Why China Hates the U.S. and What It Means for Your Portfolio

It spent the past 30 years adopting the rules of capitalism. It transformed sleepy fishing villages into pulsating manufacturing metropolises. It opened its borders to multinational corporations. It became the world's factory, pumping out cheap goods for the likes of Sony (NYSE: SNE  ) , Ford (NYSE: F  ) , and Gap (NYSE: GPS  ) . As a result, it built up nearly $2 trillion in foreign currency reserves, mostly in U.S. dollars.

After all that, we are threatening to wipe out the value of those reserves by inflating away the value of the dollar. China is not happy.

Don't raise your voice at me
If you had an investment portfolio over the past four or five years, maybe you can empathize with China. Watching the value of your savings evaporate is not a pleasant experience. Especially when you thought you were doing everything right.

So you might excuse Luo Ping, director-general of China Banking Regulatory Commission, for his outburst in February when he admitted, "We hate you guys ... we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

You brought this on yourself
Now, to be honest, China isn't really an innocent victim in this story. The phenomenal economic growth the country has seen over the past three decades was driven by astounding export growth, powered by cheap labor and, importantly, an artificially cheap currency.

By selling mountains of cheap goods to companies like Costco (Nasdaq: COST  ) and Target (NYSE: TGT  ) , China accepted dollars by the truckload. Normally this would cause a domestic currency to appreciate as the manufacturers converted their dollars into yuan to pay workers and suppliers (and buy new cars and office furniture).

But if the yuan were to appreciate, China's exports would become less attractive, and the spectacular growth would stall. So China's government took steps, such as printing more money and instituting currency restrictions, to keep the yuan weak in relation to the dollar (and euro). So if the U.S. cranks up the printing press, devaluing the dollar, it not only reduces the value of China's reserves, but it means China has to increase its efforts to keep its exports cheap -- hence China's irritation.

Not completely helpless
Despite Luo Ping's apparent despair, there are some things China can do -- and has been doing -- to lighten its exposure to the potential weakening of the dollar. The government has been transforming dollars into hard assets by buying up now-cheap commodities like iron ore, copper, molybdenum, and oil to prepare for further expansion once the economy kicks up again.

Chinese companies have been in on the act, as well, some more successfully than others. The recent failure of Aluminum Corp. of China to acquire an 18% stake in minerals giant Rio Tinto is countered by China Minmetals' acquisition of the majority of OZ Minerals' assets.

China's major cash-rich state-owned oil companies, PetroChina, Sinopec, and CNOOC, have been taking advantage of the drop in oil prices to acquire oil and natural gas assets around the world.

Looking inward for the way forward
While these acquisitions help position China for future growth, they can only use up so much of that $2 trillion. The long-term answer to China's problem is to wean itself off exports and its dependence upon foreign consumers, which requires the growth of domestic demand.

China is home to 1.3 billion consumers -- the largest single pool in the world. However, domestic consumption makes up less than 40% of China's GDP, compared to nearly 70% for the United States. If China wants to draw down its dramatic exposure to the dollar, the proportion of the economy derived from domestic spending will have to rise.

As the government increases domestic consumption, the companies that benefit most will be those targeting Chinese consumers. But often, these companies are small and fly under the radar of most investors, or are viewed with skepticism because of concerns about Chinese regulations and reporting standards.

Fortunately, the Motley Fool Global Gains team just returned from China, where they investigated several of these companies and gathered firsthand knowledge of their markets, operations, and management teams. To get the inside track on finding the Chinese McDonald's (NYSE: MCD  ) or Johnson & Johnson (NYSE: JNJ  ) , click here to sign up for a risk-free 30-day trial of Global Gains. There's no obligation to subscribe.

Nate Weisshaar is incredibly impertinent, but does not own any of the stocks mentioned above. CNOOC is a Motley Fool Global Gains selection. Johnson and Johnson is an Income Investor recommendation. Costco is a Stock Advisor and Inside Value recommendation. The Motley Fool owns shares of Costco. The Fool's disclosure policy has already gone through its awkward stage and is now a wonderful young lady.

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  • Report this Comment On August 15, 2009, at 10:49 AM, abbie116 wrote:

    Isn't China one of the biggest holders of US treasury's? If they may want to reduce their exposure to a dollar that's on the decline and are among a growing crowd calling for a new reserve currency, how do they reconcile their position? They certainly can't dump their treasury's and they can't think the Yuan would ever replace it. Whats the story with the World bank currency credits I keep hearing whispered?

  • Report this Comment On August 15, 2009, at 10:54 AM, abbie116 wrote:

    Sorry...not the world bank, the International Monetary Fund and their "special drawing rights" or SDR's circulated as an international reserve currency

  • Report this Comment On August 16, 2009, at 12:32 AM, EIFConsultants wrote:

    "Now, to be honest, China isn't really an innocent victim in this story"

    Did we all forget that when our financial Institutions needed to be bailed out who stepped up to the plate? China! Where was our government who could have done that? Did we forget who holds most of our US Treasury notes, boxes, and gold back paper? CHINA! And may I add since the 1920"s no less. When are Americans going to wake up and smell the roses. The sleeping Giant went into a deep sleep after a big dinner and the one who was the most hungry took its place now and for the 50 years.

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