China: China won’t turn its back on the euro zone. Not necessarily because it doesn’t want to. A falling euro bodes ill for the undisclosed portion of China’s $2.4 trillion in foreign currency invested in assets denominated in the single currency. But the Faustian pact between Beijing and its trade partners ensures Chinese capital will continue to flow into the Old Continent.
The People’s Bank rushed to calm markets on Thursday, after rumours it was ‘concerned’ about the euro’s status as an investment currency. The Chinese were protecting the value of their own portfolio. Trade flows and some basic arithmetic suggest around 20 per cent of the total assets — or about $500 million — are at stake.
But even if Chinese leaders are really worried about the euro zone, pain-free diversification is impossible.
First, there are no realistic safer alternatives. Only the euro, dollar and yen are really liquid and stable enough to host big chunks of China’s reserve pile. American trade and fiscal deficits make dollars unappealing over the long run. Japan’s government deficit is frighteningly large. Also, China runs a trade deficit with Japan, so it would have to pay up to buy big quantities of yen. The euro is not clearly the ugliest of the three sisters.
Second, China has pegged its rapid economic growth on a kind of risky vendor financing. On one hand, it churns out goods for export, and reaps the rewards in job creation and development of technology. On the other, it recycles a big portion of the revenues into loans to deficit-running buyers. Without China’s financial backing, the euro zone might have struggled to rack up its ¤90 billion bilateral trade gap with China last year.
Changing the arrangement now would have painful consequences for China. Europe is the country's biggest export market. Without easy funding from the seller, the trade would be likely to shrink. China, as the biggest exporter to the euro zone, would be squeezed. Given the choice, the People’s Bank may be better off buying up more euro paper rather than less.
