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Cablegate: Us-China Economic and Security Review Commission Discusses

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DE RUEHBJ #3863/01 1802355
ZNR UUUUU ZZH
P 292355Z JUN 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 0639
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 013863

SIPDIS

SENSITIVE
SIPDIS

USDOC FOR DAS LEVINE AND ITA/MAC/AP/MCQUEENTREASURY FOR
OASIA/ISA KOEPKE AND DOHNERSTATE PASS USCC
STATE PASS CEA FOR BLOCKSTATE PASS FEDERAL RESERVE BOARD FOR
JOHNSON/SCHINDLER; SAN FRANCISCO FRB FOR CURRAN; NEW YORK
FRB FOR DAGES/CLARKSTATE PASS USTR STRATFORD/WINTER/MCCARTIN

E.O. 12958: N/A
TAGS: EFIN ECON PREL CH
SUBJECT: US-China Economic and Security Review Commission Discusses
Exchange Rate with China's Foreign Exchange Regulator


(U) This report is sensitive but unclassified. Please
handle accordingly.

1. (SBU) Summary: On June 19, Wei Benhua, Deputy
Administrator of China's State Administration of Foreign
Exchange (SAFE), repeated to Chairman Larry Wortzel and
Commissioner Patrick Mulloy of the U.S.-China Economic and
Security Review Commission familiar arguments that China's
currency now follows a managed float currency policy, that
there is no consensus on whether China's currency is
currently undervalued and that the U.S.-China deficit is not
as large as the United States figures indicate. Chairman
Wortzel and Commissioner Mulloy emphasized that the growing
imbalances are unsustainable and that the U.S. Congress is
growing impatient with China's slow progress on exchange
rate reform. China's exchange rate policies are also
leading to other distortions, including harming the ability
of U.S. companies to export their goods from the United
States to China. FinAtt pointed out that a more flexible
exchange rate is in China's own interest and can help China
manage its own economy better. End summary.

Congress Concerned
------------------

2. (SBU) Chairman Wortzel opened the discussion by
emphasizing that China's slow pace of exchange rate reform
has become an important bilateral political problem. While
acknowledging that China has made progress, he urged China
to allow its currency to have more flexibility to respond to
market forces. He noted that Congress remains very
concerned about the issue and that Senators Schumer and
Graham, who visited China in March and are the sponsors of
trade legislation aimed at China, are again calling for
action. Commissioner Mulloy, commenting that he helped
draft the legislation that requires Treasury to issue semi-
annual reports to Congress on countries that manipulate
their currencies, noted that the United States previously
cited China in 1991. Although the Administration failed to
cite China in its latest report, Mulloy added that China's
export-led growth is widely viewed as unsustainable because
of the imbalances it is producing.

Managed Float Policy
--------------------

3. (SBU) Responding, Wei maintained that China's currency
is based on market supply and demand, but is adjusted in
reference to a basket of currencies through a managed float
arrangement. As for whether China's currency is
undervalued, Wei insisted that there is no consensus on this
point. When he served as China's Executive Director at the
IMF (until 2003), Wei said he attended a number of meetings
where this subject was debated but without reaching a
conclusion. Wei argued that there is also disagreement on
the size of the U.S.-China deficit. Although the United
States calculated the deficit in 2005 to be over USD200
billion, he said according to Chinese statistics, the
deficit was only USD114 billion. Moreover, nearly 60
percent of the profits from China's exports go to foreign-
invested enterprises. Whatever the numbers, Wei said
adjusting the exchange rate will do little to improve the
trade deficit problem, although he asserted that relaxing
U.S. restrictions on high-tech exports would make a big
difference.

Other Countries Will Follow
---------------------------

4. (SBU) Referring to Wei's last point, Chairman Wortzel
countered that high-tech export controls only represent 1.5
percent of the trade deficit, and as long as the currency is
out of balance, this will have little consequence to the
overall trade figures. Commissioner Mulloy warned that no
matter how the deficit is measured, it is large and growing
and could poison the bilateral political relationship. He
pointed out that other Asian countries also have inflexible
currency regimes and suggested that if China led the way,
these other countries would follow suit. Regarding the
foreign-invested companies that benefit from exporting to
the United States from China, Mulloy noted that the
interests of such U.S. companies are not necessarily aligned
with U.S. national interests. He added that by maintaining

BEIJING 00013863 002 OF 002


an undervalued currency, China discourages U.S. companies
from exporting from the United States and instead encourages
them to relocate operations to China. He compared China's
policy of using its dollar earnings to buttress government
industries to that of GMAC offering loans to customers to
buy GM cars. As a result of China's undervalued currency,
distortions are appearing in both the Chinese and in the
U.S. economies.

5. (SBU) Although he disagreed with their views, Wei
thanked the Chairman and Commissioner for their frankness in
discussing the exchange rate issue. Wei suggested that it
is important to analyze the makeup of China's exports. As
China is still a developing country, Wei contended that most
of China's exports are for low-value, labor-intensive goods.
However, Mulloy pointed out that USD45 billion of the
bilateral deficit is in high tech goods.

In China's Own Interest
-----------------------

6. (SBU) As the meeting came to a close, FinAtt noted that
an op-ed piece by Treasury Under Secretary Tim Adams will
soon appear in several Chinese newspapers. In the article,
U/S Adams will focus on how a more flexible exchange rate is
in China's own interest. Referring to Premier Wen Jiabao's
recent statement of concern over overheating problems,
FinAtt noted that a more flexible exchange rate will help
China manage its economy more effectively.

7. (U) This report was cleared by the delegation.

Randt

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