rescue

Can China play Santa for the euro?

December 23, 2010: 11:42 AM ET

Is China Claus about to deliver a heart-warming ending to the euro crisis?

That is the latest hope of the financial markets, which have rallied around promised Chinese support of Europe's scramble to find a solution to its debt problems. But gifts from the world's most aggressive trader often come with costly strings attached.

Ho ho ho or no no no?

Wang Qishan, vice premier of China, said Tuesday that China had taken "concrete actions" to help some European countries. A Portuguese newspaper reported this week that the Chinese are preparing to buy some Portuguese bonds, helping to cool a simmering financing crisis on the euro zone's periphery.

The news helped boost two modest rallies in the U.S. stock market and stabilized the euro, which has been sliding for seven weeks against the dollar, at around $1.31.

It seems plausible that Chinese buying of euro bonds could make a difference for stressed-out European borrowers, given China's trade surplus-driven financial might and the modest immediate financing needs of Portugal.

Should China buy, say, 4.5 billion euros ($6 billion) worth of Portuguese bonds, it would in one fell swoop satisfy half of the country's refinancing gap for 2011, FT Alphaville notes.

What's more, a purchase of that size hardly seems outlandish: Mark Williams, an economist at Capital Economics in London, writes that even conservative assumptions suggest China has been taking down $7 billion to $8 billion a month in euro-denominated assets this year, just as a matter of course.

Yet this gift may not keep on giving. China agreed this summer, for instance, to buy some Spanish bonds. That helped to assure the success of a key debt auction, though China demanded in return that European ministers publish the results of their bank stress tests – an effort that is now widely regarded as something less than an overwhelming success, given that Spain and other weaker euro economies are now back in the soup.

What's more, as FT Alphaville's Joseph Cotterill asks this week, is what's the quid pro quo this time? The mind boggles, because, as Howard Simons of Bianco Research has been saying, bringing the Chinese in to help clean up messes in Western financial markets has a, let's say, mixed track record.

He points to the unofficial accord reached in the summer of 2008, in the days before Hank Paulson started waxing on about his bazooka. That one kept China buying U.S. debt and supporting the dollar in exchange for what turned out to be a two-year pause in the yuan's appreciation against the dollar.

At the time, this deal seemed to offer everyone something: China got a bit of exchange-rate relief for its politically powerful exporters, Europe got an end to the surge in the value of the euro that was bringing domestic economies to heel, and the U.S. got to stop worrying its biggest creditor would pull back from its nervous debt markets. The way was paved for a continuation of global growth, surely?

Made in China?

But two months later, what we got instead was a global financial meltdown.

Of course, there is no shortage of moving parts in global finance and it would be unfair to blame the bazooka accord for what followed. But it's also hard to ignore that deals like the one apparently being pursued by China and Europe have costs as well as benefits -- and that any deal that delays European leaders' reckoning with their structural problems is likely to register in the final accounting as a cost.

It would obviously be nice to avoid a default in Portugal, but Chinese bond buying alone is not the solution to anyone's problems.

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