Triple Crisis blogger Mark Blyth originally published this article in Foreign Affairs Magazine.
Last week’s EU agreement to refinance Greece’s debt seems to have calmed markets concerned with the possible default of Greece and subsequent contagion in the eurozone. But EU refinancing was not the only solution on offer: in June, an entirely different solution was hinted at from an unlikely source.
When Chinese Premier Wen Jiabao was on a tour of European capitals last month, he stressed two things at each stop: that a stable eurozone is vital to China and that China is Europe’s friend. Indeed, from Beijing’s perspective, when it comes to Europe, self-interest and altruism neatly coincide. If China were to buy only half of all outstanding Greek sovereign debt (a bargain at around $220 billion, a fraction of China’s dollar assets), it would not only resolve the eurozone crisis and add to Chinese prestige but it would help give Beijing the sort of reserve asset that it needs to diversify its holdings out of dollars. Currently, 70 percent of China’s reserves are in dollars, and China does not even make the list of the top 40 holders of Greek debt. But why would China not take such an opportunity?
For one, China probably has as little faith in the EU’s ability to solve its debt crisis over the long run as do the rest of the world’s financial markets, more bailouts notwithstanding. But another answer is possible — one that links the 2008 financial crisis and the 2011 European bond market crisis to a possible Chinese end run around the 2007 Foreign Investment and National Security Act. This U.S. law makes it hard for China to diversify out of its $3 trillion-plus holdings of U.S. dollars and buy sensitive U.S. assets such as aerospace, technology, and defense-related companies.
As a result of the unintended consequences of U.S. and European actions in financial markets, there is now the possibility that, even with this latest bailout, China could buy such sensitive assets from Europe, at fire-sale prices.