The Treasury Department urged China to allow its currency to appreciate and estimated global growth will slow in the first half of 2009 in a report to Congress released Wednesday.

The biannual report on International Economic and Exchange Rate Policies describes the currency policies and exchange situations in 19 individual counties plus the Euro countries and the Gulf Cooperation Council Counties.

The report calls on China to diversify its economy by promoting internal spending. So far Treasury’s urgings have been unpersuasive as the report details how China has built a massive surplus on its export trade. Chinese leaders have indicated recently that they are satisfied with the economic model.

In the report, the Treasury states that China “needs to rebalance its economy by relying more on domestic private consumption rather than exports and by further developing its financial markets.”

Expeditious movement toward a market-determined exchange rate is an integral part of this process. As a first step, the pace of appreciation in early 2008 needs to be resumed. Treasury continues to use every opportunity to impress upon Chinese authorities the importance and urgency of exchange rate reform.”

One dollar bought 6.86 Yuan in trading today. The Yuan has appreciated about 17 percent against the dollar since China removed its currency peg to the dollar in 2005. China continues to keep its currency cheap relative to other currencies so that its exports are less expensive globally.

The report comes after Paulson visited China last week and said he was “distressed about the movement of the Yuan.” China, which owns $1 for every $10 of U.S. debt, said it is “highly unlikely” to change its currency policy, according to Yu Yongding, a former adviser to the Chinese central bank.

China has built a dominant surplus fueled by its exports despite the global economic downturn, the report showed. In the first ten months of 2008, China’s global trade balance grew to a record high of $216 billion, with exports growing by 22 percent over the same period in 2007.

Chinese imports grew by 30.7 percent in the first half of 2008 from the first half of 2007, in part due to rising import prices, but import growth in the second half of 2008 has decelerated on a monthly basis, down to a sixteen-month low of 15.6 percent in October versus October 2007.

China’s global trade surplus in the first three quarters of 2008 declined slightly to $181 billion (6.6 percent of GDP) from $186.1 billion (9 percent of GDP) in the first three quarters of 2007.

The report estimates that emerging market growth will fall to 5.7 percent in 2009 from 8.0 percent in 2007. Middle East countries, which are still profiting from high oil prices this summer, are likely to maintain high growth next year, the report said.

The report also includes an appendix on sovereign-wealth funds. The Treasury estimates that $2-3 trillion dollars are under management in SWFs and that the amount will increase to $7-11 trillion by 2013. The report said SWF representatives he met and agreed on policies to promote greater financial disclosure and macroeconomic policies to insure investment health. The report emphasized the need for SWFs to be financially, not politically motivated.

Look Homeward (The Economist): The “wall of money” argument is a hardy investment perennial. Back in the 1980s, it was the Japanese who would sweep in and push up stock markets. In recent years, sovereign-wealth funds have assumed the role of sugar daddies, with cash readily available to support asset prices.

SWFs will obviously grow a little older and wiser as a result of the U.S. mortgage collapse. They are likely to invest in their own backyards from now on spelling trouble for U.S. companies desperate for foreign relief. Why invest in the Big Three when you can start your own car company for less?

Emerging Market week – Weak Commodity prices to hurt EM (Reuters): Emerging markets are likely to continue their downward spiral this week, pressured by a slump in commodity prices as demand wanes due to the intensifying U.S. recession.

This summer, U.S. stock indices were tightly correlated to oil prices. As oil futures rose, stocks fell. Now as oil prices have fallen, the the emerging market indices are retreating. The correlation goes both ways.

U.S. Sees China Intent On Yuan Gaining Value (Washington Post): Treasury Secretary Henry M. Paulson Jr. said Friday that China remains committed to market reforms and to allowing its currency, the yuan, to appreciate in value even though it fell steeply this week.

U.S. Treasury securities are the only major export to China. If the yuan appreciates then piddly return China is already getting will weaken even less.

Paulson sought to play down American concerns about China’s growing financial influence in the United States, particularly its position as the world’s top holder of Treasury bills. “It’s a fact that China is an investor in the U.S.,” the Treasury secretary said. “But as I look around the world, I don’t see any country with a stake so big that I consider it a threat.”

I don’t know if I understand this right, but how does China gain as its currency appreciates?