Will Beijing cross Rubicon?

Italy asks China to buy its government debt and help save eurozone

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16 Sep 2011
Week in China

After 10 years of restoration by skilled artisans the George C Marshall Center was reopened in the Hotel de Talleyrand in May last year. The timing was telling. After all, it was from this building that Europe was last saved from economic collapse.

From this iconic Parisian headquarters, US secretary of state George Marshall executed his eponymous plan to rescue a bankrupt and beleaguered Europe in the aftermath of the Second World War. Almost $13 billion of American aid helped Europeans rebuild their shattered economies and avoid financial disaster.

Once again, debt-ridden Europe needs to be rescued. But with its finances vying with Europe in the feckless stakes, Washington is in no position to repeat the rescue act it staged nearly 65 years ago.

So who else has trillions of dollars of spare cash lying around?

No prizes for guessing the answer: China. The big story this week was whether Beijing would also seek to earn political goodwill, with a resuscitated version of the Marshall Plan, this time from the East.

China to the rescue?

As the week began, markets were selling off after a spate of grim headlines from Europe.

In brief: the Germans seemed ready to allow the erstwhile 'unthinkable' outcome of a Greek default, despite rising French anxiety that their own banks would be worst hit by the prospect. Meanwhile the contagion had spread to Italy, with investors worrying that its own debt burden was unsustainable. An Italian default would be much, much worse than a Greek equivalent, say analysts – probably enough to sink the euro. On Monday, Bloomberg TV even interviewed an American fund manager who suggested Germany would exit the euro and revert to the Deutschmark.

Respite for battered investors, however, then seemed to come from an article in the Financial Times.

It reported: "Italy's centre-right government is turning to cash-rich China in the hope that Beijing will help rescue it from financial crisis by making 'significant' purchases of Italian bonds and investments in strategic companies. According to Italian officials, Lou Jiwei, chairman of China Investment Corp, one of the world's largest sovereign wealth funds, led a delegation to Rome last week for talks with GiulioTremonti, finance minister, and Italy's CassaDepositi e Prestiti, a state-controlled entity that has established an Italian Strategic Fund open to foreign investors."

The news cheered up markets immediately. "Reports that Italy is in talks with China to buy some Italian sovereign debt have completely turned around the stock market. The Dow has regained about 100 points in a very short period of time," reported the Wall Street Journal.

Asian stock markets rose on Tuesday morning, buoyed by the idea of a China bailout.

Other media were quick to pick up on the wider implications. "Euro propped up by China," ran the headline in The Australian.

"The idea that the Chinese may step up and buy Italian bonds puts a halt to the idea of contagion," Jim Bianco of Bianco Research told Bloomberg Television. "The big question is whether they follow through and buy Italian bonds."

The news alone was enough to help Italy auction off €7 billion of government bonds on Tuesday (albeit it at an average yield of 5.5%) and thus complete 70% of its fundraising for the year.

Does China have the firepower to make a difference?

On this score most people think yes. China has $3.19 trillion of foreign exchange reserves, and they keep growing: in the first half of this year alone it invested a further $274 billion overseas. "A similar amount in the second half would allow China to cover the cost of redeeming all the debt the Italian finance ministry has falling due," reckons the Wall Street Journal.

China could buy all of the outstanding sovereign debt of Spain, Ireland, Portugal and Greece ... And it would still have almost half of its reserves left over.

In April, The Economist wrote a piece along similar lines. "China could buy all of the outstanding sovereign debt of Spain, Ireland, Portugal and Greece, solving the euro area's debt crisis in a trice. And it would still have almost half of its reserves left over," it mused.

The half that's left over – almost $1.5 trillion – could make a serious dent in Italy's €1.9 trillion debt pile too...

But are the Chinese keen?

The newsflow from China on its potential role as Europe's saviour has been mixed.

On the one hand, officials clearly like to be cast as responsible global citizens. According to Sohu Finance, one senior source said in an interview that financial help for Italy "benefits China and the world". Wu Xiaoling, a former vice-governor of the central bank and current National People's Congress member also donned the Superman cape, telling investors that they "need not fear" as China was ready to boost market confidence.

However, Wei Jianguo, a former vice minister of commerce, told CBN that China cannot be "the saviour of Europe's debt crisis". Wei said too that China should be in no hurry to buy more European bonds, having already made losses on existing purchases (CBN reckons European debt makes up a quarter of foreign exchange reserves).

Wei added that the future of Europe could only be settled by Europeans themselves (pretty much mirroring what Beijing likes to say about its own affairs) and what China can do is limited.

China Securities Journal was also negative: "The debt crisis in Europe has been reduced to a terrible black hole, which means no matter how much money is injected it will be to no avail."

Public opinion was also largely sour. Though not a scientific measure, Sina's popular Twitter-like Weibo gave a good idea of the mood. One commentator asked whether China hadn't learned from buying Fannie Mae bonds. Another queried why the Chinese should foot the bill for over-spending Italians. The general tone was that the reserves belonged to the people of China and should not be wasted by bureaucrats from Beijing on buying "respect" in Europe.

A poll on Sina of almost 11,000 respondents asked whether China should buy Italian bonds. A resounding 74.5% said no.

And asked whether the European debt crisis would get worse, 82% said they thought it would.

What does it mean for China's relations with Europe?

The EU is a major market for China's exports, and likewise a significant source for potential overseas acquisitions. The European Council on Foreign Relations told Reuters that Chinese firms had invested $64 billion in Europe in the six months to March this year.

In an op-ed in The New York Times, Parag Khanna and Mark Leonard argued that China increasingly favours a G3 world – with the EU alongside the US as global partners.

"The United States, the European Union and China are the three largest actors in the world, together representing approximately 60% of the world economy – with the EU being the largest of the three," they write.

(Khanna is a non-resident senior fellow at the European Council on Foreign Relations, where Leonard – author of the excellent book What Does China Think? – is also a director.)

The two men see this triangular relationship as vital to China: Europe is a major source of high technology and invests more in China than the US. The Europeans also run a larger trade deficit with the Chinese than with the Americans.


The big fear for China is that it will find itself back where it was at the end of 2008, with exports falling off a cliff.

The relationship with Europe remains complex. The Financial Times points out that the man now going cap-in-hand to the Chinese, GiulioTremonti, Italy's finance minister, has written extensively in the past about his fears of China's "reverse colonisation" of Europe.

Readers of WiC will recall our Talking Point in issue 93, after a number of attempted Chinese acquisitions in Europe had been thwarted by apparently nationalist responses ("They suck us like vampires").

Such experience had the China Securities Journal asking what China would get in exchange for lending Europe a hand.

"No matter how many times the Chinese leaders visit Europe or buy the debt of European countries, Europe still blocks arms sales to China, still will not recognise China's market economy status, still criticises China's human rights, and still tries to force China to revalue its currency."

Fu Ying, the vice foreign minister, aired similar grievances in an interview with China News Service. She complained that Europe was yet to show that it regarded China as a "true partner".

A new 'coalition of the willing'?

After breaking the story, the Financial Times then wrote a follow-up piece noting that China's track record of delivering on its bailout promises was unreliable.

In the past, Beijing has spoken publicly of buying the bonds of various eurozone countries. Usually, it has failed to follow through.

But could the rescue party dispatched this time be bigger? Brazilian business daily Valor Economica quoted Guido Mantegna suggesting Brazil, Russia, India, China and South Africa were all considering a plan to switch more of their assets into euro-denominated debts.

Mantegna, Brazil's finance minister, said: "We're going to meet next week in Washington and we're going to talk about what to do to help the European Union get out of this situation." But when Premier Wen Jiabao spoke at the World Economic Forum on Wednesday, he sounded much less enthusiastic. Speaking to an audience in Dalian, he said European governments should "put their own house in order". Wen then seemed to suggest that so-called richer nations now needed to examine the cost of their social models (i.e. entitlements and welfare), as well as adapt to the new realities of globalisation.

He also indicated a quid pro quo may be necessary for a deal: speaking in terms of how 'friend should help friends', he suggested the EU should affirm China's full market economy status (a technical designation which would get Chinese more favourable treatment in trade disputes with the EU).

But can China afford to be complacent about what happens in Europe – and a potential knock-on effect in the US?

Patrick Chovanec, a professor at Tsinghua University, thinks Beijing probably is worried about the impact on economic growth. "The big fear for China is that it will find itself back where it was at the end of 2008, with exports falling off a cliff because of a drop in US and European consumer demand."

HSBC chief economist QuHongbin agrees that the eurozone debt crisis remains a "big unknown" for China's policymakers – and there is a fear that it will drag the global economy into recession. But he thinks China is better prepared this time than in 2008.

"China's growth is much less dependent on exports so the amount of stimulus required will be much smaller if the government has to fight a new global recession," he says. Back in 2008, net exports constituted 7-8% of GDP, and accounted for 3% of GDP growth (of 9%). Now exports are 2-3% of GDP. In the first half, Qu says, net exports contributed "almost zero" to the GDP growth rate. The upshot? Thanks to more domestic consumer demand and infrastructure spending, China may be in a position to be less concerned about a slowdown in its export markets in Europe and the US. But whether it could escape the fallout from a full-blown European financial crisis is another matter entirely.

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