BEIJING (Reuters) - US Treasury Secretary Henry Paulson on Thursday urged China to open its financial sector to foreign competition and said a critical challenge would be to hold back global trade protectionist forces.

Paulson spoke to students at Tsinghua University in Beijing, using the forum to reiterate the U.S. call for more open Chinese capital markets and to warn that the possibility of trade action against China was real.

The U.S. Treasury chief said freeing up financial markets was "absolutely necessary for long-term economic success" because it would allow more efficient investment and greater returns for China's rising savings.

Paulson spoke a day after the United States and China announced a plan for regular high-level talks about their long-term economic relationship that U.S. officials said would not overshadow immediate concerns including the yuan exchange rate.

The "strategic economic dialogue" was agreed by President George W. Bush and Chinese President Hu Jintao last month but only revealed as Paulson began a three-day visit to Beijing on Wednesday. He is to meet Hu on Friday before returning to the United States.

But signs were evident already on Thursday that U.S. legislators remain unhappy at what they perceive to be an undervalued Chinese yuan, or renminbi, and that Chinese officials intend to proceed at their own pace toward letting it become more responsive to market forces.

TROUBLE AT HOME

Paulson hinted at the pressure he faces from U.S. lawmakers when he cautioned about the risk of trade barriers.

"I think one of the biggest challenges will be to make the case in the United States and around the world for the benefits of trade, openness, because virtually everywhere in the world we have protectionist sentiment," he said.

Some of that was unavoidable as China's booming economy and America's huge consumer markets tie the two countries more closely, he said, but added that each side must also take into account the positive impacts of stronger ties.

"Global trade benefits all the countries that participate, and those that don't open themselves up to reform and change don't benefit and they get left behind," he said.

One sponsor of a U.S. Senate bill, which proposes tariffs against Chinese imports unless the yuan is swiftly revalued, indicated he was not yet satisfied with China's actions.

"We have had four years of talk," said Democratic Sen. Charles Schumer (news, bio, voting record) of New York. "Everyone knows the Chinese are flouting the rules. We need action."

Paulson's call for China to open its financial markets comes as foreign banks are rushing into China, in part to tap the roughly $2 trillion in personal savings in the world's fourth-largest economy.

Paulson said he sought "a long-term strategic view" of U.S. and Chinese relations that went beyond short-term irritants.

But senators Schumer and Lindsey Graham, a South Carolina Republican, are threatening to put their tariff proposal up for a vote by September 29 before Congress adjourns for November congressional elections.

Democrats seeking to wrest control of the U.S. House of Representatives and Senate from Republicans are expected to campaign hard on the issue of job losses and modest income gains for American workers, blaming the problems on unfairly cheap Chinese-made goods.

Paulson said the issue of lost U.S. manufacturing jobs needed to be balanced against the benefits of cheaper goods for U.S. consumers.

"There's more weight being given to the production side, to the jobs, and there's less credit to the benefit you guys (China) give, which is the ability to buy products for a lower cost."