This is fascinating and I'm about to say something many readers will find quite controversial. It might even anger some of you. I believe it is a reality and can help us understand how to control our destiny.
by Bill Mann
Some Chinese guy is helping you pay your mortgage.
I know, you don't recall ever getting a check from a Mr. Li, and if you were to find this Mr. Li, he'd disavow sending funds to you, but the nature of the balance of trade between China and the United States guarantees that what I'm about to tell you is true (unless you don't own a home or it's paid off, but let's not get pedantic).
Over the last decade, China's trade surplus with the U.S. has added up to $1.3 trillion. What this means (tautologically) is that these dollars accumulate in the Chinese financial system, most notably at People's Bank of China (PBOC) -- the Chinese equivalent to the Federal Reserve. What then happens is -- OK, this is boring. How about we track what happens using a Barbie doll?
And yes, that's what I'm saying: Our willingness to consume Barbie dolls is forcing some Chinese guy to pay your mortgage.
So, we head off to Target (NYSE: TGT) to buy a Barbie Doll. They cost approximately $20 apiece. Of this amount, most goes to Target, manufacturer Mattel (NYSE: MAT), various tax authorities, etc. And a smaller amount -- let's call it a dollar -- goes back to China.
The Chinese factory where Barbies are made is, redundantly, Chinese. All of its costs are rendered in Chinese yuan, but all of its contracts are rendered in U.S. dollars. So its contract with Mattel to produce 100,000 Barbie Fairytopia Rainbow Adventure Elina dolls (yes, I have girls) is worthless to the company until it converts those sawbucks into yuan. They do so by taking their dollar receipts to a commercial bank, which converts them into local currency.
Stick with me now -- for without even paying attention, we've just met our Mr. Li. He makes a paltry 1,500 yuan per month ($200) assembling Barbie dolls at the factory. We'll get back to him in a second.
Keeping with our dollar
So this dollar meets up with thousands and millions of other U.S. dollars in this Chinese bank, residuals from our consumption of Nike (NYSE: NKE) basketball shoes, Apple (Nasdaq: AAPL) iPods, whoopee cushions, and so on. Banks all over the world use their foreign currency holdings to invest them for their highest marginal use -- but not in China, where all foreign currency gets surrendered to the PBOC.
Now our single dollar has joined a river of them flowing toward the PBOC. The PBOC, in turn, has to figure out how to invest this unending stream of cash. Mostly, it's purchased U.S. Treasuries, but it's started buying U.S. equities, such as when China invested $3 billion in Blackstone Group (NYSE: BX) last May.
As a result, the dollar which we sent to China when we purchased a Barbie doll boomerangs back to the United States as some type of investment.
Wait, what about Mr Li?
In effect, this relationship means that every American has borrowed several thousand bucks from someone in China. Because remember what Treasury notes are -- an obligation to pay someone who is lending money.
In this case, while the lender here may seem like it's the PBOC, China's policy to keep its exchange rate artificially low means that the country's workers are bearing the brunt of the cost. (An interesting dynamic for a "communist" country, don't you think?)
See, the low exchange rate benefits Chinese companies by keeping costs low, but by the same measure, prevents laborers from benefiting at all. Just imagine if the yuan was allowed to float freely. Suddenly millions of folks like Mr. Li would see their paychecks double in dollar terms, China would be wracked with inflation, and its export-based economy would be a lot less cost competitive.
This has real consequences for Mr. Li. Not only does he get paid an artificially low amount (in effect, lending the balance to you), but since China has to keep finding places to stick all of those dollars that keep inflation in check, the government won't make the kinds of expenditures that make sense in a rapidly developing economy: Schools, pollution controls, and so on. If you've been to China, then you know that there are a lot of good places where $1.3 trillion could be put to work.
This makes zero sense until you realize that the overarching goal of the Chinese government is to improve the standard of living for as many of its citizens as possible, while limiting the income gap between those whose lives have already improved and those whose have not. Still, the overall impact -- the fact that our comparatively exorbitant spending is subsidized by low-paid Chinese workers is shocking on many levels.
Scratch?that: It's stunning.
You have two choices
One way to combat this reality is to consume fewer Chinese goods. While some are attempting to do just (call it a?Lou Dobbs-ian form of protest), it's unlikely to move the needle. Besides, why get into a trade war when the burgeoning Chinese middle class will soon be an extraordinary growth market for our own product?
So rather than make a pyrrhic political statement, I suggest you act to benefit from this reality by investing overseas. This way you can profit from the natural downward pressure on the dollar created by our spending habits. And while you needn't pick Chinese companies, an outstanding company such as Motley Fool Global Gains recommendation New Oriental Education & Technology (NYSE: EDU) would fit the bill nicely. (Incidentally, this is also a business that benefits from the burgeoning and education-focused Chinese middle class.)
If the prospect of investing in China frightens you, you can also consider picking up American names that do substantial business in the country. Yum! Brands (NYSE: YUM), for example, has opened more than 3,000 KFC, Pizza Hut, and East Dawning restaurants in China.
Pick your passion
Given today's global economic realities, it makes great sense to invest overseas and ensure that your savings have exposure to other (stronger) currencies.
Each month, my team and I seek out the best foreign investments for American investors in our Motley Fool Global Gains international stock investing service. You can see all of our research and recommendations, including our top picks for new money now, free with a 30-day trial. Click here for more information.
Bill Mann's own plan to lower American trade deficits involves marshmallow Peeps. That's all we can tell you for the time being. He holds shares of none of the companies mentioned in this article. New Oriental is a Global Gains recommendation. Apple is a Stock Advisor recommendation.
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