China’s Stimulus Plan…effect on US

China’s huge currency reserves are about to be put to use, and while 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, than the one we’ve seen up to now.

Chinese premier Wen Jiabao called his country’s stimulus the “biggest contribution to the world.” Whether that’s true or not, China’s ability to reach deep into its huge coffers to finance further growth gives it a huge advantage over the rest of the world’s struggling economies. This is why more American investors should be taking advantage of this current temporary downturn to diversify their portfolios into previously expensive Chinese stocks. China announced a 4-trillion-yuan ($586 billion) stimulus package for its domestic economy recently. It plans to fund extensive infrastructure construction, aid poor farmers, and cut export taxes.

While 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 U.S. and China. Here’s how it was One of the big debates over the past several years was whether China had reached a point in its economic development at which its internal economic gravity would allow it to separate from the global economy.

If so, it could continue along its fantastic growth trajectory, even as growth in the U.S. or Europe ceased or reversed. That may sound like gobbledygook, but it’s important. The U.S. 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 (Yuan) to the dollar at an artificially low rate, and by not worrying so much about environmental regulation and labor protection. It’s a mutually beneficial arrangement — a weak Yuan supports Chinese exporters, helping 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 U.S. has gotten dirt cheap financing, by virtue of China parking more than a trillion dollars in U.S. government securities. That 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 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 deemed 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 U.S. to further spur our debt-fueled consumption…basically some poor Chinese guy was essentially helping you pay your mortgage. The announced stimulus package reverses that. Hundreds of billions of dollars that would have gone to propping up the greenback are now being reinvested in China, helping it to transition from its reliance on exports to a self-sustaining economy. So while China isn’t yet parting ways from its export markets, this new spending plan will help it along that path.