Playing with a weak hand in China

Beijing (Fortune) -- In case anyone might miss his point, Hank Paulson landed in China this week alongside four U.S. cabinet secretaries, two agency heads and the chairman of the Federal Reserve. One more top American player and the Treasury Secretary could field a baseball team on the Wukesong Olympic field.

This unprecedented display of U.S. economic officialdom is meant to send the message that "we mean business" - not only for often recalcitrant Chinese leaders but also for the Democrats who now control Capitol Hill.

Treasury Secretary Henry Paulson throws his weight around in China this week.

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"Paulson knows how to overwhelm his host with sheer political force," says Minxin Pei, director of the China program at the Carnegie Endowment for International Peace. "He wants to demonstrate he has full political capital."

But the pomp surrounding this first meeting of the U.S.-China Strategic Economic Dialogue, launched in September, also highlights the Bush administration's weak hand.

On one side, the former Goldman Sachs CEO faces a go-slow Chinese regime, which is overseeing an economy that some economists predict will surpass the United States in 30 years - and is not especially eager for guidance on reforms that could disrupt its power at home.

"The Chinese response is to chuckle up their sleeves" at well-intentioned American advice, says Barry J. Naughton, professor of Chinese economy at the University of California, San Diego. "They think their policy is responsible and serves their interest."

On the other side, Paulson faces pressure from Democrats eager to punish a country that has become the poster-child for American job losses overseas. With the November election, the Democrats are now in a position to follow through on threats to impose tariffs on Chinese imports if the country's policymakers don't address the currency concerns fueling its massive trade surplus.

"Paulson's message is 'you can deal with me, or you can deal with Nancy Pelosi,'" Pei says, referring to the incoming Democratic House speaker, who has been critical of China.

This week's meetings take place against a backdrop of mixed messages from the American delegation. On Wednesday night, Commerce Secretary Carlos M. Gutierrez celebrates new commercial contracts between U.S. and Chinese companies.

But Paulson said earlier this week China could and should do more to reduce its massive trade surplus and revalue its currency. And a WTO report released Monday complained bitterly about continued rampant counterfeiting and piracy, policies limiting imports and regulatory barriers to U.S. service companies.

"We see troubling indications that China's momentum toward reform has begun to slow," US Trade Representative Susan Schwab, a participant in this week's meeting, wrote in the Financial Times.

In addition to Schwab and Gutierrez, the delegation to the two-day meeting includes Labor Secretary Elaine Chao, Health and Human Services Mike Leavitt, Energy Secretary Sam Bodman and EPA Administrator Stephen Johnson. Topics will range from energy security to rural health care.

Federal Reserve Chairman Ben S. Bernanke will give a speech at the Chinese Academy of Social Sciences on Friday.

Despite the display of big U.S. guns, Bush officials have gone out of their way to lower expectations, describing the talks as a first step in a continuing dialogue on how best to "facilitiate China's integration" into the global economy with maximum growth and minimum disruption, as a senior Treasury official told reporters last week.

American officials talk of China's "shared responsibility," and its role as "responsible stakeholder" in the global economy, the latter a term coined by former deputy secretary of state Robert Zoellick.

"We're not going in to lecture or finger-wag but to truly have a conversation," said the senior Treasury official.

But it's hard not to conclude that the Americans want to offer advice to the world's most determined social engineers on how to engineer their own economic growth.

"Paulson is selling hope to a patient who thinks he's doing just fine," says Mei.

Behind closed doors, Chinese officials are expected to subtly point out the hypocrisy of the biggest debtor-consumer in the world counseling the biggest saver in the world to buy more washing machines and cars, or the largest per-capita consumer of energy discouraging China from building more polluting coal plants.

"There are a lot of areas where they can point to us," says Albert Keidel, a former top Treasury official who handled Asia issues.

Still, Paulson is drawing praise for producing an ongoing, high-level dialogue on a range of issues. (There are some 35 to 40 bilateral forums already in place, but they deal with narrow, low-level concerns like chicken parts).

The problem is the tough task the Treasury Secretary has set for himself - convincing the Chinese that "what's good for them in the long run may be painful in the short run," as Pei puts it.

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