Wall Street Needs to Wake up to Security Risks in Chinese Stocks, Kyle Bass Says

October 1, 2019 Updated: October 2, 2019

WASHINGTON—A rising number of Chinese companies in U.S. capital markets pose a national security risk, warns a hedge fund manager who urges Wall Street to “stop blindly investing” in China.

“Wall Street needs to wake up to the national security implications and the fiduciary problems with investing money in China,” said Kyle Bass, the founder and chief investment officer of Dallas-based Hayman Capital Management, in an interview for the American Thought Leaders 🇺🇸program.

Through public pension and retirement funds, investors are unknowingly transferring wealth from the United States to Chinese entities that don’t comply with U.S. laws, a problem that has been overlooked for more than a decade.

“We are allowing and forcing even the U.S. Federal Retirement Thrift plan—the money of our U.S. military” to invest in Chinese companies that don’t get U.S. oversight, Bass said.

And some of these companies, he implied, build concentration camps in China’s Xinjiang region.

U.S. retirement funds hold China-based companies such as Hikvision, which has recently come under increased scrutiny over its role in the mass surveillance of millions of Chinese citizens.

“It’s insane that U.S. military retirement money is helping China with their mission,” Bass said.

There are more than 650 Chinese companies traded in U.S. stock markets, including the New York Stock Exchange, Nasdaq, and the over-the-counter market.

Some of these companies, such as China Unicom, AVIC Aircraft, and China Shipbuilding, are involved in sanctions violations, the proliferation of weapons of mass destruction, cyberhacking, or militarizing the islands in the South China Sea, according to researchers.

And a majority of U.S. investors are unaware of the identities of these companies.

Human rights violations in China are back to the worst they have been, which is absolutely awful, Bass said.

“Wall Street just seems to be disconnected. Hollywood’s disconnected,” Bass said. “This is about greed versus national security. Those are the two competing notions in the United States, and I think national security should win.”

During the financial crisis of 2008, the fund manager gained a reputation for forecasting the mortgage market crash and successfully betting against subprime mortgages.

In recent years, Bass has bet against the Chinese yuan, with the belief that China will eventually face an economic crash because of its mounting debt problem. He says that China’s credit system has grown much faster than its gross domestic product since 2008, which has led to the explosion of bad debts.

MSCI Index

The Chinese government holds $3.1 trillion in foreign exchange reserves, the largest in the world, with the majority invested in U.S. dollar-denominated assets. But it faces the risk of running short of U.S. dollars.

China burned through $1 trillion to defend its currency during the last economic downturn, in 2015.

“They actually have dollars leaving, net. What they have to do is find other sources for dollars because their labor arbitrage is gone,” Bass said, adding that the country has lost its competitive edge as a low-cost manufacturing base.

“So, China’s figured out, through the back doors, how to get dollars to flow into China,” he said.

One way for China to attract money, he said, is to convince global index companies to boost Chinese stocks’ weighting in major indexes.

In February, global index provider MSCI said it would gradually quadruple the weighting of Chinese large-cap stocks in its global benchmarks this year. The firm also said it would add Chinese mid-cap stocks to its emerging market benchmark in November.

The move marked a win for Beijing, which has been pushing hard to attract foreign investment to China and internationalize the yuan. The foreign capital inflows into Chinese stocks would double this year as a result of this change, according to estimates.

MSCI publishes numerous indices that act as a benchmark for investment funds. Hence, if a fund wants to benchmark its performance against the index, it would need to buy the stocks included in the index.

Bloomberg Barclays also announced early this year that it would include hundreds of China’s yuan-denominated bonds in its flagship Global Aggregate Index, one of the most widely followed fixed income benchmarks.

The move might draw nearly $150 billion new capital into China’s onshore bond market, according to estimates.

“These are big pools of capital that the globe invests in, and they’ve convinced and coerced these people into making the Chinese representation in these indices bigger,” Bass said.

‘We Hold All the Cards’

Bass believes the United States has significant leverage as it controls China’s access to U.S. dollars, and all Washington needs to do is to start requiring Chinese companies to strictly adhere to the rule of law when raising money in the U.S. capital markets.

“Their hundred-year plan is to win, is to dominate the world, without ever firing a shot. So far they’re doing a damn good job of it,” Bass said.

“But we hold all the cards,” he said. “And when we realize that, we can start operating in a different way as a country. We need a whole of government approach to working against the Chinese.”

Bass estimates that investment in Chinese companies by U.S. investment funds would reach $400 billion by the end of this year.

“The thing that’s keeping the blood flowing to the tumor is U.S. investment capital—we’re funding China’s entire ascendancy,” Bass said, adding that China’s geopolitical, military, and economic assertiveness is rooted in the belief that their system is superior to that of others.

Bass, however, believes the Chinese system is “built on a house of cards.”

“It’s a foundation of sand, and the sand is U.S. dollars. We have to stop blindly investing U.S. dollars in Chinese companies,” he said.

Last week, media reports surfaced that Trump administration officials were looking into ways to curb U.S. investment in China, including removing listed Chinese companies from American stock exchanges.

The Trump administration, however, pushed back against such reports, saying that there were no plans to block Chinese stocks.

‘Worst Nightmare’

According to Bass, the Chinese regime has overstepped its bounds in Hong Kong, which faces the worst protests since it reverted to Chinese rule in 1997. The clashes intensified on Oct. 1 during citywide protests coinciding with the 70th anniversary of Communist Party rule in China.

Bass said that Hong Kong has become “the Communist Party’s worst nightmare.”

“It’s 7.5 million people that are used to freedoms and a British–Western rule of law—that’s why it’s thrived so well over the last 20 years,” he said.

Hong Kong, which is one of the world’s largest hubs for equity and debt financing, has been a boon for Chinese companies seeking foreign capital, due to its long history of good governance, ease of doing business, and sound judicial system.

Over 1,000 mainland companies with a market capitalization of $2.6 trillion are listed on the Hong Kong exchange.

“Hong Kong is the place, it’s the nexus of where China raises a lot of its dollars,” Bass said.

He has bet against the Hong Kong dollar in recent months, predicting that the continued unrest will cause both human and capital migration from Hong Kong to other financial centers in the region.

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