China will capitalize on the euro’s decline
As Europe falters, its troubled assets will be bought up by China
On Jan. 15, the Swiss Central Bank abruptly announced the end of its “bail-out-buying” scheme, wherein it spent high-value Swiss francs in exchange of weak euros. Formed in 2011, this currency peg was intended to prevent the Swiss franc from rising to the high value the market would otherwise place upon it. The Swiss were protecting their exports and holding off what might have been an indigestible excess of inflowing foreign money capital. Among other things, they did not wish to be the safe haven vis-a-vis the Euro. The plan was expensive. By the end of 2014, Switzerland’s accumulation of “excess” euros caused SNB’s foreign-exchange reserve to balloon to €174 billion.
After the announcement, the Swiss Franc jumped 20%. It was a clear sign that the Swiss central bank cannot fight the market, which views the prudent, moderate Swiss tradition of rule of law, respect for property rights and contract law as a much needed safe haven. The ECB’s adoption of trillion dollar quantitative easing might easily force all other central banks to buy up excess euros rather than allow euro depreciation and consequent disturbances in the trade and capital markets world-wide.
In imitation of the U.S. Federal Reserve, bonds issued by euro nations will soon be bought up by the European Central Bank at the rate of 60 billion per month, effectively turning those bonds into paper money. This excess supply of new paper euros will likely depress the value of existing euros while worsening European “asset price” inflation. (During such inflation, assets like big city property, securities, and investment assets – not so much ordinary consumer prices – go up and down in destabilizing ways that divert and confuse investors.) Holding a €174 billion stake in the one asset that loses most value during a bubble-up, bubble down asset price inflation is not a winning strategy. And so the Swiss central bank stopped buying euros. The Swiss regret the bad investment choice they made in conducting their earlier, losing attempt to support the euro’s value.
The Swiss regret their earlier, losing attempt to support the euro’s value
Investors are not just running towards the Swiss Franc, but away from the euro. So-called “generational accounting” shows that governments have over-extended every variety of future spending promises. Economists measure true debt by asking two questions. What is the present value of future committed spending (pensions, welfare, housing, medicine) and what is the present value of future revenues (tax, excise, license fees)? Subtract excess spending from inadequate revenue and the resulting negative number measures true debt. Thus measured, debts are gigantic, unsustainable and – unless promised spending and threatened taxing plans are radically rewritten – guaranteed to end in repudiation, inflation and crisis.
The problem is especially severe in Europe. The PIIGS (Portugal, Italy, Ireland, Greece, Spain) have enormous unpayable debts, and even Germany and France have large net generational imbalances. This creates the contrary pulls in Merkel’s dilemma: one in favour of Germany’s commitment to the euro and another in support of the cries of Germany taxpayers. Germans have an export economy, and its intra-euro trade is fluid and – so far – without the costs and inconveniences that burdened the old multiple-currency world. To hold onto Germany’s role as regional exporter of goods and receiver of investment capital, Merkel will likely continue to help the PIIGS service and even expand their indebtedness. She has accepted the ECB’s assurances (unlikely to be honoured, but nonetheless given to the Bundesbank) that the proposed debt purchases will be so allocated as to prevent “cross-national” support by Germany of the bonds of others.
A quiet China looks on as the euro weakens. But China is not merely enjoying the spectacle. Rich with foreign exchange, able to survive temporary cash drains, far-sighted in its investment plans, able to stay focused on distant horizons, China can step in at a critical moment when the euro totters. China is the only player able to make offers to buy troubled assets, support faltering security prices, and re-connect a fragmented Europe. Oddly, China superficially resembles the USA during the Marshall Plan years: the only man left standing with money in his pockets, and overseas investment in mind.
China is not Switzerland. It does not invest in paper; equity is more to its taste. As the euro loses value due to the monetization of European government debt, the value of China’s money, unimpaired by any fanciful notions that increasing paper claims is a good policy idea, will mean that Chinese central bank investments can be much more profitable than is the case for the Swiss investments. Using its good money China will be even more able to continue on its current role of divesting itself of paper wealth (largely consisting of bonds issued by the U.S. Treasury). Instead China’s vast foreign exchange reserves, now having relatively more international purchasing power, may be even better used to buy equity assets around the world, a process the Chinese have been undertaking for some years.
China well-understands a second-order of generational accounting problems within the eurozone. There, the component economies are too different to be forged together. China is a united nation, has a united currency and enjoys a single-minded economic strength and growth potential. Europe, although it has a single currency, has few of these unifying qualities. The euro was invented, along with the EU, to create a United States of Europe. But the work was done, if at all, backwards. You can’t create a country. A country has to be there, and a currency simply reflects the commonalities in the country. China has been a real nation for thousands of years.
The end of the day will mark another instance where China’s astute financial practices will prove to be much more profitable than the choice made by the once-wise gnomes of Zürich.
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