Epiphanies from Hank Paulson

What is happening to the Chinese economy? After averaging roughly 10 percent annually for three decades, the pace of GDP growth began to slow in 2012 — and may drop into the low single digits in a few years. Pessimists say the country could face a hard landing or even long-term stagnation. But Hank Paulson, who as U.S. treasury secretary stewarded the American economy through the darkest days of the financial crisis and now runs the Paulson Institute, a think tank that promotes cooperation between the United States and China, remains cautiously optimistic about China’s long-term prospects — so long as it implements important reforms. After all, ebbs and flows are all part of the game. "As long as you have financial markets and banks, there will be financial crises," Paulson says. Interviewed in his Chicago office in February, Paulson talked about what Beijing needs to do to avoid its own Great Recession — and more.

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Like so much of the rest of the world, the Chinese watched in horror as the financial crisis began because they had been working hard at best practices and they thought that the United States had the right model. I’ve worked extensively with the Chinese leadership and with Wang Qishan [China’s top anti-corruption official], and we have a good working relationship. When I was pressing them very hard on their financial-market reform, Wang very nicely said to me, "You used to be our teacher, but right now, our teacher doesn’t look quite as wise."

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The Chinese economy is too big and too complex to be run by this jerry-rigged structure of a combination of state-planning and markets. I have no doubt the Chinese leadership knows what the big economic issues are. They know they need a different economic model — one that’s less dependent on investment and exports — and to move to normalize the labor market, reform the capital markets and the municipal finance system. The 100 percent issue on my mind is, are they going to be able to solve these problems? Because reforms haven’t been done for so long. The scale of their challenges is truly awesome.

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When you step back and look at this in a bigger context, one of the huge problems China faces is that they need to modernize their government. They don’t have the institutions they need to govern. China is a country ruled by men more than laws.

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The reform debate in China is mostly a conflict between those who want to reform domestically and those who want to open up to foreign competition. In my judgment, the true reformers are those who want to open up to competition, because that’s the only way China is going to realize its economic potential — and it’s also only fair to the rest of the world.

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China invests in our Treasurys because it is in their interest to do so. As important as that is, I would much rather see investable dollars going into something that’s more permanent: investment in greenfield plants that create jobs or acquiring failed or failing companies.

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I think people have to be very careful with new ideas. If something is a bad idea, you never really need to worry about it too much. It will come and go and maybe do a little bit of damage — some people will lose some money — but it’s not a big thing. What you need to worry about is when you have something that’s a really good idea, but you get too much of it too fast, like over-the-counter derivatives. Complexity and innovation are not always good things. I haven’t studied Bitcoin in detail, but even if I had, I’d be very careful with anything that volatile.

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For those who say, "Well, Washington is just more poisonous than it’s ever been," they just don’t know their history. I went to work in the Nixon White House six weeks before the Watergate break-in, so I saw a little bit of poison. It’s not unusual for there to be periods like this, and I’m more optimistic than some that we will get our political act together.