SENATOR EVAN BAYH: I want to thank you for your presence today and for your public service. Some of the questions you are getting, including some of my own, relate to legacy policies that you have inherited from your successors that have been part of the administration’s record for some years. I know you are trying to grapple with this, so I hope you take this into consideration when you field our questions.

I listened with some interest to Senator Shelby’s comments and the chairman’s comments, and I would like to follow up on that a little bit. You alluded to it yourself, Mr. Secretary, when you said, that ultimately it is not what we say, but what we do that matters. That applies to other countries as well.

As you know, the Chinese have a history of saying the right things. I am glad that in your private conversations they understand that it is in their best interest to begin to allow their currency to float, to protect intellectual property, and to reform their banking system. We have been saying for some time that we have been frustrated, you said that this morning as well. Here is my question: when asked by my colleagues what we intended to do, you mentioned regular meetings and further dialogue and that sort of thing, but it might strike many of us that that is what we’ve had in the past. Are there any specific steps we intend to take if they don’t show material progress toward moving in a better direction?

SECRETARY HENRY PAULSON: Senator, the process that we have is not just dialogue. We are going to be speaking with a single voice to the key decision makers, and we are going to be doing it very regularly and we are going to be following it up and holding them as well as ourselves accountable. Having said that, what you have said very nicely, I have had a number of other Senators say in private.

I’ve met with Senators Schumer and Graham, and a number of other senators, and had them ask what kind of leverage do you have, and what are you going to do if you don’t get results? We are dealing with a sovereign state that has to deal with its own public. I really do believe that what we have put in place gives us the best chance to get some progress. Not to sound naïve, because after all this we may not be satisfied with the progress, but I still believe that we will get more progress with the course that we have adopted than we will going any other way.

What I need to do is make a very, very strong case as to why it is their best interest and how strong you and the American public feel about it. I need to be at the table pressing and pounding on these issues.

BAYH: I hope you are right, Mr. Secretary. I know you are sincere, as you can appreciate the issue for many who observe this process. My staff compiled a list of the statements on behalf of our own government in consultation with the Chinese urging them to take these steps, and they responded that they intend to pursue the necessary reforms.

After a period of years passes, it becomes an issue of credibility on their part. They are saying the right things, but what do they really intend? Are they just placating us but continuing to pursue their own interests? Ultimately our own credibility comes into question because we say the right things, but what are we willing to do to back up what we say?

PAULSON: Senator, I would also mention the compliance with the WTO. Susan Schwabb, our representative, is quite aggressive: You saw the auto parts case, the other things we have in our arsenal. We are not being passive about this. This is a very important relationship to all of us, and managing it properly and making sure we get some progress is key.

BAYH: That is what the steel worker that Senator Shelby referred to and the auto worker in Indiana is looking for, what they want to know. To use the colloquialism that they would, “What the hell do we intend to do about it?” That is what we are looking for: backing up our intentions with actions if there is not material progress. Because at the end of the day, this global trading system that we all embrace has to be one of mutual interest, not unfairly weighted on one side or the other, otherwise it is not sustainable. That is not in our interest, or China’s interest, or anyone’s interest.

If I could just shift subject matter for just a minute this relates again to the currency issue. I was interested in your comments in regard to Senator Shelby about the size of Chinese reserves compared to the daily volume of trading with U.S. securities. I gathered from your comments that you didn’t feel that they could have a material impact on the value of the dollar regardless of the policies of the Chinese government.

My thoughts went back to a couple of years ago, when the South Koreans were thinking about diversifying their own holdings. The dollar fell off temporarily until an official in their treasury came out and said that that wasn’t true. A couple of months later, the same sequence of events happened with Japan. My question to you, Mr. Secretary, is that at least in those two instances, the market place seemed to disagree with your assessment. My concern is this that we can not allow the value of our money to be affected. Do I understand that you are of the opinion that they cannot, even if they wanted to diversify, affect the value of the dollar; and if so, how do you explain the examples of Korea and Japan?

PAULSON: What I was addressing was our treasury and the marketplace for our treasuries, and the impact on interest rates and on treasury securities. I made the point that what they owned in treasuries, 350 billion dollars, 500 billion trade in one day. I made the further point that the key thing that the confidence in our economy and our country is why people hold treasuries. I think you all know my strong views on how important a strong dollar is to our nation’s interest.

Let me just simply say as someone who has been around markets my whole life, I watch people say things. I watch the treasury secretary just say something wrong or misspeak and markets move. I see that all kinds of rumors move markets. What I am talking about is long term fundamental movement because I am a big believer in markets. You can get gyrations, and they can be misvalued at any point in time. The key to our situation is going to be to have economic policies that drive productivity, keep this economy strong, and that is really where our confidence should come from.

BAYH: Mr. Chairman, my time has expired. If I could just make one comment, Mr. Secretary: Your statement that a strong dollar is in the best interest of the United States is absolutely right; my concern is whether another country has the ability to manipulate the value of that dollar in a way that is adverse to us. Given the trade imbalances, I am concerned about that.

PAULSON: I don’t mean to trivialize that comment because I probably get that question more than any other question since I’ve been in this job; but again, as I tell you, the confidence in our economy is the big driver in our economic policy. If we keep this country strong, if we keep our economy strong, people invest in dollar currencies. They invest in treasuries because they believe they get the best risk adjusted return, and that is key.

With regard to the Chinese holding of treasuries, it is not as big as you think when you look at it in terms of how broad and liquid our securities are, and how diverse the holdings are.

BAYH: Thank you, Mr. Secretary. I appreciate it.

PAULSON: Just to make a point, Senator Bayh: I was looking at the quotes from Paul Voker and Warren Buffet and the IMF all have raised the same concerns Senator Bayh has raised about this issue. You get the IMF saying the other day that large current account deficit, 6.4 percent of GDP last year, makes the United States vulnerable to a swing in investor sentiment. It could put downward pressure on the dollar and cause a spike in long-term interest rates. I know Warren Buffet has expressed a similar message, and I just want to say there are a large number of people out there worried about this issue.