Europe Doesn't Need China's Money

By Philip Bowring

2 November 2011

Eurozone leaders seem to think that seeking outside money to help resolve their debt problems will shore up confidence. The opposite is true. Europe's problems can and should be handled within the zone, and suggesting otherwise means Europe's leaders have lost their nerve, or at least their political sense.

Beijing has certainly come out ahead in the last week. The Europeans handed China a propaganda coup, enabling it to present itself as key to global financial stability and gain leverage on political and trade issues at Europe's expense. The request for foreign cash also conflicts with Europe's expressed concern with Japan's intervention to weaken the yen, partly by buying Euros.

Europe's appeals for aid are all the more baffling given that normally proud France is host to the G20 meeting this week. French President Nicolas Sarkozy was on the phone to President Hu Jintao trying to persuade the China's leaders to invest in this bailout fund, a special purpose vehicle which exists to cover up policy disagreements within the Eurozone. Meanwhile Klaus Regling, the head of the European Financial Stability Facility, has been playing the role of mendicant monk in Asia, taking a begging bowl around the capitals.

Europe's self-abasement comes just weeks after the last round of Eurozone crisis mismanagement. Italy's Prime Minister Silvio Berlusconi tried to arm-twist the managers of Chinese foreign exchange reserves to buy the country's bonds, prompting Premier Wen Jiabao to call for Europe to put its house in order before asking China for a bailout.

Nobody should blame China for playing hard to get. In the past it appeared to win European friends by commenting positively on Portuguese and Spanish bond issues while not committing much of its money. Now China is expecting concessions on a list of trade issues: treatment as a market economy, ending of bans on sales of high technology, easing of pressure for yuan appreciation, and a further enhanced role at the International Monetary Fund. Russia and Brazil are also watching to see if they can use their large reserves as a political or economic lever.

The bizarre thing here is that the Eurozone as a whole has no need of Chinese, Russian or anyone else's money. Europe is not in the position of the United States, with a huge foreign debt and a $450 billion current account deficit. Euroland is roughly in external balance and most of its governments' debts are held within the region.

The crisis is an internal political one resulting from the unwillingness of the strong to support the weak. Germany in particular is responsible for making the euro a strong currency within a zone that lacks the mechanisms or will to ensure either fiscal discipline or burden-sharing.

China will, rightly, only invest in the EFSF as a lever on other issues. The bottom line for Beijing is that it does not want a declining euro any more than it wants rapid yuan appreciation against the dollar. Europe is now its largest single market, so it badly needs to sustain exports at a time when European demand is weak.

To keep the yuan down, China will have to keep buying euros in some shape or form anyway. Indeed the euro's relative strength over the past year despite its various national debt problems has already been to China's advantage. Despite a small appreciation against the U.S. dollar, the yuan is exactly where it was a year ago against the euro and down against most Asian currencies. The gains of non-dollar bloc currencies such as the yen have also been partly a result of China's desire to diversify its reserves and to ensure that the yuan does not rise against them.

The stronger that China's buying makes the euro, the harder it becomes for the troubled countries such as Greece and Portugal to resolve their current account imbalances. These are set to remain long after the fiscal chasms are papered over by debt haircuts and the EFSF. So inviting new inflows of Chinese capital for the EFSF is likely to make economic life doubly difficult for the zone's weaker members.

European appeals for foreign support only prompt opposition to the rescue plan both within the zone and in China. Investing public funds in Europe, even if it comes with important trade concessions, is not popular among ordinary Chinese, who are already dismayed by the losses China Investment Corporation , the sovereign wealth fund, suffered after investing in Morgan Stanley and Blackstone in 2007. Meanwhile the prospect of trade concessions to China to compensate for the failings of Europe's central bankers and politicians is causing dissatisfaction among the continent's manufacturers.

Putting Europe's relations with China on a sound footing requires that Europe develop a plan that does more than put off fiscal reckonings, a point that Premier Wen and others have made repeatedly. China's financial strength conceals its own set of weaknesses, and as a developing country with much reform left to undertake, it should not be expected to prop up uncompetitive economies that are themselves unwilling to undertake reforms. Neither should its leaders be encouraged to think they can make demands on troubled trade partners while running an export-oriented economy that strains the trading system. Europeans need to wise up to China and treat it with respect rather than awe born of ignorance.

ends