Recycled dollars may help China limit the damage from an economic slowdown. Those dollars can also help the euro survive the debt crisis facing Europe.
China has been struggling with a slowing economy. Economists at Morgan Stanley recently downgraded their outlook and are now expecting GDP growth to fall under 9 percent next year.
China’s economy depends on healthy exports, and one of its key export markets is Europe. Turmoil in the eurozone has the potential to decrease demand for imports from China.
Europe’s trade deficit with China is even larger than the U.S. deficit. Part of that difference is due to the strength of the euro. Even as governments in several European countries struggle under unsustainable debt loads, the euro is still within 10 percent of its all time high.
That strength has helped China hold down the value of its own currency. The Chinese yuan is linked to the U.S. dollar and the weak dollar has helped both the yuan and the euro retain their value. A declining euro would mean stronger dollar and a higher yuan.
Slower growth in Europe will reduce demand for China’s imports and a weaker currency will make the imports even more expensive, decreasing demand even further.
China has a powerful weapon in its arsenal to prevent a downward spiral. Thanks to the U.S. trade imbalance, China has more than $2 trillion in reserves. Those dollars can find their way to Europe and help ease the crisis there.
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