China and Aussies joined at the hip

Further to Jim O’Neill’s talk at the Tutor2u conference one wonders how the Chinese economy is going to land over the next few months. According to the National Australia Bank most believe it is going to be a soft landing given that:

1. The slowdown is desired
2. Policy makers are looking at an expansionary policy to ease the fall
3. Policymakers have a lot of ammunition left to stimulate growth – currently high interest rates (which can be cut) and large surpluses.

Australia’s links with China

The National Australia Bank’s markets weekly looked at the how Australia and China have been closely linked over the last 10 years. They have come up with the following:

Australia is joined to the hip (see graph – Australian GDP Growth – Correlations
Rolling correlations of real quarterly growth) with China given they are its largest export destination. China growing at 8% or 7.5% is probably inconsequential and to materially change the direction of the Australian economy China would need to land so hard that commodity prices would fall sufficiently to turn off many of the big resource projects that are underway. It is naive to think that a recession in China will bring a similar scenario in Australia.

In a small open economy like Australia, the floating $A exchange rate is arguably the most important macro stabilising tool – more so than interest rates. So a Chinese hard landing should mean lower commodity prices and a much lower $A which in turn would help promote growth in some sectors (like tourism) just as the high exchange rate is now curbing these sectors.

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