China, Wall Street, and the Financial Crisis: Francis Fukuyama Talks with Henry Paulson

Article excerpt

Scholar Francis Fukuyama and former Treasury Secretary Henry Paulson talk about China, Wall Street, and the global financial crisis.

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. …