China hard landing

In the event that China will have an hard landing, it would be interesting to estimate the impact of this scenario on various asset classes.

Société Générale has modeled this situation defining 6 per cent as the hard landing threshold. In this scenario a real GDP growth rate below 6 per cent is seen as the minimum level needed to keep the job market stable and avoid systemic financial risk.

The following are the global implications of a China hard landing:

  • World GDP: -1.5 per cent (0.3 per cent a direct effect of China’s slowdown and the remainder through transmission mechanisms outlined below);
  • Trade partners GDP: Taiwan is the most hit country with a drop of 4.5 per cent followed by South Korea and Malaysia with a -2.5 per cent and Australia with a -1.2 per cent. The less hit would be Japan (-0.6 per cent), the Eurozone (-0.3 per cent) and the US (-0.2 per cent).

In the following chart is summarized the impact for all the major world area with respect to the target China’s growth, estimated by SocGen for the next year at 7.4 per cent.

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In the next part of the post, I will recap the implication of a China hard landing for the major asset classes – equities, bonds, currencies and commodities – as expected by SocGen analysts.

EUROPEAN EQUITIES could fall 20 per cent. A Chinese slump would be primarily China-driven, rather than both China and Europe suffering the same thing.

BONDS: safe assets would be in strong demand but, at the same time, sovereigns bond already considered unstable would probably come under more stress.

CURRENCIES: is expected an appreciation of 10% (trade-weighted) of the US Dollar in the first year even if the US Federal Reserve responds by extending its quantitative easing program. It is also probable an even austere scenario in which a China hard landing activates currency wars and potential protectionist actions on trade flows. However, there could be some positive news: sinking Chinese demand would provide support for commodity importers thanks to lower prices.

COMMODITIES:

  • Gold: the impact of a Chinese hard landing on gold demand is the most complicated to forecast. The model suggests prices would rise around 15% to over $1900/oz but then drop very quickly. This would repeat the pattern of 2008-09, in which gold originally rallied on a flight to quality, but then retraced.
  • Base Materials: the model suggests that a Chinese hard landing would drive prices sharply lower over the first quarter (at least a drop of 50%). However, the impact should be less than in the Lehman Brothers bankruptcy, (prices dropped by 75%). However prices could fall to the 60th percentile of production costs and the cost of production would eventually limit declines.
  • Oil: the model suggests that Brent should drop about 30% (to 75$). Oil prices are also influenced by politics. Saudi Arabia for example has low production costs but needs the oil price to be at $90-$100 to meet its national budget.

In the end, the following would be the most probable progression path of the crisis.

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