The Paulson Push in China

In imperial times, visiting foreign plenipotentiaries were compelled to kowtow--touch their foreheads to the ground--in front of the Chinese emperor. The weaker the Chinese government, the more it insisted on such groveling. Beijing's mandarins don't make such demands anymore, but they do tend to mark their "red lines" up front. So it was when China's steely Deputy Prime Minister Wu Yi hosted U.S. Treasury Secretary Henry Paulson and half the U.S. cabinet last week. As a PowerPoint presentation flashed images illustrating 5,000 years of Chinese history, Beijing's most powerful female official didn't mince her words: "We have had the genuine feeling that some American friends are not only having limited knowledge of, but harboring much misunderstanding about, the reality in China." She said her government wanted the world to know China's development "is an opportunity instead of a threat."

Her main audience wasn't just Paulson and his "dream team" of top U.S. officials. The real target was the U.S. Congress, where anti-China protectionist measures were being prepared in case the delegation failed to wrest concessions out of Beijing. The touchiest issue remains reform of the Chinese currency, or yuan, which U.S. critics say is artificially undervalued by up to 20 percent, giving China an unfair trade advantage. At the end of the two-day gathering, Paulson said the Chinese pledged greater exchange-rate flexibility, but gave no timetable. Asked whether that would satisfy Congress, Paulson declared himself "very pleased." That's because he's focusing on a longer time frame--two years, aides said--and a big-picture approach. "If you want immediate results, it's just not realistic," he cautioned, stressing instead that he had his eye on "really big issues."

The first of them being the unusual nature of Paulson's unprecedented "strategic economic dialogue" itself. The new bilateral forum has made the Wall Street veteran Washington's new point man on China. And by all appearances, Paulson is seeking to reframe the relationship in a more comprehensive way--beyond the narrowly defined and often contentious issue of trade. The implicit message: there are two national economic superpowers on the map now, America knows it and Paulson is ready to deal. "The idea is to get at issues we don't normally get at in other fora," Paulson said.

The fact that Chinese officials seem to greet this approach as natural, rather than suspicious, shows how far their confidence has risen. For much of China's history, the country's leaders have been deeply defensive about change--especially when the suggestion comes from foreign officials. Top officials never want to be perceived bowing to external pressures--especially on sensitive topics such as human rights, trade imbalances or sovereignty- related issues like Taiwan--that might be perceived as allowing outsiders to "meddle'' in Chinese affairs. Yet here, in a city busily primping and rebuilding for the 2008 Olympics, top-level U.S. officials discussed with their counterparts everything from China's health-care schemes to the savings rates in both nations (too low in the United States, too high in China).

That's not all. Past Sino-U.S. trade summits normally involved rounding up the usual suspects--the U.S. trade representative, the secretaries of Commerce and Finance. But Paulson pulled in colleagues whose portfolios lie outside the traditional economic box, including Health and Human Services Secretary Mike Leavitt, Energy Secretary Sam Bodman, EPA Administrator Stephen Johnson and Labor Secretary Elaine Chao. "Secretary Paulson is taking the most comprehensive approach to China that any senior U.S. official has ever taken," says Daniel Rosen of the New York-based consultancy China Strategic Advisory, who has advised Paulson on China-related matters.

The value of this synergistic approach was underscored during Friday's press conference, when Chao explained the links between Beijing's dysfunctional pension schemes, its even wobblier health-care system and the fact that Chinese save instead of spend so much of their cash. "Chinese save so much money because they don't have secure retirement or health-care systems." One way to stimulate Chinese demand (and reduce Beijing's overdependence on exports) is for U.S. experts to help China reform its pension and health-care services so that Chinese can feel secure enough to spend. Says Chao, "Chinese would be prompted to consume more, buy more American goods and create more American jobs."

With the aim of meeting again this May in Washington, both sides set up working groups on issues from financial services to energy to environmental technology. And Paulson's interdisciplinary approach seems to be infecting Chinese counterparts as well. Finance Minister Jin Renqing turned out to be deeply interested in energy and environment issues, Bodman observed, more so "than any other Finance minister except for Paulson himself."

The irony is that Paulson, who is seen as an old China hand dating back to his days with Goldman Sachs, came away with little more than "an unusually good exchange of ideas" on his headline request that China allow its currency to float more freely. Just before his visit, Beijing allowed the yuan to appreciate much faster than it had before. The currency hit an all-time high of 7.8196 during Paulson's visit and is now up more than 5 percent since July 2005. That may be all China dares do, for now. "If the yuan revalues too much, many Chinese enterprises could go bankrupt, and many more workers will lose their jobs," warns Prof. Guo Xiangang of the China Institute for International Studies, who says he has gained a "good personal impression of Paulson."

In Chinese eyes, Paulson's new approach could be the right idea at the right time. His bigger problem may be in Washington. "Will pundits call Paulson a 'panda hugger' for understanding the Chinese perspective?'' asks Rosen. "If being a panda hugger means being able to make a $949 million profit on an investment in China in less than one year, as Goldman Sachs did in 2006 by understanding the value of the Bank of China IPO, then by all means call Henry Paulson a panda hugger. And please have him teach the rest of America how to be one too!''

But the fact is that the mood in Washington is increasingly less patient with China, not more. The resurgent Democrats learned during the recent congressional election that bashing China can win votes. As Paulson wrapped up his visit, back home on the Hill the incoming Democrat chairman and outgoing Republican chairman of the Senate Banking Committee issued a joint statement warning: "We cannot continue to wait" for the yuan to float upwards more quickly. So just when the Treasury Secretary seems to have done pretty well selling his new paradigm to China, he may find himself knocking on closed doors back home.