Thursday, September 15, 2011

China in Win-Win Position as Europe Nears Collapse


The urgent need of a growing number of European countries has put China in a position to gain financially and politically. Chinese Premier Wen Jiabao and National Development and Reform Commission Vice Chairman Zhang Xiaogiang recently stated that China is open to buying bonds from European nations facing sovereign debt crises including Italy, Spain, Greece, and Portugal. Zhang believes that increased global coordination is necessary to prevent the global economy from sinking into a second recession. Nevertheless, China urged the U.S., Europe, and Japan to address their debt and deficit problems instead of relying on China to bail them out.

Each day Europe looks closer to needing external financial support. Greece is nearing default. French banks have invested heavily in Greece, meaning if Greece defaults, France’s banks will face catastrophic losses. Ireland, Portugal, Italy, and Spain are all facing debt crises thanks, in part, to their close financial ties with Greece and each other. Without corrective action, the debt crisis is likely to spread to other European countries. A large scale European default would devastate Europe’s trade partners, specifically China, which is one of the EU’s largest trading partners. China can help Europe avoid such a doomsday scenario by buying bonds from countries in need, thereby providing them with the cash they need to continue to pay their debts.

Though helping Europe during its economic struggles is China’s main objective, China itself could benefit economically from buying European bonds. China’s economy has grown by an average of nine percent per year since 2008 in the face of a global recession. Growth is good, but some economists believe that China is growing too quickly. By buying European bonds, China could slow its domestic growth by investing its excess capital (money) overseas instead of using it to push domestic growth. Slowing growth would relieve some of the inflationary pressure that threatens China’s entire economy by making its exports more expensive and, therefore, less competitive globally. The shift could delay China’s goal of transitioning from an export-based economy to a more sustainable economy based on domestic consumption, but only temporarily.

Buying European bonds may also help increase China’s exports by opening new markets. In return for its support of Europe, China wants the European Union (EU) to recognize China as a “market economy” immediately. Currently, China is classified as a “non-market economy” under the World Trade Organization’s definition, which has significant trade and legal implications under WTO rules. The WTO defines market economies as economies in which prices are determined by the forces of supply and demand. Because the EU does not recognize China as a market economy, WTO rules allow EU countries to place tariffs on Chinese goods, nearly doubling the cost of those goods and making them less competitive in the EU. The tariffs allow the EU to protect its own industries that would not otherwise be able to compete with China’s low production costs. The WTO will require all member countries to recognize China as a market economy by 2016, so the EU’s refusal would only serve to delay the inevitable. However, if the EU agrees to China’s demand, the cost of China’s exports to the EU would fall overnight, likely resulting in increased export revenue. With such large potential benefits, it is easy to understand why China is open to the idea of helping Europe.

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