Paulson Pushes China on Trade Barriers

Speaking at Shanghai's newly opened Futures Exchange, Paulson urged Beijing to embrace the Wall Street creed that open markets are the fastest way to prosperity for all.

With its economy growing at a rate of about 10 percent annually, China should act fast, he said.

"One lesson I have learned over the years is that although perhaps not as easy politically, it is better to implement reforms during periods of economic strength," Paulson said.

"The risks for China are greater in moving too slowly than in moving too quickly toward transparent, liquid, stable capital markets," he said.

The setting illustrates the progress and limitations in China's ambitions to become a world financial power.

Just last week, the country's growing heft in international markets hit home when a 9 percent drop in Shanghai triggered declines around the globe. Yet in the newly opened futures exchange, only a handful of commodities are traded by local brokers.

Paulson urged China to move faster on shifting away from the reliance on low-cost manufacturing that has powered its ascent as a world trading power but caused devastating environmental damage and unbalanced growth.

"Your long-term economic strength requires a diverse economy, with high-value-added manufacturing and world-class services, including financial services," said Paulson, a former head of investment powerhouse Goldman Sachs.

Paulson's call for China to do far more to open its financial sector and underdeveloped capital markets is also meant to appease mounting pressure on the Bush administration from the Democratic-controlled Congress to address the U.S. trade deficit with China, which hit a record $232.5 billion last year.

Paulson met Wednesday in Beijing with Chinese Vice Premier Wu Yi, a former trade minister, China's most powerful woman and a key point person for dealings with Washington. Those talks were in preparation for the next round of talks called the "Strategic Economic Dialogue," meant at defusing tensions through collaboration on a wide range of issues.

Paulson urged China to loosen currency controls that keep the yuan from rising more quickly in value against the dollar. The system, critics say, makes Chinese goods relatively cheap and adds to the trade imbalance.

It also limits China's monetary policy options and puts a huge burden on China's banking system, he said.

"A more effective monetary policy -- one less absorbed by managing the exchange rate -- could assist efforts to reform the banking system, making it more market driven as well as help assure more stable growth," Paulson said.

China's leaders acknowledge that the country's financial markets are a work in progress. Just a week ago, Premier Wen Jiabao rued the "many problems" needed to build up the industry. But they have balked at more drastic reforms that they say might damage the country's fragile financial systems.

Beijing has domestic politics to consider. With an eye toward a once-in-five-years Communist Party congress in the autumn, leaders are focusing on quality-of-life social issues like free rural schooling, health, housing and pollution.

Major initiatives that might placate Washington will likely be on the back burner.

"It certainly is possible China could open even further but I would be surprised if they did so ahead of next fall's Party Congress," said Nicholas Lardy, a China expert at the Peterson Institute for International Economics, a Washington think tank.

"Even if I am wrong and they do move sooner to open, I don't think it will mitigate problems on the trade and exchange rate front," he said.

In January, a major government financial policy conference in Beijing focused on rural lending and on China's management of its more than $1 trillion in foreign exchange reserves. There was scant mention of market-opening issues.

China made broad commitments to open its financial markets as a condition for joining the World Trade Organization. In December, the banking industry opened to full foreign competition, though foreign investors wanting stakes in Chinese banks are limited to 25 percent.

Paulson urged China's financial leaders to open the banking sector to more foreign investment and to allow wider foreign participation in the country's mainstream yuan-denominated share markets. He praised Beijing for giving select foreign institutions share trading quotas, but noted that they amount to less than 2 percent of total market capitalization.

Offering more financial products, such as financial futures, would also help stabilize markets by creating more investment options and giving investors tools to hedge risk, he noted.

"With an underdeveloped financial sector, investment in China doesn't reach its potential in generating returns, personal saving is not adequately rewarded, and risk is not appropriately priced, managed, and diversified," Paulson said.

He also called for removing restrictions on insurance companies' investments.

Opening and expanding the still government-dominated bond market would relieve pressure on banks, which currently provide nearly all corporate financing, while creating new ways to hedge risks, he said.

"China has come a long way in developing its capital markets, but the journey is not complete. At the end of this road lie benefits for all the Chinese people," Paulson said.

While at Goldman, Paulson visited China dozens of times and is well acquainted with China's financial movers and shakers.

But given the Democratic-led U.S. Congress's preoccupation with protecting American jobs, it is unclear how much political mileage Paulson can get out of lobbying on behalf of Wall Street, says Edward Gresser of the Washington-based Progressive Policy Institute.

"On the Congressional side, I think the main focus is on piracy issues and currency rates rather than on market access," Gresser says. "Congress has been willing to give him some space to operate on China policy, but I have a feeling they are now beginning to look for results."