Last week on a bullet train from Kyoto to Hiroshima, I sat back to listen to a Kyle Bass interview.

If the name sounds familiar, it’s because he bet against the US housing market right at the time when the 2008 financial meltdown hit.

It was a brilliant trade. And while most say they saw it coming, few actually made money on the event.

With such a trade on the resume, it’s not surprising Bass has been able to encourage millions to his fund. And with this capital, he’s been betting against the Chinese yuan for years.

In 2017, Bass was down about 19% on the trade. But he keeps the faith…

Bass says China has a whole lot of debt, is chock-full of bad loans. And with fewer American dollars reaching Chinese shores, the Chinese central bank has less firepower to prevent things from getting ugly.

It’s only recently that things have started to move in Bass’ favour. All it took was a couple of words from President Trump…

I thought this was Endgame…

Not just another Marvel hit, ‘Endgame’ was also thought to be the title of this whole trade war. Here’s how Bloomberg put it:

President Donald Trump and Chinese President Xi Jinping will decide after negotiations this week in Washington whether they’ll meet to sign off on a pact. White House spokeswoman Sarah Sanders said Thursday that the U.S. sees such a meeting as likely.

Concluding a deal will hinge on the two sides resolving the stickiest issues in their dispute. They include an enforcement mechanism to police the agreement and a decision over whether tariffs will be removed or stay in place, according to people briefed on the talks.

“A Sino-U.S. deal would be a positive for the global economy, when the outlook is dimming and the U.S. is threatening to raise trade tensions with the European Union,” said Chang Shu, chief Asian economist at Bloomberg Economics. “A deal would also certainly help to relieve the short-term stress on the Chinese economy, as well as facilitate structural reforms.”

With the 2020 elections coming up, you’d imagine Trump would want a deal soon. It’d be another success to put on the resume for re-election. It’s why Trump said he might increase tariffs even further if a deal with China is not reached soon. The tariff hike could hit another US$200 million worth of Chinese goods.

In response to Trump’s ultimatum, China is considering cancelling trade talks all together, one Reuters headline read. Bloomberg continues:

China’s yuan plunged the most in three years and equity markets were roiled after President Donald Trump’s threat to increase tariffs on Chinese imports cast a cloud over talks this week that were expected to finalize a trade deal.

The yuan slumped as much as 1.3 percent against the dollar, and Chinese shares tumbled more than 5 percent when the market opened after a holiday. Futures on the S&P 500 Index sank as much as 2.2 percent after Trump tweeted a plan to hike tariffs on Friday and China was reported to consider delaying the upcoming talks.

But there’s fat chance China won’t make a deal. And there’s little chance Trump will cave in and make exemptions to his initial deal, according to Bass. [openx slug=inpost]

China is in sore need of US dollars. It’s why they pressured the world’s largest index provider, the MSCI, to include Chinese stocks in its most prominent global benchmarks. The result led to billions of US dollars flowing into China. It’s also why they export so much to the US, so more US dollars flow into the country.

With these US dollars, Bass explained in the interview, China can recapitalise banks, which have far too many non-performing loans on their balance sheets. With US dollars, China can also create more yuan to circulate their economy too. And that’s because, to China’s central bank, US dollars are a reserve asset, something that backs the monopoly money they print.

Bass explains this whole trade war as not a war on trade, but a war on dollars. Trump is trying to starve China of US dollars. The longer he waits, the most desperate China becomes to make a deal.

Weeks earlier, when I attended the Grant’s Conference in New York, speaker Russell Napier said more or less that same thing. This is a war on dollars, not goods. Trump is trying to reduce the dollars going to China, reducing their ability to print money.

He’s effectively using US dollars as a bargaining chip to stop China from stealing technology and secrets from the US. And so far, everything’s going according to plan, says Bass.

Of course, any number of things could happen from now that could squeeze Bass and other China bears out of their positions. But I suspect something else could happen…a Chinese collapse maybe…a restructure at least.

What this means for you

What does that mean…a Chinese restructure? Well, it could mean China unpegs the yuan. As it stands, China spends hundreds of billions to have the yuan track the US dollar.

Such a situation would also give China back control of the money presses, according to Napier.

But for that to happen, something drastic has to happen. China will only reform if there is a need to, and that need might mean an economic shock and far lower stock prices globally.

If that’s the case, maybe it’s time to think about selling the highflyers in your portfolio. Maybe it’s time to sure up some capital for the bargains yet to come…

Your friend,

Harje Ronngard