[Senate Hearing 110-905]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-905

 
                  THE TREASURY DEPARTMENT'S REPORT TO
CONGRESS ON INTERNATIONAL ECONOMIC AND EXCHANGE RATE POLICY (IEERP) AND 
               THE U.S.-CHINA STRATEGIC ECONOMIC DIALOGUE

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   ON

REVIEWING DEVELOPMENTS IN INTERNATIONAL ECONOMICS AND THE EXCHANGE RATE 
POLICIES OF OUR KEY TRADING PARTNERS WITH AN EMPHASIS ON THE U.S.-CHINA 
                      STRATEGIC ECONOMIC DIALOGUE


                               __________

                      WEDNESDAY, JANUARY 31, 2007

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate /
                            senate05sh.html


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania        ELIZABETH DOLE, North Carolina
JON TESTER, Montana                  MEL MARTINEZ, Florida

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel
                       Aaron D. Klein, Economist
               Roger M. Hollingsworth, Professional Staff
                    Mark Osterle, Republican Counsel
          Peggy R. Kuhn, Republican Senior Financial Economist
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                         George Whittle, Editor


                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, JANUARY 31, 2007

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Carper...............................................    14
    Senator Sununu...............................................    17
    Senator Bayh.................................................    19
    Senator Bunning..............................................    23
    Senator Brown................................................    24
    Senator Bennett..............................................    27
    Senator Reed.................................................    30
    Senator Allard...............................................    32

                               WITNESSES

Henry M. Paulson, Jr., Secretary, Department of the Treasury.....     6
    Prepared Statement...........................................    56
    Report to Congress on International Economic and Exchange 
      Rate Policies, December 2006...............................    59
Richard Trumka, Secretary-Treasurer, AFL-CIO.....................    39
    Prepared Statement...........................................    91
Michael Campbell, Vice Chairman, National Association of 
  Manufacturers..................................................    41
    Prepared Statement...........................................    98
Albert Keidel, Senior Associate, Carnegie Endowment for 
  International Peace............................................    43
    Prepared Statement...........................................   111
Fred Bergsten, Director, Peterson Institute for International 
  Economics......................................................    46
    Prepared Statement...........................................   126


THE TREASURY DEPARTMENT'S REPORT TO CONGRESS ON INTERNATIONAL ECONOMIC 
AND EXCHANGE RATE POLICY (IEERP) AND THE U.S.-CHINA STRATEGIC ECONOMIC 
                                DIALOGUE

                              ----------                              


                      WEDNESDAY, JANUARY 31, 2007

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m. in room SD-G50, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Good morning. The Committee will come to 
order. I want to thank all of you for being here. Let me thank 
our witnesses for participating this morning in the first 
hearing with Secretary Paulson, and with the second panel of 
very distinguished witnesses as well.
    Let me inform my colleagues on the Committee that as soon 
as we get a quorum here, I will interrupt the proceedings and 
adopt the rules and lay out the structure very quickly for 
Subcommittee assignments and the like. That could happen as 
soon as the clerk and others will let me know when we achieve 
that critical mass here. I will apologize in advance to the 
Secretary or any of the other witnesses who may be testifying 
when that occurs, and we will interrupt knowing that that can 
be a fleeting moment. Members may disappear again, and I may 
not have a chance to reconvene the Committee. So if that 
happens here, we will take care of that business. I want to 
thank Senator Shelby in advance for his cooperation and work on 
those issues when we come to it.
    This morning, the Committee meets to consider the Treasury 
Department's Report on the International Economic and Exchange 
Rate Policy and the first meeting of the U.S.-China Strategic 
Economic Dialogue. We are pleased to have our Nation's 74th 
Treasury Secretary, Henry Paulson, as our first witness. And, 
Mr. Secretary, welcome and thank you for being here.
    In each of the past 5 years, this Committee, pursuant to 
statute, has received exchange rate reports and taken testimony 
from the Treasury Secretary. I want to take a moment to commend 
Senator Shelby and Senator Sarbanes for hearings and for their 
excellent oversight on the issue of exchange rates. This is a 
critical issue for millions of Americans who run businesses, 
work at jobs that depend on a level playing field in the global 
marketplace. This is the only report to the Congress that 
addresses international economics, exchange rate policy, and 
currency manipulation, and it requires testimony requested from 
the Treasury Secretary to the Congress.
    As America's economic fortunes becomes more entwined with 
the global marketplace, I think we all agree that this report 
serves a very important role in allowing this Committee to 
discharge its oversight responsibilities. More importantly, it 
allows us to have a very frank, candid, and hopefully 
constructive conversation about how we can foster freer, fair, 
and more transparent, and more dynamic markets where America's 
businesses and workers can compete successfully. That 
conversation must begin with an assessment of how our National 
Government is doing in securing opportunity and prosperity for 
working Americans.
    The record, in this Senator's view, over the past 6 years 
leaves much to be desired. Policies put in place well before 
Secretary Paulson's confirmation have helped to turn record 
surpluses into deficits. Those deficits mean that today we are 
underinvesting in our most important priorities, such things as 
health care, schools, our Nation's infrastructure, and targeted 
tax relief. I would point out that just the interest payments 
alone exceed the entire expenditures in education, the 
environment, energy policy, unemployment compensation, and job 
training. I think most Americans, most people would be 
concerned, given the expenditure of those dollars in interest 
payments, considering the other things where investments could 
be made, either in tax relief or support for critical 
investments in our Nation. And while the economy has produced 
great results for some, and while we can all be encouraged by 
some recent positive signs, the fact remains that the median 
family income has declined by $1,300.
    Now, the Secretary and I had a great conversation 
informally here before the hearing began, with the reports on 
this morning's GDP growth rate, which are encouraging and need 
to be cited here. This is welcome news. After 6 months of sub-
par growth, the economy is again growing at a healthy rate. A 
very large component of this economic growth has come from 
international trade. Without the growth in trade, I think our 
economic growth would have been under 2 percent, and the 
Secretary may want to comment on this in his remarks. Much of 
that improvement in our trade situation I think came from a 
decline in the price of oil, which reduced our imports, and the 
fall in the value of the dollar, which helped increase our 
exports, obviously. It just demonstrates how critically 
important it is that we not only be allowed to be ready to 
adjust against all currencies, making the point further along 
here.
    At any rate, we have seen over the last 2 years the decline 
in the earning power of Americans. More than 3 million 
manufacturing jobs have been lost since 2001, which is the 
steepest and most prolonged loss since the Great Depression. 
About 1 million of those manufacturing jobs have been in 
critical defense-related industries. I would point out that 
this Committee has jurisdiction over the Defense Production 
Act, which is subject to reauthorization, and we will be 
looking at defense production issues, Mr. Secretary, at the 
appropriate time in the Committee. And obviously a loss of a 
million jobs in defense-related areas is an economic issue, but 
it also raises some very significant national security issues.
    This is the first economic recovery, I would add, that we 
have ever seen in which the manufacturing jobs that were lost 
have not come back. In a sense, for millions of Americans, the 
recession has not ended but goes on. In addition to this 
historic dislocation of America's manufacturing base, we have 
also outsourced the capacity to produce items of vital 
importance to our national security.
    Just to take one example, every smart bomb is guided by a 
special kind of magnet, as we know. These magnets used to be 
produced in two plants in Indiana, which our colleague from 
Indiana, Senator Bayh, is all too familiar with. Today these 
magnets are manufactured in China. What would be the 
consequences if these essential items ceased flowing to our 
military? The mere question supports what I believe to be an 
unmistakable and inescapable fact that significant changes are 
urgently needed to adequately secure America's future, both 
economically and militarily.
    One such change--namely, the exchange rate policy--is the 
subject of today's hearing. If the global marketplace is going 
to be truly free and fair, then currencies must be equally 
subject to the discipline of that marketplace. China's 
continued resistance to allow its currency to move to where the 
market would value it has had a distorting effect on global 
markets and a detrimental effect, I believe, on U.S. companies 
and workers.
    I have already spoken about the loss of manufacturing jobs. 
China's currency, which credible analysts say is devalued by 
anywhere from 15 to 40 percent, is not the sole cause of these 
job losses. But many experts believe it is a significant factor 
for that result. Likewise, it is a significant contribution to 
our Nation's record trade deficit. By now, the deficit is 
projected to be over $750 billion for the year 2006. Nearly 
one-third of that deficit, $230 billion, consists of U.S. 
bilateral trade deficit with China. The Treasury's 
International Economic and Exchange Rate Report requires the 
administration to examine whether any of our trading partners 
are manipulating their currency to gain an unfair trade 
advantage. Previous administrations, including that of former 
George H.W. Bush, have found several countries to be 
manipulating their currency under the rules of the report, 
including China. Many leading economic experts have said for 
some time that China and other Asian countries are manipulating 
their currencies to gain an unfair trade advantage.
    When he was in China as part of a delegation led by 
Secretary Paulson, Federal Reserve Chairman Bernanke talked 
about the distortions that result from, and I am quoting him, 
``an effective subsidy that an undervalued currency provides 
for Chinese firms that focus on exporting.''
    When the administration's Exchange Rate Report was 
released, Senator Shelby and I issued a joint statement 
expressing our disappointment that the report failed to 
recognize what is obvious to most, and that is that China 
continues to manipulate its currency.
    As I said a moment ago, exchange rate policy between the 
U.S. and China, as well as other countries, is but one of many 
challenges that our Nation faces in order to secure a 
prosperous future for our people. But it is a vital challenge. 
It is critically important that we have a level playing field 
in the global economy.
    One of the issues that the Secretary has made a priority is 
the importance of ensuring the competitiveness of U.S. capital 
markets in the global marketplace. I strongly support, by the 
way, the need to ensure a level playing field for U.S. 
companies, and I applaud your interest, Mr. Secretary, in that 
subject matter. But we also need to make sure that we have a 
level playing field for U.S. companies when they compete 
against China and other nations in Asia. With a level playing 
field, I believe the American worker and the American 
entrepreneurial spirit can compete with anyone in the world.
    I want to thank the Secretary for testifying this morning. 
I believe that this is not only his first appearance before the 
Congress since returning from China, but it is also his first 
testimony to the Congress since being confirmed last July. It 
is especially fitting that Secretary Paulson's first hearing is 
on the Treasury Department's report on International Economic 
and Exchange Rate Policy and the first meeting of the U.S.-
China Strategic Economic Dialogue. In his previous career at 
Goldman Sachs, Secretary Paulson worked extensively with 
Chinese officials. I don't know of anyone in this 
administration who is as knowledgeable, I might add, about 
China and the Pacific Rim as the Secretary of the Treasury. In 
fact, I cannot think of anyone in recent past history at this 
level that brings as much talent and ability and knowledge 
about the Pacific Rim and the importance of it as Secretary 
Paulson does. And I applaud your strong interest in it, your 
knowledge of it, and we hope this morning as a result of 
talking about this policy, you can also share with us some 
additional insights and thoughts as to the importance of this 
relationship and how we can manipulate or work it better in the 
coming years. Your skills will be needed if the administration 
is to achieve better results than it has so far, in my view. 
Given your impressive experience and ability, Mr. Secretary, I 
believe you are uniquely qualified to help create a global 
marketplace where America's work ethic and ingenuity will win 
the day.
    So I am very pleased that you have taken the time to be 
with us here this morning, and I look forward to hearing your 
testimony. I am also pleased that we will have a second panel 
of witnesses to share their knowledge and concerns as well 
about the conclusions of this report.
    Senator Shelby, my colleague, I would ask if you have an 
opening statement, and then with the permission of my 
colleagues, in order to move along, I am going to go right to 
the Secretary's testimony and then use the time available for 
members to raise their own opening comments, and I will include 
every comment you have as part of the opening statements for 
the record. But to move this along so we can get to the 
question-and-answer period, I am going to limit the opening 
comments to the Ranking Member.
    Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Secretary Paulson, we are pleased, as Senator Dodd has 
indicated, to have you before the Committee. The Omnibus Trade 
and Competitiveness Act of 1988 requires you as the Secretary 
to provide a semiannual written report on international 
economic policy, including exchange rate policy, to the Senate 
Banking Committee and to the House Financial Services 
Committee. This morning, we will focus on the most recent 
report which the Committee received on December 19th of this 
past year. We also look forward to hearing more about our 
ongoing Strategic Economic Dialogue with China. We are 
interested in both the results of the first meeting and your 
plans and expectations for the coming meeting in May.
    Secretary Paulson, your first Exchange Rate Report 
indicates that no major trading partner of the United States 
met the technical requirements for currency manipulation during 
the first half of 2006. Your findings, although consistent with 
your predecessors, are not consistent with my own views. Maybe 
you have information that we do not have here, and if you do, I 
hope you will share it.
    I believe myself that China is manipulating its currency as 
part of an export-driven growth strategy. The continued 
imbalance of trade with China is of significant concern to us, 
and I know it is to you. The U.S. reported a nearly $23 billion 
trade deficit with China in November, by far its largest with 
any country. According to the Commerce Department, Mr. 
Secretary, the November data shows a year-to-date deficit with 
China of almost $214 billion, and I am sure it is more. The 
2005 full-year deficit was slightly more than $201 billion.
    As our trade deficit grows, China continues to accumulate 
significant foreign exchange reserves. In fact, China recently 
overtook Japan as the largest reserve holder. The value of 
China's reserves are now estimated, Mr. Secretary, to exceed 
US$1 trillion, the majority of which is invested in dollar-
denominated assets. The growth in China's foreign exchange 
reserves has slowed in recent months, but the pace remains 
quite rapid. This continued growth raises troubling questions 
as to the sustainability of China's enviable economic growth 
rate and its ability to control credit and inflation within its 
domestic economy.
    Because the international trade and financial markets are 
truly global, the pace of China's actions toward greater 
currency flexibility are critical, I believe, to both China's 
continued strong domestic economy and to the world economy. The 
Chinese currency has appreciated roughly 6 or 7 percent since 
July of 2005 when China first announced plans to move toward 
flexibility. However, as your report points out, that pace 
toward greater flexibility has not been fast enough. As a 
result, we have seen no reduction of the current account 
surplus of foreign reserve accumulation.
    While some may argue, Mr. Secretary, that these numbers are 
a natural outgrowth of globalized financial markets, the 
numbers also raise questions about whether world trade has been 
conducted on a level playing field.
    Secretary Paulson, I am interested in hearing about the 
specific steps today that the administration is taking through 
our Strategic Economic Dialogue to move China toward a more 
flexible rate policy. I would also hope to hear more about how 
international bodies such as the G-97, the International 
Monetary Fund, and perhaps the Asian Development Bank can also 
play a role in facilitating increased flexibility.
    Over the long term, both the U.S. and the global economy 
will benefit from the continued pursuit of free trade and 
flexible exchange rate policies. And I believe the most 
desirable way to reduce our current account deficit will be 
through stronger growth abroad and more open trading markets 
and policies. I look forward to hearing from you this morning.
    Thank you, Mr. Chairman.
    Chairman Dodd. Mr. Secretary, the floor is yours. Why don't 
you bring that microphone right down close to you.

 STATEMENT OF HENRY M. PAULSON, JR., SECRETARY, DEPARTMENT OF 
                          THE TREASURY

    Secretary Paulson. I have it. OK. This is my maiden voyage.
    Chairman Dodd. Yes, and we are one member away from having 
a quorum, so why don't you get going here. But if someone walks 
in the door, we will take a break for 2 minutes.
    Secretary Paulson. OK. Mr. Chairman, Senator Shelby, and 
Members of the Committee, thank you very much for the 
opportunity to have this dialog with you today on an issue of 
vital importance to American workers and the American economy. 
As you know, the Foreign Exchange Report recently issued by the 
Treasury reviews developments in international economics and 
the exchange rate policies of a number of our key trading 
partners.
    Let me first take a few minutes to talk about the important 
and multifaceted relationship we have with China. Getting it 
right is vitally important to the citizens of both our nations 
and the world and will be so for many years to come.
    Since the economic relationship between our two countries 
is an important part of our overall relationship, I have 
focused intensely on China from the day I was confirmed. It is 
my job to press for opportunities for American businesses and 
American workers. The successful management of our economic 
relationship with China will benefit the United States and 
China greatly.
    The United States and China share many strategic interests. 
These range from national security to economic growth and trade 
to the health of our environment. As a growing leader on the 
world stage, China must be a full participant in the rules-
based world economy. Recognizing this, the President and 
Chinese President Hu established a Strategic Economic Dialogue 
to manage the economic relationship between our two nations on 
a long-term basis.
    The SED should help us make progress on fundamental long-
term structural economic issues as well as on very pressing 
short-term issues. It is not a scripted ceremony. It is a 
serious, focused discussion of the economic issues that matter 
most.
    The SED provides a mechanism through which, for the first 
time in our relationship, our Government can speak with a 
single voice on economic issues to the highest levels of the 
Chinese Government and do so on a regular basis. The dialog is 
goals based and designed to keep both sides moving forward on 
goals that we establish. By meeting regularly, we can actively 
monitor the progress we are making. By making progress on 
critical immediate issues such as currency reform, we will 
build the confidence to deal with the important longer-term 
economic issues, such as the structural challenges China faces.
    China's currency policy is a key factor in our economic 
relationship. China does not yet have the currency policy we 
want it to have and that it needs. Treasury's Foreign Exchange 
Report clearly states that China's cautious approach to 
exchange rate reform exacerbates distortions in its domestic 
economy and impedes the adjustment of international imbalances. 
I look forward to discussing the report with you during this 
hearing.
    We are actively pressing the Chinese to introduce greater 
currency flexibility and to undertake wider market reform. We 
are seeing some results. China abandoned its pegged exchange 
rate in July of 2005 and began to introduce some flexibility. 
Since last July, the pace of appreciation has been more than 
three times as fast as it had been in the first year after the 
initial renminbi reform. Foreign currency trading, once 
conducted entirely by the Chinese Government, is now conducted 
almost entirely by commercial banks.
    China has introduced financial instruments to hedge foreign 
exchange risk, and the Chinese Government has begun to allow 
increased fluctuations in the currency. This is welcome 
progress, but we need to see much more. Although China is 
moving faster, it is still not moving fast enough. Nor is 
currency flexibility enough. A major objective of my 2 
remaining years as Treasury Secretary will be pressing the 
Chinese Government to advance toward the goal of renminbi whose 
value is freely set in a competitive marketplace based upon 
economic fundamentals.
    I will work with the Chinese Government to develop the 
market infrastructure they need for a freely floating currency. 
This involves several key steps.
    First, the government should progressively widen the band 
that limits the daily movements of the exchange rate. Widening 
the band will help businesses and financial institutions learn 
to operate with a fluctuating currency.
    Second, the central bank should progressively reduce its 
intervention in foreign exchange markets.
    Third, China must develop the fundamental components of a 
capital market, a bond market and a yield curve, to absorb 
inflows and outflows of foreign exchange and provide ways to 
hedge against exchange risk.
    And, fourth, China's central bank must set clear policy 
targets to avoid inflation and thereby provide confidence in 
the value of the Chinese currency.
    I want to be clear. Increased flexibility in the short run 
is absolutely necessary, but it is not sufficient. My goal is 
to make significant progress toward a fully market-determined 
floating Chinese currency. The message I delivered to Chinese 
decisionmakers in the first meeting of our Strategic Economic 
Dialogue in December is that they are not moving quickly enough 
to make their currency more flexible. While they agreed they 
need to increase currency flexibility and move to a floating 
exchange rate, they are not moving quickly enough for the 
United States or the rest of the global community, and they are 
not moving quickly enough for their own good. The Chinese 
leaders believe there is risk in moving too quickly when, in 
fact, as I argued to them, the greater risk is in moving too 
slowly. China may be in some respects a developing country, but 
it is also a large and powerful country. The international 
community will run out of patience with China unless the pace 
of its reform accelerates.
    Reform of China's currency policy is a crucial issue for 
China and the United States, and, Mr. Chairman, the need for 
reform in the Chinese economy goes beyond currency. Currency 
movement alone will not eliminate the distortions in the 
Chinese economy, nor significantly reduce its trade surplus. 
China needs to restructure its economy so that household 
consumption--rather than exports and excess investment--powers 
growth. This is the only way that China can grow without 
generating huge trade surpluses.
    To do this, Chinese policy must address the reasons why 
Chinese households feel compelled to save so much and spend so 
little. Only 20 percent of 800 million people who live in rural 
areas in China have health insurance. The basic government 
pension covered only 17 percent of Chinese workers in 2005. And 
only 14 percent of the population is covered by unemployment 
insurance. China must invest in its people by strengthening its 
health care system and the social safety net, and Chinese 
households need financial products that insure against risk and 
finance major expenditures. The Strategic Economic Dialogue 
addresses all of these issues.
    I believe that the openness of the U.S. economy to 
competition and our participation in international trade are 
key to economic growth, higher wages, and increased 
opportunities for U.S. workers. We saw the importance of trade 
for U.S. workers, as the Chairman just mentioned, in this 
morning's strong GDP data. GDP growth in the fourth quarter was 
3.5 percent, and inflation was moderate at 1.5 percent. Trade 
contributed more than 1.6 percentage points to growth, with 
double-digit exports gains accounting for more than 1 
percentage point.
    We have reached a crossover point at which American exports 
are now growing faster than imports and have been doing so for 
four consecutive quarters. We are pressing China to follow our 
example of openness, and I am working to ensure that China's 
growth and expanding market create maximum opportunities for 
the United States. China must live up to its WTO commitments. 
It must protect and vigorously enforce intellectual property 
rights. It must increasingly open its markets to foreign 
competition for its own good as well as ours. And it must 
introduce greater transparency in regulation and observe the 
rule of law. Through the Strategic Economic Dialogue and 
through the various economic dialogs we have with China, the 
administration will continue to press very hard in all of these 
areas.
    Mr. Chairman, America's economy and workers benefit 
significantly from our trade with China. China is our fourth 
largest export market. Our exports to China have increased more 
than 350 percent over the last decade, 6 times the growth of 
our exports to the rest of the world. And nearly half of our 
exports to China are capital goods, including high-value-added 
goods such as civilian aircraft, electrical machinery, and 
medical devices.
    I believe strongly that a healthy Chinese economy, growing 
without large external imbalances, is of vital interest to the 
people of the United States, to the people of China, and to the 
global economy as a whole. More constant flexibility in the 
short term and a fully market-determined floating renminbi in 
the intermediate term are essential to accomplish this goal. So 
is restructuring the Chinese economy so that the domestic 
consumption demand, not exports, fuels Chinese growth. Broad 
structural changes are necessary to have a major impact on our 
trade deficit with China.
    The next round of the SED will take place here in 
Washington in May. I understand that all of your constituents 
are very concerned about the impact of our relationship with 
China on their jobs and on their livelihoods. China is a big 
and important part of the world economy. It needs a currency 
whose value is determined in an open, competitive marketplace 
and an economy that supports more balanced, stable growth.
    I look forward to working with the Members of this 
distinguished Committee on the many important issues we have 
before us, and I now welcome your questions. Thank you.
    Chairman Dodd. Well, thank you very much, Mr. Secretary, 
and we have a quorum here present. In fact, come on in, Jack. 
You can add to it here this morning. So I am going to move the 
Committee into executive session, if I can. We will briefly 
interrupt here the flow of this.
    [Whereupon, at 10:29 a.m., the Committee proceeded to other 
business and reconvened at 10:32 a.m.]
    Chairman Dodd. Let me begin, and I am going to ask that the 
clock run for 7 minutes. We have a good turnout here this 
morning, and that is not a great deal of time to get into great 
length. But so that everyone gets a chance to engage in the 
discussion, I think it is going to be important that we follow 
the early bird rules that have applied in the past here, which 
the exception, obviously, of the Ranking Member.
    Mr. Secretary, again, thanks for being here, and we 
appreciate your comments. I was looking at this report also 
sent to Congress--this was in November of 2006--on the U.S.-
China Economic and Security Review Commission, which I presume 
you may be familiar with. Their report here, which is a rather 
lengthy report, goes on at some length, and they concluded, on 
a 12-0 vote, by the way--not actually a divided vote--that 
China is manipulating its currency and engaging in other unfair 
trade practices. They are worried about it. As I said, they 
voted 12-0 that China is engaged in currency manipulation as 
defined by the statute.
    They wanted to point out, by the way, and you made the case 
about the difficulties China has in serving its large 
population--unemployment insurance, health insurance, and the 
like. But I think it is also worthy of note here that China has 
increased its military budget by double-digit growth over the 
last 10 years. The U.S.-China Economic and Security Review 
Commission warned, and I quote them here, ``The People's 
Liberation Army is developing anti-satellite capabilities and 
space warfare weapons that impede U.S. command and control. Two 
weeks ago, China launched the first anti-satellite weapon in 20 
years.''
    So while we understand they have got a lot of work to do in 
providing for the needs of their people, they are not finding 
any difficulty in providing for what they perceive to be their 
national security needs, investing some massive amounts into a 
defense structure at the expense of serving the people of 
China, who deserve a lot better than they are getting. So here 
is one Commission that reaches a conclusion on a 12-0 vote 
that, in fact, China is manipulating its currency.
    Now, putting aside, if I may ask you here, the 
technicalities of the statute here, let me ask you very 
directly at the outset: What is your personal view about this 
matter? You have spoken eloquently this morning about what is 
going on. Is China manipulating its currency in your view?
    Secretary Paulson. Well, Mr. Chairman, let me say I share 
everybody's----
    Chairman Dodd. Is your mike on, Mr. Secretary?
    Secretary Paulson. Is it on?
    Chairman Dodd. You have got to----
    Secretary Paulson. OK, I have got you. I will get the hang 
of this in a minute or two. I share the views of everyone who 
is frustrated about the currency because I would like to see 
China showing much more flexibility, and I am going to be 
frustrated until they do so.
    Now, let me also say that I did not wait for this report to 
come out. I was not holding my breath for this report to come 
out to take action. So from the day I was confirmed as Treasury 
Secretary, I started focusing on China. Shortly thereafter, I 
was pressing the Chinese on the matter of currency flexibility, 
and pressing them hard.
    They now embrace currency flexibility as a policy. It is a 
stated policy. It is a goal. And so as you have pointed out, 
intent is what we look at because the law calls for intent. But 
what I think is important is action. Even if China had been 
named as a manipulator in this report, the remedy under the law 
is to negotiate with them directly on currency and to negotiate 
through the IMF. That is what we have been doing.
    To me, it is not just about currency flexibility in the 
short term. As I said in my testimony, the Chinese need to make 
progress over the next couple of years so that they will be in 
a position in the intermediate term where we will not be having 
this discussion because they will have a currency where there 
is no argument about it because the value is determined in a 
competitive, open marketplace.
    Chairman Dodd. Let me ask you this: Your predecessor, 
Secretary Snow, in the 2005 report--and I am quoting from it 
here--found the following: He says, ``If current trends 
continue''--speaking of China. ``If current trends continue 
without substantial alteration, China's policies will likely 
meet the technical requirements of the statute for designation 
as a currency manipulator.'' He went on to say, ``This 
adjustment has to be material and has to be significant, has to 
be something that would significantly close the gap between 
current value and an appropriate, more appropriate value.''
    I guess the question I would ask you in light of that, 
Secretary Snow made that statement that China has 
significantly--or, rather, Secretary Snow made the statement 
that China has significantly closed the gap, or do you agree 
with his interpretation of the statute in this sense? I mean, 
this is your report. It seems to me the language here that at 
least looking at the predecessor's comments here, it is not 
materially changing its direction.
    Secretary Paulson. I do not know what was in my 
predecessor's mind, but as I have said, I have been focused on 
results and putting a process in place where we can speak with 
one voice to the top decisionmakers and indeed get movement and 
get action. As I testified, I have said the way we looked at 
this I am just like John Snow. I read John Snow's testimony, 
and he said repeatedly to Members of this Committee that he was 
in heated agreement with you. And I am in agreement. We need 
more movement on the currency.
    I am not satisfied, I know what my job is, and I know I 
need to get results. And it is not just flexibility in the 
short term because, if we do not do something about some of the 
structural reforms they need and have them move forward on the 
path of reform, we will still have these trade imbalances 
because we will need broader structural reform in addition to 
the short-term movement in the currency.
    Chairman Dodd. Well, I agree with you about action. I think 
action is important. And this conversation is important, except 
if you are the guy out there who has just lost his job in the 
manufacturing sector because of the disadvantages here, the 
subsidies that the Chairman of the Federal Reserve talked about 
on the trip that you all took there. And this is a boiling 
concern of people across the country to watch this manipulation 
and to watch the disadvantage and to watch the hardship it 
imposes on people who work very hard. And losing 3 million jobs 
in the manufacturing sector, losing 1 million of them in the 
defense-related areas, while you are watching the country who 
is sort of dawdling along here having double-digit increases in 
its defense spending at the expense of its own people's needs 
raises concerns about whether or not we are going to stand up 
and insist upon some real concrete action before sort of going 
along year after year sort of tolerating this behavior at the 
expense of jobs here and our own economic security in the 
future.
    You point out the action stuff. I am looking--and I know 
you care about this. In your testimony, you talk about building 
components of a strong capital market structure, a bond market 
and a yield curve, which will enable the country to get to the 
point where it can freely float its currency. And yet only 
modest concessions have been made as China continues to set 
barriers intended to prevent foreign financial services--
something you were very familiar with obviously in your 
previous incarnation, the difficulty this critical component of 
our economy, the financial service sector, has in accessing the 
markets in China, the barriers they put up to us, and how 
critical a component that is for getting to the point where 
they are no longer manipulating their currency. And yet here is 
action they could be taking that they refuse to take.
    How do you square that in a sense?
    Secretary Paulson. Well, let me say, Mr. Chairman, first of 
all, I really share your concern about people who are losing 
their jobs in this country. That is what drives me and one of 
the major reasons I took this assignment on. And I agree with 
you on the capital markets. I look at the capital markets, and 
I cannot think of any country in the world that has an economy 
that works properly and allocates capital efficiently and has a 
currency where the values are really set in a broad, deep, 
competitive market that does not also have strong capital 
markets. And I cannot find any country that has strong capital 
markets that has not opened itself up to foreign competition 
and taken off investment caps.
    This is one of the things that we are going to be pressing 
on in the Strategic Economic Dialogue opening up capital 
markets to the banks and investment banks, and a multitude of 
other service industries, because a lot of what the Strategic 
Economic Dialogue is about is the path of reform that China has 
and the pace of reform post-WTO, opening up their economy to 
our goods and our services. And so that is very closely 
related. I am pleased you see that relationship between that 
and currency.
    Chairman Dodd. Absolutely.
    Secretary Paulson. Because the two go together.
    Chairman Dodd. Thank you very much.
    Senator Shelby.
    Senator Shelby. Thank you.
    Mr. Secretary, I just have some technical questions, but I 
was wondering what would you say to someone who had been 
working in the steel or foundry business, like in Birmingham, 
Alabama, my home State, for the third generation and finally at 
55 years of age, laid off, had good jobs always, because 
obviously they see the manufacturing jobs gone. And these are 
good jobs. They sustain families, they sustain communities a 
long time. We have to face our constituents like this and 
explain what is going on with the manipulation of currency, 
what is going on in the imbalance of trade, and so forth.
    What would you say to someone if they would confront you 
like they confront us, our constituents?
    Secretary Paulson. Let me tell you, when I have met--and I 
notice you are going to have the NAM here later, and so I have 
had some very explicit conversations, and let me say that is a 
very, very tough situation because what I would say to someone 
is that I am going to do everything I can to represent you and 
represent our country in opening up markets and ensuring that 
we have fair trade; but that, unfortunately, we do not always 
have a level playing field. And although the benefits of trade 
benefit a whole society and benefit a country by raising the 
standard of living, the immediate losses we see from time to 
time are very, very painful.
    Senator Shelby. Do you believe we have a level playing 
field in our trade relationship with China?
    Secretary Paulson. I clearly do not believe that the 
American people believe the benefits are shared equally. I know 
that. And I do believe that our trade with China right now 
benefits both of our countries, but I want to fight to get it 
to benefit U.S. workers to a greater extent.
    Senator Shelby. Mr. Secretary, getting into some technical 
stuff, about a week ago Premier Wen gave a speech, and in that 
speech he noted, and I will quote, ``Management of reserves 
should be improved and the channels through which they are 
invested diversified.''
    How do you interpret this comment and the general theme of 
his remarks focusing on expanding the use of the reserves? And 
how do you believe global financial markets and currency 
traders are reacting to these comments?
    Secretary Paulson. OK. You almost hate to speculate on what 
someone else has in mind and what he meant, but let me----
    Senator Shelby. Well, obviously, he meant something, didn't 
he?
    Secretary Paulson. Yes, he did. He sure did.
    Senator Shelby. OK.
    Secretary Paulson. And so let me speculate a bit about what 
he might have meant, and let me talk a little bit about China's 
reserves.
    I believe that it would be very healthy for China to 
diversify their investment policy as it relates to reserves and 
see more direct investment in certain areas in China and direct 
investment in other areas of the world.
    Now, as I look at their reserves--and let me say to you 
that I am concerned about a lot of things. I am concerned about 
the question you raised about people losing their jobs.
    Senator Shelby. Absolutely.
    Secretary Paulson. I am concerned about the income of the 
average worker. I am concerned about the trade deficit. I am 
concerned about the Chinese currency. I am concerned about 
rebalancing the Chinese economy.
    The thing that concerns me the least of all of these things 
is when I look at their reserves and how those reserves are 
invested. The comment I get most frequently, as I go around and 
talk with people, is, ``Aren't you concerned that they own too 
much in the way of the U.S. treasuries? Aren't we somewhat''--
--
    Senator Shelby. Our debt, in other words.
    Secretary Paulson. Yes, hostage, our debt. Our debt, our 
Treasury debt. And I look at it and say that they currently own 
somewhat less than $350 billion of U.S. Treasury debt by our 
estimates. Our public Treasury debt outstanding is over $4 
trillion. Our Treasury securities trade $500 billion in a day, 
so there is more Treasury trading in a day than the Chinese 
own. They also own other U.S. dollar-denominated securities 
debt of private parties, non-government debt. And I believe 
that the Chinese own dollar debt because it gives them the best 
risk-adjusted rate of return, and the key for us is keeping the 
confidence up in our economy and have economic policies that do 
that.
    So when I looked at the Premier's comments, and, again, I 
do not know exactly what he had in mind, but certainly any 
country has to think carefully about how they manage their 
reserves. I think it is a healthy sign.
    Senator Shelby. But $1 trillion of hard currency reserve, 
that is a lot of money--is it not?--by anybody's reckoning.
    Secretary Paulson. It sure is.
    Senator Shelby. What dialog, Mr. Secretary, have you or 
other officials had with the Chinese officials to determine 
what direction any change in reserve strategy might take? I 
know you do not want to be left in the corner on this. Are 
there any potential negative repercussions to the U.S. from 
various alternatives that they would pursue?
    Secretary Paulson. When I was in Beijing in December, 
Chairman Bernanke and I sat down and we had lunch with Zhou 
Xiaochuan, who runs the central bank, and the Minister of 
Finance, and the woman who chairs SAFE, which manages reserves. 
We had a general conversation, as you would expect us to do, as 
we would with any other nation in the world that has big 
reserves--and none of us on our side had any real concern.
    As I have said, I take all the things I mentioned to you 
before very seriously, and we obviously take this seriously. 
But, again, given the size of our debt outstanding and the way 
it trades and the diversity and so on, that is not at the top 
of the list of----
    Senator Shelby. Do they own about 8 percent of our total 
debt, something like that?
    Secretary Paulson. I would say they own about 8 percent of 
our treasuries. The Japanese own more than any other 
Government. The Japanese----
    Senator Shelby. What would that be?
    Secretary Paulson. What?
    Senator Shelby. What percentage would that be, larger than 
8 percent, that the Japanese----
    Secretary Paulson. I do not have the exact number, but if 
the Chinese own about $350 billion of our Treasury securities, 
the Japanese own something over $600 billion.
    Senator Shelby. OK, twice that. Mr. Secretary, thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator Shelby.
    Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Mr. Chairman, thanks. Mr. Secretary, 
welcome. It is good to be here on your maiden voyage, and I 
just want you to know I appreciate very much a number of the 
things you said, but especially when you said, ``I am focused 
on results.'' And you have been focused on results with respect 
to another issue that you know I have talked a lot about in the 
last couple of months, and that is, trying to make sure we have 
a strong independent regulator for our Government-sponsored 
enterprises.
    Just take, if you will, just maybe 30 seconds and give us 
an update on what is going on there. I know there are 
negotiations between you and your staff and some folks, some of 
our colleagues in the House side.
    Secretary Paulson. The question, Senator--the Senator is 
very interested in, as I know the Chairman and Senator Shelby 
and Senator Bennett and a number of other people are, in GSE 
reform. And I would just simply say that the Administration and 
I personally feel very strongly that we do need a strong, 
independent regulator. I was encouraged by some of the progress 
late last year that we made, and we are going to continue to 
work toward that goal. So far the conversations have been very 
constructive, but we have got a lot further to go.
    Senator Carper. Thanks very much.
    In your testimony, Mr. Secretary, you go through about four 
or so key steps that the Chinese need to take, and it is about 
halfway through your testimony. I will not read them all, but 
there are one, two, three, four. And let me just ask, I presume 
that the way we measure progress is to look at what is 
happening with respect to those four key items. Is that 
correct?
    Secretary Paulson. That would be one way to measure 
progress.
    Senator Carper. I always like to say that we measure the 
things that we do best, and in terms of--what are we measuring 
here?
    Secretary Paulson. I think that is--well, let me give you a 
little bit of a longer answer because that is something I have 
been focused on from literally the first month after 
confirmation. I thought a lot about how to engage with China to 
discuss their economic reform. Currency is very important, but 
more broadly on economic reform, how do we engage? Because this 
is so important. What hit me was that the U.S. Government and 
the Chinese Government were agreeing on the principles and the 
directions. There was broad agreement but big disagreement on 
the pace of reform, the speed. And we felt very strongly that 
they needed to move quicker.
    And so I took a look at how we were working with China, and 
I saw that at the top, President Bush and President Hu had a 
very good dialog. Below that, in the economic arena, we had 
some effective dialogs in the JCCT and the JEC, all the things 
you are aware of. But it seemed to me that we were not 
organized as effectively as we needed to be. We were a bit 
siloed, and so what we needed to do was to come up with a 
process where we could speak with one voice to the key 
decisionmakers and a broad range of decisionmakers at the top. 
We needed to organize multiple long meetings during the year so 
we can measure our progress.
    Now, what you are getting at is what are the things we want 
to measure. On the currency, you mentioned four of the things. 
But, again, as the Chairman and Senator Shelby both said, 
actions are what matter, and with regard to the currency, I 
would summarize it to say we definitely need more flexibility. 
No matter what they do to give it to us, we need more 
flexibility in the short term. And then we need those actions 
in the medium term that are going to get us to the point--get 
them to the point, actually, where they have a currency that 
trades in the marketplace.
    Now, part of that is going to be----
    Senator Carper. I would ask you to wrap it up because I 
have one more question.
    Secretary Paulson. OK. Then here is how I will wrap it up, 
because this will be opening up their economy to products and 
services going beyond WTO, and doing some things to make their 
capital market stronger, opening to our competition, 
international competition, and, again, doing some things that 
are going to help them bring more balance to their economy. But 
we will be establishing those benchmarks.
    Senator Carper. All right. Thank you.
    One question that I would ask you for the record and just 
submit in writing a response, if you will. Somewhere in your 
testimony, you talked, I believe, about a sixfold increase in 
the amount of exports from the U.S. to China. What I am going 
to ask you to answer for the record is: What is the increase in 
exports from the Chinese to us during that--don't answer it 
now.
    Secretary Paulson. I tell you----
    Senator Carper. No, I have another question I want to ask 
you and I want you to answer right here.
    Secretary Paulson. OK. I would like to just tell you, 
because the estimate----
    Senator Bunning. Your microphone is off.
    Secretary Paulson. Sorry. This last year, we had a very 
important crossover point. We had a very important change in 
the export-import balance with China. According to the latest 
estimate that I am looking at, it looks like our exports will 
have gone up about a third to China, 33 percent, to about the 
$56 billion level, and imports will have increased 19 percent.
    Senator Carper. OK. I appreciate that, but the question I 
want you to answer for the record is: For the period of time 
that you cited for our exports to the Chinese were up by, I 
think, six-fold, what was the increase, the similar increase 
for them?
    Secretary Paulson. Right.
    Senator Carper. And also, for the same timeframe, what was 
the growth in their purchase of our debt over the same 
timeframe?
    Secretary Paulson. All right.
    Senator Carper. A hundred percent, 200 percent, whatever. 
Here is my question that I want you to quickly answer. You met, 
along with the President, with the heads of GM, 
DaimlerChrysler, and Ford a month and a half or so ago at the 
White House. Among the issues that they raised were investments 
in battery technology and also the issue of Japanese currency 
manipulation. You and I have discussed it a little bit. They 
still feel very strongly that something is going on. Could you 
just speak to why you think that is not the case?
    Secretary Paulson. OK. I will be as quick as I can, and let 
me say I have been watching the Japanese currency very, very 
carefully. I talked with the Finance Minister several weeks 
ago. I will see him when I am in Germany, in Essen, at the end 
of next week. The yen is close to--don't hold me exactly to 
this--a 20-year low on a trade-related basis.
    What I said to the auto manufacturers is that there has 
been no intervention in the yen since March of 2004. I do not 
believe there has been--although I could be wrong on this, 
because I cannot read every quote, but I do not think there has 
been verbal intervention for almost a year. I do not like 
verbal intervention. I do not think it determines where markets 
trade.
    I think what is going on in the Japanese currency is this: 
Japan is the second largest economy in the world. All through 
the 1990's and a couple years, in this century, the Japanese 
economy was not growing. There was deflation. There was a huge 
drag on the global economy. They have turned this around now. 
It is a big reason that the global economy is doing as well as 
it is. This is an economy where there has been weak growth, 
where there has been deflation, and so interest rates are very 
low. I think it is those economic fundamentals that are driving 
it. And then, of course at any one time, who knows why markets 
trade the way they do? I am watching it carefully, but the 
things that concern me are exchange rates--excuse me, 
currencies where the value is not determined in a competitive 
marketplace, and the yen has a broad, deep, competitive 
marketplace.
    Senator Carper. Thank you, and I would just urge you to 
stay focused on that. Thank you.
    Secretary Paulson. OK.
    Chairman Dodd. Senator Sununu.

              STATEMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Mr. Chairman.
    Secretary Paulson, last year, Under Secretary Quarles 
testified on insurance, and a number of other Treasury 
officials commented in the hearings we had about the potential 
benefits and, in fact, the need to modernize the insurance 
industry, in particular, insurance regulation. I have been 
working on this issue for a couple of years with Senator 
Johnson, and we have developed legislation together. And most 
recently Senator Schumer and Mayor Bloomberg worked with a 
group of financial service industry representatives about the 
competitiveness of the U.S. financial services industry.
    One of the conclusions of their report was that we need to 
reform the insurance regulatory system, and they recommended an 
optional Federal charter approach to that reform. I would like 
to get your view on the current State-based regulatory system 
for insurance and whether or not you think that modernization 
can contribute to some of the competitiveness issues you have 
been discussing in recent speeches around the country.
    Secretary Paulson. OK. Senator, thank you very much, and 
thank you for your concern and knowledge and interest in this 
area. I would also say I was very impressed with the Bloomberg-
Schumer report and the issues it raised.
    Let me also say that one thing that we are going to be 
looking at carefully at Treasury is competitiveness in the 
insurance industry and the impact of regulation on that and, 
you know, the advantages of an optional charter. As you know, 
this is not an easy issue given how insurance companies are 
regulated, and there are strong views on both sides, and it is 
one that I very much look forward to getting involved in.
    I think although we don't have a clear position yet on the 
optional Federal charter, I personally think it has got a lot 
of merit, and we are going to be thinking this issue through 
very carefully.
    Senator Sununu. Do you feel that in such an approach, if we 
were to take such an approach, do you feel confident in the 
ability of a Federal regulator to adequately address safety and 
soundness issues?
    Secretary Paulson. Well, you are taking it beyond where we 
are to date, and we are going to be spending a fair amount of 
time on this. We are going to have a conference at Treasury in 
March, and as we look at competitiveness, one of the key issues 
we are going to look at is the regulatory structure in the U.S. 
So it will take us a while----
    Senator Sununu. Are you suggesting to me you want to get 
back to the easy questions about Chinese currency manipulation?
    [Laughter.]
    Secretary Paulson. There is no important question that is 
easy. And this is a very important issue, and it is one that we 
are going to be thinking very carefully about.
    Senator Sununu. And I appreciate that, and I know this is 
not an issue that you have to discuss or testify on here, but I 
certainly want to compliment the work of your staff in 
approaching this issue in a very constructive way, and the 
testimony we received last year was extremely helpful.
    The regulatory issue in the financial services industry is 
one that has come up recently. There was an article in the Post 
about it recently. A few people have visited me on the issue, 
and that is the 10-percent cap, the statutory limit that we 
have on banking deposits, limiting total deposits for any bank 
in the United States to 10 percent of the aggregate. And a very 
specific concern that has been raised is that that would make 
it more likely that U.S. banks are acquired by foreign banks 
because those foreign banks are not necessarily subject to 
those growth constraints. And so if a U.S. bank gets to a 
particular level, they really cannot grow through acquisition 
any longer, and it makes them a little bit less competitive 
around the world, and they could potentially be acquired.
    Do you sort of agree with that view that an arbitrary cap, 
in this case of 10 percent, could make a foreign acquisition a 
little bit more likely?
    Secretary Paulson. Senator, this is, a complex issue that 
touches on competitiveness from two different angles. This is 
something that I am sure will receive some discussion, but, 
again, let's remember what the reason for the 10-percent cap 
was to begin with, which was, concern about competition in our 
markets.
    Senator Sununu. I appreciate that viewpoint. Although, as I 
understand it, I certainly wasn't here. It was a negotiated 
tradeoff, shall we say, a compromise that was reached between 
different constituent groups weighing in on both sides of a 
piece of legislation, and they decided to set the cap at 10 
percent. I don't know that it necessarily had a great deal of 
economic validity to it, but it certainly has served to 
maintain a much more fragmented market, which could have some 
strengths, but also could have drawbacks.
    All right. I will keep skipping down then. The last 
question gets back to something raised by Senator Shelby, who I 
think asked a very good question about the diversification 
statements of the Chinese leadership, and you gave a very good 
answer as well. But I am curious about a specific concern or 
potential concern, which would be, How would you respond if the 
Chinese Government announced that as part of that 
diversification strategy they were going to start purchasing 
U.S. equities, and in particular, let us say for the sake of 
discussion, they made a tender offer to purchase Ford auto 
manufacturer? How would the Secretary of the Treasury respond?
    Secretary Paulson. Let me say one thing I have learned is 
that as Secretary of Treasury, I should not be responding to 
hypotheticals. So----
    Senator Sununu. I thought it was only United States 
Senators that were not supposed to respond to hypotheticals.
    Secretary Paulson. Let me just leave it there. Thank you.
    [Laughter.]
    Senator Sununu. Mr. Chairman, Mr. Ranking Member, I tried. 
Thank you very much.
    Chairman Dodd. Mr. Secretary, I told you there is no 
germaneness rule in these hearings.
    [Laughter.]
    Chairman Dodd. As I told the Senator the other day, when he 
asked what the subject matters would be, I said the subject 
matter is the exchange rate policy, but the subject matters my 
colleagues may raise might digress a bit from that subject 
matter, and Senator Sununu certainly has every right to raise 
the questions he did here this morning, and I appreciate it.
    Senator Bayh.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Bayh, I talked about your State a 
little bit. I mentioned the companies in Indiana that closed 
their doors that produced those magnets in the smart bombs.
    Senator Bayh. That is exactly right. A subject for another 
day, perhaps, Mr. Secretary. It is a matter of national 
security when the manufacturers of important defense systems 
are acquired or moved to another country. But that is not the 
subject matter at this hearing.
    I want to thank you for your presence today and for your 
public service, and some of the questions that you are getting, 
including some of my own relate to, shall we say, legacy 
policies that you have inherited from your successors and that 
have been part of the administration's record for some years. 
And I know you are trying to grapple with this, so I hope you 
take that into consideration when you field our question.
    I listened with some interest to Senator Shelby's comments 
and the Chairman's comments, and I would like to follow up on 
that a little bit. And you alluded to it yourself, Mr. 
Secretary, when you said ultimately it is not what we say but 
what we do that matters. That applies to other countries as 
well.
    As you know, the Chinese have a history of saying many of 
the right things, and I am glad that in your private 
conversations they understand that it is in their best interest 
to begin to allow their currency to float and to protect 
intellectual property and to reform their banking system and 
those kinds of things.
    We have been saying for some time that we have been 
frustrated. You said that this morning as well. And so here is 
my question. When asked by my colleagues what we intended to 
do, you mentioned regular meetings and further dialogs and 
those sorts of things. But it might strike many of us that that 
is, in fact, what we have had in the past.
    Are there any specific steps that we intend to take if they 
do not show material progress toward moving in a better 
direction, other than meetings and dialog and consultation?
    Secretary Paulson. Well, Senator, as I said earlier, the 
process that we have, which I would not characterize as just 
dialog, because we are now going to be speaking with a single 
voice to the key decisionmakers. We are going to be doing it 
very regularly, and we are going to be following it up, and we 
are going to be holding ourselves and holding them accountable.
    But having said that, let me say what you said very nicely, 
and what I have had a number of other Senators say to me in 
private. I have talked with Senator Schumer and Lindsey Graham 
and so on, and they have said when you do this, is that going 
to get results? And if it does not get results, what are you 
going to do? And what kind of leverage do you have and so on?
    What I have said is that we are dealing with a sovereign 
state in China, a sovereign nation. It has got its own public 
to deal with; that I really do believe what we have put in 
place gives us the best chance to get some progress. I do not 
mean to sound naive because it very well may be that after we 
have worked hard, I will be dissatisfied, you will be 
dissatisfied with the progress, and the American people will be 
dissatisfied. But I still believe that we will get more 
progress with the course we have adopted than we will going any 
other way.
    And what I need to do is make a very, very strong case as 
to why it is in their best interest and how strongly the 
American public feels about it and how strongly you all feel 
about it, and be there and be at the table continually pressing 
and pounding on these issues.
    Senator Bayh. Well, I have you are right, Mr. Secretary, 
and I know you are sincere. As you can appreciate, the issues 
for many who observe this process, and my staff compiled a list 
of the statements on behalf of our own Government in 
consultation and meeting with the Chinese urging them to take 
these steps, and then the Chinese respond that they intend to 
pursue the necessary reforms. Ultimately, when a period of 
years passes, it is a question of credibility on their part. 
You know, they are saying the right things, but what do they 
really intend? Are they just sort of placating us but 
continuing to pursue their own interests? And then ultimately 
our own credibility, we say the right things, but what do we 
intend to do to back up our words with actions?
    And so many of us are looking for some more material steps, 
both on their part and on our part.
    Secretary Paulson. Senator, I would also say when it comes 
to compliance with the WTO, Susan Schwab, our Trade 
Representative, is quite aggressive. You saw the auto parts 
case, the other things we have in our arsenal.
    So I don't think I would characterize it as being passive 
about this. This is very important. It is a very, very 
important relationship to all of us, and managing it properly 
and making sure we get some progress.
    Senator Bayh. Well, that is what the steelworker that 
Senator Shelby referred to or the autoworker in Indiana, quite 
frankly, is looking for. You mentioned that the playing field 
is not always level. What they want to know, to use the 
colloquialism they would use to me, is: ``What the hell do you 
intend to do about it?''
    Secretary Paulson. Right.
    Senator Bayh. And I think that is what we are all looking 
for, backing up our intentions with actions if there is not 
material progress, because at the end of the day, this global 
trading system that we all embrace has to be one of mutual 
interest, not unfairly weighted on one side or the other. 
Otherwise, it is not sustainable, and that is not in our 
interest or China's interest or in anyone's interest.
    If I could just shift subject matter for a second, this is 
a matter of not only financial policy but, frankly, my own 
concerns about our national security interests, and it relates 
again to the currency issue and that sort of thing. I was 
interested in your comments, I think it was with regard to 
Senator Shelby, about the size of Chinese reserves compared to 
the daily volume of trading in U.S. securities and that sort of 
thing. And I gathered from your comments that you did not feel 
that they could really have a material impact upon the value of 
the dollar, regardless of the policy of the Chinese Government.
    But my thoughts went back to--and I am sure you will 
remember this well--a couple of years ago when a rumor went 
through Seoul that the South Koreans were thinking about 
diversifying their own holdings and set off a free fall in the 
dollar temporarily until an official of their treasury came out 
and said that that is not true.
    A couple months after that, there was a misstatement, I 
think by the Japanese Prime Minister, along the same lines. It 
set off a similar trading pattern in the--so my only--my 
question to you, Mr. Secretary, is: It seems, at least in those 
two instances, the marketplace seemed to disagree with your 
assessment. And so my question to you is--my concern is this: 
As a great country, we cannot really afford to put ourselves in 
a position of vulnerability where another nation can affect 
something materially as profoundly important to us as the value 
of our money. And so I get back to your question. Did I 
understand your opinion correctly that they cannot, even if 
they wanted to, if they chose to diversify to the dollar, 
affect the value of the dollar? And if so, how do you explain 
the incidents in Korea and Japan?
    Secretary Paulson. Let me, because what I was addressing 
was our Treasury and the market for our treasuries and the 
impact on interest rates and on Treasury securities. Because I 
made the point that what they own in treasuries, $350 billion, 
that $500 billion trade in 1 day. And I made the further point 
that the key thing is the confidence in our economy and in our 
country, which is why people hold treasuries.
    Now, let me say that I think you all know my very, very 
strong view on how important a strong dollar is to this 
country. It is clearly in our Nation's interest, and so that is 
something I feel very strongly about.
    But your comment----
    Senator Bayh. My time is----
    Secretary Paulson. Let me just simply say, as someone who 
has been around markets my whole life, I watch people say 
things. I have watched the Treasury Secretary just say 
something wrong or misspeak and markets move and I see all 
kinds of rumors move markets. What I am talking about is long-
term fundamental movement, because I am a big believer in 
markets. And you can get gyrations, and they can be mis-valued 
at any point in time. But the key to our situation is going to 
be to have academic policies that drive productivity, keep this 
economy strong, and that is really where our confidence should 
come from.
    Senator Bayh. Mr. Chairman, my time has expired. If I could 
just make one comment, Mr. Secretary. Your statement that a 
strong dollar is in the best interest of the United States is 
absolutely right. My concern is if another country has the 
ability to manipulate the value of that dollar in a way that is 
adverse to us. And given the trade imbalances, I am concerned 
about that.
    Secretary Paulson. Right, and my point was just to not--I 
do not mean to trivialize the comment because I will tell you I 
received--I probably get that question as much as any question 
since I have been in this job. But again, as I tell you, the 
confidence in our economy is the big driver, and in our 
economic policies. If we keep this country strong, we keep our 
economy strong, and people invest in dollar currencies. They 
invest in treasuries because they believe they get the best 
risk-adjusted return, and that is key.
    My only point with regard to the Chinese holding of 
treasuries is that it is not as big as you may think when you 
look at it in terms of how broad--excuse me--like what our 
securities are and how diverse the holdings are.
    Senator Bayh. Normally it is the microphones you cannot see 
that get you in trouble, Mr. Chairman. In this place----
    [Laughter.]
    Thank you, Mr. Secretary. I appreciate it.
    Chairman Dodd. Before I turn to Senator Bunning, I hope, 
Senator Bunning, just to make the point, Senator Bayh, I was 
looking at the quotes and statements from Paul Volcker and 
Warren Buffett and the IMF. All have raised the same concerns 
that Senator Bayh has raised here about this issue. You get the 
IMF saying the other day that a large current account deficit, 
6.4 percent of GDP last year, makes the United States 
vulnerable to a swing in investor sentiment that could put 
downward pressure on the dollar and see a spike in long-term 
interest rates. No one less than Warren Buffett has expressed 
similar language, and Paul Volcker.
    I am going to turn to Senator Bunning, but I would just 
make the point there are a lot of people out there very worried 
about this issue, Mr. Secretary.
    Secretary Paulson. I would say that is a--what you are 
doing, to me, they are related. But, you know, I guess there is 
some relationship in the amount of treasuries that China holds 
and the imbalances. But with regard to the imbalances, a lot of 
people have spoken about the imbalances, and it is important 
enough. I will just take a minute and say a word about this. As 
long as we have an economy where we are not saving and we are 
growing and China has an economy where they are saving at 50 
percent, and they don't have domestic-driven consumption, and 
we don't have the kind of growth that we would like with our 
trading partners in their economy. Japan has begun to grow but 
it is still growing fairly slow, and we don't have the kind of 
robust growth--and I am very encouraged by what we are seeing 
here, but not the kind of robust growth we would like to see--
we are going to have those imbalances unless we all work on 
those together.
    We have all got our things that we need to do to deal with 
the imbalances, and that is what Warren Buffett happened to be 
talking about. But I think that is a different question than 
the question that Senator Bayh was asking.
    Chairman Dodd. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman, and, Mr. 
Secretary, thank you for being here. I am going to read a quote 
by Chairman Bernanke, and I want you to respond to it. This was 
a quote that he gave before the Social Science Academy of China 
on December 15, 2006. ``Greater scope for market forces to 
determine the value of the yuan would also reduce an important 
distortion in the Chinese economy, namely, the effective 
subsidy that an undervalued currency provides for Chinese firms 
that focus on exporting rather than producing for the domestic 
market.'' When this speech was delivered, however, the term 
``subsidy'' was not mentioned.
    Why did the Fed Chairman only refer to the undervalued 
currency in his written remarks? Did Treasury or any other 
Department ask him to omit the term ``subsidy''?
    Secretary Paulson. I was sitting in the audience. I heard 
the speech the way he gave it. I never even knew that there was 
the line that you are referring to in the original. So, no, I 
never had any conversation with the Fed Chairman about this.
    Senator Bunning. Thank you.
    Now, all the wonderful things that you have said today that 
you and the administration and the Trade Representative and all 
those wonderful conversations you have had with the Chinese and 
their compliance with WTO regulations or their noncompliance, 
and you talking back and forth and back and forth--the Chinese 
do not get it. The people up here make the laws, not you. You 
can talk about them. You can complain about them. But when you 
come as an administration to these Senators and ask for support 
for a policy that we violently disagree with, then who is going 
to sell it? The Chinese Government whom we are fighting like 
heck every day on their undervalued currency?
    Mr. Secretary, there is an imbalance here. The Chinese will 
not listen and refused to meet with certain Senators when they 
went to Beijing to talk trade. I use that as an example because 
five of our Senators from the Trade Subcommittee of our good 
Finance Committee went over to talk about it. They will talk to 
you. They will talk to people who raise the devil, and that is, 
Senator Schumer and Senator Graham. But the people that make 
the policy they do not want to deal with. And, therefore, all 
the jawboning and talking that you are doing with the Chinese 
is not going to affect one iota that steelworker in Bessemer, 
Alabama, or that worker in Indiana, who are complaining to us 
about the unfair practices of the Chinese regulated government 
in relationship to our open government.
    There is a difference, and until you get it, and until you 
are able to express it forcefully to the Chinese hierarchy that 
you are dealing with, you are going to have difficulty with the 
Senators and the Members of the House who pass on whether we 
want to expand most-favored-nation status for China or regular 
trade relationship with China.
    So I want an answer to the question: When will the Chinese 
Government listen to the people who make policy, not the people 
who are supposed to influence policy but the people who 
actually make it?
    Secretary Paulson. Senator, I thank you very much for that 
comment. We will have a senior delegation from China here in 
May for the Strategic Economic Dialogue, and I will encourage 
them to meet directly with you, and I can use plenty of help in 
delivering the message. But I appreciate your comment.
    Senator Bunning. But we gave permanent trade relations with 
China in 1993 or 1994, and we helped them to ascend to WTO, and 
they have all the rules and laws in place, but they never 
enforce them. And if you walk the Beijing streets, you can buy 
anything you want that is illegitimate, that is a knock-off of 
something that is produced under patent or restrictions here in 
the United States. And that is never going to be solved just by 
talk.
    Secretary Paulson. I appreciate how strongly you feel about 
intellectual property. Some of the companies I worked with in 
my previous job that sold products that were counterfeited in 
China felt equally strongly. And this is something that this 
administration has focused on, and it is something----
    Senator Bunning. That is the problem----
    Secretary Paulson. This is something the USTR, something 
Sue Schwab and Carlos Gutierrez are very, very engaged in.
    Senator Bunning. They will engage you, talk to you, talk to 
you until you are blue in the face, but we are not getting any 
results. We are not getting anything done. The yuan has floated 
very slightly since we first put it in legislation to market to 
27-percent reduction. And I can tell you this: We feel very 
strongly that that is going to have to be done because all the 
talking and all the wonderful things that you are doing are not 
getting it done.
    Thank you.
    Secretary Paulson. Well, I would just say this, Senator. I 
very much appreciate your comments. I have been here a short 
time----
    Senator Bunning. Well, I am tired of talking.
    Secretary Paulson. We had our first dialog in December. We 
are going to work very hard to get results. When the Chinese 
are here in May, I will welcome the opportunity to arrange for 
you to have a meeting with them.
    Senator Bunning. Thank you.
    Chairman Dodd. Thank you very much, Senator Bunning.
    And do you have a sense here, Mr. Secretary, of the 
bipartisanship up here on some of these questions.
    Secretary Paulson. Yes.
    Chairman Dodd. Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman.
    I want to follow up on Senator Bunning's comments about 
talk and little action for the last decade, decade and a half, 
from your administration and from the administration before 
that. I came to the House in 1993. That year--1992 I was 
elected. That year, we had a bilateral trade deficit with China 
of barely into the double digits. In 2006, it will perhaps 
exceed $250 billion. In 1992, when I was elected to Congress, 
to the House, we had a $38 billion trade deficit with the 
entire world. Today it will exceed 800-who-know-what for 2006.
    I hear your comment--Senator Bunning's comments and your 
response, and I look back at the opportunities we have had as a 
Government in the last 5 years to actually respond tangibly. 
And I would just like to sort of lay out those opportunities 
and kind of wonder what happened. Back 5 years ago, the 
national AFL-CIO, with others, filed a Section 301 petition 
calling on China--calling on our Government to petition WTO--
that is the process, you know, with NAFTA it can go directly to 
the Tribunal. Under other trade law, we have got to get the 
Government to do it on behalf of our country, whether it is an 
intellectual property issue or a labor issue or anything in 
between. But they filed a Section 301 petition saying China had 
failed to enforce its own labor, minimum wage, health and 
safety laws, environmental laws, that they had not even 
enforced their own laws, which amounted to about a 75-percent 
subsidy, they claimed, a reduction in the cost of production. 
The administration out of hand just dismissed it, did not even 
entertain the thought of it.
    Then a couple of years later, in 2004, the China Currency 
Coalition, a group representing several dozen U.S. industrial 
service, agriculture, and labor organizations, did the same, 
filed a Section 301 petition alleging that China's currency 
manipulation was an unfair trade practice, did that in 
September of 2004. The administration again summarily dismissed 
it. In fact, the petitioners believed because it was done 
within a few hours of the filing, the rejection of the 
petition, not even to read it and hand it on to the WTO and 
advocate for these industrial, agriculture, and labor 
organizations in our country representing tens of millions of 
people.
    Apparently, they believe--and I think it is hard to prove 
otherwise--that they did not take the time--the administration 
did not even take the time to read the several hundred pages of 
analysis, documentation, statistics, and tables.
    Then 35 Senators and Representatives, we filed a petition 
in April of the following year, 2005, to have it rejected 
summarily, just dismissed out of hand again.
    So we have these tools that we at least ought to get a 
hearing in the World Trade Organization, yet our Government is 
not interested enough to pursue on currency, on labor 
standards, on the environment, on health and welfare. Why not? 
Why can't we, Mr. Secretary, at least try something specific? 
This is not jawboning. This is not just talking. This is 
following the legal channels of a Section 301 petition, going 
directly to the WTO on behalf of tens of millions of Americans, 
many of whom you say are very concerned--I believe you--many of 
whom have lost their jobs or have tremendous anxiety that they 
are about to lose their jobs. Why don't we do that, and will we 
do it in the future?
    Secretary Paulson. Senator, I am a big believer in using 
the dispute resolution procedures of the WTO. That is one of 
the real strengths of the WTO. We have rules and we have 
enforcement measures.
    This is something, I can tell you, as I have talked with my 
colleagues, the U.S. Trade Representative, the Secretary of 
Commerce, and others who are involved--we all feel the same 
way. I think the key will be, and I do not know the details of 
the cases you have cited, but I know one of the things I have 
looked at is if we cannot get recourse and we cannot get more 
effective recourse directly, then is it worth going to the WTO? 
They say, ``Is it a case where we can win? What are the merits 
of the case?''
    So I do not--I cannot----
    Senator Brown. With all due respect, Mr. Secretary, they 
did not look at it, can we win, because they summarily 
dismissed the petition within a day or a few hours.
    Secretary Paulson. Well, I cannot----
    Senator Brown. I am not saying it was your decision.
    Secretary Paulson. I cannot even debate the merits because 
I don't know that that is true. But what I can tell you is that 
I want and this administration wants a level playing field and 
we want compliance with the WTO rules.
    Senator Brown. OK. I guess I would ask you to commit to 
this Committee, commit to those of us who are passionate about 
this, as everybody on this Committee--Senator Shelby's 
comments, Senator Bunning's, Senator Dodd's, Senator Bayh's--
that these petitions will get a fair hearing. I mean, they--it 
is almost--a cynic would say about this that this 
administration does not care a whole lot about labor and 
environmental standards in the United States. Why would they 
care about labor and environmental standards internationally?
    I will put that cynicism aside and just implore you--it is 
a new team. It is a different USTR today. It is a different 
Secretary of the Treasury. But I ask you that you will at least 
give it--at least take a little while, make us think you looked 
at it, so that we really, in fact, are satisfied that--we have 
got to do something other than jawboning and other than saying 
let's play a little with the currency and get a 2-percent 
adjustment. This is an average that is legal--this is trade law 
that gives us those opportunities and dispute resolution.
    Secretary Paulson. I am a big believer in trade law and 
dispute resolution opportunities. I will pass your comments 
along to our colleagues, and I welcome the opportunity to talk 
with you more about it.
    Senator Brown. Thank you. One more thing.
    Mr. Secretary, as I mentioned, the trade deficit, $38 
billion the year I was elected to Congress 14\1/2\ years ago, 
today $800 billion plus. The President is in--I think Wall 
Street today, yesterday was in Peoria, exhorting the benefits 
of free trade. All of us think there are terrific benefits from 
trade if it is conducted on a more level playing field and it 
really is fair trade.
    What is curious about this is the Treasury Department in 
both parties--it is not a partisan thing, as Senator Bunning 
knows. The administration has exhorted us to pass these trade 
agreements saying things are going to get better. Every couple 
of years, the Treasury Secretary, the Chamber of Commerce, the 
newspaper publishers all exhort us to pass more free trade 
agreements with weak or non-existent or unenforceable labor and 
environmental standards.
    Now the President is doing it again. He is saying he wants 
Trade Promotion Authority. He is going to call for that today. 
So we have got a $38 billion deficit that went to 200, then 
400, then 600, now to $800 billion, and the answer is let's do 
more of the same.
    How do I explain that to a steelworker in Lorain or a 
textile worker in southeast Ohio?
    Secretary Paulson. Well, Senator, it is going to be very 
hard to explain anything about trade to someone who has just 
lost a job. But what I would say to you is that trade is 
benefiting this economy to a large extent. You heard--I do not 
know if you were here when I made my comment about the GDP 
number this year--I mean this quarter, the fourth quarter. It 
was announced 3.5 percent. A big reason for that was the 
component that came from trade and the fact that our exports 
are now growing faster than our imports.
    Senator Brown. We know all that, but you also know, Mr. 
Secretary, that if you look at economic growth from the post-
war years until 1973, our society across the board fared in 
that economic growth by a decent distribution of wages that--
everybody pretty much saw their wages go up. Since 1973, the 
day we went from trade surplus to trade deficit in this 
country, a persistent trade deficit, the people on the bottom 
have not done well. You know the kind of salaries where you 
came from, the kind of salaries that just kept going up and up 
and up. And GDP has gone up, but most people in this country 
are not sharing in that, and part of that is trade policy, that 
the distribution--you said yourself you know that some are 
hurt, some are helped. Just I hope you think that through, that 
part of the reason for this huge chasm in wages has been 
because of our trade policies, inability to distribute benefits 
even close to equally.
    Secretary Paulson. Well, I would say to you, Senator, that 
the widening gap in income distribution is something that I am 
focused a lot on.
    I want to come back to the one thing that you said that I 
do disagree with, which is equating a trade deficit with 
workers not doing well. And, frankly, what we would tell you is 
that growth is important. Some of the times when you look where 
we have a trade surplus, it will be when the economy is not 
doing well or there is a recession. I think the important thing 
for our workers is to keep the economy growing. I really do 
believe if we keep productivity up, and keep the economy 
growing, you are going to see the benefits pass through to the 
average worker. That is what we have seen now in this last 
year, and the last couple months in particular.
    So I think there are some positive signs, but I understand 
your concerns.
    Senator Brown. Well, 1 year out of six does not convince 
me, but I am hopeful that you are right. Thank you.
    Chairman Dodd. Thank you, Senator Brown.
    I would just point out that trade has been a drag on 
growth. In 9 of the last 12 quarters--and the drop in oil 
prices I think maybe had more to do with these numbers. We 
welcome the numbers, but I think realistically why they have 
come down----
    Secretary Paulson. The exports added significantly this 
quarter, also.
    Chairman Dodd. Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you very much, Mr. Chairman.
    I came here a little late because I was at the hearing of 
the Joint Economic Committee that was talking about the issue 
of the disparity in income gap, and I presented some charts 
there that I probably should have brought here, not realizing 
we were going to get into this. But if you look solely at 
wages, the income gap between the top quintile and the bottom 
quintile is 14 times. And then when you start making 
adjustments in the real world, it is three times.
    By this, I mean the top quintile is paying taxes; the 
bottom quintile is getting an earned income tax credit. The top 
quintile has larger families, so if you take the household 
members and adjust them for the number of individuals, the 
bottom quintile, which includes a large number of retired 
people, one or two people in the household, it adjusts.
    When you adjust for hours worked, because the top quintile 
is employed and a large percentage of the bottom quintile is 
not, it adjusts.
    And as you make those adjustments all the way down, you 
find that the disparity, instead of being 14 times between the 
top quintile and the bottom quintile, it is three times. And I 
would be happy to supply those charts for the information of 
the Committee and that part of my testimony or my comments 
before the Joint Economic Committee.
    I want to focus on several things. First, with respect to 
the loss of jobs, I have seen it in my State. Everybody has 
seen it. But I would just take two figures to illustrate one of 
the things that we tend to ignore. We had a steel mill in the 
State of Utah that was put there in the 1940s in an effort to 
keep it away from the Pacific coast so the Japanese could not 
bomb it. It was really a stupid place to put a steel mill, but, 
nonetheless, in the World War II mentality, that was what they 
did. At the time it employed 4,500 people. The steel mill 
finally closed in 1990. It was under competitive pressure from 
around the world. And they were producing something like three 
or four times as much steel as they had produced in the 1940s, 
and their employment was 1,500.
    The loss of 3,000 jobs did not come from the Chinese. It 
came from a place called ``productivity.'' We must recognize 
that we have been losing manufacturing jobs for the last 50 
years because of increased productivity, and the economy and 
the level of productivity and the impact of the Information Age 
today means that our economy has no more resemblance to the 
1973 economy than the 1973 economy had to the days when we were 
an agricultural economy. If this hearing had been held a 
hundred years ago, we would say over 60 percent of Americans 
work on the farm. And a hundred years later, in 2006, that 
number will be two. And what are we going to do about those 67 
percent of Americans that are going to lose their jobs?
    Well, the 2 percent that work on the farm produce something 
like five times as much food and fiber as the 67, 68, 69 
percent that worked on the farm a hundred years ago. And as we 
have these discussions, we need to understand that the whole 
world has changed and the economy has changed in a dramatic 
fashion.
    Now, to get to the Chinese, with that in mind, I would like 
your response to this. I remember when the bugaboo was Japan. 
Hollywood was producing movies. There were novels. The Japanese 
were going to take over everything. And downtown real estate in 
Tokyo had a higher appraised value than the entire State of 
California. And then something happened. The economic reality 
began to intrude on the bubble that occurred in Japan. I owned 
a business in Japan at the time, and bank balance sheets became 
readjusted to reality. They were putting appraised values of 
real estate on their balance sheets as if they were real 
assets, and all of those kinds of things happened.
    I look at China, and I see the following things that tell 
me that China is not going to be what some commentators are 
telling us it is.
    No. 1, the United States GDP has grown more in the last 5 
years than the entire Chinese GDP is. Our GDP growth in the 
last 5 years, cumulative, was about $2.7 trillion. Don't hold 
me to the exact amount, but it is close to that. The total 
Chinese GDP is about $2.3 trillion. That is not something that 
causes me to quiver at night by comparison that they are going 
to take us over.
    No. 2, their statistics are not that reliable. Any country 
that issues their GDP growth statements for the year on the 
31st of December, it says, Wait a minute, some of these numbers 
were cooked in advance.
    The banking system is a disaster. An editorial in the Wall 
Street Journal that appeared on the 29th talks about that and 
the things they need to do to shore up their banking system.
    But, finally, the last time I was in Beijing, I looked at 
all these fabulous buildings and asked the obvious question: 
Who is building them? The U.S. Ambassador told me that question 
was put to the Chinese officials, and the answer was, 
``Speculators.''
    So the next question is: ``Who lives in them?'' And the 
answer was, ``Corrupt government officials.'' Sooner or later, 
they are going to run out of corrupt government officials to 
fill all those buildings.
    Would you comment on what China's long-term prospects are 
with these kinds of structural problems and how that affects 
all of these things as opposed to just a narrow conversation on 
currency rates?
    Secretary Paulson. Senator, I think it is a very good 
question, and I have been very impressed with the capability of 
the Chinese leadership and no one can argue the success they 
have had with their reform program. But I also have learned 
that when something looks too good to be true, it generally is. 
No one is going to defy economic gravity. There are going to be 
bumps along the road in every economy.
    And so the point that I have made when talking about China 
is they are now partway between a market-driven economy and an 
economy with administrative controls. As they become bigger and 
bigger and more complex and they become increasingly integrated 
into the world economy, the greater the risk to China and to 
all of us. Frankly--and I will get to that in a minute--if they 
don't move quickly enough and they hit some big bumps in the 
road, because I do believe that many people who worry about 
China worry about the wrong thing. They are worried that China 
is going to greatly overtake the United States and it poses 
some huge threat. And, frankly, what we should be concerned 
about is that we--it is in all of our interests to have China 
keep doing well.
    China has been, right along with the U.S., one of the 
engines for growth in the global economy for a good period of 
time, and a bump in the road, a serious bump in the road would 
have repercussions for all of us. And so I really think that is 
a concern.
    I feel also what you feel about the U.S. economy. It is a 
very interesting thing, because before taking this job, I 
thought about it this way: I have traveled all around the 
world, and we can focus on our problems, and we have got 
meaningful problems to focus on. But our problems are so much 
less than any other nation's problems, and we have such great 
competitive strengths, if we just continued to make the changes 
we need to make to keep our economy competitive.
    And so I do agree with you, it is an interesting point and 
part of the reason why it is so easy for me to push the Chinese 
very hard on currency and other reforms is that reforms are not 
only necessary to make sure that we have a level playing field 
and that our workers share in the benefits, but it is going to 
help them much more. If they do not open their markets to 
competition and they do not move more quickly to market-driven 
forces, there are real problems that they will hit, more than a 
small bump.
    But I would say to date they have managed magnificently 
well and they have very strong leadership, and I would like to 
believe they will do the things they need to do to keep their 
economy moving forward, which would be good for all of us, not 
just good for them. It is a win-win.
    Senator Bennett. Thank you. I appreciate that, and just a 
quick comment, Mr. Chairman. One of the reasons they have done 
well is they have basically ignored the advice of the IMF. 
Thank you.
    Chairman Dodd. Thank you, Senator Bennett.
    Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Well, thank you, Mr. Chairman. Thank you, Mr. 
Secretary. A lot of the discussion today is focusing on our 
continuing negotiations and discussions with the Chinese, but 
let me ask a simple question. What is our leverage against the 
Chinese in these negotiations? If we do not have any, then it 
is a long discussion without results. So how would you classify 
or what would you point to as our leverage against them in 
these negotiations?
    Secretary Paulson. Whenever you are--and I found this in 
business also. Whenever you are negotiating with a strong 
counterparty--in this case we are negotiating with a sovereign 
nation that is accountable to their people, and it has got 
strong public sentiment--leverage is a difficult thing. But you 
need leverage. And what I can say to you is we have thought 
about this. Obviously, we have got the leverage if they do not 
comply with WTO, all those enforcement mechanisms and dispute 
resolution procedures. So you have got that. We have got the 
force of law in our country and the force of law in the WTO.
    But in terms of the kinds of things that I am talking to 
the Chinese about, I think their leverage comes from having 
very direct and regular meetings--regularly meeting with the 
key decisionmakers, and I need to advocate very effectively why 
this is not only important to them, but how strongly all of you 
feel and how strongly the American public feels. And, again, I 
know that is not--I know you want to hear more than that, and 
all I can tell you is I think the plan we have has the best 
chance of getting progress, and it will get more progress than 
going other routes. And other things that have been suggested 
from time to time I think are counterproductive. So that is----
    Senator Reed. Well, in what way--well, let me go back to 
Senator Brown's questioning, which I thought was very 
interesting. You have already suggested you have legal means, 
that there are at least initial claims that could be made--they 
might not be favorably decided, but they are certainly at 
least--I mean, they are credible claims. Why wouldn't you 
invoke those legal mechanisms as a way, if not to secure final 
judgment, simply to communicate our seriousness and also to 
give you more strength in your discussions?
    Secretary Paulson. I would say when we get to what we do, 
if there is noncompliance with the WTO, that is a topic that 
Sue Schwab, and a number of people in this administration are 
focused on, and I am interested in also.
    In terms of the kinds of things we are talking about here, 
which are currency and the path of reform, I believe that the 
path we have chosen is the way we will get the most results. If 
we do other things it could be--it is just my judgment this is 
the best way to go as opposed to getting into a situation where 
the Chinese get locked into defending their current policies.
    Senator Reed. How long will you let this process go 
forward, Mr. Secretary?
    Secretary Paulson. I will tell you something. I have 2 
years and you have me for 2 years being a very strong advocate 
of the policy that I think has the best chance of getting 
results over that 2-year period of time.
    Now, a lot of these issues are going to take much longer 
than 2 years to resolve when we talk about some of the 
fundamental reforms. But I will be very disappointed if we do 
not make some progress over this period.
    Senator Reed. Well, I think, Mr. Secretary, you bring 
extraordinary talent to this job, and dedication, but this 
seems to have been the constant refrain not only of yourself 
but your predecessors of the last at 6 years about, well, we 
talk to them, et cetera. And I think Senator Brown made an 
excellent case about the legal grounds we have to pursue, and 
if we do not pursue those grounds, I think the Chinese assume, 
as I would, as you would if you were, I think, in a similar 
position, that this is important to us but it is not the most 
important thing.
    Secretary Paulson. Senator, let me just make the one 
obvious point. What we are doing with the Strategic Economic 
Dialogue does not determine what legal grounds we are going to 
pursue with all of the other mechanisms we have in place. What 
we are doing here, in all due respect, is a different level of 
dialog, because being able to speak with one voice regularly to 
all the top decisionmakers--two major meetings a year, frequent 
smaller meetings, tracking progress--I argue is a different 
plan.
    Senator Reed. I appreciate your point, Mr. Secretary. You 
know, those of us who did support--and I think many here, if 
not all--admission of China to the WTO did so on the assumption 
that the rules would be available to the international 
community to use against China. That was the understanding the 
Chinese had when they entered the WTO. And yet we are very 
reluctant to use those rules. I will just make that point.
    Another point, a final point that you might comment on if 
you want, is that one of the problems I think we have is that 
our relationship with China is not strictly one dimensional in 
terms of the economy. And let's be realistic. I mean, we are 
asking the Chinese right now to be immensely helpful to us with 
respect to the North Koreans. We are asking them to be helpful 
to us with respect to the Iranians because they have great 
equities. And I get the sensation--again, you could comment or 
not--that many times when you take up these economic issues, 
particularly at the Presidential level, they are third, fourth, 
fifth, sixth on the list because when you talk about North 
Korea breaking out, testing nuclear weapons, when you talk 
about the Iranians doing the same thing or attempting to do the 
same thing, and China plays a critical role in the Security 
Council and just as a force in the world, that many times 
because of the strategic situation we find ourselves in--and I 
think some of that is the result of decisions that this 
administration has made--that we are sacrificing some of our 
economic--what is the right word? Our economic issues with 
respect to other issues.
    Secretary Paulson. Senator, the economic issues are very 
important to us. They are very important to China. Very, very 
important to China. And I do believe that we are going to get 
more leverage because we are no longer siloed. We are now 
coordinating what we are doing economically, and we are 
speaking with one voice. And I think that gives us great 
leverage.
    The other thing I would say to you is that rather than 
being a hindrance, I think that the stronger the economic 
relationships are between any two countries, the more shared 
interests they have, and the greater interest they have in 
peace, prosperity, the more harmful disruptions are. So, again, 
I really believe if the economic dialog is handled properly, it 
will not hurt any of the other dialogs, and, in fact, it will 
help it and will complement them.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator Reed.
    Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman. I want to express 
my view on free trade since we have gotten into that issue.
    This country practiced a lot of trade restrictions first in 
the 1900's, and it simply did not serve us well. When we look 
at those times when our economy was most depressed, that is 
when our trade balance was most favorable. So we had a more 
favorable trade balance during the Depression, and in the late 
1970's when we had the Misery Index, our trade balance was most 
favorable.
    Now, the last four Presidential administrations basically 
had a free trade policy, both Democrat and Republican, and it 
served this country well. I hope that we do not get ourselves 
in a position where we get into trade wars, because they are 
not going to serve our economy well. That is my view.
    Now, I have a State with big portions of its economy in 
agriculture and high-tech. In fact, we have the highest 
percentage of high-tech jobs in the country. It is not commonly 
known. Senator Bennett next door in Utah, also has a very 
prosperous high-tech industry. We rely on the Far East--China 
and Japan and others--to trade with because we have a lot of 
high-tech. I am curious to know your perspective. We have heard 
from the manufacturing aspect of the economy, and I agree with 
Senator Bennett. The loss of jobs in that sector has more to do 
with high-technology where we are more efficient, we get more 
done with less.
    So I would like to hear your comments on the agricultural 
industry and also the high-tech industry, because those are two 
very important aspects of the economy that I have in the State 
of Colorado.
    I would also point out that Colorado has benefited as much 
as any State on our trade agreements. I would just like to hear 
you talk a little bit about the high-tech and the agricultural 
aspect of the economy.
    Secretary Paulson. Well, let me say in terms of trade with 
China, you have hit two of the big areas where we export 
products: high-tech, medical devices, aircraft, and, of course, 
agriculture has been an important part of that trade.
    I wonder whether I might make, if you would allow me, a 
comment--you triggered something when you talked about the 
trade balance. If I could just take a minute and explain one 
thing that I think is important to understand, and this is not 
to say that the trade deficit with China is not too large, and 
it does not say we do not care about it a lot. But it is 
fascinating what happens. It is happening in Asia, because what 
happens as you look at production patterns, we have had sort of 
an integrated production system develop in Asia where China 
imports components and raw materials from this country also, 
but largely from other countries in Asia, and then they are the 
last point of assembly and so China is the exporter of record.
    But when you look at what has happened and going back to 
1999 to the present, what you see is that China's share of our 
trade deficit has gone up and the rest of Eastern Asia's has 
gone down. If you look at China and Asia together, their share 
of the trade deficit was 46 percent in 1999 and it was--excuse 
me, it was 53 percent in 1999 and 46 percent today, so it has 
gone down.
    It is really very dramatic in a number of products. For 
instance, if you look at footwear, big imports. In 1999, 9 
percent of our footwear imports came from China. In 2004, 70 
percent came from China. But if you looked at the rest of Asia, 
in 1999, 51 percent came from the rest of East Asia, and in 
2004 it was 1 percent.
    So you see what is going on, and then your point, Senator, 
on high-tech, if you look at China's trade deficit with the 
U.S., there is a Stanford study that showed that for every 
$1,000 of imports China made to the U.S., they were going out 
and they were paying $614 to import products or components from 
other countries. So there was a little bit more than $380 of 
value added for Chinese employees and manufacturers. But our 
exports, on the other hand, were high-value-added exports where 
there was $843. So this is not for me to say this is not 
important, because it is very important. We need to reduce that 
deficit. We need to open up the economy. But the reason I give 
that example is because it is very misleading to look at the 
trade deficit bilaterally. We need to focus on it with China, 
but we need to focus on it overall for the U.S. And we need to 
increase our exports, and we are getting some very positive 
growth both in our exports to China and globally.
    Senator Allard. Now, one area, if I could be critical of 
the administration, is when they put trade restrictions on 
lumber. Because they put high tariffs on lumber, the cost of 
lumbers goes up, and it impacts every American family. It 
impacts the price of our homes. For those people who are 
building new homes, it raises the cost of that home 
substantially. This leads me into the subject of the housing 
market. Senator Bunning and myself last fall had a joint 
Subcommittee hearing, Subcommittees of this Banking Committee, 
to examine the state of the housing market and its impact on 
the U.S. economy.
    Your report notes that the U.S. housing market has had 
international impacts. Now, I know the trade has had an impact 
on housing, but I am trying to figure out how U.S. housing has 
an international impact.
    Could you elaborate on that?
    Secretary Paulson. Well, I would just say I cannot tell you 
exactly what those who made that comment had in mind. I can 
just say to you that this was a significant correction in our 
housing market, a very, very significant correction. We were 
growing at an unsustainable level. And I think as the recent 
numbers have shown, we are making the transition to a more 
sustainable level of growth, and the economy is so strong and 
diverse that we are getting through it.
    But the U.S. economy is so important to the world and such 
an important engine for growth that anything that has a 
material impact on our growth has an international impact. I 
would say to you that when I would travel around the world and 
talk at G-7 meetings, meet with the G-7, with leaders at the 
World Bank meeting, international economists, and international 
Finance Ministers, one of the first questions they ask me is: 
What is going on in the housing market? Because they care a lot 
about our economy, and I think that is probably what they had 
in mind.
    Senator Allard. Thank you.
    Chairman Dodd. Thank you very much, Senator.
    Senator Shelby has a point he wanted to raise, and I have a 
closing comment, and then, Mr. Secretary, we are going to let 
you depart.
    Secretary Paulson. OK.
    Senator Shelby. Thank you, Chairman Dodd.
    Mr. Secretary, we all know that economies constantly 
change, and they do not remain static. They always have. But 
there is a lot of concern by all of us in America about the 
erosion of our manufacturing base, of jobs, good jobs. I 
alluded to it earlier dealing with the steel and foundry 
business, but this is just part of it. It not only affects a 
lot of the people in the Birmingham, Alabama, area but 
Pittsburgh, Cleveland, you name it. And I think that goes on.
    I think we have to concede the basics that trade is good. 
Trade should be fair. We are taught trade should be free. Free 
trade. Economics. That is a principle of economics. But I am 
not sure that it is, and that concerns me in a big way. And I 
see the erosion of the working middle class in America, as you 
do.
    Sure, we benefit from high-tech. We have a high-tech area 
in Huntsville, Alabama, big time. And we appreciate all that. 
But everybody--there are 300 million people--will not be 
involved in high-tech. We have benefited over the years in 
America with the manufacturing base, and I think we are losing 
that, and there has got to be a reason.
    I think we are competitive. This is a great economy. It is 
a great Nation. But, you know, if the roof is leaking, we 
better fix it. I think the roof is leaking as far as the 
imbalance of trade. It is just too much.
    We have talked about this before, and you have got 2 years 
left as the Treasury Secretary. You did not come down here to 
just be here. You came down here to make a difference. I know 
you and I believe that is why you are here.
    Do you believe--I know there is always hope. And I hope but 
I do not believe that there will be much change in our 
imbalance of trade with China 2 years from now. I think it will 
keep growing, the deficit will keep growing, to our detriment 
overall. And that is a real concern.
    I do not want to build walls around this country. That is 
the worst thing we could ever do. But we have got to do 
something. I don't know. Somebody asked about leverage. We know 
they are a sovereign nation. They are an important trading 
partner and an important nation in the world, and they have 
many facets--in fact, there are many facets of our 
relationship: trade, international diplomacy, and you name it.
    But do you really believe that 2 years from now when you 
will be gone as Secretary of the Treasury that there will be a 
balance of trade with China? Or will we be working toward a 
significant goal, I mean, progress, benchmark toward making 
that imbalance close to even, Mr. Secretary?
    Secretary Paulson. Senator, you ask the right questions, 
and I would say to you that I can think of very few big 
important issues that can be solved in 2 years' time. As I said 
in my testimony, currency flexibility is essential. We need it. 
China needs it. We need a currency whose value is determined in 
the competitive marketplace. But the primary driver of the 
trade imbalance with China has to do with structural issues 
that we have talked about today. And do I believe that those 
structural issues can be resolved in 2 years? No way.
    Senator Shelby. Well, at least----
    Secretary Paulson. But do I believe we can make progress 
and benchmarks to doing some things we can look at as progress 
along the way? Yes, I do. And if I did not think we could make 
progress, I would not be working as hard at it as I am.
    Senator Shelby. Thank you.
    Chairman Dodd. Mr. Secretary, thank you very much as well, 
and I am going to pick up on that point because I think you 
have--I was sitting here, and I was trying to imagine if I were 
listening to this or watching the hearing this morning, what I 
would come away with if I were a steelworker in Birmingham or 
that autoworker in Indiana or a small manufacturer in 
Connecticut. What do I get out of this?
    I am concerned that--and I appreciate your last statement. 
It is a strong statement, the very last response you made here. 
But if you look back over it, we have been through this so many 
times on this over the last number of years, and it is hard to 
find any consistency in this. Again, I am not talking about 
this was on your watch per se, but what has come before. I was 
looking back at what happened under George Bush 41's watch when 
these numbers were substantially less than the numbers we are 
talking about today, but that I presume make up the 
determination of intent. So you look at a bunch of these 
factors. It isn't you listen to someone give a speech about 
intent but, rather, what is the hard evidence that exists in 
this relationship that draws us to the conclusion that the 
intent is what you have suggested here today as opposed to 
being a different set of judgments.
    Obviously, in previous administrations they drew different 
conclusions, and it is hard today to wonder why we are not sort 
of following a similar set of conclusions given the multiples 
of the numbers that they relied upon to decide that not only 
China but Taiwan and I think it was--China, Korea, as well as 
Taiwan were all currency manipulators, going back to Bush 41's 
Presidency, the Treasury Department drawing its conclusions in 
1992. And I will not go into the numbers and so forth, but we 
have talked a lot about this already, the reserves and so 
forth.
    And so I am worried in a sense that we are not--if you are 
sitting here watching this, you would say it sounds like more 
of the same in a sense. What are we really going to be doing 
here? And you made a point earlier that I think we did not 
bring up enough here today that the lack of currency 
flexibility has not only been disadvantageous to China and 
certainly to us and the people who paid a price for it in this 
country, but China's neighbors in the Pacific Rim. It 
disadvantages them tremendously as they try to compete for 
markets and for services and goods.
    So the implications of China's actions I suggest certainly 
are bad for them in the long term, and not only bad for us in 
many ways because of what is occurring here, but also from a 
global perspective, this is having a huge negative impact.
    So I would like you to give some consideration, if you 
could, on this watch of yours. And I agree with you the 
likelihood we are going to dramatically change all of this in 2 
years is pretty small.
    But it seems to me on your watch we could maybe change--
maybe we ought to look at this law again. Are the criteria for 
intent--but we can get far more consistency out of this. We can 
set some real benchmarks. I think it is important that China 
understand what we care about and that we watch this carefully. 
We are a very attractive market to them. We are in a buyer's 
market in a sense. They want to be here. They want this 
relationship. That is our leverage point to a large extent.
    So how do we leverage that point to set up a good set of 
criteria that have a degree of predictability to it so that we 
can get the kind of responses that we would all like to have in 
a far more expeditious way than certainly has been the pattern 
over the last number of years? And I would invite your 
knowledge and expertise. What I said at the outset was not just 
a gratuitous comment. There are very few people I have ever met 
in Government in my 26 years who bring as much knowledge about 
this relationship as you do. And so you are a valuable asset in 
this moment of time we have here to figure out how to do a 
better job of this, because that person out there watching this 
hearing today is going to wonder if we are just going to be 
back here again next year or the year after with the same kind 
of conclusions, no one really wants to take this on, their jobs 
disappear, the problems get worse, the balances grow higher, 
and they wonder if there is going to ever be light at the end 
of the tunnel. And then the day arrives where we find ourselves 
behind the eight ball, and we wonder, What were we thinking of 
that we did not take stronger action, more clarity in our 
relationship with this country, with China, than we should have 
at the outset of the 21st century?
    So I raise that for you for a quick comment, if you would, 
about whether or not we might think about restructuring 
something here that gives us a higher degree of predictability.
    Secretary Paulson. Well, first of all, Mr. Chairman, I 
thank you very much for the opportunity to be here today. I 
thank you for your comment.
    To your specific question, I think one thing is clear. We 
all have the same goal. Clearly, we have got to----
    Chairman Dodd. We all agree with the same result, despite 
the language here.
    Secretary Paulson. Now the question is we say----
    Chairman Dodd. We also agree with the same conclusion today 
despite--they are still manipulating this currency.
    Secretary Paulson. Well----
    Chairman Dodd. I understand you have got a position and I--
--
    Secretary Paulson. Well, I would say we have got the same 
goal. We are talking about tactics as to how to get there. I 
think what you are saying is, what specific target do you put 
out there and, again, I am very open to talking to you about 
it, any option.
    I would just say to you that having thought about it very 
carefully, I don't think a specific target, a specific public 
target will help us make more progress, or I would have 
suggested that. I really do believe--and I know it is 
frustrating for some people, but I do believe we have come up 
with a plan in place that gives us the best chance of making 
progress. That could actually be true, and we could still be 
frustrated because we would like to see more progress.
    But I think we are going to get progress, but, again, I 
welcome continuing this conversation.
    Chairman Dodd. I thank you for that. And I would just add, 
having been in this body and on this Committee for 26 years, I 
have the same warning. Events are going to overtake, and all 
this other goes back, and my colleagues here--you listen to 
Senator Bunning. He is not alone in his comments here, and this 
is not about Republicans and Democrats. This is about people 
who go home every weekend in these times off, and we meet our 
constituents, and they are livid. They are livid, Mr. 
Secretary. And the Congress is not going to wait necessarily 
for us to get some sort of vague definition of how this is kind 
of progressing when they watch 3 million manufacturing jobs 
leave this country, when they watch a country that is investing 
heavily in armaments and not investing in its own people, and 
then complaining they cannot do this quickly enough because of 
their problems with unemployment insurance, and yet the tenfold 
increase in defense spending, people are going, ``What are you 
people thinking of up there?'' And you are going to get blown 
by with this problem if we do not get a better handle on this. 
And that is why this is important to recognize the moment is 
now to start to think this thing through so we don't have the 
inconsistencies in it.
    I thank you very much, and I apologize to our second panel. 
We will get to you right away. But this has been tremendously 
valuable. I hope you have enjoyed your first appearance here. 
[Laughter.]
    Secretary Paulson. Thank you. Thank you very much.
    Chairman Dodd. We hope you come back more often, and thank 
you very much for being here.
    We will move right to the second panel, if we can. Thank 
you, Mr. Secretary, very, very much.
    Let me introduce the second panel and thank my colleagues 
as well, on this very important hearing.
    As the Secretary and his team are leaving, I will do the 
introductions and people can make their way to the table here.
    The committee is very pleased with our second panel of 
witnesses: Richard Trumka, a good friend of mine. I must say we 
have known each other many, many years. Mr. Trumka is the 
Secretary-Treasurer of the AFL-CIO, a position he has held for 
10 years. Previously, he was the President of the United Mine 
Workers.
    In fact, I recall that you testified before this committee 
about 5 years ago on the very same subject. So we welcome you 
back. You know a lot about it.
    I am also delighted that we have Mr. Michael Campbell who 
is testifying today as both Vice Chairman of the National 
Association of Manufacturers, the NAM, and as President and CEO 
of Arch Chemicals. Politics is always local. It is nice to have 
a constituent here. Mr. Campbell thank you, and congratulations 
on your assumption of the presidency of the NAM, an 
organization we deal with quite frequently here, as well.
    I know that Mr. Campbell will be able to discuss these 
issues in great depth. We should note that he is going to be 
taking over from Chuck Bunch, who has served his 29-year term 
as the Chairman.
    Albert Keidel is a Senior Associate at the Carnegie 
Endowment for International Peace. Before joining the Carnegie 
in September 2004, Dr. Keidel served as the Deputy Director in 
the Office of East Asian Nations at the Treasury Department. 
That experience has provided him a very useful perspective on 
the subjects we have before us today. Doctor, we thank you for 
being with us.
    And Dr. Fred Bergsten, who is no stranger at all to this 
committee. We thank you for coming back. He is the Director of 
the Peterson Institute for International Economics. He has been 
a Director of the Peterson Institute for International 
Economics since its creation in 1981. He served as the 
Assistant Secretary of International Affairs at Treasury during 
the Carter Administration, and also testified before this 
committee and many other committees on this and related issues.
    We will ask you to submit your testimony in full, and I 
would like you, if you could, to try to keep your comments to 
five or 6 minutes. I am not going to hold you to that too 
tightly, but if you keep the idea in mind we can get through 
here. And I promise, all of your documents and supporting 
material that you think would be valuable to the record will be 
included in the record.
    Richard, we will begin with you.

   STATEMENT OF RICHARD TRUMKA, SECRETARY-TREASURER, AFL-CIO

    Mr. Trumka. Thank you, Mr. Chairman, members of the 
committee.
    I am delighted to have the opportunity to testify today on 
behalf of the 10 million working men and women of the AFL-CIO.
    I am also the co-chair of the China Currency Coalition.
    As you know, the issues you are discussing today go right 
to the heart of the economic challenges facing America's 
working families and our middle class.
    We, in the labor movement, feel a certain amount of urgency 
to develop and implement concrete solutions sooner rather than 
later. Unfortunately, it often appears that this Administration 
does not share our sense of urgency. We hope that Congress will 
step into the void left by the Administration's failure to act, 
and we welcome this hearing as a crucial first step in that 
direction.
    In December, the Treasury Department issued its 2006 Report 
to Congress on International Economic and Exchange Rate Policy. 
The report finds no currency manipulation on the part of any of 
our trading partners.
    Yet the same report also finds that China's current account 
surplus rose to around 8 percent of GDP in the first half of 
2006. That is a 500 percent increase since 2001. China's 
foreign exchange reserve reached $1 trillion in October. That 
is $200 billion more in 1 year. The U.S. trade deficit with 
China will reach about $230 billion in 2006. That is a 15 
percent increase in 1 year. And the Economic Policy Institute 
estimates that the growing bilateral deficit with China has 
displaced more than 1.5 million jobs.
    Now either there is something wrong with the criteria 
Treasury is using to determine currency manipulation, or there 
is something wrong with the Treasury Department's math.
    Josh Bivens and Rob Scott of the Economic Policy Institute 
laid out three very clear criteria for determining whether or 
not a country is manipulating its currency. First, does it have 
a high and rising bilateral trade surplus with the United 
States? Second, is the global current account surplus high and 
rising? Third, does it possess a high and rising accumulation 
of international reserves?
    Table 1 in my testimony compares China's current position 
to nine past instances when Treasury Department found that 
nations were manipulating the value of their currency vis-a-vis 
the dollar for competitive gain. On each front, the current 
position of China well exceeds the previous threshold that led 
to a finding of manipulation.
    Many respected academic experts have also weighed in on 
this issue. As you noted, the bipartisan U.S.-China Commission 
found that China's currency manipulation harms American 
competitiveness and is also a factor encouraging the relocation 
of U.S. manufacturing overseas while discouraging investments 
in U.S. exporting industries.
    Ben Bernanke, Chairman of the Federal Reserve wrote 
recently that China's undervalued currency provides an 
effective subsidy for Chinese firms that focus on exporting 
rather than producing for the domestic market.
    Mr. Chairman, Japan has also intervened aggressively and 
repeatedly in their currency markets to gain an unfair trade 
advantage, spending nearly $450 billion to keep the yen 
undervalued since the year 2000. That is according to the 
Automotive Trade Policy Council.
    And not only did the Treasury Department fail to cite Japan 
as a currency manipulator during that time but, according to 
John Taylor's recent book, Treasury officials implicitly 
sanctioned the Japanese interventions. We find that extremely 
troubling.
    I know the Treasury Secretary is no longer here, but we 
would like to ask Secretary Paulson and his staff exactly what 
it would take for Treasury to find that a country had, in fact, 
manipulated its currency. Perhaps more important, what it would 
take to move beyond yet another round of endless diplomacy and 
strategic dialog to concrete action and results.
    This is not an academic exercise for the union members that 
I represent. The difference between currency manipulation and 
market equilibrium exchange rate is the difference between 
having the job and watching your factory shut its gates. It is 
the difference between having health insurance for your kids or 
not having it. And for our country, it may be the difference 
between having a healthy middle class or sitting back and 
watching as economic divisions tear us apart.
    Giving the soaring U.S. trade deficit with China and the 
burgeoning Chinese foreign exchange reserves, we are bitterly 
disappointed that Treasury found no manipulation again this 
year, and we were underwhelmed by the announcement of the 
Strategic Economic Dialogue as a response to the global 
imbalances that the report did concede. On paper, the SED 
promises a forum for addressing critical economic issues and 
planning for long-term cooperation. The SED offers too little, 
too late.
    The proposed forum, dialog and cooperation are grossly 
inadequate given the magnitude of the economic problems that we 
face with respect to China. And the SED does not even begin to 
address a separate and equally serious economic concern, and 
that is the egregious and widespread repression of workers' 
rights in China.
    Violation of workers' rights is just as much an economic 
issue as currency manipulation, violation of intellectual 
property rights, or illegal subsidies. We estimate that 
hundreds of thousands of U.S. jobs are lost because the Chinese 
government brutally suppresses the rights of Chinese workers to 
form independent unions and bargain collectively for their fair 
share of the wealth that they create.
    I do not mean to sound cynical, but I am starting to feel 
like Bill Murray in the movie Groundhog Day. Every year, I come 
up and testify on the importance of these economic issues, the 
effect that they have on workers throughout this country. Every 
year the trade deficit worsens, more jobs are lost, and the 
economic pressure on workers and the middle class continues to 
grow. And every year, someone from the administration comes up 
here, agrees completely with everything that we say, responds 
with pledges of increased dialog, engagement and cooperation.
    Now my written testimony lists quote after quote from 
administrative officials over the last several years offering 
more meetings, more reports, more dialog. The time for talking 
is past. The Administration needs to move beyond consultation 
and dialog. The Congress cannot wait for this administration to 
act.
    We urge Congress to give immediate consideration to the 
Fair Currency Act, which we expect to be introduced shortly. I 
would like to thank Senator Bunning for his leadership in 
addressing this important issue. The Fair Currency Act is a 
crucial first step in addressing the urgent economic problems 
that we face today.
    The thing I would like to end with is I listened to the 
Secretary's testimony. And I listened to him say that he would 
do everything that he could to help that steel worker in 
Alabama that got laid off, the same people that I see every 
day. Or a coal miner somewhere, or an auto worker, or a teacher 
or anything else.
    And I would like to ask him if he is willing to take any 
action and use all of the tools? If taking every action he can 
to help them includes using all the tools at his disposal? That 
is what needs to be done, Mr. Chairman.
    Thank you.
    Chairman Dodd. Thank you very much, Richard. I appreciate 
very much your testimony and your caring of the issue, too. It 
has been very impressive over the years. And I could not agree 
more with you about running out of patience here, with these 
conversations about dialog and conversations.
    Mr. Campbell, welcome.

    STATEMENT OF MICHAEL CAMPBELL, VICE CHAIRMAN, NATIONAL 
                  ASSOCIATION OF MANUFACTURERS

    Mr. Campbell. Thank you, Mr. Chairman
    The National Association of Manufacturers seeks a positive 
and mutually productive trading relationship with China. 
China's emergence as a leading world economy has meant 
significant new opportunities for many of our members, 
including increased exports and investment opportunities.
    However, as we all know, China is also posing great 
challenges for other of our NAM members. Some of our members 
see prices of Chinese products so low, sometimes even lower 
than the cost of raw materials, that it becomes virtually 
impossible for them to see how they can compete. And others are 
seeing their customers move to China and cannot find new ones 
to replace them.
    NAM's concerns with China cover a range of issues, 
including protecting intellectual property rights, maintaining 
a currency value that reflects the strength of the Chinese 
economy, and ending prohibited trade subsidies.
    We are also concerned by a growing Chinese industrial 
policy that favors domestic producers, making it more difficult 
for foreign firms from the United States to participate in 
China's economy.
    On the issue of China's currency, manufacturers large and 
small are united. We may come from different points of view, 
but we have all agreed that the Chinese government needs to 
allow much greater flexibility in the valuation of their 
currency. Our goal is to see the currency moving closer to what 
a market value would likely be, with the eventual goal of a 
free-floating currency set by market forces.
    The need for the yuan to appreciate has been recognized by 
the International Monetary Fund, the World Bank, many finance 
ministers, most economists and, even recently, Chinese leaders. 
It is no longer a matter of if but when and how rapidly.
    But this matter of timing is very important as frustration 
is growing, evidenced by the last speaker, as it has negative 
effects on support for free trade if it does not contribute to 
a sense of fairness in global free trade. If we point out that 
the Chinese currency is undervalued, say they must do something 
about it. But if they do not, we cannot or will not respond. We 
must respond.
    I do note that there has been a 6.5 percent appreciation 
since July 2005, but that is not enough progress. More needs to 
be achieved. Without more progress, we risk seeing action that 
could do serious damage, not just to our bilateral relationship 
but also to our own economy, and the world's as well.
    Would a considerably stronger Chinese yuan have beneficial 
effects? Unmistakably yes. Yes for U.S. manufacturing, yes for 
adjusting global imbalances, and yes for the Chinese economy 
itself. Not infrequently, companies have told NAM staff that 
even a 15 percent shift could change their competitive 
situation dramatically.
    Much reference has been made to the Treasury's Report to 
Congress, and that report can play an important role in the 
process. NAM has consistently called on the Treasury Department 
to cite China for currency manipulation, as discussions have 
seemed to have borne very little fruit.
    NAM understands that citing a country for currency 
manipulation would not, in and of itself, compel change. But it 
would provide a strong and highly visible signal that the U.S. 
Government believes it important for the currency to move.
    Citation under the Report is also an important signal to 
the International Monetary Fund, as IMF officials have already 
noted that it would be incongruent for them to cite China for 
currency manipulation if the U.S. Treasury is not willing to do 
so.
    I will say that we did not criticize the Administration 
when the last Treasury report came out in December and was 
silent on China. Secretary Paulson asked for time to let the 
efforts made at the new Strategic Economic Dialogue work, and 
we agreed to support him in that effort. We will certainly be 
following progress on this issue and we will revisit it at mid-
year.
    The Strategic Economic Dialogue is, we believe, an 
excellent idea. We hope that the SED will help shift the 
balance from those within the Chinese government who feel that 
China must move more slowly on its currency to those who 
understand a more rapid appreciation is necessary to achieve 
both internal domestic goals as well as international goals.
    In September of last year Secretary Paulson addressed our 
board of directors and indicated that the Chinese currency 
issue was a top priority in the SED. At that meeting, the NAM 
board considered whether or not to support legislation that 
would make currency manipulation subject to U.S. countervailing 
duty laws. The majority of board members, after discussion, 
decided not to support the legislation.
    The board instead called for the creation of a board level 
U.S.-China Task Force to work with the Administration on SED 
issues, especially currency. I chair this task force with 
executives from large and small companies that span the whole 
spectrum of views on China's currency.
    We met with Secretaries Paulson and Gutierrez and U.S. 
Trade Representative Ambassador Schwab prior to their trip to 
Beijing for the first SED meeting. In our extensive meeting 
with Secretary Paulson, we made it very clear that 
manufacturers want to see significant progress in the 
appreciation of the yuan or we risked actions that could do 
serious damage with our bilateral relationship. We have seen 
some progress but we are looking for much, much more.
    In conclusion, I would like to point out that we, as 
American manufacturers, must take advantage of opportunities 
offered by the large and emerging market in China, as well as 
constantly improve our own competitiveness. However, it is 
important that there be confidence that our Government will 
insist on our trading partners living up to their commitments, 
including commitments regarding currency.
    I applaud the committee's interest in China's currency 
issue and in seeing that all major currencies are market 
determined.
    The NAM thanks you, Mr. Chairman, for holding this 
important hearing and we look forward to working closely with 
you and other members of the committee and your excellent 
staff.
    Thank you.
    Chairman Dodd. Thank you very much, Mr. Campbell. We 
appreciate your testimony very much and again, congratulations.
    Dr. Keidel, thank you.

    STATEMENT OF ALBERT KEIDEL, SENIOR ASSOCIATE, CARNEGIE 
               ENDOWMENT FOR INTERNATIONAL PEACE

    Mr. Keidel. Thank you, Mr. Chairman, and thanks for the 
opportunity to testify.
    In my comments today on the Treasury Department's currency 
report, I want to pull out and amplify some of its findings, 
especially the muted criticism of Germany and Japan. At the 
same time, I want to question and criticize other of the 
report's findings, especially its characterization of China.
    I also want to emphasize how important the Treasury 
Department's new dialog with China could be for American 
competitiveness. But if the dialog is going to play this 
important role, we have to use it wisely and avoid squandering 
its potential.
    Let me start with the Treasury report's coverage of global 
imbalances. The key statistic here is trade in goods and 
services, not the current account balance which the report 
uses. As a share of the U.S. trade deficit, global trade 
surpluses by Germany, Japan, and the rest of non-China Asia 
have been large for many years, continue to be large. In 
contrast, until 2 years ago, China's trade surplus was quite 
small. I will come back to China in a minute.
    In this score, let me give you what I call a user's warning 
alert. When the U.S. Commerce Department reports each month how 
big the U.S. trade deficit is and says which countries make up 
what share of that deficit, you should ignore the latter part 
of that information. It is meaningless. A country could have a 
surplus with the United States and a deficit with the rest of 
the world.
    The bilateral two-way balance for the U.S. says nothing by 
itself about how much a country contributes to our deficit. 
This is especially true of China, which processes and 
repackages exports from other countries for final shipment to 
the U.S.
    America has a large deficit with a global supply chain. 
Other countries have surpluses with the global supply chain. If 
we look at which rich countries are running large, long-term 
surpluses with the global supply chain, the list includes 
Germany, Japan, and other non-China Asian countries.
    Let me point out a second lesson on the U.S. trade deficit. 
We may think it is a problem. But the U.S. trade deficit is 
essential for the global economy. Poor countries need markets 
so that they can develop and become eventually markets for the 
U.S. exports. America wants to promote healthy growth, but not 
with foreign aid and not with subsidized loans, but with trade. 
Somebody has to buy their products. America plays that role in 
the world.
    Other major industrialized countries are not helping, 
especially Germany and Japan. Germany and Japan, to put it not 
too politely, are slackers. Instead of running modest deficits 
and sharing the burden with America, Germany and Japan are 
feeding off our deficit themselves. They should not need to do 
that. They have per capita GDP 20 times China.
    We need to pressure them to get with the program. They 
should spur their own domestic demand, especially consumption. 
This is an important message, and it is one stressed in the 
Treasury report. But the report's position is kind of muffled. 
It is polite. I do not think it should be so muffled or polite.
    People say but Germany and Japan have foreign exchange 
markets. Their currencies must be at the right levels. This 
misses the point. Exchange rates will not fix this problem. 
Germany and Japan run surpluses because they have structured 
their economies and their finances to save rather than consume. 
Exchange rates will not fix this. Germany and Japan need to 
change this structures and America needs to strongly encourage 
them to do so.
    Yes, I know, Germany and Japan host our troops and military 
bases on their soil. But that should not be a Treasury report 
concern. From the prospective of global economic leadership, 
Germany and Japan are, as I say, slackers and have been for a 
long time.
    Now let us turn to China. Until 2 years ago, China's global 
surplus was 8 percent of America's deficit. Only 8 percent. The 
Netherlands had the same surplus size. The European currency 
areas, the euro area surplus that year was 27 percent of the 
U.S. deficit. And non-China Asia had an even larger surplus.
    China's surplus was only 8 percent then. In 2005-2006, yes, 
its surplus jumped. What happened? It is not an exchange rate 
shift. China, over the last 5 years, has joined the WTO, a 
wrenching change to its trade relations with the world that has 
nothing to do with its exchange rate.
    And then the multi-fiber agreement ended. In the short 
term, the repercussions of these changes are certain to be 
unstable, and they have been. These are huge adjustments 
compared to any exchange rate effect.
    China's global surplus really took off with the domestic 
credit tightening that slowed imports in 2004-2005 to let them 
grow less quickly. In 2005, China's surplus was slightly less 
than Germany's 17 percent instead of Germany's 20 percent.
    In the first half of last year, 2006, China's surplus was 
slightly more than Germany's, 20 percent instead of 19 percent. 
This change over two short years did not reflect a sudden shift 
in China's exchange rate. At this preliminary state in China's 
WTO adjustments, so many parameters are changing so fast that I 
think it would be foolish to insist that they are caused by 
exchange rates.
    Let me repeat that point. China's global trade surplus has 
grown suddenly larger, putting it on a par with Germany's, but 
not because of exchange rate shifting.
    Will China's WTO accession process eventually shake out to 
a more balanced trade pattern? We have to wait and see. WTO 
requirements that China open more to imports, for example by 
enabling foreign retail branches, have not really matured. They 
came online with a delay, with a lag. If we want to pressure 
China, this is the place to do it, on our exports' access to 
the Chinese market, not the exchange rate.
    I have a second quick warning. Do not look at China's 
foreign exchange reserves for evidence of exchange rate 
manipulation. There is a speculation game going on out there 
and the U.S. Congress may be an unwitting participant. When a 
speculator hears the U.S. Government criticism of China's 
reserve levels, they are encouraged to think America will force 
China to revalue, so they speculate more. And China's reserves 
go up as a result. And then there is more criticism and then 
more speculative floats. And then higher reserves, and so on.
    This all could have a bad ending for the speculators, but 
it is not a sign of exchange rate manipulation.
    My most important point for this hearing is that China is a 
legitimate commercial competitor. Its success does not rely on 
currency manipulation. And China will continue to be a 
legitimate commercial competitor. America's strategy has to be 
focused here at home. Strengthen our own fundamental 
competitiveness, education, labor force mobility, pension 
mobility, health care, and safe cities as attractive places to 
work so we can compete in the global market for technical and 
managerial talent. Visa reform would help.
    Instead, if we pretend that our problems are because 
China's exchange rate or China's banking system or China's low 
wages, that is like sticking our heads in the sand.
    Treasury's China dialog is a chance to move away from this 
misperception of our challenge. It is a terrific opportunity, 
and I was in Treasury when we worked on this. We tried long and 
hard to elevate our access to Chinese leaders, and we 
mistargeted. Now we have succeeded. Let's use it well. It has 
taken many years. Let's not waste it on what I consider to be 
dead end, feel good distractions like exchange rates.
    Thank you, sir.
    Chairman Dodd. Thank you very much, Doctor.
    Mr. Bergsten.

 STATEMENT OF FRED BERGSTEN, DIRECTOR, PETERSON INSTITUTE FOR 
                    INTERNATIONAL ECONOMICS

    Mr. Bergsten. Mr. Chairman, my written statement tries to 
provide a succinct but comprehensive statement of the current 
account problem and China's role in it. The bottom line is the 
problem is even worse than you have been describing today. And 
I just mention two points.
    Because of our huge current account deficit and our own 
foreign investments, the United States now has to attract $8 
billion of foreign capital inflow every working day to keep our 
economy afloat. If we do not get $8 billion of happy foreign 
investment coming in every working day, we will see our 
interest rates shoot up, our equity and housing markets tank, 
and the economy could even go into recession, depending on how 
rapidly it happens.
    So the problem is huge. I am talking our global current 
account deficit. I regard it as the single biggest threat to 
the prosperity and stability of the American economy because if 
that $8 billion dropped to only $4 billion or $5 billion a day 
huge as that would still be, we could go into a dollar collapse 
which would cause significant adverse effects to our economy.
    Second, the role of China. I agree with Dr. Keidel that we 
should not focus on bilateral imbalances. But the truth is the 
global imbalances tell the exact same story. China is now 
running a global current account surplus in excess of $250 
billion per year. It has risen in an almost vertical line for 
the last 5 years. It is now exceeding 10 percent of China's own 
GDP. It has accounted for between a quarter and a third of all 
China's growth over the last several years.
    In short, the global pattern with China's massive and 
rapidly soaring surplus tells the same story as the bilateral 
imbalance. So in this case, the message is the same.
    I want to mention two or three analytical points that came 
up in the discussion and then spend most of my time answering 
your frustrations and the issue of what to do about it. Just 
two or three quick analytical points.
    Several people, including the Secretary have said the 
renminbi at least has gone up 5 or 6 percent over the last 18 
months. Yes, but no. It has gone up 5 or 6 percent against the 
dollar. But the fact that the Chinese still essentially peg to 
the dollar, and the fact that the dollar has gone down against 
everything else, means that the average exchange rate of the 
renminbi has not gone up a whit.
    The stunning conclusion, in fact, is that the average 
exchange rate of the Chinese currency is weaker today than it 
was in 2001, when their current account surplus was 1 percent 
of their GDP, and today it is 10 percent. That increasing 
undervaluation of the renminbi is indeed a major factor why 
their trading surplus and current account surplus has soared.
    Second, a very important distinction has to be made among 
the terms that are used as to what we want from the Chinese. 
The Secretary and many of you have used the term greater 
flexibility and then gone on to say in a second stage we want a 
freely floating currency.
    He is right to say that in the short run they cannot float 
freely, for reasons of weakness of their financial market. But 
the key thing to us should not be a more flexible renminbi. It 
should be a stronger renminbi. What we want, at least in the 
short run, is not for them to go to a more flexible currency. 
They are going to manage their currency. There is no doubt that 
they are going to manage it day to day, minute to minute, 
whatever they call their regime.
    What matters to us is the price of their currency. It 
should be much stronger. Our estimates are that to eliminate 
China's surplus, which they have said is their goal, would 
require a revaluation of about 20 percent in the trade weighted 
average of the renminbi which, as I said, is flat over the last 
6 years. And that would imply a rise of about 40 percent 
against the dollar. Because if the Chinese currency goes up, 
other Asian currencies will go up with it. Their average will 
not rise as much as all of their currency values against the 
dollar.
    But the key thing is that what counts to us is the price 
relationship between the Chinese currency and ours. Better if 
they did it in a one-step revaluation.
    Now they will not go 20 or 40 percent overnight, but they 
could do it in a series of step level moves, like the 2 percent 
they did in the summer of 2005, only much bigger. It is very 
important to keep in mind what we want.
    When we say to the Chinese we want a more flexible 
currency, it is easy for them to say well, the forums are 
asking us for a floating exchange rate, we cannot do that. And 
they are correct. So we have to be very clear on that point.
    The third thing I want to mention is the Secretary's 
comment that what really is at stake here is the structural 
underlying feature of the Chinese economy. He is right, of 
course. We want to see better capital markets, improved 
economic reform across a wide range of issues in China.
    But make no mistake. The reason the exchange rate is so 
weak is massive, blatant intervention, $15 billion to $20 
billion per month over the last 3 years, as documented in the 
Treasury's own report. That is very clearly what is holding the 
renminbi down. Any other currency in the world, with that kind 
of capital inflow, would have already risen probably the 20 
percent or more that we need. It is blatant intervention, call 
it manipulation, which is in fact the source of the huge 
currency imbalance.
    Finally, everyone has expressed frustration, including the 
Secretary, including all of you, including all of us who watch 
this closely and have worked on it a lot. And your question, 
quite rightly, is what to do about it. On pages eight to the 
end of my statement, I suggest a five-part strategy.
    First, the Treasury should tell the Chinese quietly that 
they will be designated a manipulator in the next report unless 
they make a significant down payment on the needed rise in the 
value of their currency. I would suggest 10 to 15 percent. This 
should be done before the next SED in May and before the next 
Treasury report in May or June.
    But I would go to the Chinese and tell them very quietly, 
privately, that I am going to have to designate you unless you 
begin to play by the rules of the game. That, I think, would 
give the Chinese then a chance to take the requisite action 
without losing face, without seeming to capitulate to the 
foreign pressure, et cetera, et cetera. So I would do it that 
way.
    Now, if they do not comply, then of course China should be 
labeled a manipulator. You have said it, Mr. Chairman, Senator 
Shelby, you have all said it. It is a manipulation. If it walks 
like a duck, call it a duck. The Chinese should be indicated on 
it.
    Incidentally, I was struck that Secretary Paulson said I am 
negotiating the currency issue with the Chinese anyway. And the 
implication was so why designate them, which requires a 
negotiation? I guess I would reach the opposite conclusion. If 
he is negotiating with them anyway over currency, as he 
obviously is, why not tell the truth, indicate that they are 
manipulating, strengthen his position by having put out on the 
table the facts and the reality, be in league with this 
committee and the Congress instead of fighting them politely 
but still on opposite sides. If he is negotiating anyway, why 
not say they are manipulating and the law calls for a 
negotiation.
    I do not see how it can hurt his negotiating position. I 
can only believe it would help it.
    But my point one is go to them quietly, tell them you are 
going to have to do it. You cannot defend them anymore for 
their indefensible practices against this committee or the 
Congress more broadly, or the public. Please take action and I 
can stay on your side.
    Second, the Administration should also tell the IMF and its 
other G-7 partners that it is going to label China a 
manipulator next time around and escalate this issue. That, I 
think, would significantly improve the support that we would 
get from the IMF and from the G-7 and other key countries.
    The Secretary failed to mention something I think is very 
important. There are IMF rules. He stressed the WTO rules. 
There are IMF rules against competitive currency 
undervaluation, against manipulation. The criteria are stated 
very clearly: a country shall not conduct large-scale, 
protracted, one-way intervention of currency markets. The 
Chinese have violated all three.
    Now those IMF rules have not been implemented with great 
force in the past. They have on some occasion. They should be 
done again. My point is, mobilize multilateral support.
    Third, and very quickly, we should also go multilateral to 
the WTO. My Institute has published an analysis of the proposed 
subsidy case against currency undervaluation. It is uncharted 
terrain. We are not sure it would win. We might even lose. But 
we should certainly pursue the case. We should make every 
effort to pursue the multilateral approaches on both finance 
through the IMF and on trade through the WTO to try to resolve 
the issue in the most cooperative multilateral way possible.
    And then finally, if none of that works, you could say 
well, what should we do? There are certainly a couple of things 
we can do. One is on finance itself. The Treasury has the right 
and all the ammunition necessary to enter the foreign currency 
markets itself and buy the foreign currency that needs to rise 
in value. We did it at the Plaza. We did it on the yen, as 
recently as 1998. We have always in the past done it in 
cooperation with the other country, and we certainly seek their 
agreement to do it.
    But the Treasury has huge amounts of resources with which 
it could do that. Nobody could say it is protectionist. The 
Chinese are buying hundreds of billions of dollars of our 
currency to keep theirs from rising in value. If we bought a 
little tiny amount to try to push it in the other direction and 
to approximate a market outcome no one could say it is 
protectionist. So I think we ought to pursue that approach, if 
all else fails.
    Then finally, as somebody said in the last discussion, the 
ultimate U.S. leverage is Chinese access to our market. I would 
hate to see us go down the road from blocking that, but 
frankly, I think this issue is so important that we might come 
to that if all else fails. And there, the Congress might have 
to take the bit in its mouth.
    Thank you very much.
    Chairman Dodd. Thank you very much. Thank all of you. 
Appreciate your cooperation.
    Senator Schumer was tied up in chairing the Joint Economic 
Committee and has a strong interest in this subject and will 
have some questions, I think, for several of you here.
    Let me pick up on Dr. Bergsten's recommendations here. I 
guess we could call it a Plaza II, or an Asian Plaza, the 
proposal here. Would any of you like to comment on the 
suggestions and recommendations that Dr. Bergsten made?
    Richard, you talked about taking some action and moving 
beyond this. I do not know if you had a chance to look at Dr. 
Bergsten's testimony, but do you have any reaction to it?
    Mr. Trumka. I have not had a chance to look at it 
carefully, but anything that has a chance of working I think we 
ought to do it simultaneously. What we have been doing is doing 
nothing but dialog. When I collectively bargain, I look at all 
the leverage I have and I employ several different avenues at 
the same time, hoping to get an agreement before you have to 
use the ultimate weapon, which in our case is labor. As a 
result, I like a lot of the things he said. We would agree with 
all of that.
    But we also ought to be taking other action to let them 
know that we are willing to go forward because--I think you 
mentioned it, Mr. Chairman, early on--by our continuous talking 
to them, our continuous idle threats at them and then taking no 
action, they look at us like a paper tiger right now. I think 
this is a country that understands and reads what you say and 
interprets it about what you are going to do, and they do not 
think we are serious right now.
    If we have not called them a manipulator over the last 3 
years, I would like to see what a manipulator is. Because 
everybody on the face of the earth that looks at it knows that 
they are manipulating their currency.
    Chairman Dodd. Dr. Trumka, I meant to ask--I read your 
testimony and the question is, what would constitute 
manipulation? It is a good question to ask the Treasury in a 
hypothetical--I really do not like hypotheticals, but what sort 
of thing should we be looking to as an indication of whether or 
not this is occurring?
    Mr. Campbell, you talked about this. I raised it but you 
have raised it as well, and that is the credibility. Beyond 
everything else--and Richard Trumka just talked about the sense 
here. So talk about that point of view, because that just 
becomes just a very major point, not just in terms of your 
bilateral relationship with China, but others around the world, 
it seems to me as well. The United States has got to be--I am 
not looking for purity on this point, but that consistency 
where your credibility becomes eroded and it has a ripple 
effect with so many other things you engage in.
    Dr. Keidel, I am going to ask you to respond as well on 
that point of whether or not--I know you do not want the 
emphasis on this point. I heard your testimony. But to what 
extent, because this is the subject matter and so to what 
extent are you concerned at all about the credibility of the 
United States in these efforts that we make around the world as 
a result of what looks like inconsistent reactions here from 
administration to administration?
    Mr. Campbell. I would agree that it does call into question 
our credibility around the world. But I also believe that it 
calls into question our credibility right here in the United 
States, because your constituents, your members, my members, if 
they do not see action, if they do not see progress on this--as 
I said in my statement, we say we believe in free trade. We 
believe that China is manipulating its currency which is 
causing an unlevel playing field. We ask them to stop. They do 
not stop, and we do not do anything as we get to the end of 
that process.
    That destroys our credibility both globally but also here 
in the United States. My concern is that it will precipitate a 
frustrated reaction that will be very harmful, not just to the 
bilateral relationship but to global trade patterns generally.
    Chairman Dodd. Would you, by the way, before I ask Dr. 
Keidel to respond to that question as well, would you respond 
to Dr. Bergsten's suggestions from the NAM's perspective?
    Mr. Campbell. Yes. I have not had a chance to read them but 
I will read them with great interest. I will say that his first 
suggestion, which to me is just using whatever leverage we can 
to try to convince the Chinese that we are serious and they 
need to take action, and that is to quietly tell them that we 
will designate them a manipulator if we do not see significant 
progress before the SED in May. I think that that is a very 
credible suggestion.
    His second and third suggestions basically were to approach 
this problem in a more multilateral fashion, involving the G-7 
and involving the IMF. We too agree that more can be done by 
bringing in Europe, Japan, the International Monetary Fund to 
help us on this problem.
    His other suggestions about going into the marketplace and 
buying the RMB is something I would not like to comment on. We 
believe very much in market forces. The Government going in 
there and playing in that market causes me some concerns, but I 
would like an opportunity to study it.
    Chairman Dodd. Yes, and the point that he raised as well on 
this, instead of focusing all our efforts on the exchange rate 
policy, let us talk about price. That is a different approach 
on this. That is really what we are talking about here is 
price.
    Mr. Campbell. Yes.
    Chairman Dodd. In trading, they can play that game but 
there is always that, market forces ought to work now and I 
will give you 10 percent NOW and fool around with it next time. 
So I hear what you are saying. I like it in the short term, but 
it worries me in the longer term that you are letting them off 
the hook on the larger question.
    Do you have any comment on that?
    Mr. Campbell. Yes. I think that you are correct in that and 
that, as I say, I think playing a harder ballgame with them is 
what is important, and getting them to understand the benefits 
to their own economy from making this change. It is not that we 
are asking them to put themselves into disadvantage in the long 
term. We are asking them to advantage their economy, our 
economy and global trade in general. I think that that is what 
the focus of the discussions have been and have to continue to 
be.
    Chairman Dodd. Dr. Keidel, if you would just respond to 
those points. I raised the issue of the defense issue, the 
tenfold increase in defense spending at the expense of a lot of 
other things that they could be doing to help their own people, 
and does that concern you at all? The fact that what we are 
talking about here is basically subsidizing the ability of the 
Chinese to be able to have an economy that allows them to 
invest that multiple in increasing defense.
    Mr. Keidel. Thank you very much. Let me just quickly reply 
to Dr. Bergsten's comments and then answer your questions.
    First, as to the strength of the U.S., I would emphasize, 
the U.S. Federal Reserve System is more than robust enough to 
deal with the needs of the American economy and where interest 
rates will go in terms of reacting to the U.S. capital source.
    I would emphasize using trade in goods and services. Dr. 
Bergsten continues to stress capital--the current account 
balance. The current account balance in China's case is use to 
longer--a lot of capital inflows, so you get a much bigger 
picture.
    But my point is still the same. If you look at the global 
picture it has changed only in the last 2 years, and that is 
part of a huge instability in China's non-price, non-exchange 
rate system, and non-tariff barriers, which are clearly 
changing in the other direction as well. So we need to look at 
how that shakes out.
    On IMF rules, I have heard that before. If you read those 
IMF rules very carefully about sustained, long term 
manipulation or intervention, that is not a criterion for 
saying that a country is manipulating its currency. That is a 
sign that you might want to look to see what a country is 
manipulating its currency or not. It is a different point. It 
says, if there is a long term intervention, go take a look. But 
you do not use that to decide whether a country is manipulating 
or not. So the Treasury report is right on the mark in how it 
is using the economics of this whole issue to decide what is 
right and what is not right for China.
    In terms of buying the RMB and a market focus, I think that 
would not begin to work. The Chinese are sterilizing because 
they need stability. They could just sterilize whatever we 
wanted to do about it. And besides, we really do not yet have 
access to that market. It is not a real currency market at all. 
So I think that is dead on arrival.
    I would also comment on something the Secretary said about 
four steps to getting to what we want, to allow the currency to 
be market based. He omitted one. He omitted an important fifth 
one, which is opening their short term capital accounts. China 
now regulates its short term capital flows dramatically. 
Without those free flows we do not have a market test. The 
pressures for appreciation now are false indicators of where 
that currency would go in a truly free market environment.
    So we really need to be careful--those five steps, and I 
emphasize the fifth one in particular, we need to be very 
careful how we evaluate whether the exchange rate itself is 
really what is going on here.
    What is a manipulator? A clear case of manipulation is that 
you have a dual exchange rate. You provide one exchange for 
some companies and some ministries, and you provide a different 
one for another. That is what China had before 1994, and that 
is when the Treasury rightly cited it for manipulating its 
currency. China unified its currency in 1994 and it has been 
unified ever since, and the IMF rules make a peg on legitimate 
currency. So we need to look at that. Yes, there can be 
manipulation, but the kind of thing that China is doing now is 
not one.
    I would also comment on idea that markets here--that 
exchange rates can really determine the trade flows. That is 
like walking into a hospital and telling a doctor that the only 
thing he needs to cure about an immune system is white blood 
cell count. It is much more complicated than that. So to say 
that it is only currency, it is kind of like the Maine 
fisherman who when he eats sausage says, smells good, taste 
good, but once you clean it, there ain't nothing to it. It is 
much more complicated and a much more powerful force is in play 
than the exchange rate in determining the trade balance.
    The credibility of the U.S. hinges just on this point. 
People around the world know what really is functioning here. 
It is structural shifts, structural changes. They look at the 
United States and see us focusing on the exchange rate and we 
lose credibility. We certainly lose it with the Chinese.
    When we talk about what would be good for the Chinese 
economy, we lose credibility if we tell them they just need to 
privatize their banks, they need to open up their whole 
exchange rate system.
    That is the kind of thing that caused the Asian financial 
crisis. South Korea and Thailand opened their short term 
capital accounts prematurely, and eventually those foreign 
loans at loan interest rates look pretty good because they do 
not have foreign exchange risk premium on them. And when they 
start going south you do not have the regulatory capacity to 
keep people from making those bad decisions. You are in 
trouble. China does not want to go there.
    So the credibility issue for us is to deal with this issue 
in a balanced, complex way that does justice to the phenomenon 
that we are facing. The benefits to the Chinese economy, the 
financial sector, I have mentioned, to their money supply. Fred 
raises this point very well. We talk about--Dr. Bergsten, 
excuse me--the idea about flexibility as opposed to 
appreciation. Why do we do that? Because any really serious or 
most really serious economists are very leery of saying where a 
currency should be. That is really tough. And the Treasury 
report has an appendix that points out just exactly why that is 
a very dicey thing to try to do.
    All economists, all good economists agree that if you are 
going to open your capital account and have a fixed exchange 
rate, you are in trouble. So if you open your capital account, 
you better get flexibility. So we are all very comfortable 
saying, China ought to have flexibility, because it deals with 
capital account. It is not dealing with trade. It is not the 
appreciation issue, but it sounds like it. It sounds good. If 
you can get through a briefing, you can get through a hearing, 
but why they are--they keep their union card, if you will 
excuse the expression, as an economist is by talking about 
flexibility, not about appreciation.
    On defense spending, my organization, the Carnegie 
Endowment, is holding a debate here next week on PLA 
modernization, the People's Liberation Army modernization--a 
debate. We have two people from different sides of the 
respectable, sort of credible, view on whether PLA 
modernization is a threat to the U.S. So I invite all of you to 
come and hear that.
    But the notion that China's defense spending has gone up 
ten-fold, we are talking about percentage increases from a 
small number. When you consider how Chinese defense spending 
and its commitment to defense really declined and suffered 
throughout a lot of the 1980's and early 1990's, then you know 
that their defense spending as a share of GDP, and in 
particular as a share of our spending, not to mention the 
accumulated military firepower or force projection capability 
that the U.S. because of its aircraft carrier task forces, 
which were not built in a year, because of its basing 
agreements around the world, then this notion that China has 
suddenly increased its defense spending would be put in 
perspective.
    So those are my quick answers. Some of it is done in more 
detail in my written statement.
    Chairman Dodd. Thank you all very, very much. As I said, 
there may be some submitted questions on the part of the panel.
    Let me turn to Senator Shelby. I want to make sure I give 
my colleague a chance----
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Campbell, you represent the National Association of 
Manufacturers. You represent so many of the big manufacturers 
in this country who provide a lot of industrial jobs. Have you 
in your last 20 or 30 years of economic history, seen anywhere 
before recently, the erosion of jobs like we have seen in the 
industrial base in the last say 10 years?
    Mr. Campbell. Senator, I do not want to minimize the loss 
of manufacturing jobs because I too understand that these are 
very good, well-paying jobs that provide great stability to us 
economically and socially. But you have to look at also some of 
the other factors going on. Productivity is one of the biggest 
issues. The average labor cost for an output of manufactured 
goods today is below 10 percent. That is an extraordinary 
testament to the productivity of American manufacturing.
    The erosion of jobs is not so much a function of what has 
happened with China as it is a reduction in our ability to 
export, because our export profile has not been as robust as it 
needs to be.
    Senator Shelby. Why?
    Mr. Campbell. There are a variety of factors. For example, 
the cost of energy and the availability of natural gas has 
profoundly affected the chemical industry, which is the 
industry that I am from. That has caused us to shut plants here 
in the United States and relocate them to areas where energy 
costs are less and natural gas is more readily available.
    Senator Shelby. Will that have an impact on fertilizer?
    Mr. Campbell. Yes, it will. That is why we were so pleased 
that Congress did pass legislation in the last Congress 
regarding exploration in the outer continental shelf to get us 
greater access to natural gas.
    So it is a very broad set of policies that have to be 
looked at in regard to manufacturing, not just the imbalance of 
trade with China. We have got to get our energy----
    Senator Shelby. You cannot blame it on one thing.
    Mr. Campbell. No, sir; it is too complex.
    Senator Shelby. But trade has got to have something to do 
with it.
    Mr. Campbell. It does. It absolutely does. But it is a 
very, very complex situation.
    Senator Shelby. Dr. Bergsten, if we go along like we are 
doing and we continue to have these trade imbalances with China 
and others, the current account, nothing happens, not in 2 
years, 4 years, 5 years, what is that going to do to our 
economy?
    Mr. Bergsten. It will do three or four things. One is that 
our foreign debt will continue to pile up. It is already in 
excess of $3 trillion and it is rising rapidly. We have to 
service that debt. More and more of our national income will be 
paid to foreigners. We will be a poorer country.
    Senator Shelby. That means an erosion in our standard of 
living.
    Mr. Bergsten. Exactly. Our national income will be lower 
than it otherwise would be.
    Second, the eventual adjustment will have to come because 
we cannot keep borrowing $8 billion a day, the nine, then ten. 
And even if it is a gradual adjustment, the higher base from 
which it comes means the more we have to cut back on our 
domestic spending in order to make room to improve that.
    Third, and in a way most critical, we are bound to run into 
a crisis. We are already way beyond the typical crisis 
threshold. The U.S. current account deficit now is more than 
double the previous record back in the middle of 1980, after 
which the dollar dropped 50 percent in the next 3 years. No one 
can say exactly when it will happen or what will trigger it, 
but unless all economic history is repealed, as long as we stay 
on this path, the numbers keep rising, the foreign financing 
requirement continues to grow, the net foreign debt continues 
to soar, there will be a crisis.
    Finally--and this is a point that came up actually from Mr. 
Campbell--erosion of our ability to maintain an open trade 
policy. I am a very strong supporter of free trade, as all of 
you know. My studies over 40 years suggest that the most 
erosive element in being able to maintain an open trade policy 
in this country is when we run a hugely overvalued currency and 
a massive deficit, because then the domestic politics of trade 
policy shifts dramatically. As Mr. Campbell said, it would be 
hard for the NAM to keep supporting free trade measures if the 
deficit keeps soaring and they are priced out of their national 
competition by a misaligned currency.
    So unless we bring that back into trade, there is no way I 
think we are going to be able to maintain an open trade policy. 
So the cost will be huge if we do not really get at it.
    Senator Shelby. Irreparable damage.
    Mr. Bergsten. Irreparable damage, even potential crises, 
with pervasive effects on the global financial and trade 
systems as well as on our own economy; yes, sir.
    Senator Shelby. Senator Dodd, I have a number of questions 
for this panel that I would like to submit for the record.
    Chairman Dodd. Absolutely, we will do that.
    We have kept you a long time and I apologize. But it is 
tremendously valuable to have your testimony. You are very 
knowledgeable and I am very impressed at how much knowledge you 
bring to a complex subject that we all recognize and are aware 
of that. But clarity on this subject matter is something that 
people are screaming for.
    To make your point again, Richard, people are out there 
paying a price and are very worried about what the future means 
to this country if we do not begin to do something about it.
    So we thank you very, very much, all of you, for being 
here. I thank Senator Shelby and the other members of the 
Committee.
    This Committee will stand adjourned until further call of 
the chair.
    [Whereupon, at 1:15 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follows:]

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