CHINA’S 2 SCENARIOS: HARD LANDING OR NO HARD LANDING?

A recent Societe Generale strategy note highlights the impact of the Eurozone crisis in China and draws out two potential scenarios – the hard landing and the soft landing.  The note strings together some potential asset class impacts in either case (via SocGen):

“The eurozone debt crisis is jeopardising China’s economic dynamism: China became the first contributor to
world GDP growth (31% on average for 2010-2013e: source IMF) in 2010. The recent cut to the country’s economic growth target to 7% by the Chinese Premier confirms that China’s economic expansion appears to be in jeopardy. Another sign came from the unexpectedly high trade deficit in February ($31.5bn far from the previous record at $7.9bn in a month). Furthermore, the political will to cool the overheated property sector is in question as home prices are now in free fall after the fifth consecutive monthly decline. Two scenarios: 1) a “hard landing” in China, with growth below 7% and dire consequence for commodities; 2) A soft
landing in China, with growth at 7.5% which would favour developed economy assets.

Scenario 1: China “hard landing” (growth below 7%): As Premier Wen Jiabao said last Tuesday, economic growth in China is still sensitive to the eurozone crisis. With fiscal tightening in Europe and structural reforms in China likely to take some time, there is indeed a risk that Chinese growth could slow. This would have negative impacts on: 1) emerging market equities, and 2) commodities. But, a fall in commodity prices, particularly oil, could support: 1) western economies, enhancing household purchasing power; 2) developed equity markets, mainly in Europe, particularly considering that only a small portion of
European revenues are generated from China, although there are exceptions (luxury goods).

Scenario 2: China soft landing (7.5% growth): This suggests, as presented in the “China 2030” World Bank report, that China succeeded in implementing structural reform with a better equilibrium between growth from exports and growth from internal demand. This could also push Chinese authorities to further revalue the yuan (already up 30% vs the USD since 2005). Under this scenario, it would be positive for risky assets. But, inflation would be a major issue for developed countries as: 1) commodity prices and particularly oil prices would remain at very high levels; 2) bond yields would go up sharply in developed countries; 3) emerging equity markets would remain bullish.”

Source: Societe Generale

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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