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: Vail Resorts (NYSE: MTN  ) , Navistar (NYSE: NAV  ) , United Technologies (NYSE: UTX  ) , Salesforce.com (NYSE: CRM  ) , Dick’s Sporting Goods (NYSE: DKS  ) , and AeroVironment (Nasdaq: AVAV  ) . Yes, in these tough times, even the outlook for unmanned military aircraft is grim. (Wait, what?)

And if that weren't enough, the International Monetary Fund recently lowered its outlook for the entire global economy.

One country's plan to step up
Against that backdrop, China announced a 4 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.

Although 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 United States 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 United States or Europe ceased or reversed.

That may sound like gobbledygook, but it's important. The United States 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 such as environmental regulation and labor protection.

It's a mutually beneficial arrangement -- a weak yuan supports Chinese exporters and helps 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 United States has received dirt-cheap financing by virtue of China's parking more than $1 trillion in U.S. government securities. That arrangement 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 United States 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 situation. Hundreds of billions of dollars that would have gone to propping up the greenback are now being reinvested in China, where the money can help China transition from its reliance on exports to become a self-sustaining economy. So although 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 although 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 it's 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 and does not own shares of any company mentioned. Vail Resorts is a Motley Fool Hidden Gems pick. Salesforce.com and AeroVironment are Rule Breakers recommendations. The Fool's disclosure policy backs up words with actions.


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