[Viewpoint] China is no white knight for euro

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[Viewpoint] China is no white knight for euro

China is worried about Europe’s economic future. But how far is it prepared to go to ensure the euro survives the sovereign-debt crisis?

Not far enough.

China’s pledges to purchase Greek and Spanish bonds as well as statements of financial support for Portugal show trade and investment are at stake. After all, Europe is China’s premier export destination.

“We do have confidence in European financial markets and the euro,” People’s Bank of China Deputy Governor Yi Gang said at a briefing in London this month. “We will be here for a very long period of time. China has been a long-term, stable investor in Europe.”

But while signaling well-appreciated support for the euro, these purchases are mainly symbolic gestures. They won’t be massive, nor will they increase in any meaningful way.

By buying bonds and striking investment deals in cash-strapped European companies, China is trying to make friends and build bridges. It is keen to be recognized by the European Union as a market economy. This recognition would force Europe to limit the number of anti-dumping cases launched by the EU against imports from China.

Building alliances with Mediterranean governments that are traditionally wary of China’s trade can help it achieve this goal. China’s display of “soft,” business-centered diplomacy may also help the Asian nation in sensitive discussions with Europe’s leaders over the EU arms embargo imposed against China after the Tiananmen Square crackdown in 1989.

Bond purchases are a double-edged sword, though. Many argue that China wants to preserve the euro to diversify its holdings of U.S. dollars. But China is faced with a dilemma: the Treasury bonds it owns help prop up the dollar, against which the renminbi is pegged at a rate some say is undervalued in order to boost exports. Diminishing its dollar holdings would lead to a further strengthening of the renminbi and depreciation of the U.S. currency, which the Federal Reserve is forcing upon the world through quantitative easing.

The precarious fate of the euro worsens Europe’s already grim prospects for this year. The European Commission forecasts 1.5 percent growth for 2011, compared with 1.7 percent in 2010. Most of this will be driven by Germany, while the slump in other euro countries will persist.

China may not have been affected by the financial crisis that originated in the U.S. and then spread to Europe, dragging down banks and finances of the governments that rescued them - China’s trade dipped only temporarily at the height of the crisis. But it might well have to accept a longer-term slowdown of exports to Europe. As European governments introduce austerity measures, domestic demand is likely to flounder again, with ripple effects on imports.

Recent International Monetary Fund research reveals that after a major banking and financial crisis, imports by affected countries take about 10 years to return to normal. In 2009, European imports from China fell to 214 billion euros ($292 billion) from 247 billion euros in 2008. That reversed an 18 percent average annual increase in imports from 2005 to 2008.

In 2010, EU imports from China grew again - by 31 percent in the January-October period. But this revival might be short-lived. Recent analysis by the World Bank says the crisis has pushed advanced countries to a lower growth trajectory. This will surely hurt export-oriented countries such as China.

China’s production model is intertwined with its trade relationship with Europe. Although China now exports more sophisticated products than a few years ago - such as iPads - it doesn’t control the technology itself. It only takes charge of the final product assembly for re-export. This happens in large-scale plants that employ millions of workers the Chinese government needs to keep happy and employed.

Even after all the recent attention in the media about China raising salaries and becoming technologically more competitive, the country still needs investment in large-scale labor-intensive manufacturing to put its masses to work. Two-fifths of its labor force is still rural and needs to be shifted to better jobs elsewhere, namely in factories.

Such massive investment is possible only with the help of foreign companies operating in China. Korean, Japanese and Taiwanese companies - not so much European - may be the top investors in China. But these Asian investments are plants that assemble for re-export to the West. If domestic demand in Europe slows, then foreign investment in China will also suffer.

These harsh realities are the backdrop to China’s charm offensive deployed during its recent roadshow in European capitals. It is responding to the frustration of European investors over practices such as forced technology transfers in joint ventures, and to a rising protectionist sentiment.

At the moment, China simply can’t dump its dollars. So Europe’s leaders shouldn’t expect much more than symbolic Chinese support for the common currency.

*The writer is an independent trade and economic policy analyst based in Paris.

By Iana Dreyer
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