Can China Rescue Italy?
On Wednesday, I went on Bloomberg TV to talk about the rumors that China might step in and buy Italian bonds, in effect rescuing the EU economy from the latest stage in its ongoing debt crisis. Later in the week, Fareed Zakaria argued that by using its vast ($3 trillion plus) foreign currency reserves to bail out Europe’s faltering bond markets, China could play a key role in stabilizing the global economy and, in the process, show that it is a “responsible stakeholder” worthy of a larger leadership role.
My own take is somewhat different. In my interview on Bloomberg (which you can watch here), I made the following points:
- China can no more “bail out” Italy (the world’s 8th largest economy, with an outstanding public debt of $2.4 trillion) than Europe can. What it can do is provide liquidity in a market that is undergoing a severe crisis of confidence, helping Italy buy time as it looks for a longer-term way to reassure investors.
- However, it’s far from clear that China is prepared to do even that. China has talked a great deal about using its currency reserves to project “soft power,” but when it comes to pulling the trigger, it has been extremely cautious about putting its money anywhere besides the safest and most liquid instruments. On his last few trips to Europe, Premier Wen made promises that China would step in and buy Greek, Spanish, and Portuguese bonds, but there’s little evidence that China has actually weighed into these markets in any sizable way. This Tuesday’s Italian bond auction, in which demand from buyers was pretty weak, certainly didn’t suggest any big buying spree by China.
- The Europeans seem pretty convinced that China is doing them a huge favor — but think again. The fact that China has vast currency reserves to invest in European bonds is actually part of the problem. China accumulates reserves because it sells more than it buys from its trading partners, and receives more foreign investment than it makes in return. The main reason so many European countries are facing a crisis is that they consume more than they produce. These “deficit” countries desperately need to grow in order to earn their way out of debt. Now, one of the obstacles is certainly internal imbalances within Europe (Germany’s surpluses), but China is also part of the imbalance. The New York Times recently published a revealing series of charts showing how pretty much every EU country besides Germany and (interestingly enough) Ireland is running sizeable trade deficits with China. If China really wants to help solve Europe’s debt crisis, it should buy more European goods or make productive investments in Europe, in order to drive real growth, rather than accumulating more and more reserves which it then graciously lends back to Europe’s deficit countries in order to keep them on life-support. China’s reluctance to do this is reflected not only in its currency policy, but also in protective measures that restrict European firms’ access to the Chinese market and require them to transfer critical technology to their Chinese competitors.
- Putting China’s substantive role aside, there’s a certain amount of political gamesmanship going on, on both sides. Obviously Italy wants to cultivate any buyers it can for its bonds. But by playing the China card, it may be sending a message to its European neighbors, much the same way Iceland did when it flirted with the idea of a Russian bailout: if you don’t help us out, maybe we’ll find someone else who will.
- China, on the other hand, is sitting on a ton of foreign currency reserves — euros as well as dollars — that it has to put somewhere. From its point of view, why not claim credit for something you have to do anyway? China wants several things from Europe: recognition of “market economy status” under WTO, an end to the arms embargo that has been in place since 1989, and banking licenses and other market openings for Chinese companies looking to expand abroad. If China can win some brownie points in Europe, just by making investments it would have had to make anyway, that sounds like a pretty smart game plan.
The title of Zakaria’s piece is “How China can help Europe get out of debt.” As you can see from my comments, the real solution is a lot trickier — but also a lot more promising — than a bailout. China can use the currency reserves it has earned from running trade and investment surpluses with Europe to buy more and more debt of questionable value, or it can use them to create demand for European goods and help Europe earn its way out of debt — and in the process, boost China’s overseas profits and domestic living standards. The latter is a real solution, but it involves a fundamental shift in China’s relationship to the global economy.
[UPDATE: To my bemusement, excerpts from this blog post were republished in the Wall Street Journal's "Notable & Quotable" column of Sept. 18, which you can check out here.]