China to the rescue?

It wasonly a matter of time before China was heralded as Europe’s escape route from its debt crisis. News that Nicolas Sarkozy, the French president, called Hu Jintao, his opposite number in China, after the crisis summit on October 27^th sparked speculation that China might put substantial amounts of money into the debt of troubled euro-zone borrowers. The chatter grew louder when Klaus Regling, the head of the European Financial Stability Facility (EFSF), the euro area’s bail-out fund, visited Beijing a day later. And a poor post-summit Italian bond auction has made the need for a deus ex machina seem even greater.

China certainly has lots of money to invest. its foreign-exchange reserves are reckoned at $3.2 trillion. It trades more with the EU than any other partner. It has exposure to the euro already. How much is not known, but currency analysts suspect that about a quarter of those reserves are already euro-denominated, giving it an incentive to keep the currency strong. It also suits China to play the part of a constructive economic actor.

Then again, we have been here many times before during the euro-zone saga. You can trace the growing seriousness of the crisis by the list of countries that have had talks with the Chinese about investments: first Greece, then Portugal, Spain and now countries at the very core of the euro zone. The pattern to date has always been the same: lots of encouraging rhetoric, perhaps even a little cash, but not enough to meet initial expectations.

There is at least something different on offer now. In the past, investment in euro-zone debt has meant taking on as much risk, and sometimes more risk, than the Europeans themselves have been willing to absorb. No one could ever explain why the Chinese would want to do that. Now China will be able to choose to invest in euro-zone debt that is ensured by the EFSF, or to buy senior tranches of the special-purpose vehicles (SPVs) that the EFSF will capitalise. China would explicitly be taking less risk than the Europeans. Read more at The Economist