Chinese Bond Buying And Exchange Rate Policy13 September, 2011, 11:48. Posted by Zarathustra
Tags: Debt Crisis, Economy, Euro, Europe, Italy
Equities rallied in the latter part of the US session after report that Italy is talking to China on bond buying. 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? Well, probably.
There is something worth pointing out here. Chins isn’t really a very noble white knight of Europe. They said they would buy Greek bonds, and that has led to nowhere as far as the Greek sovereign debt crisis is concerned. And one should probably not be surprised by Chinese bond buying because that can be understood as their exchange rate policy.
Although Chinese Yuan has been appreciating against the US dollar since mid-2010 quite steadily, Chinese Yuan has actually been depreciating against a few other major currencies, including Euro, Japanese Yen, Swiss Franc, etc.
Yes, the appreciating Chinese Yuan against the US dollar have been making Chinese exports look less competitive in US dollar term, but it has still been very competitive for other countries because their exchange rate has not appreciated (in nominal term here). That is in part due to the weakness of US dollar over the same period of time against other currencies, so that Chinese Yuan, despite strengthening slowing against the US dollar, has actually been weakening against many of other currencies, together with the US dollar.
The trouble is, if US dollar strengthen and if Chinese maintains its “soft peg”, if you will, against the US dollar, then that would mean the now Chinese Yuan is really appreciating against other currencies. Europe, of course, 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 dollar, but if the US dollar starts to strength, as it seems to be now, and as a result of that making Chinese Yuan really strengthen against all major currencies, 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 and the likes has supported 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 Chinese intense rubbishing of the US public finance, they have not stopped buying bonds. And despite even greater danger of default, the Chinese may still appear to be interest to buy European bonds. Not for the Eurozone sake, but pure mercantilism.