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Can China Rescue Italy?

September 17, 2011

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.]

10 Comments leave one →
  1. September 17, 2011 11:10 pm

    I cannot agree more on “China is part of the imbalance”. A joke about China’s reserves says, whatever China buys, the price of which soars. Seemingly China’s reserve is as headache to the government as other country’s lack of reserves, and the way of China using it can create even more problems.

    Will China help Europe by buying things? Maybe, since China did buy planes from Airbus. But frequently China’s drive to buy currently is not to buy in future- the plan of learning, copycat and taking over. So even to create demand for European goods, China does not want to see the importing to last for long.

    • September 18, 2011 7:20 pm

      yes, I remember that soaring of foreign inventions 50% down (2007-8,
      BTW. it seems newly 1 billion will run to Belarus = is it plan of learning, copycat and taking over?

      • September 21, 2011 7:36 am

        As far as I can see the 1 billion for Belarus is more like racing with Russia to take over valuable resources and historical heavy industry knowhow. Resources are always focus of China’s investment since with denominator of 1.3 billion populations, China in any way is far from resourceful. Ah in the trade China serves a satellite and gets an unprecedented market entry permit as well. I do not know much about the details but up to now all this seems good value for money.

        The Belarus trade can not be applied onto Europe’s current trouble, because many European countries – especially the Western Europe, stand on knowhow rather than on resources. While resources’ mining has to happen locally, I suppose production based on knowhow will be quickly shifted to China or Asia because of relatively lower labor cost and economy boosting pressure. In this way Europe’s headache continues, i.e. high unemployment rate and low exportation and now with a potential rival for even worse.

      • September 21, 2011 4:50 pm

        “production based on knowhow will be quickly shifted to China or Asia because of relatively lower labor cost and economy boosting pressure”?
        i think initially was mostly shifted production based on manual work “because of relatively lower labor cost”

        (and also lack of ecological and safety standards)

        why do you think such shift did not happen in last 30 years

        and should happen right now when china becomes more and more expensive and probably slowing?
        i think opposite: now could be time to produce more for Chinese consumption because it has growing labor cost

        “Europe’s … low exportation”? $1.952 trillion (2007) $1.33 trillion (2005)
        what about china than? $1,581 trillion (2010)
        i see bigger problem in EU trade deficit

  2. Rommel permalink
    September 19, 2011 5:16 pm

    Good article as always. Thanks. I read your posts religiously as I consistently find them to be among the most thoughtful on China.

  3. September 21, 2011 7:37 am

    News yesterday said China was extremely disappointed that the European Union hasn’t recognized its market economy status. Hopefully I can read something here about it. I am curious of westerners’ view on China’s market economy argument. And I find Chinese’ comments on this piece are interesting.

    • September 21, 2011 5:47 pm

      in .cn news i found was missing “State-set pricing in some sectors of the economy and special financial support for key state companies” part if story

      • Hua Qiao permalink
        September 26, 2011 3:09 pm


        I would also love to see a post on Market Economy status. What does it mean for China? (As best as I can tell, it means that dumping cases get resolved differently.)

  4. September 23, 2011 12:51 pm

    I think, what we have in here is that China try to save their own. Europe is important partner to sell the goods from China so if Europe in crisis, the China industry (and business) will also face the consequence.


  1. Kina kommer inte, och kan inte, "rädda Europa" | Finansliv

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