It will be the greatest garage sale in European history. This week, for two days only, China will have unlimited access to a huge inventory of trophy assets in Europe. The Eiffel Tower! The Colosseum! The Parthenon! Those assets are marked to move. And everything must go! Two days only!
But will China be the bailout saviour in the European debt crisis?
That seems to be Europe’s plan. Make the Chinese pay! China has $3.2 trillion in foreign exchange reserves. It has to do something with that money, doesn’t it?
Europe is hoping China becomes an investor in its bank bailout fund. A few hours after the Eurozone members announced their big plan last week, Klaus Regling, the head of the European Financial Stability Facility (EFSF), got straight on a plane (presumably not a grounded Qantas flight) for Beijing. What kind of offer did he make?
Well, the EFSF is not structured like a bank. It must borrow the money it intends to lend. It will do that by selling bonds to investors. If it wants the Chinese to buy those bonds, the bonds may have to be priced in yuan (to protect the Chinese from currency losses) and the bonds may need to be insured against losses (since owning government bonds in Europe is no longer risk free).
In the role of supplicant, Regling made remarks at China’s Tsinghua University in which he said Europe would be pretty flexible (as in on bended knee) in order to get the money it needs from China. On the issue of bonds denominated in yuan he said…
“We have so far only issued euro bonds but we are authorised to use any currency we want if it seems efficient…It also depends on the Chinese authorities, whether they would approve that. I think it is probably more difficult. But I could imagine that over the years it might happen.”
Regling also described a feature of the new bailout fund. He said, “The EFSF will take a certain tranche that will be a junior tranche, which means if something goes wrong, the first loss will be carried by the EFSF. It could be around 20pc.”
Insurance against a 20% loss on their bond investments may not be enough to attract the Chinese, even if the Europeans are willing to be publicly servile. After all, the non-default default that the EU has just declared on Greek bonds will leave investors with a “voluntary” loss of 50%. Who’s to say losses won’t be greater on EFSF bonds?
The bonds to be issued by the EFSF are backed by the full faith and credit of the major European countries. Standard and Poor’s currently gives France an AAA rating. But with a public-debt-to-GDP ratio of 80% and climbing, French government debt could be downgraded. If it is, the EFSF could face a downgrade too. And then the 20% guarantee would be largely worthless.
The Chinese know this. They know that by allowing Greece to default but not calling it a default, the Europeans have made global credit more expensive. Why? Investors who bought credit default swaps as insurance against default in government debt now know that that insurance is worthless. If the government coerces bondholders to accept a “voluntary” loss, it doesn’t trigger a “credit event” in which the CDS kicks in.
This suggests to us that the Europeans are going to have to offer the Chinese something a lot more compelling to get the money they’re after. Like a free lifetime pass to Euro Disney. Or all the wine in Italy. Or all the olives in Greece. Or all the gold in Germany. When Chinese President Hu Jintao arrives in Cannes for the two-day G-20 summit later this week, it may be a European garage sale like no other!
In the meantime, if Europe is a junior partner in the New World Financial Order, where does that leave Australia? Well, for starters, it puts the Reserve Bank of Australia in a pinch for its price fixing decision tomorrow. If global interest rates are headed higher thanks to the Europeans nullifying the use of credit default swaps on government debt, the RBA can’t very well cut interest rates can it?
for Markets and Money