The U.S. and China Put on Their Boxing Gloves …

If someone loaned you $600 BILLION, and you wanted to borrow even more, you’d be very careful to stay on his good side, wouldn’t you?

Of course you would! But that is exactly the opposite of how Washington is treating Chinese government lenders.

Each month, the United States sells trillions of dollars worth of Treasury bonds. Who buys all these bonds? Banks, pensions, mutual funds, insurance companies — but mainly foreign governments that are running gigantic trade surpluses with the U.S.

In the past, the biggest buyer — by far — has been the Chinese government. China currently holds more than $600 billion of U.S. government bonds and is our largest creditor.

China is getting tired of buying all those bonds and lending to the United States, especially since the U.S. dollar has been tanking and sending the value of China’s dollar-denominated bonds lower and lower and lower.

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Where the Rubber Meets the Road

And if losing millions and millions of dollars isn’t bad enough, Washington is adding insult to injury by announcing two new, anti-Chinese actions last week.

After a complaint from the United Steelworkers union, which represents American tire workers, that cheap Chinese tires were damaging the U.S. tire industry, President Obama slapped a 35 percent tariff on Chinese tires.

The Obama administration recently slapped a 35 percent tariff on imports of Chinese tires.
The Obama administration recently slapped a 35 percent tariff on imports of Chinese tires.

The case brought by the United Steelworkers is the largest safeguard petition filed to protect U.S. producers from increasing imports from China.

Neither the union nor the Obama administration is claiming that Chinese tire makers used subsidies or competed unfairly. All it claimed was that Chinese tires were hurting the U.S. tire industry.

By the way, President Bush was previously asked for the same tariff, but declined to enact it. And neither Goodyear nor Cooper Tire supported the move.

China Responds

How does China feel about it? It responded by proposing tariffs on imports of American poultry products and auto parts as well as some harsh words.

“China consistently and resolutely opposes trade protectionism, which has been proved by its behavior since the financial crisis,” China’s Ministry of Commerce said in a statement.

“This is going to damage financial and trade cooperation between China and the United States, and does not help push the world economy toward an early recovery,” said Foreign Ministry spokeswoman Jiang Yu.

My View:

Frankly, I believe this has little to do with economics but is instead payback to the trade unions for their support of Obama.

Not only does Obama “owe” the unions for their political and financial support during his election campaign, but Obama also desperately needs the help of labor unions to mobilize support at the grassroots level for his health care reform.

Also, the timing is funny for two reasons.

First, President Obama will meet with China’s leaders when he hosts a meeting in Pittsburgh with members of the Group of 20 later this month. I’m sure that will be a very icy meeting.

Secondly, Obama is making his first trip to China in November. That’s good because he has some serious fence-mending to do with the Chinese, but the President might as well throw hot sauce in the Chinese leaders’ eyes because he has also scheduled a meeting with the Dalai Lama … a MAJOR insult to the Chinese.

China has vocally criticized governments that permit visits by the Dalai Lama, who is considered by the Chinese government to be a separatist leader who wants to divide the country.

Human rights issues aside, I don’t think we should be going hat-in-hand to our largest creditor — and at the same time erect trade protectionist measures or meddle in someone else’s business. It’s just bad economic policy. Period.

The Investor Perspective

What’s this mean for your investments? Any decline in relations between the U.S. and China does not bode well for the U.S. economy, nor the global economy.

It’s likely, at some point, to (1) send interest rates higher as the Chinese become more and more reluctant to lend us money and (2) also drive the Chinese to diversify their reserves and assets away from the U.S. dollar.

The best way to protect your portfolio and even profit from the falling dollar is to add some non-dollar denominated investments to your portfolio. That is exactly what I am recommending that you do this month.

What I am talking about is the Merk Hard Currency Fund (MERKX). Never heard of it? Don’t feel bad because few people have.

MERKX is similar to a money market fund in that it keeps the average maturity of its holdings to less than 90 days and invests primarily in top-quality government debt.

Its similarities with money funds ends there, though. Instead of investing in U.S. government debt, MERKX invests in the debt of foreign countries.

Not just any countries, but only those of established countries that follow a sound economic, fiscal, and monetary policy, such as Switzerland. The fund does not invest in any emerging-market debt.

The $250 million fund, launched in 2005, is a pure play on “hard” currencies and even includes a small amount of gold in its holdings.

What you end up with is a liquid portfolio of short duration, high credit quality, non-U.S. government debt of countries that pursue sound monetary policies.

I’m not the only fan of MERKX. The folks at Morningstar, who know a thing or two about mutual funds, have given MERKX its coveted 5-star rating from a pool of 183 world bond competitors.

The minimum investment is $2,500 or $1,000 for retirement accounts, such as IRAs. The fund is no-load and has no redemption fees or minimum holding periods.

Regards,

Tony



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