How do you view China’s reactions to the proposed sanctions?

I am quite concerned about the possibility of mounting trade frictions between the United States and China. Strong reactions from both sides underscore my concerns.

The U.S. complaint on IPR was not a surprise in Beijing. I think the message they are trying to send is that this is a two-way street. The United States trades a lot with China and depends on China and it wants China to play fairly. But China also has some very strong views about the way in which it is being treated fairly.

How co-dependent are the Chinese and U.S. economies today?

They are very dependent. The United States is China’s largest or second-largest export market, depending on which number you look at. Exports are big portion, maybe 38 percent, of Chinese GDP, so if the exports to the United States slow down that would have a big impact on China.

On the other hand, America depends on China to buy treasuries or other dollar-based assets to prop up our asset markets, which are playing an increasingly important role in driving our economy, especially the consumer. If China would stop buying dollar-based assets the United States will feel real pressure from that potential development.

U.S. Treasury Secretary Henry Paulson has urged China to speed up its pace in opening up to more competition and financial market reforms, but some Chinese economists said it may affect the stable development of the Chinese economy. What’s your opinion on this?

I think China has made great progress in financial reform and in SOE (state-owned enterprise) reform, and the currency reform issue is very much on the minds of the senior leadership. However, the financial system itself, the banks or insurance companies are relatively unsophisticated and unprepared to deal with ramifications of a sharp adjustment of the currency or a freely floating currency. So, from the Chinese perspective of maintaining economic stability, if they [Chinese officials] make the judgment that the system is not ready for a fully convertible floating currency, then we have to respect that. That doesn’t mean that some of our politicians will like that. But the currency is moving up slowly, which is, I think, a perfectly appropriate path for a still poor developing economy.

Do you think it’s time for the United States and other WTO members to stop calling China a “non-market based” economy?

China, because of the unique character of its growth model so much in the export area, should be held accountable for adhering to WTO rules and regulations like anybody else. I don’t think that China needs special treatment because it’s a developing economy. The non-market provisions that were written in for exemption under WTO pertain to an old Soviet-style model that no longer exists. It’s not clear to me that China needs to fall under that umbrella. I think in large part there is good reason [that China should be treated as a market economy].

China’s first quarter economic statistics show the economy has continued growing fast despite the government’s effort to cool it down. How do you evaluate the health of the current Chinese economy and its future?

I think the government wants to slow China down. They have been trying for about three years, but it hasn’t worked. I do believe, when I heard Premier Wen Jiabao say-at his press conference after the National People’s Congress [annual session] and then at a meeting I was in three days later in Beijing-that the Chinese economy is unstable, unbalanced, uncoordinated and unsustainable, he is prepared to do that. It is clear to me that the Chinese authorities are going to tighten up further in the next several months, with an aim toward slowing down excessive investment in a fashion consistent with the underlying objectives on environment and energy conservation. Those two issues are critical in understanding the leadership’s imperatives in guiding the Chinese economy.

In their five-year plan, they embraced structural change and a shift in their growth model. They will move away from an investment-export to a much more pro-consumption dynamic. Especially in a planned economy, you don’t push a button and start a consumer culture, [because] they are lacking safety net. I think over the next three to five years, you are definitely going to see the emergence of a much more broad-based consumer-led growth dynamic in China.

What do you think of China’s recent decision to diversify its huge foreign exchange reserves?

I applaud the Chinese decision to set up a Temasek-type fund that will invest a significant portion of excess foreign exchange reserves in a broad portfolio of companies or other types of assets. I think China needs that and Asia needs that. In general, the region is awash in excess foreign exchange reserves. Reserves go well beyond any possible contingencies that could be required to use those sources of funds to temper any financial disturbances. China and other economies in Asia are still relatively poor countries. They need to get higher returns for their assets under management. The new reserve management fund, I think, will give China a chance to achieve those higher returns and use the proceeds of that to fund a lot of social and environmental programs.

Early this year, a dramatic fall in the Chinese stock market reverberated around the world. How do you evaluate the role of China’s stock market in the global capital market?

It was a very difficult week or two. China was only part of the story and the other part of it was that it became increasingly evident in those days in late February and early March that the United States is going to be weaker than expected. So the market focused on both of those developments.

China definitely has a bigger global role today than it did three to five years ago. The Shanghai A-share has risen 100 percent in the last six months. That gave investors a false sense of confidence that China will keep growing 10 or 11 percent forever. The government doesn’t want that. What is interesting is that the market moved down sharply, it’s now back up 17 to 18 percent above the previous highs. That’s a huge move.

So far are you satisfied with the pace of the appreciation of the renminbi?

Absolutely. I think China is on the right track. When I testified in front of the House of Representatives, I was on a panel with four experts on the currency. The other three recommended immediate revaluation of the renminbi by 15 to 20 percent. I said no, 3 to 5 [percent], stay with it.

(Wang Yanjuan and Chen Wen reporting from New York)