This is a historic moment for the eurozone. The sovereign debt crisis has put European monetary union in jeopardy and called into question the sustainability of the European project. Given the economic and political weight of the eurozone, the crisis has the potential to match the damage wrought by the 2008 US financial crisis on the global economy. So China should welcome last week's agreement in Brussels and, in advance of the G20's meeting this week in Cannes, consider using its wherewithal to lend a supporting hand.
Europe is China's largest trading partner and China is Europe's second largest trading partner. Their bilateral dealings were valued at €363bn last year. In 2009, the onset of global recession cut China's exports to the EU by 15.6%, resulting in a sizable surge in unemployment and factory closure in southern China. A deep financial crisis in the eurozone and the resulting reduction in spending would be felt particularly strongly in export-oriented provinces in southern China. To the extent that a supporting hand from China can contribute to a creditable resolution of the sovereign debt crisis and limit its negative impact on economic growth in the eurozone, there is little reason for China to stand on the sidelines.
Maintaining the euro as a reserve currency is in China's interest. China currently lacks the necessary institutions that would permit the country to adopt a floating exchange rate regime with free capital flows. The People's Bank of China, the country's central bank, isn't run as an independent monetary authority. And even its monopoly control over monetary policies can sometimes seem questionable. Under the prevailing institutional environment, China's only viable option is to maintain its currency peg, but add some upward flexibility on the exchange rate.
A stable euro, underpinned by sound monetary policies of the European Central Bank, would offer China more options in managing its monetary policies. It would give Chinese policymakers time to diversify its foreign exchange reserves and to correct the imbalance in its economic structure, while creating a relatively stable economic environment that is conducive to longterm economic development.
A prosperous Europe also offers the best chance of creating a multipolar global economic system. As the US enters another election year, it is again open season on China. With Republican candidates and the Democrat-controlled US Senate clamouring to label China a currency manipulator, trade and investment frictions are bound to increase. China will need to rely on the independence and impartiality of the WTO in adjudicating any future trade disputes with the US, and only a multipolar global economic system can guarantee this.
Even as China agrees in principle that it will contribute to the European rescue plan, details of the support will need to be negotiated. For Chinese participation to receive broad political support both at home and in Europe, the rescue plan must provide sufficient safety margins for success. China cannot be expected to lose money in this venture, although it should not have the right to dictate economic policies in the eurozone.
While uncertainties can never be completely ruled out, last Thursday's agreement represents a solid step toward resolving the crisis. China's participation could bring a sizable amount of capital to bear and should materially improve the chance of success.
How can China help? It could contribute to the European Financial Stability Facility (EFSF) directly or by providing it with a back-stop on request. EFSF, which is owned by eurozone governments, looks like a safe bet so long as measures can be taken to mitigate the exchange rate risks that China faces. For example, part of the contribution can be denominated in Chinese yuan. China could also contribute to a European rescue fund within the IMF.
And what would China ask in return? It could ask for the EU to recognise its market economy status. This would be a symbolic victory for China, since the EU has acted largely responsibly over trade with China in the past. And since it is symbolic, the EU could equally refuse to do so. Either way, both sides win, or at least don't lose, on the political scoreboard.
China could use this opportunity to raise its share of voting rights in the IMF by taking over additional voting shares from European countries. This would increase China's influence in this multilateral institution commensurate with its economic weight in the global economy. By participating in the rescue plan, China announces to the world that it is a willing and responsible stakeholder.
By Li Wei, a professor of economics at Cheung Kong Graduate School of Business, Beijing.