This will be Mr. Paulson’s fifth trip to China since becoming Treasury Secretary. Each time, the agenda and the cast of characters have been roughly the same. He’ll probably make the obligatory visits to the Shanghai stock exchange and talk to various Chinese business leaders. But his primary interlocutor is Vice Premier Wu Yi.

And in their talks, he’ll stress to Madame Wu that the yuan has been appreciating at too slow a rate.

China pegs its currency to a basket of foreign currencies that in effect simulates the dollar, and they allow exchange rates to fluctuate in a narrow range, determined on a daily basis. Even though yuan have appreciated more in the last twelve months than they have in years, the currency is still strongly undervalued against the dollar.

The headline effect of an over-weak yuan is that it makes China’s exports cheaper to foreign buyers. American politicians wrongly assume that this effect hurts American workers. But China’s primary export is low value-added manufactured goods. On this basis, they don’t compete against the US. Rather, they compete against countries with lower labor costs, like Thailand and Vietnam.

[Sidebar: how big would you guess Vietnam actually is? I was surprised to find that Vietnam has about the same land area and population as Germany, which has one of the largest economies in the world. I won’t be surprised if Vietnam becomes a major economic power over the next few decades.]

But there is a problem with currency manipulation: it violates the laws of nature. (Chief among these is that markets are free and will ruthlessly counteract efforts to control them.) Foreign exchange rates are remarkable things. Not only do they exquisitely measure the balance of global trade and the relative competitiveness of national industries, but they do so nearly at the speed of light. It’s as if an oil supertanker were nimble enough to make a 180-degree turn at full speed, in the blink of an eye.

In China’s case, the price of currency undervaluation has been extremely high food-price inflation, and an extraordinary asset-price bubble. (They don’t have significant energy-price inflation because they tightly control retail prices for fuel. This inflation is coming out of the earnings of the country’s large energy producers, which are all government-owned anyway.)

This is the case that Mr. Paulson will be making in China this week.

If Madame Wu is true to form, she’ll repeat recent public statements that China wants the dollar to rise, instead of the yuan. Of course, she would like to see the US reverse our recent improvement in export performance. But Paulson understands as well as anyone that currency markets are far too big for governments to control. That’s why he won’t (and shouldn’t) take any concrete steps to support the dollar.

She may also repeat remarks of her own, rejecting recent calls for a higher yuan by the Europeans. If you think Americans are pushy and aggressive about what we want, that’s the perception of the rest of the world, too. And European finance leaders’ demands for currency reform in China have become uncharacteristically strident, leading Wu to pronounce herself “very disappointed” in them, partly for acting like Americans.

This week’s meeting will probably end up producing little of substance beyond the standard photo of Hank Paulson shaking hands with Wu Yi, a woman who almost small enough to fit in his pocket, with broad smiles all around.

But the Chinese really do need to do something about their inflation problem. They are systematically undertaking broad changes in their economy, which is a topic for another post. But in the near-term, they face a diminution in the value of their huge holdings of dollar assets, mostly US Treasury debt. They also face the prospect that the US economy will slow, which will certainly have an effect on world markets.

So they’ve started talking about buying assets in the US. From the news-service story I linked above:

“China at this stage needs to be looking to opportunities provided by the weakening U.S. dollar,” Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation’s largest investment bank, said in an interview last week. “Very recently the government is becoming more interested in channeling money out of the country.”

The Ministry of Commerce said last week it will encourage businesses to buy American assets. Twenty insurers were granted licenses to invest overseas. China Investment Corp., the nation’s $200 billion sovereign wealth fund, said it will be a “stabilizing force” in markets rocked by credit losses, signaling it may invest in American banks.

Lest you think this is a new idea, China has already invested billions of dollars in the Blackstone Group and in the Bear Stearns Companies, two major Wall Street firms.

There should be no need to connect the political dots for you. If you think resentment against Chinese imports is bad, just wait till you see the headlines about Chinese ownership of America’s greatest businesses and signature properties.

Like most businesspeople, I’m not afraid of foreign direct investment. Again, I trust markets to reflect reality and balance everything out. Additionally, one of the greatest (and perhaps underappreciated) strengths of the US economy is flexibility. When business conditions change, American businesspeople adapt. They change their mix of investments and production to fit their best advantage in any environment.

Frankly, we could use China’s capital. And they have nothing better to do with it. I’m absolutely certain that they will have learned from the mistakes that the Japanese made two decades ago. You’re not going to see Rockefeller Center or the golf course at Pebble Beach majority-owned by interests controlled by the Chicom regime.

But politicians here will make a great deal of noise about being “taken over” by China. Already a hot issue, expect it to get worse. And expect it to play in favor of the economic populists in the Democratic Party.

But Chinese capital in the US is not what you need to fear. As long as we stay competitive and flexible, we won’t be at a disadvantage. You need to fear a decrease in our competitiveness, which will happen if the Democrats enact many of their economic and social proposals.

By the end of the lifetime of most of the people reading this, China will be the world’s most powerful nation, politically and economically. That’s inescapable unless they really screw up (and I never underrate my opposition). Our job is stay even with them by being tough competitors. That will preserve living standards and a leadership role for us. If we take ourselves out of the game, they will take us over, and they will deserve to.

What the bond markets are saying is that unexpectedly strong performance in the economy during the financial and housing crises is reducing expectations for further interest-rate cuts from the Federal Reserve.

This sentiment is echoed in the recent rally in the dollar against the euro. (The greenback has rallied above-parity against the loonie after Canadian officials cut interest rates the other day. The dollar’s recent strength against the yen reflects increased risk-tolerance in carry trades, which is positive but volatile from day-to-day.)

As we have come to expect, the BLS statistics show that jobs continue to be lost at very high rates in the goods-producing, manufacturing and construction sectors. The job growth in services, retail, education and government more than made up for these losses.

To an ever-increasing degree, Americans no longer make or build things. Instead, they perform services for each other and work for the government.

There is one element in the Labor report that may be taken with a wary eye: wages growth was strong in November. The Federal Reserve spends a great deal of its time worrying about inflation. Any significant amount of inflation in the economy basically eliminates lower interest rates as a policy tool.

This matters because a great deal of the recent optimism in the stock markets is predicated on further cuts in rates by the Fed. In the Fed’s view of the world, food and energy-price inflation don’t really matter all that much.

What they care a very great deal about, however, (in addition to “core” consumer prices) is wages. Because if wages grow, businesses may find that they are able to pass higher labor costs along to consumers in the form of higher prices. That’s the kind of inflation that can get out of control.

Other recent reports show that consumer confidence is at cyclical lows. This measurement is important because it’s theoretically a leading indicator of future spending, even though it probably measures news-bias more than anything else. And obviously the news bias has been overwhelmingly negative for the economy.

If consumers are facing distress from the strong drop in the value of their homes which continues uninterrupted, they’re not showing any signs of it. As mbecker and others have pointed out (and as my own private conversations indicate), a lot more shoes will drop as adjustable Alt-A mortgages start to reset over the next year and beyond.

I’m not inclined to the prevailing view that housing weakness will badly hurt consumer spending. We have yet to see any evidence of that. It may just be too early to tell, and perhaps the holiday retail season is masking the effect.

I continue to see daily evidence of exceptionally strong growth in the global economy outside of the US and Europe. To repeat what I’ve said in prior posts, I strongly expect that export growth will lead the US economy for years to come.

Before you ask, no, Representative Pomeroy (D-ND) isn’t fearful for his job - he got almost 66% of the vote last election, which means that he’s more bulletproof than Superman right now - so this is a rather significant switch in position. And it is a switch in position: even with the obligatory nods towards BDS factored in, you’ve got a 180 degree turn here. Rep. Pomeroy may not be off of the antiwar movement train quite yet, but he’s grabbing his coat and looking for his bag in the overhead rack.

But why? What could lead him into such obvious madness? What could possibly have turned away from the light? Who could have possibly dissuaded him?

Damned if I know, folks. Damned if I know.

More from MRC:

Back in September, when General David Petraeus reported that the surge in U.S. troops had improved the security situation in Iraq, the big three broadcast networks were openly skeptical.

“Insurgent attacks are down from 170 in January to 120 in August,” ABCs Terry McCarthy noted on the September 9 World News Sunday, the day before Petraeus testified before Congress. “But that is still four attacks a day, on average. Iraq remains a very violent place….Life in central Iraq is still deadly dangerous.”

“Victory is not at hand, not even in sight,” CBSs David Martin similarly contended on the next nights Evening News. On the NBC Nightly News, reporter Jim Maceda found it “palpably quiet”in an area of Iraq once controlled by Sunni insurgents, but “this is really an exception….That civil war as, again, as you get out of the capital of Baghdad, it is truly brewing. So this is really just a partial success for this surge so far.”

Based on this analysis, it appears that the tone of reports is improving consistent with the results on the ground…a promising revelation. The problem seems to be that good news from Iraq has caused less OF it to be shared with the American people…we ‘consumers of fine journalistic excellence’ from the big networks. Must be a coincidence, right?

The numbers, according to MRC:

MRC researchers examined all 354 Iraq war stories that aired on the big three evening newscasts from September 1 through November 30, including weekends. That figure includes 234 field reports, plus 120 short headline items read by the news anchor.

Back in September, as reporters voiced skepticism of General Petraeus progress report, the networks aired a total of 178 Iraq stories, or just under two per network per night. About one-fourth of those stories (42) were filed from Iraq itself, with most of the rest originating in Washington.

In October, TVs war news fell by about 40 percent, to 108 stories, with the number of reports filed from Iraq itself falling to just 20, or less than one-fifth of all Iraq stories. By November, the networks aired a mere 68 stories, with only eleven (16%) actually from the war zone itself.

It’s pathetic…not only the numbers, but the origins of the reporting. Remember, please, that not so long ago anyone with an opinion on Iraq was vilified (if the opinion was positive) for not actually having BEEN there…soundly disqualifying anyone who might have wanted to be hopeful or optimistic or…

wait for it…

in SUPPORT of the efforts on the parts of our men and women over there.

No surprise really, but sad nonetheless. The silver lining in this report is the extent to which the dinosaur/driveby/lamestream media only continues its slide down the slope, getting ever-closer to obscurity.

There’s that, at least.

Rep. Mike Ross (D-AR) was livid. We run for reelection every two years. They run every six years. Don’t try to tell me the Senate can’t take a tough vote,” he said. Other Blue Dogs joined in the chorus of boos emanating from the House side of the Capitol. Rep. John Tanner (D-TN) put the Senate action in stark terms, saying, If we waive paygo on this, it will open the door for more financial — bordering on criminal — irresponsibility.”

Just two days ago, Blue Dog Democrats addressed a letter to Reid and House Speaker Nancy Pelosi, vowing to oppose any and all fixes to the AMT that did not include offsets.

We believe that waiving PAYGO, no matter the political pressure, is both fiscally reckless and an abdication of our duties. Under no circumstance will we vote for any piece of legislation that does not meet the requirements of PAYGO, nor will we vote to waive the PAYGO rules to allow for such legislation.

The Blue Dogs are very serious about their insistence on following the paygo rules. One leading Blue Dog, Florida Rep. Allen Boyd reportedly told the Washington Post that he would rather see the AMT balloon out of control than have the Democrats go back on their campaign pledge of enforcing fiscal discipline.

In truth, Democrats arent any more interested in fiscal responsibility than past Republican-led Congresses were. But their lust for power caused their leaders mouths to write checks that realities of governing cant cash. Blue Dogs want tax increases every bit as much as more liberal Democrats. Their insistence on paygo rules is only a fig leaf intended to hide this fact from their conservative constituents.

Of course, Republicans will be very happy to sit back and let the Democrats ideals clash with reality. All of which bodes well for Republicans in the 2008 Congressional elections. Harry Reid has handed them a ready made and very effective campaign message to run in Blue Dog districts as well as nationally: No matter whether they call themselves liberal, moderate, conservative, or Blue Dogs, the only thing standing between Democrats and their plan to raise taxes, is the Republican Party.

Some minor observations:

a), The GOP is not actually going to stop pushing on the funding thing. I mean, why should we?

b), I hope all you netrooters reading this have saved your receipts. I say this because I don’t think that the Party that you supposedly bought is the same one that was described on the box.

c), To those same netrooters: George W Bush is beating you. Again. The Establishment Democrats are letting him do that to you. Again. You will be given a pseudo-choice in your choice for President, only to have it given to the previously-anointed Establishment candidate. Again.

d), And she hates all of you, by the way. Even more so than the usual Establishment candidates do. Better start giving her lots and lots of money. She won’t do anything for you if you do, but she might not do anything to you.

e), And last, I’d like to thank the entire liberal/progressive blogosphere for this wonderful Christmas present that you have helped give us: we’d offer back victory in Iraq in exchange, but I’m afraid that it doesn’t go with anything in your collective wardrobes.