Has China the Capacity to Save Europe?

Has China the Capacity to Save Europe?
Written by He Qinglian on November 3, 2011
(translated by krizcpec)
[Words in brackets are added by translator]

In this half a year or so, the expectation that China would invest and rescue the EU became the pillar of faith that hold up the Euro market. On October 28, after being lobbied by various EU members, China's Vice Foreign Minister, Fu Ying, officially announced that “the proposition of China rescuing Europe does not exist”. The topic that was being heatedly discussed for months has finally settled. Now that Beijing is determined not to assume the role of “White Knight” to save Europe, European leaders like Nicholas Sarkozy will have to discard their illusion and rely on themselves to weather this crisis.

I think that China refrained from “saving Europe” this time is good for both sides for two reasons.

First: for the EU, the problems in the region are deep rooted and have been around for long. The high welfare benefits the EU member countries adopt that enable the people there to live comfortably without having to work have resulted in both the people's lacking motivation to work and the heavy tax burden weighing on businesses and those who are employed. It has become an abscess that demanded surgical removal a long time ago. The problem is, however, the Leftists who are good at giving out money dominate most of European politics arena; and no matter which party win an election, with election votes in mind, they couldn't make up their mind to remove this ulcer of high welfare benefit that will cause serious problems sooner or later. [Now they might have to take the difficult decision to cut back excessive welfare benefits as Beijing refused to help financially.]

Second, China has already purchased €500 billion worth of European bonds, and is suffering losses all along. It is said that almost half of the investment made in Eurozone this year was lost. In view of China's own interests, no more money should be placed in Europe indeed.

What I will discuss next is whose assets the foreign exchange reserves of China really are.

The 3.2 trillion foreign exchange reserves of China has become the gold chest that attract high attention from both inside the country and elsewhere. It's not just the EU which has nothing to do with these assets that has an eye on them; the Chinese people, who are more eligible than the EU [to ask for a share], too are fixing their eyes on those assets.

Even since someone proposed that the foreign exchange reserves should be distributed among the whole country, discussions on this topic appear from time to time. As beneath this topic there are insider details that are best kept from the public: for instance, when the government acquires foreign exchanges, huge amount of RMB is needed, these RMB coming out of money printer would definitely bring inflation; and where the massive amount of China's foreign exchange reserves is placed as well as the gains and losses are, except the over one trillion worth of U.S. dollar bonds, state secrets to the Chinese government and it basically wouldn't explain the details to the public.

But as the call for distributing the foreign exchanges reserves grew, people from government think-tank in the banking sector came out to say that the foreign exchange reserves are actually the debts of the central bank: each dime of the reserves is matched with debts; and in the end the central bank shall have to repay them.

While I do know that this saying is indeed true: as China implements a foreign exchange control system stipulating that whenever foreign currencies turn up in front of bank counters, the banks must buy in those using corresponding amount of RMB, like every greenback has to be purchased with 6.5 RMB; they did not mention two things.

First, this money is printed by the government. To purchase 3.2 trillion worth of greenbacks over 20 trillion worth of RMB will be needed, this massive amount of new money would definitely cause inflation when it enters the market, in the end it is the public who pays the bill.

The other thing they didn't mention was that this money is used in investment, and the beneficiaries of any surplus resulted from the investment should be the populace of China who foots the bill of inflation. Even if the gains are not given out to the people, they should be committed to public causes which are related to the people's livelihood, namely medical insurance, unemployment benefits and subsidies to water, electricity, and gas that everyone need to use, and so on.

Now let's look at whether or not China has the capacity to save the EU.

When the EU was hoping that China would inject one trillion to European Financial Stability Fund, they seemed to imagine that all those reserves are sitting idly inside the gold chest of China's central bank and needs to go somewhere. That's not true. To alleviate the pressure of inflation, China has long resorted to all channels to relieve the pressure of its foreign exchange reserves: they bought bonds from other countries, invested and encouraged individual use of foreign exchanges among its people, so on and so forth.

Beijing had ceased to be the country pumpkin miser that knew nothing but to bury its gold underground long ago. It has been contemplating ways to make good use of this foreign exchange asset. Since 2003 or so it implemented the policy of “a basket of currencies” to diversify its foreign exchange reserves; and from 2008 on, Beijing increased its purchase in EU bonds, Japanese yen has also become its target. Now the greenback makes up only about 70% of China's foreign exchange assets.

Although China has been reluctant to disclose information of its baskets of foreign exchange reserves, such as the specific ratios of euro, the greenback and the Japanese Yen, based on rough calculation we could still get an idea, albeit inaccurate, of the respective amounts of foreign currencies in China's reserves: $1.15 trillion in US bonds; €500 billion in euro bonds; as for the Japanese bonds, the specific figure could not be worked out.

Apart from these, China signed currency swap agreements [with other countries.] To cite an example, it struck a deal with Russia [in exchange] for over twenty billion US dollars worth of petroleum. It also reached agreements with ASEAN countries. Currently, China has only about 500 billion in foreign exchange reserves that is available, the minimum amount needed for paying three months of imports and clearing all short-term foreign debts.

We can say that the over three trillion worth of foreign exchange assets are by-and-large committed here and there. The EU's request that China inject one trillion in the Eurozone is nothing but sheer wishful thinking.

[Instead of looking for outside help,] the EU countries should make their peoples understand that there will come a day when “free lunch” is no longer served and take the opportunity to cut the exceedingly heavy burden of welfare benefits that is driving these countries broke. Sweden at one point had a stagnant economy because of high welfare benefits and staggering taxes that made its people less motivated to work, causing businesses to move out of that country and various problems for a long time.

But in 2006, there was a political earthquake in the country: the left-wing political party that had been governing the Sweden for sixty-five years consecutively lost in the general election, the conservative that stressed market economy came to power and was reelected in 2010. It was then that Sweden started a comprehensive reform package: lowering the tax rates; scaling back social welfare; lifting the various restrictions imposed upon corporations; and abolishing the inheritance, and gift taxes. As a result of these measures, Swedish economy is slowly gaining back its vitality. This country serves as an example for the EU countries to learn from.

China's own economic problems have only just begun. Judging both from the country's capability and its investment strategy, China's decision not to inject more money into the Eurozone should be seen as a wise move of self-protection.