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China has too much to lose from a messy European bust-up

China’s currency reserve managers would do well to begin early preventative measures

PUBLISHED : Monday, 27 February, 2017, 10:55am
UPDATED : Monday, 27 February, 2017, 11:00pm

It is a worrying time for investors right now, and the world can ill-afford another financial crisis following on the heels of the 2008 global crash.

It is a prospect that markets need to take very seriously as Europe heads for a potentially messy break-up. And that could leave China’s economy badly exposed.

The country’s currency reserve managers would do well to begin early preventative measures

China’s policymakers already have their work cut out tackling a host of homespun problems. Its housing boom, the explosion of household and corporate debt and steep industrial overcapacity remain deeply challenging.

The last thing they need now is the threat of any new external shock.

As one of the world’s foremost trading nations, China is extremely dependent on a thriving global economy to stand any chance of hitting a GDP growth range of 6 to 7 per cent this year.

Forecasters might be hoping for a better post-election US economic boost, but it is Europe that needs careful watching right now.

Upcoming French elections in May, a failure to strike a new bail-out deal with Greece and the groundswell of European populism all threaten to blow Europe into a deep crisis this year, placing its survival as a political and economic union in deep jeopardy. The consequences could be deadly.

The importance of Europe to China’s economy is unquestionable.

The ominous march of European populism that may prove too much even for Europe’s fudging lawmakers to salvage

Germany and France both pip America as China’s two biggest trading partners, so what happens to Europe in coming months will be far more critical than hopes of better things to come from US President Donald Trump’s economic reflation plans.

It works both ways. German bilateral trade with China is worth up to US$170 billion annually and a key driver of German business optimism at the moment. Thanks to the weaker euro, German exporters have gained a vital advantage, boosting IFO’s business climate index to a three-year high in February.

Germany’s export success has helped push the economy to the top of the G7 growth tree, with annual GDP growth currently running at 1.9 per cent. And it has been a big factor behind Germany’s unemployment rate falling to a new post-second world war low of 5.9 per cent.

Strong growth and low unemployment, coupled with healthy trade and budget surpluses, look great on paper for Germany – but it is aggravating the “politics of envy”, especially among those European economies faring less well, like Greece, Italy and Spain.

It is rubbing up European voters fed up with endless austerity, high unemployment and falling living standards. And it is stoking up the fires of anti-EU sentiment and national populism, dangerous tendencies threatening European unity in the wake of Britain’s Brexit vote and Trump’s shock US election victory.

Winds of change ... Le Pen is tapping into a ‘zeitgeist’ of anti-establishment feeling in France and calling for a referendum to quit the euro

These winds of change are making investors extremely nervous about the possible election of French far-right National Front candidate Marine Le Pen in presidential elections in May.

Le Pen is tapping into a “zeitgeist” of anti-establishment feeling in France and calling for a referendum to quit the euro.

While opinion polls suggest Le Pen will be squeezed out in the second round voting in May, it is the fear of the unexpected that will haunt markets with a vengeance over the next few months.

The unforeseen Brexit and Trump outcomes are cogent reminders that markets need to stay very wary.

It is the reason why European policymakers are leaving nothing to chance and will be battening down the hatches and papering over the cracks in the next few months. The European Central Bank is going overboard to accommodate faster euro-zone recovery, while EU officials are bending over backwards to stop a calamitous debt default by Greece before a key repayment deadline in July.

Whether this succeeds, or not, remains open to a lot of doubt. Le Pen may be squeezed out and Greece may be bailed out a bit longer, but it’s the ominous march of European populism that may prove too much even for Europe’s fudging lawmakers to salvage.

When the house of cards finally comes crashing down, shockwaves will be felt across the globe, harming world trade flows and financial markets. Stock market optimists could end up being caught badly “long and wrong”.

China will just have to grin and bear any potential downturn from its European trade. But if the euro’s survival looks in doubt, protecting the nation’s US$3 trillion official currency reserves from any subsequent exchange rate fallout is paramount.

China’s currency reserve managers would do well to begin early preventative measures.

David Brown is chief executive of New View Economics

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