China, U.S. face bumpy road after trade talks

WASHINGTON (Reuters) - High-level economic talks between China and the United States this week failed to ease trade rifts between the two economic giants, risking rising tensions ahead of the race for the U.S. presidency.

Chinese Vice Premier Wu Yi and a delegation of ministers left the U.S. capital on Friday, after days of talks that made modest advances but were overshadowed by a lack of concrete progress on the key issue of China's currency.

What U.S. Treasury Secretary Henry Paulson had billed as a dialogue to address long-term issues gave way to short-term political jockeying as Washington pushed for rapid currency reform and China pushed back.

Wu made it clear that China would stick to reforming its exchange rate regime at its own pace. That riled China's critics in Congress, who renewed the threat of punitive legislation. They also were unimpressed by commitments Beijing made to further opening of its financial services and aviation sectors.

"An American friend of mine likened them to two rich men with bad table manners," Sun Zhe, a professor in the Center for American Studies at Fudan University in Shanghai, said of the latest round of the "strategic economic dialogue."

"China sees itself as a guest who turned up and is then treated to criticism and bad treatment. The U.S. sees China as too stiff and inflexible," Sun said. "So it appears that we can expect more bills over Chinese trade."

A number of U.S. politicians are preparing legislation that would penalize imports from China to counter what they say is a currency that is unfairly undervalued by as much as 40 percent.

POLITICAL CALENDAR

William Overholt, director of the Center for Asia Pacific Policy at the RAND Corporation in Santa Monica, California, said both sides were at fault for sticking to untenable positions.

For one, the argument that the value of the yuan was responsible for the large U.S. trade deficit with China -- which hit $233 billion last year -- was "just wrong," Overholt said.

"On the other side, the Chinese stalling on letting American beef into their market on the grounds that it's unsafe ... just makes no sense at all," he said, referring to one of the issues on which the Bush administration pressed Beijing this week.

China stopped importing U.S. beef when mad cow disease surfaced in the United States in 2003.

Overholt said protectionist sentiment would only get worse as the 2008 presidential election neared. "It's building towards one of those crescendos we often see as political campaigns heat up," he said.

Susan Shirk, a former U.S. State Department official responsible for relations with China, said the fact that Beijing had not offered any major initiatives in the talks would not sit well in Washington.

Smaller disputes, such as worries about toxins in Chinese ingredients making their way into pet food and other products, also were swaying the public mood, said Shirk, now a professor at the University of California, San Diego.

"We're going to have a hard time managing the political process so that we don't overreact," she said, noting that it was tough for politicians in favor of a milder approach to speak up.

China's own political cycle could put it on a collision course with the U.S. Congress on the yuan, as a Communist Party Congress later this year will give Chinese officials an incentive to avoid any drastic reforms on the yuan, some analysts say.

CULTURE SHOCK

Nicholas Lardy, a China expert at the Peterson Institute for International Economics in Washington, said China needed to let the yuan appreciate significantly.

But China was caught in a bind, Lardy said. A large one-off revaluation could hurt many exporting firms, while a faster pace of appreciation could invite large inflows of speculative capital.

"I think they're in a huge dilemma and it really reflects the fact that once you start falling behind the curve, it gets worse and worse and your options become more and more constrained," Lardy said. "This is not going to have a happy ending, one way or another."

In a show of how the gulf facing Beijing and the U.S. Congress is cultural as well as political, some members of Wu's delegation looked astounded when lawmakers abruptly left a meeting on Wednesday to vote on a bill.

Wu later played down the incident, saying she understood that was how things were done in Congress.

But a gaffe by the same members of the House of Representatives -- New York Democrat Charles Rangel and Louisiana Republican Jim McCrery -- would be more difficult to explain.

In a letter to Wu complaining about trade issues, they addressed her as vice premier of the "Republic of China" -- the other name for Taiwan, the self-ruled island that Beijing considers as a renegade province.

"These small incidents reflect the lack of serious engagement with China," said Fudan University's Sun.

(Additional reporting by Chris Buckley in Beijing)