PLP Market Review

China and the U.S. Ecomony

China is always in the business news lately and a broad overview of how China is affecting the U.S. and world economy is essential for stock investors. China is growing so fast in one of the biggest building booms ever undertaken. This has caused raw materials or commodities prices to rise to very high levels. The price of high grade copper is an excellent indicator of building activity and it has boomed in 2006. China’s building boom began in earnest in the late 1990’s.

For comparison the U.S. Federal Reserve considers a growth rate around 3% per year as the “speed limit” for the U.S. economy. Any faster than that there is a risk of inflation, which is the Fed’s primary enemy and mandate to control. China has been growing at 8 to 10% per year since 1999. They are exporting manufactured goods primarily and creating millions of jobs in the country. China has a mixed economy combining free enterprise with government controls in certain areas. Overall, the Chinese people seem to adopting large parts of western culture without protest.

One of the easiest ways to invest in Chinese growth is to buy ticker symbol EWH (iShares MSCI Hong Kong Index). This is an exchange traded fund (ETF) that is a basket of stocks based in Hong Kong.

You can see from the price chart that there has been a steady climb in price since mid-2003. Other ETF’s involving the China market are FXI and PGJ. Major trading partners of China are another way to play as well. Ticker EWA (Australia) is one because they supply China with a lot of raw materials. EWT (Taiwan, the other China) is a modern democratic society and trades extensively with mainland China.

The Chinese economy is currently the seventh largest in the world. The larger economies are the U.S., Japan, Germany, France, England and Italy, in that order. The U.S. has the largest economy by far being twice the size of number two Japan. In fact the U.S. has 5% of the world’s population but has 25% of all of the money. But economically the U.S. is not invincible.

The U.S. economy is slowing to a "subdued" pace but is not moving toward recession, a survey of leading business economists showed. The survey of 50 economic forecasters by the National Association of Business Economists called for the U.S. economy to cool to a 2.6 percent annualized growth rate in the second half of the year. This growth rate would definitely be worse without the growth of China and the southeast Asian countries sometimes referred to as the Asian Tigers.

The U.S. trade deficit has surged to a record 68 billion dollars in July, 2006 as rising oil prices created a mammoth fuel bill for the world's largest economy. Another large part of this deficit was due to the purchase of Chinese exports. It is the low labor prices that make Chinese manufactured goods so cheap. You need only ask any Wal-Mart shopper. While this costs the U.S. some jobs it keeps all prices lower. This keeps inflation low which is good for everyone.

China is building a massive amount of cash as well. In 2000 China had $168 billion in foreign cash reserves. In just 6 years that amount has risen to $769 billion. The huge amount of cash is due to its exporting goods to the U.S. while China imports relatively little from the U.S. Much of this cash is in the form of U.S. government debt (U.S. treasury bonds). Actually it is primarily China that is financing the U.S. war in Iraq. For the first time in history the U.S. is going into debt to fight a war.

The biggest issue the U.S. has with China is the value of their currency, the yuan. With the yuan being cheap against the U.S. dollar and other foreign currencies it makes China’s goods also cheaper. If the yuan had a higher value Chinese goods would cost more. China’s edge on the competition would decrease and other countries goods would be cheaper by comparison.

However experts say that China can't afford to revalue the yuan very much because continuing increases in exports are critical for job creation in China. If unemployment becomes too high the still totalitarian government of China could become threatened. There is still a lot of unrest in the poorer areas.

The Bush administration is pushing China to move more quickly to allow its currency to rise in value against the dollar as a way to narrow the yawning trade gap. This would make American exports cheaper in China and Chinese goods more expensive for U.S. consumers.

Senators Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., have warned that if China does not act, they plan to push for a Senate vote before the end of September, 2006 on legislation that would impose 27.5 percent penalty tariffs on all Chinese imports. In my opinion tariffs are a dangerous idea. It was high tariffs and the resulting retaliatory high tariffs that slowed world trade to the point of causing The Great Depression beginning in late 1929.

Finally, in an odd but hopeful event China has agreed to send 1,000 peacekeeping troops to Lebanon. Around 200 Chinese engineers already work for the United Nations in Lebanon clearing mines and unexploded ordnance. I think it is hopeful that China is taking a more active role in world affairs after decades of isolation.

Next month I will explore India in plain language. India is the other potential monster economy coming on in the world scene. One of the best ways to stay in touch with world economic events is the Wall Street Journal. Subscribe now to The Wall Street Journal and get up to 8 weeks FREE One good trade can easily pay for your subscription.