Paulson Warns China in Latest Visit

With congressional heat on the record U.S.-China trade deficit as a backdrop, the Treasury Secretary presses again for a more open market

One might think U.S. Treasury Secretary Henry Paulson really, really likes China. After all, his whirlwind two-day trip to Beijing and Shanghai, which ended Mar. 8, was his third visit in seven months (all told, his tally has topped 70 trips, including those during his previous incarnation as chief executive for Goldman Sachs Group). But the reality is far different. Paulson's quick meeting with Vice-Premier Wu Yi in Beijing and a speech at the Shanghai Futures Exchange were focused on the rising U.S.-China trade frictions, fueled by a trade deficit that grew 15.4% to a record-breaking $232.5 billion last year.

Paulson's daunting job brief? To help nudge Beijing toward a more open market and stronger intellectual property protection. He also wants a faster move toward real flexibility in the Chinese currency to head off a host of potential trade-disrupting measures, including possible new tariffs on Chinese goods being considered by Congress back in Washington. Citing those measures, Paulson recently warned of a "worrisome" protectionist trend now growing in the U.S.

Of course, a faster appreciation of the yuan—up 6.5% since China started to loosen the peg in July, 2005—to make U.S. exports more competitive is still a key goal in Washington. But on this visit Paulson laid greater emphasis on overall market-opening measures, particularly in the financial industry.

Rebalancing Trade

"An open, competitive, and liberalized financial market can effectively allocate scarcer resources in a manner that promotes stability and prosperity far better than government intervention," Paulson said in his speech at the Shanghai Futures Exchange. He asked that China abandon its restrictions on foreign financial firms that want to go it alone in China (they are now required to form a joint venture with a local Chinese enterprise). "Time is of the essence," he added.

Paulson also made a point of stressing that a greater market opening in China fits with its goal of creating more balanced economic development, a plan now being hailed by Chinese officials at the ongoing National People's Congress in Beijing. That means economic growth focused less on exports and more on domestic consumption. If it works, such a rebalancing would reverse the growing income gaps between urban and rural China.

"China's growth is increasingly imbalanced—among regions, households, and sectors," Paulson said in his Shanghai speech. "Today China depends heavily on low-cost manufacturing goods, mainly for export. This has produced tremendous growth, but over-reliance on a single part of your economy has the potential to cause problems in the future," he added.

Taking It Slow

The emphasis on market opening rather than on a stronger yuan may reflect a growing realization in Washington that Beijing is unlikely to change soon its very slow and cautious approach to currency liberalization. "It is unrealistic to expect a rapid yuan appreciation," National People's Congress Vice-Chairman Cheng Siwei said in an interview with Reuters on Mar. 7.

"The Chinese are convinced that there is no guarantee that a more accelerated appreciation of the renminbi might not cause economic problems. So they want to do it their usual way. That way is to do it gradually and speed up as they become more confident," says Andy Rothman, chief China strategist for CLSA Asia-Pacific Markets in Shanghai. "I'm sure Paulson knows that this year there will once again be a 3% to 5% revaluation of the RMB, no matter what Congress says."

Despite the continuing trade frictions, Paulson also used his visit to talk about the value of the so-called Strategic Economic Dialogue (SED). That's the biannual high-level policy talks that were launched last September. The first session of talks was held in December when Paulson led a delegation of U.S. officials, including Federal Reserve Chairman Ben Bernanke, to Beijing. In May, Vice-Premier Wu will reciprocate by bringing a group of Chinese officials to Washington to talk trade.

"I am confident the SED will help us make progress on fundamental long-term structural issues, as well as on very pressing short-term issues," Paulson said while in Shanghai. No doubt he hopes he's right, even as China shows few signs of picking up its gradual pace of financial reform. Meanwhile, the growing trade deficit fuels ever greater calls for trade retaliation back in Washington.

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