Can China save Europe?

September 14, 2011: 1:29 PM ET
Brazil, Russia, India and China -- the so-called BRIC nations -- may look to buy the debt of troubled European countries. But will it end the euro crisis?

Brazil, Russia, India and China -- the so-called BRIC nations -- may look to buy the debt of troubled European countries. But will it end the euro crisis?

NEW YORK (CNNMoney) -- In the late 1980s, developed nations helped bail out Latin America and other emerging markets.

The issuance of so-called Brady bonds (named for the former Reagan/Bush-era Treasury secretary) enabled Brazil and other debt-laden countries to find a way out of the fiscal abyss.


Oh, how the tables have turned.

With Europe's credit and banking crisis seeming to get worse by the day, there are now several reports that Brazil -- as well as Russia, India and China -- may look to buy up a portion of sovereign debt from troubled European nations. You could a call it a BRIC Brady bond plan for the 21st century.

"Capital is flowing from lesser developed countries to higher per capita income countries. We are not used to that," said Jeffrey Bergstrand, a professor of finance with the Mendoza College of Business at the University of Notre Dame." But it makes sense because of the dramatic shift in global wealth."

Although China premier Wen Jiabao confirmed at a World Economic Forum meeting Wednesday that it may step up its purchase of European debt, nothing is set in stone (or BRICs if you will.)

But a rescue of Europe by some of the more rapidly growing emerging markets would be a delicious twist. And it would also be a savvy move by the leaders of the developing world.

After all, it doesn't do Brazil any good if Europe is in such a mess that it starts to buy less oil. And all those "made in China" consumer goods? Europe (and the U.S., of course) is a big importer.

"It's an ironic turn of events. But emerging market sovereign wealth funds can invest in Europe to help keep their customers afloat," said Robert Howe, CEO of Geomatrix, an Asia-focused hedge fund based in Hong Kong. "It could stop the euro zone from freezing up, which would help keep their own economies from stalling."

Europe's debt crisis: 5 things you need to know

But Howe said that while investments from Brazil, China and others could help stem the bleeding, it's not the ultimate solution.

"There isn't the capacity for all the BRICs to get together and bail out Europe," he said. "The problem is bigger than the sovereign wealth funds of Russia and China. What saves the day is the ECB and Germans blink and issue euro bonds."

The creation of a so-called euro bond, which would act as a common debt instrument much like the euro now acts as a unified currency, has been mentioned by many economists and financial experts as a possible way to help end the crisis.

A euro bond, in principle, would have lower yields than bonds for Greece, Ireland and Portugal -- the three most troubled Europe members.

If those nations could refinance some of their higher-yielding debt, that could provide much needed-relief. But stronger nations like Germany have not been keen on the idea of paying higher interest rates for their debt to subsidize Europe's weakest links.

Still, experts said a euro bond can't be ruled out yet. China and other nations may be able to exert pressure on Europe to get its fiscal house in order as a condition for investments.

And keeping potential purchasers of their goods and services financially flush wouldn't be the only motivation for the developing nations to buy up bonds of European nations.

It would also give emerging markets a way to spice up some of their foreign debt holdings and move away from the low-yielding United States. China, in particular, has voiced some displeasure about how the uncertain economic environment in the U.S. has devalued the dollar and U.S. Treasury bonds.

As of July, China held $1.17 trillion worth of Treasuries. The remaining three BRIC nations held a collective $356 billion. The yield on the 10-year is now a paltry 2%. Euro debt, while obviously much riskier, could offer these countries more bang for their real, ruble, rupee and renminbi.

"It's no secret that emerging economies want to diversify beyond the U.S. But the question is what are they willing to buy and what are they willing to pay for it," said Steven Huber, manager of the T. Rowe Price Strategic Income Fund (PRSNX) in Baltimore.

But is it really that simple? If the BRICs just bought Greek and Italian debt, would that really help stabilize Europe and boost potential returns in their own fixed-income portfolios?

Bergstrand thinks so. He said developed markets are more worried about another Lehman-like event hurting them and that's why they realize they have to do something. Adding higher-yielding bonds may be an added benefit but it will not be the driving factor behind a decision to act.

"Buying euro debt would not be a Machiavellian move," he said. "It is in the best interest of the developing world for Western Europe to do well."

Is default the next Greek tragedy?

But Aaron Gurwitz, chief investment officer at Barclays Wealth in New York, said he wasn't sure if China or other emerging market countries really wanted to make a bold bet on all of Europe. He said that it may be safer to buy more German bonds, as opposed to debt from the PIIGS.

Gurwitz said that if China was truly sincere in wanting to assist Europe, there's another way to do so.

It could let the renminbi, or yuan as its more commonly known, float more freely on the global financial markets. China has been criticized for keeping the yuan artificially low to make Chinese-made goods cheaper.

"What I really wish the Chinese would do is stop buying so many foreign bonds and just let its currency appreciate a bit," he said."That would allow the Europeans and U.S. to export more to China, and that could help the global economy."

That may be asking for a bit much. It is becoming increasingly clear that the gap between the developing and developed markets is continuing to narrow -- and the emerging markets are dealing more from a position of strength than ever before.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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