By Nin-Hai Tseng
January 7, 2011

As Europe’s debt crisis unravels, leaders in the most troubled parts of the region have found an unlikely savior: China. Why its investments in Spain, Greece and Portugal are so smart.

Just as billionaire investor Warren Buffett swooped into the rescue when General Electric (GE) and Goldman Sachs (GS) found themselves battered during the height of the financial crisis, Greece, Portugal and Spain have found a vote of confidence from China at a time when talk of bailouts and debt defaults are unnerving international investors. It’s quickly becoming the world’s lender of last resort.

Earlier this week, China promised to back Spain by signing $7.3 billion in deals, which included investments in everything from energy to banking, as well as a $7.1 billion acquisition of certain assets of the Spanish oil firm Repsol. What’s more, the country expressed confidence in the Spanish economy when Chinese Vice Premier Li Keqiang on Wednesday reiterated that Beijing would continue buying up debt from the euro zone’s fourth-largest economy. China is already one of the biggest foreign owners of Spanish sovereign debt with about 10% of its total foreign holdings.

This follows China’s pledge to back Greece and Portugal, although leaders have yet to confirm details of its bond purchases. Last summer, China struck more than a dozen major commercial contracts for business in Greece in what was its largest European investment to date.

Of course, there’s plenty of self-interest at play here. The euro zone is China’s largest export market, so the country has lots to lose financially. And in a way, China has everything to gain in terms of winning friends at a time when its international reputation has suffered over what many consider an undervalued currency.

“From the Chinese side, I think it is an irresistible opportunity – a huge public relations coup at relatively little cost,” says Barry Naughton, China expert and professor at the University of California in San Diego.

A wider crisis in the region could send the euro on a downward spiral, making Chinese exports less competitive across the region. This would not only be bad news for Europe, but it would also work against China’s growth prospects as the country has overwhelming relied on exports to become one of the fastest growing nations in the world.

Of course, China is not in the position to single-handedly save Europe from its financial mess, just as Goldman Sachs and GE probably didn’t survive the crisis purely on Buffett’s purse strings.

What does matter is appearance. The way China values its currency has increasingly become a sensitive topic, especially as many economies look to export more during the economic recovery. And China has long been criticized for holding way too much in foreign-exchange reserves – a whopping $2.6 trillion, which is more than any other country holds. The Asian giant is America’s largest creditor, with more than half of its reserves invested in Treasury securities and other U.S. government bonds. However much this might unnerve U.S. leaders as the typical “China is taking over the world” rhetoric takes holds, it appears the tone might certainly change in times of crisis.

“When you’re desperate to sell your debt, you don’t worry about somebody holding too much of it,” Naughton says.

It’s true that Beijing is under pressure to make wiser investments with its reserves after suffering some large and high-profile losses during the global financial crisis. But the way Naughton sees it, with China converting some of its foreign reserves into government bonds from Greece, Ireland, Spain and Portugal – or even just saying that they are going to – the country implicitly pushed back the criticism, helping build a case that there’s indeed some value in holding such reserves.

Now that China has so publicly announced its support for troubled Europe, this could very well position leaders to smooth out some of the rough patches developed over the past year. China may no longer be cast as a self-interested, unfair player in the global marketplace and instead become regarded as a contributor of global economic stability.

Moreover, the investments may prove quite profitable. “The question is just the risk,” Naughton says. “But the risk is relatively low, since if things go really bad the European Union, or its constituent governments, or the European Central Bank will presumably step in.”

If anyone can bear the risk, he adds, it’s probably China with its lofty reserves.

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