Attention Europe: The Asian Cavalry Is Not Coming

The Chairman of China Investment Corporation (China’s Sovereign Wealth Fund) yesterday confirmed exactly what this blog had been speculating would be the outcome from Greece’s debt restructuring. The Chairman stated that the CIC is no longer buying European Government debt.

My guess is that the CIC is not alone in shunning European debt. The State Authority of Foreign Exchange, the CIC’s much bigger brother with USD 3.5T in assets was the hardest hit ‘private’ investor in Greece so they too will have ceased investing. [To refresh your memories, Asian Central Banks and Sovereign Wealth Fund’s were not afforded the same ‘official lender’ status as the ECB and the IMF during Greece’s restructuring, and therefore suffered the same haircut as the private sector.] My suspicion is that it would be hard to find any Central Bank or SWF in Asia who is prepared to commit additional capital to European government bonds.

The market distortion this policy is creating is quite evident in the US Treasury market and the JGB market. US Treasuries have staged a miraculous recovery from their March sell-off, largely driven from buyers in Asia. JGB yields have fallen well below 1%. Clearly, the massive foreign reserve holdings in Asia are gravitating to the non-European bond markets…

Has Europe gotten the message? While European governments can still coerce their domestic banking systems to purchase their debt, there is no need for foreign support. However, this puts the banking system on decreasingly thin ice and the prospect of a banking crisis builds every day. The ECB has backstopped the banking system so far but ultimately their credit has to be repaid – if European government’s repudiate their debt, the ECB’s solvency is questionable. In this environment, its remarkable how the Euro has managed to stay above parity with the USD…

So what happens? We are witnessing a very new form of ‘capital flight’ out of Europe driven by Asia’s official institutions rather than private individuals. Put simply, Europe cannot rely on its trade deficit with Asia being recycled back into European capital markets. Europe will starve for capital for years, if not decades, all because its governments spend too much and then turn around and refuse to pay their creditors who are small in number but large in influence.

Sell the Euro.