Sept. 20 (Bloomberg) -- U.S. Treasury Secretary Henry Paulson's top international adviser called on China to let the yuan trade more freely, a sign the Bush administration considers a 10 percent appreciation in the past two years insufficient.

A more ``flexible'' currency would improve domestic demand, lower the risk of asset bubbles and ease ``perceived unfairness'' in trade with the U.S., David McCormick, Treasury's undersecretary for international affairs, said today in a speech at Peking University in Beijing.

A higher yuan would lower the price of imported goods and, as exports become less competitive, create incentives for companies to make products for consumers at home. U.S. lawmakers argue that China has kept its currency undervalued by as much as 50 percent, giving its exporters an unfair edge in global markets and damping Chinese demand for U.S.-made goods.

``What McCormick was saying to China is that: `You may think you are doing enough, but there is the political side of the equation you need to address more aggressively,''' said Arthur Kroeber, head of research at Dragonomics Advisory Services Ltd. in Beijing. A higher ``currency is only a piece of a whole set of government policies to boost consumption.''

Currency Gain

China's currency has appreciated about 10 percent against the dollar since the central bank ended a fixed exchange rate in July 2005. China's economy grew 11.9 percent in the second quarter this year, the fastest expansion in more than 12 years.

``What currency flexibility will do for China is support -- and in fact be a necessary component of -- a growth strategy that brings higher consumption to Chinese households,'' McCormick said.

The yuan traded at 7.5160 against the dollar as of 11:28 a.m. in Shanghai from yesterday's 7.5135, which was the highest close since Sept. 13.

A spokeswoman for the central bank declined to comment on McCormick's remarks. Paulson will visit China in December for the third round of a series of twice-annual talks called the Strategic Economic Dialogue.

``For China, more currency flexibility will not restrain growth, nor will it lead to deflation,'' McCormick said in his first policy speech. ``We have already seen the resilience of China's exporters to currency appreciation, with many enjoying higher profit margins than they did two years ago.''

A more freely traded yuan will ``remove a major cause of the perceived unfairness in our bilateral relationship,'' he said.

Exchange Rate

McCormick said after his speech that Chinese officials he met had agreed that a market-driven exchange rate is the right approach, though they differed over how fast the yuan should appreciate. He declined to name the officials.

EU Commissioner for Economic and Monetary Affairs Joaquin Almunia said earlier this week in Beijing that the yuan needs to rise against the euro to help ease the increase in the European Union's trade deficit with China. The Chinese currency has declined about 3.6 percent against the euro since 2005.

McCormick said greater currency ``flexibility'' will give policy makers more freedom to use monetary policy ``to maintain price stability and avoid asset bubbles''

``This is of particular significance given China's recent acceleration of inflation,'' he said. China's inflation rate in August accelerated to a 10-year high of 6.5 percent.

Congress Criticism

McCormick's call for faster change in China's economic policies comes as the Bush administration tries to blunt criticism from Congress that China-U.S. trade relations are biased in favor of the world's largest developing economy.

The Senate Finance Committee in July approved legislation aimed at pressuring China and other countries over their currency practices.

McCormick disputed the contention by U.S. lawmakers including New York Democratic Senator Charles Schumer that a stronger yuan would help alleviate the record trade gap with China, the U.S.'s second-biggest trading partner. That deficit swelled to $141.3 billion through July this year, a 16 percent jump from the same period of 2006.

``What it will not do is cause a significant reduction in the U.S. trade deficit, nor will it provide a magic bullet for solving the problems of American industries facing overseas competition,'' McCormick said.

McCormick said the deficit ``can only be reduced through decisive measures to increase both private and public saving,'' adding the U.S. ``must also continue to strive to avoid the siren song of protectionism.''

Asked if he was concerned that the Chinese authorities may sell part of their holdings of dollar-denominated assets should the currency weaken, McCormick replied: ``The U.S. capital market will continue to be extremely attractive to investors going forward.''

To contact the reporter on this story: John Brinsley in Washington at jbrinsley@bloomberg.net

Last Updated: September 19, 2007 23:32 EDT