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Hank Paulson on China & the financial crisis

Thursday 16 December, 2010

The Chicago Council on Global Affairs hosted A CONVERSATION WITH HANK PAULSON ON U.S.-CHINA RELATIONS AND THE GLOBAL ECONOMIC OUTLOOK in a Q&A session with former Chicago Fed Chief Michael Moskow &  with 1100+ of their closest friends.  Here is a summary:

  • Paulson prioritized the US bilateral relationship with China by holding regular formal & informal discussions to develop understanding on both sides.  Accomplishments with China were getting them to change their exchange rate, short-term crisis resolution, & food/product safety improvements.
  • The Chinese need to better develop fundamental structures like a social safety net, social security, etc. & reform their financial markets so that saving outpaces inflation, but that takes time.
  • Chinese leaders are competent, understand the issues, & get things done.  They’ve looked around the world for best practices on privatization & will be less dependent on low-value-added environment in the future.
  • There is truth to the fact that some Chinese decisions are made outside of the marketplace, which creates inefficiencies, but they are on the path of economic reform.  It’s in their best interests to let currencies float.  It becomes more difficult as it becomes more integrated & complex, such as with pace & timing issues.
  • The challenge in China is that the economy is growing so quickly, although they’re very competent, much of the power resides at the local/regional level & there are misunderstandings on both sides.
  • Chinese leaders are limited in what they can do with their administrative policies toward 4 1/2% inflation rate because they don’t have a freely floating exchange rate.  Although they could not have 10 years ago, China propped up the world during the financial crisis.  Not all loans they make are good loans:  there will be bumps in the road.
  • China is an anomaly:  it’s the 2nd largest economy in the world, but ~#100 in GDP/per capita.  Therefore how they manage issues like whether or not to float their exchange rate is important.
  • Paulson is more concerned about the US fiscal situation than how much debt the Chinese & others hold.  They show confidence in the US by holding our debt.  There is still no other better reserve currency.
  • In dealing with the financial crisis, Paulson had limited authority over non-banking financial decisions, (for example to save Lehman Brothers) so there wasn’t much he would have done differently.  They made communications mistakes (for example a 3 page outline for TARP), which looked arrogant.  He intended to save people, not Wall Street.
  • Paulson is pleased with the Obama Commission’s recommendations & gratified at the level of public debate with realistic options.  The issues are broader than entitlements:  we need to reform the tax system, etc.  The longer we wait, the more pain we will have to endure.  We’re selfish:  we want what we can’t pay for.
  • Look @ Europe today if you want to do nothing about the financial crisis.  Although markets will question our debts & deficits, we have a little wiggle room to deal with it now.
  • Of course, our present trends are unsustainable.  We need to reform social security & health care.  Democrats & republicans will have to agree or the markets will force their hands.

open Q&A

  • Paulson believes in a strong $, which is a proxy for the economy & stability.  Every country has issues, but ours are less difficult.  The question is “Can the US political system deal with it?”  He worries about the political polarization &  gerrymandering.  There is no future for ideologues.  Many western democracies face the same challenges.
  • It’s a concern that members of congress still don’t have passports.  They need to listen & learn better.  We can’t be unilateral & arrogantly force our system on others.
  • Financial reform depends on how it’s implemented.  There are no longer any financial institutions that are too big too fail:  they are just too big to liquidate quickly.  Regulatory arbitrage has changed:  the Fed has become a systemic risk regulator.  Regulators will not find all of the problems:  we need market discipline.  Market crises come with rhythmic rapidity:  we need to manage them better.
  • Lehman couldn’t be saved because they couldn’t find the authority to save it.  The Brits couldn’t save BlackRock for the same reason.  The perception was that AIG was an unregulated holding company, but their liquidity problem was solved by a government loan.  Lehman had worse problems, so no one else was interested in them.  There were only 2 potential buyers, & the Bank of America bought Merrill Lynch (which would have been worse had it failed) & Barclays couldn’t get UK regulatory authority.  Making loans in the middle of a bank run won’t work:  investors won’t wait.
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