Your Portfolio Needs China Right Now

Last year's market horror show starred three conspicuous villains: ignorant (but not always innocent) homebuyers, clueless regulators, and of course, those greedy Wall Street bankers. It was a scary mix that sucked 38% out of the U.S. stock market -- its worst showing since the Great Depression -- and sent America's GDP spiraling to a 26-year low.

Yet, the unheralded star of the show -- and my nomination for best supporting actor -- is China. You see, just like nearly every plastic toy, ceramic bowl, or T-shirt that you've bought over the last decade, last year's financial collapse was partly "Made in China."

It all started with a simple peg
Back in 1981, China's currency, the renminbi yuan, was as strong as 1.53 yuan per U.S. dollar. By 1994, the currency had weakened substantially. That same year, China adopted a fixed exchange rate regime and pegged its currency to the U.S. dollar at a rate of 8.28 yuan per dollar and held it there for the next 11 years. The implications of this abrupt change in policy were deep and far-reaching.

With the Chinese currency devalued, U.S. manufacturers couldn't compete with China's ultra-cheap goods and its massive, artificially cheap labor pool. Real U.S. household incomes stagnated, and America's trade deficit with China surged from $32 billion in 1994 to as high as $251 billion in 2007. All these U.S. dollars going to China, along with China's efforts to maintain its currency peg, resulted in a vast recycling of dollars into U.S. Treasury and agency (Fannie and Freddie) bonds. From 1994 to 2007, China purchased $2.3 trillion in U.S. bonds. This immense buying pushed U.S. interest rates to historic lows.

No one benefited from this policy more than the U.S. financial services industry. Banks like WaMu, Citigroup, Bank of America (NYSE:BAC), and other financial firms used cheap, easy money to fund credit expansion to large portions of the U.S. population. Home prices and stock values soared. American households were able to improve their standard of living -- despite anemic incomes -- by borrowing more and more.

We need only to look at our 401(k) balances right now to see how this all turned out.

China to the rescue
Sure, China helped us get into this mess, but it might also be the best way right now to make some serious money and revive your beaten-down portfolio.

China has a lot going for it right now. While slower than previous years, China's GDP is still set to grow by 6% in 2009. Compare that to the U.S., where GDP is expected to decline. And unlike our stimulus bill, which sets aside only $111 billion for direct infrastructure spending, China is going to spend the bulk of its world-changing $586 billion stimulus plan on infrastructure projects.

Why is that an important distinction? Infrastructure spending is an efficient way to stimulate the economy and build long-term growth. For example, studies show that every dollar spent on highway construction delivers $5.40 in economic output. And while the U.S. stimulus bill includes less than 1% of GDP worth of infrastructure spending, China's mostly infrastructure-related stimulus package makes up 13% of its GDP. That's some powerful stimuli, and I believe it almost assures that China's growth will be faster and more durable than our own.

So, instead of getting excited about possible U.S.-based infrastructure beneficiaries like Caterpillar (NYSE:CAT), Manitowoc (NYSE:MTW), and Qualcomm (NASDAQ:QCOM), consider those more focused on China's building boom. These Chinese-based stocks will have tremendous upside.

Here are a few ideas:

Want more ideas?
Of course, if you're a little bit gun-shy about investing in individual stocks, you can put some money to work in a Chinese exchange-traded-fund (ETF) like the Xinhua China 25 Index. But that general market index is also loaded down with names like China Life Insurance (NYSE:LFC) and Bank of China that, while they might be good companies, won't necessarily be direct beneficiaries of China's stimulus.

Investors who want to get the most bang for their investment buck from China's coming infrastructure boom should consider individual Chinese-based firms. If you're looking for more ideas, you can read all about what companies our Motley Fool Global Gains international investing service thinks will best benefit from this opportunity, plus our top five favorite international stocks ideas, free for 30 days. Click here to get started.

Matthew Argersinger and The Motley Fool own shares of KHD Humboldt Wedag, which is both a Motley Fool Hidden Gems and a Motley Fool Global Gains recommendation. CNOOC is a Motley Fool Global Gains recommendation. Huaneng Power is both a Rule Breakers and Income Investor pick. The Motley Fool has a full disclosure policy.