CHINA HAS MUCH TO GAIN FROM SUPPORTING THE EURO / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

China has much to gain from supporting the euro

By Henny Sender

Published: February 3 2011 15:20

There are many factors behind the euro’s climb from $1.28 to the dollar in mid-January to almost $1.38 today. While events in Egypt could yet derail the rally – Europe being more vulnerable than the US to any disruptions in the flow of Middle East oil – sentiment about European prospects has improved a lot. For all the uncertainty, the dollar has lost more than 6 per cent against the euro.


Analysts cite several successful eurozone government debt auctions, hawkish statements from the European Central Bank and buoyant risk sentiment as among elements in the newfound optimism.


But there is one additional factor. The Chinese have been buying European sovereign debt in a big and – for China – very public way.


The People’s Bank of China may not wish to see its own currency appreciate against the dollar, but it is more than happy to see others’ currencies do so. Indeed, senior bankers in Hong Kong speculate that Chinese buying may have taken up as much as one-third of recent eurozone bond issuance.

That means it is no longer just the ECB standing behind the euro. The Chinese are backstopping it, too. With China’s $2,850bn in reserves, there is good reason to be optimistic about the euro’s prospects, assuming stability in the Middle East and North Africa.


The reason is simple. The Chinese have every interest in promoting a world where there is more than one reserve currency and have been vocal about their dissatisfaction with American monetary policy. If the US dollar is the only game in town, the Chinese have little leverage. Today, the euro is the only currency that can serve as a reasonable alternative to the dollar.


It will be a while before China will be willing to let its own currency act as a reserve currency. At the moment, China wants to keep capital controls in place and, as long as those controls remain in place, the renminbi cannot act as a reserve currency.


But that is not to say the renminbi will not play an increasingly important role in the world. It is in Beijing’s financial interest for that to happen since internationalising the renminbi allows liquidity to flow out of China in a controlled way. It is also in its political interest as a way to win friends among the cash-strapped governments of Europe.


The world, for its part, had better get used to China being both a cheaper and more flexible source of capital than many alternatives, including very possibly, the International Monetary Fund.

Beijing is eager to encourage its partners to trade in renminbi and is offering sweetheart deals to bring that about.


For example, as Chinese banks offer attractive financing for foreign buyers of Chinese goods, more and more of those buyers will receive renminbi loans at subsidised rates in payment for those goods. Those financings are especially attractive in countries where capital is still scare and expensive, such as India.


Thus, recently, India’s Reliance Power received a commitment for $12bn from a group of Chinese banks in connection with an order to import $10bn of power equipment from China. Part of that financing was in renminbi, with an offer from the Chinese side to help Reliance hedge the risk that the renminbi will appreciate over the 12-year life of the financing.


Capital controls along with household savings equivalent to more than 50 per cent of gross domestic product enable the Chinese to keep their cost of capital low. That makes it possible in turn to finance an increasingly awesome national infrastructure and other big projects at affordable rates – and finance others’ as well.


Exporters to China are also accepting renminbi in payment, even though they cannot invest in China or buy up Chinese assets or companies, as long as capital controls remain in place. They can only buy goods from China. Nevertheless, these exporters are still happy to receive renminbi because they believe the renminbi will inevitably appreciate over time.


Of course, it is easy to exaggerate the role of the Chinese in international financial flows. This summer, Chinese hands were widely believed to be behind the jump in the value of the yen and the rise in Japanese government bond prices, though Bank of Japan officials later said that Chinese buying explained only a small part of the move.


Still, at some point, this will change. The Chinese will lift those capital controls and the rest of the world will join Hong Kong in buying (and perhaps selling) renminbi.


But today, from the Chinese point of view, it can only be a blessing to have investment alternatives to US Treasuries – and earn the gratitude of beleaguered trading partners in the European Union in the process. If even just incremental flows from China are diverted to the eurozone, that could have big implications for US interest rates.
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Copyright The Financial Times Limited 2011