or not you actually committed a murder RAOUL PAL: So, how can people like Li Ka- shing remain within Hong Kong? KYLE BASS: I think they have to leave. I think it’s a real problem My friends that are very well-off are leaving. Now, if you remember Nancy Pelosi just had a group of 10 delegates from Hong Kong here to the States two weeks ago And was very forceful with some language and said, there are 85,000 Americans that live in Hong Kong And we are very concerned about the new proposals that are being floated in the legislature in Hong Kong If this becomes law, more importantly, this goes back to this word autonomy The Brits agreement with Hong Kong and the US agreement with Hong Kong, for instance, the 1992 US-Hong Kong Policy Act is re-ratified annually The State Department submits report to the President and then it’s up to the President to either take the State Department’s recommendations or do whatever he wants to do If he determines that they are no longer sufficiently autonomous, we can treat Hong Kong as China Well, that changes the entire complexion of Hong Kong’s economy, meaning all of a sudden, all the tariffs, all the restrictions, all the rules of trade that we engage with China on, we start treating Hong Kong that way. Today, Hong Kong is treated as its own sovereign There are no tariffs, it’s free trade, unabated free trade And as long as, again, they maintain that autonomy, we honor that agreement If this law goes through, it is a clear violation of our policy act and it’s a clear violation of the Brits agreement with Hong Kong That in itself will force- remember in 1995, during the Tequila Crisis, what happened?

What precipitated the Mexican decline? What precipitated Thailand in ’97? It’s always one thing. It’s always the wealthy lose faith or fear the government and they start moving their assets out RAOUL PAL: Yeah. I was thinking too. It was the same KYLE BASS: That’s what happens. So, if the wealthy in Hong Kong either convert to dollars or start leaving, which I think both will happen, then Hong Kong is finished RAOUL PAL: So, what do you think? How does this play out? So, we’ve seen the HKMA is running low on the accessories The currency is staples to the limit, so they haven’t intervened almost every day The US dollar as of today looks like it’s breaking high and it’s going to get stronger, which will only put more pressure on this situation How does it play out? What’s going to happen in this? KYLE BASS: I really don’t know. All I know is the pressure that is being applied is not a- this is not anomalous, it’s not a one-off, it’s not they’re just caught up in the in the tide of people moving to dollars everywhere and in Hong Kong, it’s not of its own problems You’re talking about the most levered developed economy in the world with the most levered consumers in the world with the most expensive real estate in the world, all of a sudden, having a real problem RAOUL PAL: So, why do people look at Australia and Canada before they look at Hong Kong? KYLE BASS: Again, 36 years of stability begets more stability It’s an availability heuristic, right? It’s the way we think RAOUL PAL: Because we all think that Australian housing market is going to blow up, the banking system is going to get trouble Canada, probably the same There’s nobody talking this Hong Kong story Everybody says, don’t be stupid because Hong Kong will be fine KYLE BASS: Yeah, well, if I were living in Hong Kong with my wealth there, I would have already converted it and left RAOUL PAL: And the currency is telling us something every day, there’s money leaving that country and nobody’s noticing KYLE BASS: And you know what’s interesting? The architect of the peg himself, Greenwood wrote an article just last week published in The Wall Street Journal, I believe In it, he says, people are starting to speculate on the Hong Kong dollar They’ve lost money for 36 years. They’ll lose money again It’s a perfect peg, nothing to see here. Then why did you write the article? RAOUL PAL: Yeah, he can’t say these things KYLE BASS: It’s just like when you incur- going into the European crisis, he said Greece will not default. It’ll never default. And then we didn’t have a meeting And then a few finance ministers said, but we just did- a reporter said, we just talked to other finance ministers that were in the meeting And they said, so you just lied to us? He said, listen, when it gets serious, you have to lie. You remember that? RAOUL PAL: Yeah KYLE BASS: So, like, no one’s ever going to tell you this is coming. No one RAOUL PAL: Before, it’s trading through KYLE BASS: No RAOUL PAL: That’s interesting KYLE BASS: They’re still trading on rate differentials So, I think when they run out, then you get the next move RAOUL PAL: I don’t think people understand quite the impact that if Hong Kong were to devalue or have to abandon their peg, let’s say they’ve dressed it up as a, we want to re-peg to the mainland KYLE BASS: Yeah, that makes a lot of sense RAOUL PAL: It would make- yeah, politically, you can get away with it But what that does is immediately put pressure probably on the Chinese currency itself, but across the region because Hong Kong is/was one of the stabilizing economies because Hong Kong and Singapore- they’re the two Free Trade Zones, you do that? It’s going to start devaluing all of the currencies across the region KYLE BASS: I don’t know. I hear you but I don’t have an opinion on it truthfully RAOUL PAL: No? KYLE BASS: No, I think that- RAOUL PAL: Maybe, it’s the knock-on effects are enormous KYLE BASS: They typically are. And nothing’s ever- because subprime wasn’t contained, right? No matter how big the problem is, there’s never true firewalls, you remember that? RAOUL PAL: Your focus is on okay, this is the one thing KYLE BASS: Yeah, I think that the rate differential is really interesting, and I think that if as a global investor and as someone that looks at risk, the way you look at risk, if you’re- there are a few people that this should appeal to Number one, it should appeal to anyone that has their wealth in Hong Kong dollars They better pay a lot of attention here because right now, it’s free to hedge yourself It actually pays you to switch to the other currency That doesn’t have all the problems that are endemic in yours The second group of people are the global asset allocators, right? If you and I are running a pension endowment or sovereign wealth fund, and we have money to your point allocated not only to Hong Kong- Hong Kong, China, Southeast Asia, this will be a destabilizing event And so, maybe there’s a way you could hedge yourself against that. There is one, right? And the most interesting thing about that is the hedge pays you, you don’t have to pay for the hedge RAOUL PAL: And so, HSBC. HSBC is an enormous bank split between London and Hong Kong

So, surely, they’re doing the hedge, right? If you’re the CEO of HSBC, you should to be switching all of your- can I see, bizarrely enough, I do know one of the treasurers or the treasurer of HSBC- I could probably find out, but somebody, they would know And they would have some idea what they will do with their reserves KYLE BASS: So, the funny thing is about Hong Kong also, just think about it The two largest banks in Hong Kong are two orphaned children of British financial institution. That are bankruptcy remote They’re firewalled from a corporate capital structure perspective RAOUL PAL: Obviously, in the UK and Hong Kong KYLE BASS: And they don’t have any British depositors. So, yeah, I’d be worried if I own- we don’t have any positions in any banks to be clear But I can promise you, I wouldn’t own either one of the rest RAOUL PAL: So, there’s another trade So, back in my youth, I see a lot of these equities pair trades KYLE BASS: Long their parent, short the Dows? RAOUL PAL: Well, particularly because there was the Jew listing I remember, in fact, when I was a salesman, I did, I don’t know, maybe $2 billion of this trade for equity before long term capital, which obviously blew them up But the point being is I don’t have a trade any longer But my guess is there’s the pairs trade because you basically go the UK and say, the Hong Kong and said they trade at the same price They won’t trade at the same price in the future because the Hong Kong entity, because it’s bankruptcy remote. I’ve tried a massive discount KYLE BASS: That’ll be for you to engage in and not me. But it’s definitely an interesting idea RAOUL PAL: Yeah. So, I think- yeah, it’s super interesting because lot of people just haven’t looked at this yet And I think what you’re on to is something that nobody’s been talking about I like the fact that most people will be cynical about it as well KYLE BASS: Oh, yeah. Look, one or 2% of the people end up getting it right in things like this, right? RAOUL PAL: Yeah. That’s right KYLE BASS: You look back to Switzerland going through a strong side, you look back to the Tequila Crisis or the Thai baht, or- there’s so many other situations that just caught everyone by surprise If you just took the time to analyze it, it wouldn’t have caught you by surprise And if you watched what the wealthy were doing in all of those situations, you didn’t know what was going to happen RAOUL PAL: So, the worst question of all, time horizon? KYLE BASS: Yeah. It’s 36 years, Raoul It’d be arrogant to say that you have any idea with what’s to happen RAOUL PAL: You can’t get away with saying I have no idea KYLE BASS: Okay. If 80% of the rainy-day fund is burned up in a year’s time, in time continuum, just 12 to 18 months a long time. I don’t think it’s very long RAOUL PAL: No, I don’t think so at all KYLE BASS: I don’t think 18 months from now, you’re going to know what happened RAOUL PAL: Yeah KYLE BASS: You were going to know and it’s probably sooner, I’m hedging RAOUL PAL: Yeah, no, I get that. Yeah, I think it probably is, if it’s going to happen, it’s likely to happen relatively soon KYLE BASS: Yeah RAOUL PAL: Well, Kyle, it’s brilliant. Thank you for coming back and unveiling the big trade. I think people have been super interested by it KYLE BASS: Thanks, Raoul RAOUL PAL: Thank you so much for your time So, there you have it, the big trade. It’s Hong Kong And that’s what interests me about Hong Kong is I lived and breathed the ’98 Hong Kong dollar peg crisis, and all the things going on I know how people are scarred by this. Nobody wants to take on the HKMA But Kyle does, and I think that’s interesting. It’s ballsy as well But I think his thesis is sound. It’s interesting, it’s unique You don’t hear it a lot. Very many people are dismissive And like, I also know people will say, well, Kyle said this about Japan, and Kyle said it about China This is the game that we play. Not everything comes to fruition But when you’ve got an opportunity like this, with a really skewed risk reward, you can make exponential amounts of money when you get them right Sometimes you don’t get them right. But the point being is the facts, tip probability wildly in the favor of this trade. And I think it’s interesting It’s also interesting I asked Kyle- I said, hey, Kyle, so tell us what trades you’re doing He’s like, well, the Coca-Cola gave away their secret sauce. People want to know, but he’s not going to give us that. But what I do know is- and I asked him in the interview, there’s a lot of knock-on effects. And again, he was lip-sealed on the knock-on effects, there are knock-on effects. I talked about the Hong Kong dollar pairs trade in HSBC There’s obviously abilities to trade the currency And there are the effects on the markets around it I think the Australian dollar, or whether it’s the South Korean won, or some of the other currencies will get caught up in this or whether it’s some stock markets, or you can just distill it down to- if this happens, people are going to buy US government bonds. So, buy bonds Either way, there’s lots of ways of skinning this cat You can filter into your own investment decisions, but I think it’s an important one and a fascinating one. So, let’s see how it plays out