THE IRONY BEHIND CHINA’S EUROPEAN BOND BUYING
The headlines driving markets in recent minutes is a rumor about Italian officials talking about bond purchases with China. The media of course will hold China up as though they are some white knight riding in to save these failing European nations. But make no mistake – that is not even remotely close to the truth.
On the one hand, China can “help” ease the strains in the Eurozone by buying bonds of various periphery nations. This helps kick the can in the debt game, but does NOTHING to solve it. We know this because we’ve already seen this movie once before. China made waves last year when they announced a firm commitment to buy Greek bonds. Of course, this announcement soothed markets for a few months and then the underlying trends took hold again and we all know what’s going on in Greece today.
You see, what happens when China commits to buy Eurozone debt is that they are actually targeting the exchange rate. It’s no coincidence that the easing fears in late 2010 with regards to Greek/China debt buying ultimately led to a sizable rally in the Euro. Make no mistake, this is an attempt by the Chinese to push the Euro higher and maintain what China views as a favorable exchange rate with EMU nations. China doesn’t want to see the Euro collapse versus the Yuan and they will do everything in their power to make sure that doesn’t occur. So, when foreigners accumulate Euro financial assets they are essentially driving import growth to the Eurozone. This actually reduces Eurozone aggregate demand and adds to the debt deflation we are seeing there. Buying the bonds helps soothe fears of credit contagion, but it in no way solves the problem of too much aggregate debt. Instead, it helps kick the can as the austerity measures instituted by the EMU will continue to cause the negative debt trends to deteriorate. This is exactly what we saw in Greece after China committed to buy their bonds last year.
China is no white knight here. They are trying to save their own skin. And who can blame them? They don’t want to be sucked down the global tubes due to the construction of a flawed monetary system in the EMU….
If they just want to prop up the EUR then won’t any euro-denominated assets work? Why not buy German bonds?
That doesn’t send the same message. China wants us all to believe that they are helping to fix the EMU’s problems by being a source of liquidity where it is needed most. Unfortunately for China and the CNY, the markets appear to be on to their games….
To be fair, if I were China I wouldn’t market it any other way. Saying I’m here to help rather than to save my own skin. Whether that’ll work over the long term it’s another story.
Right. And in a sense, they are helping as best they can (they have a lot invested in keeping the EMU somewhat healthy), but let’s not go saying that their motives are anything but selfish.
The best way to be “selfish” is to help those who are helping you. Selfishness does NOT need to have a negative connotation. Hyperselfishness, where you look out ONLY for yourself is blind to the value of helping others. We also call that…………………………. greed!
Using the US example, the “risky” assets will be a minority and as you said is just for show (viz a viz China’s buying of Tsys vs. MBS, junk bonds etc.). They will buy Bunds to suppress the exchange rate, and force the Germans, to bail out the Greeks (just like Feds and BABs, Tarp etc.).
…well, the yield is probably a lot better on the italian bonds, for starters.
China is terrified of a Euro collapse. If Greece were to default and bring back the Drachma the Euro would surge as it would essentially become a safehaven based on the increased strength. The new drachma would collapse and the endgame could be a much higher Yuan and weaker economic growth for China. They have a lot of skin in this game and like the Germans, they want this game to continue forever.
Ding ding ding!
No ding ding ding….
The Euro and Yuan will rise against the Drachma? Who cares?
China is doing this because a default will mean a big fall for the Euro against everything else, which will hurt Chinese exports to EU. If they can avoid this with a little money in Italian bonds at a high interest rate, fine.
Re-read LVG’s post. He’s arguing that the Euro will surge if Greece defaults. Huh?
Even if it were true, China wouldn’t fight that.
I think the argument’s inside out.
Perhaps I am misinterpreting his point then. But I agree with the idea that it’s all about propping up demand to China.
MOTO! lol It’s obvious to a few people at least! I wrote a bunch of stuff last year about how China was “helping” the eurozone.
Still before we get too far, there has been a significant change in China. A massive and huge change….
Read the 12th 5 year plan and tell me what they are going to do with reserve policy. Almost undoubtedly, they are going to shift their reserve allocation to higher euro, yen, and other countries, and less USD.
You should throw your links in here TC. I’d be interested in reading. Thanks. CR.
“Almost undoubtedly, they are going to shift their reserve allocation to higher euro, yen, and other countries, and less USD.”
Materially higher? I’ll believe it when I see it. Maybe not even then.
China doesn’t collect any currencies as investments, merely as byproducts of their currency manipulation. When they want the yuan to rise against the dollar, they’ll stop buying/holding dollars. Not before.
I am watching for it though. Someday they’ll benefit greatly by having a stronger Yuan as they purchase more commodities that are denominated in USD for themselves than they re-export.
After their bubble crash. After their recovery and eventual rebuild to full employment.
And probably sometime after the revolution….
Whoa…did I write that or this most excellent Cabernet? Anyway, that’s my opinion and I’m stickin’ to it. But I’d be grateful if you prove me wrong before Mr. Market does!
This does not seem to make sense. If China’s purpose is to keep the Euro relatively high, under your scenario, a collapse in weak Euro countries would accomplish this, but you say that is what they are trying to avoid. You then say that this would push the Yuan higher as well, which is the opposite effect of the one described?
BTW it seems unlikely that Greece leaving to the drachma would all of a sudden make the Euro gold-plated – I would guess that the chaos would have the opposite effect – just a guess though.
I think the key is the word collapse. China is trying to prevent or help prevent a collapse of the Euro zone economy. If the periphery defaults/exits/collapses then the Core nations see rapidly rising unemployment. Even if the Euro rises as a result of the collapse the rising unemployment will likely me falling total Chinese exports.
In the end its not the actual level of exchange rate that China cares about its the total net value of exports. If the Drachma (and the lira and peso, ect…) comes back then they will likely be too weak to buy Chinese exports. Conversely Germany’s and the other Core nations loose their key export markets and unemployed core nation citizens wont be buying Chinese exports regardless of the value of the Euro.
Kinda hilarious right? Countries like Germany and China want the best of both worlds. They want to have artificially low exchange rates so that their goods are more competitive and they can be net exporters to boost their domestic employment. They want to lend to other countries too to earn interest income. They want their loans to be paid back in full and with interest. But they don’t want to let their debtor counter parts to actually produce any goods or services to pay for the debt that they loaned them, because it would hurt their domestic economy! All the creation of debt does is let one group realize greater terms of trade than they otherwise would. In the end, trade must always be balanced otherwise things eventually blow up.
This is also why we will always and forever have inflation, because in the end someone will always end up with all the money and they won’t want to share it with anyone else. And by share I mean to actually purchase goods and services at fair terms of trade from others. The only way to keep this from happening is to constantly inflate.
help me with the mechanism – the potential Euro strength is trumped by the weakness in the Drachma…?
Actually, they’re probably more interested in keeping Greece in because of the new Chinese port there.
I think it is ironic that by doing so they help the US a bit.
Unrelated question:
Cullen,
The 1 year Greek bond hit at least 125 today. How can someone in the US buy those bonds? When Greece defaults and there are haircuts of lets say 50%, are they going to be on the principal only? What about the interest?
Very astute insight Cullen.
And the fact they China likely exchanges USD/treasuries and Euro/Eurodebt will depreciate the reserve currency.
Now does the MMT macro view expect this treasury selling produce
- no change to treasury yields or
- have a small increase to yields
I tried to look find the treasury yield change during the China Greek bond date purchase, but I couldn’t find the time frame of purchases to see how well MMT expectations line up with the real world.
Looks like a similar response to the announcement last year on greek bonds. The markets are reassured by the Chinese intervention and the Euro is rallying huge. It’s hilarious watching an irrational market in real-time. I am consistently amazed at your ability to see things for what they really are Cullen. Thanks.
I wander how much have they lost on Greece bonds bought last year (if any). My thought is there is a lot of talk from their side on the subject, but very little action.
That’s the beauty with government accounting. They only need to book losses in case of default.
I didn’t think they’d actually find another way to kick the can. I continuously underestimate the Europeans. (sells EUO position).
The euro is still climbing against other currencies, why? Have market participants don’t considered this. A really insightful idea, and fully believable, but still a strong euro???
Did China ever buy any Greek debt ? I remember the headlines that they “might”, but if the idea was to boost confidence, the lack of further information was strange. Or maybe I just missed it, of course.
Also, wrt Italian debt, I’m not clear if the current rumours concern an approach by China to buy Italian debt, or an approach by the Italians for China to do so.
Now, if the Chinese were to buy a large chunk of the Italian banking system (assuming that they would be allowed to do so), that would light a fire ! Say a few billion of prefs and a few billion of options, a la Buffet. Maybe some Libyan oil as a sweetener ?
At somepoint the internationalization of the RMB must occur; the Chinese cannot continue to absorb Western Debt without it negatively affecting their economy. It is sad that the Chinese have to support the standard of living of the United States and Western Europe.
The sooner the Chinese convert from an export model to manufacturing with an emphasis on internal consumption the sooner the Chinese can tell the west to go pound salt.
On the other hand, if China continue the export model then dump these toxic assets from America and Western Europe forcing them to settle all transactions in RMB.
Regards,
Rob
Sorry to post this here, Cullen, but you’ve got the smartest bunch of commenters around and I’d like to hear their (and your) take on it. I hope it’s forgivable.
“At least it is no longer complicated. We know a European Lehman is upon us. Or, more like it, a European Lehman/Bear/Merrill/Washington Mutual/Wachovia/Citigroup.
That’s the first proposition.
Second, we know that “they” have no plan to deal with it.
Third, we don’t even know who “they” is anymore. Is it the Germans? The French? The IMF? The European Central Bank? Trichet?
Fourth, it is now too late for the banks to raise capital. As you recall, when the ratings agencies strike, it very quickly leads to Lehman. The banks can’t get short-term funding and they collapse.
Fifth, the French banks in particular have been getting away with hiding their version of subprime debt, Greek debt, forever.
Sixth, our country isn’t able to stop any of this. We are too weak and it is none of our business.
Seventh, because of how tightly correlated we are with Europe, individual stocks can’t buck the trend, at least initially. Later on they will, because while our banking system won’t collapse, it can’t help but cause a worldwide recession if it all goes bad, which it looks like it is going to do.
So, the only battle plan is to brace yourself if you can’t short. Raise some cash if you can. And short the S&P and double- and triple-short the financials — the levered ETFs will certainly give you that chance.
At least we will get this over with soon and we can see what it looks like when the smoke clears.
Dire?
No.
Honest.”
This came from Jim Cramer of all people.
He’s got it all pretty much dead on as far as I can tell. The bottom line for me is the fact that they’re not solving the root of the problem which is the fact that the currency union is unworkable. Until they do that, there is no fix here.
Jim Cramer? Run for your investment life, and bet against him. His analysis leads me to consider if the crisis has peaked and that the ECB will soon step up and start buying periphery debt in a big way, and tell Angela Merkel: “lead, follow or get out of the way”. That is Goldman’s advice in a nutshell, and isn’t Draghi an alumnus of Goldman? That will likely lead to a melt up in stocks and a rocket launch in periphery debt values, a drop in the euro exchange rate and a boost for gold and commodities. The ECB is like the Fed; know in advance what it is going to do and you’ll get rich. “Macro” equals central bank machinations.
Seriously, lol. I heard him say it today and my jaw almost hit the floor. He’s been saying cash and yield for a while but this was out of the norm for him.
I didn’t think he could / would recommend shorts, or at least never would, cause it goes against his ‘there’s always a bull market somewhere’ schtick, but he is literally saying until Greece folds there is no way but down.
Thought for a second CR may have brainwashed the poor guy!
I think he’s still smarting from those Lehman Brothers and Bear Stearns calls. He pretty much guided a whole lot of people not the slaughter house and he might not want to be the guy who make the same mistake twice.
I thought the same thing when I saw the Cramer post. This guy is usually wrong. But not always. A week or two before Lehman fell he was making correct calls and said to get out of all financials.
Then later he advised us to buy Wachovia.
He has been a bit more sane lately. I would never take investment advise from someone who makes his money with TV appearances though
#2-7 strike me as true, but are dependent on point 1.
Is this the precipice of “a European Lehman/Bear/Merrill/Washington Mutual/Wachovia/Citigroup” or will this drag out much longer with fits and starts?
Who’s got the crystal ball?
The chinese aren’t that dumb. If the ecb is not buying the junk why should they?
http://www.zerohedge.com/news/reminder-here-what-china-really-thinks-about-italian-bond-purchases
Because the Chinese don’t have to listen to the Germans.
Why do I feel I have to take a shower after visiting Zero Hedge?
Because you don’t know how to read ZH. IMO, ZH is great for for up to the minute information but use it for investment advice and you will go broke. I love reading ZH. His high frequency posting is great and I agree with his view often
“Why China want to buy when ECB not buying”…
Chinese Marshall plan and a new China centric world ?
Let’s not forget that China has a political transition coming up in 2012. Hu Jintao is doing every thing he can to kick the can down the road till he is out of the office.
The last thing Hu wants is to have the Chinese economy blown up under his watch, even thought the seeds were planted under his watch.
The simple truth is that all the countries of the world are jockeying for position in a race to the bottom, attempting to salvage their own export market by devaluing their currency against all the others.
The whole world financial system based on Central Banks issuing a nations currency on a fractional reserve basis is just one colossal Ponzi scheme, to which new layers are being added to kick the can down the road, to avoid a mathematically certain collapse.
Since all currency comes into existence as DEBT, and over a 25 year period (on average) as much is withdrawn in interest as was originally created in principle, destruction of purchasing power through inflation is simply inevitable. When there are no more willing borrowers to REPLACE the paid back currency and outright currency printing to monetize debt becomes routine then the end game is near.
Funny I came to a similar conclusion on Cullen’s SS ponzi post.
That is, fiat issuance is a “ponzi” when unfunded deficit spending is “unproductive”
You might want to read my primer on the monetary system. I think that would help dispel some of the myths. http://pragcap.com/resources/understanding-modern-monetary-system
I agree with Cullen. To put his point a different way, the Chinese are making the classic mistake of targetting what some economists call an “intermediate objective”.
The basic and proper objective is maximising living standards (within environmental constraints). The Chinese are targetting exports – something that hoards of politicians in the West have done over the last century.
If China can keep a huge internal RE bubble with empty cities being built as far as the eye can see going, they can float the Eurozone for a few years as a captive export market. I wouldn’t underestimate them. They may have plans to eventually buy out all the productive German industry and gain a complete mercantilist monopoly.
IMHO the Chinese simply prefer ECB-austerity over Fed-fiat-currency. And if you look at the EUR/USD exchange rate from 1999 until 2011 one was better invested in Euro than in dollars.
So I think Cullen is right: the Chinese simply try to get the best for their money and are not a white knight.
BTW: Jim Rogers proposes to buy massively Euros in case of a greece default, because he thinks the trend of the past 12 years continues.
http://www.cnbc.com/id/44452871
The Chinese authorities have many tools to influence the exchange ratios, one of these, the cheaper one, is let the markets know they are going to do something. When they really do something, they don’t tell you. There are hundreds of chinese finance holdings everywhere in the world and plenty of cash.
But instead of losing time debating of chinese intervention on the currency market look at a much more important thing. What are they doing with a massive pile of cash well over 3 trillions USD ? Well, I left my work a couple of years ago at just 47 because I’ve a little money and I think wiser spending it travelling, climbing, skiing etc… than waiting in a such an unstable world. I’m an avid reader, a good observer and with friends all over the world. I’m just back from a long trip in South America the backyard of the USA. There they bougth good farm land as large as Missouri, most of the new mines (copper, iron, gold…) are chinese. The influence of the USA is fading at an unbelievable pace. This is happening in Africa, south east Asia, Iran is living thanks of chinese money, etc.. Bomb Iran ? let’s try.
So they are doing a lot of things, but the most important is spending USD to buy real stuff and price doesn’t matter.
Currency intervention is just a tool.
Cullen I like your blog, very much, but WHY you are STILL optimist ?
If you are not an optimist, what’s the point of even staying alive? As a pessimist you can only take joy in being proven wrong. Being wrong is no fun.
Make no mistake, China needs the USA far more than the USA needs China. How would they sustain their growth without the foreign trade surplus? Who else would supply it? Europe? China has become a formidable power, but they are far from being like the USA in their prime or even their current state. And how can you not be optimistic when the US trade deficit helped millions after millions out of poverty in a life that offers far more choices than working on a rice farm? Economics is not a zero sum game. If the Chinese are smart they’ll move to a more balanced foreign trade approach over the years. This will help the other big exporters in the world: Japan, USA, Germany.
I’m confused, what Ironic here?
Smile at the irony of a nation that is propped up by China. Say to your merchant banks to relax, spend time with us …
China’s policy makers are neophytes to capitalism and unfortunately their American/Western advisors have dismissed, as has Japan, the fundamental base element necessary for capitalism to survive and that is debt liquidition. They’ve attempted to replace falling worldwide demand with internal capital projects that add little to future production as P&E and entire cities sit idle. Now they intend to use the last of their capital to purchase bonds that foreign debt that will ultimately be rendered near worthless through either outright default or inflationary policies.
They are following the road paved by the current Western economic and political leaders..waisting current resources, the energy and intellect of a younger generation as they reach for any policy tool they can deploy in order to defy the realities of self discipline that capitalism yields as a mechanism to purify economies and build a solid foundatin for economic vitalitiy…all for the sake of self gratification.
Is not all this just posturing. Everyday China takes in fx from its trade imbalance and this money must go somewhere….US$, Euros, Gold, oil sands in Canada, coal in Australia…somewhere…so I wonder if they really stepped up, ie increased their purchase of Italian debt…or just simply announced to the media they were buying Italian bonds…debt they would have bought in any event, bought some yesterday, will buy some more tomorrow!
And besides all this chatter about China controlling currency valuations to benefit their economy is disingenuous from the perspective that the European or US governments are helpless to manage its effects on their economies. There are policy choices that Europe or the US could impose if they really want to see a resurgence in export based industrial manufacturing.
They are not pleasant choices, such as capital controls or a dramatic decrease in the size of the welfare state of our economies, but it is our choice as Americans or Europeans to continue to live well beyond our means, not the Chinese imposing this upon us. They are merely dealing with the reality of our chosen largesse.
So nobody has yet found evidence of the Greek bond purchases ?
Hmm.
@quark. I suspect that the Chinese leadership understand capitalism very well indeed. But they are not in the business of perpetuating capitalism, they are in the business of perpetuating the Peoples’ Party of China, and in the short term, the leaders thereof. That demands a very different policy approach.
So far, so good….
If you realized those has to go somewhere funds came from the average salaries less than 159 EURO per month of your fellow human being plus they living standard so low that half of their salaries saving less than your monthly cafe spending,maybe you should behave more responsibly to make sure that your superior echo positively pay them back,BABY,grow up!!!
“Has to go somewhere funds” appropriate destination:
http://www.tianya.cn/publicforum/content/free/1/2273186.shtml
No option to upload.
There are too many spot needs those money except manipulative interest group has no interest about them!!!
And to add to that if eurozone countries default and can no longer pay their debts, China becomes a debt collector and will collect european assets.
“So, when foreigners accumulate Euro financial assets they are essentially driving import growth to the Eurozone. This actually reduces Eurozone aggregate demand and adds to the debt deflation we are seeing there.”
We agree that euro appreciation per se would not help the euro area emerge from its crisis. We disagree as to the analytics behind that statement.
Actually no, import growth to the Eurozone does not decrease aggregate demand, which is the total demand for goods and services (produced anywhere in the world) in an economy at a given time and price level.
If the euro area’s trade balance deteriorates, however, GDP (a measure of output) does drop. But not because demand does. Rather, because residents are demanding relatively more from foreign suppliers than form domestic ones.
As to your view of China, we disagree. China wants respect. Clout.
If China were seeking merely to drive the euro up, it would not be seeking to buy toxic euro area sovereign assets. It would be accumulating clean euro-denominated assets, or euros alone, expanding their shares in the portfolios of its international reserves, SAFE, and other funds. Also, instructing SOEs to invest directly in the region, but of course to choose good bets, not such risky ones.