Former Treasury Secretary and former Goldman Sachs CEO Hank Paulson tells us in the latest issue of Foreign Affairs that things between the United States and China are just no longer the way they used to be in the good old days of 2008. Then, Beijing was helping to save Hank’s ass by doing nothing more than simply holding onto (rather than selling) the huge stash of U.S. Treasury bills in which it had invested the huge trade surpluses it had accumulated every year for the twenty five years since U.S.-China trade relations had been established. ( I might mention that I was a leader of that first U.S. trade mission to China in 1982.)
Actually, Paulson doesn’t mention the part about China’s trade surpluses nor does he explain why he, on the one hand, might have found the Chinese particularly friendly and, on the other hand had his own special sense of gratitude toward them.
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Let me take you back to 1999 when Paulson emerged as Chairman and CEO of Goldman Sachs, Wall Street’s leading investment bank. This was also the year during which most of the negotiation to make China a member of the World Trade Organization (WTO) had taken place and it was three years after the giant State Owned China Construction Bank became the first state owned enterprise (SOE) to be listed on the New York Stock Exchange thanks to none other than Hank Paulson then of Goldman Sachs. In fact, so good was Paulson to the Chinese that he managed to make this bank, owned not by investing shareholders but by the government of Communist China, the first company ever to list on the New York exchange with an exception allowing it to keep secret information about itself that every other company listed on the exchange had had to provide.
Was it any wonder that the Chinese Communist Party decided to make Hank Paulson a member of that insiders club of special friends of China initially formed for Henry Kissinger? (One wonders if there is something about the name Henry). Anyhow, as a leading club member, Paulson made over 100 trips to China ( in the Goldman personal jet mind you, none of that pedestrian jet lag for a champion wheeler dealer) and showed the way not only to get the huge backbreaking load of the state owned Chinese enterprises off the backs of the government and the Chinese Communist Party but actually to make the government and party rich by selling the enterprises to the U.S. public which could only be done because Hank’s magic was so good that it got special listing privileges for Chinese enterprises technically owned by the state but really owned by the Chinese Communist Party. Mind you, these were not Alibaba, or Huawei, or Tik Tok. These were the state owned behemoths that had finally pulled the Mao model down and led to Deng Xiaoping’s famous comment that “to get rich is glorious.” In selling them, Hank, of course, made big bucks as did Goldman and so also did the Chinese Communist Party. Did they like Hank Paulson? You betchum Red Rider. And, having been a big part of the reason why Hank had emerged as CEO of Goldman, he liked the party and its leaders and seemed to have become convinced that they were all just in a kind of pre-capitalist free market and democracy stage.
Nor was Paulson unique in this regard. Readers might recall that Frank Fukuyama wrote a best selling book entitled: The End of History and arguing that with the fall of the Soviet Union, the world’s future could be nothing other than democracy and free market capitalism. Bill Clinton ran for President on a platform of “no dictators from Baghdad to Beijing.” Once having become President, Clinton shifted to a policy of “positive engagement” with China. I have never been sure exactly what that was supposed to mean, but in practice it meant encouraging U.S. business to invest in China, dramatically increasing U.S. imports from China, transferring technology and jobs to China, moving the entire production of all Apple ,products from California to China, and declaring, as President George W. Bush did, that free trade inevitably planted the seeds of democracy wherever it went.
I find it fascinating that all of these actors and their advisors, Republicans and Democrats, major think tank leaders, top professors at all the top universities, the top columnists like Tom Friedman at the New York Times, and David Ignatius at the Washington Post watched in 1997 as China built its Great Firewall to cut the Chinese Internet out of the World Wide Web. I was at the Davos meeting of the World Economic Forum that year. None of the rich and beautiful there paid a bit of attention to this loud, symbolic declaration by China that it would not be part of the World Wide Web and thus of what the free world was calling globalization. Clinton and then George W. Bush moved smoothly ahead with the negotiations to bring China into the World Trade Organization (WTO) as if the Great Fire Wall were a joke. In fact, Clinton said it was a joke. When made aware of it, Clinton laughed and said China could not succeed in controlling the Internet. Said he: “it will be like trying to nail Jello to the wall.” (wonder how Bill feels about that today). '
So Paulson had a lot of good company in his thinking in those days.
Now fast forward to 2008 when Paulson says relations between the U.S. and China were in such good and friendly shape. Why was he particularly looking for special friends at the time?
I recall being at a global meeting in New Delhi in late 2007 at which a bright Indian financial analyst asked the question: '“where is the risk?” Risk"? What Risk? The cost/price of the risk that should be showing up in global financial markets as a result of the huge and growing bubble of U.S. financial derivatives based on home mortgages was the answer. No one seemed to know.
Later in early 2008, I was at a meeting also attended by a senior executive of Lehman Brothers. I asked him the question the Indian analyst had raised. “Where is the risk?” “There is none” was the reply. “ Look, Clyde, we have our VAR (value at risk) models working overtime and we just don’t see any risk. Don’t worry. Be happy. Times have never been better.”
About six months later there was no Lehman Brothers. The risk had swallowed it whole. As things turned out, the VAR models were useless because they did not anticipate a systemic breakdown. This is not the place to explain the global financial crisis of 2008 beyond saying that it was essentially a fraud based on falsification of U.S. home mortgage values. Michael Lewis’s best selling book The Big Short captures the action best. Instruments known as derivatives were constructed to include several layers of mortgage payments some of which were sure to be paid and others of which might have some risk of non-payment. The big Wall Street investment banks like Lehman Brothers, but also including Goldman Sachs made huge profits by pushing these derivatives to their clients. Often the actual risk contained in the derivative was much greater than advertised either because of sloppy construction or because of outright fraud. Unlike Lehman Brothers, Goldman Sachs did not disappear. But it did pay a $500 million penalty for inappropriate activity. Of course, by this time Paulson was heading the U.S. Treasury and trying to prevent the fraud his Wall Street associates had perpetrated from taking the whole country under along with the banks.
The crisis was global and was the worst economic crisis since the stock market crash of 1929 and the ensuing Great Depression. In the midst of this kind of a crisis, the last thing Paulson needed was for the Chinese to sell a significant part of their enormous U.S. Treasury Bond holdings. That they showed no signs of doing so and acted in concert with Paulson to contain the damage naturally endeared them even further to him. On the other hand, what was to be gained from a sale of U.S. treasuries by China. Further global turmoil would not have been good for China, and what would have been a better investment? The world’s other major currencies were also in trouble. What advantage would there be in selling Treasuries and buying say Euros or Yen which were also in trouble? It was very clear to Beijing that the best thing for it was to backstop Paulson and the U.S. Of course, the party bosses liked Hank, but they refrained from selling their Treasuries because that was what was best for Beijing. If it also happened to help an old friend, so much the better.
What Paulson was largely if not completely unaware of was the China State Council’s 2005 publication of the National and Medium Long Term Science and Technology Development Plan Outline for 2006-20. This was the fifteen year plan aimed at overtaking the United States in science and technology and especially in semiconductor technology. Of course, Paulson was not alone in his ignorance. Most leaders of both parties in Washington as well as most business and academic leaders were still in the honeymoon period of what Niall Ferguson has labeled “Chimerica” to describe the tight coupling of the two economies that was then proceeding apace. The conventional wisdom of the time, which Paulson certainly fully embraced, was voiced by former Deputy Secretary of State and former Goldman Sachs manager Robert Zoellick who intoned that: “we want China to be a responsible stakeholder in the liberal, rules based, global order.”
One of the very interesting aspects of the period from 1982 to about 2016 is the willful suspension of disbelief by otherwise hard boiled free world leaders across the board (political leaders of both liberal and conservative persuasion, corporate leaders, academic leaders, and press leaders) regarding the nature, objectives, and methods of the Chinese Communist Party. It was known that in the Party’s debate about opening China to outside influence, Deng had admitted that some “flies” would get in but reassured his comrades that they could be swatted. The Tiananmen Square massacre of hundreds of students demonstrating for democracy in June, 1989, was quickly forgiven in the free world. Indeed, none other than President George H.W. Bush on whose staff I worked for some time immediately sent his National Security Advisor Brent Scowcroft to Beijing to tell Deng not to worry, that “President Bush was his best friend at this moment and would keep the boats from rocking.” Big time CEOs like Fred Smith of Fedex begged to be chosen to introduce key Chinese leaders at international conferences. (I was there when Fred introduced Jiang Zemin at the APEC conference in Shanghai in 2001). Despite the constant strengthening of the Great Fire Wall that cleaved the Internet in two and the exclusion from the Chinese market of U.S. corporations like Microsoft and Google and the strict censorship of the Chinese press, writers like lead New York Times foreign affairs columnist Tom Friedman could make a runaway best seller out of a book entitled The World is Flat, meaning China, Germany, America and others were essentially the same economically. U.S. Trade Representatives like Charlene Barshefsky could argue with a straight face that bringing China into the WTO and thereby requiring it significantly to reduce its tariffs would cut the then roughly $80 billion annual U.S. trade deficit with China in half. In fact, the deficit grew nearly five fold, but that error did not get in the way of Barshefsky being invited as an expert speaker on China to all the major business and academic conferences.
In this time when Paulson was a major player, it was as if the American establishment was determined that China would be the China of its dreams, a kind of second America which would inevitably democratize and evolve into co-hegemon to rule the world in concert with the United States.
Lamenting the good buddy days of the U.S.-China relationship in the 1990s and early 2000s, Paulson today appears to be a bit preserved in amber. Since he left the W administration, developments in China have dramatically revealed the superficiality and ignorance of the establishment’s mindset. In 2012, Document 9, On the Ideological Sphere, was published by the CCP. It clearly states that the Party does not recognize universal human values, does not recognize a rule of law, does not condone a free press, and certainly not western style democracy. In 2015, the Chinese government announced the policy of Made in China 2025. Under this policy advanced semiconductors, telecommunications equipment, artificial intelligence and virtually all other high technology goods and services were to be made in China with 70 percent Chinese content by the year 2025. Hmm. This hardly jibbed with being a “responsible stakeholder in the liberal, rules based, global economic system” or with the warm, friendly collegiality of the old Friends of China Club of which Paulson was a charter member.
It was at about this same time that the Chinese Coast Guard and Navy began dredging reefs and small islands in the South China Sea while seizing some that International Law said belonged to the Philippines, Vietnam, Malaysia, and Indonesia. This looked like a precursor to effective militarization of the South China Sea. In his 2016 meeting with President Barack Obama, Xi denied militarization and Obama thought that Xi had promised not to militarize the area. But, in the wake of the visit, the dredging increased, and military aircraft runways were built by China on several key islands. In fact, the South China Sea has been militarized by Beijing. Not only that, but in 2017, China’s number one leader Xi Jinping created the Central Military-Civil Fusion Development Committee and charged it with removing all barriers between the joint development of civilian and military technology. In effect, any corporation (whether privately of state owned) could be designated as essential to military development and directed to fuse its technology with that of military goods and services suppliers.
A final episode may capture the full essence of how Paulson and the U.S. establishment completely missed the reality of China under the CCP. In 2015, a shooter in Bakersfield, Ca. dropped his iPhone will running away from the crime. The FBI asked Apple to help solve the crime by opening the iPhone for FBI investigation. Apple (under present leader Tim Cook) stoutly refused and contested against the FBI in U.S. courts saying it had to protect the confidentiality of the data of its customers. Fast forward to 2019 in Hong Kong. Students then were demonstrating against the loss of freedom being imposed by Beijing. In the iPhone App store was an app called Hong Kong Map Live. With the app, the students could see all of Hong Kong in real time. They could see where the police were stationed and so naturally went to demonstrate where the police were not. This was driving Beijing crazy. It threatened CCP style informal coercion in the Peoples’ Daily (main party paper) and within two days, the app was out of the Apple app store. If you are a murderer in America, Apple will protect you. But if you are a kid demonstrating for democracy in a Chinese Communist controlled jurisdiction, don’t expect Apple to have your back.
I have not much mentioned China’s enormous military build up (its navy now has more ships than the U.S. Navy), especially of nuclear weapons, nor its threats to invade Taiwan, nor its use of coercion on countries like Norway, Australia, and South Korea by shutting off its imports from them if they say or do things China doesn’t like.
The key point to be made is that the American establishment really badly misjudged and misunderstood China and essentially kept fooling itself about the reality of China and its objectives and methods. It obviously never asked itself why did Deng Xiaoping, a Marxist/Leninist/Maoist Chinese Communist through and through, urged his followers in the late 1980s to “hide your light, bide your time.” There must be a reason to hide and bide. You must be doing or planning to do something or arrive somewhere that you do not want others to know about until maybe it will be too late for them to oppose you and save themselves.
Hank Paulson is no doubt an admirable person in many respects, but, like his establishment peers, he seems never to have asked himself the question “why”. Why hide and bide? Why did the CCP play so nice with Hank? Or, questions about his own interpretations. Why was the Great Fire Wall not a warning? Why were the violations of WTO commitments, forced technology transfer by foreign companies to Chinese companies as a condition of doing business in China, Made in China 2025, the coercion of Norway by halting imports of its salmon because it awarded the Nobel Prize to a Chinese person who was a dissident from the Party, the strong anti-free world statements of Document number 9, and all the other warning signs ignored by Paulson and his establishment compatriots?
With his recent Foreign Affairs article, Paulson, nice and decent and admirable guy that he is, demonstrates that he and the Establishment of which he was a part, were wrong about China when he was listing its state owned enterprises on the New York Stock Exchange, wrong about China when he was Secretary of the Treasury, and wrong about China now.
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thank you very much Billy. You have a very good story to tell. Clyde