The market panicked yesterday on rumors that China was selling euros due to the instability of the EU region. China denied it. “Europe has been, and will be one of the major markets for investing China’s exchange reserves,” the State Administration of Foreign Exchange said. China’s statement means that a story by the FT, claiming that the People’s Republic was reviewing its holdings in Europe was wrong.Or, the Chinese may be involved in a bit of misdirection. It would not be to their benefit for it to be publicly known that they are reviewing the euro situation. Any sane holder of the currency would be doing just that since the euro has dropped from more than $1.40 at the beginning of the year to $1.22 now. The region is in a state of confusion. Even with a $1 trillion support package, there are still significant concerns that Greece, Spain, and Portugal could default on sovereign debt. The idea is not far-fetched. Deficits in the countries are still mounting, and clawing back social support costs may be nearly impossible. The people of these nations are used to decades of support for jobs, medical costs, and termination payments. The other plan to close deficits is to raise taxes, which could cut GDP growth.
China gets hurt if there is deep concern that it is selling euro assets. A public admission on China’s part would cause a huge sell-off . China would be doing the one thing that it could do to accelerate the collapse of the euro. It is not unlike the support that the People’s Republic gives the US by continuing to hold and occasionally buy treasuries while at the same time chiding America for its lack of fiscal discipline.
And, China is trapped by its own riches. It currency surplus is more than $2 trillion. It has to own some amount of debt from nations across the globe, not just to hedge for problems in one region, but also to keep its capital fully invested.
China may say one thing about Europe, but it is almost doing something else.
Douglas A. McIntyre