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Analysis
The motives behind China’s euro purchases

The motives behind China’s euro purchases

Beijing factors in power politics, economic self-interest

by David Marsh

Mon 17 Jan 2011

China and Japan are turning into the euro’s best friends. Beijing is conducting a charm campaign over purchases of government bonds from the hard-up southern states of Greece, Portugal and Spain. Relatively small amounts, of course — but good public relations. For its part, Japan, the second largest owner of foreign exchange reserves after China, says it wants to acquire more than 20% of planned bond issues of the European bail-out fund as a means of boosting market confidence.

This is all part of a natural desire to maintain diversified stocks of currencies by the world’s biggest dollar holders. Especially in the case of Japan, which has built up its non-dollar stocks on a more regular basis than the Chinese over the years, technical and financial reasons have been the decisive factor behind the declaration in favour of European bonds.

The Beijing leadership is pursuing a more diverse mix of objectives. Behind its bond-market buying for peripheral euro states lies a goodly portion of political power play.

First, China wants to show the Europeans and Americans who’s boss on the currency scene when things get rough. China certainly has no plans — at least not now — to establish hegemony over the financial markets. But at a time when the Chinese face continued American pressure on revaluing the renminbi, a gentle reminder of who’s king of the currency castle cannot come amiss.

China is guided, too, by pure self-interest in its international trade relations. The European Union is now China’s most important trading partner. Given the likelihood of further upward pressure on its own currency, Beijing wants to do everything to oppose a further fall in the euro and avoid negative consequences on its own exports.

The rivalry with America extends, too, to hearts and minds. China wants to win respect, if not affection, by demonstrating how it can work in partnership to support economic reforms in other parts of the world. A bid to show themselves more interested in promoting stability than the Americans may win the Chinese significant plus-points over the longer term. Diverting international attention from overheating in its own economy is an additional bonus.

Finally, building a relationship with the most powerful country in the European Union, Germany, plays a key role. Visitors in Beijing’s monetary parlours in recent months have been left in no doubt about Chinese dismay over shortcomings of some European countries in terms of debt, fiscal consolidation and so on. China stands four square behind German efforts to corral the euro area toward more discipline.

With its announcements on European government bond purchases, the Chinese appear to be helping the nations on the brink of the monetary abyss. In reality, however, Beijing is showing solidarity with the strongest but also the most potentially vulnerable member of the single currency, Germany — which has most to give in contributions to failing states, and most to lose if monetary union were to collapse.

The Chinese are no doubt thinking that, whatever the final outcome of the euro saga, the German position will prevail. China can only buttress its longer-term political position in Europe if, by siding with the weaker peripheral states, it actually aids the strong one at the core.

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