The last day or so has seen a string of wild rumours about China buying European bonds. A hilarity in the whole thing is that in another report, Giulio Tremonti, the Economy Minister, complained that Asian investors just won’t buy bonds because the ECB isn’t buying enough. So are Chinese really buying? Probably.
There is something worth pointing out here. China isn’t the noble white knight of Europe. They said they would buy Greek bonds, and that has led nowhere as far as the Greek sovereign debt crisis is concerned. But, one might still be unsurprised by Chinese bond buying because it is a part of thei exchange rate policy.
Although Chinese yuan has been appreciating against the US dollar since mid-2010 quite steadily, the yuan has actually been depreciating against a few other major currencies, including the euro, Japanese Yen, Swiss Franc, etc.
Yes, appreciating the yuan against the US dollar has been making Chinese exports look less competitive in $US terms, but it has still been very competitive for other countries because their exchange rate has not appreciated (in nominal terms). That is in part due to the weakness of the $US over the same period of time against other currencies.
The trouble is, if the $US dollar strengthens and if Chinese maintains its “soft peg” then that would mean that now the yuan is really appreciating against other currencies. Europe, being another big trading partner, with its currency somewhat in trouble, might be problematic for China. China may be able to tolerate a gradual small appreciation against the $US, but if the $US jumps, that would be much less tolerable from their export sector’s perspective.
So if China does buy European bonds and to prop up the euro, it is purely a mercantilistic behaviour, not a noble white knight. From peripheral European countries perspective, what they need is probably a weaker euro, not stronger. The strength of Germany has supported the euro exchange rate a great deal, but the strength does not help for the peripheral countries which are uncompetitive while at the same time unable to devalue their currency. With Chinese buying and propping up the euro, it will not help these indebted countries to perform necessary structural reform nor deficit reduction.
So, despite China’s intense rubbishing of the US public finances, they have not stopped buying bonds. And despite even greater danger of default, the Chinese may still appear to be interested in European bonds. Go figure.