Feb 04

Did Paulson Accuse China to be a Root Cause of Today’s Global Economic Crisis?

Written by Allen on Wednesday, February 4th, 2009 at 9:10 pm
Filed under:Analysis, General, News, politics | Tags:,
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In an interview to XinHua, Former U.S. Treasury Secretary Henry Paulson declared that he was wrongly portrayed to have laid blame on China for causing today’s global economic crisis.

According to yesterday’s XinHua report,

Former U.S. Treasury Secretary Henry Paulson said Tuesday that he was wrongly portrayed in a Financial Times article as claiming China is to blame for the global economic crisis.

“In the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters– at a time of low inflation and booming trade and capital flows — put downward pressure on yields and risk spread everywhere,” the British newspaper quoted Paulson as saying Monday.

That, the newspaper quoted Paulsen, pushed down interest rates and drove investors to riskier assets, sowing the seeds of a global credit bubble that extended beyond the U.S. subprime or high-risk home loan market and eventually burst.

“The Financial Times reporting was wrong,” Paulson said in a statement sent to China’s Xinhua News Agency Tuesday.

“In assessing the financial market crisis, I have repeatedly and consistently targeted the vast majority of my criticism at problems in the United States, particularly our flawed and outdated regulatory structure,” Paulson said.

“Whenever I have commented on global imbalances, it has been against that backdrop and I have gone out of my way to say that no single country is to blame for the imbalances,” he added.

In his statement to Xinhua, Paulson said that “the U.S.-China relationship continues to be vital to both our nations and to the global economy.”

“To maintain a strong and mutually beneficial relationship, we must rely on direct communication rather than media reports,” he said.

When I saw the Financial Times Report for the first time last month, I didn’t think much of it.  According to the report:

The US Treasury Secretary said that in the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters – at a time of low inflation and booming trade and capital flows – put downward pressure on yields and risk spreads everywhere.

This, he said, laid the seeds of a global credit bubble that extended far beyond the US sub-prime mortgage market and has now burst with devastating consequences worldwide.

“Excesses . . . built up for a long time, [with] investors looking for yield, mis-pricing risk,” he said. “It could take different forms. For some of the European banks it was eastern Europe. Spain and the UK were much more like the US with housing being the biggest bubble. With Japan it may be banks continuing to invest in equities.”

This argument – already advanced by a number of economists and largely endorsed by Federal Reserve chairman Ben Bernanke – suggests that the roots of the crisis do not simply lie in failures within the financial system.

It also implies that avoiding crises in future will require global macroeconomic co-operation as well as better financial regulation and risk-management.

Am I missing something here?  The report merely stated that global trade imbalance is likely one of the root causes of today’s economic crisis.  Isn’t that what Paulson has been saying – even if with slightly different emphasis – all along?

In a speech Paulson himself gave last November, Paulson stated

And we recognize that our financial institutions and our markets are global, but our regulatory regimes are national, so we will examine how best to improve cooperation and information sharing to foster global financial system stability.

But let us not forget one fundamental issue which lies at the heart of our problems. Over a period of years, persistent and growing global imbalances fueled a dramatic increase in capital flows, low interest rates, excessive risk taking and a global search for return. Those excesses cannot be attributed to any single nation. There is no doubt that low U.S. savings are a significant factor, but the lack of consumption and accumulation of reserves in Asia and oil-exporting countries and structural issues in Europe have also fed the imbalances.

If we only address particular regulatory issues – as critical as they are – without addressing the global imbalances that fueled recent excesses, we will have missed an opportunity to dramatically improve the foundation for global markets and economic vitality going forward. The pressure from global imbalances will simply build up again until it finds another outlet.

Clearly (based on my reading of this speech) Paulson felt that the world’s global trade imbalance (to which China’s trade surplus with the U.S. is a part) is a problem and will ultimately cause an economic crisis – if not today, then some other time in the future.

Why is Paulson backtracking now?  Why such a strong refutation?

We live in an interdependent world.  Is trade one of the many thorny issues that are better discussed between governments in private behind closed doors than through the media in public using sensationalistic, emotionally laden rhetoric?

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22 Responses to “Did Paulson Accuse China to be a Root Cause of Today’s Global Economic Crisis?”

  1. WillF Says:

    I don’t really see any inconsistency in Paulson’s statements. I’m not really sure what the issue is.

  2. Jed Yoong Says:

    I can’t really recall Paulson being unfairly anti-China.
    He is largely responsible for the mess in the USA.
    In my view, Keynesians tend to criticise countries with a “lack of consumption and accumulation of reserves”.
    For years since Japan’s economy stagnated about a decade ago, the media has been pointing to its high savings rate and reluctance to spend as reasons behind the prolonged “recession”.
    The general theory of interest rates, forex, etc argues that if rates are low, then you must lend. Is that really necessary so? If the yields won’t be safe enough, why risk an investment? It’s as good as having no yield as you won’t know if you will receive it or recover your investment should the whole thing goes belly up as in the US of A.
    If you take away interest rates, and the “need” to put your money in places that yield the highest interests and where rates are a function of supply and demand, this crisis may have been averted….

  3. AG Says:

    It seems as if China realizes they saved too much, to everyone’s detriment (referring to Mr. Wen’s statement this morning that “Confidence is the most important thing, more important than gold or currency”) but that doesn’t mean they have to spend in any one country. They can completely exclude the U.S.A. if they feel slighted by a politican’s comments. Interestingly, this morning FT reported that China is going on a European spending spree, which seems to exclude America. http://www.ft.com/cms/s/0/e9f43b92-f14b-11dd-8790-0000779fd2ac.html

    For this reason I think American politicans will go out of their way to avoid offending China. You won’t have a successful store if you upset potential customers. If China’s spending continues, expect the world to say lots of flattering things as they compete for its money.

  4. TonyP4 Says:

    All the great minds from the x-Federal Reserve chairmen and the x-Treasury did not work in the past, so I do not expect the current great minds work in present and in future. Would some one shed light on why the best minds do not really work in practice. At least one admitted that he was wrong after learning/working on economy for 40 years.

    My common sense.

    – You cannot improve the economy by spending stuffs you do not need. Infrastructure spending is different.

    – You cannot improve the economy by starting a war, except for the arm manufacturers.

    – We need to balance the budget and cannot borrow money forever to force our children to pay for them.

    – It is easy to blame others on our problems.

  5. AG Says:

    You cannot improve the economy by spending stuffs you do not need.

    Spending always improves the economy. It’s very hard to spend money without giving someone a job. The economy only collapses when people hoard money.

  6. TonyP4 Says:

    China and US are just extremes.

    With the low average income, the average Chinese citizen does not have much to start with. With lack of insurance products and social security net, naturally they need to save. However, the Chinese government is rich with excessive foreign reserves, which could help the global recession.

    The US had unlimited loans to the consumers who in turn bought consumer products (most were not needed and most are made in China) from China, who in turn bought raw materials/oil… When US/EU consumers stop buying, it causes the global recession.


  7. WillF Says:

    @AG #3:

    “You won’t have a successful store if you upset potential customers.”

    China has a lot of reserves at the moment, but China is the one who should be worried about upsetting customers. One of China’s economic weaknesses is that its citizens don’t spend enough domestically. If they did, China would be far more insulated from the global recession than it is now. Of course, in the short term it’s very unlikely China can suddenly boost consumption among its relatively risk-averse population during these uncertain times. At the same time, consumption is currently down everywhere. China thus needs to keep all foreign markets, including the US, open to Chinese goods if it wants to keep unemployment as low as possible. Unfortunately for China, it’s a favorite target of populist politicians around the world precisely because of its past economic success. These politicians are in their element right now thanks to the recession. Thus, in order to keep markets open, China has to prove that it’s willing to narrow its trade surpluses with other countries; otherwise, it faces an anti-China backlash that it can’t afford. In other words, China is in no position to overreact over “hurt feelings.”

    China should use the foreign currency reserves as carrots to entice world leaders to keep their markets open. The recession has made everyone more receptive to carrots. But they are also more sensitive to Chinese sticks.

  8. AG Says:

    the average Chinese citizen does not have much to start with. With lack of insurance products and social security net, naturally they need to save.

    If China absolutely refuses to spend, then I don’t know why anyone would want to trade with them. If I spend my money to hire an American, I know he will spend it to hire someone else, who will continue the chain, creating a productive economy. If I spend money to hire someone in China, he’ll make a big pile of that money and look at it as the world’s economy collapses.

    If the trillions are in the hands of a tiny few then China needs to change their social structure to put that wealth in the hands of people who earned it. The U.S. went through the same thing during the industrial revolution, when a small group of people controlled the nation’s vast wealth as the average citizen slaved away in factories. If lack of insurance is the problem then spend money to create a scheme.

    The situation is bad everywhere right now. In China, the U.S., and Europe. Who knows how ugly it can get.

  9. DJ Says:


    I recall a response from China years ago when the U.S. was complaining loudly how unfair it was for China not to buy more of her products. It went somewhat like this: there are lots of things we want to buy from you, particularly the hi-tech products, precision machinery, etc., and you won’t sell. Not only that, you actively prevent anyone else from selling things we need to us.

  10. TonyP4 Says:

    @AG #8

    As in my posts, the Chinese government is rich but not the common citizens. They buy a lot and more if US government allows the high tech dual use technologies as DG pointed out. They’re perfect trade partners as Chinese is the largest consumer manufacturers while US has high tech and agricultural products (soy, wheat, rice… 25 years ago when I was in China, the rice I ate was 2 years ago as China wanted to have a reserve of rice for 3 years..

    I read that Bush tried to abandon the ban on dual use products in his last days of office, and I believed it did not go thru. A lot of products like jets are purchased from Russia. EU and Israel sell China some products that US would not be too happy. I do not think EU will be US’s puppets for too long esp. with the current recession. George and Tony used to sleep together, now both are in the unemployment line. 🙂

    Super computer is an interesting topic. China has many top 50 super computers when you measure instructions per second. However, are they effective super computers? In theory, they can buy US supercomputers that do not exceed the instructions per second of the most advanced Chinese computer. You can buy unlimited number of Intel or AMD processors, when they link up together they are as powerful as the top 50.

    Do you think what your banker will do if you upset him?

    Have we learned the lesson of reckless spending? First, the citizens and now the government with reckless bailouts. China is spending the reserve on infrastructure for the future. The commodity markets seems to start to recover due to Chinese spending plans to stimulate the economy – a lot of them are from foreign countries.

  11. William Huang Says:

    The first law of economics states that “there is no such thing as free lunch”. A corollary of this law is that you can only spend what you can afford. If the actual buying power (not saving’s rate) is limited for majority of Chinese, they will need to borrow in order to consume more to have significant impact on world economy. If they do borrow, they will be following the footsteps of US consumers for the past decade.

    This crisis is originated from US for the simple reason that US is the leader in world economy. My two cents is that it comes from two sources. One is the structural problem in financial industry where capital allocation business (a vital part of economy) has been turned into a gigantic casino thanks to the financial products such as sub-prime MBS, derivatives and swaps. There is nothing inherently evil about these financial instruments but when they are combined with high leverage, excessive greed and lack of oversight, they can turn deadly, as Warren Buffet called it, “the financial weapon of mass destruction”. The second one is so called assets based economy where people borrow money against their house for consumption not investment. If people consume more than they produce, a bubble is created and it cannot go on forever.

    People will continue to spend and consume simply we all need to live and enjoy. Sooner or later, this crisis will be over and we all have to make adjustment. Some will do more than others and hopefully all for the better.

    Politically speaking, Henry Paulson’s comment won’t cause any commotion at Chinese side. He has very personal and close relationship with past and present top Chinese leaders. He visited China 70+ times during his tenure at Goldman Sachs.

  12. Steve Says:

    Why won’t the USA sell China dual use technology? Just ask General Xiong Guangkai in 1995 and General Zhu Chenghu in 2005. Until the CCP can get their generals to stop threatening nuclear attacks, I doubt that provision will change anytime soon.

    William, I agree with your two points. I read something recently about younger people in the major eastern cities discovering the temptation of credit cards. Back when I was there, they weren’t really credit cards since your credit limit was covered by an even higher savings account. Did that change? Does China have actual credit cards based on credit history and not backed by savings?

  13. William Huang Says:

    @ Steve #12.
    I don’t think the situation as you described has changed much. For average wage-earners, credit card is a luxury while rich people can have Visa and American Express partially because they travel abroad. Even with people who do use it, credit card is just a convenience rather than a source for spending. Of course, there are always some exceptions where someone trying to cheat on the system.

    As for the credit card based on credit history, I don’t have full picture. What China doesn’t have is a credit system like in the US. The system will have to consist of major credit cards accepted nearly everywhere and backed by the credit rating system and debt payment record system that supports it. What goes behind that system is a whole credit card industry with thousands of skilled workers. Without it, majority of Chinese cannot enjoy a credit card service system based on credit history rating. I won’t be surprised to know if someone actually have such credit card and lives on monthly payment but it will most likely being an exception rather the rule.

    Living on borrowed money is something very new to Chinese and a very difficult concept for them to accept. It will take at least another generation to get used to. Most city folks are comfortable with mortgages now but not with credit card debt payment. Early on, the government has a lot to do with the overcoming the fear on mortgage. They simply saw this as a part of engine to push for economic growth so there was some kind of “propaganda”, if you will to educate and “brainwash” people in this respect. It worked and the result is major housing boom and improved standard of living. However, I doubt that the government will ever push people to live on credit card. Just look at what they have done on the government reserve (surplus) as contrast to US government (deficit). I don’t want to comment which one is good or bad but I am sure the culture has a lot to do with it.

  14. Jed Yoong Says:

    @ William

    “Living on borrowed money is something very new to Chinese and a very difficult concept for them to accept.”

    Agree. All this leveraging is not typical of Chinese finance. Perhaps it’s because we have wealth.

  15. S.K. Cheung Says:

    To Jed:
    PRC has a wealth of foreign reserves. But I didn’t think the average PRC citizen could be considered wealthy (speaking in monetary terms only, of course).

  16. Jed Yoong Says:

    Hi SK,

    But I still don’t think it’s typical Chinese culture to binge on credit, unless trends are changing.
    Is loan sharking a problem in China? Over here, loan sharks refer to unlicensed “micro-finance” creditors usually associated to triads and red paint…

  17. FOARP Says:

    “Living on borrowed money is something very new to Chinese and a very difficult concept for them to accept.”

    Depends. For the last decade at least certain people have been able to get loans far beyond their current means to pay back either through connections or otherwise – but this is not the problem it was back in 2002/3 where a large proportion of bank loans were non-performing. However, there is not the large-scale taking out of loans using the family home (or rather, the future value of the family home) as security that one finds in the UK/US, which, now that the housing markets have collapsed, has left many in negative equity – just as the job market has become severely hostile.

  18. S.K. Cheung Says:

    To Jed:
    “But I still don’t think it’s typical Chinese culture to binge on credit, unless trends are changing.” – oh, I completely agree with that, though I also don’t know if trends are changing. I would imagine that the concept of a mortgage is no longer foreign. Besides, I can’t imagine someone not buying a house unless they could pay with cash. But of the Chinese I know, they are all credit-averse when it comes to day-to-day consumer stuff. That’s not to say we don’t have credit cards, or use it with aplomb. We just pay it off every month. However, you could certainly argue that the Canadian Chinese I know may not necessarily represent the values and habits of PRC Chinese.

  19. TonyP4 Says:

    Here is a joke passed to me with some personal modification. However, it is untrue as Bush cannot prevent this financial crisis (though the wars make us not in a good situation). Bush is a friend to Chinese and should be treated same by Chinese.


    Looking for work…

    An Israeli doctor says:
    ‘Medicine in my country is so advanced that we can take a kidney out of one man, put it in another, and have him looking for work in six weeks.’

    A German doctor says:
    ‘That is nothing; we can take a lung out of one person, put it in another, and have him looking for work in four weeks.

    The Russian doctor says:
    ‘In my country, medicine is so advanced that we can take half a heart out of one person, put it in another, and have them both looking for work in two weeks.’

    A Chinese doctor says:
    ‘Hey we can replace a damaged dick of a male prostitute in one hour, and he can work that night.’ 🙂

    An American doctor from Texas , not to be outdone, says:
    ‘You guys are way behind, we recently took a man with no brains out of Texas, put him in the White House for eight years, and now half the country is looking for work.’

  20. Allen Says:

    Slightly off topic: whatever your view is on the currency issues, most economist agree that for the world to avoid a truly long-term global recession / depression, the most important things to do is for individual countries to make sure each country does not fall much deeper into a recession.

    Here is an interesting report from the Wall Street Journal where economists discuss whether there are signs of economic stabilization in China.

    February 4, 2009, 2:51 am
    Economists React: Signs of Stabilization in China?

    Analysts respond to the January uptick in China’s purchasing managers’ index. Though still in negative territory, the latest reading was quickly seized on by those looking for signs of improvement after a sharp slowdown.

    # January’s PMI shows that the Chinese economy is bottoming out and the trend of a gradual recovery is taking shape. In 2008 there were large fluctuations in the prices of domestic and foreign raw materials, resulting in a severe inventory adjustment and a sharp decline in industrial production. Since November 2008, the inventory adjustment has been largely completed, and the domestic prices of some raw materials, for instance iron and steel, have recovered. –- Zhang Liqun, China Federation of Logistics & Purchasing

    # Manufacturing in China is still contracting, but the bottom is now in sight. The purchasing managers’ index rose for the second straight month in January, coming in at a reading of 45.3 compared with 41.2 for December. … China’s PMI may have bottomed in November, when an alarming reading of 38.8 was reported. Although manufacturing continued to contract in January, the pace has clearly slowed. A rebound in activity may be not far from now. The massive fiscal stimulus announced late last year has not only helped to sustain business confidence, but has also given direct support to local manufacturers. – Sherman Chan, Moody’s Economy.com

    # The January reading suggests 1) sequential manufacturing growth momentum has been improving from its trough in November; 2) but it is still contracting at a sub-50-threshold level. To put it plainly, things are still getting worse though the pace of deterioration is not quite as rapid as it was in November and December. … However, year-on-year activity growth is likely to remain weak at least in 1Q2009 due to a high base and the time lag for the effects of the stimulus measures to fully surface. -– Yu Song & Helen Qiao, Goldman Sachs

    # While there is still a risk that continued fall-off in global demand may further undermine China’s growth, the January PMI data at least provide further support to our view that GDP growth should be stronger in Q1 2009 than in Q4 2008. In fact, we believe the government’s massive stimulus package should be able to push up GDP growth further in coming quarters and help achieve 8.0% growth in 2009. – Mingchun Sun, Nomura

    # Overall, we take this, together with the CLSA PMI released yesterday, as an early sign of a stabilization in manufacturing contraction. Combined with the reports of a sharp acceleration in bank credit growth in January following a strong expansion in December, and signs of progress in the implementation of the fiscal stimulus, we expect final domestic demand will increasingly become an offsetting force to the weak external demand. – Wensheng Peng, Barclays Capital

    # The accelerated rise of manufacturing PMI undoubtedly points to a recovery in China. The rebound of PMI in December and January suggests that the Chinese economy is resilient (due partially to the economic-stimulus plan) and the destocking process is near its end. Today’s PMI reading supports our call of a V-shape recovery and an 8.0% GDP growth forecast for 2009… The first quarter will still be tough for China, as the decline of exports will offset some of the rise in domestic demand; but we expect the economy on the whole to see a salient rebound in as early as 2Q09. – Ting Lu, Merrill Lynch

    – Compiled by Andrew Batson

  21. Allen Says:

    Here is an Economist article on why recent alleged U.S. accusations of currency manipulation against China may be wide off the mark:

    Those who argue that the yuan is still too cheap point to three factors: China’s foreign-exchange reserves have surged; it has a huge current-account surplus; and prices are much cheaper in China than in America. Start with official reserves. If China had not bought lots of dollars over the past few years, the yuan’s exchange rate would have risen by more. So does the yuan’s fixed level against the dollar in recent months mean that intervention has risen? On the contrary, in the fourth quarter of 2008, China’s reserves barely rose, despite a record current-account surplus. This suggests that private capital is now flowing out of China.

    Charles Dumas, an economist at Lombard Street Research, argues that outflows of hot money could become a flood if China did not have capital controls. Currency “manipulation” amounts to more than foreign-exchange intervention; China also has strict capital controls which, although leaky, keep private savings at home. If Beijing scrapped those controls, firms and households would want to invest abroad to diversify their assets. In other words, if the value of the yuan was not “manipulated” and instead was set entirely by the free market, it might fall, not rise.

    Some argue that China’s large current-account surplus is incontrovertible proof that the yuan is too cheap. Morris Goldstein and Nicholas Lardy, at the Peterson Institute for International Economics in Washington, DC, estimate that the yuan’s real trade-weighted value needs to rise by another 10-20% to eliminate the surplus. But other economists say it is wrong to define the yuan’s fair value by the revaluation required to eliminate the current-account surplus. Trade does not have to be perfectly balanced to be fair. And China’s surplus partly reflects its high saving rate. A stronger yuan will help to shift growth away from exports towards domestic consumption, but is unlikely to do so on its own. In 2005 Messrs Goldstein and Lardy reckoned that the yuan was 20-25% undervalued; it has since risen by that, yet the surplus has doubled. To reduce China’s external gap, policies to boost domestic spending will be more important than its exchange rate.

    An alternative way of defining the “fair” value of a currency is purchasing-power parity (PPP): the idea that, in the long run, exchange rates should equalise prices across countries. The Economist’s Big Mac index offers a crude estimate of how far exchange rates are from PPP. Our January update found that a Big Mac cost 48% less in China than in America, which might suggest that the yuan is 48% undervalued against the dollar. But by this gauge, the currencies of virtually all low-income countries are undervalued, since prices are generally lower in these countries than in rich ones (see right-hand chart, above). This is the basis of the Balassa-Samuelson theory which holds that average prices will be higher in countries with higher productivity (ie, high GDP per head), because higher wages will push up prices in labour-intensive goods and services. This implies that it is natural for China’s exchange rate to be below its PPP, but as it gets richer and productivity rises, its real exchange rate should rise.

    A new study* by Yin-Wong Cheung, Menzie Chinn and Eiji Fujii arrives at a similar result using World Bank price data across the whole economy. Previous assessments of such data had found that the yuan was around 40% undervalued. But the latest price surveys have raised the estimated price level in China (and so reduced GDP per head measured at PPP). The authors conclude that the yuan was 10% undervalued against the dollar in 2006, which means that it might now be close to parity.

    In the longer term, the yuan needs to keep rising against a basket of currencies. But for now, some of the accusations being thrown at China are wide of the mark.

    *For more on study, see here.

  22. Allen Says:

    If you want a good and brief read on the world economy, its past, its present, and its futures, this article – published in 2005 – is a MUST READ for its prescience and succinctness.

    For insight on what is causing the American-led economic crisis of today – read this article by the same author – published in 2004!

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