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May 29, 2012 7:35 pm

The riddle of German self-interest

By Martin Wolf
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David Humphries illustration©David Humphries




How will the crises inside the eurozone end? Many people have asked me this question in the US in recent weeks. How, in particular, might the eurozone move from crisis into stability? To address this question, we need to distinguish three aspects of the turmoil: where the eurozone is going; where Germany wants the eurozone to go; and where the eurozone needs to go.



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The eurozone’s current position seems depressingly clear. A number of member countries, two of themItaly and Spain– being large, already have, or are on the verge of having, governments unable to manage their public debt unassisted. Much of that debt is held by their banks. Many of these have been damaged, particularly in countries that experienced huge real-estate bubbles, large fiscal deficits or both. Governments with weak creditworthiness feel compelled to rescue fragile banking systems that are, in turn, expected to finance the governments trying to support them: the drunks are seeking to stay upright by leaning on one another.
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Governments are also required to attempt fiscal austerity when private sectors are retrenching: between 2007 and 2012, the financial balance of the private sector shifted from deficit towards surplus by 16 per cent of gross domestic product in Spain (see chart). Austerity further weakens both economies and banks.


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This, in turn, raises unemployment and lowers government revenue, rendering fiscal austerity ineffective. Meanwhile, slack demand in the core reinforces economic weakness in the periphery, rather than offsets it.



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With banks impaired, private demand damaged, government demand contracting and external demand weak, the fragile economies are likely to have smaller output and higher unemployment two or three years hence than now. The reward for pain today is pain tomorrow.
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Click to enlarge





Whether or not Greece is “saved”, for the moment it is hard to believe today’s eurozone would survive this, particularly when the principal argument in its favourthat for economic and financial integration – is being destroyed. Businesses, particularly financial institutions, increasingly seek to match assets and liabilities by country. Equally, only the bravest business will plan production in the belief that exchange rate risk has been eliminated. With a rising share of cross-border risk now assumed by the European Central Bank, the way to break-up is becoming more open.


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This looks like a long day’s journey into night. It might take weeks, months or years. But the direction, alas, seems ever clearer.



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Now turn to the second issue: how does Germany want the eurozone to be organised? This is how I understand the views of the German government and monetary authorities: no eurozone bonds; no increase in funds available to the European Stability Mechanism (currently €500bn); no common backing for the banking system; no deviation from fiscal austerity, including in Germany itself; no monetary financing of governments; no relaxation of eurozone monetary policy; and no powerful credit boom in Germany. The creditor country, in whose hands power in a crisis lies, is sayingneinat least seven times.




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How, I wonder, do Germany’s policy makers imagine they will halt the eurozone’s doom loop? I have two hypotheses. The first is that they believe they will not. They expect that life for some of the vulnerable economies will become so miserable that they will leave voluntarily, thereby reducing the eurozone to a like-minded core, and lowering risks to Germany’s own monetary and fiscal stability from any pressure to rescue the weak economies. The second hypothesis is that the Germans really think these policies could work. One possibility is that the weaker countries would have so big an “internal devaluation” that they would move into large external surpluses with the rest of the world, thereby restoring economic activity. Another possibility is that a combination of radical structural reforms with a fire sale of assets would draw a wave of inward direct investment. That could finance the current-account deficit in the short run, and generate new economic activity in the longer run.



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Maybe German policy makers believe that it will be either harsh adjustment or swift departure. But “moral hazard” would at least be contained and Germany’s exposure capped, whatever the outcome.



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Yet the “exit of the weak option looks very risky and the “painful adjustment and fire-sale option so implausible as to lead swiftly back to exit. The danger, moreover, is not just to the weaker countries. Germany sends just 5 per cent of its exports to China, compared with 42 per cent to the rest of the eurozone, much of which would be disrupted by a meltdown. What has already happened has weakened its export-dependent economy: German GDP was only 1 per cent higher in the first quarter of 2012 than four years earlier. Beyond these narrowly economic dangers from damage to the “irrevocableunion would surely lie an enduring political disaster for the eurozone’s economic hegemon.



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In brief, the eurozone is now on a journey towards break-up that Germany shows little will to alter. This is not because alternatives are inconceivable. 


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What is needed is to turn some of the Nos into Yeses: more financing, ideally via some sort of eurozone bond; collective backing of banks; less fiscal contraction; more expansionary monetary policies; and stronger German demand. Such shifts would not guarantee success. But they would give the eurozone at least a chance of avoiding the cost of partial or total break-up. To work in the long run, such shifts would also require greater political integration.




In October 1939, Winston Churchill said: “I cannot forecast to you the action of Russia. It is a riddle, wrapped in a mystery, inside an enigma; but perhaps there is a key. That key is Russian national interest.” The key in Europe today is Germany’s perception of its national interest. Once it becomes evident that their conditions will not work, German leaders will have to choose between a shipwreck and a change in course. I do not know which Germany will choose. I do not know whether its leaders know. But on that choice hangs the fate of Europe.


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Copyright The Financial Times Limited 2012.

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May 28, 2012 7:36 pm

Commerce: Tempestuous trade winds

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European Commission President Jose Manuel Barroso (R) gestures as he speaks to reporters as Chinese Premier Wen Jiabao (L) looks on during a press conference at the Great Hall of the People in Beijing on February 14, 2012. Chinese and EU leaders met for a major summit set to be dominated by Europe's debt crisis, as an increasingly worried Beijing considers coming to the rescue of the embattled continent.©AFP
Fright and flight: Wen Jiabao, Chinese premier, and José Manuel Barroso, European Commission president, at this year’s Beijing summit





In February, the EU’s two most senior officials arrived at a Beijing summit with an expensive favour from their host in mind: tens of billions of euros to help douse the flames of the continent’s debt crisis.


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But even as José Manuel Barroso and Herman Van Rompuy, the respective presidents of the European Commission and the European Council, were trying to charm Chinese premier, Wen Jiabao, bureaucrats back in Brussels were plotting something completely different. They were gathering evidence for an unprecedented trade case that some observers believe could dramatically escalate tensions with China.

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It centres on allegations that Beijing illegally subsidised its fast-growing telecommunications equipment companies, including Huawei Technologies and ZTE, helping them grow at lightning speed to snatch business from western rivals such as Nokia and Alcatel.



The case is a departure from the EU’s focus on low-end goods such as textiles and ceramics, and targets conspicuous high-tech businesses. If it were to go forward, it would also mark the first time the EU has opened a trade investigation on its own initiative, and not at the behest of a European company. The Chinese, says Jonathan Holslag of the Brussels Institute of Contemporary China Studies, would “view this as a declaration of war”.




Brussels’ conflicting impulses illustrate the growing conundrum posed by China for crisis-hit Europe. On the one hand, the EU has been forced to go cap in hand to Beijing to help with its debt crisis.


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At the same time, European manufacturers – and some politicians – are increasingly demanding that China be confronted over trade practices they believe are contributing to the bloc’s double-digit unemployment rate and putting entire industries at risk.


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“The economic crisis is making a lot of member states concerned about protecting their remaining industries and that is making China look more like a competitor to them than an economic partner,” Mr Holslag says.



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That change in perception is underscored by the EU’s trade deficit with China, which more than tripled to €168bn between 2000 and 2010. European companies have also become increasingly alarmed as Chinese rivals bite into higher-value industries.



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“We are facing several issues with China, and we are not giving strong enough answers,” says Daniel Caspary, a German member of the European parliament’s trade committee, which has gained new authority over EU trade policy. “We missed lots of opportunities during the last 20 or 25 years when China was opening to set up red lines, and now it’s becoming more difficult every day.”




There are signs Brussels has begun to heed that call. In recent months, Karel De Gucht, the EU’s blunt-speaking trade commissioner, has confronted China at the World Trade Organisation, accusing it of hoarding the rare earth minerals that are vital for making smartphones and other high-tech goods.




The commissioner has also accused China of illegally subsidising businesses and has proposed new legislation that would allow retaliation against governments that do not open their public procurement to European companies. A case against China’s manufacturers of solar panels appears imminent.



“What we are seeing is much tougher rhetoric and a much greater desire from some European industries to take action,” acknowledges one EU official. “In most cases, China is their most dangerous competitor.”



Chinese companies, such as Huawei and ZTE, deny accusations they are breaking trade rules, saying they are simply more agile than competitors. They argue the disputed subsidies are akin to the ones the EU lavishes on its own companies.


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The timing of the dispute has proved awkward. While Mr De Gucht was gathering evidence, the EU was seeking to dispatch a technical team to Beijing with a portfolio of government bonds the Chinese might consider purchasing, according to Chinese officials.


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The EU has also sought to enlist China in a campaign to increase the International Monetary Fund’s capital base by €700bn, which would give it more firepower to battle the crisis. Those tasks have become more urgent as the crisis has flared anew, leading to fears that the brush fires in Greece could spread to Spain and Italy.


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Looming over the negotiations – even when it was not explicitly mentioned – has been China’s persistent pursuit of an EU trade concession it has long coveted: market-economy status. Such a designation would make it far more difficult for European companies to lodge successful complaints against Chinese rivals.


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Under the terms of its WTO accession agreement, China is expected to receive market-economy status automatically in 2016. Still, even if only for symbolic reasons, the wait has rankled in Beijing and some EU officials late last year believed they might secure financial support as a quid pro quo for granting the concession early.



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But both sides have since cooled on the idea. In spite of Mr Wen’s occasional public pronouncements, Japannot China – has emerged as a far bigger buyer of European government bonds, according to several EU officials. Japan has also come through with a $60bn pledge to the IMF.


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Chinese officials were apparently fearful of the public outrage if they were seen using hard-won savings to prop up the wealthy nations of Europe. As Wu Hailong, the new Chinese ambassador to Brussels, told reporters in March: “Many of the richest countries [in the world] are in Europe. So in the end, I think Europe has the resources to properly resolve the debt crisis.”


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For Europeans, the allure of a quick rescue has run into the political reality of having to secure approval from member states and the European parliament. “It would be political suicide,” says one diplomat. “Who could be seen selling a policy for a pile of money?”



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Beneath the politics, EU-China trade remains robust. It is set to surpass €500bn this year – a record high – with the bloc now ranking as China’s largest trading partner. That, in itself, provides a rationale for the two sides to repair any holes in the relationship, according to Fredrik Erixon of the European Centre for International Political Economy, a Brussels think-tank.



But Mr Erixon also points to a host of daily frustrations on both sides. Co-operation on trade and investment is fraught with misunderstanding, offended egos, discontent and anger,” he says. “In some quarters, frustration is reaching boiling point.”



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Further straining the relationship has been the EU’s controversial policy of forcing all airlines to pay for greenhouse gas emissions on flights to and from Europe. The US, Russia and India have all objected to what they consider an extraterritorial tax grab. But China has gone further by ordering its carriers not to comply and threatening to cancel more than $14bn in aircraft orders from Airbus, the European aerospace company.

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Such hostility is a far cry from the optimism that prevailed when Britain’s Peter Mandelson served as EU trade commissioner from 2004 to 2008 – the prosperous years before the debt crisis.



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Under Mr Mandelson, Brussels and Beijing waged a notable war over textiles that threatened to deprive millions of European women of bras. Yet the EU operated under the assumption in those years that China would gradually reciprocate its own liberalisation.



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Instead, European executives bemoan continuing restrictions. One particular source of irritation is the requirement that makers of wind turbines and other innovative products transfer valuable technology to local joint-venture partners. Companies that were once seen as pioneers in promising industries, such as Denmark’s Vestas, had to cut European jobs because of Chinese competition.


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At the same time, Chinese companies have begun to draw attention by purchasing small and medium-sized German companies whose talents and technologies may help their new owners move into more specialised manufacturing. Recent targets include construction group Putzmeister Holding and auto-parts company Kiekert.


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“In the long term, China’s influence in Europe will not be from any help they gave in the eurozone crisis. It’s going to come from buying companies here with world-class technology,” a western diplomat says.



Mr De Gucht is credited with opening Belgium’s trade policies when he served as the country’s foreign minister. But he has taken a colder view of China in his current post. “He’s a free-trader at heart, but he feels cheated by the Chinese,” explains Mr Holslag.



Under Mr De Gucht, the EU has imposed its first anti-subsidy duties against China for supplying below-market loans and property to a big producer of glossy paper. In practice, the penalties for subsidy cases are no more onerous than those for the far more prevalent and easier to prove offence of dumping.



But by targeting state subsidies – the economic arrangement at the centre of almost all state-owned or controlled Chinese companiesMr De Gucht is going after the heart of the Chinese system that has boosted the country’s exporters. One De Gucht aide last year likened the paper case to “launching a torpedo against the mother ship”.


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So far the torpedo has proved a damp squib, with observers arguing that Europe has not gained any leverage to press its demands.


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Working against Mr De Gucht is the EU’s unwieldy nature. Its 27 leaders demand tough action on China during private meetings in Brussels but tend to embrace Beijing on state visits, appealing for big contracts and investments, diplomats say.



To Brussels’ irritation, Beijing has encouraged this by routinely circumventing the commission to deal directly with national capitals.



Europe’s corporate sector has also been fickle. Companies have besieged Mr De Gucht with complaints about their treatment in China but almost never go publiclet alone put their name to formal complaints – for fear of being locked out of China’s market.



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Mr De Gucht has seized on the notion of a case initiated by Brussels as a way to shield companies.



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But the EU’s defence comes when Europe’s standing in the world has been brought low by its inability to get its own fiscal house in order. Chinese officials do not seem to be trembling.




“The problem more or less rests with Europe itself,” responds a Chinese diplomat. “I don’t think it’s fair to look at China as a scapegoat.”

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EU-China disputes: The complexity of complaining


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After months of behind-the-scenes lobbying, SolarWorld, the German manufacturer of solar panels, says the European solar industry is now backing a trade complaint it is determined to launch against its Chinese competitors.



SolarWorld has already prevailed in the US with a similar complaint that accused the Chinese of benefiting from illegal government subsidies to undercut domestic manufacturers and gobble up the market.


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But support for SolarWorld is hardly universal. The legion of smaller companies that install panels on rooftops and buildings are balking, worried that the imposition of tariffs by the EU would only push up the cost of their products and hurt business. Companies that supply equipment to Chinese companies that manufacture the panels are also concerned.

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Together they have formed the Alliance for Affordable Solar Energy, a coalition that has managed to delay if not derailSolarWorld’s plans.



The industry’s divisions are a reminder of the complexities of mounting trade complaints in a globalised age in which supply chains are flung around the world.



While SolarWorld points to a recent rash of bankruptcies among fellow European manufacturers undercut on pricing by the Chinese, such as Germany’s Q-Cells, Afase has argued that its constituents account for the majority of the European solar industry’s 300,000 jobs.




Adding to the complexity for EU policy makers are the bloc’s environmental goals. The EU has made a commitment to derive at least 20 per cent of its electricity from renewable sources of energy, such as wind and solar power, by 2020 – a goal that might prove easier to achieve with cheap imports.



Milan Nitzschke, a SolarWorld vice-president, warns that European consumers will pay a higher price in the long run if the Chinese take over the market and then push up prices. “It’s a threat to the complete European industry,” he says. “It is only beginning with solar energy. The rest of the renewable energy industry will be next.”

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Additional reporting by Kathrin Hille

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Copyright The Financial Times Limited 2012.



Greece-Proofing China

Yu Yongding

28 May 2012



BEIJINGDespite repeated assurances by European Union leaders, after more than two years, there is still no light at the end of Europe’s debt-crisis tunnel. Recently, the president of the European Commission, José Manuel Barroso, referring to a possible Greek exit from the eurozone, told the European Parliament that there is noPlan B.”



Barroso’s statement was meant to be reassuring. But, after so many disappointments, China cannot accept at face value the assurances of European politicians, which even they themselves do not know whether they can redeem. China should have its own Plan B in case Greece has to leave the eurozone.



Indeed, it is increasingly likely that Greece will renege on its bailout obligations. If that happens and the “troika” (the European Commission, the European Central Bank, and the International Monetary Fund) cuts off financial support, Greece’s exit from the euro will become all but inevitable. In that event, China must be prepared for any ensuing global financial turmoil and longer-term consequences.


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For starters, Chinese officials should be under no illusion that the country will be immune to financial contagion. A “Grexit” would hit European banks that hold peripheral eurozone countries’ sovereign bonds. Shock waves from the deleveraging would, in turn, spread to emerging markets like China.


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Although the exposure of Chinese banks and financial institutions to eurozone sovereign and banking-sector assets is negligible, post-Grexit capital flight from risky markets could rival, or even surpass, that in the weeks following Lehman Brothers’ collapse in September 2008. Compared to 2007 and 2008, foreign investors’ holdings in emerging markets are much higher, owing to these countries’ relative economic strength in recent years and rock-bottom returns on developed-market financial assets.



In fact, China already experienced the impact of deleveraging late last year, when the European financial system seemed on the brink of collapse. With European banks hunkering down, the renminbi’s exchange rate fell for 11 consecutive days, even though China was running a current-account surplus.



The performance of emerging-market currencies and other assets so far in the second quarter suggests that deleveraging has begun once again. Disappointing first-quarter growth data have already led foreign investors to have second thoughts about keeping money in China. A Grexit could prove to be the last straw, and would surely lead to a tightening in domestic monetary conditions at a very precarious point in the economic cycle.



As such, the timing could not be worse to float the idea of speeding up capital-account liberalization. On the contrary, the Peoples Bank of China (PBoC) and other relevant authorities should consider capital controls, market suspensions, and emergency liquidity provision.


.These measures are not dissimilar to those that the eurozone will pursue if Greece exits. Ideally, the response would be coordinated with China’s international partners in the G-20. The infrastructure for such cooperation has developed strongly since 2008, and China must not shy away from advocating its deployment.



Moreover, China must have a medium-term plan to deal with the economic aftermath of a Grexit. Should contagion prove to be limited, with Greece the only casualty, the drop in eurozone output may be severe, but not catastrophic. Nonetheless, the EU is China’s most important trading partner, and China must be braced for serious job losses in the export sector.



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Japan’s experience shows that a recession that results from a financial crisis can be extremely prolonged, because deleveraging is a long process. It is highly likely that today’s recession will drag on for many more years in both America and the EU. So China’s government must have a medium- and long-term plan to address problems caused by a drawn-out global slump.


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The problems include a surge in unemployment, and the need to reallocate fiscal resources to these individuals, whose welfare is critical to the preservation of social stability. More importantly, the Chinese government should not retreat from efforts to implement structural reforms aimed at shifting China’s growth model to one that places much greater emphasis on domestic demand.


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In addition, net foreign capital inflows are likely to dwindle for several quarters at least, affecting domestic monetary conditions while aggregate demand is weak. As such, the PBoC will need to maintain counter-cyclical policies in order to avoid a deflationary spiral.



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Although bound to be controversial, especially in an election year in the United States, enough flexibility should be given to the renminbi in both directions when it is needed. One of the biggest failures of the eurozone periphery is a loss in competitiveness, hidden by a wall of credit that has been leveraged from Germany’s balance sheet. This is always unsustainable. Any loosening by the PBoC should not be used to avoid painful structural reforms.


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Finally, China should be ready to extend a helping hand. To ensure that the post-Grexit eurozone’s integrity faces no further immediate threats, China must join international partners in establishing a fully credible firewall, via the IMF. However, the eurozone, and Germany in particular, must fully acknowledge the fundamental causes of Greece’s exit and pledge to move towards fiscal union, while acknowledging that an austerity-only approach towards other at-risk members is a dead end.


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An adequate firewall and a European commitment to structural reform would go far toward calming markets and reducing the risks to any Chinese contribution. In other words, any assistance that China provides must be “throwing good money after good potential results.”



Of course, IMF governance reform will also need to be part of the discussion. Meanwhile, the eurozone will likely be more open to foreign investment out of necessity, and cash-rich Chinese companies should continue to pursue opportunities via FDI or corporate acquisitions.

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A potential Grexit will present entirely new challenges to China in the coming months, and the country must avoid complacency over its own exposure. A battle plan for both the present and the future is needed now.



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Yu Yongding, President of the China Society of World Economics, was formerly Director of the Chinese Academy of Sciences Institute of World Economics and Politics. He has also served as a member of the Monetary Policy Committee of the Peoples’ Bank of China, and as a member of the National Advisory Committee of China’s 11th Five-Year Plan.