The Euro crisis is a global problem

As the current Euro zone crisis appears to be hanging on a knife-edge the debt ridden nations of southern Europe seem to be looking towards the BRIC nations (Brazil, Russia, India and China) to aid in solving their sovereign debt problems. China has been the most outspoken about the issue and last week, China suggested that it might be prepared to help Europe by acting as a buyer of last resort by making a major purchase of euro-denominated bonds. The Euro crisis is not just a problem that threatens the future of the European economy, but of the whole global economy which is currently as fragile as ever; picture a frozen lake with many cracks already appearing, and a person, who cannot stop themselves, running down a hill towards this lake. This person, who we’ll call “Europe”, may break the whole lake if they cannot be stopped and run over it. A similar situation may occur if various nations in the Euro zone cannot be saved. China especially has an increased interest in the EU as they are the largest market for exporting Chinese manufacturers.

Debt Crisis in Europe – China and EU flags

It would appear that, at the current point in time, it is not even Greece that is the main problem, but rather Italy. Italy is a member of the G7 and thus has one of the largest economies in the world and a sovereign debt which is larger than all of the other PIIGS nations put together therefore poses the greatest threat. As this is the case however, it may be that as Italy is too big to be allowed to fail, it may also be too big to bail. Even Germany may not be able to credibly rescue Italy. The EU does not have a large enough amount of money to be able to scare the markets into submission; therefore they must look east to China with its foreign reserves of over US$3 trillion. Whereas Italy may pose the greatest relative threat to the Euro crisis, Greece poses the most immediate as it has become more a case of when it will default rather than if. A Greece that defaults may destabilize the global economy and hurt the Chinese economy as a breakup of the euro zone would be disastrous for Chinese manufacturers.

A window of opportunity for China

There has been a great debate in recent days about whether China should come to the rescue of failing Europe or whether it is structural reforms that Europe needs and not a bail-out. One side of the argument is that the IMF should go to the BRIC nations as well as maybe Saudi Arabia and Japan to extend a line of credit to the worst affected Euro nations to cover the cost of borrowing while insisting reform over a period of years. In this scenario China would have to be the largest creditor and could stand to benefit from such a move. It could have greater lines of influence in the EU and also the IMF which is currently US dominated.

The US became the world’s creditor after most of the world was debt ridden in the mid twentieth century after two costly world wars. China currently stands next to a similar window of opportunity. Its recent European push comes after years of investment in Africa spent securing mostly natural resources. However Chinese firms now see Europe as an attractive investment destination as all these companies that have grown due to a low-cost “buy direct from China” mentality now realize that they need to go to the next step and have technologies that make a difference and brands that have customer loyalty. Nevertheless, some Chinese economists would argue that China needs to address the needs of its own people and economy before investing a large amount of reserves in Europe.

BRIC Building?

How will BRIC Nations react to European Debt Crisis - Leaders of the BRIC nations

Despite this, there are many skeptics who believe a BRIC rescue is not the best solution. In many people’s opinion, the EU is in need of structural governmental and financial reform not a credit extension. This seems a rather credible argument as the ECB is in disarray and is unable to decide on a suitable contingency plan should the BRICs not provide a life-line. Also, from a purely economic perspective, EU bonds are a bad investment. They offer low yields and a high default risk, an unattractive prospect for any potential investors. There are also political reasons why a BRIC bailout may be risky. Brazil has publicly announced its plans to diversify its reserves away from dollar domination so therefore its intentions are purely selfish with no intention of aid. Also, the BRIC nations, mainly Brazil and India, may ask for political favors in return for investment in European sovereign bonds. They may ask for some involvement within the UN Security Council or offer trade terms in terms of liberalization. This could be a risky move if Europe agreed. It would appear that a very credible solution for the BRICs to aid the global recovery without buying European bonds would be a drive to boost global aggregate demand. This could be achieved through large-scale investment in infrastructure projects in emerging markets which would offer, most importantly, a non-inflationary way to boost global aggregate demand.

The next few weeks will not only be incredibly interesting from an economic perspective but also crucial in determining the fate of the global economy for the foreseeable future. For now, China’s recent involvement in the EU has been more charming than helpful with many expressions of faith aimed at building trust rather than real solutions translated into large disbursements. If China is the key to saving Europe from impending doom it needs to act hard and act soon.

  • Neil Rylander, CPG Marketing Intern