Author Article by Lyric Hale: Europe’s China Dreams Turned Upside Down

Lyric Hale

Lyric Hale

Continuing her regular column, top economic commentator and What’s Next? author Lyric Hale looks at the Eurozone debt crisis, and how the increasingly febrile situation impacts on China’s ever-changing relationship with Europe and the rest of the world.

By Lyric Hughes Hale

In a period of crisis, the focus on short-term survival can blur the longer view. China has now learned the hard truth—Europe is not a country, but a bold economic experiment. The unintended political consequences of the Eurozone debt crisis will be a stronger bilateral relationship between the US and China. As Henry Kissinger told Fortune Magazine:

We are the two major economic engines of the world. China and the US interact with each other all over the world. And so the economic progress of the world and peace of the world depend on the nature of that relationship. At this particular moment, both governments seem to understand this.

The continued success of this relationship will depend in part on upcoming political transitions in both these countries, but in many important ways, China and the US are already really one country. Neither will eclipse the other nor become the other, despite all the hype about China taking over America’s position in the world.

George Osborne and the IMF's managing director, Christine Lagarde

George Osborne and the IMF’s managing director, Christine Lagarde

Europe’s slow motion fall from financial grace and global confidence has been painful for the Chinese. Beginning in 1999, China had sought to balance its growing US dollar portfolio with euro holdings. Now they must be rethinking this strategy, and their currency basket. (The SDR is not yet a viable alternative, although China and France have recently formed a working committee to propose that the Chinese renminbi be included in the IMF currency basket.)

There must be disillusionment in Beijing with the published antics of Dominique Strauss-Kahn and Silvio Berlusconi. It was reported that the latter took a personal procurement specialist with him on his trade mission to Beijing several weeks ago. Whatever their private peccadillos might be, the upper echelon in China does not see them displayed in the press. China, like the US, has a puritanical streak. Character and public deportment both matter. During the 1930’s Shanghai’s native bankers made their loans based upon the personal character not only of the business owner, but his family. If they heard that the eldest son was frittering his time away in the red light district, they did not make the loan. DSK will be ultimately responsible for the appointment of the first Chinese head of the IMF, and a diminution in Europe’s global institutional power.

China is of course lavish with public pronouncements about their faith in the euro and the ability of the ECB to solve the current debt crisis. The more such stories appear on the front page of China Daily and the People’s Daily, the more worried they really are. Here is a great one-two punch from China Daily today:

Beijing: China’s Aid to Europe is Unconditional

Beijing reaffirmed yesterday that its support to European economies to help alleviate its debt woes is “unconditional”, although, a Ministry of Commerce spokesman said China is disappointed at EU’s inaction to recognize the country as a market economy.

The bottom line here is that China now sees Europe as a market, not a political force. All of China’s current demands, for greater market access to the EU in exchange for financial assistance, bear this out. A wonderful historical irony, when one thinks of the foreign treaty ports forced upon China a hundred years ago. Who could have imagined that China would be in a position to demand entry for her companies in Europe? That she would be in a position to buy European assets at vastly reduced prices? In those days, China was a serial debt defaulter.

Bank of China

Bank of China

Not that the Chinese wouldn’t have preferred stability in Europe. In spite of their pledges of support, I imagine that there is some pretty frantic scrambling behind the scenes in Beijing. According to Reuters today,

Bank of China, a big market-maker in China’s onshore foreign exchange market, has stopped foreign exchange forwards and swaps trading with several European banks due to the unfolding debt crisis in Euro, three sources with direct knowledge of the matter told Reuters on Tuesday.

Basically, no Chinese official wants to be caught out with worthless foreign bonds or devalued assets. The Chinese worry that while Germany and France get their banks in order and offload debts, China hangs on for the sake of global financial stability and loses out. China does not want to get the short end of the stick, or lose face in financial markets while they try to play the role of a global stakeholder.

As a result of this crisis, we all know and understand what the European Union really is, and what its weaknesses are. China and the US, which each possess monetary and fiscal union, will find it easier to deal with each other as traditional countries, rather than with a fragmented Europe. Unless we get an unexpected change of leadership in 2012.

What's Next?

What’s Next? Unconventional Wisdom on the Future of the World Economy by David Hale and Lyric Hale is available now from Yale University Press.

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