```

[Senate Hearing 109-505]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 109-505

 
                       THE REPORT TO THE CONGRESS
                       ON INTERNATIONAL ECONOMIC
                       AND EXCHANGE RATE POLICIES

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

                                HEARING

                               before the

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

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINATION OF THE REPORT TO CONGRESS ON INTERNATIONAL ECONOMIC AND 
 EXCHANGE RATE POLICIES, FOCUSING ON IMBALANCES IN THE GLOBAL ECONOMY, 
                      AND CHINA'S CURRENCY REGIME

                               __________

                              MAY 26, 2005

                               __________

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

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

                                 ______

                    U.S. GOVERNMENT PRINTING OFFICE
28-972                      WASHINGTON : 2006
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512�091800  
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001

            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

               Peggy R. Kuhn, Senior Financial Economist

                Skip Fischer, Senior Staff Professional

              Stephen R. Kroll, Democratic Special Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                         THURSDAY, MAY 26, 2005

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Allard...............................................     2
    Senator Dole.................................................     3
    Senator Schumer..............................................     4
        Prepared statement.......................................    35
    Senator Crapo................................................     6
    Senator Sarbanes.............................................     7
    Senator Bennett..............................................     9
    Senator Bayh.................................................     9
    Senator Hagel................................................    11
    Senator Stabenow.............................................    11
        Prepared statement.......................................    35
    Senator Carper...............................................    27

                                WITNESS

John W. Snow, Secretary, U.S. Department of the Treasury.........    13
    Prepared statement...........................................    36

                                 (iii)

                       THE REPORT TO THE CONGRESS
                     ON INTERNATIONAL ECONOMIC AND
                         EXCHANGE RATE POLICIES

                              ----------                              

                         THURSDAY, MAY 26, 2005

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:02 a.m., in room SH-216, Hart 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order. We are 
very pleased this morning to welcome Secretary of the Treasury 
John Snow to testify on the Treasury Department's Report to the 
Congress on International Economic and Exchange Rate Policies.
    Secretary Snow, the Treasury report is of great interest to 
this Committee and will provide us much to debate this morning 
and in the weeks to come. As you are well aware, many Members 
of Congress, including myself, find the continued imbalance of 
trade with China to be a significant concern.
    The U.S. current-account deficit hit a record $666 billion 
last year, or 5.6 percent of GDP. Coinciding with this deficit 
has been the purchase of large volumes of Treasury securities 
by the Chinese and Japanese central banks. As of March of this 
year, Japan's reserve holdings of Treasuries stood at $679.5 
billion while the value of China's reserves were at $223.5 
billion. While some may argue that these numbers are a natural 
outgrowth of globalized financial markets, the numbers also 
raise questions about whether the current world trade situation 
present a level playing field. The continuing weakness in the 
manufacturing sector made the trade and exchange rate policies 
in China and Japan a tangible issue to U.S. businesses and 
taxpayers.
    Treasury's May report indicates that no major trading 
partner of the United States met the technical requirements for 
currency manipulation under the Omnibus Trade and 
Competitiveness Act of 1988 during the second half of 2004. 
However, Mr. Secretary, the report went on to indicate that 
``Current Chinese policies are highly distortionary and pose a 
risk to China's economy, its trading partners, and global 
economic growth.'' As you will hear this morning, Members of 
Congress were disappointed to hear that once again Treasury had 
failed to make a currency manipulation determination. They 
think you punted.
    Secretary Snow, this Committee would like to engage you in 
a serious discussion this morning about the specific measures 
the Administration will take in the next 6 months to move China 
forward on a flexible rate path. Over the long-term, both the 
United States and the global economy will benefit most from the 
continued pursuit of free trade and flexible exchange rate 
policies. The most desirable way to reduce our current account 
deficit would be through stronger growth abroad and more open 
trading markets and policies.
    We look forward to a thoughtful discussion this morning so 
that we might all leave this hearing with a broadened awareness 
of the situation and the direction ahead. This is a very 
important issue to the American people, I believe, Mr. 
Secretary.
    Secretary Allard.
    I mean Senator Allard. I do not know if I have promoted you 
or demoted you.
    [Laughter.]

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman. You gave me more 
than one job there.
    Chairman Shelby. I will give you two jobs.
    Senator Allard. That is for sure.
    First of all, I would like to thank you, Mr. Chairman, and 
I would like to thank Secretary Snow in particular for 
appearing before the Committee today to discuss international 
economic and exchange rate policy and its impact on the U.S. 
economy.
    The Treasury's report is required under the Omnibus Trade 
and Competitiveness Act of 1988 and reviews the effects that 
significant international economic developments have had on the 
United States and foreign economies.
    The report also evaluates certain factors that may bring 
about these economic developments. I am pleased that this 
year's report indicates China's desire to move forward to a 
more open economy with a flexible exchange rate.
    However, it is important to remember that there are many 
factors that contribute to our current trade relationship with 
China, not just the currency valuation issue. To attribute the 
source of our trade difficulties with China solely to the 
matter of currency valuation would be foolhardy and, frankly, 
much too simple.
    While a more aggressive United States foreign policy with 
China may be necessary, I believe that it is not the job of the 
Senate to intervene by threatening legislation. Stricter World 
Trade Organization rules regarding China's membership is one 
option that needs to be explored further. This can be done 
through the WTO Dispute Settlement Process or by adjusting what 
many would consider existing rules that are entirely too 
lenient.
    The United States is committed to promoting and encouraging 
free and open markets, providing the ability for capital to 
find its most productive home. This flexibility implies that 
markets in goods and services will see growth beyond national 
boundaries.
    In order to see that the United States is not at a 
competitive disadvantage with other countries, policymakers 
need to see that Americans stay ahead of the curve with top-
notch education, innovation, and research and development.
    I feel strongly that the United States must have a 
comprehensive and consistent policy when dealing with China, 
and I look forward to hearing from you, Secretary Snow, on the 
Administration's progress over the last year and their plans 
for advancing in that momentum.
    Secretary Snow, thank you again for appearing before the 
Committee, and I look forward to your testimony.
    Chairman Shelby. Senator Dole, former Secretary Dole, 
twice.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Mr. Chairman, and thank you, 
Secretary Snow, for joining us here today. I want to commend 
you and your colleagues at the Treasury Department for your 
work on this recently released report. This report is a good 
outline of the problems inherent to the Chinese currency peg.
    Since we first spoke about this issue in 2003, you have 
recognized my strong interest in the Chinese currency peg, and 
you have shown a sincere willingness to keep me informed about 
your progress, including the call from China that you made, 
which I appreciated very much, when you were there discussing 
this issue with your counterparts.
    In the 1980's, as President Reagan's Transportation 
Secretary, I had my own experience negotiating with the 
Chinese, and that was an interesting time. We were negotiating 
a number of issues. One was maritime, for example, but also I 
met with the Director General for Aviation while I was there, 
and we discussed a United States airline opening an office in 
China.
    Now, this had been brought up again and again over a long 
period of time, and every time this subject came up, we were 
told, and others before me, that the office ``would open 
soon.'' Unfortunately, as I say, that existed over quite a 
period of time--``soon.'' And when I was not able to pin down 
the Director General as to what ``soon'' meant, I suggested 
that I would just leave behind one of my Assistant Secretaries 
for Transportation until the office opened. And within 5 days, 
the office was opened in Beijing.
    Now, while I know your negotiations are far more 
complicated and far-reaching, with great ramifications for the 
international monetary system, I must say that my experience 
left me with the impression that the Chinese are sometimes 
reluctant to follow through unless real pressure is applied. 
Given this fact, our message to the Chinese must be an 
insistence on action now.
    We are all familiar, of course, with the manufacturing job 
losses that have hit us on a nationwide basis, and certainly 
that has been very true in my State of North Carolina, where we 
have had many job losses over these recent years. Available 
jobs in the textile and furniture industries have been cut in 
half since 1998. Earlier this week, I met with John Bassett, 
who is President of the Vaughn-Bassett Furniture Company, and 
he informed me that a full bedroom set imported from China 
sells for $399 in North Carolina, and his company must pay $461 
just for the raw materials to make the same bedroom set in 
North Carolina. Now, that is astounding. The peg on the Chinese 
currency is a large part, I believe, of what makes that 
possible.
    Textiles and furniture are not the only industries affected 
by the unfairness of the peg. North Carolina computer software 
companies are also deeply concerned about this issue, as well 
as high-tech manufacturers. Just last week, Art Rutledge, 
President of Fawn Electronics, with about 100 employees in Elm 
City, North Carolina, was in my office. He explained that 
because the yuan is so undervalued, the materials for one small 
printed circuit card, which they manufacture, that uses about 
five different parts, would cost them $1.98 in North Carolina. 
Unfortunately, we can buy the finished card from China for 
$1.57.
    These business leaders tell me that they can compete with 
anyone, given a level playing field. The Chinese currency peg 
has given Chinese manufacturing an advantage that cannot be 
explained simply by their lower cost of labor, which we hear 
about so often. The finished product cannot cost less than the 
raw materials. That just does not make sense.
    Secretary Snow, you have moved the bar with this recently 
issued Treasury report, and I appreciate that. We have moved 
the bar here in the Senate. While 2 years ago we were calling 
for a freely floating yuan, today all we ask is that it simply 
be revalued. That is why I cosponsored an amendment to the 
State Department authorization bill to pressure the Chinese to 
revalue. Sixty-seven Senators voted in favor of this amendment, 
and only 2 weeks ago, Senators Snowe, Voinovich, and I 
introduced legislation that would update the technical 
requirements in the law for designation as a country that 
manipulates the rate of exchange between their currency and the 
dollar. I think it is clear that this is not an issue that the 
Senate is willing to wait on. Given all of the evidence that 
has been available and referenced in this report, I frankly am 
astounded that the Administration continues to report that the 
Chinese peg is not currency manipulation. While I appreciate 
all the steps that the Administration has taken thus far, I 
think it is time to redouble these efforts.
    In this report states, ``It is now widely accepted that 
China is now ready and should move without delay in a manner 
and magnitude that is sufficiently reflective of underlying 
market conditions.'' Everyone here agrees with that, Mr. 
Secretary. Now let us make sure that the Chinese back up their 
words with actions.
    Thank you, Mr. Secretary. I look forward to your testimony 
because this is a critical issue to the people of North 
Carolina, and it is a critical issue to the United States as a 
Nation. Thank you Chairman Shelby.
    Chairman Shelby. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman for holding the 
hearing. I want to thank our Secretary of the Treasury for 
being here, and I want to make a few points. Obviously, the 
Secretary and I have talked both publicly and privately about 
this issue ever since he became Treasury Secretary.
    First, I would say this: It becomes clearer and clearer 
that China wants the advantages of free trade and not the 
responsibilities. They play half the game. When they have an 
advantage, they are all for free trade. When they have a 
disadvantage, they come up with all sorts of reasons, excuses, 
or just abject violations of trade rules to avoid it. And I 
will argue this: As the global economy expands and free trade 
becomes more and more important, no matter where you live in 
this country, if there is not a feeling that it plays fair, we 
will never get a U.S. consensus or a world consensus for it. 
And as long as China is allowed to do what it has done, they 
set back the cause of free trade.
    I am utterly amazed. It is not business people, it is not 
practical people who oppose our legislation. They may say, hey, 
can you do it in a nice way? But all the nicer ways have 
failed. It is the academics and editorial writers. But they do 
not get it. They can afford to sit there in the ivory tower and 
say everyone should just play by the rules. They do not 
understand the political reality that you cannot ask one side 
to play by the rules while the other does not, and all the 
world shrugs their shoulders and says, well, they do not have 
to.
    China is no longer a Third World country. It is a major 
player on the world economic scene. And it is a different 
situation than it was 10 or 15 years ago.
    And it is issue after issue. It is the theft of 
intellectual property, which they do nothing about. Those are 
our crown jewels in America--intellectual property. And if you 
believe, as I do, that people should be recompensed for it, 
whoever they are, whatever Nationality, to let them just 
violate these rules and they shrug their shoulders and say they 
cannot do anything, bunk. They do not want to do anything.
    And how about all the companies that are just excluded? I 
know company after company in my State, and my country, where 
China does not let the good in. And I have told the Secretary 
some of these stories. It is big companies, it is little 
companies. China is not a free trading country. They are 
mercantilist country. Their goal is to increase their balance 
of trade and bring jobs and wealth into their country no matter 
what the consequences. And in the long-run, they do better by 
playing by the free trade rules, but they do not.
    And so the currency manipulation is the area that has 
become the focal point, not because it is the only one but 
because it is the one that affects everything across the board. 
My colleague from North Carolina mentioned textiles and 
furniture, which are labor-intensive industries, and then some 
kind of computer--what was it? High-tech, which is obviously an 
idea-centered industry. But in all of them, my business people 
say the same thing to me. They said: We will compete against 
lower labor costs and everything else, but when you put a 27.5- 
or 30-percent barrier in the way, then we cannot compete.
    I would disagree, however, with my friend from North 
Carolina in one way. I am not willing to settle for just a 
revaluation of 5 or 10 percent and say never mind. The Chinese 
have to let their currency float. It is a tenet of free trade. 
When balances of trade become too great in one direction, when 
currency floats, there is a wash-back, and the whole situation 
gets straightened out eventually. It is not something that is 
optional. If free trade is to work, currencies have to float.
    And so while I certainly do not demand--and Senator Graham 
and myself, who have put our bill forward, which Senator Dole 
referred to that got 67 votes, we do not demand that they let 
it float immediately. We need a plan and then we need progress 
toward the plan. That is why our legislation, even if it were 
to pass, gives the Chinese a chance to put out a plan before 
any kind of tariff is imposed.
    Finally, I want to salute you, Mr. Secretary. I think for 
the first time, the Administration has called it like it is. 
They have said--or almost called it like it is. They have said 
there are real problems here, and they said if China does not 
change, we will call it currency manipulation. Well, my view is 
if it quacks like a duck and walks like a duck and swims like a 
duck, it is a duck. They are manipulating their currency. We 
all know it. And I do not mind you moving in that direction, 
but let us not delay much further.
    The Administration has now stepped into the batter's box. 
We had to push you a little bit, but you are there. Now you 
have to swing at the pitch. And you will benefit not just 
American industry but the whole construct of world trade when 
you do.
    So, I want to ask unanimous consent that the rest of my 
statement be put in the record.
    Chairman Shelby. Without objection, so ordered.
    Senator Schumer. And thank you for being here.
    Chairman Shelby. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman. Mr. 
Secretary, I join with other Senators here in welcoming you to 
the Committee to discuss this issue. And, frankly, I want to 
associate myself with the comments of the Senator from New York 
and the Senator from North Carolina and others who have spoken 
here today about the importance of making certain that we 
develop the right trade and monetary policy with China.
    I was a supporter of the legislation that was voted on in 
the Senate and for a long time have been a strong proponent of 
doing everything we can to cause China to stop its currency 
manipulation and to stop pegging the yuan to the U.S. dollar.
    I am concerned, however. I am concerned about what the 
proper U.S. response should be to the overall issue. The 
Senator from New York indicated that the focus on the currency 
manipulation issue is where the focus of the day seems to be, 
but that is not the only issue. And, frankly, it is not an easy 
solution. As you are well aware, the Chairman of the Federal 
Reserve, Alan Greenspan, has indicated that, along with many 
others, he expects to see China move in this direction, but 
does not expect that that move will necessarily have a 
significant positive impact on the U.S. economy because of the 
rise in domestic prices and potential other dynamics in terms 
of where the United States will get the imports that we are now 
getting from China if that reduces Chinese imports.
    It seems to me that we have a much larger issue here than 
simply the currency manipulation issue, and it is an issue of 
such magnitude that this Congress, this Administration, and 
this country has to develop a broad, overall policy of how we 
are going to deal with the current trade and monetary policies 
that we see emanating from China, one of the most powerful 
economies in the world and one which will continue to grow.
    So, anyway, I just wanted to say to you I appreciate your 
willingness to come and meet with us today and report to us. I 
appreciate the report that has just been issued. And I do 
support the efforts of the Administration to try to work with 
China to get it to move in the direction of fair and free trade 
and proper monetary policy. But I really hope, as a result of 
this hearing and the other efforts that we are all engaged in, 
that we can get a much broader and more focused action plan put 
together or game plan, if you will, as to what U.S. policy 
should be, not just with regard to the currency manipulation 
issue but with regard to the entire panorama of how we should 
deal with a nation like China, which is acting in the ways that 
have been described here, that literally take advantage of 
proper WTO policies and U.S. trade policies when they benefit 
them and then ignore them and erect trade barrier and establish 
monetary policy that is detrimental when it benefits them. And 
I know that this is a tall order, but as a Nation, we have to 
develop an overall policy that does much more than just 
determine what we will do with regard to currency manipulation.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman, and, 
Secretary Snow, we are pleased to have you back before the 
Committee. This is obviously a very important subject. I notice 
the Administration is moving a little bit on this issue, but I 
am not sure it has moved enough yet. And I do not see how you 
could do anything but move on this issue given the evidence 
with respect to currency manipulation, which is, after all, the 
focus of this hearing under the legislation passed by the 
Congress.
    It has been my view for some time that nations, first and 
foremost China, but other key economies as well in Asia, have 
been manipulating their currency to gain unfair competitive 
advantage in international trade within the terms of the 1988 
Trade Act.
    First, China, Japan, Taiwan, and South Korea are all 
running material global current account surpluses and 
significant bilateral trade surpluses with the United States 
within the terms of the 1988 Trade Act, in my view. I have a 
chart here that shows the global current account surpluses and 
bilateral trade surpluses each of these countries is running 
with the United States. And as you can see, China's trade 
surpluses in particular with the United States now, in the most 
recent 12 months, $173 billion, 10.5 percent of GDP. Japan is 
78.1; South Korea and Taiwan.
    Now, the size of China's bilateral trade surpluses with the 
United States relative to the size of its economy is 
particularly striking. Furthermore, each of these countries has 
been engaging in sharply increasing accumulation of foreign 
currency reserves, principally dollars. As the following charts 
will illustrate, the first chart shows the growth in China's 
stock of foreign reserves, $215 billion over the past 12 
months. This is just an incredible run-up in the stock of 
foreign reserves on the part of China. The second chart shows 
the growth in Japan's stock of foreign reserves. It has tailed 
off. It has only been $11 billion over the past 12 months, but 
that follows very sharp increases of $171 billion in 2004 and 
$202 billion in 2003. So we have had a tremendous run-up. And 
the next two charts show the same increase in the stock of 
foreign reserves held by South Korea, and then by Taiwan.
    Now, to get some comparison, because I do not think the 
same kind of manipulation is taking place in the European 
Union, the next chart shows that the stock of foreign reserves 
held by the European Union, it has actually declined over the 
last 12 months.
    So it is a very sharp contrast, what has been happening 
with respect to the countries in Asia accumulating foreign 
reserves compared with the European Union.
    The final chart I want to show is a consequence of these 
reserve accumulations for the value of the currency relative to 
the dollar. The euro has experienced a significant appreciation 
against the dollar over the past year. That is the blue line at 
the top that has been rising. The currencies of Japan, South 
Korea, and Taiwan have experienced a significantly smaller 
appreciation. Those are these three, which show some 
appreciation. And the value of the Chinese currency, since it 
is pegged to the dollar, as represented by the horizontal axis 
of the chart, has not appreciated at all of course since it is 
pegged at a fixed figure. So it is an absolute straight line 
across the bottom. So this economic theory that the currency 
appreciates, it helps to straighten out the trade imbalances 
and so forth is just not working.
    The trade imbalances are breathtaking. We have the figures 
here on what has happened to the U.S. trade imbalance. This is 
the U.S. trade deficit. This is 2001, when your watch began, 
and this is what has happened to the trade deficit, and the 
current account of course more or less parallels that 
obviously. That is what has happened to the current account.
    I do not think there is much doubt or ambiguity about what 
is taking place. Each of these countries is intervening 
actively in the market to purchase dollars in order to depress 
the value of its currency. The United States ran trade and 
current account deficits last year of more than $600 billion, 
and that was by far the largest we have ever done.
    The four countries collectively account for over 40 percent 
of the U.S. trade deficit. We have now accumulated an external 
debt in excess of $2.4 trillion, over 20 percent of GDP.
    Only yesterday, the Organization for Economic Cooperation 
and Development released its semiannual economic outlook. The 
OECD forecasts that the U.S. current account deficit would 
continue to rise, hitting nearly $900 billion or 6.7 percent of 
U.S. GDP in 2006. The Chief Economist of the OECD told the 
Financial Times, ``We are not saying there will be a doomsday 
tomorrow morning, but because the adjustments to global 
imbalances are relatively slow, we are running the risk that an 
accident will happen. That is where we are. Time is running 
out. The numbers are getting big, big, big.''
    It seems to me if we are going to make any progress we have 
to address this directly, this issue of currency manipulation. 
Each of these countries is a member of the WTO. All but Taiwan 
are members of the IMF. Condition of membership in both 
organizations is not to engage in currency manipulation for 
competitive trade advantage. Clearly, the intervention has been 
most egregious in the case of China. There is reason to believe 
that the other countries in the region, for competitive trade 
reasons, are hesitant to allow their currencies to appreciate 
unless China appreciates first. They are standing in the shadow 
of China, and there is considerable, as I understand it, expert 
opinion that if China moves they will be able to move as well 
and get this thing into better balance.
    Mr. Secretary, we have differed in the past over how China 
should try to adjust. You have consistently said, well, we have 
to move them toward floating rates, and some of us have 
suggested to you that there is little expectation that they 
would let their currency float freely because there is 
considerable concern of the impact on the banking system, and 
that therefore, the way to approach this is to get a 
substantial upward revaluation of its currency in terms of the 
peg, rather than to allow its currency to float.
    I notice in The Wall Street Journal only yesterday, you 
say, and I am pleased to see this statement, I want to say to 
you, ``Unfortunately, the debate on China's currency regime is 
clouded by a number of misconceptions of U.S. policy.'' I am 
not sure we misconceive them. I think you may be--I think you 
are changing U.S. policy. ``First, we are not calling for an 
immediate full float with fully liberalized capital markets. 
This would be a mistake at this time. China's banking sector is 
not prepared for such a move today. What we are calling for is 
an intermediate step that reflects underlying market conditions 
and allows for a smooth transition when appropriate to a full 
float.''
    Actually, I regard that as a significant step in the right 
direction on the part of the Administration in terms of what we 
should be seeking and what our policy should be. This notion--
the Chinese keep saying, ``Well, we want to go to a flexible 
system,'' you have been saying. ``You should go to a flexible 
system,'' then all the experts say, ``Well, if they go to a 
flexible system they are going to have a banking crisis. They 
cannot go to a flexible system because the banking system 
cannot withstand it.''
    So we have this kind of kabuki--wrong country reference--
but we have this kabuki going on between us and the Chinese on 
how to remedy this problem. Now, I gather you are moving away 
from that position, and it seems to me, obviously, they can 
reset the peg. How much they do it of course is a critical 
question, but that would help to address this issue.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Senator Hagel. He is not here.
    Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Time is far spent. I will forego, Mr. 
Chairman, and look forward to listening to the Secretary.
    Chairman Shelby. Senator Bayh.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you very much, Mr. Chairman.
    Mr. Secretary, thank you for being with us, and thank you 
for your service to our country. You have made some 
considerable sacrifices to be here, and we appreciate that very 
much.
    You also arrive at an auspicious time when it is nice to be 
talking about something other than judges, and looking to the 
long-term economic future of our country. So, I am sure we are 
delighted to be focused on that here today. I know that I am.
    This whole issue of globalization, Mr. Secretary, that this 
in some ways relates to, is one of the great challenges of our 
time, the move of our economy from an agricultural based 
economy to an industrial one, then from an industrial one to a 
service-based economy, and now looking to the future and 
thinking about what our comparative advantage going forward is 
going to be.
    I have broken this down into three parts. First and most 
important, we need to have a positive strategy about what we 
can do more quickly with higher quality and less expensively 
than anybody else on earth. What are we going to do to grow our 
economy and to empower our citizens with research and 
development, education skills, and all the other things 
necessary to be globally competitive.
    Second, what do we do about those who are dislocated 
because of globalization, through no fault of their own, people 
who need to get back on the ladder toward being upwardly 
mobile? We have an obligation to them than to say, ``Well, it 
is too bad for you. You are on the scrap heap of history and we 
are moving on.'' We need to put into place ways in which 
through hard work they can get back on their feet, moving 
forward again.
    And then third, Mr. Secretary, as we have discussed before, 
when we embrace the difficult decisions to define our 
comparative advantage, when we embrace open and free 
competition and make the hard choices, the sacrifices, work 
hard, think smart, and all the rest, what do we do when there 
are others who choose a different path and instead engage in an 
industrial policy, or try and cheat on the rules to give 
themselves an artificial advantage? We owe it to our workers 
and businesses that when they work hard, think smart and are 
productive, that the fruits of that effort not be stolen from 
them by those who would break the rules by cheating.
    So the question is, what do we do in a situation like that? 
And the answer cannot be nothing, cannot be protectionism but 
it cannot be nothing. And so in some ways we are gathered here 
today to answer the question, what do we do when countries seek 
to gain an unfair advantage for themselves through artificially 
manipulating their currencies? As you heard today, and I agree, 
I think we have to take a stand.
    I know it is a difficult challenge. In some ways it 
requires you to not only be the Secretary of Treasury but also 
an international diplomat as well. Our relationship with China 
is an essential one, one of the most important going forward in 
this century, and we need to be sensitive to the fact that they 
have concerns. Particularly, how do they reallocate 
approximately 140 million excess workers in agriculture to 
other lines of work? What do they do about surplus workers in 
their state-owned enterprises? That will require some real 
transitions within China. And they understandably have a 
concern about stability within their country. We need to be 
sensitive to that.
    But our sensitivity to the concerns for stability in China 
cannot lead us to a place where we unfairly displace hard-
working Americans here at home. That simply would not be right. 
So that is the balance that we need to strike, and it is one 
that we look forward to having a good dialogue on here today, 
and how do we pursue our comparative advantage economically? 
How do we do justice for individual Americans and still retain 
good relations with countries that we need to to secure our 
national security interests and others moving forward?
    I thank you for your time, and would just say in 
conclusion, we owe it to individual Americans to ensure that 
there is justice in the global marketplace. I think that is 
really what this hearing is all about. Thank you for your time.
    Chairman Shelby. Senator Hagel.

                STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. I have no statement at this time. I just 
want to welcome the Secretary and thank the Chairman for 
holding this important hearing.
    Chairman Shelby. Senator Stabenow.

              STATEMENT OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Thank you, Mr. Chairman. This is an 
incredibly important issue that we are speaking about again 
today. I want to welcome the Secretary for coming before us 
again, several times now as I have been a Member of the Banking 
Committee, and each time this issue has become more critical, 
more severe. It is really now on par with health care costs as 
an item that is crippling economic growth in our country and is 
of great concern to manufacturers as well as farmers and all of 
the business community in my State of Michigan.
    I, frankly, Mr. Secretary, have to share the concerns of 
many of my colleagues who are deeply disappointed with the 
Treasury report that was released on Tuesday. I believe that 
the Treasury Department has failed to do what is right and 
obvious as the report relates to China and Japan. The report 
states that no country met the technical requirements of the 
law governing manipulation, and we all know it is occurring. In 
Michigan, we would say that is too cute by half. I mean the 
reality is we know it is occurring, but yet we are told it 
technically does not meet the requirements as we every day are 
losing jobs in Michigan and across the country.
    Most economists agree that China's currency is undervalued 
against the dollar so it is difficult to see why once again the 
Treasury Department is unwilling to state the facts. In fact, 
given the clarity of the problem I am led to believe that 
something other than facts are driving this reluctance to find 
violations. I am wondering if it is the fear of retaliation by 
the Chinese or the Japanese on our goods and services. Is it 
because, as many of us have said, that we are becoming more 
dependent on these two nations to shoulder more and more of our 
budget deficit? Does this relate to the reluctance to move 
forward? I think these are serious questions and serious 
issues.
    Many of us have warned the Administration that continued 
large budget deficits would eventually limit our ability to 
address trade problems, and here we are. The day has arrived I 
believe.
    I am certain that much of the discussion today will focus 
on China, but Japanese manipulation is a problem that, Mr. 
Secretary, I hope we do not lose sight of. In Michigan, where 
auto manufacturing makes up such a large part of our economy, 
Japanese manipulation is a major and ongoing concern, and I am 
doing everything I can to make sure that it is addressed.
    The decision by the Treasury Department to again go easy on 
China and Japan will cost the State of Michigan jobs at a time 
when unemployment remains staggeringly high. Last month, United 
States gained 274,000 jobs, but in Michigan we added 7,500 to 
our unemployment rolls. Specifically, China's currency policies 
have cost the United States economy over 1\1/2\ million jobs in 
the last 15 years, and in Michigan that is over 51,000 jobs. 
That is why this is such a critical issue for us. These job 
losses are damaging diverse sectors, not only auto 
manufacturing, which is critical, but farming, things like 
apple juice, as well as auto parts and furniture and boat 
manufacturers. I can go through a long litany of the types of 
businesses that are being impacted in Michigan, and the jobs 
that are being lost as a result of that.
    The response that the report gives to these facts is that 
the Treasury Department is ``continuing to engage actively with 
economies to encourage in both bilateral and multilateral 
discussions flexible, market-based exchange rate regimes 
combined with a clear price stability goal and transparent 
systems for adjusting policy instruments.''
    I think for all of us today listening to those words, it is 
murky at best. What it means, of course, is that we are talking 
to the Chinese, we are talking to Japan, and if talk would make 
this go away, it would have been solved a long time ago. I do 
not question the sincerity of the talks, but the reality is 
that talking has not done it, and it, in my opinion, will not 
get us the results we need.
    The Treasury report dedicates one sentence, one sentence 
out of 17 pages, to the negative effects of currency 
manipulation on U.S. workers and U.S. businesses, one sentence, 
but repeatedly describes why manipulation would be bad for 
China. I am certainly not opposed to being concerned about 
China, but as colleagues on both sides of the aisle have 
expressed we are deeply concerned about American businesses and 
American workers.
    First let us be clear about it, that currency manipulation 
kills American jobs, and it is illegal under the WTO and IMF 
obligations. Even foreign exchange markets are sending clear 
signals that China in particular should revalue its currency. I 
believe there is a strong case for pursuing action against 
China in both the WTO and the IMF. China's exchange rate policy 
frustrates the intent of the WTO and can be viewed legitimately 
as providing an illegal subsidy to exports and imposing an 
illegal tariff on imports. Mr. Secretary, we need to crack down 
both on China and Japan and make sure they are playing by the 
rules.
    Finally, I would just indicate, and would welcome your 
feedback, I have introduced legislation, along with Senator 
Lindsay Graham and Senator Bayh, who has additional legislation 
which I think is very important. We have introduced legislation 
that would create a chief trade prosecutor within the Office of 
the U.S. Trade Representative. This is an issue and actually a 
suggestion that came from the discussions with the United 
States-China Commission members, and it would set up for the 
first time someone whose job it is to police our trading 
partners and to basically speak out and take action on behalf 
of American manufacturers and workers when there are unfair 
trade practices like currency manipulation.
    I am hopeful that we will be able to move that forward. I 
think it is incredibly important that we not wait for a report 
every year, Mr. Chairman, but that we have someone who is 
watching out on a daily basis for our businesses and workers, 
and working hard every day to create a level playing field.
    So thank you again, Mr. Secretary, for being with us, and 
Mr. Chairman, for holding the hearings. I cannot stress enough 
the sense of urgency that the business community and the 
workers in Michigan have regarding this issue of currency 
manipulation and the larger issue of having a trade policy that 
creates a level playing field so we can compete.
    Thank you, Mr. Chairman.
    Chairman Shelby. Secretary Snow, we welcome you again to 
the Committee. Your written testimony will be made part of the 
hearing record in its entirety. You proceed as you wish.

                   STATEMENT OF JOHN W. SNOW

           SECRETARY, U.S. DEPARTMENT OF THE TREASURY

    Secretary Snow. Thank you very much, Mr. Chairman. It is 
always a pleasure to be here and to continue the dialogue that 
now goes back well over 2 years with this Committee on a 
variety of important issues, of which none really is more 
important than the one that has been so well-addressed by your 
opening comments this morning, and that is the global 
imbalances.
    It is critically important that we address these global 
imbalances and that we understand them, and that we address 
them in the appropriate and right way, and China is part of the 
adjustment process to deal with the global imbalances.
    We have said that it is imperative that China move to 
greater flexibility of its exchange rate. It is only recently 
though that we have concluded that they have taken sufficient 
preparatory steps to be able to introduce exchange rate 
flexibility, greater exchange rate flexibility without untoward 
risks to their own banking system and to their own financial 
system.
    One reason they are where they are, I think, is the 2-year 
engagement that we have had with China, an engagement that has 
secured from them the commitment to move to flexibility, has 
secured from them the acknowledgement that flexibility is there 
a float, in other words, is there a long-term objective, and 
intermediate steps that are really quite remarkable in 
preparing the way, in putting in place a strong bank regulator 
and seeking to recapitalize the banks and opening up some 
financial market opportunities for non-Chinese firms, widening 
the amount of capital the Chinese can take out of the country, 
and that non-Chinese can bring in, opening up opportunities for 
non-Chinese financial firms to engage in their economy.
    All of that is designed to strengthen their financial 
infrastructure so that they will be able to implement a greater 
flexibility to their exchange rate. They understand the need, I 
am convinced, to move to greater flexibility, and they have 
taken a number of steps to prepare the way.
    What is different with this report from our prior reports 
is that we now say, you are ready and it is time to move. And 
we have clearly indicated in this report that since you are now 
ready, you have now taken the positive steps to put yourself in 
a position to do it, failure to do it will weigh very heavily 
on us when we do our next report. That is really the principal 
message of this report as it relates to China, Mr. Chairman.
    We have appointed a very talented and able negotiator as 
the Treasury Secretary's representative, a former Assistant 
Secretary of the Treasury, Olin Wethington, who is now in 
Beijing, who will be spending an enormous amount of time, 
energy, and effort--and this is an extraordinarily capable 
individual--in working with the Chinese authorities, in helping 
the Chinese authorities come to the conclusion that now is the 
time to put in place the appropriate flexibility.
    One very encouraging note on this is the fact that the 
Chinese have indicated their interest in having a forward hedge 
mechanism put in place, in other words, a derivatives market in 
their currency, and they have engaged the Chicago Mercantile 
Exchange, the leading currency derivatives market in the world, 
to enable them to do that. You do not put in place a forward 
hedge. You do not put in place a derivatives market. You do not 
do the effort to prepare for a derivatives market unless there 
is some interest in moving to flexibility.
    But having said all of this, let me say, Mr. Chairman, I am 
disappointed. I know you are disappointed. The Administration 
is disappointed that we have not seen action, and we are going 
to stay on this until we get action. I know from your comments 
in here today and I know from personal conversations with many 
of you the intensity with which you address this issue. And it 
is absolutely essential that China adhere to the rules of fair 
trade. It is absolutely essential that China play by the rules, 
and whether it is opening markets, or whether it is enforcing 
intellectual property rights, stopping the stealing and theft 
of other people's ideas, or whether it is moving to a currency, 
we are committed to seeing that they play by the rules.
    The larger issue that we are dealing with here is, of 
course, the consequences of a major player in the international 
global trading system who does not play by the rules and 
getting their attention to assure that they do play by the 
rules because the consequences of not playing by the rules, of 
course, are to invite protectionist measures that I think are 
unwelcome, untoward and damaging and destructive. So it is 
awfully important for the appropriate actions to be taken here 
to ward off things that Senator Allard said none of us want to 
see come to be.
    While the Chinese currency is an important component of the 
global imbalances, it is not the only one. Global imbalances 
start with the recognition, I think, that the United States is 
growing at a rate that is far higher than our trading partners, 
particularly our euro zone trading partners and Japan.
    With our higher growth rates we are creating more 
investment opportunities in the United States and we are 
creating more disposable income. Our higher investment 
opportunities, giving our relatively low savings rates, mean 
that we have a current account deficit. That is what a current 
account deficit is, our level of savings opportunities compared 
to domestic savings. We need to work on both sides of that. We 
need to save more in the United States. It is critically 
important that we increase our savings rates. It is also 
critically important that the euro zone and Japan and our other 
trading partners put in place policies to grow faster. The 
framework we are dealing with encompasses all of those points, 
faster growth, stronger growth, better growth with our trading 
partners, higher savings rates in the United States, including 
reducing dissavings through deficit, and I think we are on a 
good path there to reduce the deficit. The recent numbers were 
very encouraging.
    And finally, China's part, and China is not just China in 
this respect, China is of course, as I think the Chairman said, 
most of Asia that ties itself to China for competitive reasons, 
adjustments of the yuan to get it into closer alignment with 
underlying demand and supply realities.
    Mr. Chairman, we are going to stay on this one until we see 
the final result that is reflected in China having a flexible 
currency, reflecting demand and supply conditions.
    Thank you very much.
    Chairman Shelby. Mr. Secretary, the Treasury report stops 
short of labeling China's actions as currency manipulation. You 
get up to the brink, but you do not cross it. The report also 
notes that a peg or intervention does not meet the definition 
of currency manipulation and that the IMF concurs in this 
assessment.
    Mr. Secretary, you are getting close, and I hope that you 
will finish your work. What condition, Mr. Secretary, or set of 
conditions would meet the technical definition of manipulation? 
In other words, what is it going to take?
    Secretary Snow. Well, as I suggested, Mr. Chairman, the 
fact that China is now ready, has now prepared the way, and----
    Chairman Shelby. To do what?
    Secretary Snow. To move to flexibility, that they now have 
the technical capability of implementing a flexible exchange 
rate.
    Chairman Shelby. Do you believe they are going to do that?
    Secretary Snow. Yes, I do.
    Chairman Shelby. And do you believe they are just going to 
repeg their currency?
    There is a lot of difference between floating their 
currency and repegging it, as you well know, Mr. Secretary.
    Secretary Snow. I do not think it is in our interest or 
their interest for them to go immediately to a full float. What 
we like to see them do is take steps in a manner and magnitude 
that closed the gap between where they are and a float. In 
other words, I see them on a path to a float.
    Chairman Shelby. Mr. Secretary, what actions, honestly, 
candidly, will China need to take in the next 6 months to avoid 
a designation of currency manipulation in your Treasury report 
to the Congress which is this coming October, 6 months from 
now? I know you are getting close, but what is it going to take 
on China's behalf to avoid you designating them?
    Secretary Snow. It is always a fact-based question and it 
is a complex question and a difficult question, but current 
trends, if current trends continue, which is large current 
account surplus with the United States, very large and growing 
surplus with the world, continuing capital inflows, and build 
up of large reserves, all of which are the current trends, with 
inflows of so-called ``hot capital'' which reflect clearly the 
sense that the currency is undervalued, those sorts of trend, 
if continued and no relief for them is put in place in the form 
of a flexible exchange rate, our certainly the things we would 
look at in making our next determination.
    Chairman Shelby. Do you believe a timetable has to be 
satisfactory action by the Chinese with the penalty being such, 
timetable such as ineligibility to continue IMF assistance, WTO 
membership, or what? What are you thinking about here?
    Secretary Snow. I am thinking we have their attention and 
they are going to move. I really believe that.
    Chairman Shelby. It will be interesting to watch. In about 
six months, you will be back here and we will see what happens.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman. I first want to 
thank you for your comments and questions. I think this is 
really the core. How do we get there? Again, it is nice to have 
words that are inching along, getting better, but how do we 
really get to the point where we are going to call it as it is 
happening?
    I know a number of colleagues will speak about China, and 
so I want to speak for a moment about Japan because both of 
these are very important, and I support comments that 
colleagues on both sides of the aisle have spoken to as it 
relates to China and what is happening, and I think that is why 
you saw 67 Members on both sides of the aisle vote for the 
Schumer-Graham proposal on the floor of the Senate, and I 
expect the same kind of a vote in July at this point.
    But Japan, while they have not been fiscally intervening in 
global currency markets for more than a year, they have been 
involved in really verbally intervening, Mr. Secretary, and 
making threats that if the yen continues to strengthen against 
the dollar, they will resume direct manipulation of their 
currency, and we have a number of quotes to that effect 
including just last week from the Bank of Japan, officials 
saying that they believe that Chinese revaluation would be an 
unforeseen sudden event that pushes up the yen. Therefore we 
will have an excuse for carrying out a yen-selling 
intervention. This was on May 17.
    My question is, now that you have chosen to warn China for 
the first time in this report--and that is a positive thing--
why have you not also warned Japan that any resumption of 
fiscal interventions of remarks from the Ministry of Finance 
and the Bank of Japan will result in their being named as a 
currency manipulator as well?
    Secretary Snow. Senator, we are in continuous discussions 
with the Japanese Finance Ministry and their Central Bank, and 
our views have been expressed to them any number of times, the 
view that the world trading system functions best with their 
reliance on open trade and free trade under rules, with free 
capital flows and currency arrangements values set in opening 
competitive currency markets with interventions kept to a 
minimum.
    Now, since I think it is March 2004, March 16, actually of 
2004, we have not witnessed any formal interventions, and the 
Japanese have signed on to that G-7 global framework, which 
calls for reliance on flexibility, and of course, over the last 
half of the last 6 months of last year or so, their currency 
had a fairly significant appreciation.
    I think there is a pretty good understanding of what our 
policies are and what satisfies the requirements of being a 
good trading partner. We do not want to see interventions 
occur. We are opposed to interventions. We have made that 
clear. There have not been interventions for a considerable 
period of time. Their currency has been appreciating, so while 
we seem to be on a good course, we are going to continue to 
carefully monitor that, and we are going to continue to 
reinforce our views.
    Senator Stabenow. Mr. Secretary, with all due respect 
though, I have in front of me 6 different quotes, one as of 
last week, and all of them since January, talking about they 
are going to monitor, they are going to take appropriate action 
if necessary, will have an excuse for carrying out a yen-
selling intervention. They go on and on, we are ready to take 
proper action against excessive moves and so on. So, I would 
just suggest again that letting them know our policy obviously 
is not enough. This is absolutely critical. When I talk to 
those in the auto industry in Michigan and around the country, 
they certainly are concerned about China, but they say, what 
about Japan? This is the area that has been so critically 
important to us and directly relates to losing jobs, which we 
cannot afford to lose any more.
    I want to ask one other question if I might because I think 
this relates to both of these things. Because I am very 
troubled by the fact that there is a reluctance to cite China 
and Japan as engaging in currency manipulation, and I would 
like you to address the fact that it is no secret now that 
Japan and China are funding a large part of our national debt. 
Together they are funding about half of the foreign debt 
holdings of our country, and I see adding another $400 billion 
a year to the national debt when we look at this budget, 
through a combination of tax cuts and increased spending, while 
no one is talking about what this does to us in the 
international arena.
    So, I am wondering if you see us continuing down this road, 
what relationship this will have to our ability to act, when on 
the one hand we see China and Japan doing things that undercut 
American businesses and undercut American workers. On the other 
hand, they are holding more and more of our debt, alarmingly 
large amounts of our debt. Can you speak to how much this chart 
relates to our ability to do more than just talk to them about 
issues of fair play and issues related to our trade situation?
    Secretary Snow. Yes, Senator, of course. China and Japan 
and the other countries you witnessed there, do have sizable 
holdings of our national debt. There is no doubt about it. But 
that debt is widely held, and held on a very diversified basis. 
And while it is something we monitor, it is not something that 
is particularly troubling to me. The governments of those 
countries, including South Korea, Japan, and China recently 
have issued statements saying that they are not going to pursue 
diversification of their dollar holdings. Why do they hold 
dollars and dollar-based assets? Because they are the best 
assets to hold. It is in their interest to hold U.S. dollar-
based assets. We have the deepest, the most liquid, the most 
efficient capital markets in the world. It is a great source of 
strength for America that our capital markets are the deepest, 
most liquid, and efficient in the world, and that investments 
in those markets provide the best risk-based returns in the 
world.
    So, no. As long as we keep our capital markets working, as 
long as we keep productivity high, as long as we keep growth 
high--and I was pleased to see that revised number on the first 
quarter coming in at 3.5 rather than 3.1--as long as we sustain 
above-normal growth, high productivity, respect for capital, 
and maintain these deep, liquid markets, I have great 
confidence in our capital structure and our ability to fund our 
obligations.
    Senator Stabenow. Mr. Chairman, I know my time is up, and I 
thank you for your response. I would just say that I have a 
very different view about whether or not adding to our national 
debt and having a trade deficit that is even larger than our 
national debt, which is the largest in the history of the 
country, and having more and more of it held by countries like 
Japan and China, whether or not this gives strength for 
America, and I would suggest that there are many of us that 
believe it does not strengthen us and in fact puts us in a much 
more difficult position to act in our own best interest.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Dole.
    Senator Dole. Secretary Snow, I want to follow up on 
Senator Stabenow's questions. With China's official foreign 
exchange reserves at $610 billion in the second half of 2004, 
how much interest does the United States anticipate it will pay 
China in 2005?
    Secretary Snow. Well, our all-in interest costs, the 
Treasury's, are roughly about 4 percent, so it is $600 plus 
billion, $25, $26 billion, something on that order.
    Senator Dole. A May 21 article in the Economist states that 
most economists believe China is concerning three options, the 
least ambitious of which would be a small widening of the 
yuan's trading bands against the dollar or a gradual shift from 
the strict dollar peg to one based on a trade-weighted basket 
of currencies. Do you believe this option goes far enough to 
avoid designation under the technical requirements of the law?
    Secretary Snow. Senator, what we have indicated that the 
Chinese need to do is take steps--and these are of course 
sovereign decisions; we cannot dictate to sovereign decisions 
they make, we can indicate what we think is appropriate--but 
steps of such a magnitude and in such a manner that they 
clearly get on a path to flexibility, and relieve some of the 
imbalances and distortions currently associated with the peg. 
Most observers will tell you that under current circumstances 
the peg results in undervalued currency. The Chinese are in the 
best position though, in our view, since it is a sovereign 
decision, and it depends on local reading of the economy, in 
which they are far more skilled than we are in understanding 
their own domestic economy and tradeoffs between job creation 
and inflation and all those things you have to do for them to 
make that decision. It has to be a decision to satisfy our 
report that is a manner and magnitude sufficient to close that 
gap in a significant way, and get that currency better aligned 
with underlying demand and supply. In other words, significant 
enough to improve materially the adjustment process that should 
be occurring.
    Senator Dole. As you are aware, more than half the loans 
the banks in China have made are classified as nonperforming, a 
nice way of saying that they are bad and they are not going to 
be repaid. In conversations with State Department officials, we 
were told that we cannot think of Chinese banks as being like 
our banks, that they are more like government lending programs. 
Are you concerned that these loans to Chinese manufacturers are 
nothing more than government grants, further subsidizing their 
exports?
    Secretary Snow. Senator, the evidence is pretty clear here 
that the state-run enterprises borrow from the state banks 
funds that are used primarily to fund payrolls. That is not 
capital going into the economy to increase long-term output. 
And in that sense it is a transfer payment, not a loan. So to 
call it a nonperforming loan in a sense is a mistake. The 
institutions are not set up as normal banks. The Chinese 
banking authorities recognize the need to deal with the dual 
problem here, the problem of state-run enterprises that do not 
deploy capital very well, and that need to become a smaller 
part of the national economy over time because they are a 
source of inefficiency, but at the same time they see a need to 
fund these enterprises so people are not out on the streets. So 
it is much more in the nature of a set of transfer payments 
through nominal banks than it is normal banking activity.
    One of our concerns is that some of the reserves of those 
banks, if China were to go to an open capital arrangement, that 
people would take the capital out of those institutions, and 
they would go into primarily dollars which would have the 
opposite effect from what we are trying to seek here, that is, 
the yuan come out, they buy dollars, they drive up the value of 
the dollar. So in our conversations with the Chinese we are 
very conscious of that risk and we are talking to them about 
the need to maintain an appropriate measure of capital control 
so they do not invite these capital outflows.
    Senator Dole. I know my time has expired. I want to just 
ask one further question very quickly.
    Secretary Snow, there are a number of farm families that 
have contacted my office, people from North Carolina, regarding 
the tax treatment of the tobacco quota buy-out and the producer 
payments. The time for signing up expires--I think June 17 is 
the deadline--and can you tell me when you expect Treasury will 
promulgate its rule regarding the tax treatment of these 
payments, because there are families waiting to see that in 
terms of this sign-up deadline.
    Secretary Snow. Senator, we agree with you. It is being 
worked on, the guidance is being worked on even as we speak 
here, and I would expect it to be out very soon. We will meet 
the deadline.
    Senator Dole. Thank you.
    Chairman Shelby. Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman.
    Mr. Secretary, you do not need to respond to what I am 
about to say, but reading between the lines, it seems to me we 
concluded that manipulation in fact has been taking place but 
they have not put into place the steps necessary to make the 
adjustment in an orderly way until more recently. But that 
looking out over the next year, understanding that they made 
those adjustment, we are going to expect something more than 
lip service moving forward. That is kind of the way I 
interpreted what you had to say.
    I would like to follow on something that Senator Dole said, 
and you answered this in general. That is, how much is enough. 
You said we expected something material, to have a material 
impact on these imbalances. It strikes me that half measures 
here might be the worst of both worlds, that they could have an 
impact upon some aspects of our economy without materially 
impacting our competitive situation. So let me ask you once 
again, and I do not want to play semantic game or anything, but 
if their currency is overvalued--or undervalued rather by 25 to 
35 percent, how do we define material?
    Secretary Snow. I think, as I said, Senator, if current 
trends continue and there is not action, we have sent the 
pretty strong signal--you read us right--what the outcome would 
be. I do not want to define ``material.'' We do have people in 
private discussions with the Chinese, and those discussions are 
probably better left to the discussants. But it has to be 
enough to matter. It has to be material and significant. I do 
not want to put quantification on ``material and significant,'' 
but----
    Senator Bayh. Fair enough. I think the two--for others who 
are listening, just to strengthen your hand--superficial steps 
alone will not be enough. This issue will not be addressed 
either substantively in a fair way or otherwise until we have 
achieved something more than superficial steps.
    Secretary Snow. Absolutely. We will not accept that as 
changing the current course that China is on. It has to be 
material and significant. It has to change the adjustment 
process in a real way.
    Senator Bayh. I apologize for having to step out. There was 
a call I had to take during Senator Stabenow's questioning. I 
gather she asked you about sovereignty and our concern about 
whether our position in other negotiations was affected by our 
need to borrow from China these days.
    I would like to ask for your reaction to something. I think 
it was a month or two ago there was a rumor going through Seoul 
that the South Korean Government might begin diversifying out 
of dollar-denominated assets, and for a period of time there 
our currency fell into a free fall until the rumors were put to 
rest. Several weeks after that the Prime Minister of Japan, in 
some public comments, either inadvertent or not, said that 
perhaps Japan should start diversifying at dollar-denominated 
assets. Again, our currency went into a free fall until someone 
in the Ministry came out and corrected the record.
    What does that say about our position of financial strength 
when a rumor in another country or an inadvertent slip of the 
tongue by a foreign leader can lead to a sharp fall in 
something as important to our national well-being as our 
currency? Is that not a sign of weakness rather than strength?
    Secretary Snow. Senator, of course, those countries, China, 
Korea, Japan, have all indicated that they want to continue to 
hold and will continue to hold dollar assets and do not intend 
to diversify out of dollars. Currency markets tend to trade on 
rumors and that is the nature of these markets. They trade both 
ways on rumors.
    Senator Bayh. I appreciate that, but is it not a sign of 
our dependency rather than our strength and independence?
    Secretary Snow. Senator, no, I would not look at it that 
way. As I said earlier--I think you were out--that the 
countries that hold dollar-based assets do so because we have 
the deepest, most liquid, and most competitive capital markets 
in the world. We talked earlier of the jewels of America. Our 
capital markets are absolutely one of the great jewels. There 
is nothing else like the U.S. Treasury market anywhere in the 
world. There is no other market nearly as deep and liquid, 
where sales can occur readily. The Treasury market trades at 
over half a trillion dollars a day. So that, no, we are not in 
any way beholden, if that is the question, or is our economic 
policy or international policy being held hostage in any way. 
Those countries are holding dollars because it is in their 
interest to hold dollar-based assets.
    Senator Bayh. Is my red light on, Mr. Chairman? Thank you, 
Mr. Secretary. I would only observe that, in conclusion, I 
understand that, but sometimes great nations make decisions 
based upon something other than maximizing their financial 
well-being. It is possible that some of these countries might 
take a course of action that we would view as not optimizing 
their finances for other reasons, and that might not inure to 
our benefit. But, again, I thank you for your presence and your 
service.
    Mr. Chairman, thank you.
    Chairman Shelby. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    What has happened to the Japanese or the Chinese thinking 
from the previous report to this report here now that you are 
bringing forward where all of a sudden they are having a change 
of heart? It is not entirely clear to me how we got from there 
to here, and I would like to have you explain that a little 
bit. And then if they do not--or if they just change the peg, 
for example, and do not really go to the market, then what are 
the consequences that you see for them and what do you see the 
consequences would be for us? I would appreciate if you could 
respond to this.
    Secretary Snow. Briefly, Senator, what has changed is the 
fact that we have come to the determination that, after long 
engagement with the Chinese now, their financial system could 
accommodate greater flexibility, that it could accommodate it 
in the sense that it would not create untoward risk, systemic 
risks to their financial system, particularly if they keep 
appropriate controls on capital outflows. So that is the 
principal thing that has changed.
    We have had extraordinary involvement with them here with 
technical teams of Treasury experts in China and their teams 
over here, just lots and lots of work to make sure the 
foundation is laid for effectively implementing greater 
flexibility.
    Now, you asked what happens if they just raise the currency 
or raise the value of the peg by some amount? Going back to the 
earlier discussion, that will not satisfy the requirements here 
in and of itself unless it is material enough to get the 
currency into the alignment with underlying forces that we do 
not see today. In other words, virtually everybody who looks at 
it says the currency is undervalued under current circumstances 
by some amount.
    Now, there is a wide variety of opinion on that. The only 
way to really get the correct answer to that is to use the 
marketplace. The only way to find out what equilibrates a 
market is to let the market work. We cannot a priori determine 
what the price will be for selling hog bellies. You have to let 
a market work to determine what that is. But you can put in an 
intermediate price and see how the demand and supply forces 
adjust to that intermediate price, and maybe with a band around 
it to give some room to see whether it goes to the higher end 
or the lower end of that band.
    We want China to come up with the right answer to that. 
They are in a better position than we are to determine just 
what is the appropriate intermediate mechanism. But we want 
them clearly, Senator, on a path that takes them to the end 
result of a float, of a freely fluctuating exchange rate. That 
is the objective here.
    Senator Allard. I am going to talk a little bit about the 
distribution issue and those distribution services in China. 
Can you explain why the distribution rights are so important to 
expanding U.S. business in China and how the Treasury is seeing 
that these rights are expanded?
    Secretary Snow. We are in continuous discussions on 
financial market openings with the Chinese authorities. The 
USTR handles the general market openings and trade issues with 
Commerce. But the financial side of those discussions is 
really--Treasury has the primary role, and we are continuing to 
press the Chinese for wider opportunities for our firms, for 
foreign firms to participate in their financial markets. And 
here, Senator, we have seen some good progress. They have 
opened up an auto finance industry, anticipating that as they 
move into higher income status and more people out of poverty 
and more middle-class citizens, there are going to be more 
people buying cars, they need a finance industry. We have seen 
them open up opportunities for non-Chinese insurance companies. 
We have seen them open up opportunities for stock brokerage 
operations. So there has been a lot.
    Now, they are doing it because it is part of WTO accession, 
but they also know that it is what is important for them to 
modernize their financial structure, to bring in the capital 
and expertise from abroad. After all, this is an economy that 
has had relatively little experience with anything but command 
and control. And there is a good appreciation on the part of 
the technical people in the government, the Zhu Rongji coterie 
of people who understand the importance of letting markets 
work, of letting interest rates play a role, and having 
financial expertise and bank examiners and bank auditors and 
all of the infrastructure of a strong banking and financial 
system in place.
    So we are making progress. Is it as fast as we would like? 
No. But is it real and is it measurable? I would say yes, it 
is.
    Senator Allard. It looks like my time has expired, Mr. 
Chairman. Thank you.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Mr. Secretary, your own reports states that concerns of 
competitiveness with China also constrain neighboring economies 
in their adoption of more flexible exchange policies. I take it 
from that it is your view that China's currency manipulation is 
putting pressure on some of our other Asian trading partners to 
suppress the value of their own currencies, which would 
contribute to further deteriorating our global trade balance. 
Is that correct?
    Secretary Snow. Yes.
    Senator Sarbanes. Is a general appreciation of Asian 
currencies plausible without a substantial appreciation of the 
Chinese currency?
    Secretary Snow. No. I think large parts of Asia are linked 
competitively to China, and that means to the yuan.
    Senator Sarbanes. If China moves in a substantial way, will 
the Treasury raise the issue of currency manipulation with 
other Asian countries, particularly Japan, Taiwan, and South 
Korea?
    Secretary Snow. Senator, we are in discussions with 
countries all through that region about what we think is the 
appropriate policies for FEx, for currency, and yes, 
absolutely, if we see countries that are not pursuing the 
appropriate policies, we will engage with them, absolutely.
    Senator Sarbanes. I am interested to get some sense of the 
extent to which the current account deficits matter. Your 
predecessor was rather dismissive of the current account 
deficits. To finance our current account deficit, the United 
States borrowed $666 billion last year from abroad, more than 
5.5 percent of our GDP. You only have to go back to the early 
1980's when the United States enjoyed a sizable international 
credit position with the rest of the world worth 12 percent of 
our GDP. We were a very strong creditor nation. Now we are the 
world's largest debtor nation.
    In his annual letter to shareholders, Warren Buffett 
recently wrote: ``Should we continue to run current account 
deficits comparable to those now prevailing, the net ownership 
of the United States by other countries and their citizens a 
decade from now will amount to roughly $11 trillion. And if 
foreign investors were to earn only 5 percent on that net 
holding, we would need to send a net of $0.55 trillion of 
goods''--over half a trillion--``and services abroad every year 
merely to service the U.S. investments then held by foreigners. 
This annual royalty paid the world, which would not disappear 
unless the United States massively underconsumed and began to 
run consistent and large trade surpluses, would undoubtedly 
produce significant political unrest in the United States.''
    What is your view of this potential situation?
    Secretary Snow. Senator, as I have said, we think that 
there are important imbalances in the global economy that need 
to be addressed. We have tried to put in place a constructive 
framework for doing so. It is a framework that we have put in 
place with the G-7, for instance, with the IMF. Rodrigo Rato, 
the Managing Director of the IMF, and I talk about this 
regularly. We talked about it yesterday morning and yesterday 
night, actually. That framework, though, it is awfully 
important to understand this. This framework involves others 
besides the United States, in addition to the United States. It 
involves the United States. We absolutely have to bring our 
deficits down, reduce our net dissavings through governmental 
policies. We absolutely have to raise household savings rates.
    But other parts of the world need to do things, too. They 
need to pursue policies that will create larger domestic 
economies that will absorb more of their savings. They need to 
develop policies that will make their economies more productive 
and innovative so that our goods will find more of a market. 
And China and Asia needs to move to flexibility. That 
combination of things I think will restrain the growth and 
eventually turn the corner on the current account deficit.
    But it is something we follow and monitor very closely, and 
we have tried to put in place a constructive--we and the other 
finance ministers and central bank governors from major parts 
of the world have tried to put in place a framework to deal 
with it.
    Senator Sarbanes. There is some concern that the shift in 
the Treasury's position is in part a move simply to forestall a 
gathering momentum in the Congress to pass limitations that 
would affect the United States-China trade, and that the 
Administration, if they could get some relatively minor 
adjustment in the peg rate--I mean, I see these preposterous 
figures being talked about in some articles of 5 percent, and I 
see the Chief Economist of the China International Capital 
Corporation says it remains too risky to relax the peg too 
much, so China may well start from a 5-percent revaluation. The 
Chief Economist of Galaxy Securities in China says, ``The 
making of decisions in China is mostly consensus-based, so that 
might lead to a compromise of a 3- to 5-percent rise in the 
renminbi's value.''
    It seems to me that thinking in those terms it completely 
misses the mark. I do not see how you begin to address this 
problem if that is the framework in which it is being thought 
about.
    I noticed the European Central Bank President has now 
explicitly stated publicly, calling in unusually frank 
language--this is an article in the Journal--for China to allow 
its currency to appreciate against the U.S. dollar and, 
therefore, the euro in a bid to damp the surge in Chinese 
exports. I think many of us see this as approaching a crisis 
status, and the magnitude of what is being talked about, at 
least in some circles, seems totally inadequate to the problem.
    What is the Treasury's view about that?
    Secretary Snow. Senator, our view is, as stated in the 
report, that this adjustment has to be material and has to be 
significant, has to be something that will significantly close 
the gap between the current value and a more appropriate value.
    As I said earlier, we have a very able representative of 
the Treasury Department like you and Senator Schumer, a fellow 
graduate of the Harvard Law School--where I guess you learn a 
lot about negotiations--in China right now dealing with the 
Chinese authorities. He is diplomatic, but he is plain-spoken, 
and he is real smart and he knows how to get ideas across. I am 
confident that there will be no misunderstanding that when we 
say material and significant and significant step on the path 
to flexibility, that he will convey what needs to be conveyed.
    Senator Sarbanes. Mr. Chairman, could I close with just one 
final observations?
    Chairman Shelby. Sure, go ahead.
    Senator Sarbanes. Under the first Bush Administration, the 
Treasury Department twice found that China was engaged in 
currency manipulation. In both instances, China was running a 
trade surplus of about 3 to 3.5 percent of GDP against the 
United States as compared to the 9.8 percent it ran last year, 
just under 10 percent. Back then, in the early 1990's, China 
had a global current account surplus of around $13 billion. Of 
course, we saw earlier what the figures are now. They are 
astronomical. And that does raise the question--and I am not 
seeking an answer. I state it as a rhetorical question. If 
China was manipulating its currency under those circumstances, 
how can we possibly find that it is not engaged in manipulation 
now?
    I would pursue with you what these technical items are that 
you say have forestalled you from finding--our current 
technical requirements from finding currency manipulation now, 
but I think it is clear this issue is not going to go away. I 
think the Congress will continue to press it, and press it very 
hard. And in some respects, the most direct thing that Congress 
can do is this legislation that some of my colleagues have put 
in which would affect the duties on the flow of goods into this 
country. And obviously there is considerable support in the 
country for such a measure.
    Let me see if I can find it here real quickly. The 
President of the National Association of Manufacturers said, 
``If this is not currency manipulation, then what else would 
ever qualify?''
    I will leave that question with you. Thank you, Mr. 
Chairman.
    Chairman Shelby. Senator Hagel.
    Senator Hagel. Mr. Chairman, thank you.
    Secretary Snow, welcome.
    Secretary Snow. Thank you.
    Senator Hagel. I know we are talking this morning about 
currency exchange rate policy and that is the object of the 
hearing. But I do not think, as has been evident in our 
exchange this morning, that we can talk about currency and 
exchange rate policy in a vacuum. The fact is, as you know so 
well, we are part of a global marketplace. We are part of a 
world trading regime. Currency is a big part of that, an 
important part, but there are many other dynamics that flow 
into that.
    I have been over the last few months concerned that we have 
focused so totally on currency that we are missing some of the 
other big pieces here. You had noted not only in your statement 
by in conversations that we have had privately and other 
opportunities you have had to talk about this issue, and 
realizing, as you have said this morning, that you are not the 
Trade Ambassador nor the Secretary of Commerce, but you are 
integral to the larger picture of trade.
    I would like to take the time I have, Mr. Secretary, to ask 
you to delve into, for example, internal reforms that you all 
have been working on with the Chinese, banking reforms, 
transparency, Senator Allard talked about distribution rights, 
intellectual property issues, opening up more opportunities for 
our financial services to compete and participate in China. But 
it seems to me we may be missing a point here. We are so 
focused--not everyone--on the currency and the exchange rate 
that we are letting all the other bigger issues in one sense 
and far more reaching with far more significant long-term 
policies and consequences in currencies, that we are not maybe 
paying enough attention to those, like getting our medium and 
small businesses into China and doing everything we can to 
break down those walls, to your point the growth of America's 
economy. Every conversation we have had this morning is about 
that, sustaining and strengthening that growth.
    Yes, at this point in the marketplace and in our history, 
we are running deficits. Those are not good, and you noted 
that. And, by the way, I think you and the Administration 
deserve some credit for a lot of the things that you are doing 
under the radar that do not get the attention and the 
headlines. But you are setting a baseline here that is very 
important for, I think, the one issue here that we are not 
paying attention to, and that is America's future competitive 
position in the world. That is complicated because it enlists 
many dynamics, and many of those are uncontrollable.
    But let us go back to something fundamental. We are in a 
world marketplace. Trade is not a guarantee. Trade is an 
opportunity. And we have everything at stake here. And so the 
blips in the currency and the exchange rates quite frankly do 
not bother me. What does bother me is that I want to be 
assured--and I think we all do, and America needs to be--that 
we are doing what we need to do, is open up those markets for 
American competitive positions and our products.
    With that, would you care to respond to any of that, Mr. 
Secretary? Thank you.
    Secretary Snow. I would, Senator Hagel. Thank you very 
much.
    I could not agree with you more. This is about a lot more 
than the currency. Currency is an important component, but it 
is far from the whole story. I think China will move to a 
flexible currency because they are going to find it is in their 
own interest to do so. But if that is all that happens and we 
do not get market openings to let our firms go in there, and 
then if when our firms get in there they get knocked off and 
their products counterfeited so they cannot succeed, we have 
not accomplished very much.
    So while the currency is important and we are going to 
continue to press it, the activities of your former colleague, 
Congressman Portman, now Ambassador Portman, are right at the 
center of this, and Commerce Secretary Carlos Gutierrez, and 
you may know that the three of us, with the NEC, meet regularly 
to make sure we have a strong, well-formulated, well-conceived, 
and clearly understood among us policy, the end product of 
which is you have to play by the rules. You have to play by the 
rules. And the rules are you are in our markets, we need to be 
in your markets. We do not rip off your public sector, we 
respect intellectual property rights, you have to respect 
intellectual property rights.
    I think you are going to see continued, forceful 
communication of those basic ideas with the Chinese and with 
the whole trading world, because it is not just China, but they 
are the largest single example of a place where the policies 
need to have major reforms.
    So, I agree with you. We are going to continue to press on 
the currency issue, but others are going to press on the other 
issues, and I will press on these financial market openings 
because many of Senator Schumer's constituents, I know, are 
very interested in being in China. They come and talk to me 
about it and ask for our help in making sure that the weight of 
the U.S. Treasury is there to press for market openings, and we 
are delighted to do that.
    Senator Hagel. Mr. Secretary, I would just add, with the 
indulgence of the Chairman, I think the Olin Wethington 
appointment was a very good one, and I congratulate you on 
putting someone like him who understands the real world in that 
position so that it gives us not just a monitoring position by 
an active participant in this process to do the things that you 
and your colleagues are attempting to do.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Secretary, welcome. How are you doing?
    Secretary Snow. Fine, sir. Nice to see you.
    Senator Carper. Very nice to see you.
    I apologize. As you can see, now I am here. We have a lot 
of different hearings we are trying to get to, and this is the 
third I have stopped by. I have one to go this morning.
    I was just going to ask you to just take a minute or two 
and just show us in a couple of takeaways that you want to be 
absolutely sure that we walk out of here being aware of. And 
underline and put an exclamation point at the end of them for 
me.
    Secretary Snow. Senator, the big takeaway from our report 
is China is ready to move to a much more flexible exchange 
rate. They have prepared the way, and now is the time for China 
to act. If China stays on the course they are on today, without 
major alteration, then we will have little option but to find 
them as a manipulator under the technical requirements of the 
statute. That, I think, is the large message of our report.
    Senator Carper. Even if that were to happen, how 
significantly would that affect the imbalance that we now have 
in trade?
    Secretary Snow. The trade imbalance with the global 
economy, I think, would be affected significantly over time if 
China moves to a flexible exchange rate that reflects the 
underlying conditions, allows the market to set it overall, 
because I think their movement would affect currency valuations 
with their competitors, who very much watch what China does, 
and that would lead to adjustments which I think would be 
favorable for our balance of payments and for our current 
account.
    With China itself, I think there would be a healthy 
adjustment process. But I think for the foreseeable future we 
are going to have a trade imbalance with China. I do not think 
that moving to a flexible exchange rate is going to eliminate 
our trade imbalance with China, but it would help the overall 
adjustment process.
    Senator Carper. If our trade imbalance with China were 
somehow magically eliminated altogether, do you have any idea 
what our trade imbalance with the rest of the world would be 
now?
    Secretary Snow. Well, it depends how it gets eliminated. If 
it gets eliminated because China revalues, moves to a flexible 
exchange rate and their currency goes up, and then the exchange 
rates of their competitors go up, then of course the United 
States is being put in a better position. That would narrow our 
trade deficit not only with China, but also with large parts of 
the rest of the world. So it would be a positive development.
    Senator Carper. Do you know, when we try to quantify our 
trade imbalance from last calendar year, do you recall what it 
was with the rest of the world?
    Secretary Snow. Yes, we were $500 billion or so.
    Senator Carper. And roughly how much of that was 
attributable to China?
    Secretary Snow. Last year, it was around $100 billion.
    Senator Carper. So if we eliminated it altogether, we would 
still have a trade imbalance of over $400 billion?
    Secretary Snow. Well, that is right, Senator, that--China 
is a part of the trade imbalance. They are roughly $160 billion 
on $700 billion--or $680 billion. So they are a significant 
part, but they are not the whole story.
    Senator Carper. When you look at the imbalance with China, 
has it been growing in recent years? It has, hasn't it?
    Secretary Snow. Yes, it has.
    Senator Carper. When you look at the imbalance with other 
parts of the world with whom we trade, what is going on in 
there? Are those imbalances growing as well? Are some stable, 
others growing, some dropping?
    Secretary Snow. Well, the picture with Asia is general 
imbalance; it has been rising. The picture with Europe is a 
slower rate of rise of an imbalance.
    Senator Carper. How about Canada, Mexico, the people to the 
south of us?
    Secretary Snow. We have a better trade picture with them 
than we do with Asia, that is for sure.
    Senator Carper. You have probably already talked about this 
and you may have said this in your testimony. I hear from a 
growing number of people, not just in Delaware but around the 
country, who are past unease to a growing sense of concern, 
even alarm with the magnitude of our trade deficit and the 
magnitude of our budget deficit. And I am hearing people say to 
me these are just not sustainable; this level of trade 
imbalance and budget deficit are not sustainable.
    As you look forward down the road and you project ahead, 
what do we see for this year or next year, maybe the year 
beyond?
    Secretary Snow. I think we see a pretty good picture on the 
fiscal deficit. The numbers that just came in for the April tax 
receipts showed a very sizable pickup in Government receipts, 
well over 20 percent over the prior year quarter, causing us at 
Treasury to conclude that we could reduce our borrowings by 
some $40 billion or $45 billion, causing the private sector 
forecasters to bring the deficit well down below the initial 
forecast of $427 billion to about--well, they vary, but in the 
$350-360 billion range, which would put us at around 3 percent 
of GDP and, I guess, make us eligible to be a member of the EU, 
since they have a 3 percent rule there.
    With respect to the current account deficit, the numbers we 
had last month on trade imbalances were encouraging. Imports 
were down and exports were up. One month does not make a trend, 
but it is at least positive to have those numbers coming in 
that way. The revised growth numbers for the first quarter, 
which went up from 3.1 to 3.5, reflected stronger exports and 
also reflected higher productivity and more people working.
    So, I think the receipts side of the U.S. Government is 
going to continue to show good results, which means we will be 
on path to bring the deficit down, as suggested in the budget 
materials we sent up earlier this year, to a level by 2009 of 
well below 2 percent of GDP, something on the order of 1.5, 
1.6--which of course was quite low by historical standards. We 
are on the right path there.
    Senator Carper. Thank you very much again for being here. I 
will just conclude to my colleagues that I believe the numbers 
that Secretary Snow has shared with us on the declining budget 
deficit assume, really, no further outlays with respect to 
Iraq. And I think they presume that we are not going to do all 
that much to fix the problems we have with the Alternative 
Minimum Tax and some of the other tax issues that are staring 
at us down the road.
    But thank you so much. It is great to see you.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    A few quick comments on the discussion that has gone 
before. Many of the goods we currently import from China we 
used to import from other countries. And China, as it has 
become more productive, has not been stealing jobs from the 
United States; they have been stealing jobs from Mexico and 
Singapore and Malaysia and other places. So we should 
understand that. This is not just the United States vis-a-vis 
China, it is China's growing power in the world taking over 
other jobs--or other goods, I should say, not jobs--other goods 
that used to come from other countries that are now losing out 
to China. We are not losing out to China. I think we should 
make that clear as people talk about, gee, China is now sending 
us so much more than they used to. It is not a sum zero game 
with the United States. There are other countries that are 
affected more than we are.
    Let us get back to the whole question of the currency 
adjustment that you have been talking about this morning, Mr. 
Secretary. It has always been my impression that if China is 
going to be a full player in a mature world economy, they are 
going to have to play by the same rules that the other 
countries do. So it is in China's long-term interest to let 
their currency react to the rest of the world economic 
pressures the same way other countries let their currencies. 
The problem is that they feel it is in their short-term 
interest not to do that. And it seems to me, therefore, that 
the problem that the Chinese decisionmakers are faced with is 
when do we shift from a short-term strategy to a long-term 
strategy. And the longer they wait, the greater the disruption 
that occurs both in their situation and in the rest of the 
world's.
    To use a term that is used in other contexts, we need to 
find a soft landing for them--or they need to find a soft 
landing for themselves, to be more accurate about it, because 
we cannot control what they do. However much we tell our 
constituents during campaign time that we Senators control all 
events all over the world and if you just vote for me all of 
the world will be marvelous, that campaign fiction does not 
hold up when we come into the world. It is in their interest to 
find a soft landing when they can make the transition from the 
short-term advantage that they think they get from manipulating 
the currency to the long-term advantage that they get when they 
join the world like the rest of the countries in the world. And 
I gather from what you are saying today, they are beginning to 
move toward that soft landing and recognizing that it is in 
their self-interest to do the kind of thing we have been urging 
them to do.
    Can you give us a sense, without violating any of the 
sensitive information that might be coming out of the 
negotiations that are going on in China, as to whether or not 
they recognize the accuracy of what I have just said and if 
they have any sense of how quickly they want to get to a regime 
that is more logical for their long-term goal of being a full 
trading partner?
    Secretary Snow. Senator Bennett, I think you have well-
defined the dialogue that is going on in China now. The 
technical people, the people at the academies, and the people 
at the financial institutions, the Ministry of Finance and the 
Central Bank, in my view from conversations I have had, clearly 
understand that it is in China's own interest to move. But they 
do not make that final decision. The final decision is the 
political decision through the State Council.
    Senator Bennett. That is what is wrong with China: The 
final decision is made still in a communist atmosphere rather 
than a free market atmosphere.
    Secretary Snow. And I think that debate is going on right 
now. In my meetings with the Chinese political leadership, I 
have emphasized that--what you said: It is in your interest to 
move; failure to move will build up these imbalances and 
distortions in your own economy. Because after all, what having 
a peg means is that they have surrendered control over their 
own monetary policy and they no longer have a monetary 
authority that can lean against the winds of inflation or 
deflation, so these imbalances cannot be dealt with except 
through command and control, not through market processes, 
which always introduces the distortions you are talking about.
    Olin Wethington is going to continue every day to be making 
that case, that it is in your interest to move and the longer 
you wait, the larger the distortions. And I am convinced that 
the momentum is all on the side of a decision that will put 
China much more in the mainstream of a flexible currency 
regime.
    Senator Bennett. If I might just quickly, Mr. Chairman, a 
final observation. As I look around the world, I see economy 
after economy, including the European Union, that is being 
structured for export. These economies are not growing as 
rapidly as the United States'. As you have noted Mr. Secretary, 
we are growing at 3.5 percent, maybe even higher, through this 
year. There is not an economy of substance anywhere in the 
world that is anywhere close. Which means we are carrying the 
rest of the world. And they structure their economies for 
export, and we are the only place where the economy is 
structured for consumption.
    And somehow, somewhere down the line, as you have said here 
repeatedly and I want to underscore, the other economies in the 
world had better start consuming because the United States, no 
matter who is President or who is Secretary of the Treasury, 
cannot, long-term, carry the rest of the world with us. We have 
to increase our savings and the other countries in the world 
have to increase their consumption if we and they are going to 
prosper. If they depend upon us ultimately to consume their 
goods in perpetuity, we are not going to be able to do that.
    So whatever we can do to get them to understand that--as I 
say, the Europeans are going down this same road. This is not a 
Chinese conspiracy against the United States or a Japanese 
conspiracy against the United States. They have to start 
consuming themselves and then create a rate of growth, maybe 
not approaching the United States' rate of growth--China, of 
course, is higher than we are, but the base is so much lower 
that it is distortive to look at the two growth rates and make 
that comparison. The other countries in the world have to 
recognize that in a period of globalization or an economy 
without borders, they cannot expect and it is not in their 
self-interest long-term to try to have the United States being 
the only consuming economy in the world. And our rate of growth 
that makes it possible for us to consume must be tempered by a 
rate of growth elsewhere. This is not a partisan issue or a 
Republican-Democrat issue; this is something that all of the 
world economies have to understand and work toward.
    Thank you, Mr. Chairman, for your indulgence.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    I still am a little confused about how we stand. As you 
know, I have appreciated the movement in the new report. But 
here is what I would like to know. It is both a prospective and 
retrospective question.
    First, what has China done differently over the last 6 
months--you have said there is progress--that has moved it 
closer, in your view, to the statutory definition of 
manipulation? What is this progress--or not progress, what is--
I mean, in other words you say there is progress, but the 
report seems to be more harsh on the Chinese than the previous 
reports.
    Secretary Snow. Senator, there is one----
    Senator Schumer. And the second, which is prospective. Let 
us say they do not change anything over the next 6 months. How 
can, then, they be found to be manipulating if they are not 
manipulating now? You know, my view is simple: They are 
manipulating now and you just did not want to say it for some 
diplomatic/political reason--that may not have bad motivation; 
I am not denying that. But I am a little confused. What was 
different 6 months ago that--what they do worse, and what do 
they have to do to get better? What if they do not change? 
Because I do not think they have changed at all, except in 
verbiage, which matters nothing to trade.
    Secretary Snow. Senator, what has changed, of course, is 
that surpluses have become larger.
    Senator Schumer. That is an effect, not a cause, of what 
they are doing.
    Secretary Snow. And the reason that we are now prepared to 
act as we suggested in the report is that, whereas in prior 
reports we did not see them fully ready to move to substantial 
flexibility, we now see them ready to do it. Their financial 
system can accommodate flexibility.
    Senator Schumer. So the lack of progress, given their 
ability to progress, is what makes it worse.
    Secretary Snow. Exactly.
    Senator Schumer. And so you could say that 6 months from 
now, if they did nothing, you might be ready to call them 
manipulators. I did not say you would, but could.
    Secretary Snow. Could. That is right.
    Senator Schumer. Well, that is important and I appreciate--
--
    Secretary Snow. You have hit on precisely the distinction.
    Senator Schumer. So it is somewhat normative. It is not an 
absolute standard.
    Secretary Snow. No, this is a standard that is somewhat----
    Senator Schumer. It is based on what the Chinese are able 
to do.
    Secretary Snow. Right.
    Senator Schumer. Okay. The next question is, let us say 6 
months from now they are officially designated a currency 
manipulator. And let us hope that does not happen. Let us say 
they take action on their own. What specific actions would this 
Administration take to get China to change its practices? You 
can ask me that question, I will tell you what I would do. But 
I am now asking you that question.
    Secretary Snow. I think you and I would have different 
answers to that question.
    Senator Schumer. I think so.
    Secretary Snow. I do not think it is helpful to speculate 
on what they are going to do.
    Senator Schumer. What you are going to do if they do not 
change.
    Secretary Snow. What we are going to do. Except I will 
speculate on what they will do. I think we are going to see 
action by China--and I may have to eat those words in 6 months 
if you invite me back.
    Senator Schumer. Oh, well, we are going to have you back. 
We would be delighted to do that.
    [Laughter.]
    Secretary Snow. But I fully anticipate that before I 
return, before we conclude the next report, that we will have 
seen the action by the Chinese that we are calling for.
    Senator Schumer. A second question relates to interest 
rates and the pegging of the yuan. Some have expressed concern 
that if China revalues the yuan, interest rates here in the 
United States. may rise. This is the same--I mean, people make 
such arguments. First they say, well, you should only make them 
increase it 5 percent, and then that will not change the trade 
deficit very much. I mean, you know, it is beggar thy neighbor 
arguments. Because we do not--5 percent will not be good enough 
for me and, I think, most of my co-sponsors on the legislation. 
Again, it does not have to be moving it immediately, but they 
have to begin to move soon and have a path for movement with a 
set date.
    So they now are saying, oh, interest rates will go up. Now, 
excluding Social Security, the U.S. budget deficit approaches 
$600 billion this year, once the new war costs are added; our 
current account deficit is already over $600 billion, as you 
have noted. A large and rising trade deficit combined with 
large budget deficits reduces global confidence in U.S. assets, 
which could cause asset prices to fall and rates to rise. In 
other words, doing nothing might also raise interest rates 
because people are getting more and more upset--who knows when 
you reach the tipping point--about inaction. So that is why I 
think your new currency report says the risks of delay outweigh 
the costs of reform.
    So, I would like you to explain this further, particularly 
as it relates to domestic interest rates.
    Secretary Snow. Senator, I do not think we need fear much 
at all on the interest rate issue. After all, treasuries trade 
daily at over half a trillion dollars.
    Senator Schumer. Right. Exactly.
    Secretary Snow. What we are talking about here is small 
relative to the volume of trading.
    Senator Schumer. No, people who just do not like our 
proposal do these arguments. But I agree with you. They can 
say, oh, it will not change the trade deficit much, but it will 
change interest rates much. That is contradictory. The 
percentage of Chinese action as a whole of our trade deficit is 
a lot greater than the percentage of Chinese action as a whole 
of our interest rates measured by treasury trades.
    Okay, I have an unrelated question, which I would like to 
ask you since I am the last questioner even though I wasn't the 
last to be here.
    [Laugher.]
    Chairman Shelby. I think you left.
    Senator Schumer. No, whoa, whoa, whoa, whoa. Okay, in any 
case, I am happy to spend more time with you all.
    This is about terrorism insurance, which is on our minds, 
and there is a deadline coming up so I thought I would, while 
you are here, take advantage.
    We are just a little over a month away from the Treasury's 
deadline to submit the terrorism risk insurance report to this 
Committee. As you know, many of my colleagues and I would like 
to see it submitted as soon as possible. We want to get a bill 
extending TRIA right away. I can tell you not just in New York, 
which is the epicenter for this, but in other areas, you are 
having projects now slow down, something none of us want. The 
ratings agencies have told the reinsurers that they will not 
give ratings unless we have a bill for future years, so you 
cannot plan a project that might go into the ground or need its 
money come January 1. And as you know, these large real estate 
projects cannot be turned off and turned on.
    So we really need to renew our bill. And certainly, whether 
people agree or disagree with our bill, to make a decision soon 
makes sense so business people can plot their actions. How 
close are we to completing the report? Is it possible to get it 
before June 30, because our schedule, if we got it a little 
earlier, maybe we could pass a law by July 31, when we recess 
for a month.
    Secretary Snow. Senator, thanks for raising that important 
issue. I am reviewing now the final version of the report. It 
looks good. A lot of work has gone into it. It is my 
contemplation and certainly hope that we will have it well in 
advance of the June 30----
    Senator Schumer. That is great news. Thank you.
    I am going to conclude on that happy note, Mr. Chairman. 
Thank you, Mr. Secretary.
    Chairman Shelby. Secretary Snow, to use a football 
metaphor, I think you were driving down on, you probably had a 
first down on China's 20-yard line. And instead of keeping on 
going and perhaps reaching the obvious conclusion in your 
report, you elected to punt. I hope you will not continue to do 
this.
    We are inviting you now and we will continue to invite you 
back in October, because we think this is a very important 
issue. And it is very complicated, we all know that. But just 
about everybody in the world recognizes that China is, has 
been, and will probably continue to manipulate its currency 
because it gives them certain advantages.
    The question is, when are we going to recognize that. And I 
hope you will. I hope you will if you have to, because if you 
come up here in 6 months and China has not done anything really 
material to make their currency flexible, then I think the 
Administration will lose a lot of credibility in that area.
    Secretary Snow. Mr. Chairman, I thank you for that. And 
with Senator Schumer leaving and you here, and your analogy to 
the football field, let me say----
    Chairman Shelby. Senator Schumer might come back. He is a 
busy man.
    Secretary Snow. No, I want to say one last thing in 
response to that football analogy, and that is we have a player 
we would like to put on the field, a quarterback for this 
initiative, Mr. Tim Adams right here, who has had his hearings 
to be the Under Secretary for International Affairs. If we had 
him on the field, I think our chance of throwing touchdowns 
would be a lot better.
    Chairman Shelby. We have you on the field, though. You are 
the Secretary.
    Senator Schumer. Mr. Chairman, he is the general manager 
and President Bush is the owner.
    Chairman Shelby. Absolutely.
    Secretary Snow. Here is our quarterback.
    Chairman Shelby. We understand.
    Secretary Snow. Thank you, Senator.
    Chairman Shelby. Thank you.
    The hearing is adjourned.
    [Whereupon, at 12:12 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]

            PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER

    I appreciate the opportunity to continue to discuss with the 
Secretary the issue of China's undervalued currency and its general 
unwillingness to play fair in the global economy--or its pattern of 
playing by the rules only when it suits their purposes. The 
Administration's strategy of ``quiet diplomacy'' has yielded few 
tangible results, and it is time for our Government to take more 
specific action.
    Secretary Snow, as you know, I have long been concerned with 
China's long list of misdeeds--currency manipulation, violation of 
intellectual property laws, limitation of access to their markets, and 
subsidizing Chinese companies--misdeeds that also happen to be serious 
violations of WTO rules.
    We have lost a lot of jobs here in the United States because of 
these actions--but the problem goes beyond job losses. It remains a 
mystery to me how those who claim to support free trade can stand so 
idly by while one of the fastest-growing economies in the world so 
willfully flouts the rules.
    Simply put, if you believe in free and fair trade, you should want 
the Chinese to play by the rules, and you should want their currency to 
float. The ``invisible hand'' at work, so to speak. I was glad to see 
in your testimony that the Administration now supports a gradual shift 
toward a full float in China. The question is, how do we push them to 
get there?
    I have been working with my colleague from South Carolina, Lindsey 
Graham, to try and level the playing field with China on the currency 
issue. We introduced an amendment on China currency during 
consideration of the State Department Authorization Bill a few weeks 
back, and to our pleasant surprise, two-thirds of the Senate voted with 
us--including half of the Senators of your party, Mr. Secretary. This 
sends a clear signal to the Chinese to shape up. We have been promised 
an up-or-down vote on our bill before August recess.
    It would be preferable, rather than imposing tariffs, for the 
Chinese to act on their own. That is what we hope will happen. But our 
bill sends a clear signal to the Chinese that if there is not some 
movement on their part, the U.S. Congress will act.
    Your report was the first time that the Bush Administration has 
called Chinese currency policies ``highly distortionary,'' but it still 
falls short of finding them guilty of actual ``currency manipulation.'' 
It is unclear to me and Senator Graham what else the Chinese would have 
to do--or not do--to have the Administration finally find them guilty 
of manipulation. You have stepped up to the plate, now it is time to 
swing the bat.
    To help you along, Senator Graham and I have also reintroduced our 
bill that would define currency manipulation for you, thereby making it 
easier for Treasury to take decisive action.
    Mr. Secretary, I look forward to the opportunity to ask you some 
direct questions about China and the currency report. Thank you, Mr. 
Chairman.

                               ----------

             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

    Chairman Shelby, thank you for calling this hearing. I want to 
welcome Secretary Snow and say that I cannot think of a more pressing 
issue facing our manufacturers and farmers. It is now on par with 
healthcare costs as an item that is crippling economic growth in this 
country. So, I appreciate that you have made yourself available to us, 
Mr. Secretary.
    I will tell you up front that I am deeply disappointed with the 
Treasury report released last Tuesday. I believe that the Treasury 
Department has failed to do what is right and obvious as the report 
relates to China and Japan. The report states that no country met the 
technical requirements of the law governing manipulation. Most 
economists agree that China's currency is undervalued against the 
dollar so it is difficult to see why the Treasury Department is 
unwilling to state the facts. In fact, given the clarity of the problem 
I am led to believe that something other than facts are driving this 
reluctance to find violations.
    Is it that we fear retaliation by the Chinese and Japanese on our 
goods and services? Is it that our Government is reluctant because of 
our dependency on those two nations to shoulder our budget deficit?
    Many of us have warned the Administration that continued large 
budget deficits would eventually limit our ability to address trade 
problems--and here we are . . . the day has arrived.
    I am certain that much of the discussion today will focus on China, 
but Japanese manipulation is a problem that we cannot lose sight of. In 
Michigan where auto manufacturing makes up such a large portion of our 
economy, Japanese manipulation is a major concern and I will be doing 
everything I can to make sure that it is addressed.
    The decision by the Treasury Department to again go easy on China 
and Japan will cost the State of Michigan jobs at a time when 
unemployment remains staggeringly high. Last month the United States 
gained 274,000 jobs. Despite this fact, Michigan added another 7,500 to 
our unemployment rolls. Specifically, China's currency policies have 
cost the U.S. economy 1.5 million jobs over the past 15 years--and 
51,000 of those jobs were lost in Michigan. And, these job losses are 
damaging diverse sectors of our economy, from auto manufacturing, apple 
juice, and auto parts, to furniture and boat manufacturers.
    The response that the report gives to these facts is that the 
Treasury Department is ``continuing to engage actively with economies 
to encourage, in both bilateral and multilateral discussions, flexible, 
market-based exchange rate regimes combined with a clear price 
stability goal and transparent system for adjusting policy 
instruments.'' For those of you here that find that statement murky, 
you are not alone. What it means, of course, is that Treasury is 
talking to the Chinese and Japanese. If talk would make this problem go 
away, it would have been solved years ago.
    The Treasury Report dedicates one sentence out of 17 pages to the 
negative effects of currency manipulation on U.S. workers. But, 
repeatedly describes why manipulation would be bad for China. First, 
let us be clear about it--currency manipulation kills American jobs and 
it is illegal under WTO and IMF obligations. Even, foreign exchange 
markets are sending clear signals that China, in particular, should 
revalue its currency.
    I believe that there is a strong case for pursuing action against 
China in both the WTO and the IMF. China's exchange rate policy 
frustrates the intent of the WTO and can be viewed legitimately as 
providing an illegal subsidy to exports and imposing an illegal tariff 
on imports. Also, its persistent one-sided intervention in foreign 
exchange markets flies-in-the-face of the rules governing membership in 
the IMF. Mr. Secretary, we need to crack down on countries like China 
and Japan and make sure they are playing by the rules.
    I, along with Senators Graham and Bayh, have recently introduced 
legislation that would create a Chief Trade Prosecutor within the 
Office of the U.S. Trade Representative to police our trading partners 
and protect our manufacturers from unfair trade practices like currency 
manipulation. In fact, the type of case this office should bring 
immediately is a WTO case against countries that manipulate their 
currency. It does American workers no good to have trade agreements 
that are not enforced.
    One outcome that would effectively address my concerns with this 
currency problem would be for China to revalue its currency 
substantially upward. And, for Japan to immediately stop intervening 
(verbally or otherwise) on behalf of the yen. Absent this, a legislated 
tariff on imports is a potential course of action.
    The bottom line is that we cannot continue to set on the sidelines 
while our trading partners continue to artificially control prices, 
look the other way when it comes to enforcing intellectual property 
rights, and fail to live up to all of their obligations under WTO and 
IMF rules.
    Mr. Secretary, I hope that you will take this opportunity today to 
provide a constructive path for the United States on this issue. Last 
week's report fell short in my opinion. And, unless some concrete steps 
are immediately taken to stem this problem, I am confident you will see 
the Schumer-Graham currency bill pass the Senate in July.
    I would like to avoid that outcome in lieu of some other remedy, 
but unless you offer a third way, what we are left with here is the 
lesser of two evils. We either allow China and Japan to continue to 
manipulate their currency and destroy our domestic job base or we take 
matters into our own hands and level the playing field through tariffs.
    Mr. Chairman, thank you. I am looking forward to our discussion on 
this issue.

                               ----------

                   PREPARED STATEMENT OF JOHN W. SNOW
               Secretary, U.S. Department of the Treasury
                              May 26, 2005

    Chairman Shelby, Ranking Member Sarbanes, Members of the Committee, 
it is a great pleasure to appear before you to testify on the Treasury 
Department's latest report on ``International Economic and Exchange 
Rate Policies.''
    The May 2005 Report encompasses a period of strong global economic 
performance, which reflects both great opportunity and challenge. The 
global expansion remains robust, more so than in many decades.
    Addressing imbalances in the global economy is a shared 
responsibility among the major economic regions of the world. While 
imbalances occur as the patterns of trade and investment flows shift 
between economic regions, uneven rates of growth in the major economies 
and inefficient or distortionary policies restrict adjustments and put 
stress on the global financial systems. Economic policymakers must 
address these imbalances now; waiting increases the risk that 
adjustments will occur abruptly.
    We know that the international economy performs best when large 
economies embrace free trade, the free flow of capital, and flexible 
currencies. Obstacles in any of these areas prevent smooth adjustments. 
At best, such obstacles result in less than maximum growth; at worst, 
they create distortions and increase risks.
    The United States is doing its part to address imbalances by 
aggressively tackling our fiscal deficit and our long-term liabilities. 
Because of strong growth and appropriate fiscal policy, the U.S. budget 
deficit in 2004 was well-below projections, and with recent data, I 
expect improvement in our fiscal deficit position this year as well. 
Some private forecasters predict that our fiscal deficit will be below 
3 percent of GDP this year if we continue to hold the line on spending. 
We are also working to put in place innovative policies to increase the 
savings rate. But our actions alone will not be sufficient.
    I expect strong economic growth in the United States to continue. 
This is in the U.S. interest, and the world's. It is an essential 
component of our deficit reduction strategy as strong growth results in 
rising government receipts, as we have been seeing. But it is important 
to recognize that there is also no one-to-one correspondence between 
reductions in our fiscal and current account deficits. We do not, and 
will not, have a current account target. The best contribution the 
United States can make to our own people and the global economy is to 
keep our economic house in order and ensure continued strong growth.
    Our actions alone will not be sufficient to unwind global 
imbalances. Simply put, large imbalances will continue if growth in our 
major trading partners continues to lag. European and Japanese GDP 
together exceeds that in the United States. Some European countries, 
such as Ireland and Spain, continue to perform well. But on the 
continent, notable weaknesses persist, and Japanese growth, while 
turning upward, remains modest. These economies must continue to adopt 
and implement vigorous and necessary structural reforms to establish 
robust rates of growth--both for the good of their own citizens and to 
contribute to reduction in the imbalances in the global economy.
    The Treasury Department's Report to Congress on International 
Economic and Exchange Rate Policies outlines the currency practices of 
America's major trading partners. The report addresses the third--and 
most immediately pressing--element of the effort to address global 
imbalances: The imperative of exchange rate flexibility, especially in 
emerging Asian economies.
    The report finds that no major trading partner of the United States 
met the technical requirements of the statute for designation during 
the period covered, which is the second half of 2004. However, it would 
be a mistake to interpret this conclusion as acquiescence with the 
foreign exchange policies of many of America's trading partners. In 
fact, Treasury is actively engaged with several economies to promote 
the adoption of flexible, market-based exchange policies and to help 
facilitate broader adjustment. Most notable among these is China.
    While the currency report that you have before you discusses 
several countries I would like to focus my remarks here on China. 
China's rigid currency regime has become highly distortionary. It poses 
risks to the health of the Chinese economy, such as sowing the seeds 
for excess liquidity creation, asset price inflation, large speculative 
capital flows, and over-investment. It also poses risks to its 
neighbors, since their ability to follow more independent and anti-
inflationary monetary policies is constrained by competitiveness 
considerations relative to China. Sustained, noninflationary growth in 
China is important for maintaining strong global growth and a more 
flexible and market-based renminbi exchange rate would help the Chinese 
achieve this goal.
    A more flexible system will also support economic stability, which 
we understand is of paramount concern to Chinese leadership. China's 
10-year-long pegged currency regime may have contributed to stability 
in the past, although it no longer does so, as China has grown to be a 
more significant participant in global trade and financial flows. 
Currently, China relies largely on administrative controls to manage 
its economy--controls that are cumbersome and increasingly ineffective. 
An independent monetary policy will allow China to more easily and 
effectively pursue price stability, stabilize growth, and respond to 
economic shocks. China has a history of significant swings in credit-
fueled investment and inflationary pressures and these have often ended 
in ``hard landings.'' Such swings are disruptive to the Chinese economy 
and may prove more disruptive in the future--not only to China but also 
to the global economy.
    A more flexible system will allow for a more efficient allocation 
of resources and higher productivity. The current system is fueling 
over-investment and excessive reliance on export-led growth while 
under-emphasizing domestic consumption. Moreover, much of the 
investment and capital flows into these favored sectors and projects 
may not prove profitable under market-determined prices, which could 
lead to another investment hard landing, more nonperforming loans, and 
a weakened banking sector.
    And a more flexible system would also quell speculative capital 
inflows that are costly to China's Government and increasingly likely 
to prove disruptive. China's ability to sterilize capital inflows is 
increasingly limited and harmful to its banking sector.
    Finally, recent history has taught us that it is better to move 
from a fixed to a flexible currency system during from a position of 
strength, and not when economic weakness compels reform.
    Chinese officials have publicly acknowledged the need to move to a 
more flexible system, have repeatedly vowed to do so, and have 
undertaken the necessary and appropriate steps to prepare for such a 
move.
    In September 2003, I began an intensive engagement with China, 
aimed at hastening China's move to a more flexible exchange rate. I 
believe that this financial diplomacy has yielded important results. 
Since then, China has taken critical steps to establish the necessary 
financial environment and infrastructure to support exchange rate 
flexibility.

 It has introduced a foreign currency trading system permitting 
    onshore spot trades in 8 foreign currency pairs and allowing banks 
    to act as market makers.
 It has adopted measures to increase the volume of foreign 
    exchange trading, for example: Eliminating the foreign exchange 
    surrender requirement for many commercial firms; allowing domestic 
    Chinese insurance firms and the national Social Security fund to 
    invest in overseas capital markets; and increasing the amount of 
    foreign currency business travelers can take out of the country.
 It has taken steps to develop foreign exchange market 
    instruments and increase financial institutions' experience in 
    dealing with fluctuating currencies. Foreign exchange forward 
    contracts can now be offered in China; foreign exchange futures are 
    being developed; and domestic Chinese banks can now trade dollars 
    against other foreign currencies, not just remnimbi.
 It has also acted to strengthen its financial sector and 
    regulation, so that this sector is more resilient to any 
    fluctuations in exchange rates.

    As a result of our approach, of constant intense engagement, China 
is now ready to introduce flexibility and should do so now.
    Unfortunately, the debate on China's currency regime is clouded by 
a number of misconceptions of U.S. policy. Allow me to address a couple 
of these. First, we are not calling for an immediate full float with 
fully liberalized capital markets. This would be a mistake at this 
time--China's banking sector is not prepared. What we are calling for 
is an intermediate step that reflects underlying market conditions and 
allows for a smooth transition--when appropriate--to a full float.
    Second, we recognize that a more flexible system in China, in and 
of itself, will not solve global imbalances--as I have said, this is a 
shared responsibility. However, greater flexibility in China and other 
Asian economies is a necessary component.
    Third, some argue that a more flexible system will prove 
deflationary and increase Chinese unemployment. In fact, a flexible 
system will provide China with a more sophisticated array of policy 
tools--namely an independent monetary policy--that will prove much more 
effective in achieving price stability and the ability to adjust to 
shocks.
    Our engagement with China over the past 2 years, including fruitful 
accomplishments associated with Treasury's joint Technical Cooperation 
Program, leaves me with little doubt that China is now prepared to 
begin reform of its currency regime.
    In fact, I believe that the risks associated with delay far 
outweigh any concerns with immediate reform. The current system poses a 
risk to China's economy, its trading partners, and global economic 
growth. Concerns of competitiveness with China also constrain 
neighboring economies in their adoption of more flexible exchange 
policies.
    As the report that was sent to Congress last week states, if 
current trends continue without substantial alteration, China's 
policies will likely meet the technical requirements of the statute for 
designation. China is now ready and should move without delay in a 
manner and magnitude that is sufficiently reflective of underlying 
market conditions.
    As the need for adjustment is global, multilateral organizations 
are addressing the need for flexibility. The Group of Seven finance 
ministers and central bank governors have adopted a policy, stated in 
its communiques, that ``more flexibility in exchange rates is desirable 
for major countries or economic areas that lack such flexibility to 
promote smooth and widespread adjustments in the international 
financial system, based on market mechanisms.'' The Asian Development 
Bank and the Asia-Pacific Economic Cooperation (APEC) have also 
publicly stressed the importance of flexible currency regimes.
    The chief officers of the International Monetary Fund and the Asian 
Development Bank have also stressed the need for currency flexibility. 
I have called on the International Monetary Fund (IMF), as part of its 
strengthening of multilateral and regional surveillance, to report on 
the potential contribution of emerging Asia to unwinding global 
imbalances, including an analysis of the regional impact of the Chinese 
foreign exchange system. As policymakers, we have a responsibility to 
fully understand these important forces that are shaping the global 
economy. As the central international institution for global monetary 
cooperation, with a wealth of technical expertise, the IMF is best 
placed to undertake this work, and indeed has the responsibility for 
doing so.
    It is critical that we address the issues of imbalances 
aggressively and in a cooperative spirit with the goal of raising 
global growth. Nothing would do more damage to the prospects of 
increasing living standards throughout the world than efforts to 
inhibit the flow of trade. However, it is incumbent on China to address 
concerns before mounting pressures worldwide to restrict trade harm the 
openness of the international trading system.

```