25/11/2011: Dear China, give me your money! Signed: the euro

In trying circumstances, European leaders can lose their aplomb, and naively expect counterparties to behave outside of economic etiquette. We can learn a lesson from China.

A couple of weeks ago in Brussels, to save the euro once and for all, leaders agreed to create an off-balance-sheet, special-purpose investment vehicle to the European Financial Stability Facility. This SPIV to the EFSF would be fed with capital from China, Japan, Brazil, Norway and anyone else with a vested interest in the euro's survival. That was the idea.

Hence, after negotiating through the night of 26-27 October, tired European leaders told bleary-eyed journalists that French President Sarkozy, still perky, was on the phone with Chinese Prime Minister Hu Jintao, begging him to back the plan with funds. So far, none of the potential donors has agreed to fund the EFSF, even after detailed explanation by European leaders at the G20 in Cannes. Distrust not only of the EFSF but also the ability of Europe to resolve its own crisis is profound.

Shameful, in my view, is that such a rich continent as Europe now needs external help from emerging markets to save its own currency. This walk to Canossa answers the question of whether the euro could ever rival the US dollar once and for all with a resounding “no!” There are more fundamental flaws imbedded in the plea for foreign aid, however. They come from international bookkeeping.

If China gave 500 billion euros to the EFSF, this would be an import of capital to the Eurozone from China. So what would stand opposite this import of capital in the ledger? Very likely it would be found in the current account balance as a deficit, implying an increase of the Eurozone trade deficit with China.

The US is getting much more money from China than Europe and the Eurozone ever will. In fact, the vast US current account and trade deficits mirror the massive growth of China's dollar reserves through buying of US treasury and agency bonds. The US never explicitly asked for this money, but did not refuse it, either. Current grandstanding by US politicians about Chinese currency manipulation aims to reduce those deficits and ultimately – by extension – at not accepting Chinese money as capital anymore.

By asking China to contribute to the EFSF SPIV, Eurozone leaders are taking a path opposite to that the US pretends to cancel. But I am not sure that European politicians really grasp the full implications of the EFSF SPIV. Begging China for money invites the fox into the henhouse, even if China does not seize the chance to leverage its own agenda.

In international macroeconomic quid pro quo, a benefit (funding) requires eventual payment. Here the Chinese are more thoughtful economists (and bookkeepers) than Europeans. Europe's petition to China will be answered: “Dear Europe, open your markets to our exports wider first, then we might consider investing into your funny currency.” China is right in this.

European politicians might consider this response a form of blackmail, but it is merely normal economic behavior. Especially in international markets and capital flows, no one gets a free lunch.