Treasury Secretary Timothy Geithner indicated U.S. patience on China's currency policy was wearing thin on Thursday as a key lawmaker warned that he would move soon on legislation that would penalize Chinese goods.

Striking his toughest tone on the yuan since delaying a decision in early April on whether to name China a currency manipulator, Geithner told a U.S. Senate hearing Chinese policies had a harmful worldwide impact.

The distortions caused by China's exchange rate spread far beyond China's borders and are an impediment to the global rebalancing we need, Geithner said.

Echoing a refrain he has used since April, he said Beijing would find it in its own interest to have a more flexible yuan, also known as the renminbi.

A stronger renminbi would benefit China because it would boost the purchasing power of households and encourage firms to shift production for domestic demand, rather than for export, he told the Senate Finance Committee.

U.S. lawmakers, many of whom face re-election in November, believe an undervalued yuan subsidizes Chinese exports at the expense of American competitors. With the U.S. unemployment rate hovering just below 10 percent, many demand action.

The time is long past for any Treasury Department to admit publicly what everyone else already knows, that China is manipulating the value of its currency in order to gain an unfair advantage in international trade, said Charles Grassley, the senior Republican Senator on the committee.

Democratic Senator Charles Schumer told Geithner to be prepared because lawmakers would move forward soon with legislation that would slap anti-dumping penalties and countervailing duties on goods from China and other countries with a fundamentally misaligned currency.

BACK TO 2005

After partly freeing its currency to rise gradually from mid-2005 to mid-2008, China repegged the yuan to the dollar at a rate that U.S. lawmakers and some economists say is as much as 40 percent below the actual value.

The level of undervaluation is back to where it was in 2005. We have not made progress, said Schumer.

Under sharp criticism, Geithner acknowledged that he did not know when China would allow the yuan to rise again.

I, to be honest, do not know whether we're at the point now when we're going to see meaningful progress in the near term, he said.

Two opportunities for the Chinese to move on the currency -- the U.S.-China Strategic and Economic Dialogue in May and the Group of 20 Finance Ministers meeting in South Korea last week -- passed without any action.

The deepening of Europe's debt crisis since April has severely weakened the euro, causing markets to dampen expectations of a yuan shift any time soon.

But new Chinese data released on Thursday showed a robust 48.5 percent jump in exports in May, putting pressure on U.S. President Barack Obama to placate critics. Chinese imports almost rose by nearly as big a margin.

Dollar/yuan offshore forwards reversed earlier rises to fall late on Thursday, implying more yuan appreciation in future. But dealers said there was not a solid uptrend for the yuan for now.

NO MORE GOOD COP?

Geithner, who in April delayed a much-anticipated Treasury report on whether Beijing manipulates the value of its yuan, said he would take stock of the currency report after the G20 leaders summit in Canada later this month.

Schumer's pressure and broad anti-China sentiment in Congress might help persuade Beijing to move, he said.

I'm saying that it's important for China to understand that Congress will act if China does not act, added Geithner.

Geithner played less of a good cop than before in the face of mounting congressional impatience, said economist Derek Scissors of the Heritage Foundation, a Washington think tank.

The Chinese need to understand that the closer we get to September, the more likely we are to actually get this legislation passed by Congress, he said, referring to lawmaker's calculations ahead of November elections.

Currency and trade are just one flashpoint in the difficult U.S.-China relationship. Ties were strained this year over human rights, Tibet and U.S. weapons sales to Taiwan.

But Washington won Chinese support for new U.N. sanctions on Iran and has turned to China to help rein in North Korea after a series of provocative actions by Pyongyang.

Senate Finance Committee Chairman Max Baucus said the United States appeared to be withholding criticism of Chinese economic policies in order to enlist Beijing's geopolitical support and should consider de-linking the two areas.

We no longer have the luxury of pursuing failed approaches, said We must rethink the U.S.-China economic relationship. We must act, not just talk.

(Additional reporting by Doug Palmer; editing by Mohammad Zargham.)

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