At the trade summit opening in China on December 14th Paulson Called for More Flexible Yuan.

U.S. Treasury Henry Paulson, facing pressure from Congress for trade sanctions against China, urged the nation to relax currency controls and better protect property rights to help close a record trade gap.

Talks in Beijing must produce “tangible results” to prevent protectionist elements in both nations damaging their trade partnership, Paulson, leading one of the biggest U.S. economic delegations to China, said in the Chinese capital today.

China should move toward a regime where “currency values are determined in a competitive open marketplace based upon economic fundamentals,” Paulson said at the inaugural meeting of the so- called Strategic Economic Dialogue between China and the U.S. “In the meantime more currency flexibility is necessary.”

China did not take too kindly to Paulson’s remarks. Fortune Magazine reported China pushes back against Paulson.

Vice Premier Wu Yi had other ideas. Like an impatient schoolmistress, she opened this historic gathering with a lecture. Her talk was one part history lesson (China has 5,000 years experience as a global citizen) and one part 21st century civics lesson (the goal is a “socialist harmonious society”), with no sign that her regime sees any need for major economic reform.

“We have had the genuine feeling that some American friends are not only having limited knowledge of, but harboring much misunderstanding about, the reality in China,” she began, striking a less-than-diplomatic note. “This is not conducive to the sound development of our bilateral relations.”

In delivering her 20-page presentation, which included slides to illustrate points on Chinese history, Ms. Wu made clear that the Chinese regime believes it has carved its own responsible global economic path, and isn’t especially eager for the Americans’ free-market advice.

According to the English translation of her remarks, she repeated six times that China was “sticking to” its “new path of industrialization,” and three times that China was “continuing to improve” on reforms already in place. Substantial free-market change wasn’t part of the equation. “By following a path of building socialism with Chinese characteristics in an independent and self-reliant manner,” she said, “we have scored glorious achievements that attracted worldwide attention.”

Ms. Wu’s remarks included veiled barbs at the U.S., noting that China had ratified the Kyoto Protocol on global warming and was “fully harnessing world peace” in its global economic development. The United States did not ratify Kyoto, and remains bogged down in an unpopular war in Iraq.

The Chinese also complained about U.S. national security policies that limit sensitive high-tech trade and acquisitions of American firms, according to Gutierrez. The American delegation, he said, was forced to “clarify” a perception that U.S. policy was moving toward protectionism.

One would think that by now the US would get the picture. China does not want or need our advice. How many times does China have to tell the US to butt out? But that did not stop Bernanke from taking a swing the following day.

The Financial Times reported Bernanke calls for renminbi revaluation.

Ben Bernanke stepped into a political minefield on Friday [December 15th] when he released remarks branding China’s undervalued currency an “effective subsidy” for its exporters that was distorting patterns of production and trade.

Although the Federal Reserve chairman dropped the phrase in a speech in Beijing, using instead the less inflammatory term “distortion”, the Fed was standing by the language of the original text.

His comments were welcomed by US manufacturers. Frank Vargo, of the National Association of Manufacturers, said: “This is a very important message. The administration has been talking simply about currency flexibility. But Bernanke has come out and called the currency undervalued and told Beijing it is distorting the Chinese economy. That is significant.”

Hank Paulson, the Treasury secretary who led the delegation and faced pressure to harden his rhetoric, said: “All I can say is that the chairman of the Fed is entitled to his independent comments.”

The incoming Congress took the speech as a cue to launch anti-dumping legislation – which has been looming since Democrats won the midterm elections on a wave of economic populism.

Sander Levin, head of the House committee on trade, on Friday night unveiled a controversial bill to permit the use of anti-subsidy laws in response to “currency manipulation” by Beijing.

Bernanke’s remarks should once and for all put to bed the idea that the Fed would be forced to raise interest rates to support the dollar. Previously it was the Treasury Department calling for China to act, now the Fed is in the game too.

The notion that a weaker dollar will help exports and help balance trade deficits is complete silliness. The way to fix the balance of trade is simple. The US needs to stop borrowing money from foreigners to fight a completely stupid war in Iraq, and US consumers need to stop buying junk they do not need and can not afford. With 20-1 wage differentials it is simply impossible to balance the trade deficit on the back of currency devaluations.

The National Association of Manufacturers called Bernanke’s speech “significant”. The only way it can be significant is if China acts (extremely doubtful as China does not react to pressure) or if Bernanke somehow manages to goad Congress into doing something totally stupid in response such as pass a modern day version of the infamous Smoot Hawley Tariff Act. With a Democratic Congress now in control, protectionist nonsense probably has a greater chance than before, especially with a weakening economy.

What is distorting the world economy is US spending is simply out of control, Japan’s interest rates are too low, and carry trades and speculation are running rampant, not just in the US but worldwide. The Greenspan Fed cutting the Fed Fund rate to 1% was certainly a contributing factor leading up to the latest mess.

Vice Premier Wu Yi in no uncertain terms told Paulson exactly where to go, yet Bernanke repeated the same message the following day. So what game is Bernanke playing anyway? Is he that dumb to think he can pressure China? It’s not like he is an elected official up for reelection and sending a message the folks back home want to hear.

For unknown reasons Bernanke risked firing up protectionist fears in Congress for close to a zero percent chance China will listen to him and not Paulson. Speaking of Paulson wasn’t he supposed to be the great diplomat that Snow wasn’t?

My friend Harmy on the Motley FOOL summed up the situation perfectly.

For as long as I can remember any number of small countries have pleaded with the US to modify it’s trade policies which caused huge damage to those countries economies. Through it all the US simply adopted a policy of indifference and did exactly as it pleased. Now we have the US trying to force China into doing what the US wants simply because the US cannot control its own economy. The problem the US has is a US one not a Chinese one and I am quite sure that behind the inscrutable Chinese smiles they will do exactly as they please just as the US has done over the years.

When your opponent starts bleating about unfair tactics you know you’ve got him on the ropes.

This much is clear: The US can no longer call the shots in the global trade arena, the US economy is on the ropes, and whatever game Bernanke is playing smacks of pure desperation.

Mike Shedlock / Mish/