Why China's Stimulus Plan Will Change the World

Brazil's President Lula told his country in September, "People ask me about the [financial] crisis, and I answer, go ask Bush. It is his crisis, not mine."

Fifty days later, British Treasury Secretary Stephen Timms told a conference of G-20 nations gathered in Sao Paulo, Brazil: "We are in extraordinary times, the global economy is facing shocks which are wholly without precedent and we need a new approach. … It is a global crisis. It therefore requires an international response."

In other words, what goes around, comes around. Global schadenfreude toward a stupid and greedy United States and its subprime mortgage meltdown has rapidly become global concern about how to rescue the world from an all-encompassing financial disaster.

Here's just a smattering of companies large and small that recently announced lowered outlooks: Hain Celestial (Nasdaq: HAIN  ) , Qualcomm (Nasdaq: QCOM  ) , Kraft (NYSE: KFT  ) , Sara Lee (NYSE: SLE  ) , Hologic (Nasdaq: HOLX  ) , and Diageo (NYSE: DEO  ) . (Yes, in these tough times, even the outlook for alcohol is grim.)

And if that were not enough, the International Monetary Fund (IMF) recently lowered its outlook for the entire global economy.

One country's plan to step up
Against that backdrop, China announced a four-trillion-yuan ($586 billion) stimulus package for its domestic economy at the end of 2008. It plans to fund extensive infrastructure construction, aid poor farmers, and cut export taxes.

While China's plan has clear beneficiaries, and should help keep more laborers in their jobs and prop up domestic consumer spending, the most important (and underreported) aspect of the plan is how it will fundamentally change the economic relationship between the U.S. and China.

Here's how it was
One of the big debates over the past half-decade was whether China had reached a point in its economic development at which its internal economic gravity would allow it to "decouple" from the global economy. If so, it could continue along its fantastic growth trajectory, even as growth in the U.S. or Europe ceased or reversed.

That may sound like gobbledygook, but it's important. The U.S. has a $20 billion monthly trade deficit with China. It's funded by China's willingness to hold U.S. treasuries in its Central Bank (essentially, we're borrowing the money). China manages the arrangement by pegging its currency (the yuan) to the dollar at an artificially low rate, and by not worrying so much about certain niceties like environmental regulation and labor protection.

It's a mutually beneficial arrangement -- a weak yuan supports Chinese exporters, helping the country industrialize and quickly integrate rural migrants into its urban workforce, with the salutary effect of keeping inflation and potential political unrest low. For its part, the U.S. has gotten dirt-cheap financing by virtue of China parking more than a trillion dollars in U.S. government securities. That has supported the dollar and allowed the Federal Reserve to fuel consumer spending by keeping interest rates low.

China's stimulus package heralds the unwinding of this relationship.

Here's how it will be
This is why the decoupling argument matters. Many analysts have pointed to the thousands of factories that have shut down in China in these past few months as evidence that a slowdown in American spending will cause a depression in China -- potentially even leading to regime change. But in fact, our trade imbalance with China is artificially preserved by the aforementioned currency peg, and by the decision of China's state-run banks to make uneconomic loans to businesses it deems worth propping up.

China has paid heavily for this relationship. Rather than invest its surplus cash in its own country, the Chinese poured money back into the U.S. to further spur our debt-fueled consumption. (Put less artfully, some poor Chinese guy in Shaanxi province was essentially helping you pay your mortgage.)

The announced stimulus package reverses that. Hundreds of billions of dollars that would have gone to propping up the greenback are now being reinvested in China, helping it to transition from its reliance on exports to a self-sustaining economy. So while China isn't yet decoupled from its export markets, this new spending plan will help it along that path.

What you need to do to survive
China's huge currency reserves are about to be put to use, and while there will be some real and perhaps severe bumps along the way, the China that comes out on the other side will be a heck of a lot stronger, more independent, and more decoupled than the one we've seen up to now.

Chinese premier Wen Jiabao called his country's stimulus the "biggest contribution to the world." We don't know whether that's true, but we do know that China's ability to reach deep into its huge coffers to finance further growth gives it a significant advantage over the rest of the world's struggling economies. This is why we continue to believe in the Chinese miracle, and why we think more American investors should be taking advantage of this current temporary downturn to diversify their portfolios into previously expensive Chinese stocks.

We've recommended some Chinese companies at our Motley Fool Global Gains service that can help you do just that. A few of them are now poised to profit mightily from China's domestic bailout plan. You can read all about them by clicking here to join Global Gains free for 30 days.

This article was originally published on Nov. 12, 2008.

Tim Hanson is a Global Gains co-advisor. Tim does not own shares of any company mentioned. Kraft and Diageo are Motley Fool Income Investor recommendations. The Fool's disclosure policy backs up words with actions.


Read/Post Comments (7) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 13, 2009, at 6:25 PM, Northville wrote:

    Tim

    I buy MOST of your arguments here, but I think that there may be one item against your argument that you are leaving out. My understanding is that most Chinese citizens must finance all of their own healthcare, not healthcare insurance but healthcare.

    This has had the effect of making Chinese citizens save more (as opposed to consume more like we here in the States).

    Question: How does the Chinese stimulus plan encourage the average Chinese citizen to spend (which will increase domestic production to offset declining US demand)?

  • Report this Comment On February 14, 2009, at 9:18 AM, murderofone wrote:

    China's plan is much better thought out than Obamas for the industrial sectors in my opinion.Has already started to get things moving again.These financial companies are going to drag our markets down for years with bad news and write-downs while the CEO's keep stuffing their pockets at our expense.I say nationalize most of them,it's the only way,look at the Japan market for instance.It has taken years to recover.

  • Report this Comment On February 14, 2009, at 10:50 AM, Dadw5boys wrote:

    China will shed these Financial Antics of the west and rise out of the their shadow.

  • Report this Comment On February 14, 2009, at 9:16 PM, TMFMmbop wrote:

    Northville,

    You're absolutely right that China's lack of a healthcare safety net has heretofore incented heavy saving. That said, China announced just last week a $120 billion plan to expand healthcare coverage to offset that incentive. We covered it here: http://www.fool.com/investing/international/2009/01/22/who-w...

    Best,

    Tim

  • Report this Comment On February 16, 2009, at 7:46 PM, shins1026 wrote:

    Didn't they used to call that central planning? Why is government spending now an indicator of transition to good economic times?

    Government control has been the one thing holding back China from being truly competitive. A true culture of innovation may still take some time to cultivate with too much government intervention. In the meantime, it would be better to help the Chinese business men and women and entreprenuers explore this strange idea of capitalism a bit further, with a less obstructive goverment.

    But I guess the article works if you're trying to push Asian stocks.

  • Report this Comment On February 17, 2009, at 11:48 AM, abientot wrote:

    Lack of healthcare? China has a birthrate that can keep up with the deathrate. People are culturaly expendable so healthcare is not a high priority in China. Perhaps the articles about 70 yr old farmers getting their first toothbrush, and children getting vaccines is more in line with the actual level of healthcare in China. The economy is dependent on manual labor. The number of laborers is what makes their economic numbers look huge. The Chinese transition to middle class/industrial will take more than 50 years. They are not really part of the world economy and this "decoupling" won't happen because they have never been connected to the world economy. They do things their way.

  • Report this Comment On February 18, 2009, at 10:54 AM, Oldmangene wrote:

    If China has deep cofers, it must be full of US Treasuries. I now understand why the Chinese hate us for what we are doing to the dollar. Their huge cofer just got clobbered. It means that they will finance their decoupling with depressed valued stuff, and will have to borrow, instead of using real value savings. We in the meantime are borrowing more to finance this so called recovery, and finane Chinese recovery thru repayment of debt. The only fortunate thing for us is repaying debt with cheap dollars.

    NewInvestorFool

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