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What You Need to Know About Obama vs. Hu

Tim Hanson
January 20, 2011

If you told the man on the street that Hu met with Obama at the White House this week, odds are the response you'd get would be: "I don't know -- who?" And you could go on like that, in a lengthy routine reminiscent of Abbott and Costello.

According to a recent Pew Research Center survey, 65% of Americans see China as an adversary. But few have taken the time to get to know China's myriad political, economic, and social realities. Incredibly, 47% of Americans already believe China is the world's leading economic power, although its GDP is less than half that of its U.S. counterpart, and its GDP per capita is one-tenth that of the U.S.

In fact, China remains a largely poor country with a variety of challenges ahead of it. Still, many Americans view China as a job-stealing, power-hungry monolith -- to borrow a phrase from economist Patrick Chovanec. This is why high-profile meetings like this week's summit between President Hu and President Obama are so important. Not only do they have the chance to build understanding between the two countries, but they are critical toward creating a long-term economic and political partnership that would be mutually beneficial. 

Unfortunately, I don't expect much to get done this week on either side. The issues are too contentious, too politicized, and neither side (wrongly) sees much incentive to negotiate.

On currency
This has been the highest-profile U.S./China issue for the past few years, with Obama having noted back in the 2008 presidential debates that "we should enforce rules against China manipulating its currency to make our exports more expensive and their exports to us cheaper." While China does manage the value of its currency against the dollar, the issue is not as black and white as U.S. politicians make it out to be. If China were to allow its currency to strengthen, it would likely lose millions of manufacturing jobs to lower-cost countries in southeast Asia (note that those jobs would not return to the U.S.), creating unemployment and unrest in its massive cities. This is bad for China and bad for the world.

At the same time, China realizes that it needs to let its currency appreciate to spur greater domestic consumption -- a key ingredient to sustaining its economic growth. This is why the government has allowed the currency to slowly strengthen. It wants people to feel richer, but it also wants to give China's manufacturing sector time to adapt. Although the pace is not fast enough for the rest of the world, China will not change its policy.

What this means for investors
Profit by buying exposure to the Chinese consumer, and be willing to hold for the long term. And while shorting Chinese manufacturers such as Nam Tai Electronics (NYSE: NTE  ) may seem attractive, given looming currency pressures, the uncertainty of the timing here makes doing so a dicey proposition.

On intellectual property
One worry U.S. companies have about investing in China is that China will not protect their intellectual property, allowing domestic Chinese companies to copy patented technologies without penalty. While this will be a topic for discussion between Obama and Hu, it's hard to figure out what leverage the U.S. might have in any negotiation. Foreign direct investment into China topped $100 billion in 2010 -- a new record -- despite a lack of protections, and General Electric (NYSE: GE  ) announced a number of significant new joint ventures in China this week, including coal gasification plants and high-speed rail projects, where GE will be contributing breakthrough technology. Clearly, companies see so much opportunity in China that they are willing to tolerate the risk of piracy. With that said, I expect China's intellectual property protections to improve over time, if only because China is diving into creating IP -- and that's something the government will want to protect.

What this means for investors
Multinationals will not stop investing in China, and companies such as YUM! Brands (NYSE: YUM  ) are some of the best-priced ways to get Chinese exposure today.

On China's trade surplus
For those who believe China manipulates some of its economic data, it's not surprising that China's trade surplus dropped in December, ahead of these meetings. But despite that, its surplus against the U.S. continues to rise. That's because the U.S. is not exporting what China needs to import: commodities.