China's low currency rate has enabled it to price goods for export very cheaply - - a major factor in China's growing trade surplus. China's trade surplus for the first 10 months of 2007 surged 59% to $212.4 billion, according to figures released by the General Administration of Customs. The annual surplus already has eclipsed the full-year record of $177.5 billion set in 2006. Further, the nation's October 2007 trade surplus increased 13.6% to $27 billion.

Meanwhile, the United States trade deficit with China increased to $23.8 billion at the end of September 2007, up 5.5% from $22.5 billion at the end of August 2007.

Analysts' estimates vary, but the median consensus suggests that the U.S. trade deficit with China would be cut by 30% or more, if China's currency floated freely. If allowed to float freely, the yuan would rise to 5 yuan to the U.S. dollar or even 4 yuan to the U.S. dollar, boosting the price of China's goods and making U.S. goods more cost-competitive. No one expects China to freely float the yuan any time soon, but a yuan revaluation consensus has emerged among key nations and economic policy analysts, according to Paulson.

"But I think everyone I talk to about this essentially agrees that they [China] should be taking steps very quickly to get to the point when they could have a market-determined currency," Reuters reported Paulson saying. "In the meantime, they should be appreciating the [yuan] more rapidly so that it will reflect underlying fundamentals."

China's view

Conversely, to-date Chinese officials have underscored that a substantial currency revaluation is not possible at this time, saying the move would hurt the nation's inflation control efforts, and (potentially) destabilize the markets. Further, China says the best way for the U.S. to lower its trade deficit would be for U.S. citizens to save more and consume less, decreasing its imports, and for the U.S. economy to grow at a faster rate, increasing its exports.

An economist who specializes in China's economy, who spoke on condition that he not be identified by name, agreed with that sentiment:

"Does the U.S. want an even weaker dollar right now? I don't think the U.S does, as it would be inflationary," the economist told bloggingstocks. "I don't think the U.S. Treasury wants a weaker dollar, and I don't think China will increase the value of the yuan, short-term, as it would be destabilizing for the markets, in addition to adding to U.S. inflation. Longer-term, the yuan will appreciate, but that appreciation has to be gradual and occur over many years."

Mood in Congress

Further, the U.S. and China differ regarding what constitutes an acceptable timetable for the yuan's appreciation. The economist specializing in China's economy said yuan appreciation is "a 5-6 year question, possibly extending out to 2015." The acceptable timetable in the United States, as measured by the mood in the U.S. Congress, is much shorter: protectionist sentiment is beginning to gain traction in the U.S. House and Senate.

Paulson said China's reluctance to adopt a flexible exchange-rate regime is widely considered unfair and puts China at growing risk of a protectionist trade backlash.

"China is increasingly seen as out of step with international norms and expectations, as evidenced by the growing number of national leaders and multilateral organizations calling for currency appreciation," Paulson said, Reuters reported.

Paulson added that if China does not speed-up its currency reforms, it may face economic consequences, from the U.S. and other nations:

"Given growing protectionist sentiments around the world, if Chinese reforms slow, China may confront a backlash from other nations," Paulson said, Reuters reported.

Economic Analysis: Don't expect major policy changes at the upcoming U.S. / E.C.B. / China talks, but look for China to outline a speeded-up timetable for the yuan's appreciation. Most likely, Secretary Paulson will seek benchmarks from Beijing by which the U.S. and E.C.B. can evaluate China's willingness to move to a market-based foreign exchange rate.