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28–972 PDF 2006

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN E. SUNUNU, New Hampshire

ELIZABETH DOLE, North Carolina

MEL MARTINEZ, Florida

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

ROBERT MENENDEZ, New Jersey

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)

CONTENTS

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)

(1)

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.

2

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

3

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 VaughnBassett 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

4

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.

5

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 laborintensive 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 eventuVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
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ally. 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 counVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
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try 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

8

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 memVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
9

bers 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.

10

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 longterm 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 understandVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
11

ably 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.

12

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 11⁄2 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

13

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.

14

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

15

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 desVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
16

ignation 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

17

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

18

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,

19

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.

20

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

21

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.

22

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.

23

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,

24

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

25

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

26

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.

27

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?

28

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.

29

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 camVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
30

paign 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.

31

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.

32

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

33

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, ex- cluding 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, beVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 28972.TXT SBANK4 PsN: SBANK4
34

cause 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:]

35

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 manipulaVerDate 11-MAY-2000 17:16 Aug 04, 2006 Jkt 025856 PO 00000 Frm 00039 Fmt 6621 Sfmt 6621 28972.TXT SBANK4 PsN: SBANK4
36

tion 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.’’

37

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

38

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.

39

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 communique ́s, 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.