Hugh Hendry: the full transcript

Below is the full transcript of Merryn'sinterview with Hugh Hendry. We'vetidied up a few bits to make them clear, but that aside, this is exactly how theconversation went.

If you haven't seen the videos, watch them here:

Part 1:'Would you rather upset God, or have Him just ignore you?'Part 2:'Desperate times breed desperate measures... QE is a grubby solution'Part 3:'China boomed but it should have boomed even more'

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Merryn Somerset-Webb: Hugh, I just want to start by asking you what you think makes a successful hedge-fund manager and whether you are, under that definition, a successful manager.

Hugh Hendry: I think I've always answered that question by relating back to the ability to conceive of a contentious posture. If I was to quote from Fight Club, I think there's a famous saying "Would you rather upset God or have God just ignore you?" There's a degree to which being a successful macro-manager is upsetting, not only God, but to the rest of the world, if you will. By being out there with the articulation of qualitatively intelligent argument, which just isn't shared by the majority. But which can stand the test of time and come to actually define the future. That is what global macro is all about.

Merryn: So part of being a good manager is being able to articulate this for everybody else. It's not just about managing the money.

Hugh: It is. I have no problem being contentious, but look back to my letter of last year where I said, if I were to tell you that I turned bullish, it is that something you might find interesting? I have to say my investors have responded "No. We would rather you say anything than say that you've turned bullish."

Actually so, with regard to language the notion of "bullish" and "bearish", I think, does an injustice to the complexity of the arguments that are necessary to construct a global macro hedge fund. I think if I had my time again, I would have been saying that we're actually, perhaps, guilty of the misconstruing of a bull market in equities, for what is actually the ongoing degradation in the soundness of the fiat monetary system. I think that's what I was trying to say.

Merryn: I think you did say that in that letter, actually. But the interesting thing is that you have a reputation of being something of a perma-bear. People think of Hugh Hendry, they think of bearish. But what they're really thinking about is your macro-economic ideas, not your investing ideas. So they're remembering your views on deflation, which by the way you've been correct on, right?

They're remembering your views on deflation and then they're remembering your previous views on what might happen to markets as a result of that deflation. The change last year was not to change your views on the economic condition, but to change your views on how they would affect asset markets.

Hugh: Yeah. A very good point and I'm sure everyone's aware that we, as a business, have experienced a substantial amount of redemptions from the fund. There was a degree to which there was that pigeonholing, and that of being a bearish diversifier, if you will, to an investors' portfolio. After all, I was the guy who made 30% odd in 2008. That's out there, and of course with the redemptions there was the notion that I turned into, rather than a diversifier, a concentrator.

Merryn: Well, there was also, slightly, the idea that you had somehow capitulated.

Hugh: Indeed.

Merryn: You had given in to a bull market that you had refused to accept previously.

Hugh: Such is my performance cabaret persona, I certainly would have alluded to that notion, and a degree of mea culpa. The weirdest element of my professional career is I almost have . . . I need a fight. I need something contentious to get me involved, to get my creative juices flowing.

Merryn: So you cannot work unless you feel you're a contrarian.

Hugh: I cannot truly engage, unless I get angry. Possibly it's back to my Scottish roots and the weather. So if you cast your mind back, the last time I was really angry was late 2010-2011. Where the market, in its wisdom, had yet to configure the changing economic landscape, and it was perceiving that the economy in Europe and elsewhere was recovering. Therefore the fixed income markets were beginning to price in a very high probability that central banks would raise their overnight rates.

To make matters worse, of course the ECB when it was governed by Trichet, actually came to the fore and raised rates. I thought that was just insane, that we weren't capturing the kind of deflationary zeitgeist that was approaching.

So with that anger, if you will, I really took on a lot of risk. I was long on fixed income and in the vernacular I was receiving interest rates. So essentially I had a large fixed income bet, which said these rate rises will have to be rescinded and the expectation that there would be further rises are just not going to happen. That proved to be correct, if you will, and that was my last moment, really. I have to say when I look back in the last three years it feels as if the sun only rose each day to humiliate me after that point.

Merryn: I doubt it was really quite that bad, was it, really?

Hugh: In my mind, at times, it's felt bad. But the mea culpa, that I think is very necessary in that I found myself unable to forgive the Federal Reserve and the other central banks for, if you will, bailing out Wall Street from the excess of 2008.

I just couldn't get over it. I luxuriated in the polemics of Marc Faber and James Grant and Nassim Taleb, in our own country, Albert Edwards, et. al. I luxuriated as they ranted and it was fine for them to rant. But I am charged with the responsibility of making money and not being some moral guardian and certainly not a moral curmudgeon. I had to get over that. So again, back to my infamous letter of last year.

That was cathartic for me to say "You know what? I get it." I think if we're going to try and explain the qualitative arguments behind why we are more receptive to the notion of not only left tails where markets can fall, but the right-hand tail of the expression, where markets can actually continue to rise if not to accelerate.

Merryn: But the key point from talking about Marc Faber and Albert Edwards, etc. is that you don't disagree with these people on the fundamental economic condition of deflation. You just disagree with them on the effect on the markets of central bank behaviour and on the longevity of that behaviour.

Hugh: Increasingly, I have to say I just disagree with them. I literally and with the utmost respect, I've turned the volume down to zero. Previously they were like sheet music. When I read it, I could see the trades appear in front of me, and I just don't hear the sound of music today. That's my difficulty. So I really feel very, very isolated from their view of the world. Arguably, we're talking about the here and now and the future's a long time. But in the future, I'm sure our paths can converge once more.

Merryn: Okay. Well, let's talk about your view of the world now. Last year there was the infamous letter, the great bullish letter. You asked is that something you'd be interested in and your clients said, "No, not really." Is there something you can say to your clients now that would re-interest them in this concept of the great bull?

Hugh: Well, let's have a go. Because there are two things unfolding. Hedge funds and within the broad tranche of hedge funds, macro hedge funds are struggling to make money, and there is a dissatisfaction with that. I'm not the only manager to have suffered withdrawals.

Merryn: Why do you think that this sector as whole is failing to make money? What's going on there?

Hugh: Well, I can't be a spokesman for other and far better managers.

Merryn: I'm sure you can allow yourself to comment on them.

Hugh: But I can reflect on my own difficulties, if you will. What I've found is that macro is distinguished, I believe, by superior risk control. It's almost analogous to a disaster insurance programme. In 2008, all the good macro managers, they made you money. That's what you pay them for. The world became profoundly unsettling and you cashed in your insurance policy.

Today, I question the relevancy of that disaster insurance. In a world where the central banks seem to have your back, seem to be underwriting risks and global asset prices, do you require that intense scrutiny of risk?

So when I look at my fund, my fund's not dissimilar to others. We go out of our way to avoid traumatic periods of losing money. For us, typically, that would be defined as losing 5% or more in one month. Such, I think, is our capability that we have 12 years, in running this fund. So 144 monthly observations. Out of that we have had the indignity of suffering nine such months. Not that many when you consider the tremendous amount of either bull market or bear markets that have gone on.

But it forces you, that disaster scheme if you will, or prevention scheme, it forces you to reduce risk. Which is to say to sell the things you like when they go down in price. Notably this year, I had constructed this argument that I wanted to be bullish, yes, and yet, with risk control, I found myself a seller at lower and lower prices. Lo and behold, it became impossible to fulfill my mandate and to make money. I think that is a problem that I shared with many others.

I'm introvert, and I look and I examine my own behaviour. I have now concluded that my risk tolerances were too taut and it was creating too much of my own intervention, in the portfolio, and it was damaging to the client's performance. So I've pulled back or I've widened the tolerance of the portfolio.

Merryn: So your basic point here is that if the central banks have your back, there's no need to have the same kind of risk controls that you used to have.

Hugh: There is less need. Less need. I tell you, I was at a conference with some of the great and the good global macro managers in September in New York and I asked them all the question, "If the S&P is down 12% what do you do? Are you selling more or are you buying?" Guess what? They're all buying. So the central banks have created a behavioural tic which is becoming self-reinforcing and I believe we saw another manifestation of that behaviour in October.

So when I look at the year, I started the year hugely bullish on Japan. Hugely bullish, let me say, not qualitatively. I'm not an advocate of the three arrows and the resuscitation to the great heights of whatever Japan represented in the 1980s.

I am saying that I can see persistent failure to achieve such honourable ambitions, which leaves no recourse but to intervene again and again and again. Therefore I see the Yen being a weak currency.

The other side of that, the stock market, being higher and higher and higher. But I think four months of the year the Japanese market had fallen 16% from its high, and I had to swallow my pride and I had to reduce position.

I had to sell at lower prices, and yet, such is the foreboding presence or shadow cast by the Bank of Japan, that not even if we mentioned the recent intervention, without that intervention the Nikkei had gone back to its previous highs. So I was wrong in selling.

Again, over the summer the European stock markets had a similar decline, even greater if you look at the banks' index, I think it was down over 20% and what happened? The ECB responded and took its rates negative and it committed to re-engaging, reutilising its balance sheet to acquire European risk assets. Prices rapidly rallied from the middle of August into September. Why did I sell?

So thankfully, you only make those mistakes a few times, if you're wise. So when we came into October, I got it. I got it. Our new rule book is, unless something has fundamentally challenged the qualitative narrative, then we are less willing, almost unwilling, to intervene in the portfolio. Unless we're down 10% or more on the year.

That, as a discipline, meant we stayed invested in the month of October and then we were able to buy more equity risk towards the middle of the month. Which is to say, we made money in October. We made money in September and we made money in August.

So if you will, it's not just the narrative, it's the risk engagement and giving trade expressions the room to breathe, such that they may prosper.

Merryn: So the simple message here, is in a market like this never sell anything and you'll be fine.

Hugh: You can say that, but I cannot.

Merryn: Okay. Let's move on to looking at markets more specifically.

Hugh: Yes. Because on that, really and again, in sort of, trying to get away from the cabaret of bull or bear, the thing that excites me, that's really got me engaged . . . and again, it's like "Okay. Hendry, the market, you have to wait five years. You have to have the market double. You have to have the market become qualitatively kind of expensive, and then you get bullish? I mean, really?" So let me kind of kick back on that.

Merryn: You can see that point from this side of your critics perhaps . . . ?

Hugh: I am certainly sympathetic to that take, and we've just discussed it. The travails of making money in the global macro community. What I want to say, again, is contentious. I want to say this is almost unparalleled in being the most exciting moment for global macro today. And I predicate that upon making an analogy with the central bank coordinated policy intervention, in the foreign exchange markets, after the Plaza Accord in, I believe, 1985. There was a profound unease at the current account and particularly the trade deficit that America was running up, especially against the Japanese, which was deemed to be contentious. The real economy is composed of slow-moving prices, wages are slow and the notion of having to wait for productivity improvements and wage price negotiations to work their course, via the US corporate landscape in Japan, such as those deficits would be resolved successfully and become less politically contentious. It was just too long. Politicians just don't have that time and so they jumped into the world of macro. Macro's all about fast-moving prices. Foreign exchange is fast. Stock markets prices are fast.

So the notion then was that the yen and the deutschmark would appreciate. Now for hedge funds that was amazing. This is the period of the alchemy of finance, as George Soros has celebrated in very successful financial adventures. They just run the biggest long positions. No one stopped to say "Well, the deutschmark's getting expensive." It didn't really enter into the vernacular of trading in that market. It was macro, there was a policy impulse, a sponsorship by the world's monetary authorities and you were trending and you had to have that position.

By and large it succeeded. So what I would said to you today is that the policy response can't be found in foreign exchange markets. It's been muted somewhat by the "Beggar thy neighbour" way that everyone can pursue the same policy. So currencies, up until very lately, haven't really moved that much. Instead the drama is unfolding in the stock market.

I would say to you that policymakers are so absolutely beside themselves with regard to how structural these deflationary forces are, and that they recognise that they really have very little to offer once policy rates are at zero, the zero lower band, that they have to stave this crisis off. They cannot have deflation today.

I believe they are now responding to the fast-moving circuit of the stock market and clearly America's demonstrated something. That policy response underwrote a very virtuous cycle of higher asset prices. There's also the shale oil gas revolution and the weakness of the dollar of the period. But the US today, is deemed to be the most robust economy, with the greatest probability of escaping the stall speed.

Merryn: You're telling us that QE worked.

Hugh: It's all about to which degree does it work? Now if you wish to take the other side and say "QE doesn't work." It worked by redistributing but it doesn't create wealth, clearly.

What it aims to do, is redistribute economic growth from one part of the global system to another. So as the US has come to the forefront in the last five years, China's found its growth rate has, from this perpetual notion of 10% GDP expansion, is now 7%, and everyone's scratching their head and has great doubts that 7% can be maintained.

Merryn: Seven? Do you really believe it's 7%?

Hugh: It's fugazi, pugazi, whatever. Yeah. It is what the market is willing to entertain and presently that's somewhere around 7% level. So QE has succeeded in that redistribution away from the Chinese mercantilist axis back into the American axis. Look back to what happened in Japan - that's the trick they missed - the fast moving reaction of equity prices. Sponsoring higher equity prices would be a means for companies issuing equity, reinvesting in their businesses, employing people, raising prices, and getting this thing moving again.

Merryn: So you see the Japanese coming round to the American's stand on QE, but wanting even to do it in double time?

Hugh: Yeah, absolutely, to catch up for 25 years from behind . . .

Merryn: There's this sudden huge catch up.

Hugh: . . . a huge, huge catch up. Now the problem, or the perception that I have of the problem, is that that's when the moral curmudgeons step in and say "This is all crazy. I disagree with this. I'm not playing."

Merryn: So they made their disapproval a reason not to play the game?

Hugh: Yeah, they say it won't work, so they don't participate. "Equities are overvalued and I'm going to tough it out. I'm just not going to be in that market." As I say there was a time in my life when the sun only rose to humiliate me, where perhaps I shared that. Its bunkum. It's nonsense.

It may not work, but presently the perception is that it will work and those asset prices are trending and you should participate. Then within Europe, such is the political timeframe and the stakes are so enormous, that is has to work now and we have the French elections, national elections are in 2017. Europe has been slow to this game of quantitative easing. As a result they are clearly behind the curve.

So economies from France to Italy and others have been unsuccessful in bringing these deficits below 3%, which of course, then imposes further austerity measures which are toxic in the political/social space, and we're seeing radicalization of policy.

It may be contentious to say, but if the French election was held today, I would worry that Marine Le Pen's party would win. That's not to say, necessarily, to cast aspersions on that side it's just to say that I think the thrust of her policy would be to take France out of the euro.

My point is that we've had this year, this further year of deleveraging the European banking system, deleveraging the commercial space and of these very slow-moving prices.

Wages are still not moving. Prices are still not moving. If anything they're moving the wrong way. Europe needs high equity prices and high animal spirits and then you'll get people feeling more confident about the collateral. The banks will be more willing to lend and slowly, but surely we will re-engage, and we will get growth, perhaps, on a par with what we're seeing in America today.

Merryn: So you're pretty certain this is going to happen in Europe - that it can't not.

Hugh: One can't be certain about anything, but I'm certain that it's a policy underwritten by the central banks, and as a macro manager I want to put myself alongside their impulse. Europe is the most contentious because politics enters the arena and will the Germans allow it? I have two points there. First of all, Angela Merkel back in the day had the chance to appoint Axel Weber as chair of the ECB, so, a good German. The German orthodoxy would prevail.

There's one thing that characterizes Merkel, she is a pragmatist, and she doesn't have that same ideology that we see from other parts of the German church. She passed him over in favor of Draghi. I think that's huge. I think she recognised that if Weber had been in charge the euro would not have survived.

Merryn: She would have taken away the options.

Hugh: Yeah. So she's already, if you will, on the political side, I think, shown a willingness to endorse this . What the ECB's gone on to do is remarkable in terms of what we thought it would be capable of doing. But of course, we keep hearing Schaeuble, the German finance minister, ranting that QE is either injustice or it doesn't work. Again, maybe he's right. Maybe he's not, but I think we have to try anyway.

Now the point is Merkel is more popular than her party. I think she's more popular because she has that pragmatic European view rather than the ideology that we hear, and of course, is disseminated through the financial press.

Merryn: Go back a bit to the moral imperative. The people who very angry about QE who disapprove of it. They would say the moral imperative is not to do QE, but you suggested that for you the moral imperative in Europe is to do proper QE.

Hugh: Well, desperate times breed desperate measures and the fatal policy errors are I believe, all in the past. Economies across the world were allowed to take on so much debt, and taking on debt, you're borrowing from the future. You're borrowing consumption to spend it today. So we overinflated the GDP growth rate. There's no surprise to me when people are disappointed by today's growth rate. Because it's like "I ate your sandwich yesterday." It's not there. So I don't see this as a clean solution.

I see this is a grubby solution, but it's closer to being a solution than anything else that I conceive of. With QE, again, I say I think we barely scratched the surface in terms of what will happen. I think it will spread into central banks essentially having to endorse higher government budget deficits to sponsor public work projects or favourably to sponsor tax cuts. I think that is in the future, because we have not resolved that deficiency of demand. Which, of course, is a function of having over-borrowed from the future to spend yesterday.

Merryn: Okay. So more complicated, if it can get more complicated, how does it end? We can talk about the money breaking down forever. We can talk about the different ways it can be used by central banks to try and stimulate demand, etc. But one day it has to come to an end.

Hugh: Indeed.

Merryn: What makes that happen?

Hugh: So I may segue into that answer by challenging the notion, the popular notion, that quantitative easing has distorted and manipulated public markets. Again, I think I use the term earlier, bunkum. Absolute nonsense. Absolute nonsense.

JGB's, if we take an example, are fairly valued. The economy just failed 7% in the last quarter on an annualised basis. There is no inflation. They've had 25 years of no real GDP growth. Where would you expect JGB's bond use to be for a fiat currency that can issues its own paper currency. US Treasury bonds, where should they be?

I think Dylan Grice was the great architect of the notion that you can define the upper bound to today's interest rates by trying to determine society's capability to meet those interest rates at higher and higher levels. What you find is we cannot live with a Paul Volcker putting interest rates at 15%. It doesn't work. There's so much debt that if you reprice debt, the economy slows down. We saw that I think in 2012, after the taper tantrum and ten-year bond use went over 3%. What happened next? The economy slowed down. If anything I would be a buyer of US Treasuries and I'll come back to that.

Merryn: What about US equities?

Hugh: US equities, some of the best companies in the world who have exceeded all expectations, both in regard to growth and returns on capital and we just had another quarter of earnings and we continue to do. Valuations again, fugazi, pugazi. When it comes to valuation one man's high valuation is another lady's low valuation, or what have you.

Merryn: You've just lost interest in valuations, haven't you?

Hugh: It's a bit like Supreme Justice . . . what's he called, Potter? In 1964, there was a successful prosecution of a cinema owner in Ohio for showing a French movie. It's always a French movie. He was charged for the notion that there was pornography. He was charged under the Obscenity Act. It was overturned. Justice Potter went on to explain that the Constitution allowed for obscenity, except for hardcore pornography. He didn't feel capable of defining hardcore pornography, but he felt sure that he'd be able to recognise should he see it. And that's my take on valuation. I'm pretty sure I'll recognise it when I see it, but today, I don't see it.

Merryn: Okay. Tell me about US Treasuries. You said you'd be a buyer of US Treasuries today. That's a pretty contrarian view.

Hugh: Well, we are long on 30-year Treasury bond use and this year we have, I think, been among a select group of macro-investors who have actually made money being long US Treasuries. It's been a very popular trade being short. It's particularly relevant since the Jackson Hole central bank soiree in late August. That there seems to have to come out of it, some tolerance that the dollar would rise.

Typically that's the fiefdom of the Treasury and not the central bank. But I'll let that pass. The dollar has been on a tear ever since that meeting. My take on that is that I think America looks at it and increasingly feels confident, rightly or wrongly. I'd err on the side of caution. But when it looks to the global theatre, it's desperately concerned about China, desperately concerned about the Europe. So the last five years were, if you will, it redistributed global growth and by "redistribution" bear in mind, I'm saying that quantitative easing as pursued by the Federal Reserve had the explicit policy aim of ensuring that the dollar would not rise.

The dollar always rises when there's a deflationary crisis in the marketplace. The dollar index was trading at 80 pre-the events of late 2008. It briefly flared and then you had . . . Immediately you had quantitative easing and it sat at 80 for five years. That's about America being determined that dollars earned in America create jobs and prosperity in America.

Whereas in the last 10-15 years the mercantilist axis of Europe, and of course, China has meant that those dollars were exported via the trade deficit to elsewhere. That just couldn't be allowed to happen. That hasn't happened, which is to say that again, boosted by shale oil, of course, the trade deficit has been falling.

Merryn: So the growth has remained in America?

Hugh: It has remained in America. But I think America now is willing to be less curmudgeonly, more generous with that.

Merryn: They're willing to share that growth.

Hugh: That smaller pot, it may not be a great expanding pot, but it's kind of buggin's turn. It's time for the other guys to get some.

Merryn: Yes. Well, that takes us to China and you were one of the first to point out the problems in China. Your rather amazing video wandering around empty houses estates, etc. which I think was pretty well watched. What's your view now?

Hugh: I think my view would surprise you. Before I surprise you, I would like to seek legitimacy of my view by telling you that I have made money. It's been my most successful profit centre in the year-to-date and we've made over 5% trading in China related macro themes. In terms of surprising you, I am more sanguine about China. Actually I've been rather impressed by their policy responses over the last two years.

When I look at China, it has got two components. It's got this manic investment which has been deepening these global deflationary fears, because they kept expanding over capacity industries such as cement and steel and undermining prices in the rest of the world. That in itself lowers inflation figures below Central Bank targets. It becomes reflexive and then the Central Bank says "Crikey, I've got to be radical here. I've got to buy equities." So there's been that going on.

On the other hand there's been a robbing Peter to pay Paul and that China's had a decade which has been very, very similar to that of the US in the 1920s. I reread The Lods of Finance by Liaquat Ahamed recently and I was very taken by the notion of how mean the Fed had been in the 1920s.

Again, I say, with cathartic crisis, the response of the rest of the world is to be long dollars invested in America and that was certainly the case in the 1920s. But America was recovering nicely from the Great War and it had this incredible productivity revolution. There was great demand for credit and so it was fine on its own.

But the rules of the gold standard meant, that as Europe pushed all this easy credit to America via the manifestation of these gold bonds, the U.S. growth should have been even more intense. The Federal Reserve had a moral obligation as part of the game of the gold standard, to let loose that gold into the economy via bank lending. It didn't. It was very, very hard money doctrinarian and it withdrew that gold and it buried it deep in the vaults.

It's never really been reflected upon. Because we just know that America boomed. The argument is it should have boomed even more, and if it had done so with even greater ferocity, and this is counter-factual, Niall Ferguson will kill me, but . . .

Merryn: It's all right. He's not here.

Hugh: But if it had, then perhaps it could have resuscitated, especially poor old England or Britain, which had got on the gold standard in 1925. A desperately poor moment. It would have given it the rationale that you went on for the rules and the other guy, the big guy who didn't play the rule, he got squashed. So counter-factual. And, I think it would have created more price inflation. So the U.S. race would have spent a decade on the floor and asset prices, they would still have bubbled, but I think the bubble would have been earlier and it could have been dealt with. Counter-factual.

Merryn: We'll never know about that. But how is that connected to China?

Hugh: The meanness . . . China's had a very similar decade where such were the huge returns on investment on offer because land prices are low, labour's low. You can borrow money. The currency's cheap, so you wanted to manufacture. You want to have business in China. So the rest of the world en masse, it's like that gold transfer from the '20s, this time there's going to be a fiat money in institutional portfolio allocations into China. So China should have boomed.

Yes, it did. It boomed. But it should have boomed even more. Rather than growing at 10%, it should have been 20%. I'm making these figures up. The reason it didn't was that they, as I said, they rob Peter to pay Paul and they took the great bounty of the productivity leap that their household sector, their workers were achieving, they got paid more. But they should have got paid way more and their currency appreciated, but it should have appreciated way more.

And they've got negative interest rates when they put this hard-earned capital back into this system. So they got screwed, if you will, on three fronts. As a result consumption declined. It didn't decline because they were just more cautious and these incredible Asians that just want to save. Nonsense. Their income got constrained versus its capability. So consumption incredibly lowers the potential GDP and this manic deflationary CapEx boom, very high. The last three years it looks as if they've sought to challenge them.

The bullish take on China is this 35% GDP, through proper husbandry, that could continue to expand 10% per annum. That underwrites a 4% floor to the Chinese economy if you do the maths. So how would you do that? Well, you would take away these negative interest rates. Tick, they've done that. Either in the misfortunate means of the higher risk from these wealth management products, but with these internet platforms offering money market rates.

So there is a movement. The currency has appreciated, much to the chagrin of those at the beginning of the year who said, "Well, it's going to devalue" and they're going to tell you that it's going to devalue.

On the currency, again valuations, fugazi, pugazi. When I look at it, I see an economy where the urban population's fully employed. I don't see an inflation problem and it seems to be able to compete in the world and it's finely balanced. So is the currency overvalued, undervalued? It's kind of close to fair value, yeah. We're long in the currency usually.

Merryn: So yes, what are your China trades now? You said there were three different trades.

Hugh: Lastly, just on that, wages. Wages have grown at a tear. So the consumer is enjoying a dramatic relative improvement in its lot. I think that's one argument that doesn't get a mention. So the notion of a Chinese devaluation would be exactly the wrong policy. Because, of course, you would then be killing the household sector again. The goose that could lay the golden egg has to be cherished, and it needs a rising currency, I would argue.

Merryn: But you're assuming that the correct policy will be followed.

Hugh: Well, it has been to date. That they haven't panicked and gone into that crazy splurge in 2009-2011, they haven't done that. Then the other point with China it's a bit like the U.S. It's had its excess. The problem in the U.S. was it was felt intently with the private banking system which went bankrupt. But, and this is not counter-factual, what if you owned, what if the state is the banking sector? Does it have a Minsky moment? I'd say it doesn't.

So the whole game with Fed QE was to underwrite the collateral values, to keep the credit system moving. So it aimed its fire at mortgage obligations more than Treasuries. The whole deal with LTRO's in Europe has been again when investors at volume banks at 40%-60% discounts to asset volume, the Central Bank's coming in and saying, "Actually we'll buy it from you at full value or something higher. So we are going to endorse the collateral of your assets."

In China it's the same deal. They're fiat currency and they can get away with this. So to bet against China or Chinese equities, or the Chinese currency is to bet against the omnipotence of central banks. One day that will be the right trade, just not ready or sure that that is the right trade today. So for us, to answer your question, our trade has been very good. This is a technical trade, but we have been paying interest rates in the offshore market.

So interest rates, the Chinese currency for many, many years has appreciated at an incredibly un-volatile manner. So you've been able to borrow money very, very cheaply by going long with CMH. Then through surreptitious means, such as the over-collateralising of bills of credit, or using commodities. But, through guile, if you can take that cheap money and get it onshore, then you can invest in a wealth management product from the guy down the street at 15%.

So it costs you, it costs the capitalists 1%. It's 15% when you go to pay it back in a year's time your liability's been diminished because it was the biggest, biggest carry trade of all time.

Our argument was, you know, China, still has this insatiable desire and indeed requirement for capital. It needs money. So it made sense as we looked at it at the beginning of the year. They had to form a legitimate bridge to tap this cheap money that was residing offshore and bring it, through a legitimate manner, onshore. And if you can do so and the latest incarnation of that would be this Stock Connect scheme, between the Shanghai and the Hong Kong markets.

But they've also developed enterprise zones where you can do that free exchange from the offshore to the onshore and a host of other developments. The net result of that is that you would get a rates convergence and a great, great macro trade of 15-20 years ago was the European rates convergence. They were very high in the periphery and you'd come down to the centre.

There was a notion that these very low rates in China offshore would come up to the levels that prevailed domestically. That's pretty much come to pass. We've made money from that trade.

Merryn: Okay. And other trades in China? I think you said at the beginning you had three trades in China.

Hugh: Three trades. Well, we have the currency. The currency we are in the grips of evaluating whether we are moving onto this, a new bull market for dollars and clearly the sensitivities, as we discussed on the Renminbi. We're long the Renminbi via options, and again because vol was so low, I can get a big exposure. But should it be that the dollar begins to precede the crisis, the Renminbi we can turn that into vol trade and vol is very low. So if you were to get an event . . . I don't think you'll get an event.

But if China was to have the misfortune of Korea or Thailand, etc. in the late 1990s and you had a 40%-50% devaluation, the volatility would go from like 2.50% to 82%, you'd just make a fortune. So we can tailor . . . So we have that. We don't think that's going to happen and we think the most likely path is the currency appreciates. But we can rapidly adjust it, if that view changes and suddenly there's this huge vol and we're protected.

And then the last trade which works only one way is that if we are correct in our notion that the terms of trade are dramatically improving for the Chinese household sector. Then what's your closest proximity to the household spending bonanza in China and it's the Internet giants. So we're in long the buyins and the $0.10 of this world, we just think, and again, valuations are high, but the growth rates are high.

Merryn: It's another area where you don't care about the valuations at the moment.

Hugh: Not at this moment. No.

Merryn: Okay. Tell me what your favourite of all those trades are? Not just the Chinese ones, every one. Everyone has a most loved trade and a most loved market.

Hugh: I don't. That's a hard question.

Merryn: Okay. Let me turn it round. What would make you saddest if it failed?

Hugh: I deal with failure all the time. Failure is part and parcel, it's moving on from failure. What would make me saddest and again it's this notion of good hedge funds is that you never fear that the consequences of your risk taking. You don't fear the consequences of being wrong. And such is the way we put our book together that's the space I am in.

So I struggle to answer the question because a failure for me is not being contentious. It's not being actively engaged because if you can put it together properly in your portfolio, who cares if you're wrong? It's boring. Move on to the next. There's always another trade.

Merryn: There's always another trade. Thank you, Hugh.