NEW YORK • Mr Kyle Bass, the hedge fund manager who successfully bet against mortgages during the sub-prime crisis, says China's banking system may see losses of more than four times those suffered by the United States banks during the last crisis.
Should the Chinese banking system lose 10 per cent of its assets because of non-performing loans, the nation's banks will see about US$3.5 trillion (S$4.9 trillion) in equity vanish, Mr Bass, the founder of Hayman Capital Management, wrote in a letter to investors.
The world's second-biggest economy may end up having to print more than US$10 trillion worth of yuan to recapitalise banks, pressuring the currency to devalue in excess of 30 per cent against the dollar, according to Mr Bass.
Mr Bass, 46, scored big after betting against mortgages in 2007, racking up gains as the world's largest banks wrote off more than US$80 billion in sub-prime losses.
But all his calls have not been as prescient.
He had wagered on a collapse in Japan's government-bond market in 2010, a short position that Mr Bass later acknowledged that other bond investors had nicknamed "the widow-maker".
What we are witnessing is the resetting of the largest macro imbalance the world has ever seen. Credit in China has reached its near-term limit, and the Chinese banking system will experience a loss cycle that will have profound implications for the rest of the world.
MR KYLE BASS, hedge fund manager and founder of Hayman Capital Management
"What we are witnessing is the resetting of the largest macro imbalance the world has ever seen," he wrote in the letter. "Credit in China has reached its near-term limit, and the Chinese banking system will experience a loss cycle that will have profound implications for the rest of the world."
Mr Bass said his hedge fund has sold most of its riskier assets since the middle of last year to position itself for 18 months of "various events that are likely to transpire along this long road to a Chinese credit and currency reset".
In an e-mailed response to questions, he said that about 85 per cent of his portfolio is invested in China-related trades.
"The problems China faces have no precedent," Mr Bass wrote in the letter. "They are so large that it will take every ounce of commitment by the Chinese government to rectify the imbalances. Risk assets will not be the place to be while all of this is happening."
Chinese growth, which averaged 10 per cent for three decades through 2010, has decelerated for five straight years and last year slowed to 6.9 per cent, the lowest rate in a quarter of a century. It will ease to 6.5 per cent this year, according to economists.
The economy continues to transition towards growth driven by services and consumption instead of manufacturing and investment, but the new drivers have not yet proven sufficient to offset the lagging older ones.
Mr Bass said that the Chinese economy actually expanded last year at a slower pace than reported, about 3.6 per cent, according to the letter. He estimated that of China's US$3.2 trillion in foreign exchange reserves, US$2.2 trillion is liquid.
The banking system, which he estimated has swelled tenfold in assets over the last decade to more than US$34.5 trillion, is fraught with risky products used by financial companies to skirt regulations, wrote Mr Bass.
The nation's expanding shadow banking system - which he said has grown almost 600 per cent in the last three years, citing UBS Group data - "is where the first credit problems are emerging".