Book review: Dealing with China by Hank Paulson

A personal account of an uneasy yet respectful relationship with a aspiring global superpower by a respected policy insider

Writing not soon after participating in a Beijing Future of Finance by The Asian Banker — so plaudits and general are of the country momentum should be expected and discounted where needed.

It took me less than an average Kindle-estimated time of 9 hours to devour Dealing with China, bought several years ago and relegated to a long and still growing backlog of worthwhile reads.

Written by ex co-CEO of Goldman Sachs, ex U.S. Treasury Secretary Henry Paulson, it casts a personal relationship with a country that has been opening up to the outside world while being able to maintain its own course: tapping into global capital markets to reinvent old management systems (or the lack thereof), purge corruption and cronyism, and to connect the industrial potential of the Mainland China with ample capital financing. The story starts with Chinese goverment at the time of Jiang Zemin looking for external advice to shepherd through the structuring and the ensuing IPO of China Telecom and then PetroChina.

As the story-telling commences, Paulson is about to discuss the looming telco IPO, the discussion happening not soon after the passing of Deng Xiaoping: the successors of whom presses on continuing with modernisation. Investing in the digital rails has been on the mind of the country’s leadership from the v. beginning:

I would be discussing with Zhu a matter that touched closely on both issues — restructuring China’s telecommunications system through an offering of shares in a newly formed Hong Kong–listed company. As part of its rapid modernization, China had been investing heavily in the area, keenly aware of how crucial state- of-the-art telecommunications were to a modern economy.

by the end of the 1980s, there was still just one telephone line per 200 citizens (up from one per 500 in 1978). China embarked on a build-out unrivaled anywhere in the world, spending more than $35 billion on infrastructure between 1992 and 1996. The payoff was striking. Fixed-line subscribers leaped from 11.5 million to nearly 55 million; mobile subscribers soared from 177,000 to 7 million. From the end of 1996 to mid-1997 alone, 2.4 million more mobile subscribers would be added. But China still had a long way to go. In 1996 just 4.5 percent of the population had fixed-line access versus 64 percent in the U.S., while 0.6 percent had cellular access versus 16.3 percent in the States.

The need for liberalising reform and the opening up was important to adapt and let in clear air of competition — to hedge against the failure of the Soviet Union managed modernisation that let the assets to be controlled by clique and vested interest groups:

Deng Xiaoping, though technically in retirement, traveled through the south calling for the pace of reform to be sped up. In Shenzhen, he said the SEZ experiment had exceeded his expectations, and he proclaimed himself reassured. He rebuked hard-liners who feared these changes would lead to capitalism and said the Party had more to fear from ideologues of the ultra-left than liberalizers

This next passage reminded me of my personal experience being driven from the Beijing Airport — all cars suddenly changing lanes and not using turn signals seem to already have M2M telematics — as one can register little anxiety and emotion in general on the face of a driver.

Beijing’s streets were filled with bicycles, and riding in the quickly growing fleet of automobiles was harrowing. I remember landing at the old airport and driving to our hotel on a single-lane road jammed with horses and carts, wobbly bicycles, and speeding cars. The driving was so aggressive—ill-advised passing, horns honking—I was relieved that we didn’t get killed, or kill someone.

The case for opening up the state owned enterprises in critical sectors was truly a gamble with little room for error: China had it’s 15th National Congress pressing for a Opening Up of China — and it happened just at the time of Asian markets implosion: at the very same time China Telecom had it’s IPO prepared and run by Goldman Sachs for Hong Kong investors:

The $4.22 billion deal was constructed around the mobile telecommunications assets of two thriving Chinese coastal provinces, but because of the complex, scattered nature of the country’s telecom system, a marketable company had had to be built from scratch. … If China Telecom’s IPO failed, it could cripple the country’s move to a more open, market-oriented system. Unfortunately, the markets had turned ugly, and China Telecom was set to go public in the midst of the worst economic crisis to hit Asia in a generation. Goldman Sachs was leading the deal, and on the hook. The stakes could hardly have been higher.

Modernising the SOEs was important based on how much capital they conserved, utilised uneconomically and what shady economies they had inside themselves: maintaining their own hospitals, roads, schools — some had many millions of employees that were unessential to the core business but were part of the social responsibility matrix. State ministries like PLA had their whole fiefdoms:

PLA officers also ran or abetted widespread smuggling operations that brought in cars, mobile phones, oil, cigarettes, and more. In 1998 President Jiang Zemin ordered the military to sell its commercial assets, increasing the PLA’s budget in return. The government cracked down on smuggling, and customs revenues jumped 81 percent in one year.

Pushing non-essential assets outside meant one had to create a vibrant services and market employement to sustain the growing population, accelerated by the number of jobs that had to be created in the private sector: hence the golden words of “allowing some people to get rich”

I recalled what President Hu had replied when President Bush had asked what gave him nightmares: having to create 25 million new jobs each year.

Looking at the China of today, it is a strange beast, often ridiculed for conflicting policies — Chinese goverment itself points to this inconsistency:

On the one hand, … some in the U.S. were criticizing China for wasting resources, damaging the environment, and contributing to global warming. On the other hand, many claimed the Chinese were hurting the U.S. by exporting too cheaply, and they were pushing China to rebalance its economy to encourage even more domestic consumption. How was China to pursue both increased consumption and sustainability?

Today, China is a juggernaut in terms of output, imports and certain vanity elements:

Six of the world’s 15 tallest buildings are in mainland China (the U.S. has three). Sixty-two of the tallest skyscrapers under way are being built there, including eight of the top ten.

It is also accelerated its borrowing: burned by the need to recapitalise banks and the need to continue with the investment in infrastructure, it often misused the opportnity to create off-balance vehicles, and so they contribute the largest portion of debt balance:

The total amount of debt in China’s economy climbed from 130 percent of GDP at the end of 2008 to 206 percent of GDP at the end of June 2014, a dangerously high level for an emerging economy. (The U.S. total debt to GDP ratio at the end of the second quarter in 2014 was roughly 102 percent.)

Paulson ends boldly: “If we want to benefit from an expanding global economy, we need the most dynamic growth engines, like China’s, to thrive.” It aslo pushes a new “soft-power” initiative with the Belt and Road Initiative, a 21st century Marshall Plan of China. To tell this story there is another good book: China’s Asian Dream: Empire Building along the New Silk Road.