Francis Fukuyama is the author of “The End of History and the Last Man.” Henry Paulson is the former US secretary of the Treasury, whose recent memoir, “On the Brink: Inside the Race to Stop the Collapse of the Global Financial System” has just been published. This conversation between them will appear in the forthcoming issue of “The American Interest,” and was made available to the Global Viewpoint Network.
Francis Fukuyama: You got to know the Chinese leadership when you were at Goldman Sachs, well before you came to be Treasury Secretary. Yet even during the period in which you made scores of trips to China, many observers expressed concern about the implications of large structural imbalances in the global economy: so much savings being accumulated in China, so much debt being racked up in the United States, and so much foreign money flowing back into the US banking and financial system in ways that may have encouraged excessive risk-taking and contributed to the real-estate bubble.
Looking back, what weight of responsibility do you assign to those imbalances for the way the financial crisis unfolded in the second half of 2008?
Henry Paulson: A big part of the imbalances, in my view, stems from our proclivity here in the United States not to save – as a nation and as individuals, and to borrow too much. There are a number of policies that contribute to this proclivity: our tax code, for example, which taxes savings and capital and encourages consumption; and the weight of a number of our housing policies, which stimulated the housing market via Fannie Mae, Freddie Mac, FHA programs, the tax code and in other ways that contributed to asset inflation.
By contrast, there are a number of nations – including China of course – where savings rates are high, and where domestic consumption plays a smaller role in their economy.
When I became Treasury secretary, we established the Strategic Economic Dialogue (SED) to address our economic relationship with China. And through the SED we looked for practical ways to address the economic imbalances. This included the currency issue because moving toward a market-driven currency would accelerate the progress of reform and help China transition toward higher levels of domestic consumption and producing higher-value-added goods and services and away from over-reliance on lower-cost, lower-value-added exports.
But I also argued for capital markets reform and opening up their capital markets to more competition, not because I was trying to do bankers any favor, but because I believed a vibrant domestic capital market would help China deal with the structural transformations they wanted to achieve.
One example I used frequently was that, in China, individuals with their savings in bank deposits received very low interest rates, well below inflation. Because of inefficient capital markets, they were, in essence, paying to save, or unable to earn any significant return on their savings. And of course inadequate government retirement programs and other safety nets led to high levels of precautionary savings.
We also focused on very high levels of corporate savings in China, particularly in the state-owned enterprises. So yes, I was mindful of the imbalances.
Fukuyama: We’ve been talking until we’re blue in the face about the kind of liberalization you’ve just mentioned, and of course about revising the value of the renminbi. The results have been uneven, have they not?
Paulson: Yes, they have. While I was Treasury secretary, we saw substantial movement in the renminbi. That shows, I think, that the right way to deal with the Chinese is directly and in private, recognizing that they place a huge priority on economic development and reform. We need to continue to make a broad case for reform that includes several dimensions.
There’s a lot of emphasis placed on currency, because that’s easy for people to understand. But the currency issue is just one of a number of significant factors. I continue to believe that it’s in China’s interest, as well as our own, that it continues toward a full transition to a market economy. We need to privately, continuously, and forcefully make the arguments as to why it is in China’s best interest, however, and avoid finger-wagging and lecturing them in public.
Fukuyama: Let me play devil’s advocate on this. It seems to me that no American policymaker has taken a hardball option with them very seriously. One way of thinking about Chinese currency policy is to liken it to a form of industrial policy. But unlike the Koreans and the Japanese, the Chinese aren’t subsidizing one particular sector, like petro-chemicals.
They’re basically giving their whole coastal manufacturing region a big advantage over the rest of the world by keeping their currency pegged to the dollar at its current, unreasonably low rate.
If it’s harming us, it’s absolutely killing the Europeans and everyone else in Asia. In a certain sense, China has been in effect de-industrializing much of the rest of the world. I’ve been to maquilas in Latin America since the end of the microfiber agreement and seen firsthand how manufacturing capacity is now being sucked out of these developing countries and into China.
If one were to regard China’s de facto export subsidy via its currency policy as theoretically no different from a direct subsidy to its manufacturing/export industries, the normal way to deal with this would be with a tariff or some other kind of sanction. That might lead to a series of threats and counter-threats, but eventually they would discover an incentive to change their policy.
An analogy might be the Plaza Agreements with Japan in the 1980s, when the Japanese similarly built up a huge imbalance. Because Japan was an ally of the United States, and because the Japanese worried precisely about a protectionist backlash, they agreed to a major revaluation of the yen. But we’ve treated China, which is not an ally and whose imbalances are even larger than Japan’s were, much more gingerly. Why?
Paulson: I’ve heard those arguments, and I understand them, but I don’t believe that tariffs or protectionism is the answer. And there are, of course, a number of countries in the world that don’t have market-determined currencies, but what is so extraordinary here is to have an economy that is so important, so large, and so integrated into the global economy in terms of goods and services but does not yet have a market-driven currency or an open financial system.
So it is important for China to move more quickly toward a market determined currency, which is its stated goal. But, it should not be the job of the United States alone to make the case. The International Monetary Fund, for example, also has an important role to play, as do its other trading partners. And again, factors other than the currency are important here, such as the extent to which corporate savings are not paid out in dividends.
The picture that emerges is a complex one. I believe that China is committed to reform, and it is very much in their interest to continue to move the currency. We need to encourage speeding this process up while working to address our own imbalances.
Fukuyama: Let me ask you about the Chinese response to the crisis. Right now everyone is giving the Chinese plaudits for their really big stimulus, and for the fact that they only suffered for a quarter or so. (The last quarter showed almost 10 percent growth again.)
They’re obviously feeling quite good about themselves as a result. But it seems to me that their response to the crisis was just to do more of what they’ve traditionally done, which is to fill in for missing external demand through huge infrastructure spending that greatly privileges the coastal manufacturers against the rural consumer population. Do you think this is sustainable?
Paulson: First of all, in terms of their response, I think one of the benefits of the SED was that we had active engagement and built up a relationship of trust. So the Chinese were quite constructive and supportive as we worked through the crisis. We talked to them regularly and this benefited both countries.
Secondly, we all needed China’s economy to keep growing. If it hadn’t, we’d be much worse off today. I give the Chinese a lot of credit for their stimulus. I believe their most important action was increasing bank lending by more than $1 trillion. There will certainly be some repercussions from that, not all of them attractive, but I think that was a net positive.
I do believe, too, that the Chinese understand there’s more to do. There are a number of countries in the world in which the gap between the top and bottom rungs of the economic ladder is widening, and this is something the Chinese are concerned about in their own country. I believe their commitment to reform includes finding ways to spread wealth more broadly. One way to do that is to encourage an increase in domestic consumption and less reliance on exports for growth.
That will certainly take time. But again, the imbalances are bilateral and we can’t overlook our own penchant to overspend, overconsume, and overborrow. We will, and we should, continue to forcefully engage with the Chinese, but we’ve got important responsibilities of our own to deal with. It will do us no good to shirk those responsibilities by focusing too much on China.