- Money Morning Australia

Is China the Bailout Saviour in the European Debt Crisis?


Written on 31 October 2011 by Dan Denning

It will be the greatest garage sale in European history. This week, for two days only, China will have unlimited access to a huge inventory of trophy assets in Europe. The Eiffel Tower! The Colosseum! The Parthenon! Those assets are marked to move. And everything must go! Two days only!

But will China be the bailout saviour in the European debt crisis?

That seems to be Europe’s plan. Make the Chinese pay! China has $3.2 trillion in foreign exchange reserves. It has to do something with that money, doesn’t it?

Europe is hoping China becomes an investor in its bank bailout fund. A few hours after the Eurozone members announced their big plan last week, Klaus Regling, the head of the European Financial Stability Facility (EFSF), got straight on a plane (presumably not a grounded Qantas flight) for Beijing. What kind of offer did he make?

Well, the EFSF is not structured like a bank. It must borrow the money it intends to lend. It will do that by selling bonds to investors. If it wants the Chinese to buy those bonds, the bonds may have to be priced in yuan (to protect the Chinese from currency losses) and the bonds may need to be insured against losses (since owning government bonds in Europe is no longer risk free).

In the role of supplicant, Regling made remarks at China’s Tsinghua University in which he said Europe would be pretty flexible (as in on bended knee) in order to get the money it needs from China. On the issue of bonds denominated in yuan he said…

“We have so far only issued euro bonds but we are authorised to use any currency we want if it seems efficient…It also depends on the Chinese authorities, whether they would approve that. I think it is probably more difficult. But I could imagine that over the years it might happen.”

Regling also described a feature of the new bailout fund. He said, “The EFSF will take a certain tranche that will be a junior tranche, which means if something goes wrong, the first loss will be carried by the EFSF. It could be around 20pc.”

Insurance against a 20% loss on their bond investments may not be enough to attract the Chinese, even if the Europeans are willing to be publicly servile. After all, the non-default default that the EU has just declared on Greek bonds will leave investors with a “voluntary” loss of 50%. Who’s to say losses won’t be greater on EFSF bonds?

The bonds to be issued by the EFSF are backed by the full faith and credit of the major European countries. Standard and Poor’s currently gives France an AAA rating. But with a public-debt-to-GDP ratio of 80% and climbing, French government debt could be downgraded. If it is, the EFSF could face a downgrade too. And then the 20% guarantee would be largely worthless.

The Chinese know this. They know that by allowing Greece to default but not calling it a default, the Europeans have made global credit more expensive. Why? Investors who bought credit default swaps as insurance against default in government debt now know that that insurance is worthless. If the government coerces bondholders to accept a “voluntary” loss, it doesn’t trigger a “credit event” in which the CDS kicks in.

This suggests to us that the Europeans are going to have to offer the Chinese something a lot more compelling to get the money they’re after. Like a free lifetime pass to Euro Disney. Or all the wine in Italy. Or all the olives in Greece. Or all the gold in Germany. When Chinese President Hu Jintao arrives in Cannes for the two-day G-20 summit later this week, it may be a European garage sale like no other!

In the meantime, if Europe is a junior partner in the New World Financial Order, where does that leave Australia? Well, for starters, it puts the Reserve Bank of Australia in a pinch for its price fixing decision tomorrow. If global interest rates are headed higher thanks to the Europeans nullifying the use of credit default swaps on government debt, the RBA can’t very well cut interest rates can it?

Dan Denning

for Money Morning Australia


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8 Comments For This Post

  1. Frankly speaking Says:

    Should read this too Dan.

    http://www.channelnewsasia.com/stories/afp_asiapacific/view/1162023/1/.html

  2. boz Says:

    The European bailout fund has a credit rating and that is AAA with a stable outlook, which is different then France that has a credit rating of AAA with a negative outlook. More then searching for money the european authorities are looking for confidence that can help interest rates to go down and have a reduced volatility. A bit like: if China buys them, they must be good! In what currency china will buy European or other countries debt is a Chinese political decision. the trillions of $ China has as international reserve are caused by the peg that they put on the renmibi against the US$. That means that China government and central banks MUST buy foreign currency to keep the current exchange rate, so if China don’t buy the euro they’ll be forced to buy something else like the US$ or other currencies.
    European debt in Renmibi can be viable in the Future when the Chinese will have a different view on their currency. It could be that the Renmibi will be the new world currency where everyone will be keen to have debt denominated in.

  3. M&M Says:

    Boz – you see an open and transparent China in the future.

    I can’t see how the whole world would trust the RMB enough to trade in it.

    They still need to clean up property rights, human rights, quality control, ohs and living wages (to name just a few).

  4. boz Says:

    M&M, I agree with you and I believe the RMB as world currency is just a possibility. But, you know, China has 3 times the population of US and once the RMB depeg from the US$ it is going to rise in importance very quickly and the US$ is becoming more and more useless to price anything. Few years ago I would think oil and commodity today would be expensive but today I don’t know, for my trading I use the oil/gold ratio to price oil and how do you price homes these days? if you use the US$ they are very expensive in Australia and very cheap in US. Anyhow China has a unsustainable credit growth, they can handle it for few more years but that is going to end.
    As world reference currency I think the world would have to come out with some new ideas with something that can’t be manipulated by a single entity that can be politically driven. but I feel like things would need to get much worse before they can get better.

  5. M&M Says:

    Boz – china is a law unto itself. The wild west. Almost anything goes.

    I’ve given up making calls about timeframes and directions.

    We know that Chinas infrastructure investments don’t make commercial returns and that they’re under pinned by trade surpluses. I think they’ll get caught out some time soon, but they defy common logic. I can’t call it. They make fools of us in what we think is sustainable.

    They haven’t begun to borrow (though don’t know who from) nor have they printed. Who knows how long they can kick the can if and when they wanted to.

    But agree that we need a new world currency.

  6. boz Says:

    Oh no, China has been borrowing, the best way I use to check on that is by the monetary numbers, they had a 20% rise in M3 for years while CPI is at 6% and GDP is at 8-9%. They had a bit of catching up to do on productivity but they can’t catch up forever, also in the GDP increase numbers a lot of that would go waste as they are not going to invest and Grow in a optimal way. Also, for example, when you look at commodity demand the use double the amount of iron ore of the whole western world, most of it is for internal construction. Chinese people that use iron ore and steel have to pay for it somehow and that would be through credit growth (which is by going to a bank and borrow the money to build something)

  7. bobby Says:

    The Greek PM I announced a referendum on the deal and that basically throws a spanner in the works. It will take time to implement, the politics will go hot, there will be uncertainty for that period. Good luck!

  8. rocco Says:

    They want a referendum why?so they can vote no to the bail out
    but still want a hand out.its black and white.thats the deal.Take
    it our just close down..

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