The Chinese currency is also highly overvalued and headed for a crisis as we explain below. By shorting overvalued Chinese equities through US ETFs and ADRs, one also gets the bonus of the yuan currency short imbedded in the trade. By shorting ultra-frothy Chinese fintech stocks, including through US ADRs, one also gets exposure to China’s coming shadow banking meltdown.

The China currency and credit bubble has only gotten bigger since early 2016. The big credit bust is still ahead of us, in our strong opinion. The bust will be triggered by bank runs from the masses of Chinese depositors as they learn that they are the ones holding the bag with respect to China’s insolvent banking system. We believe this is why the Chinese currency has already been under so much pressure from capital outflows over the last several years. It is pressure from the Chinese trying to get their money out of the banking system. The capital outflows to date it appears have been less from the masses and more from the wealthy Chinese elites who have seen the writing on the wall for some time already. Like money that fled the Soviet Union and Russia prior to and during its two big currency crises in the 1990s, that money is probably never coming back. The masses in China – as opposed to the elite smart money that has already fled – are the ones buying WMPs on their smartphones.

When the outflow pressure shifts from the elites to the masses of domestic bank and shadow-bank depositors, there is high risk of bank runs and social unrest. When this threat begins to transpire, in our analysis, that is when Chinese authorities will be left with no other viable option than to resort to massive quantitative easing to bail-out and recapitalize their banks and re-stimulate their economy. That is when the insolvency problem in the Chinese banking system must be addressed. If China has true ambitions to transition from an emerging market to a developed economy, it would be need to come clean on the true amount of its NPLs as part of the recapitalization. QE would bail out depositors in local currency terms, but not after taking into account currency devaluation and local inflation that would result. The size of QE needed for the banking recapitalization is so large that it will almost certainly coincide with a currency crisis and massive domestic inflation. In real terms, therefore, QE is not a guarantee against a crisis for Chinese depositors.

So how much money will China have to print to recapitalize its banking system? Let’s be conservative and say that China’s non-performing loans are only half as bad as they were when it recapitalized its banks in the early 2000s. China ultimately confessed that 40% of its banking assets were non-performing loans that had built up in the wake of the 1997 Asian Financial Crisis. Let’s say it is only 20% today. It is probably more. Let’s also assume the most conservative estimates for shadow bank assets of USD 9 trillion. Along with USD 35 trillion of on-balance sheet assets (the Telegraph article says it is now $38 trillion), our conservative estimate equates to USD 8.8 trillion of loans in the Chinese banking system today that will effectively never be repaid and will need to be written off. Such an amount is equal to 84% of China’s GDP, more than enough to wipe out all the equity in its Chinese banking system twice over. If the banks were to write that debt down and recapitalize the banks with money printing, it would equate to 37% of its M2 money supply, all else equal a 37% currency devaluation. This is our best-case scenario for the inevitable devaluation of the China currency. It will likely be worse.

The 1997 Asian Currency Crisis provides several mid-case scenarios for what we should expect from the coming Chinese yuan devaluation. In the second half of 1997, four Asian Tigers came off extensive credit bubbles that had been building over a prolonged period including Thailand, South Korea, Malaysia, and Indonesia. In the bust, their currencies all declined between 47% and 85% within six months. Another mid-case comparable would be post-Soviet Russia where in the Russian Financial Crisis of August of 1998, the ruble crashed 70% in one month. For the worst case scenario, the comparable is China’s former communist neighbor, the Soviet Union. The Soviet ruble was essentially a 100% wipeout, a zero though hyperinflation after the Soviet Union breakup the early 1990s.

One key signal that the China’s credit bubble is about to burst is housing prices in China’s Tier 1 and Tier 2 cities. Home prices in Tier 1 and Tier 2 cities reflect one of the biggest asset bubbles in China to go along with its massive credit expansion. Real estate prices have been soaring for many years led by Tier 1 cities such as Beijing and Shanghai. Rent yields in Beijing recently hit a new low of about 1.25% an insanely high price-to-rent multiple of 80 times. As part of China’s massive infrastructure buildout, there is an oversupply in housing. As shown in the chart below, price appreciation in Tier 1 cities has been decelerating for over a year. Prices may have turned negative in July in Beijing and Shanghai according to local sources. If true, this is just one of many signs that we have laid out herein that China’s Minsky moment is imminent.