China’s Yuan Is ‘Spanner in Works’ at Paulson Talks

By Li Yanping and Dune Lawrence

Dec. 4 (Bloomberg) -- U.S. Treasury Secretary Henry Paulson will press for a stronger yuan in talks starting in Beijing today, just three days after the currency’s biggest drop since the nation scrapped a fixed exchange rate in 2005.

“A spanner’s been thrown into the works,” said Dwyfor Evans, a strategist with State Street Global Markets in Hong Kong. “It may mean a more heated debate on the currency.”

The fifth round of the Strategic Economic Dialogue between China and the U.S. is a swansong for Paulson, who initiated the talks and will exit with the Bush administration. The currency appreciation that he’s applauded -- a 20 percent gain since the end of a peg to the dollar -- may be wound back as President Hu Jintao seeks to protect exporters from the global recession.

Still, the two sides are seeking to highlight areas of agreement as their intertwined economies face a common threat: the global financial crisis.

Paulson didn’t refer to the currency in his opening remarks and praised China for playing “a responsible role” in efforts to counter the crisis.

The U.S. is China’s second-largest export market after Europe. China, with the world’s largest currency reserves -- poised to top $2 trillion -- surpassed Japan in September to become the biggest foreign holder of U.S. Treasuries.

Its role as a buyer of U.S. debt may only become more important as the U.S. spends to revive an economy in recession. China’s own economic slowdown is deepening as exports dry up.

‘Unprecedented Challenges’

“When the whole world is facing unprecedented challenges and uncertainties are increasing, it’s of special importance that China and the U.S. increase their dialogue and strengthen cooperation,” said Chinese Vice Premier Wang Qishan. “To work together to tackle the financial crisis is the most pressing task that we are facing.”

The nations need to counter protectionism and cooperate in “reforming the global financial system,” Wang said.

The achievements of the two days of talks will be limited because President-elect Barack Obama is taking office in less than two months, said Sun Zhe, a Beijing academic who advises the Chinese government. Obama’s transition team is not taking part, U.S. Agricultural Secretary Ed Schafer said yesterday.

The discussions will yield “substantive agreements” on electricity generation, transportation, and environmental cooperation, Paulson said.

Obama Administration

Wang said he was pushing for the dialogue to continue under the Obama administration. Paulson, who may be casting an eye to his legacy, said the talks had helped in managing complex issues, such as the global turmoil, and he was committed to “a strong finish.”

The crisis may lead to progress on rules encouraging Chinese and American companies to invest in each others’ assets, according to Shen Jiru, a senior researcher at the government- backed Chinese Academy of Social Sciences in Beijing, adding that China may be interested in taking stakes in struggling U.S. automakers.

Discussions will also continue on food safety, after a series of Chinese scandals, from lead in toys to melamine in milk. The U.S. Food and Drug Administration opened three offices in China last month to try to make exports safer.

The 0.7 percent fall by the yuan versus the dollar on Dec. 1 triggered speculation that China had switched to favoring a depreciating currency, which would help exporters by pulling down prices in overseas markets.

The plunge may instead have been a message to Obama, who has called China a currency manipulator and “is taking a much harder line on trade issues,” said Frank Gong, head of China research at JPMorgan Chase & Co. in Hong Kong.

China wants to highlight both the urgency of the nation’s own economic problems and the importance of continuing the Strategic Economic Dialogue, the economist said.

“We believe China likes the SED platform very much,” said Gong. “However, U.S. President-elect Obama has so far never indicated that he would want to continue the dialogue.”

To contact the reporter on this story: Li Yanping in Beijing at yli16@bloomberg.net; Dune Lawrence in Beijing at dlawrence6@bloomberg.net