China’s Vice Premier Li Keqiang has been on a shopping spree in Europe – not for fine French wine or the latest Italian fashions, but for greater influence. Just as Europe is desperate for a new source of ready cash, Li has offered up some of China’s vast hoard of reserves to support the struggling euro zone through its debt crisis. In Madrid last week, Li pledged to buy more Spanish government bonds, saying that China “has confidence and great interest in the Spanish market.” With its bonds continuing to weaken, and its borrowing costs continuing to rise, Spain needs all of the customers it can find. (The two countries also signed $7.3 billion in business deals.) Then Li went on to Berlin, where he pledged in a speech that China would continue to support Europe and its monetary union. Li’s comments follow similar statements made by Premier Wen Jiabao during the latter’s visit to Greece in October. Wen, too, promised to aid Europe through the crisis by buying Greek debt.
Is China the silver bullet for the euro crisis? Clearly, Beijing has the money. Analysts estimate that China’s currency reserves likely came close to $2.8 trillion at the end of 2010 – almost triple the size of Europe’s entire bailout fund for weak sovereigns, cobbled together in May. And there are logical reasons why Beijing would want to use some of that war chest to help Europe. But like all of the previous efforts to resolve Europe’s problems, the notion that China can or will significantly alleviate the debt crisis is likely just another mirage. That’s not only because China is highly unlikely to commit the sort of funds necessary to rebuild investor confidence in Europe’s debt-heavy, slow-growing economies, but also because cash is only part of the solution to Europe’s current problems.
In some ways, China’s promises to support Europe make perfect sense. China has already been using its financial clout to expand its influence around the world (in the rest of Asia, Latin America and Africa) so why not in Europe as well? And since Europe (not the U.S.) is China’s No.1 export destination, stabilizing the economy of Europe is in the interests of the Chinese economy. Buying euro assets also helps China in its stated goal to diversify its currency holdings (which are probably about two-thirds in U.S. dollars). The Wall Street Journal printed an interesting estimate the other day that China may already hold some $900 billion in euro zone sovereign debt, or nearly 10% of the total issued. So China probably will keep buying euro zone debt.
But how much? Who knows. An unconfirmed newspaper report claimed that Li said China was willing to splurge on about $7.9 billion in Spanish bonds. That would help, of course, but in reality it’s merely a drop in the bucket. Greece, Portugal, Spain and Italy are looking to raise billions in bond auctions this week alone. It would also be very wrong to assume China will choose political over economic priorities when allocating its currency reserves. China, like any good investor, wants to maximize its returns, and Chinese policymakers aren’t stupid enough to buy more and more European government bonds when debt restructurings and defaults are a real possibility.
And if China is buying, Beijing isn’t buying enough to make a bit of difference. The confident statements and pledges of funds from Li have had no discernable positive impact on investor sentiment towards the euro zone. Bonds of weak euro zone states have taken a pounding during Li’s visit; so did the euro, which plunged more than 3% against the dollar last week. China, then, isn’t the answer to the euro’s prayers.
Yet something will have to be. Portugal, the markets’ likely next victim, is spiraling towards an EU/IMF rescue, joining Greece and Ireland. Yields on its bonds reached a euro-era high last week, and reports are bouncing through the press in Europe that Germany and France are pressuring Lisbon to take a bailout right away, hoping that that, finally, would put an end to the contagion. Officials in Portugal are of course making the standard denials, insisting they can solve all of their problems on their own.
A pre-emptive strike probably wouldn’t work anyway. Europe’s leaders believed they would put a stop to the crisis when they bailed out Greece; then they thought they’d put a stop to the crisis when bailing out Ireland. And now we’re at Portugal. Meanwhile the contagion is spreading, not only to Spain, but also to new entrants in the debt crisis, Italy and Belgium.
The reason is that money is only a partial solution at this stage of the game. Europe’s leaders have mistakenly believed from the beginning that the debt crisis was simply a liquidity crisis, and by providing more liquidity, the crisis would abate. But as many of us have been warning, the crisis is rooted much deeper in the monetary union; in fact, in its very structure. I think Wolfgang Münchau summed this up nicely in his latest comment in The Financial Times:
The most glaring manifestation of this lack of leadership is the EU policy consensus that this crisis will eventually be self-correcting, and that a robust liquidity backstop is all that is needed. This is a tragic error. What makes this crisis self-sustaining is the presence of two interacting components: a combined private and public sector solvency crisis, and a competitiveness crisis… It may just be conceivable that the periphery will get on top of their competitiveness problem, or on top of the debt problem, but surely not on top of both at the same time, without devaluation or default…The longer this dual crisis drags on, the more radical, and improbable, any solutions would have to be…Europe’s political establishment is of the opinion that such a radical response is unwarranted and politically infeasible. The first assessment is wrong. As the world comes out of its Christmas stupor, it discovers the second may well be right.
Until Europe’s political leaders concede that something much bigger and more dangerous is afoot, and they institute more comprehensive plans to solve them, the euro zone will remain vulnerable to bailouts. And the euro’s survival will remain in question. That’s something all of the reserves in China may not be able to fix.