In China, Paulson's Currency Is Patience
With Expectation High, Treasury Chief Plans Go-Slow Approach in Trade Talks

By Peter S. Goodman
Washington Post Foreign Service
Wednesday, September 20, 2006

BEIJING, Sept. 19 -- U.S. Treasury Secretary Henry M. Paulson Jr. is fond of recounting stories from his dozens of visits to China as chief executive of Goldman Sachs, a legacy that has fueled expectations he can accomplish a feat that eluded his predecessors: persuading China's leaders to significantly raise the value of their currency, the yuan.

Tall and lean, Paulson in the past has applied his brash charm toward securing mega-deals here. He has visited remote villages and the highest offices of the ruling Communist Party. He refers to China's central bank governor, Zhou Xiaochuan by his given name.

"In China, I've had a lot of experience," Paulson said Monday in Singapore, on the eve of his departure for an official visit to the world's largest country. "It helps if you have spent time, know the culture, know the people. And so I've got to believe that's an advantage."

But as Paulson landed in China on Tuesday for his first trip here since assuming his post in July, his knowledge of the local terrain prompted him to play down expectations. He was cognizant that outside pressure tends to backfire in China, and he was aware of the cautious ways of China's leaders, who are loath to tinker with a burgeoning economy. Above all, Paulson sounded like a man trying to avoid having his report card based on his ability to extract something from China's government, which has said repeatedly that it will act on its own timetable.

"Everyone today wants to measure everything immediately," Paulson said, sidestepping a question about what would constitute a success here. "I am not looking for immediate solutions or quick fixes to any particular economic issue. I'm looking to set a tone."

In recent years, the shrill tenor of the U.S.-China trade relationship has centered on the Chinese currency. Unlike major economies, which allow their currencies to float freely on world markets, China tightly controls the value of the yuan. In the American view, China's prodigious exports and its resulting trade surplus with the United States, which was $202 billion last year, are the result of an undervalued yuan, which makes Chinese goods unfairly cheap on world markets. China responds that its factories are providing the United States with desired wares at good prices and that it has been made a scapegoat for the decline of U.S. manufacturing.

Paulson brings a new perspective, asserting in recent pronouncements that China should adjust its currency upward not because it is a rogue trading power, but because doing so is in China's own interest. In place of hectoring, he says, the United States would do well to persuade China's leaders that it wants China to succeed, that U.S. fortunes are linked to China's rise. Without change, he warns, both countries will suffer from a protectionist backlash.

"When sovereign nations are working on important issues, generally the way to make progress is you need to convince the other side that there's a mutual interest," Paulson said.

Analysts suggest these may be good days for such a tack because of a palpable shift in Beijing: After years of resistance, a tentative consensus is emerging that increasing the currency is the proper course for managing China's economic challenges.

Grave concerns remain about dampening the fast-growing export trade that provides tens of millions of factory jobs to peasants streaming toward China's cities. There are worries about China's troubled financial system, which is choked with $500 billion in bad loans, according to private estimates. A dip in China's exports would likely diminish deposits.

In recent months, China's leaders have seen concerns about exports eclipsed by fresh worry about an excessive surge of investment. Beijing has been snuffing out new ventures in the economy's fastest-growing sectors, such as automaking and real estate, worried that the boom would yield more factories and office parks than even China can use, eventually sending prices plummeting. A crash could leave China's banks reeling.

According to two senior economists who advise the central government, China's leaders view booming exports and the resulting pile of foreign exchange reserves, now nearly $1 trillion, as added fuel for unwanted bank lending that is exacerbating the pace of investment. China's leaders have come to see a faster appreciation of the currency as a useful tool in the effort to slow investment and stave off trouble.

"A consensus among policymakers has emerged," said He Fan, an economist at the Chinese Academy of Social Sciences in Beijing, which is affiliated with the State Council, the equivalent of the cabinet. "More and more people now agree that China needs a more flexible exchange rate."

Even as China's leaders have come to see a moderate appreciation of the currency as being in the national interest, debate continues over the pace. The central bank pushes for a more aggressive timetable. The Ministry of Commerce, representing exporters, lobbies for little change. The State Council must decide.

Since China announced in July 2005 that it would allow the yuan to float a little more freely, it has gained about 4 percent. Analysts expect a gradual appreciation of 3 to 5 percent over the next year, not enough to have any real impact on China's exports or its trade surplus with the United States.

Now, this problem belongs to Paulson, who landed Tuesday in the lakefront city of Hangzhou, where he planned to meet officials in one of China's booming provinces, Zhejiang. He is expected in Beijing on Wednesday for three days of meetings highlighted by a talk with China's president, Hu Jintao. Chinese here say Paulson is a familiar and comforting figure to his Chinese counterparts from his days at investment banking firm Goldman Sachs. But while the name on his business card is the same, the logo has changed.

"You should not underestimate that I'm wearing a different hat," Paulson said. "This is a very different job."

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