Why China Can’t and Won’t Save Europe, Part I

Why China Can’t and Won’t Save Europe, Part I

Editor's note: This is the first of a two-part series on the unlikelihood of a Chinese contribution to a financial bailout of Europe. Part I examines the domestic obstacles to a Chinese contribution. Part II will examine the European obstacles to a Chinese contribution.

SHANGHAI -- Recent optimism regarding possible Chinese involvement in addressing the European debt crisis is misplaced given China's domestic political and economic conditions, resistance within the European Union itself and the growing international perception that Europe's leaders simply do not have the capacity to design a sustainable solution for the continent's economic woes. The disappointing outcome of the Cannes G-20 summit, accompanied by yet another Greek convulsion, have confirmed the view that Europe cannot help itself. Meanwhile, the assumption that China will invest significant amounts of its sovereign wealth in an as-yet-undefined bailout fund without any major concessions from the EU is deeply misguided.

This assumption is based on the premise that China needs a healthy European economy to support its export sector, protect the value of its approximately $1.3 trillion in denominated assets and keep the yuan cheap relative to the euro. These arguments, however, may be overstated. A 10 percent reduction in European import demand, which totaled $325 billion in 2010, would reduce Chinese GDP by only around half of 1 percent -- an unwelcome drop, but nowhere near enough to derail the China growth story. With regard to foreign exchange (forex) reserves, declines in euro-denominated asset values would likely be counterbalanced by gains for dollar- and yen-denominated holdings, resulting in only marginal net damage. Meanwhile, under the present currency regime, Beijing is still able to fix the value of the yuan more or less regardless of market signals.

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