China to the rescue?

The Economist
Oct 29th 2011, 12:34 by A.P. | LONDON 
IT WAS only a matter of time before China was heralded as Europe’s escape route from its debt crisis. News that Nicolas Sarkozy, the French president, called Hu Jintao, his opposite number in China, after the crisis summit on
October 27th sparked speculation that China might put substantial amounts of money into the debt of troubled euro-zone borrowers. The chatter grew louder when Klaus Regling, the head of the European Financial Stability Facility (EFSF), the euro area’s bail-out fund, visited Beijing a day later. And a poor post-summit Italian bond auction has made the need for a deus ex machina seem even greater.
China certainly has lots of money to invest. its foreign-exchange reserves are reckoned at $3.2 trillion. It trades more with the EU than any other partner. It has exposure to the euro already. How much is not known, but currency analysts suspect that about a quarter of those reserves are already euro-denominated, giving it an incentive to keep the currency strong. It also suits China to play the part of a constructive economic actor.
Then again, we have been here many times before during the euro-zone saga. You can trace the growing seriousness of the crisis by the list of countries that have had talks with the Chinese about investments: first Greece, then Portugal, Spain and now countries at the very core of the euro zone. The pattern to date has always been the same: lots of encouraging rhetoric, perhaps even a little cash, but not enough to meet initial expectations.
There is at least something different on offer now. In the past, investment in euro-zone debt has meant taking on as much risk, and sometimes more risk, than the Europeans themselves have been willing to absorb. No one could ever explain why the Chinese would want to do that. Now China will be able to choose to invest in euro-zone debt that is ensured by the EFSF, or to buy senior tranches of the special-purpose vehicles (SPVs) that the EFSF will capitalise. China would explicitly be taking less risk than the Europeans.
That helps, but probably not enough to deliver a different outcome. The Europeans are taking more risk but that does not mean that they are offering lots of protection to other buyers. And it will take time for these structures to be set up: China will want lots more detail, and to see how the Greek bond swap with private creditors goes, before it commits cash.
Grand political bargains between China and Europe—money in return for more representation at the IMF, or market-economy status—seem wildly improbable. These prizes will eventually come anyway; and weak though parts of Europe are, the EU cannot be seen to trade them too nakedly. Bargaining of this sort would also require both parties to change their positions markedly. China is keen not to be seen as a source of “dumb money”, but requiring big political concessions in return for cash is a pretty clear signal that this is not a commercially attractive investment. As for the euro zone, it can hardly claim that senior Spanish and Italian debt is now safe for institutional investors if it has to horse-trade too hard to get China on board.
That does not mean that Mr Regling’s trip, which now takes him to Japan, is wasted. It is plausible that China will put some money into euro-zone debt alongside other non-European countries. How that money could be used depends a bit on whether it is channelled by the IMF or some other means. One option might be for other governments jointly to invest in a thick junior tranche of an SPV so that private investors would have an even greater cushion protecting them from any losses. A financial vehicle that saw the euro zone take most risk through equity, other governments a bit more through subordinated debt and private-sector investors the least through senior debt is still a long shot. But it is more realistic than expecting China to splash enough cash to save the euro.