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Eurozone’s Collapse: China’s Geopolitical Nightmare?

Feb 12 , 2015

In the early days of 2015 Chinese President Xi Jinping emphasized the rising threats in China’s security environment and the need for increased alertness of the communist party. Xi has been bold and transformational in bringing China to the global stage, capturing headlines around the world with multibillion-dollar investment initiatives like the New Silk Road and the formation of new regional and global order institutions like the BRICS development bank and Asian Investment Infrastructure Bank (AIIB). However, the current tragedy in Europe has been ignored, and deserves serious attention for China’s sustained political and economic vibrancy.

Following the revelation of UK’s cabinet meeting on a contingency plan from a potential Greek exit from the Eurozone, analysts now predict a 50 percent possibility of Greece doing the unthinkable and dropping the Euro. A potential “Grexit” would be perhaps devastating for the economic and social stability of the EU – the largest market in the world and China’s largest trade and technology partner. Public opinion in Italy is against the Euro; it is seen as the key reason that the all-powerful Italian industry lost the emerging markets to Germany. In Spain and Portugal left “Eurosceptic” parties are currently leading the polls boosted significantly after Syriza’s triumph in Greece. A Grexit could thus trigger a political domino effect that would end 50 years of seemingly irreversible European integration and create a significant moral hazard for the future of the European dream.

Apart from the potential losses in investments in Greece and Europe that a prolonged EU crisis would have for China, implications could reach strategic dimensions and adversely affect the country’s economy and long-term national security strategy for a peaceful recovery from a century of chaos.

Geo-economic Implications of Eurozone’s Collapse for China

While the communist party has undertaken a series of reforms to boost internal consumption and diversify China’s economic growth model, the Chinese economy is still highly dependent on enormous export flows that amass to about 15% of the Chinese GDP. Almost a fourth of these exports are directed to the European Union. Latest data highlight that Chinese exports in the beginning of 2015 have underperformed while Chinese GDP growth stands at 7.3% – a two decade low. A Grexit would thus, at least in the short-to mid term, destabilize the European economy and substantially harm Chinese exports to Europe adversely affecting Chinese GDP growth that could fall bellow 7%.

Add to this scenario the insights of President Obama’s SOTU address and the need for the U.S. to write the rules of the trade game in Asia with the TPP and China would face a geo–economic encirclement that could cut growth to the lower 5 if not 4 percent. A divided Europe could also make TTIP negotiations proceed faster, raising yet another obstacle to Chinese exports. Such a trade catastrophe would heavily impair the Party’s rhetoric of a prosperous society and a harmonious middle class. After all Xi Jinping had himself admitted to President Obama two years ago that his biggest nightmare has been a potential inability to offer jobs to the 20 million Chinese workers who immigrate from the villages of China to its megacities every year.

In addition to the trade shock China would have to face the unilateral monetary hegemony of the United States and the undeterred position of the U.S. dollar as a reserve currency well into the 21st century. This perplexes Chinese economic and strategic environment as the U.S. “exorbitant privilege” to pay its debt in its own currency allows Washington to fund the world’s largest military budget and also support it’s internal welfare system that keeps the U.S. society harmonious. Without the dollar as a reserve currency the U.S. would need to follow a more contractionary fiscal policy that would limit its military posture in Asia or else risk societal collapse due to the impossibility of the federal budget to fund both a record military spending and an advanced welfare state.

China had slowly but gradually followed a strategy of diversification away from the U.S. dollar with the Euro seemingly been the best alternative and Chinese leadership has been vocal on the need for a strong EU. However without the Euro China would have no immediate choice but to continue funding U.S. deficits by buying treasury bills, accept U.S. expansionary monetary policy and even see the real value of its currency reserves declining.

To break away from U.S. monetary primacy, the end of the Euro would thus leave China with a pressing choice to liberalize its well-guarded financial sector, as this is a first order economic condition to promote the internationalization of the RMB. In that case however Beijing would have to face the intrusion of Wall Street finance and thus see the leverage that the party has in the Chinese economy decreasing substantially. In addition without the Euro, negotiations at the IMF’s special drawing rights would leave the U.S. as the leading power and China’s long-term global monetary interests would also suffer.

Geopolitical Implications

Chinese leaders had immediately rejected a U.S. proposal for a G2 back in 2011 staying committed to decade long declarations for multilateralism and a multipolar world order. Crucial for the Chinese strategy has been the role of the EU to balance U.S. global engagement not only in trade and commerce but also in political and ideological affairs.

If the U.S. attempted to contain China at least economically, a strong EU would oppose such a decision and China would never be cornered. This stems from the evident position of the EU as a security neutral behemoth in East Asia. The EU has no military installations in the Chinese sea and no security commitments to Asian allies and although in a case of a U.S.-China military engagement EU states would have to support the U.S. due to NATO’s article 4, in a non-confrontational yet highly competitive Sino-US relationship the EU blocks China’s containment.

However as a Grexit would lead to increased uncertainty and instability in Europe, a window of opportunity would open for United States that could utilize EU’s internal distress to intensify its 2012 pivot to new levels. As the recent rising trilateralism among Japan, India, and the United States highlights, China now risks facing a powerful coalition of countries from both its western and eastern front. The economy of those three countries combined is more than 250% bigger than China’s and their aggregate military expenditures 4 times higher. U.S. and Japanese technology could also accelerate Indian growth and thus create a formidable economic/ technological competitor in China’s Western frontiers. Eventually Japanese and U.S. companies could also outsource their production to India and further cut Chinese growth and employment before China’s move from “assembled to designed in China” economic model.

Finally the Economic collapse of the Eurozone and the political chaos in Europe would negate President Xi Jinping’s initiative for the one belt one zone megaproject. The project had two main aims. First to connect China to an increasing set of neighbors and most importantly to connect China with the European market by rail and sea. Such a multidimensional project demands concerted effort and also needs EU commitment. Without a strong EU the project would take longer to be built and also would produce lower returns as the trade flows would be below expectations.

Evading the nightmare

Chinese leadership has not been surprised by the tragic events in the Eurozone. It is not accidental that both president Xi and Premier Li visited Greece last year and that in this crucial week a Chinese flotilla will visit the Pereus port in Greece where China has strategically invested since 2008. Beijing supports weaker Eurozone member states and since 2009 has directed its investments to European periphery states. Continuing to do so will remain important for advancing the EU’s sui generis project and limiting the risks of disintegration. However the larger geo-economic and geopolitical game also includes U.S. engagement in a harmonious partnership with China.

In the early 20th century the founding father of modern China, Sun Yatsen saw in trade a powerful force for peace and prosperity. Since President Wilson has proposed a League of Nations to end military war in the future, I desire to propose to end the trade war by cooperation and mutual help in the Development of China. This will root out probably the greatest cause of future wars,”Sun declared. This is a statement that must shape the operational code of both U.S. and Chinese elites. Independent of the concurrence that is inherent in the interstate system, Sino-U.S. competition can be rule based and always shaped by multilateral rather than unilateral and arbitrary norms.

A great opportunity for both China and the U.S. is to engage together in a summit along Europe with the inclusion of the IMF to safeguard the stability of the Eurozone and shape a global norm on tax evasion and tax heavens that have adversely affected insolvent states like Greece. This will be a pragmatic diplomatic pillar to build a sense of community and tame unnecessary selfishness and old cold war zero-sum mentality. A strong statement by both President Obama and President Xi on the importance of development and growth in Europe would be an auspicious omen for both Europe and sustained Sino-U.S. cooperation.

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