Dealing With China: A Conversation With Henry Paulson

Treasury Tenure and Crisis Management (2006–2009):

• Paulson served two and a half years at the Treasury, characterizing the period as a mix of "sweat, blood, and tears" but ultimately successful in preventing a far worse economic collapse.
• He asserts that most major decisions made during the crisis were correct, noting that mistakes were identified and corrected in real-time rather than being perfect from the start.
• Specific Corrections Made:
  • Fannie Mae and Freddie Mac: Initially requested only unspecified congressional authority, hoping to avoid direct intervention; later took the "bazooka" action (nationalization/conservatorship) when the situation worsened.
  • Bank Capital Injection: Initially told Congress they would not use TARP to buy illiquid assets to avoid nationalization; subsequently pivoted to President Bush to implement direct capital injections when the market disintegrated.
• Lehman Brothers Decision: Paulson denies actively deciding to let Lehman fail, stating there was no legal authority available to save the investment bank; argues that a failed run on an investment bank with a loan from the Fed would have disintegrated the institution without a buyer.

Strategic Engagement with China:

• Established the Strategic Economic Dialogue (SED) in 2007 to navigate the complex, diffuse decision-making structure of the Chinese government.
• SED Outcomes:
  • Successfully navigated the 2008 financial crisis with Chinese cooperation.
  • Secured a 10-year framework on energy and the environment that continues to influence current climate agreements.
• 2007 Tensions: Despite public image of a "nadir" in relations (e.g., refusal to dock the Kitty Hawk, arms sales to Taiwan, and the Dalai Lama meeting), internal dialogue remained robust across multiple government levels.

Key Lessons from Chinese Negotiations:

• Economic Strength as Leverage: Paulson highlights a 2008 meeting with Wang Qishan, where the Chinese counterpart questioned US wisdom while the US was in crisis, underscoring that economic credibility is essential for leadership.
• Reform Strategy: Advises working with domestic Chinese reformers (e.g., using WTO accession or a Bilateral Investment Treaty) rather than external pressure alone.
• Current Chinese Economic Challenges: Identifies structural issues including a broken municipal finance system, excessive debt from infrastructure overinvestment, over-reliance on exports, and state-owned enterprise (SOE) dominance.

U.S.-China Relations Outlook:

• Current Status: Describes the relationship as a "partner" on a complex spectrum, not an ally or a foe, noting that the consensus that "helping China helps America" is breaking down due to competition and military buildup.
• Future Advice:
  • Prioritize pragmatic cooperation on shared interests (e.g., climate change, economic stability) while managing healthy competition.
  • Avoid "destructive competition"; focus on building economic linkages to insulate the relationship from security tensions.
• Cybersecurity and IP:
  • Identifies cyber theft of private sector intellectual property as the most troubling economic issue, distinct from state espionage.
  • Advocates for a multi-pronged response: improving US cyber security, multilateral sanctions, and avoiding a total wall-off of mutual economies.

Internal Chinese Politics and Corruption:

• Xi Jinping's Anti-Corruption Campaign: Estimates over 250,000 officials punished and more than 70 at the ministerial level removed.
• Assessment: Paulson views the campaign as serious and necessary for the Party's survival but notes it addresses symptoms rather than systemic causes (e.g., government dominance in the economy, lack of rule of law).
• Long-term Solution: Argues that the ultimate cure for corruption requires transparency, a professionalized legal system, and a free press, though he acknowledges Xi's current focus on party authority over liberalization.

Human Rights and Policy Approach:

• Rejects the notion of trade-offs between economic security and human rights, viewing them as complementary.
• Pragmatic Success Story: Secured the release of a pro-democracy activist in 2007 while simultaneously negotiating environmental frameworks, using shared interests to build trust.
• Public Sentiment: Notes that Chinese public anger over corruption (e.g., officials wearing expensive watches) provides a driver for transparency and reform from the bottom up.

Global Infrastructure and Institutions:

• Asian Infrastructure Investment Bank (AIIB): Dismisses the AIIB as a watershed threat to US influence, noting the US does not prioritize infrastructure funding and that China's own Ex-Im Bank already outspends US institutions in this sector.
• Strategic Recommendation: Advises the US to join the AIIB to influence standards rather than fight a losing battle, and to push for modernization of the World Bank and IMF to better address modern infrastructure needs.

Geopolitical Tensions (South China Sea):

• Confirms the US position is neutral regarding the underlying sovereignty merits but strongly opposes the use of force or coercion.
• Highlights the risk that territorial disputes could disrupt the region's economic integration, emphasizing the US obligation to ensure freedom of navigation.
• Acknowledges China's military buildup as a reaction to US presence, urging a strategy of maintaining strength while building economic linkages to mitigate security risks.

Financial Crisis Anecdotes:

• Ted Spread: Paulson recalls the critical moment with President George W. Bush where the "Ted spread" (risk measure) indicated the system was on the edge of collapse, necessitating the unconventional bank recapitalization.
• Zhu Rongji: Recalls an encounter where Premier Zhu Rongji's "long johns" were visible, highlighting the informal, human side of high-level negotiations.
• Climate Hypocrisy: Relays Wang Qishan's challenge to the US regarding air conditioning usage in the US versus China's climate commitments, forcing a pragmatic conversation about resource constraints.