China and the Doomsday Scenario for Europe
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The Fiscal Times
September 14, 2011

What was once considered a worst-case scenario is quickly becoming a real, if not a likely possibility: A European country—most likely Greece, but maybe Italy or Spain—is going to default in the very near future.

Germans are quietly scrambling to make contingency plans. They might back a Eurobond. They might create a European monetary union. Or they might kick Greece out of the eurozone.

Officials in the United States are in an early state of panic. Treasury Secretary Tim Geithner sternly warned European leaders last week that Europe’s larger countries must act now to save the economies of the smaller ones. Meanwhile, the U.S. economy stands at the brink of a double-dip recession, while politicians squabble endlessly on how to lower debt and spur growth. 

But efforts to stave off another economic downturn would be useless in the event of a Greek, or Italian, or Spanish default. Markets have shown in recent weeks that there is little faith in European politicians to solve the Continent’s problems; confidence in American politicians is not much better. A default would devastate European banks, sparking an economic tidal wave that would sweep west from Athens across the Atlantic. It could bring the already fragile U.S. and European economies to the brink of disaster.

“Politicians do little tricks here and there, throw money around right and left,” says Charles Wyplosz, a professor of International Economics at the Graduate Institute of International Studies in Geneva. “With Spain and Italy, we are now talking about 2 trillion euros [about $2.7 trillion]. That’s big, big, big. And they can’t just play around with that. The size of the thing brings the moment of truth forward.”

If and when this moment comes, options to counteract it are few. The European Central Bank does not have the power of the Federal Reserve, so it would be unable to take the kind of action the Fed took in 2008 to stave off the crisis. In the U.S., the kind of spending required to save the economy through cash infusions similar to the ones made in 2008 is unthinkable in the current age of austerity.

So who remains to play savior to the United States and Europe? Look eastward.

China, the Last Man Standing
A Chinese bailout of Europe and the United States is not likely, but it’s also not beyond the pale. In fact, it’s a possibility that’s already been floated by China.

For instance, in December 2010, Chinese Foreign Ministry spokesman Jiang Yu offered to purchase European debt with his country’s $2.7 trillion overseas investment fund. In June of this year, Chinese Premier Wen Jiabao floated the idea again. “China is ready to work with Europe to share opportunities, cope with challenges and achieve common development,” Wen said at a June event in Hungary. 

Late Monday, markets rallied on the rumor that China was willing to buy Italian debt at auction this week. Italian officials confirmed the rumor today, stabilizing European markets in trading Tuesday.

If a European country were to fail, China, with its vast economic reserves, might ultimately benefit from a direct intervention.  Still, says Mitchell Orenstein, a professor of European studies at Johns Hopkins School of Advanced International Studies, “China is very careful not to take any action that would undermine the sovereignty of other nations, so it would be extremely complicated for the Chinese to get involved in Europe’s playing field.”

China has yet to offer assistance to the U.S., its rival for global economic dominance. But in a doomsday scenario, the United States might not have any choice but China. Europe couldn’t help, and the Federal Reserve has pretty much run out of bullets.

U.S. politicians often speak of the danger of borrowing so much money from the Chinese. But in reality, the relationship is a two-way street. China has the money to lend the U.S. because American consumers purchase Chinese goods. If American consumer spending were to stagnate, the Chinese economy would take a direct hit. So the terms of a bailout deal would not be so draconian as to severely damage the U.S. economy.

A Chinese bailout of Europe and the United States is, of course, the last option. But just the fact that it’s not implausible shows just how dangerous the financial situation in the West is and how close Europe is to the brink of disaster.

Of course, the insolvency of a European nation wouldn’t be great for the wider global economy either. China would suffer as well. But once the dust cleared, it would be in a position of enormous economic strength compared with the United States and Europe.

An editor-at-large for The Fiscal Times, David Francis has reported from all over the world on issues that range from defense to border security to transatlantic relations.