During the last few weeks the media has been teeming with rumours about China purchasing Italian bonds. Although buying EU bonds would help ease current euro zone pressures, China is unlikely to become the saviour of the peripheral economies, as this action will not solve the sovereign debt crisis.
And, nobility isn’t the main motivation behind China’s purchase of the bonds. It is really targeting the exchange rateand propping up the EUR.
Although the Chinese yuan has been appreciating against the US dollar since mid-2010, it’s been depreciating against a number of other major currencies, including the EUR, Swiss Franc and JPY.
An appreciating yuan against the US dollar makes Chinese exports costlier when they are priced in US dollars; however, Chinese exports are still very competitive for other countries as their nominal exchange rate has not appreciated.
Nevertheless if the USD appreciates and China maintains its soft currency peg, then that would end in the yuan appreciating against other countries. Europe is China’s largest export market so a sliding EUR would be a problem for the Chinese economy.
Consequently, the desire to support the euro.
Ironically, despite the fact that China’s commercial motivations have been as China’s noble attempts to save the eurozone, a weaker euro would probably be more beneficial for Europe’s periphery economies.
German strength has supported the EUR, which implies that while the periphery economies are unable to compete with the producing giant, they’re also unable to devalue their currencies.
As an appreciating EUR decreases the demand for EU exports and the capability for these economies to grow their way out of debt, China’s EU bond purchases will not help the situation.
And all of this has resulted in a vicious cycle where China is probably going to continue purchasing euro bonds, regardless of the heightening danger of periphery nation defaults.
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