By MARTIN CRUTSINGER
The Associated Press
Wednesday, January 31, 2007; 5:06 PM

WASHINGTON -- Treasury Secretary Henry Paulson insisted Wednesday that new high-level talks with China offer the greatest chance of success in reforming a Chinese currency system that critics blame for soaring U.S. trade deficits.

He faced a skeptical Senate Banking Committee where both Democratic and Republican senators said they believed China would listen only if the country faced punitive economic sanctions.

The lawmakers said nearly 3 million manufacturing jobs have been lost since early 2001, a period during which the trade deficit has hit records for five straight years and the imbalance with China has soared to an all-time high.

"All the jawboning and talking you are doing with the Chinese is not going to affect one iota that steel worker" who has lost his job to unfair foreign competition, Sen. Jim Bunning, R-Ky., told Paulson.

Many senators said they were upset that the Bush administration did not cite China as a currency manipulator in a report it sent Congress in December.

Such a designation would have triggered negotiations with the Chinese and could have led to punitive sanctions against imports if the United States had won a case before the World Trade Organization.

Paulson said he believed a better approach was the new Strategic Economic Dialogue he began with the Chinese in December, involving seven members of the Bush Cabinet in meetings with top Chinese officials in Beijing.

He said those twice-a-year discussions offered the best hope for persuading China to make the types of economic changes that would reduce the U.S.-China trade gap. He said he would make these discussions a top priority in the two years left in the Bush administration. The next meeting is scheduled for May in Washington.

"I really believe we have a plan in place that gives us the best chance of making progress," Paulson said while conceding that at the end of two years "we could still be frustrated because we would like to see more progress."

Paulson said pursuing economic sanctions against China could cause the Chinese government to abandon reform efforts for fear they would be seen as caving to foreign pressure.

Senate Banking Committee Chairman Christopher Dodd, D-Conn., said he believed events could quickly overtake Paulson's effort given the level of unhappiness in the U.S. over trade deficits and lost jobs.

"The Congress is not going to wait and see how this is progressing when they watch 3 million manufacturing jobs leave this country," Dodd told Paulson. "You are going to get blown by if we don't get a better handle on this."

Senators on the panel pressed Paulson to outline exactly how the administration planned to persuade China to move more quickly.

Paulson did not say whether the administration would support economic sanctions although he did not rule out future WTO cases. He said he would be pressing the Chinese to allow the value of the yuan to rise by larger amounts on a daily basis and to allow currency markets rather than government intervention to play more of a role in setting the yuan's value.

No lawmakers suggested a specific alternative to Paulson's approach, although some did refer to a bill pushed last year by Sens. Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., that gained widespread support. It would impose penalty tariffs of 27.5 percent on all Chinese imports coming into the United States if China did not go further to revalue its currency.

"We have been talking to the Chinese for five years and we're not getting enough results," Schumer said in response to Paulson's comments. "The Chinese should know Congress is exasperated and will act on a strong bill this session."

Graham, talking to reporters, said that he and Schumer along with other senators were working to come up with legislation that would enforce sanctions against China and still comply with WTO rules.

The administration opposes imposing across-the-board tariffs, arguing that this would penalize American consumers who depend on low-cost clothing and electronic products from China.

American manufacturers contend that China is manipulating its currency to keep it undervalued against the U.S. dollar by 20 percent or more. Such an action makes Chinese goods cheaper for American consumers and American products more expensive in China.

China in the summer of 2005 announced that it was removing the Chinese yuan from a fixed value against the dollar.

Since that time, it has risen in value against the dollar by 6.5 percent, but critics say that increase is far below what is needed to make a dent in the huge trade gap.

Paulson said he was not concerned about the size of China's holdings of U.S. assets including around $350 billion in U.S. Treasury securities, saying this still represented an amount that was small compared to the more than $4 trillion in federal debt held by the public.