This week China told the world that it’s committed to helping Europe solve its debt crisis. Like a lot of official Chinese statements, what that means is open to interpretation. Financial markets chose to read the news as a sign of future financial commitment. The euro on Wednesday strengthened 0.3 percent, to $1.31, and Chinese stocks rose to a two-month high.The euro subsequently slid to $1.29 on Thursday morning before rising above $1.30 again.
Yet China hasn’t offered details about the size or even the nature of its new commitment. On Tuesday, Chinese Premier Wen Jiabao said China’s support for Europe is “sincere and firm.” A nice sentiment, but by no means a hard pledge to start buying up euros. “There’s still no money on the table,” says Steven Dunaway, an adjunct senior fellow at the Council on Foreign Relations and an expert on international economics and China. “The markets are being too optimistic here. This is by no means a solution to Europe’s problems.”
The only thing that can be taken as a sure thing from the recent statements is that China doesn’t plan to sell its euro holdings. “China will always adhere to the principle of holding assets of EU sovereign debt,” People’s Bank of China Governor Zhou Xiaochuan said in Beijing on Wednesday. That alone might’ve been enough for markets to breath a sigh of relief. “Perhaps the market was building in a significant risk that China was gonna dump its euro holdings,” says Derek Scissors, an Asia economist at the Heritage Foundation. “But by no means is this an indication that the Chinese are going to surge into euros.”
China has a significant interest in keeping the euro alive. Europe is the biggest market for Chinese goods, and without the euro as a stable currency, China would have little choice but to increase its holdings of dollar-backed assets, something it has been trying to diversify away from.
The best case scenario for Europe would be for China to buy up risky Italian, Spanish, and Portuguese debt. But that’s not likely, given China’s longtime aversion to risk. “China does not want direct exposure to Southern Europe,” says Desmond Lachman, a resident fellow at the American Enterprise Institute and a former deputy director of the International Monetary Fund. “The bottom line is that China will look after its own interests. They do not want to be the dumb money at the table.”
A much safer move would be for China to contribute to Europe’s bailout funds, the European Financial Stability Facility, and its permanent successor, the European Stability Mechanism. Earlier this month, during a meeting with German Chancellor Angela Merkel in Beijing, Wen raised that possibility. Securities issued by the AAA-rated EFSF are backed by guarantees from the euro area’s 17 member states and would carry a small return if China were to invest in them.
Most China experts, however, believe that China will ultimately funnel its investment through the IMF, which is still regarded as the safest option. The IMF is backed by the commitments of its 187 member countries and has a much longer track record than the EFSF, which was created in 2010. “In so far as China supports the euro, it will do so in a way that fully protects its investments,” says Kenneth Lieberthal, director of the Brookings Institution’s China Center. “Parking their money at the IMF insures them against losses and provides them a nice risk buffer.” Investing in the IMF would likely carry a lower return for China than investing in the EFSF.
However China decides to support Europe, it’ll most likely want something in return: a bigger voice at the IMF or certain guarantees on its investment. “Who knows, they could push Europe to give them early recognition of market economy status,” says Scissors. China is slated to be given market economy status by the World Trade Organization in 2016, assuming its currency is fully convertible by then, which means the state would have to give up its tight capital account controls. Were China considered a market economy, it would be tougher for countries to impose dumping surcharges on Chinese exports. Last September, Wen floated the idea that China would like the EU to beat the WTO to the punch by conferring market economy status sooner rather than later.
In the end, whatever support China does give Europe, it’s not likely to be a game-changer. Europe will ultimately have to solve its debt crisis itself. But there is a sense that the Chinese are relishing their new-found position of power. “There’s no question that China, more so than the U.S., has an interest in not seeing Europe blow up,” says Lachman. “But to a degree they appear to like having the Europeans come begging them for money. It makes the point that China is on the way up and Europe is on the decline.”