The Telegraph
Monday , July 4 , 2011
Since 1st March, 1999
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Before the European Unionís finance ministers met on July 3, the Greek parliament passed legislation mandating 28 billion euros of spending cuts and tax rises over the next five years. This means that each of the 10 million Greeks will ultimately be about 2,800 euros poorer.

Thatís why theyíre rioting in Athens. Without the next 12-billion-euro instalment of the current EU-International Monetary Fund bailout package, Greece would default on its gigantic debt. The IMF recently hinted that the euro itself might crash, taking the European or even the global economy down with it ó and yet China seems strangely unworried.

Used-car salesmen know that if you donít give the customers credit, they wonít buy your cars. For the past decade China has operated on the same principle, lending the government of the United States of America money in order to keep the US dollar high and the orders for Chinese goods flowing. Beijing now holds $1.15 trillion of US treasury bills, but as of late last year, it has stopped expanding its US dollar holdings.

This makes sense, given that the US budget deficit is 11 per cent of its gross domestic product. The US is so deeply in debt that it might be tempted to inflate its way out of the problem, and nobody wants to be sitting on a pile of a trillion US dollars when the value of the currency collapses. What is astonishing is that China is now buying large amounts of euros. So what do the Chinese know that the pundits donít?

They know that there is nowhere to hide. Holding euros is risky, but holding US dollars is riskier, and the pound and the yen are only marginally safer. China has to put its money somewhere, and it calculates that the euro is not quite as bad a bet as it seems. Even though Greece certainly will default at some point. Greece can never repay the 300 billion euros it owes, no matter how harsh the austerity measures that it forces on its own population. If it still had its old currency, it could make the debt shrink by printing more drachmas and inflating the currency, but itís stuck with the euro.

Debt trap

Itís a trap. The euroís low inflation rate meant a low interest rate, so although Greece could not keep its economy competitive, it could borrow money very cheaply. And since the euroís value is backed by much stronger economies the banks were willing to lend Greece large sums. Ridiculously large sums, in fact. So large that Greece could never pay them back. The banks realized this ó but they reckoned that the richer countries in the euro zone would cover Greeceís debts in order to preserve the integrity of the currency. That is what is happening now.

The banks stopped lending Greece money after 2008, and the EU stepped in to prevent a default. The enormous sums that the EU and the IMF are now lending Greece (at a high interest rate) are immediately handed over to the foreign banks that let the situation get so far out of hand in the first place. But the political price extracted from Greece for this bailout is savage cuts in the countryís budget and a soaring unemployment rate.

A lot of Greeks donít see why they should pay such a high price for this charade. They are far from blameless ó they cynically milked the EU system for a long time ó but their rage is understandable. So at some point Greece will decide to default on its debt. The money that the EU and the IMF are giving to the banks by laundering it through Greece will then have to be shovelled directly into their coffers by the financial authorities, embarrassing though that is.

The euro will survive all this because everybody knows that the default is coming, and is quietly making arrangements to contain the damage. China is putting its money in the right place.

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