Economy

Dealing with the Euro trash

How bad will a European slowdown prove for China?

It all started here...

The financial mess in the Eurozone has been “surpassing expectations” in terms of its severity, according to Chinese premier Wen Jiabao. But for some of the country’s legion of speculators and stock-pickers, there just might be a silver lining.

So where will China be feeling the impact most? Something approaching a quarter of its foreign exchange reserves is thought to be euro-denominated, so the currency’s plunge will have led to significant write-downs. All somewhat ironic given that SAFE – the foreign exchange custodian – has often been urged to diversify further into the euro and away from the greenback.

In fact, some say SAFE should be doubling down. Best to accumulate more of the euro while it is so weak, is the advice. But China was back buying up US government debt in March ($17.7 billion worth, in the most recent data), with its first purchase of Treasuries since last September. So it looks like the dollar is desirable again – or perhaps just a little less undesirable than the alternatives.

Exporters are also ruing the euro’s decline, and predicting that demand for Chinese goods is going to be hit hard (the EU is China’s largest export market). HSBC data from earlier in the month suggested that this was still to show up in the export numbers, perhaps because the worst hit economies (the so-called ‘PIGS’) only account for 3.5% of total exports.

The wider concern is that the euro’s slump – down 24% against the renminbi since last November – will see Chinese goods lose their pricing edge across the Eurozone in general. This is helping opponents of renminbi revaluation, like the Ministry of Commerce, who argue that it is a risky time to be fiddling with exchange rates. A few weeks ago the emerging consensus was that the renminbi was on the verge of a gradual rise against the dollar. It no longer looks quite as certain.

This isn’t good news for Tim Geithner. The US Treasury secretary has been in Beijing this week for the Strategic and Economic Dialogue (see page 4), suggesting that there is no need to delay the yuan from appreciating. If revaluation does get held up, there are fears that Sino-US trade tensions could crank up another notch, especially with campaigning season for the US Senate on the horizon.

Of course, a weaker euro will make European goods cheaper overseas. So it looks like we might be heading for a situation in which the US, Euroland and China are all trying to boost domestic growth through increased exports. The point, of course, is that demand is finite, and that all three won’t be able to export their way back to rude health at the same time.

Finally, uncertainty in the global financial markets has been hitting share prices. Volatility has more than doubled in the last two months, as measured by the Vix Index in Chicago (Wall Street’s “fear gauge”). Risk aversion has pushed down markets across Asia and Chinese stocks have been no exception.

Yet here is where China’s speculators and stock-pickers thought they might have caught a break. Domestic equity markets actually had their best day for seven months on Monday, with the Shanghai Composite Index jumping by 3.5%. The rationale? That the leadership in Beijing would turn a lot more cautious on its tightening measures, to avoid shocking the economy into domestic standstill while the export environment is still so uncertain.

Hence press speculation that further measures to cool property prices would likely be dropped. The China Securities Journal thought that interest rate hikes would go on the backburner until the second half of this year too, and possibly well into 2011. Events in Europe seemed to be putting a natural break on the economy, nullifying the need for a further tightening.

So it looks like it might be a case of Europe’s woes lifting spirits among some Chinese investors. Beware of Greeks bearing gifts? Not always, it seems.


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