China’s Play to Help Europe

During German Chancellor Angela Merkel’s visit to China, the prime minister of the People’s Republic, Wen Jiabao, said his country might invest money in the European Financial Stability Facility and the European Stability Mechanism bailout facilities. The action, even if modest, may help to create the “firewall” against debt contagion across the eurozone. China’s perceive clout is that big, even if an investment would be almost entirely in its own interest.

There are two persuasive arguments about the size and investor composition of the EFSF and ESM. The first is that if the facilities are as large as $1 trillion, global capital market investors will believe that the amount of money available for bailouts is so huge that the bailouts will not be needed. Investors will accept that austerity and such a huge safety net will make bets on sovereign debt, even in weaker economies, safe. That, in turn, will bring down long-term yields and make the borrowing costs for nations like Portugal and Spain manageable as each tries to cuts its deficits. China’s willingness to invest large amounts in the EFSF and ESM will improve the odds that the firewall will be sufficient, and, if needed, the facilities might be able to draw on more capital.

The second important issue about the EFSF and ESM is whether the capital that goes into them will come only from the stronger nations in the region. If so, it would mean that countries like China do not believe that a fund of almost any size is a reasonable investment. Capital markets bond buyers will ask why only the eurozone’s nations will invest in their own futures. It will appear that they are desperate to do so to prevent the eventual collapse of Greece, Spain, Portugal and perhaps Italy.

China’s self interest is simple, and it is why the country probably will put money into the EFSF and ESM facilities, or the International Monetary Fund, as the agency tries to provide a financial foundation for the eurozone. China needs an economically healthy Europe to support its exports. Without Europe, China’s manufacturing sector could flag and its own GDP would, in turn, slow.

China’s risk in investing in Europe is small — practically nonexistent. The benefits outweigh the risks by that much.

Douglas A. McIntyre