Helping Europe: Proceed with caution

Updated: 2011-09-23 11:04

By Wu Jiangang (China Daily European Weekly)

Twitter Facebook Myspace Yahoo! Linkedin Mixx

Relatively poor China should not dole out money to save rich countries

Helping Europe: Proceed with caution

There was little surprise when US stocks rose on Sept 13, reversing losses in the previous 90 minutes, as concern about Europe's debt crisis eased after a report that Italy was in talks with China about asking Beijing to buy "substantial quantities" of Italian debt.

The report, possibly a rumor, has been widely discussed in China.

China's foreign exchange reserves reached $3.2 trillion (2.3 trillion euros) by the end of June, of which about a quarter is held in euro assets. The euro zone debt crisis must have already caused great losses for these assets. Now China needs to consider investing more in them.

With the need to diversify its foreign exchange reserves and to maintain a stable economic relationship with euro zone countries, China welcomes a unified and prosperous Europe and is willing to offer help. But as an investment decision, the risk of serious loss must be under control, which unfortunately is not the case when China considers increasing investments in Italy's public bonds.

As Greek Prime Minister George Papandreou failed to reassure international investors that his country can survive the euro-region crisis, market expectations of his country's chance of defaulting in the next five years soared to more than 90 percent.

While Greece is the immediate concern, an even bigger problem may come from the larger economies of Spain and Italy. Since Italy is the third biggest country in the euro zone it can be the key to containing contagion of this crisis.

With public debt of 120 percent of GDP, a GDP growth rate of less than 1 percent, and marginal debt costs of more than 5 percent, Italy seems incapable of changing its situation in the short term and has exposed itself to markets attacks.

A unified and strong Europe has been a long-held dream of Europeans, and the big countries such as Germany and France have greatly benefited from a uniform currency and unified market, but the euro zone's weakness is obvious. With different languages and nationalities, the gaps between the member countries' fiscal, political and defense policies are difficult to bridge. Nevertheless, fiscal union may be the only way out.

At a time when euro zone leaders ought to be showing their mettle through responsibility and determination, almost all of their countries seem to be bogged down in the mud of internal politics. On one hand, people in countries like Germany are unwilling to pay for the cost of a bailout; on the other, people in countries like Greece are unwilling to have welfare payments cut or to pay more tax. Although crises can often present opportunities, the different living customs in the different countries cannot simply be imagined away.

You would resolve the short-term crisis, but the underlying imbalances would persist, and cause a further build-up of debt. According to one report, there is now a consensus among senior policymakers in Berlin that Greece is likely to default inside the euro zone.

The prolonged inability to deal with Europe's debt issues puts its banking system at severe risk. Now, when these problems have the potential to disrupt growth around the world, all nations have an obligation to insist that Europe find a viable way forward. That is why five central banks, including the Federal Reserve and central banks of Europe, England, Japan and Switzerland, plan to pump US dollars into European banks.

Euro countries have also asked for more help. While Rome may have asked China or even BRICS to buy its bonds as much as they could to ease its crisis, China must first seriously consider its own situation.

Euro zone countries have a relatively complete social welfare system. However, such welfare is so good that many are not inclined to work hard, and many people ask for more welfare, cultivating laziness, decreasing competitive advantage and creating a heavy public burden.

Governments can keep on supporting this welfare system by borrowing from other countries or from the future, but this just creates more and more debt until euro bond problems turn into euro bond crises.

China has just begun to build its social welfare system. Chinese bear a heavy a burden in paying for education, healthcare and housing. Chinese used to be able to depend on their children to support them when they got old. Now, with the one-child policy and incomplete social insurance, Chinese find they must save money to support themselves when they get old.

While euro zone countries' problems are easy to see, China's problems are often hidden. Thanks to the mature social welfare systems, the social costs of Western countries are clearly identified. But in China many social obligations of government are left out of sight. China's rapidly growing foreign exchange reserves are based on high pollution, high labor intensity and high resource consumption. Such reserves are needed to help cure these ills. What's more, its 1.3 billion people are facing the problem of getting old before getting rich.

In all, since China is still very poor and the euro zone countries still very rich, China, which has many hidden social costs, cannot afford to pay a penny to "save" rich countries.

European bonds, including Italy's bonds, can still be China's investment destination, but China needs to remain cautious in the absence of greater clarity on what is happening in Europe. China must always be aware that the significant changes or historical reforms must come from inside the euro zone and that any unconditional bail-out could be dangerous before the emergence of a fiscal union. US Treasury Secretary Timothy Geithner says the EU's growing reliance on foreign lenders could imperil the bloc's ability to control its own destiny.

European governments need to tackle the question of closer fiscal union or a bigger bailout fund to recapitalize teetering banks.

China needs to keep its foreign exchange reserves safe. Italy's public bonds barely provide that chance. China may also buy euro bonds if the prices provide enough risk protection on the margin, but for China's foreign exchange reserves there are better choices.

Since safety is the most important requirement of any investment of China's foreign exchange reserves, before any investment it should wait for the situation to become clearer and the risk of bonds to decrease. If Italy wants immediate support, China can lend it money with its strategic assets as guarantee.

Since euro bonds have been thrown into the discussion, China can also wait to buy them, provided they are guaranteed by the euro zone as a whole.

In the short term, China does have other choices. But in the long term it should manage its balance of payments.

For the current account, since its huge foreign exchange reserves have caused many problems, it should seek balance of its international trade. China should decrease its exports, which means encouraging companies in the country to develop the domestic market. This will be good for China's economic transition from export-driven to consumption-driven. At the same time China should increase imports, meaning it can buy more commodities or technology from Italy. In this way China can help the Italian government in increasing its taxes.

For the capital account, China needs to provide more channels for domestic companies or civilians to invest abroad, which could be direct investment, by way of a qualified direct institutional investor or through allowing foreign companies to be listed in China. China's foreign assets are almost all controlled by the government, which is not normal. Japan, as a comparable country in foreign asset management, has less than 20 percent under government control; the rest is controlled by nongovernmental companies or civilians.

The author is a research fellow at the China Europe International Business School Lujiazui International Finance Research Center. The opinions expressed in the article do not necessarily reflect those of China Daily.


The snuff of dreams

Chinese collectors have discovered the value of beautiful bottles

Perils in relying on building boom
Fast forward to digital age
Bonds that tie China. UK

European Edition


Let them eat cake

Cambridge University graduate develops thriving business selling cupcakes

A case is laid to rest

In 1937, a young woman'S body was found in beijing. paul french went searching for her killer

Banking on change

Leading economist says china must transform its growth model soon

Sowing the seeds of doubt
Lifting the veil
Exclusive attraction