六月號 - 經濟連線

The Eurozone debt crisis and China

Paul Cochrane in Beirut

The Eurozone debt crisis (EDC) is a tangled web of complexities. How the crisis will unravel may shake the European Union to the core, with the possibilities of two Eurozones developing, even the end of the Euro/EU if the European public have its way, and the spectre of a double dip if there is a run on the $3 trillion in holdings in Eurobanks. Amid such doom and gloom, the EU is seeking inflows from China at the same time the IMF is forecasting China's growth to halve this year.

The EU-27 is China's biggest trade partner. What happens economically in the EU is clearly of crucial importance to Beijing. Indeed, the IMF lowering its growth forecast for China is an indication that the Eurozone is on shaky ground. It is no surprise therefore that the EU looks to China to aid in resolving the debt crisis by buying up Eurobonds from the PIIGS – Portugal, Italy, Ireland Greece and Spain – and investing in EU economies. That was the aim of the China-EU Summit held in Beijing in February, which drew a degree of press attention but from which nothing substantial was concluded.

“There were a lot of nice words but it was hard to see anything concrete. Europe needs someone to lend that cannot repay the debt, and China is not willing to take on that role,” said Michael Pettis, professor of international finance at Beijing University.

There were signs that it would be a PR show to bolster global economic sentiment and placate the markets even before the summit was held, with the China Investment Corporation (CIC) brushing aside a call by German Chancellor Angela Merkel to buy European government debt, saying such investments were “difficult” for long-term investors. On the other hand, the Governor of the People's Bank of China, Zhou Xiaochuan, echoing comments by Premier Wen Jiabao, said: “China will always adhere to the principle of holding assets of EU sovereign debt...We would participate in resolving the euro debt crisis.”

Such opposing statements reflects the Catch-22 that China is in – the Eurozone needs to recover for China to export and the economy to remain buoyant, yet sinking money into EU sovereign debt and companies is arguably not the most savvy financial move, particularly as other foreign investors are not willing to make the same gamble.

“At the height of the EDC when (French president Nicolas) Sarkozy called Beijing, cap in hand, the Chinese were miffed that they were viewed as the the rich patron, so the request got nowhere. In a way the Chinese are between the proverbial rock and a hard place. There is a desire and perceived need to be financially engaged with Europe, and where Europeans are in a situation to buy Chinese made goods, but they are not sure what is happening and how safe their money is,” said Jean-Pierre Lehmann, Professor of International Political Economy at the IMD Business School in Switzerland.

Moreover, the EU does not need capital. It is the banks that lent to governments, particularly the PIIGS, that need capital to stay afloat, tied up as they are with debt exposure.

“Europe doesn't need capital. That one of the most capital rich places in the world needs capital from China is silly,” said Pettis. “I don't think the EU needs China. It needs someone foolish enough to pay and China is not willing to play that role. It is silly for EU politicians to think of foreign capital as it worsens the trade balance; they don't need liquidity but growth.”

Indeed, in August and September, 2011 alone, over $25 billion was withdrawn from emerging market funds to head back to Europe, and a further $85 billion of portfolio inflows went into the Eurozone, with balance of payment statistics showing a large share went to France, according to data from the Bank for International Settlements.

EU companies are seeking to reduce portfolio liabilities and ease cash flow issues as the banks are making life tough for businesses when it comes to stop-gap loans. An example is a French company, which shall go un-named, that manufacturers water purifiers, pumps and the like. It is well established with clients around the EU, as well as in India and China. Manufacturing a needed product, orders keep coming in, but the issue is that past customers - which include public entitites - are not paying up on time. Yet with $500,000 of salaries and overheads to be met every month, will banks step in to keep the company afloat? Very reluctantly, depsite banks pledging to the governments that bailed them out in 2007 and 2008 that viable small and medium sized enterprises (SMEs) would be extended a financial hand.
Similar experiences are occuring throughout the EU, as well as in the US and globally.

The result is a vicious circle – another business folds, putting more burden on government revenues, more debt that needs to be written off, and another brake is put on economic recovery. But rather than forcing banks to bolster the economy by aiding businesses, the EU is acquiesing to the banks and big corporations, of which few pay taxes, with 99 of Europe's 100 largest companies, including banks, using offshore subsidiaries and tax havens, which hold the equivalent of over one-third of the world's gross domestic product (GDP) while more than half of world trade passes through these fiscal paradises.

The United States is of course implicated in the EDC. The US Federal Reserve's quantitative easing policy - printing dollars to boost base money supply to get the economy out of recession – has meant, in the words of Jim Rickards in his book,” Currency Wars: The Making of the Next Global Crisis,” that “the Fed has effectively declared currency war on the world.” The result is stagflation – stagnant growth and high inflation - and the world going deeper into financial crisis.

“There is definitely a currency war being waged. Everyone is doing the same thing to grab a bigger share of global demand through a trade war,” said Pettis. “In the US, we are starting to see debt levels come down. In Europe we are not seeing that, and in China it is going up. We are still not out of the crisis.”
Furthemore, financial moves in the US could trigger a double dip that scuppers economic recovery and leads to a new global financial shock. US money market mutual fund holdings of Eurobank assets are estimated at $3 trillion. As they are in extremely short-term liabilities, which are similar to deposits but not insured, any problem with the Eurobanks could cause significant loses to US funds, but unlike in 2007 and 2008, the US government will not step in to guarantee such holdings, as the Dodd-Frank Act disallows such intervention. “The appearance of a problem among eurobanks could bring down that whole market—which is about twice the size of the US subprime mortgage market that brought on the global financial crisis last time,” wrote Randall Wray in Real-World Economics Review.

The leadership crisis

EU leadership has not risen to the challenge presented by the EDC, and not acted in accordance with the EU's esposed democratic principles, instead dictating to the likes of Greece what they can and cannot do fiscally. For Germany, which is in the driving seat of the Eurozone cargo train, it is the PIIGS that are the pressing problem.

“The problem is no one wants to lend money to the PIIGS. China doesn't have problem buying Eurobonds issued by Germany. What Germany needs is someone to buy Spanish bonds,” said Pettis.

It is no surprise therefore that how the EDC is being handled is coming under heavy criticism, and that sentiment among Europeans towards the EU and the Euro is at an all time low, with Eurobarometer surveys showing less than half of those polled support the EU. In Spain, one of the countries hit the worst by the EDC, 62 percent of Spaniards "tend to distrust" the EU, against 30 percent who "tend to trust" it.
“One of the things that very rarely appears in discussions is that the mood in nearly all of Europe is very anti-European. Many are in favour of disengaging from the EU and I am not aware of any country where Euro sentiment is strong. If treaties needed to be ratified and go to referundum, I think they will be strongly rejected,” said Lehmann.

Such sentiment has led to a flurry of speculation on the future of the EU and the Euro, from the relatively optimistic, such as “How to Save the Euro” by George Soros in the New York Review of Books, to historian Walter Lacquer's grim forecast in his new book, After the Fall: The End of the European Dream and the Decline of a Continent.

“We are seeing an implosion. Sarkozy and Merkel are calling for a greater degree of unity but pushing it the other way, toward dis-unity. Countries are talking about ending the Schengen Agreement and limiting the movement of people. I cannot think of anything currently holding Europe together,” said Lehmann.

There have been suggestions that two Eurozones may develop, a northern, core EU of founding members, and the southern and eastern blocs, although the East is not such a possibility, given German and Austrian financial influence in the Baltics, Czech Republic and Hungary. Such an occurance would be tantamount to writing off the PIIGS debt, which is being avoided at all costs, as it could signal the demise of the Euro.

As the world's second reserve currency, at 26.6 percent, this is unlikely in the near future, if at all. But with European banks likely to offload 3.5 trillion euros of assets to meet tight new capital rules, few saviours are in sight. Even the IMF has stated that the Eurozone needs to increase the size of its permanent rescue fund, the European Stability Mechanism that is set to go into operation in July, from Euro 500 billion to Euro 1 trillion, a stance which Beijing supports.

The dragon in Europe?

So, is it prudent for China to try and help disentagle the debt web, or will it get stuck in it? Last year, China's foreign direct investment into the EU surged by 95 percent on 2010, but was still just $4.3 billion, according to Ministry of Commerce data. By contrast, last year, in terms of actually utilized value of foreign capital investment in China, European countries ranked seventh to tenth respectively, with the UK the top EU investor ($1.61 billion), followed by Germany ($1.136 billion), France ($802 million), and the Netherlands ($767 million).

What is important to note is that Chinese companies' forays oversees have not always proved too stellar. According to data complied by the Heritage Foundation in the US, China's failed foreign forays totalled $32.8 billion in 2011. From 2005 to the middle of 2011, “China has seen 70 business deals each worth $100 million or more partly or completely fall through, with an aggregate value of $165 billion, such as by Chinalco, CNOOC, CDB, and Huawei,” stated the foundation's report.
Such failings, said Lehmann, “are partly due to insufficient understanding of the softer side of overseas investment, as human skills are not so good.”

There have however been some success stories, such as the China Ocean Shipping Company (Cosco), which has operated two terminals in Greece since 2009, and bolstered exports to China by 50 percent. In February, car manufacturer Great Wall Motors opened an assembly line in Bulgaria, enabling the company to qualify for a “Made in Europe” label, a move that other Chinese manufacturers may follow.

When it comes to sovereign debt, China is hesitant to mix up its current foreign reserve spread, which is primarily in US dollars, at 60 percent, versus 26 percent in Euros, according to IMF and Woodsford data. But perhaps more crucially, appetite in China for investment in the EU seems elusive. “Clearly what we've seen is public opinion counts more and more in China. And opinion raises questions when so much money goes abroad as Chinese think they need the money at home to develop the country,” said Lehmann.

Internal issues will also dictate any readiness to invest abroad if the Chinese economy contacts this year. “I think this will be devastating, and that is the political risk,” added Lehmann.

Global instability is a further reason why the BRICs (Brazil, Russia, India, China) are not getting ensnared in the EDC web. The surge in outflows of capital from China is equally indicative of the degree of confidence in the Chinese economy and policies, evidenced by the inflows of capital to Hong Kong and the buying up of real estate, as well as further afield to onshore and offshore financial havens.
“The rich Chinese are placing more and more money out of China, and very significant sums, in real estate and tax havens. What is very interesting is that this is the kind of data that should be looked at as it reflects confidence of the people in economic prospects,” said Lehmann.

While China is economically interdependent with the EU, any major financial forays into the Eurozone outside of the more stable economies – and those are export driven – may prove disingenous if not painful in the short to medium term. As for sinking money into Eurobonds connected to the PIIGS, China is likely to get stuck in the sticky EDC web.