By Philip Newswanger, Inside Business - Hampton Roads, June 11, 2007

The dialogue between the China and the United Sates seesaws between impatience on the part of Americans and indignation and obstinancy on the part of the Chinese.

Washington wants Beijing to change its practice of artificially keeping its currency, the yuan, lower in value than the dollar.

Beijing protests. Washington presses on other issues, such as increasing U.S. flights to China and allowing financial institutions to offer credit and debit cards in yuan denominations.

China produces everything from toys to shoes. The United States, in turn, buys the toys, the shoes and the tea. This has created a huge trade deficit with China, causing some alarm among U.S. policy-makers.

Economists like Vinod Agarwal of Old Dominion University consider the trade deficit meaningless as long as the Chinese buy U.S. assets, such as mortgage-backed securities, Treasuries or stocks of U.S. companies.

But the trade deficit has generated $1.2 trillion in foreign reserves for the Chinese. That's equivalent to the entire budget of the United States. The question is, where will China park its money?

Some of that excess cash has bought Treasuries and $100 billion in mortgaged-backed securities, both safe investments. In a sense, the Chinese are bankrolling the U.S.'s budget deficit, just as Japan did in the early 1980s when it held Treasuries.

While talks, known as the Strategic Economic Dialogue, between the U.S. and China were progressing last month, Chinese delegations visited 25 cities in search of products to buy.

But the biggest news yet was the $3 billion, or 10 percent, stake a Chinese state fund took in the private equity firm of New York-based The Blackstone Group.

Maybe some of those billions will trickle into Virginia.

"What form their investments takes is still unknown," says Paul Grossman, director of international trade and investment for the Virginia Economic Development Partnership. "My guess is that it will take many forms: from financial investments, to the purchase of American companies in order to gain immediate market share, to green-field manufacturing facilities to large distribution facilities."

"While China certainly has many self-interests that are not good for the United States, this is not one of them," said Jim Flinchum, managing partner of Bay Capital Advisors in Virginia Beach. "China is now sitting on a huge amount of U.S. dollars earning almost nothing. This is a logical way to improve their return by 'partnering' with one of our best-known large investment firms."

Flinchum said China's investment is good for the U.S. because the dollars are recycled back into the country, and the huge reserve in liquid dollars held by the Chinese government is reduced.

"I expect to see more recycling of dollars into the U.S., just like Japan and the OPEC members did when they held huge dollar reserves," Flinchum said.

Grossman said that the Chinese have realized that it is not good to be in a position of being a low-cost center of manufacturing, so it is in their best interest to move up in the value chain.

"With these levels of reserves, it only makes sense to move up the value chain in the world's largest, most prosperous market, the U.S.," Grossman said.

"I view this stake in Blackstone as yet another early indication of the investment activity that is sure to increase out of China: many forms and lots of opportunities for them to invest and Virginia to receive that investment," Grossman said. IB