Paulson: Chinese Yuan Needs to Strengthen

U.S. Treasury Secretary Henry Paulson said on Thursday that China should pick up speed in making the reforms necessary to allow the yuan to float, warning China about rising trade protectionist sentiment.

After a speech in which Paulson said China was becoming more "out of step" with global economic expectations, he stressed the need for more rapid appreciation of the Chinese currency, also known as the renminbi.

"The issue with the renminbi is simply that it's not market determined, and I don't think anyone I talk to is arguing that China is ready to have a market-determined currency," he said in answer to an audience question at an event organized by the China Institute of New York.

"But I think everyone I talk to about this essentially agrees that they should be taking steps very quickly to get to the point when they could have a market-determined currency," Paulson added. "In the meantime, they should be appreciating the (yuan) more rapidly so that it will reflect underlying fundamentals."

China's managed currency has been the source of frustration for everyone from finance officials at the world's top economies to business leaders. The yuan's value is determined according to a basket of major currencies, and not freely floated.

Economists generally agree that the yuan is substantially undervalued compared with the U.S. dollar, which gives China, the world's fourth largest economy, an advantage in the cut-throat world of international trade.

Beijing's reluctance to adopt a flexible exchange-rate regime is widely considered unfair and puts China at growing risk of a protectionist trade backlash, Paulson warned in his prepared remarks.

"China is increasingly seen as out of step with international norms and expectations, as evidenced by the growing number of national leaders and multilateral organizations calling for currency appreciation," he said.

Be More Flexible

Paulson, who will travel to Beijing in December to continue a so-called "strategic economic dialogue" initiated with China in 2006, said China's "extraordinary" growth was creating growing imbalances that threaten to spur trade conflict.

He said Beijing needs to let market forces play a greater role by adopting "a much more flexible, market-driven exchange rate" to replace its practice of managing the value of the yuan within a narrow band.

China has pledged to move toward a more flexible currency as part of a broad package of reforms, though at its own pace; Paulson left no doubt the Bush administration considers Beijing is moving too slowly.

Paulson said he was doing his best to resist protectionist calls in the United States against China, but added, "Frankly, it is easier to keep the U.S. economy open if the American public sees China continuing to open up their markets."

He said if China doesn't speed up reforms, it may face consequences.

"Given growing protectionist sentiments around the world, if Chinese reforms slow, China may confront a backlash from other nations," Paulson said. He suggested China could "leap-frog years of costly and problematic practices" simply by opening its financial-services sector to foreign competition.

Since China depegged its currency from the U.S. dollar in July 2005, it has strengthened about 9 percent to 7.42 yuan to the dollar. China manages the yuan/dollar exchange rate by buying dollars in the foreign exchange market and then parking most of the proceeds in U.S. Treasuries.

The issue of China's exchange rate therefore carries implications far beyond bilateral trade between the two economic superpowers, since allowing the yuan to appreciate could cause China to buy fewer U.S. Treasuries, which could also push up U.S. bond yields.

Paulson has been pressing China steadily to let the yuan rise more rapidly in value, which might help stem the surpluses that China is racking up on its trade with the rest of the world, but so far with little visible success.

Nonetheless, he noted that the Group of Seven industrial countries concluded at the end of a Washington meeting two weeks ago that faster yuan appreciation was needed and suggested that represented a rising chorus of calls for Chinese action.

"While some in China and elsewhere may see danger in moving too quickly with reforms, I believe moving too slowly is the bigger risk to Chinese and world prosperity," Paulson said.