from Follow the Money

Will Polish plumbers give way to the China price?

October 8, 2007

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The Economist seems to have taken note (finally!) of the impact of the RMB’s depreciation v the euro.  Chinese exports to Europe are growing very, very fast.   EU-27 imports from China are up 20% y/y in euro terms; imports from the US are only up 2% on the same metric. 

And China now has a very substantial surplus with Europe.  The eurozone's deficit with China from mid-2006 to mid-2007 was close to 100b euros (98.9b euros).  It is on track to rise to maybe 105b euros for the year.  The EU-27's deficit with China rose to $72.5b euros in the first two quarters of 2007, and is on track to reach 160-170b euro (easily over $200b) for the year (data: Eurostat and the ECB)

Charlemagne predicts – I think accurately – that the explosion of Chinese imports will transform the European debate over globalization.  Up until now, the European debate on globalization has largely been a debate about “Europeanization,”  and more specifically the integration of the Eastern European and Western European economies in the context of the European Union.  

With cause.  European firms are manufacturing more goods in Eastern Europe. Eastern European workers migrated to the west.    Within Europe capital generally flows downhill not uphill – the wealthy countries of the north generally finance the poorer countries in the south and east.   

All this has had an impact. Bratislava, for example, is the new heart of European automobile production. The Polish presence in London’s service sector is hard to miss.   And those worried about financial crises increasingly worry about a few Eastern European economies with very large current account deficits and growing currency mismatches.

But with European imports from China growing exceptionally quickly, with the RMB continuing to depreciate against the euro, and with China’s new investment company poised to make – I would expect – more visible European acquisitions than the state administration of foreign exchange, China’s impact on Europe is growing.   

If Europe’s economy slows and Chinese imports don’t, it isn’t hard to see why more Europeans would be inclined to adopt Sarkozy's tougher line, and start to more overtly criticize Chinese economic policy choices.    Charlemagne:

China's currency, the yuan ... has lost about 40% of its value against the euro since 2000, making Chinese exports ever cheaper. President Nicolas Sarkozy of France loudly argues that euro-area governments should join forces with the European Central Bank (ECB) and back American demands for the Chinese to let their currency appreciate (it is still loosely pegged to the dollar).

China didn’t have to follow the dollar down against the euro.  The dollar's slide be the euro is a market outcome, though one perhaps influenced by central bank and sovereign wealth fund portfolio choices.  The RMB's depreciation against the euro is clearly the result of a Chines policy choice.

It is hard to argue that the surge in China's surplus with Europe stems from differences in relative growth rates.   Sure, Europe's growth rate picked up recently, but so did China.  By every measure China is growing far more rapidly than Europe. 

There is another reason, beyond the RMB's depreciation, why tension is likely to rise:  China is increasingly starting to produce products that compete directly with European and American products, not just with other low-wage economies.  Think auto parts.  Think autos for that matter.    Europe makes a lot of machinery.  Increasingly, so does China.

The rapid expansion of China’s surplus with Europe has another implication:  the term vendor finance is less and less an accurate description of Chinese reserve growth.   Vendor finance implies that China finances its customers, lending so they can buy its goods.  But right now, China’s customers are increasingly in Europe while the bulk of its financing is going to the US.


I would guess that in 2007 China will provide the US with around $350b in financing – a sum that far exceeds its likely $250b or so trade surplus with the US (using the US rather than the Chinese data to estimate the surplus).  China increasingly lends the surplus it earns selling to Europe to the US.


China cannot run a large surplus with Europe without financing the US since its surplus with Europe reflects its decision to limit the pace of the RMB’s appreciation v the dollar, and thus to let the RMB depreciate v the euro. Nonetheless, the growing disconnect between China’s trade (increasingly with Europe) and China’s financial flows (still overwhelming toward the US) is a potential source of instability in a global financial system whose stability still hinges on large-scale Chinese financing of the US, at considerable (financial) cost to China ...

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