China Rides To Europe’s Rescue

Senior Chinese officials have said they will buy more sovereign debt from European nations. The remarks helped spur global markets briefly. The effect did not last long. The euro dropped back down below $1.31.

Nouriel Roubini wrote recently that China is still anxious to diversify the dollar holdings of its $3 trillion foreign reserves. “Despite the Chinese government’s continued attempts to diversify its portfolio by currency composition and asset allocation—including significant forays into Asian currencies this year—the dollar still dominates and will continue to do so until China allows significantly more flexibility in the RMB.” China does not appear to be ready to offer that “flexibility” which vexes the US and other trade partners.

The FT reports that ‘Wang Qishan, a Chinese vice-premier, had given assurances that China would step up support for European stabilisation efforts “if necessary”.’ China has indicated in the past that it believed EU nations had taken the right path through adoption of austerity measures. Most capital markets investors still find the debt of the eurozone’s weakest nations very risky, which in turn continues to drive up interest rates on paper issued by these countries.

China, for the most part, has not invested in countries which have financial trouble. That is one of the reasons it has bought up so much US debt, which is still considered a safe haven. But, yields on Treasuries are down. China may want to increase its returns.

There is another reason China may want to put money into the debt of Europe’s weakest nations. They will owe something to China if the People’s Republic helps them keep reasonable debt ratings and access to capital. There has been a fear for years that China would use its ownership of US debt as leverage in disputes between the two nations. Most experts believe that China cannot afford to do this. Its US debt holdings are too large for China to begin to aggressively sell them for political leverage. The People’s Republic would devalue its own position by lowering the value of US debt.

China does not have the US debt ownership problem in Europe. It would have very little of its money in the region, even if it provided large investments in sovereigns which need tens of billions of dollars in support. With little risk, China could easily become a huge holder of debt in the paper of Europe’s troubled countries.

Eurozone nations would then have a debt to China which would go beyond the paper that it would hold.

Douglas A. McIntyre