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Wednesday, June 29, 2011

Beijing bets on the euro


LONDON — The deadline is now July 3. That's when the European Union's finance ministers meet again, and by then the Greek parliament should have passed legislation mandating ?28 billion of spending cuts and tax rises over the next five years.

If it goes through, each of the 10 million Greeks will ultimately be about ?2,800 ($4,000) poorer.

That's why they're rioting in the street these days in Athens. But unless the European finance ministers approve the plan, Greece will not get the next ?12 billion ($17 billion) installment of the current EU-International Monetary Fund bailout package in July, and it will default on its gigantic debt.

As the IMF recently warned, "A disorderly outcome cannot be excluded." It was hinting that the euro itself might crash, taking the European or even the global economy down with it — and yet China seems strangely unworried.

Used-car salesmen know that if you don't give the customers credit, they won't buy your cars. For the past decade China has operated on the same principle, lending the U.S. government money in order to keep the dollar high and the orders for Chinese goods flowing. Beijing now holds $1.15 trillion of U.S. treasury bills — but as of late last year, it has stopped expanding its dollar holdings.

This makes sense, given that the U.S. budget deficit is 11 percent of GDP. The U.S. is so deeply indebted that it might be tempted to inflate its way out of its problem, and nobody wants to be sitting on a pile of a trillion dollars when the value of the currency collapses. What is astonishing is that China is now buying large amounts of euros instead. So what do the Chinese know that the pundits don't?

They know that there is nowhere to hide. Holding euros is risky, but holding dollars is riskier, and the British pound and the yen are only marginally safer. China has to put its money somewhere, and it calculates that the euro is not quite as bad a bet as it seems. Even though Greece certainly will default at some point, and probably quite soon.

Greece can never repay the ?300 billion ($425 billion) it owes, no matter how harsh the austerity measures that it forces on its own population. If it still had its old currency, it could make the debt shrink by printing more drachmas and inflating the currency, but it's stuck with the euro.

Like other Mediterranean countries that joined the euro, it has a less efficient economy than the big northern European countries that dominate the currency. It used to stay competitive by letting inflation rip, thus making its exports cheaper in foreign markets. But the European Central Bank keeps the euro's inflation rate low, so now it can't do that.

It's a trap. The euro's low inflation rate meant a low interest rate, so although Greece could not keep its economy competitive, it could borrow money very cheaply. And since the euro's value is backed by much stronger economies the banks were willing to lend Greece large sums. Ridiculously large sums, in fact. So large that Greece could never pay them back.

Didn't the banks realize this? Of course they did — but they reckoned that the richer countries in the euro zone would cover Greece's debts in order to preserve the integrity of the currency. That is what is happening now.

The banks stopped lending Greece money after 2008, and the European Union stepped in to prevent a default. The enormous sums that it and the IMF are now lending Greece (at a high interest rate) are immediately handed over to the foreign banks that let the situation get so far out of hand in the first place. But the political price extracted from Greece for this bailout is savage cuts in the country's budget and a soaring unemployment rate.

A lot of Greeks don't see why they should pay such a high price for this charade. They are far from blameless — they cynically milked the EU system for a long time — but their rage is entirely understandable. So at some point Greece will decide to default on its debt.

The money that the EU and the IMF are currently giving to the banks by laundering it through Greece will then have to be shoveled directly into their coffers by the financial authorities, embarrassing though that is. And Greece, using heavily devalued drachmas, will still face a long period of austerity and falling living standards, but at least it will be in charge of its own fate.

The euro will survive all this because everybody knows that the default is coming, and is quietly making arrangements to contain the damage. China is putting its money in the right place.

Gwynne Dyer is a London-based independent journalist whose articles are published in 45 countries.


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