China: The Winner of the Eurozone Crisis?

Manassinee Moottatarn CMC’13

The eurozone is in a bind. First EU leaders prohibited sovereign defaults, harming Greece’s liquidity flow. Now, euro-zone exits are possible, with German Chancellor Angela Merkel and French President Nicolas Sarkozy allowing Greece to return to the drachma- leaving the leaders with little to no credibility to save the euro any longer. Without any mechanism for fiscal transfers, members with large fiscal deficits such as Portugal, Ireland, Italy and Spain are forced to handle their debt with harsh austerity measures- giving them an uncompetitive exchange rate and higher borrowing costs as banks cut back lending.

From the editorials of major media outlets, it seems as if China, the world’s second-largest economy and the biggest holder of foreign currencies with $3.2 trillion in reserves, is currently the EU’s best hope to solve its sovereign debt crisis. But even if China will lend to the eurozone, does that guarantee a sustainable East-West partnership?

photo credit courtesy of Risk.net

On October 27th, European Commission president Herman van Rompuy announced that leaders of the eurozone had agreed to expand the European Financial Stability Facility (EFSF) from 440 billion euro to 1 trillion euros. The leaders will set up a special investment fund to absorb sales of bonds to private investors, sovereign wealth funds, and IMF contributions. European leaders had expressed hope that non-European countries, especially BRIC countries, would buy EU treasury bonds and help fuel liquidity in the eurozone. But Brazil, Russia and India have shown little interest. President Sarkozy is thus counting on his Chinese counterpart Hu Jintao to support EU’s new bail-out program.

Beijing’s response to the EFSF has been promising because the leaders have enough self interest to help Europe. China seeks stability for the European economy and the euro in international financial markets, which will curb the influence of the US dollar. The EU is China’s largest trading partner and largest export market. Bad times in Europe will hurt Sino-EU bilateral trade and may lead to further protectionism of the EU market, which is a worst case scenario for China’s export-led economy. A financially strapped Europe would also reduce its investment in China.

The tables are now turning in favor of China. Both SAFE, the Hong Kong branch of China’s sovereign wealth fund, and the Chinese Investment Corporation itself have tried to avoid alarming the West by presenting themselves as financial investors with no political agenda. But although “the West imposed [rules] on countries with sovereign wealth, like China, to force them to invest along commercial and not political lines…it’s ironic that Europe may now be side-stepping that principle,” said Ashley Monk, co-director of the Oxford SWF Project which researches sovereign wealth funds.

But Beijing has held back from publicly announcing to help the eurozone. This indicates their reservation about the structure of European financial policies where there is no EU level control over the independent fiscal policies of eurozone member states. In addition, diversification of reserve holdings may prove to be a problem. China may want to preserve the value of the euro to diversify its reserve holdings of U.S. dollars. But the renminbi (RMB) is pegged to U.S. Treasury bonds at an undervalued rate in order to boost its exports. Diminishing its dollar holdings would lead to an appreciation of the RMB and depreciation of the U.S. currency. And so China simply cannot get rid of its dollars.  As the euro loses value again, Chinese exports to its largest trading partner will lose competitiveness. Beijing may want to help the euro, but certainly not at the expense of its dollar peg.

No doubt, if there is to be a deal, Beijing seeks reciprocity from Europe.  If Brussels asks Beijing to help them with their debt crisis but continues to shun China’s claim for recognition as a full market economy, restrict high-tech exports to China and keep the arms embargo in place, why should Beijing budge? China aims to reduce its reliance on exports by stimulating domestic consumption and can afford to sustain its own development even while putting FDI on hold. There is also something deeply paradoxical for many ordinary Chinese people that China, a developing country, should be helping the eurozone, a collection of developed nations.

Human rights groups fear that EU leaders will placate Chinese leaders and ignore the brutality of Chinese government crackdown on activists, dissidents and lawyers. Will feigned myopia by the EU lead to an even more renegade China on human rights? In what situation can you confront your banker on rule of law and transparency? Klaus Regling, the chief executive of the European Financial Stability Facility who went on a charm offensive in Asia to rally support for the eurozone, dismissed the idea that Europe would need to offer political concessions to China in return for investment. “I am not here to discuss concessions,” he said, adding that China already buys EFSF bonds and gets no special treatment in return.

Professor Patrick Chovanec of Tsinghua University’s School of Economics and Management in Beijing thinks that China’s real opportunity to help Europe isn’t just about bailing it out in the short term. To ensure a sustainable partnership, the Chinese government should invest in the EU and encourage domestic consumption of European goods. “What the Europeans lack isn’t money, but growth,” said Professor Chovanec. “The real way Chinese can help Europe is by using their money to help create jobs, earnings and opportunity in Europe.”

China has been doing just that. In addition to investing in the country’s railways, telecom and construction sectors, Premier Wen Jiabao offered to buy more Greek government bonds when Greece returns to borrowing on the international debt markets. Other high profile visits include Wen visiting Hungarian Prime Minister Viktor Orban in Hungary, where he pledged to buy Hungarian bonds and extend 1 billion euros in credit. China and Germany signed trade deals worth $15 billion. These overtures are purely strategic- Hungary is located in central-eastern Europe, a region that China seeks greater trade and investment ties. Germany is an important economic and technological partner for China and the key EU member in dealing with the Greek debt crisis.  Now is the perfect time to expand because established EU member states have become increasingly protectionist toward Chinese goods and investment in the past few years.

All in all, China has shrewdly seized the opportunity to engage Europe in economic and technological cooperation, regardless of the rest of the world’s opinions.  China is “almost always condemned whether it does something or if it does not”, says Duncan Freeman, researcher with the Brussels Institute of Contemporary China Studies.  But this time around, there are high hopes for Asia’s economic giant. The world waits with baited breath for China to lend a helping hand to an increasingly desperate eurozone.

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About Adrian

formerly published under the name Wendy Qian at the Atlantic, China File and Tea Leaf Nation.
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