Can Greece Sink China?

Ivan Martchev, April 9, 2010

It seems absurd that a small, mismanaged Balkan country can hurt an amazing economic powerhouse like China -- and it is. Still, Greece was the catalyst that started the unraveling of the euro, which had long been seen as the only alternative to the dollar. We see by the relentless selloff in the euro since December -- and the incredibly firm bullion markets despite the surging dollar -- that the real alternative appears to be gold, not the euro. As we mentioned in our previous Asia Insider issue, we are bullish on the precious metal and think that there is a huge move in gold bullion coming.

Why the Euro Matters To China

Chinese retail sales are likely to expand at a 20% rate in both 2010 and 2011. The rise in Chinese consumer spending was bigger than the rise in U.S. consumer spending in 2008, and in 2009 U.S. consumer spending shrank. In 2010, we see a stronger U.S. economy with U.S. consumer spending rebounding, but likely not as much as the growth in consumer spending in China. As we reported last issue, General Motors has for the past three months been selling more cars in China than the U.S., so it's clear that the economy in China is doing great.

But, things are not doing well in Europe. Eurozone and Great Britain consumer spending is about the size of the U.S. consumer spending -- $10 trillion or so. The British economy barely grew in the fourth quarter and the numbers from the rest of Europe are not great. The only saving grace in 2009 had been the appreciating euro.

An appreciating euro had been helping the weak sales to European consumers in renminbi terms. Asia -- especially China -- has so far operated on a de facto dollar peg. The renminbi has been trading near 6.83 against the dollar for a while despite the gradual appreciation allowed by the PBOC pre-2008. The reason for the stopping of the renminbi appreciation was simple: exporters needed all the help they could get and an appreciating currency was going to be an extra headwind.

So, because the renminbi is pegged to the dollar, a rapidly falling euro against the dollar is causing the renminbi to appreciate against the euro. Combine that with weak European consumer spending and one has to wonder about the fall in the renminbi value of exports to Europe.

An Easy Solution -- Let the Renminbi Appreciate

Chinese companies and Chinese consumers are doing great. And they'll be even better with a stronger renminbi, in our opinion. That way any potential escalation in the deterioration of economic conditions in Europe, resulting in a further euro fall, will be muted by an appreciating renminbi against the dollar and a rise in the value of sales to the stronger U.S. economy. Combine that with a strong Chinese consumer, and Europe only has to muddle through for China to prosper.

In addition, Chinese consumers' wages are rising. In the Guangdong province -- China's most populous province with 79 million residents and 31 million migrant workers -- the government is raising the minimum wage by 21% on average for both corporate employees and part-time workers beginning on May 1. Bigger wages mean more consumer spending, and a stronger renminbi means those consumers will be buying even more imported goods, which is great for China's trading partners.

Another way to play the rise in Chinese consumption is with Asian companies that export to China. China's imports from Asia rose by 64% year on year in the first two months of this year to $108 billion, which shows that the Chinese economy is healthy. We have made money with South Korean steelmaker POSCO (NYSE: PKX), which has exposure to the rising import volumes into China.

South Korea, in particular, is highly geared towards the stronger Chinese economy. iShares ETFs are one way to play the most vibrant economies in Asia. The iShares MSCI South Korea Index Fund (NYSE: EWY) have seen a strong appreciation over the past year and given how quickly South Korean exports to China are growing, the fund is likely to continue its climb.

The NYSE is also the home of several other South Korean ADRs. One of the more conservative ways to play the rise in the Korean economy is with Korea Electric Power Corporation (NYSE: KEP), the country's electric utility. Electricity usage tends to grow reliably with rapidly developing economies and this is great way to benefit from that trend.

To see how we are playing the rise of Asian exports to China.....