China's Power Gambit Gives Us a Profit Play

The planet's number two economy is growing more comfortable with its predominance on the world stage.

Despite attempts by the U.S. to dictate other nations' dealings with China, the Middle Kingdom has been establishing new economic and financial institutions to develop its global sway. And it's inviting the world to participate.

Meanwhile, America is staying away and warning others to do the same. But scores of leading nations are ignoring that advice and joining with China.

That's allowing the Chinese to foster deeper, more profitable international relations, and creating new opportunities for globally oriented investors like us...

China Takes the Purse Strings

Unafraid and intent on rivaling the International Monetary Fund, World Bank, and Asian Development Bank, China has established the Asian Infrastructure Investment Bank (AIIB).

The Chinese leadership has been frustrated by what it sees as lethargic reforms and governance of the leading multilateral institutions, as well as their perceived Western and Japanese domination.

For its part, the Obama Administration has been discouraging its allies from joining the AIIB, saying its standards of governance, as well as social and environmental safeguards, might be lacking.

Yet just recently, and despite pointed U.S. objections, Britain has joined the AIIB in a (rare) act of defiance.

Shortly after that news hit, Germany, France, and Italy announced they too would participate, joining India and other heavyweights as members.

Even Australia, another historically strong U.S. ally, has chosen to sign on for negotiations as a member of the AIIB. And now there's news that South Korea, Luxembourg, and even Switzerland are considering it.

And in a major blow to the United States, now the IMF, World Bank, and ADB have thrown in their support.

Observers are still eyeing Japan, a longtime holdout thanks to its close alliance with the U.S. Until just a few days ago, the overwhelming consensus was that Japan would side with America.

But Japanese Finance Minister (and deputy Prime Minister) Taro Aso has now said that if the AIIB can deal with the specific concerns raised by the U.S., "there could be a chance that we would go inside and discuss."

That would be a watershed moment, isolating America and leaving it as the only major economy shunning the AIIB.

There is another, though less obvious, benefit for China to having these major nations participate. The U.S. Congress has long delayed addressing the issue of reforming voting rights at the IMF. The AIIB would allow China and other emerging powers increased influence over the governance of the world's economy.

Meanwhile, China is pushing forward with another one of its not-so-secret financial weapons.

China Brings Its Financial Arsenal to Bear

As I explained back in January, China is resolute about building its international economic influence. And it's using its currency as a strategic tool to that end.

According to news website, China is vigorously pushing for the yuan's integration into the basket of currencies making up the IMF's Special Drawing Rights (SDR), the multilateral's foreign exchange reserve assets.

The BRICS Post said Yi Gang, vice governor of the People's Bank of China, has indicated his country is "actively communicating" with the IMF, and says "We hope the IMF can fully take into account the progress of [renminbi] RMB internationalization, to include RMB into the basket underlining the SDR in foreseeable, near future."

The choice of currencies that make up the IMF's SDR will undergo its twice-per-decade review later this year.

And don't expect China to back down. There's a lot at stake, and its leaders would surely prefer to gain just this sort of reserve status for their currency now, rather than wait until 2020 for the next assessment.

I think the IMF's willingness to work closely with the AIIB portends well for inclusion of the yuan in the SDR.

According to the Chinese, a number of nations and regions already employ the yuan as a reserve currency.

What's more, we know that China's been diligently establishing large currency swap deals with its trading partners, and setting up currency hubs in major financial centers across the globe in an effort to facilitate trade in the yuan. These hubs allow transactions to be cleared and settled more quickly and at lower costs, effectively bypassing the U.S. dollar.

All of this expanding and facilitated Chinese trade will help support the country's economy and financial markets, spelling profits for investors.

Our Chinese Profit Play

In late February, China cut interest rates for the second time in three months, anxious to keep its economy stimulated.

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Other measures include a widened income-tax break to cut corporate tax rates for small companies, and cuts to unemployment insurance contributions.

As many as 100 already-approved large hydro projects will soon begin construction as well. So investors need to remain exposed to China or start including its markets in their portfolio allocation.

One of the soundest ways to accomplish this is through the iShares China Large-Cap (ETF) (NYSE Arca: FXI). It invests in 50 of the largest Chinese companies that trade in Hong Kong. FXI was the first Chinese equities ETF.

It currently trades at a P/E of just 10, which compares well with the S&P 500 at 19. But it also trades at a discount to its A-shares comrades, which change hands in Shanghai and Shenzhen.

A-shares are only accessible to mainland Chinese, who've moved on from real estate and have started to bid up stocks, encouraged by the government to invest in the markets.

Back in November China set up a program called the Shanghai-Hong Kong Stock Connect. This basically makes A-shares available to foreigners and H-shares (Hong Kong-listed) available to mainland Chinese.

Meanwhile, FXI has considerable room to catch up as Stock Connect kicks in and starts having the desired effect. Consider that FXI pays a reasonable dividend of 2.4% and sports a 0.74% expense ratio, with $6.2 billion under management.

Remember, China is intent on making its mark and assuming its place in the world economy. That means pulling out all the necessary stops to ensure its own economy remains robust.

The new Asian Infrastructure and Investment Bank and a more widely accepted yuan will further support those goals.

At least the rest of the world gets it.