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China Offers to Buy Italian Debt – For a Price

Aaron Task
Daily Ticker

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Financial markets have seemingly stabilized in the past 36 hours in part on rumors that China will come to Europe's rescue and buy Italian debt. Overnight Wednesday, Chinese Premiere Wen Jiabao confirmed the speculation, with caveats.

"We have been concerned about the difficulties faced by the European economy for a long time and we have repeated our willingness to extend a helping hand and increase our investment," Wen said at the World Economic Forum's annual meeting in Dalian.

In exchange, Wen asked the Euorpean Union to recognize its status as a market economy under WTO rules prior to 2016 as currently scheduled. "If EU nations can demonstrate their sincerity several years earlier, it would reflect our friendship," Wen said.

The quid pro quo offer is consistent with what Kenneth Lieberthal director of the John L. Thornton China Center and a senior Fellow at the Brookings Institution expects from China, which in 2010 purchased $500 million of Spanish debt and pledged to buy Greek debt as well.

"When China sees a diplomatic opportunity they may put a little money behind it and reap some diplomatic benefits," Lieberthal says. "I wouldn't be surprised if they do buy some [Italian debt], I will be surprised if they buy a lot."

Given China's $3.2 trillion of reserves, there's legitimate reason to hope the People's Republic can become the world's new buyer of last resort. But "I don't think we're going to see the Chinese on a large scale moving money where the smart money people said you shouldn't go," Lieberthal says. "On the margins they'll make some political points and it's some value to them to diversify a little more vs. a little less in terms of dollar holdings."(See: China Unlikely to Rescue Italy or Europe: Strategist)

While the global economy is fixated on Europe and the U.S. right now, Lieberthal notes China is still keenly focused on its internal battle with inflation. In August, Chinese CPI rose 6.2%, down from a 37-year high of 6.5% in July but still above the government's official target of 4%.

As with hopes that China will come to Europe's rescue, Lieberthal says market speculation the People's Bank of China is done tightening will also prove mistaken.

"I think that if they err, it's likely to be on a little over-tightening," he says of China's central bank. "They really don't want to see inflation climb anything beyond what it is now. So they're going to be cautious" despite the global economic slowdown.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at altask@yahoo.com

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