Thu, Jan 17, 2008 - Page 8 News List

Why Europe should thank China

By Melvyn Krauss

EUROPEANS ARE WRONG to be angry with China because its yuan peg to the US dollar has boosted the euro against most currencies on foreign exchange markets. On the contrary, they should view the peg as a valuable gift.

In New York and other US cities, European shoppers are on a spree. They're enjoying first-hand the euro's enhanced purchasing power abroad.

The currency peg has also helped turn the euro into an important reserve currency, rivaling the dollar. Investments from all over the world are flowing into Europe as a result.

It was predictable that China's currency peg would have this effect. It forced China to accumulate huge amounts of dollars to stabilize its currency and gave the euro an extra boost as the dollar depreciated.

To protect itself from the declining greenback, China and other countries are converting a portion of their accumulated dollar reserves into euros. The IMF estimates that the euro's share of foreign exchange reserves rose to 26.4 percent in the third quarter of last year from 25.5 percent in the second quarter and 24.4 percent in the third quarter of 2006.

The euro's becoming a major reserve currency bestows important economic advantages on the eurozone economy. Europeans should thank the Chinese currency peg for the part it is playing in this.

Of course, with an augmented supply of euros, China can be expected to make substantial investments in Europe, which is also a good thing, especially since, in the US at least, China has demonstrated a preference for investments in financial institutions rocked by the subprime crisis. Europe has plenty of those.

So far, China's biggest European investment has been in the Belgian financial company Fortis NV, where Ping An Insurance recently acquired a 4.2 percent stake, making it the largest shareholder in the company.

China Development Bank also made an investment in Barclays to bolster its bid for ABN Amro which, though it failed, helped the Dutch bank get full value for its assets.

This is only a start. Merrill Lynch predicts that as currency reserves climb in countries like China, state-run investment funds will grow to US$7.9 trillion from US$1.9 trillion now.

China's currency peg has also come in handy for Europe in its fight to keep inflation in check, while its monetary policy remains constrained by the subprime crisis.

Experts estimate that, in terms of guarding against inflation, the euro's appreciation has been equivalent to about a 35 basis point rise in the interest rate. The strong euro has helped insulate Europe from skyrocketing oil and commodity prices, which are priced in dollars on the world markets.

The big downside of the currency peg for Europe is supposed to be exports.

That's what sent French President Nicolas Sarkozy and other high-level European officials scurrying off to China in November -- and why many ordinary Europeans continue to think of the Chinese as not playing by the rules.

This is protectionist thinking par excellence. What makes exports so special? Why are they more important than cheap imports or the bargains that European shoppers get in New York? Should Europe give up all the advantages of the currency peg just because it makes European exports more expensive?

Of course not.

Note that it was Sarkozy who went to China to protest the peg, not German Chancellor Angela Merkel.

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