Italy's Tremonti has been meeting with a China Investment Corp. about a potential investmetn. Image... [+]
Wall Street reversed losses in a rocky session Monday afternoon thanks to word of a meeting between Italian officials and a Chinese sovereign wealth fund, but even a big purchase of Italy’s bonds from China will not be enough to snuff out Europe’s debt crisis or solve the continuing mess in Greece that has been hampering global markets.
The news that Italy’s finance minister Giulio Tremonti met with Chinese officials last week, said to include China Investment Corp. boss Lou Jiwei, offered a dose of hope Monday, but that balloon is sinking fast.
In a note Tuesday, High Frequency Economics chief economist Carl Weinberg warns that the math of China rescuing Italy from the perils of the sovereign debt crisis just doesn’t quite work:
Italy’s debt is a bit less than €1.7 trillion, or around $2.3 trillion at today’s exchange rate. China’s currency reserves add up to only $3 trillion or so, and more than two thirds of that is in U.S. dollars. These maths suggest that China is just not big enough to move the Italian bond market much, or to save the entire economy.
Weinberg goes on to argue that the European Central Bank doesn’t have the firepower to rescue Italy either. A Chinese vote of confidence in the European bond market would help, “but China alone cannot pick up the slack if the world decides it ain’t buying more Euroland paper,” he concludes.
(Moreover, if China really wants to get the most bang for its buck, Weinberg wonders why they wouldn’t just come in after the European crash looming on the horizon and pick up assets and bonds at liquidation levels? “If default is inevitable, why pay retail when discount prices will be available soon?”)
Even if Italy gets some funding from China’s coffers and investors continue to buy its paper – and they did that Tuesday albeit demanding a euro-era record 5.6% yield on five-year bonds, up from 4.93% in a mid-July auction – the specter of a Greek collapse still hovers over the continent.
Weinberg expresses concern that the ECB’s bond buying appears to be having little success in stabilizing markets, with the Greek two-year yield spiraling to just under 80% Tuesday, and says it will remain to be seen if the central bank will “throw in the towel and walk away from its bond support efforts or…increase the pace of its purchases” In fact, he says, consider the fact that the ECB could already be in the red on its bond purchases. If Greece does default – which Weinberg expects if the country does not get its September round of bailout money from the IMF and EFSF – the ECB itself could fail and have to be recapitalized by euro zone governments.
“Unless Germany takes the lead and agrees to walk away from short-term discipline in favor of financial stability, Greece will fail within a few weeks,” Weinberg writes, basing his view on the fact that Angela Merkel’s recent talk about avoiding an “uncontrolled” default does not appear to signal a substantial shift in the German opposition to further aid that was epitomized by the departure of Jurgen Stark from the ECB board last week. On Tuesday, Merkel was quoted saying a Greek default would not solve Europe's debt crisis, according to TradeTheNews.com.
Of course, the real concern with a Greek failure is the impact on European banks. Those firms “will not have to write down their Hellenic assets – and take the hits to their capital bases – until and unless Greece defaults,” Weinberg says. “That is when the trouble will begin.”