China Means Business

At the end of 2008, China owned US$727.4 billion worth of U.S. Treasury bonds. And Japan was second, at US$626 billion. Japan has drastically curtailed buying U.S. bonds now that its economy is in shambles. But China has been — and continues to be — the most important lender to the U.S., and that essentially funding a big chunk of President Obama's US$787-billion economic stimulus plan.

In the closing press conference of China’s National People’s Congress – China’s annual legislative session - Chinese Premier Wen Jiabao dropped this verbal bomb on the Obama administration.

"To be honest, I am definitely a little worried. We have loaned huge amounts of money to the United States, so of course, we have to be concerned. We hope the United States honors its word and ensures the safety of Chinese assets."
They are a clear message to the Obama administration that it needs to stop spending like a drunken sailor if it expects the rest of the world to buy U.S. government bonds. The line of Chinese policymakers, economists, and scholars voicing concerns about investing too much of their country's $2 trillion surplus in U.S. debt is growing longer and longer. Many are urging diversifying out of U.S. bonds and into more tangible assets such as natural resources and gold.

Last summer, China's big state-owned banks — such as the Bank of China and the Bank of Communications — began dramatically reducing their holdings in Fannie Mae and Freddie Mac debt. It turns out the Chinese made a pretty savvy move ... Fannie Mae and Freddie Mac bonds have gotten annihilated since then. Now, the Chinese are concerned that U.S. Treasury debt could suffer as well.

If you're a fixed-income investor, you could shorten the maturities of your bond portfolio. The Obama administration can't spend, spend, spend without creating a big inflationary problem down the road. That means long-term bonds are the very last thing you want to be holding when inflation takes off.
Another high-profit strategy is to bet that the U.S. dollar is headed for trouble. The Merck Hard Currency (MERKX) fund invests in the currencies of countries with the strongest economies and budget surpluses and could do very well if the U.S. dollar falls. A lot lower!