A Bridge over Troubled Water

Paulson thus views his job as something like cajoler-in-chief. He says he has sympathy for Beijing's argument that it must move cautiously. But he also wants the Chinese to pick up the pace, because it's in their own interest to do so. Unless they continue to push reform throughout the economy—especially in a financial sector dominated by bloated state-owned banks that lend lavishly to uncompetitive state enterprises—the cost of dealing with the problem later will balloon. (And the argument is fair enough: it's a lesson the Japanese learned in the 1990s when Tokyo dragged its feet on banking reform).

Besides, Paulson says, the world may run out of patience if Beijing doesn't get a grip on currency and trade issues. The threat of protectionism in the U.S. is very real, he warns: "It's one of the major risks we face. If China were a relatively small economy that was in a period of transition, it would be very easy for the rest of the world to say, 'take your time.' But ... they're already a global economic leader, so they aren't going to get as much time as they might like." China may not be in a position to float its currency today, he adds, "but it needs to get itself into that position."

Will China take Paulson's message to heart? The yuan has risen slightly since last month's summit in Beijing, but it's still not clear that Hu and his fellow leaders have any real sense of urgency on trade and currency issues. Lardy, the Institute for International Economics fellow, is skeptical that there will be any significant policy changes soon. He calls China's leaders "momentum players," observing that they are loath to change course while things are going well. After all, China has double-digit economic growth, huge trade surpluses, and more than a trillion dollars in foreign-exchange reserves. Why mess with success?

Paulson disagrees with that characterization. "No one [in Beijing] is saying 'everything's great, let's leave it alone,'" he says. "Their discussion is all about, 'how fast do we move?'" He and his boss in the White House are hoping China's leaders move decisively within the next two years, before Bush's term expires and a new Cabinet is appointed. Otherwise, Hank Paulson might be the last friendly face at the U.S. Treasury the Chinese see for a while.