Many economists, pundits and policymakers in Europe think that China is in an ideal position to rescue the Eurozone from its debt problems. The main argument goes more or less like this: China has $3.2 trillion foreign reserves, of which two thirds are in US dollars and only one quarter is in euros. It would make perfectly sense for China to diversify its portfolio and so reduce its foreign exchange risks. Further, by investing in European debt China can finally demonstrate that it is a responsible stakeholder in the new economic world order. As the saying goes, you recognise your friends when they come to help you in moments of need. Well, time has come for China to show how much it cares about the fate of Europe. European leaders, first the prime ministers of debt-laden Eurozone peripheral countries such as Greece, Portugal, Ireland, Spain and Italy, and recently even German Chancellor Angela Merkel, the de facto chief representative of the Eurozone, went cap in hand to Beijing to ask for support. So, should China take this once-in-a-lifetime opportunity and become Europe’s White Knight? The answer is no. Why?
First of all, why should a relatively poor country like China rescue a comparatively prosperous and rich currency area like the Eurozone? Let’s not forget that in 2011 annual per capita income measured in Purchasing Power Parity (PPP) was still over $27.000 in Greece, over $23.000 in Portugal, and over $30.000 in Spain and Italy. By contrast annual per capita income in China is just over $8.000. Furthermore, the Eurozone as a whole does not have a large current account deficit. Its balance of payment position is roughly, yes, in balance. So the Eurozone is not short of capital. Core Eurozone countries have enough savings to rescue the periphery. The problem is that they do not have sufficient trust and/or political will to invest in their partner countries. It is certainly awkward to ask your friend to invest in a project that you are not fully committed to. As Xia Bin, an influential Chinese economist and adviser to the Central Bank, has been eager to point out after Merkel’s recent visit to Beijing, the Chinese may be poor, but they are not stupid.
The crux of the matter is that only the Europeans can save the Eurozone. This is a line that Chinese policymakers have tiresomely repeated over the years. As Prime Minister Wen Jiabao has recently stated, and my own research has corroborated, China is not interested in investing in Spanish, Portuguese or Italian debt. It wants to invest in EMU debt. It wants to see that the euro endeavour is a consolidated and longstanding project that will be around in 10, 20 or even 30 years time. Europe needs to sort out its own house. It needs to decide whether it is an economic and, more importantly, a political union, or just a community of independent sovereign states. Besides, given the fragmentation and lack of liquidity in the Eurozone debt markets, if China were to invest large amounts of cash in the Eurozone, this would trigger a rise in the nominal exchange rate of the euro. The value of the euro is already too high for the Eurozone periphery. Even amidst the greatest existential crisis in the history of EMU, the euro is still above $1.30. Do we want again a euro at $1.60? This would kill the export sector in the periphery and, with it, any hopes to rebalance the current account deficits of Portugal and Spain.
In sum, my advice is to leave China alone in regards to the Eurocrisis. China will keep investing in the euro, as has been confirmed recently again by Zhou Xiaochuan, governor of the Chinese central bank. The Chinese authorities have already invested $800 billion in the European currency. Thus, the euro is ‘too big to fail’ for them. On top of this, China needs to keep the value of the euro relatively high for another reason. The EU is its largest export market. If the euro exchange rate falls, Chinese goods would lose in competitiveness and harm Chinese manufacturers. Hence, there is no need to worry. China will do its part of the job.
The most important question, though, is whether Europe can save itself. Steps have been taken. Mario Draghi, President of the European Central Bank, has asked for a ‘fiscal compact’ and European leaders have delivered. We are closer to a fiscal union. The problem is that fiscal union will not work without democratic union. I wonder why no-one is asking for a ‘democratic compact’? Why not strengthening, for instance, the role of the European Parliament? The President of Greece, Carolos Papoulias, has recently criticised other European officials for taunting Greece on its debt problems. He asked: “Who is Mr Schäuble? Who are the Dutch? Who are the Finns?” Who knows, maybe in the future someone might be able to respond: “Well, yes, they might be Dutch or German, but, you know, they have been elected by your people too”.