Slowing China Won’t Rescue the Eurozone

I was in China for much of last week, watching the eurozone crisis unfolding from a safe distance. There have been many contenders but this was the eurozone’s worst week. Greece’s on-off referendum may have all been about domestic politics but it also called the bluff of Angela Merkel and Nicolas Sarkozy.

They, for the first time, accepted that the departure of a member country was possible, indeed could be brought about by a democratic vote. Their tactic may have been intended to stoke up the pressure on the Greek people but it let the cat out of the bag. There is no such thing as a permanent, irrevocable monetary union.

All those learned pieces saying euro break-up was not possible because there was no mechanism for it were as daft as they always seemed. In desperate circumstances, governments do desperate things, whether treaties allow them to or not.

As for the G20 in Cannes, tasked six weeks ago by George Osborne with saving the world, it was the dampest of summit squibs. The one decision, to increase the resources of the international Monetary Fund, has been signalled so often that you believe it when you see it.

The “grand plan” agreed in Brussels 10 days ago is no clearer on the detail of how the rescue fund, the 440 billion euro European Financial Stability Facility, will be boosted to 1 trillion. The Greek shenanigans have taken us further from that.
What the past week has given us is a glimpe of the kind of disorderly break-up the euro could face when democracies are stretched to breaking point by protest and even big debt writedowns solve nothing.

I am all for an orderly reduction in euro membership, having argued a Greek exit, properly handled, is the best outcome. The key is “if properly handled”. That means successfully ringfencing other vulnerable economies and gaining market confidence. It is hard to have any confidence in the ability of eurozone leaders to achieve this.

So the eurozone, which the new president of the European Central Bank (ECB) Mario Draghi conceded is heading into “mild recession” (which could be a highly optimistic forecast), remains the big threat to the world and to Britain. The ECB cut its key interest rate from 1.5% to 1.25%.

The crisis will run and run. As things stand, it is no nearer resolution than it was in May 2010, the first Greek rescue.

I mentioned I was in China. One issue I was exploring was whether the country would be the eurozone’s sugar daddy. Even before the question of Chinese assistance through bond purchases was kicked into the long grass by Greece, it was clear hopes were being unrealistically raised.

Seen from China, any decision to purchase eurozone assets will be done – as everything is done – in the national interest. If there is a case in terms of diversification of reserves or because the return is attractive, China may act. There is no question of a modern version of Marshall Aid. China may be the world’s second largest economy but its 1.3 billion people remain poor, on average, by Western standards.

Not only that, China has her own problems, the other thing I was keen to explore. There is no shortage of pessimism about China, inside and outside the country. Analysts point to a property bubble bursting and an inflation problem disguised by official figures. Some hedge funds have done well betting against China.

China is attracting some colourful analysis. Albert Edwards, Societe Generale’s super bear, says China’s economic situation is “precarious”, “a credit bubble waiting to burst”. A soft landing is, he says, “surely yet another pyramid of piffle”.

Charles Dumas and Diane Choyleva of Lombard Street Research, in a new book The American Phoenix (which is upbeat about America), say China’s “red-hot” economy will slump in the remainder of 2011 and 2012. Its model of export-led growth, they say, has broken down.

How seriously should we take this? When you visit China, the story is familiar. The pace of development is blistering, cities expanding upwards and outwards. The anecdotes about money badly spent on shopping malls, roads, railways and other infrastructure projects are legion.

So is the fact that, while a growing Chinese middle class has never had it so good, life for the majority is tough, sharply rising prices making things uncomfortable.

China is still a fast-growing economy, however. Growth in the third quarter was 9.1% and so far this year 9.4%;. four times the rate, at least, of advanced economies.

Bearishness about China is not new. Analysts have been calling an end to the China growth story for most of the 33 years since it embarked on its reform-based revival, a period that has seen growth close to 10% a year. So far they have been wrong.

China is different. Even before the global crisis, there were worries about non-performing loans in China’s banks, a property bubble and debt hidden in local government and state-owned firms. The fears are back but need to be put in perspective.

China still has an underdeveloped financial system. Mortgages are only about 14% of GDP. There is not the leverage to cause advanced-economy type problems.

China also has the firepower most of the rest of the world can only dream of. It showed it three years ago by unveiling a $586 billlion fiscal stimulus and cutting interest rates and bank reserve requirements, instantly boosting credit.

More recently it has been raising rates and tightening reserve requirements, slowing the economy. But those moves could be reversed. HSBC says China is the least vulnerable of emerging economies.

So, piffle or not, it looks like a soft landing. Growth will slow, but to about 8% next year. The growth target under the current (2011-15) Chinese five-year plan is 7%.

Does Chinese growth matter for Britain? British exports of goods to China are growing, up an annual 15.9% in the latest three months, while imports from China fell 7.5%. But there was still a £5.49 billion goods deficit in the latest three months.

Britain sells other things to China. On my visit I gave a lecture at Nottingham University’s Ningbo campus. Education is an important and growing export to China, as are financial services, business services, civil engineering and so on.

We have an interest in China’s growth. We have a bigger interest in the eurozone avoiding disaster. You can be more confident about the first than the second.

My regular column is available to subscribers on This is an excerpt.

This post originally appeared at David Smith’s EconomicsUK and is reproduced with permission.