China to Europe: What Have You Done for Me Lately?

China EUFor those of us in Southwestern Ontario, Europe seems so far away.  However, over the last few months if you have been following your investments, almost every day you hear about the European debt problem.  It’s easy to understand why an investment of capital in southwestern Ontario shouldn’t be impacted by problems in Europe.  Clearly though, in 2011, that is not the case.  Our economic financial system increasingly is interwoven with all the risks inherent in that.  If you invest $100 in southwestern Ontario, your returns will surely be affected by the European global debt contagion.

I know that there is a double negative in that last paragraph.  Canadians are not all that happy with investing their money in a bank account and getting less than 1% interest.  So over of years, investors have been encouraged by their own banks as well as their friends and neighbors to invest in far more complex vehicles for their money.  Usually this means exposure to risk assets in far-off lands.  Some of you might have a great risk aversion and want that money invested in emerging markets.  Others may not and some of it may have ended up in some Greek or Italian bonds.  There are so many choices for that disposable income.

So the basic problem in Europe has been countries like Portugal, Italy and Greece being unable to service their sovereign debt.  In other words those countries spent far more than they were bringing in.  The only problem with that is that they are part of the European Union, which has a common currency, the Euro.  So now that they cannot pay that debt back, countries like Europe and France are not too fussy about paying it back for them.  On top of that European banks have guaranteed much of this debt, which is essentially no good.  So if you remember that Lehman Brothers problem back in 2008, this makes that look almost like Sunday school.

So when the Chancellor of Germany and the President of France last week announced that there was a European bailout package in place, there was joy in the markets.  In fact the Dow Jones had one of its largest days ever since 2008.  Commodity markets spiked on the news because it was the thought that somehow these rotten sovereign assets could be salvaged.  In other words there was joy in Joy-ville.  It was the 1st good news in a long time about the European debt problem.

The European deal hinged on convincing private banks to take a 50% loss on Greek bond holdings and give the country a chance to pay off their public debt.  This will help reduce the Greece debt to GDP ratio to 120%, which is down from 180% now.  The Europeans have also decided to increase their bail out fund to about $1.4 trillion.  They are even enlisting a country like China to help them raise the money.  So it was a huge deal.

Moreover, be careful what you wish for.  China this week is saying that it is not going to be the moneybags Santa Claus for Europe.  I’m sure from an Asian perspective, it is so delicious.  For centuries, European powers have tried to push China around, even colonizing parts of it.  Add Japan to the mix with their occupation of China in the 1930s and 40s.  So now in 2011 the Western world has come asking for “Eastern capital” to help them out.  It is so bizarre, asking a developing country to provide capital to bail out Western European nations who were living too high on the hog.  As this new week dawned, markets staggered a bit.  China will not be fooled in the markets know that.

That attitude might be a bit hard to take for some Western European nations.  However, it might be a harbinger for the future.  We all know that it’s always better to have the money versus not having the money.  It just so happens that China has been the factory for the world over the last 20 years and they are rife with foreign reserves.  Now, when they look out their window, it’s obvious they have so much more power.  This latest problem with the European debt bailout issue will be one of the 1st times they will exercise it in a way which will affect the economic lives of Western citizens.

In Canada, our economic growth forecast is not so good but it is still positive and much better than other parts of the world.  Needless to say, the European debt problem continues to fester even after the deal struck last week.  Yes, it will take time to bring Europe back.  In the meantime, the global economy will grow slowly, backing up on the economic shores of Southwestern Ontario.  So let’s hope the cup is half full.  Let’s hope the deal struck with the implication of Chinese help comes through in spades.  Our world is changing, no doubt.  Asian help is on the way.