According to SLJ Macro Partners’ Stephen Jen, concerns about China and its property market probably will weaken Australia’s and Brazil’s currencies, bringing the Australian dollar to parity with the US dollar, while Brazil’s real may drop to as low as 2.50 per U.S. dollar. In his recent note on China’s soft landing, Mr. Jen had some interesting points about China… the good news is that China’s government will engineer a soft landing. The bad news: Even a soft landing is painful for industries that have become dependent on the world’s fastest-growing major economy as their main profit engine.

Below you can find the highlights of his interesting 5-page report….

Summary…

“…We do not subscribe to the hard-landing view of China… most investors seem to expect a soft landing in China to have, at worst, negligible effects on the rest of the world and, at best, actually be positive for risk assets if the PBOC eases aggressively. Instead, we believe it is important to understand that a property market correction in China will hurt China’s GDP through (real estate) investment, not through consumption. Further, a slowdown in global trade, which has already commenced, will also hurt (manufacturing) investment. Since investment is the biggest component of GDP in China (accounting for 46% of GDP), and the biggest contributor of GDP growth (investment accounted for 54% of China’s growth in 2011 and 2010, and 91% of its growth in 2009), such a prospective weakening in investment will have a meaningful effect not just on China’s headline growth, but, more importantly, disproportionate effects on China’s imports from countries like Australia and Brazil. Further, we believe the PBOC’s monetary easing is ‘reactive’ in nature and not ‘proactive’. The chances of the PBOC helping to proactively reflate global asset prices are slim, even though some monetary easing should take place to remove the risk of a hard landing…

Chinese trade is decelerating…

Impact on the rest of the world

We suspect the impact of the prospective soft landing in China could be quite negative for the likes of Australia and Brazil. If manufacturing and real estate (construction) investment does falter in China, demand for industrial metals will weaken, which should in turn undermine AUD and BRL. Further, it is not clear exactly how the PBOC’s rate cuts stimulate the world’s equity markets. The RMB is not a reserve currency, and the world’s risk assets should rise only if the monetary easing in China manages to keep GDP growth from falling. But if the PBOC merely constrains the size of the growth deceleration, it is not clear why US equities should go higher, for example.

Bottom line. A soft landing in China seems probable, and desirable. There is no question in our minds that China will be fine: the policymakers will make sure of it. However, China being fine does not necessarily imply that China’s trading partners will be fine. Investors may not be too sanguine on China, but they are likely to be too sanguine on Australia and Brazil.”

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