China helps take pressure off euro

By Gabriele Steinhauser

Associated Press

Published: Wednesday, Jan. 5 2011 12:00 a.m. MST

China's deputy premier Li Keqiang, left speaks with Spain's Foreign Minister Trinidad Jimenez before a meeting at the Zarzuela Palace on the outskirts of Madrid Wednesday Jan. 5, 2011. Spain says it hopes to sign several important business accords during Li Keqiang's three-day visit to Spain.

Paul White, Associated Press

BRUSSELS — Spain, Portugal and Greece — three of the eurozone's most financially shaky members — in recent months have touted a lifeline thrown to them by China: a promise to buy these countries' embattled bonds.

The pledges from the government in Beijing temporarily took some pressure off European debt markets, but China has been quiet on how much money it will actually invest. What is clear is that China has an immense interest in helping the eurozone, its biggest trading partner, out of its current woes.

On Wednesday, Spain signed more than a dozen business accords with China, two days after Vice Premier Li Keqiang wrote in daily El Pais that his country will keep on buying Spain's public debt as a show of support.

That follows similar deals and promises from China for already bailed-out Greece and Portugal, seen by many as the next weakest link in the 17-country eurozone.

Europe has been fighting a bruising battle to keep its currency union together. But a €110 billion rescue loan for Greece and the €67.5 billion bailout of Ireland have failed to erase fears that mounting debts in several member states might be too much for the struggling eurozone and could eventually even endanger the euro.

A deepening crisis in Europe or a meltdown of the euro — which already appeared to be in a state of free-fall last spring — would hurt China, now the world's second largest economy and holder of massive foreign currency reserves, most of it in U.S. dollars.

Beijing believes that a stable global economy needs at least two lead currencies, and China has already invested heavily in European government bonds to prop up the euro as a viable alternative to the dollar, says Vanessa Rossi, a senior research fellow at Chatham House in London.

Much of China's clout come from its large trade surplus and the savings that result from it, a sharp contrast to the debt woes of some of Europe's governments. Rossi estimates that of China's massive $2.5 trillion foreign exchange reserves, close to $1 trillion are holdings in Europe. That's still far behind the $1.5 trillion invested in the United States, but would imply that China on average now holds about 10 percent of eurozone government debt, says Rossi.

Any new promises to buy bonds come on top of significant existing investments, and are mostly meant as a "psychological support" for the euro, says Rossi.

Yet psychological support is significant, as more confidence in government bonds means lower interest costs when indebted countries borrow and could help prevent a death spiral in which rising borrowing costs feed default fears and end with the country unable to borrow — and needing a bailout.

Beijing's interest goes beyond the stability of the euro. A deep or prolonged economic depression in Europe — a possible consequence of a breakup of the eurozone — would hurt China, which sells about 25 percent of its exports to the continent.

Greece, Portugal, and Spain are relatively small in terms of trade. But their collapse could hit Germany, which gobbled up some €29 billion in Chinese exports in the first 6 months of 2010, while supplying the Peoples Republic's elite with luxury cars, industrial investment and technologically advanced goods.

China's recent deals with Europe's weaker members also include investments in key sectors such as ports and telecommunications — investments that other countries have been reluctant to allow.

Indirectly tying support on debt markets to other business accords presents China with "a dream opportunity to hammer out some lucrative business deals," says Jonathan Holslag, a research fellow at the Institute for Contemporary China Studies at the University of Brussels.

Once a country has advertised Beijing's help with its bonds, it becomes much harder to say no to other investments, says Jean Pisani-Ferry, the director of Brussels-based think tank Bruegel.

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