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China's Price for Rescuing the Euro

The latest plan to save the euro depends upon the enlargement of a special fund, the EFSF, with contributions from China and other large lenders. But – as Europe’s liquidity crisis threatens to become a solvency crisis beyond Greece – what price would China demand for its large-scale lending support?

Following on from their acclaimed report, ‘The scramble for Europe’, which examined the political implications of China’s purchases and investments in Europe, François Godement and Jonas Parello-Plesner are currently working on ‘Rescuing the euro: What is China’s price?’, which will be published in the coming weeks. Its arguments include:

• Although the US has borrowed extensively from China for a decade without making major concessions, European disunity on debt management will make it a struggle for the EU to avoid such concessions to Beijing. But the more united and transparent the European borrowing process is, the more leverage Europe will have in dealing with China and other creditors. Political will and commitments from Europe must also be explicit, and not shielded from public view.  
   
• China (among Asian and other economies) wants to invest money away from the dollar, and has an interest in preserving and growing exports in Europe. It also fears the global bust that would follow a deep European recession or systemic crisis.
   
• But China is deeply risk-averse, and particularly unenthusiastic about the sort of political uncertainty that Europeans are creating for themselves – both in domestic politics and in their byzantine institutional set-ups. Any large-scale investment in European bonds would have to explained at home as a safe investment. China’s financial decision makers look primarily for safe havens. They may fear American monetary policies, but are repulsed even more by European political doubts.
   
• China will therefore "help" Europe if Europe helps itself. This means setting up a convincing argument and guarantees for outside investors. The eurozone must be seen again as an effective debt union, with member states taking on at least as much risk as external lenders. 
   
• The US has found such a modus vivendi with China on debt. Europe has yet to get to such a level playing field.

‘Rescuing the euro: What is China’s price?’ explores several scenarios:

1.  Best case: Eurozone as a new sovereign – with the EFSF emerging as a European super borrower and lender, with unassailable guarantees. China shifts some currency reserves towards the euro.

2.  Medium case: a sovereign with crutches – thanks to a time/credibility gap, lenders impose IMF conditionality, or an IMF loan vehicle. China may even employ the opportunity to further its onw goal; the internationalisation of the renminbi and choose it as the currency for the new lending, transferring exchange risk to the European borrowers.

3.  Worst case: a run for the lifeboats – if the EFSF fails to contain the systemic crisis or the Eurozone is unable to negotiate terms with the IMF and others, the IMF may undertake direct country by country rescue, each with different contributors and conditions, with the public knowledge that they cannot rescue larger economies. The Eurozone loses all traction on the debt crisis. Creditors – including China – are in the driving seat.

“Bilateral borrowing on beggar’s terms by weak European member states is where the main political risk lies. What is at stake is the fate of the Eurozone, Europe’s ability to remain a global actor, and China’s trajectory as an international power.”   François Godement.

“Europe must be as transparent as the US on bond purchases. This would end some of the media alarm about Chinese purchases, and reassure both Chinese and European publics about the size of stake that China actually takes in Europe.”   Jonas Parello Plesner.

Click here to read ‘The scramble for Europe’.

Click here to visit ECFR’s webpage.

Notes to editors:

1. All ECFR publications represent the views of the authors, not the collective position of ECFR or its Council Members.
    
2. The European Council on Foreign Relations (ECFR) is the first pan-European think-tank. Launched in October 2007, its objective is to conduct research and promote informed debate across Europe on the development of coherent and effective European values based foreign policy.