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21/11/2007 | Germany, China - A Portent of a Trade War?

Stratfor Staff

German Finance Minister Peer Steinbruck was forced to cancel his planned December visit to China because China's finance minister has refused to meet with him. The reason given for China’s snub is far from the real reason.

 

German Finance Minister Peer Steinbruck canceled his planned December visit to China because his Chinese counterpart’s schedule no longer has room. The given reason for the refusal was German Chancellor Angela Merkel’s September meeting with the Dalai Lama, whom Beijing accuses of supporting separatist aspirations in Tibet.

While German-Chinese relations are not exactly cordial, such logic is hogwash. The Chinese do not allow Dalai Lama-related issues to interrupt their economic policy.

There is more at stake than the German-Chinese economic relationship (which yielded $96 billion in trade in 2006, excluding Hong Kong). Germany is the de facto leader of the European Union, and EU-Chinese trade for the same period is a whopping $272 billion. The collective European Union is China's largest trading partner.

The European Union has an internal problem that is beginning to impact its global trade attitude. The eurozone is made up of 13 widely variant economies, from the extremely advanced technocracy of Finland to the relatively backward agricultural and heavy-industry-based economy of Spain. Though the euro has helped smooth over and unify the European economies -- or at least the 13 of the 27 EU states that have joined the common currency to date -- monetary policies are not one-size-fits-all.

Since the euro's creation 10 years ago, this disconnect has been the currency's greatest flaw -- and in the past year as the euro strengthened it has been a key feature in intra-European tensions. So far those tensions have not resulted in any breaches because the euro's positive effects -- lower intra-European transaction costs, greater purchasing power, lower inflation, lower interest rates for smaller EU states, etc. -- have granted Europe moderate to strong growth rates.

But the European position is inflecting, and a European-Chinese trade war could be brewing. Key to this inflection is Germany.

Economically, Europe can be broken into four parts:

  • The agricultural/industrial south, comprising Portugal, Spain, France, Italy and Greece;
  • The bulk of the newer members -- Estonia, Latvia, Lithuania, Poland, Czech Republic, Slovakia and Hungary -- who compete largely on their low-cost labor;
  • The high-tech industrial core of Belgium, the Netherlands, Germany, Austria and Slovenia; and
  • The high technocracies whose industries are extremely high value-added and where the bulk of the economy focuses on services: Finland, Sweden, Denmark, Ireland, the United Kingdom, Luxembourg and Cyprus.



All members of the first group are eurozone members, and while none of the second group are, all have linked their currencies to the euro and intend to eventually join the common currency regime. These two groups have suffered the most from the strong euro, as they face stiff international competition to their products and therefore their exports compete largely on cost.

Members of the third group -- also all eurozone members -- make up the true power core of the European Union and the eurozone. These are the economies for which the euro was explicitly designed. A moderately strong euro does not threaten these states, as these economies use capital with brutal efficiency and can demand top euro for their products.

The high technocracies in the fourth group are even more insulated from currency moves because their services and products are of such a high technology and skill level that they have very few competitors.

When the euro rises -- or, put more directly, as Chinese exports flood the market more aggressively -- governments in the first two groups clamor for measures to project jobs and industry. The latter two groups, however, do not suffer when the euro is strong; they see it as both a guarantee of more investment funds and an increase in consumer purchasing power.

However, the euro is continuing to strengthen. It is up by more than 50 percent versus the U.S. dollar since 2002, and in the past two years the pace of that rise has only accelerated. Though the exports of the core countries -- most notably Germany -- are highly resistant to price pressures, they are not immune.

A big source of the pain is China, whose currency remains tightly aligned to the U.S. dollar. Beijing's currency policy is a de facto peg, so Chinese goods are funneling into Europe at an ever-faster rate. The first two groups are becoming a touch hysterical in their calls for protectionist measures. Germany holds the balance of power in all of this, and as Berlin shifts from being blasé to becoming alert and concerned, EU policy will shift with it.

But EU foreign policy works by consensus, so how can EU policy change if that fourth group is not yet worried? The reason is simple: Of the fourth group, Denmark, Sweden and the United Kingdom are not even in the eurozone. And Finland, Ireland and Luxembourg are not the sort of states that will stand in the way of consensus. (Cyprus will join the eurozone in 2008, but is not any more likely to gum up policy than is Finland.)

That broadening rhetorical consensus is that Beijing knowingly and willfully distorts trade for domestic political purposes (which is
true), and that such distortion has reached the point that EU-wide action is fast becoming a necessity. European pressure on China over the yuan has been steadily building since just before the last G-7 summit, the European Union is dragging its feet on lifting tariffs and quotas as promised and has started joining World Trade Organization (WTO) cases targeting China, and pan-EU action on the yuan is beginning to be pieced together.

However, EU action on the yuan -- while building and probably inevitable -- is not yet imminent. The reason is EU Trade Commissioner Peter Mandelson.

Mandelson is a dedicated free-trader who has worked overtime to short-circuit the efforts of many European states to implement restrictions on Chinese imports. But even he has gotten annoyed with China's unwillingness to change aspects of its system that are causing some of the trade problems. His most recent scheme is a system by which European states can levy charges against individual Chinese firms previously targeted for trade-distorting practices. This gets the aggravated European governments off his back and redirects their ire toward firms in China that are causing their industries the most difficulties -- thereby solving two problems at once.

Where things go from here depends on laborious negotiations between the European Commission -- of which Mandelson is a part -- and the 27 EU governments. There is no shortage of options on the table -- the European Union could choose an aggressive WTO stance, wide-ranging product tariffs, the implementation of a quota system for Chinese goods or even a deep currency-based tariff on all Chinese imports. About the only tool that is off the table is a devaluation of the euro. The institution with control over that is the European Central Bank, an entity independent of both the commission and the member states, according to EU treaty law.

Stratfor (Estados Unidos)

 


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