China lies at the heart of euro survival

THE effects of speculation that China would be buying up Italian sovereign debt displayed just how much sway the Chinese government holds over the world currency markets. China has been accumulating foreign currency reserves at a rapid rate – its forex reserves increased by $750bn between June 2010 and June 2011. It is reported that China now holds more than $3 trillion in foreign currency reserves and has made commitments to further euro-denominated debt purchases in Greece, Spain and Portugal.

REALPOLITIK
So why is China buying up euro currency so heavily? After all, with the Eurozone project seemingly teetering on the precipice, Europe doesn’t seem like the safest of bets, but yet China now has more than a quarter of its forex holdings in euros. As John Hardy, consultant FX strategist at SaxoBank points out, despite the “awful” condition of the Eurozone, the Chinese authorities are always concerned about their exposure to the dollar. “The wrangling over the US debt ceiling and the S&P downgrade will have hit China hard. China’s export economy is obviously heavily influenced by the dollar, and what is bad for the US is bad for China.”

While Greek bond yields are pricing in an imminent default – whatever form that default will take – there has been a disconnect between a Eurozone that has been lumbering from one crisis to the next and the euro, which has held its own against its major pairs. And it would seem that Chinese currency purchases have gone a long way towards supporting the euro. “There is a strong element of realpolitik from China,” says Hardy. China has an interest in a healthy euro, and as a fully fledged economic big beast, is trying to use their purchasing power to defend its interests. But its support certainly doesn’t come without strings. In a speech yesterday, Chinese premier, Wen Jiabo, went on manoeuvres saying that while China will continue to expand its investment in the Eurozone, those countries must “put their houses in order.” At the speech to the World Economic Forum he added that “based on WTO rules, China’s full market economy status will be recognised by 2016. If EU nations can demonstrate their sincerity several years later, it would reflect our friendship.” Loaded words indeed, and a stark reminder that if the Eurozone is to survive, it is the institutional foreign exchange holdings of the Chinese government that will play a key role in keeping it intact. This week will have reminded markets that in this arrangement, he who pays the piper will call the tune.