Author: Jacob Kirkegaard, PIIE
A persistent theme since the beginning of the euro crisis in May 2010 has been whether China — with the world’s largest foreign exchange reserves — would ride to Europe’s rescue with a bailout, and if so, what political demands it would make in exchange for this favour.
But since December 2011 it has been abundantly clear that it is the European Central Bank, and not the Chinese State Administration of Foreign Exchange, that will provide the cash the euro zone needs to stabilise its financial system and its sovereign debt markets. So China’s principal role in the euro crisis resolution will likely be as part of a coordinated G20 effort pledging more money to the IMF, which will potentially be announced at the IMF and World Bank meetings in April 2012.
Since 2010 there have been rumours about large Chinese investments each time a senior Chinese official has visited Greece, Ireland, Portugal, Spain or Italy, but the reality is that no large transactions have taken place and no deals have been closed. The total Chinese exposure to the euro zone’s periphery financial assets has remained trivial, while the limited direct investments that have taken place have been strictly on a commercial basis as Chinese firms expand abroad. Given that Europe has relatively fewer national security concerns than the US, it is expected that ongoing Chinese commercial investments in the EU will accelerate in the future.
The Chinese government prudently refrained from directly investing official funds in the European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) in 2011, when European leaders suggested that the fund could be ‘leveraged’. China will instead only contribute through the much safer option of the IMF. Having risked very little to assist the euro in its hour of need, the euro zone countries are not in a rush to arrange a quid pro quo. The only likely way China will benefit from the European crisis is by securing voting power at the IMF commensurate with the size of China’s pledge to that organisation.
Meanwhile, European leaders will be aware that as the crisis unfolded China continued to gradually shift its foreign exchange reserves away from the US dollar and quite likely into the euro. In undertaking to diversify its reserves the Chinese government has adopted a sensible risk management strategy. This ongoing diversification has helped ensure the euro has retained its value throughout the crisis, despite widespread market predictions of its imminent collapse. But given that Europe is China’s biggest export market, the Chinese government has good reason to ensure the dollar — and by extension the renminbi — does not fall too far against the euro. Implicit Chinese support for the euro in the global foreign exchange rate market via ongoing diversification is therefore hardly something the euro zone leaders need to thank Beijing for. After all, whatever euros China has bought, it has done so with its own best interest in mind.
The euro zone crisis is gradually stabilising. Appropriately for a very wealthy region, the EU has relied on its own resources to address the crisis, with the EFSF/ESM receiving a top-up by the IMF, and China largely playing on the financial sidelines. As a result, it is not expected the crisis will lead to a sudden deepening of Euro–Sino relations. Certainly, the euro zone will not be compelled to do China any particular favours in other policy areas, as reflected by ongoing disputes over airline emissions, the arms embargo and various trade-related issues. So while strong economic and political relations between Europe and China are in the best interest of both parties, it is unlikely the euro zone crisis will play any significant role in bringing about this outcome.
Jacob Funk Kirkegaard is a research fellow at the Peterson Institute for International Economics, and is also a senior associate at the Rhodium Group, New York.