- Money Morning Australia

Is China the Bailout Saviour in the European Debt Crisis?

Written on 31 October 2011 by Dan Denning

Is China the Bailout Saviour in the European Debt Crisis?

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

Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...

Dan Denning
Dan Denning is Editor in Chief at The Daily Reckoning and the Publisher of Port Phillip Publishing. Dan is also the investment analyst and editor of The Denning Report. His high-level, macro-economic and stock market forecasts are read by more than 35,000 high-dollar investors and fund managers in over 70 countries. If you're already a subscriber to these publications, or want to follow Dan's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au

8 Comments For This Post

  1. Frankly speaking Says:

    Should read this too Dan.


  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..

How Money Morning Can Help You Can Become a Smarter, Better, Investor

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

New Frontier Investor

The last investment megatrend birthed stock gains of 11,095%, 20,621% and 50,760% over 20 to 40 years.

If Kris Sayce is right, gains from this next megatrend won’t just reach those heights...

They’ll SURPASS them...

To see why, click here.

Iron ore leadgen

  • ^NDX3965.165-18.023 - -0.45%
  • ^FTSE6791.55-29.91 - -0.44%
  • ^AORD5563.100-11.100 - -0.20%
  • ^AXJO5571.000-12.500 - -0.22%
  • AUDUSD=X0.9397
  • USDJPY=X101.775

PAN [predict literally ban]

interest rates leadgen

Australian Small-Cap Investigator

Why Holden’s future lies
beneath the soil in

And not just the future of Holden…but Toyota,
Hyundai and Mazda too


investing success leadgen

TDR [war in the pacific ban]

Resource Sector leadgen

Gowdie Family Wealth

Which type of family are you?

  1. The kind that ends up in court
    battling over inheritance money…

  2. Or the kind that knows how to
    protect, pass on and grow wealth forever.

Click here if you want the kind of family
that grows its wealth for generations.

The Money For Life Letter

A giant wrecking ball is about to smash Australia’s retirement system to smithereens...
And unless you take the evasive action outlined in this Special Issue, everything you’ve saved and invested over your whole working life could soon be GROUND to DUST.
Click here to read.

Gold Stock leadgen

Revolutionary Tech Investor [BANNER moonshot]

Graphic Ad 1 – Blue Chip Stocks Report

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

If you answer ‘yes’ to the following questions, then you’re hoarding your investments. Don’t despair [Read More...]

Most large super funds have limits on where they can invest superannuation. This means many investor [Read More...]

Russia and its supporters have nothing to gain from attacking civilians. Russia and Putin were winni [Read More...]

You owe it to yourself take this advice. But even if I’m right and you act now, you may not be able [Read More...]

New Zealand may not be an emerging market, but it’s highly leveraged to growth in emerging markets. [Read More...]

China’s moves are as much about food security as they are national security. Whether its fish, fuel, [Read More...]

The real estate and credit bubble blew up in 2007. And now, prepare yourself for the biggest blowup [Read More...]

Australia’s financial industry is getting away with murder. Forcing people to put money into superan [Read More...]

So where does the trade-off trade off? How low can interest rates go before Glen Stevens’ hair catch [Read More...]

Investing part of your portfolio overseas is a vital part of proper asset allocation. It’s a corner [Read More...]


"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery