China’s investing woes

For those who believe it is just a matter of time before China rides its commercial success to global hegemony, this week offered some compelling imagery: Europe, on its knees, reeling from political discord, rising bond yields, and bank downgrades; China, sitting atop its $3.2 trillion hoard of foreign exchange reserves, condescending to dictate the terms of European surrender.

Of course, Chinese Premier Wen Jiabao was not so tactless as to describe it as surrender. He actually expressed a "readiness to extend a helping hand and a readiness to increase (Chinese) investment in Europe." It wouldn’t hurt, he went on, if Europe should decide to grant China market economy status, effectively lowering trade barriers.

Fareed Zakaria translates this into great power politics terms:

In a world awash in debt, power shifts to creditors. After World War I, European nations were battered by debts, and Germany was battered by reparation payments. The only country that could provide credit was the United States. For America, providing desperately needed cash to Europe was its entry into the councils of power, a process that ultimately brought a powerful new player inside the global tent. Today’s crisis is China’s opportunity to become a ‘responsible stakeholder.’"

That’s a twist on the original conception of what it meant to be a responsible stakeholder, but no matter. This interpretation falls apart as soon as one scratches at it a little.

The idea that a big infusion of Chinese cash would set Europe aright misinterprets the problems facing the Eurozone. Although the troubled countries there — Greece, Ireland, Portugal, Spain, and Italy — each took their own paths into difficulty, they are all in unsustainable fiscal situations. These require difficult choices about future taxes and spending, not just a quick bridge loan. Oddly enough, Zakaria recognizes this early in his piece, when discussing the implausibility of a "eurobond" solution, under which France and Germany would effectively co-sign loans taken out by their neighbors:

The minute such bonds are floated, Italy, Greece and the others would lose all incentive to make painful reforms; they could borrow all the money they need at German-subsidized rates, so why go through the dreary work of restructuring? The Germans know this — hence their opposition."

Yet Zakaria plows ahead with the idea that a Chinese bailout would be qualitatively different than a German bailout. The Chinese are under no such illusions. Bloomberg quoted the Chinese premier:

Countries must first put their own houses in order," Wen said (Wednesday) at the World Economic Forum in the Chinese city of Dalian. "Developed countries must take responsible fiscal and monetary policies."

While there might be symbolic appeal to the idea of China riding to Europe’s rescue, the reality would be less romantic: a relatively poor country would be sending its savings to a collection of wealthy ones. Moreover, to be useful, China would have to be willing to stockpile the Spanish and Italian bonds that are scaring everyone else. Jamil Anderlini of the Financial Times nicely documents Chinese reluctance to take on that role. 

In fact, it sounds as if the Chinese have already demurred. One adviser to China’s central bank said explicitly the country should refrain from buying too many European bonds. While there are reports of Italians making sales pitches to lure Chinese investment, they do not seem to have gotten very far. Despite Wen’s offer of a helping hand, the Financial Times story reports:

…analysts and European officials say China’s actual purchases of Greek, Portuguese, Spanish and Italian bonds have been quite limited and its Euro-denominated foreign reserves are overwhelmingly invested in much safer German debt."

It is tempting to see China’s foreign exchange reserves as a massive political war chest, but so far the Chinese have been unwilling to use the stash for anything more than token gestures. China seems to be acting more like a worried investor than an aspiring hegemon.