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What China really wants from the U.S. and Europe

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flag-china-america China has some $2.8 trillion in international reserves, placing the Middle Kingdom at the center of global finance. This is a geo-strategic advantage not lost on Beijing, but one not yet fully understood in the West. It is a lesson U.S. President Barack Obama needs to take away from his meeting this week with Chinese Premier Hu Jintao. If the United States and Europe want help with their sovereign debt, and help creating jobs, they must be willing to accept more Chinese investment.

Barely into the new year, Europe’s sovereign debt crisis has moved back to the front burner. Sensing the time was right to ride to Europe’s rescue, China has publicly come out in support of the euro and is rumored to be considering making sizable purchases of Portuguese and Spanish debt. The symbolism of Beijing buying up European sovereign debt may be more important than the amount it actually purchases. To date, the total China has bought or has suggested it might buy is a small fraction of the outstanding obligations of Europe’s most indebted economies.

What that means is that China is ready and willing to ante up some badly needed capital to Europe’s near-broke periphery, a move that would not only serve China’s own interests by keeping Europe, a key export market for Chinese companies, afloat, but also enhance the nation’s standing as a responsible stakeholder in the global economy. So, for China, the global financial crisis of 2008 is the gift that keeps on giving.

For the rest of the world, it was a gift that came at the right time. By dramatically boosting lending and state spending, China provided badly needed ballast to a global economy staggered by one of the worse financial crises of the past century. Minus Chinese demand for copper, oil and other commodities, as well as demand for finished goods like automobiles, cell phones, and computers, 2010 would have been a much tougher year for the world’s commodity producers and for a host of western multinationals that have come to rely on China for earnings growth.

This year, absent China’s financial presence in debt-wracked Europe, the continent’s simmering debt crisis could very well morph into something far more insidious—a protracted recession in the eurozone, for instance, accompanied by rising social and political instability.

This scenario is not likely to happen if China’s words of support are backed by significant debt purchases by Beijing. But that financial lifeline to Europe will come with a cost.

While China still finds the West—especially the United States and Europe—a relatively attractive place to invest its excess savings, China’s investing mandarins are keen on diversifying their Western holdings. Starkly put, China wants to buy Western plants, not Western paper. Beijing’s preference is for companies rather than coupons.

This tilt in investment bias, however, has not and will not go down very well with the United States and Europe, who have been all too happy to see Beijing gorge itself on their sovereign debt. Chinese buyers of U.S. and European firms is a much harder idea to swallow. To the latter point, earlier this month, a Chinese firm dropped a $1.3 billion bid for a Dutch cable wire company after the EU’s Industry Commissioner expressed hostility toward the planned takeover. The Chinese firm ultimately backed down.

Both Europe and the United States should expect China to become more aggressive and adamant about sealing deals in the West. Beijing wants to not only diversify its foreign investments, but also to level the competitive playing field between Chinese firms and their American and European counterparts. While China enjoys a trade advantage over the transatlantic partnership in world markets, Europe and America enjoy a massive investment advantage over China.

It increasingly irks Beijing that America’s foreign direct investment stock in China, some $49 billion, is more than 20 times larger than China’s investment presence in the United States ($2.3 billion in 2009). The EU’s investment position in the China, meanwhile, was 10 times larger than China’s in the EU in 2009, with total EU investment of $81 billion in China versus the Chinese investment stock of $8.1 billion in Europe. Beijing would like to correct this lopsided advantage but cannot if Europe and the United States continue to torpedo potential Chinese mergers and acquisitions.

Large Chinese firms want to go global, which means they want direct access to the markets of the United States and Europe, a strategy that entails less trade and more foreign investment. And like Japanese firms in the 1980s, Chinese firms, fearing rising trade barriers in the West, hope to jump or skirt these barriers by investing directly in the West. However, Chinese investors are hardly getting the warm and fuzzy feeling from the United States and Europe. Hence, prevented from expanding its corporate presence in the transatlantic economy, is it any wonder China has become more hostile and less welcoming to U.S. and European investment in China?

In the end, the debt-laden United States and Europe need to wake up to the new reality before them: China will only remain a trusted source of portfolio inflows (buying Western debt) on the condition that its corporations are able to expand their foreign direct investment position in Europe and the United States. That means they have to be allowed to buy and acquire companies in the United States and Europe. Minus this alternative, China might just think about leaving the West financially high and dry.


Federal Reserve Bank

WALL STREET JOURNAL

U.S. Bureau of Economic Analysis