What Does The U.S. Trade Deficit Have To Do With Chinese Education?

by: Alberto Savrieno

Let me begin with a chart.

That's the U.S. trade deficit. Nobody likes to look at it. In fact, most people like to ignore it, because the implications of it are quite bad. The deficit can only get worse. To understand why, take a look at an eerily similar chart:

(Courtesy TDAmeritrade)

That's the dollar index. The reason for the trade deficit is simple, really. As the dollar weakens faster than other currencies, it becomes cheaper to import and more expensive to export. The conventional thinking is the reverse, but the reality is that when the domestic currency weakens, raw materials become so expensive that exports are nearly impossible to manufacture at competitive prices, so they fall. Prices in other countries are lower, so imports rise. So the weaker the dollar, the more dollars we give for imports, and the less we get for exports. Hence the deficit. Since the Federal Reserve has a dollar-killing policy, the deficit will only widen. There is no other possibility.

So essentially America is exporting dollars and importing stuff. The net amount of dollars America exports for the stuff is the deficit. It amazes me that the people with the stuff haven't yet figured out that they are in charge and for some reason unbeknownst to me, they would rather have the dollars than the stuff.

Take China, for example. The argument goes that China needs the U.S. as much as the U.S. needs China because China needs a place to sell its stuff. This argument is nonsense. China can sell its stuff to China and get rid of American dead weight dragging down its economy. At that point America will no longer be able to exchange dollars for Chinese stuff, the dollar will fall, the RMB will skyrocket, and the entire global economic sands will shift to the East. We'll start having rich Chinese tourists coming here on the cheap, exchanging their RMB for big wads of dollars at Disney Land, and we'll start being proud of stacking up RMB instead of the Chinese being proud of stacking up dollars. We'll be the ones working 15-hour days to make the stuff to sell to the Chinese to cover for the decades of exporting paper and producing nothing, and our trade deficit will then turn into a surplus.

When will all this happen on a major scale? It is hard to pinpoint exactly, but as of September 13, 2012, when the Fed announced its intentions to print dollars ad infinitum until the currency basically dies an ignominious death, it shouldn't be too long now. I'd say two years maximum. When the Chinese finally realize there is no way they can prop up the dollar any longer, they will simply stop trying. Then the process should accelerate very quickly.

If you believe I'm correct, then there are several ways to play this. Purchasing power will move to the East, so move with it. It's not easy to buy Chinese stocks on its stock exchange, but one can certainly buy Chinese companies on our own stock exchange. The question is, which industry? The easy way out if you don't want to do the picking is to just go with GXC, the SPDR China index fund. That would be the safest bet with the smoothest, gradual returns.

If you're a little more adventurous, zero in on an industry that will benefit from increased Chinese purchasing power. One that is often overlooked but crucial is education, because that's usually among the most heavily subsidized by government when a country starts getting rich. As the RMB rises, the Chinese will have more power to educate themselves. I can already see them getting into that weird American mentality of anyone-who-doesn't-go -to-college-is-a-failure, let's-have-the-government-subsidize-it, and then education prices skyrocketing like loaves of bread in Weimar, Germany.

China's not exactly there yet, but growth in the private education sector is substantial, with the first government legislation supporting private schools - the Law on Promotion of Private Education - being passed in September 2003. The chart below will give you a basic idea of how private education has expanded from 1997 to 2003. Just to pick out one piece of data, enrollment in private secondary schools in the People's Republic increased from 580,000 to just below 4,000,000 in that time frame.

Some Chinese education companies to look at are Ambow Education Holding (AMBO), which recently discontinued one of its ventures and is reorganizing, putting its stock at a steep discount. Another is New Oriental Education (EDU), which is also trading at a heavy discount due to allegations of misleading statements about its finances. (One might want to wait for an all-clear on that one before jumping in.) A third is K12 Inc. (LRN), which sells education technology in China. This one has been consolidating for a week after a 27% run since the end of July.

For those looking for a home run and with a few extra bucks to speculate with, there's China Education International (CEII.OB). This one should be paid particular attention to, due to what I see as an exceptionally conservative business model; 90% of its revenue comes from the student base, which is a difficult thing to fabricate if you're worried about Chinese fraud a la EDU. Each student translates to $1,200 - $1,500, and tuition is prepaid, precluding any issues with unpaid debts. The progression of the balance sheet looks rather dull and linear in a good way. The more schools it controls, the more revenue it earns. It just closed another deal with Shanghai Fuyi Education this month.

The downside is that it technically has no hard assets, and cash flow is entirely dependent on people fulfilling contacts. CEII just came off some deflation as well and the company is actually growing (stockholder equity has increased 300% since last year), so if you have the flexibility to buy and hold with this one it may be well worth the wait.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.