China Plays the Euro Card

Buried on page 3 of the business section of The New York Times on January 7 was an obscure article reporting that China had committed to purchase 6 billion euro ($7.8 billion) worth of Spanish bonds.  What went unnoticed by the writer was that the economic and political consequences of such an event could be quite far reaching.

China currently has $2.7 trillion in foreign currency reserves, over $900 billion of which takes the form of U.S. Treasury debt.  For years critics of U.S. monetary policy have argued that in response to low yields on U.S. Treasury notes and the risk of a precipitous decline in the value of the dollar, China might pull the plug on its U.S. Treasury investments.  Others claim that this will never happen because the Chinese economy is so dependent on exports to the United States, which could dry up if China were to trigger a collapse of the U.S. economy by its actions.

In the meantime, the White House continues to harass China on its human rights record as well as what the U.S. claims is the inflated value of the Chinese currency, the yuan.  When China refused to allow Nobel Peace Prize winner Liu Xiaobo to go to Oslo to receive the prize, China was subjected to intense criticism by Washington.

In a series of recent visits to European capitals China’s executive deputy prime minister Li Keqiang promised Chinese support for European Union economies.  By pledging to buy bonds worth billions of euros and committing billions more to European based business deals, could Beijing be signaling to Washington that “enough is enough”?  By investing in European economies, China strengthens one of its other most important export markets and makes itself less dependent on the United States.

It is interesting that Spanish bonds should be the first euro-denominated government investment made by China.  Spain is arguably the most independent country in the EU.  Its prime minister, Jose Luis Rodriguez Zapatero, is the only leader in Europe who has the guts to stand up to Washington, Tel Aviv, and the Vatican.  The Spanish socialist government is also the most left-leaning government in Europe today.

Spain has significant strategic holdings in Latin America and Africa, two parts of the world where China would like to expand its influence in its quest for oil and other natural resources.  Playing the Spanish card was a stroke of genius by Beijing.

I believe there are two reasons why Washington has not succumbed to Israeli pressure to take out Iran’s nuclear program.  First, Russia could severely damage the European economy, if it were to cut off the supply of natural gas to Europe in retaliation.  Second, China could precipitate the collapse of the U.S. economy, if it were to walk away from U.S. Treasury bonds.  By stepping in to help bail out the European Union, China demonstrates that the threat of pulling the plug on its investments in U.S. Treasury securities is a credible one.

The only thing surprising about China’s move on Europe is that it didn’t happen sooner.  But the message from Beijing to Washington is loud and clear, “Don’t mess with us, or Iran.”

THOMAS H. NAYLOR is a professor emeritus of economics at Duke University. He is the co-author of Downsizing the U.S.A. and The Abandoned Generation: Rethinking Higher Education and co-founder of the Middlebury Institute.