Paulson: China Needs Flexible Yuan to Curb Inflation

China needs a more flexible currency to ward off rising inflation risks and the danger that its economy might boil over, U.S. Treasury Secretary Henry Paulson said on Wednesday.

Eugene Hoshiko

Speaking at the opening of a two-day "strategic economic dialogue" near Beijing with Chinese officials led by Vice-Premier Wu Yi, Paulson also warned of the dangers of protectionism in both countries.

"China's leaders have voiced concerns about China's macroeconomic stability, in particular mounting inflation, growing asset bubbles and possible overheating. A more flexible exchange rate policy is especially important to China now, given these risks," Paulson said.

China's consumer price inflation blazed to an 11-year high of 6.9 percent in November. Although the yuan has risen 9.9 percent against the U.S. dollar since it was revalued by 2.1 percent and floated in July 2005, many economists say China keeps the currency unfairly undervalued, helping its exporters.

"Whereas trade was once largely a source of stability in U.S.-China relations, it has recently become a source of tension, and not only because of safety concerns," Paulson said.

He said he was worried about a rise in economic nationalism and protectionist sentiment in both China and the United States.

"Neither China nor the United States can protect our way to further prosperity. We must resist attempts to reduce transparency or increase regulatory obstacles in order to protect domestic industries," the Treasury chief said.

China's central bank governor Zhou Xiaochuan said on Tuesday, that China plans to let the yuan move more freely next year, but a stronger exchange rate does not hold the key to reducing the country's trade surplus.

Zhou brushed aside criticism that Beijing has not done enough on the yuan. But, in an important acknowledgement, he said China should look at the currency's trade-weighted value, adjusted for inflation, rather than its rate against the dollar.