Monday, June 27, 2011

China Buying Into Europe May Be Attempt To Push Dollar Down

The big news this week is China's continuing big move into European debt, giving the EU a little bit more wiggle room as it makes contingency plans for Greece's probable departure.  China doesn't take actions this big without attempting to hit several targets at once.

Target one is diversification.  China has been making noise for at least a year about diversifying its foreign exchange holdings away from Treasuries.  Telegraphing such an intent for so long without following through would have harmed China's credibility in capital markets. 

Target two is the U.S. dollar's reserve status.  Buying euros must precede buying European debt.  This props the value of the euro against the U.S. dollar; indirectly, a weaker dollar makes the renminbi stronger with no need for a forced revaluation. 

Target three is U.S. foreign influence.  Forcing Europe to become beholden to Chinese capital will make Brussels think twice before committing to U.S. pet projects like expanding NATO, increasing European defense spending, or funding economic development projects in emerging markets that would otherwise compete with China's drive for resources.

China is playing its weakening hand well.  Domestic inflation is forcing it to chase yield abroad, and euro-denominated debt is the new risky trade.  Buying European debt will give it some cushion against insolvent banks and real estate projects at home, for at least as long as the European experiment in unity lasts.