China Tries to Play Nice

By Marc Chandler

NEW YORK ( BBH FX Strategy) -- China President Hu Jintao was very polite in pubic comments as the 14th Sino-EU summit began Wednesday. He made pleasant remarks about China's willingness to support Europe. The foreign exchange market initially bought euros on the headlines but, alas, the twists and turns of the Greek saga exert the stronger pull. Still, it seems that many observers misunderstand what is happening.

China has about $3.2 trillion in reserves. It is one of the few countries that do not reveal the currency composition for its reserves. Economists assume that around 25% of the reserves are invested in euro denominated instruments. That means that China holds roughly $800 billion of European bonds. For numerous reasons it seems unlikely that it is about to increase its holdings of peripheral bonds and to the extent it buys core bonds, like German bunds, it aggravates the pressure by widening the intra-European spreads.

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The ever-colorful Dennis Gartman advised, just as the crisis was emerging, to buy things that hurt when you drop them on your foot. China appears to be taking this advice. It has little interest in expanding its holdings of paper. It wants real assets.

Many may not appreciate the extent to which the combination of cheap credit and "bargain" pricing is encouraging Chinese companies and funds to buy assets in Europe. Here is just a short list of some recent transactions.
  1. A China state fund agreed to buy for 387 million euros a 25% stake in Portugal's national electric grid
  2. China's largest construction equipment maker bought a German family owned engineering firm for 360 million euros
  3. China's sovereign wealth fund bought a stake in the UK's Thames Water
  4. China's Three Gorges bought a 21.3% stake for 2.2 billion euros in a Portuguese energy company
  5. A Chinese company bought a 25% stake in the Ferretti Group, an indebted Italian yacht manufacturer
  6. China's National Chemical Corp bought a stake in Norway's Elkem for $2.2 billion
  7. Manganse Bronze makes London's famous black taxis and is owned by Geely, the Shanghai-based car manufacturer than owns Volvo
  8. China's sovereign wealth fund has the third largest stake in Songbird Estates which owns the Canary Wharf Group
  9. Chinese banks have bought or leased 28,000 meters (300,000 square feet) of office space in the financial district in London

To be clear, China is not invading Europe. Last year, its direct investment in Europe as about $4.3 bln, almost double the 2010 figure. However, in terms of stock, only about 3.5% of China's foreign direct investment is in Europe. China's current five-year plan calls for direct investment outflows to grow at an annualized rate of 17%, so that in 2015, its stock of foreign direct investment will be a little more than $560 billion. China's shopping plans and financial wherewithal finds a Europe that wants to sell assets. The privatization programs are an integral part of the recovery plan for the periphery.

Yet there is political resistance too. The conservative Heritage Foundation found that last year almost $33 billion in deals were blocked by officials in the target country, including Bright Food Group's attempt to buy France's Yoplait. China's Ministry of Finance estimates that some $60 billion in deals were approved.

In a similar way that the U.S. once triangulated, using China to help check the Soviet Union, so too is China using Europe to triangulate the U.S. Europe offers China a way to at last partially diversify away from the U.S. dollar. Europe is also an important buyer of China's goods, allowing it to diversify away from the largest consumer market in the world (the U.S.).

One important political concession that China is seeking is for Europe to classify it as a market economy. The current designation of as a non-market economy makes it easier for European companies to seek redress against Chinese trade practices. Yet China is likely to find what other great powers including the U.S., have found: It is difficult to translate financial prowess into political leverage.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.