James K. Galbraith: Paulson and Bernanke were clueless in China


By James K. Galbraith
The Guardian, Manchester, England, UK
Monday, December 18, 2006


Speaking as I rarely feel entitled to do, on behalf of all my fellow professional economists, I felt true, true sympathy last week for Ben Bernanke, as he trailed after Henry Paulson in China.

Paulson's China policy is easily understood. In the United States government the Treasury represents the interests of Wall Street, as Joe Stiglitz has written eloquently from direct observation. An alumnus of Goldman Sachs, Secretary Paulson is ideally suited to his job.

And what Wall Street wants from China is what Wall Street always wants: the freedom to speculate (excuse me, invest) in currency, corporate stocks and bonds, and real estate. Wall Street loves risk, uncertainty and volatility. The Chinese don't. This is a conflict. It is not in any sense a complicated question.

Paulson made a power play, based on a threat: open up or we'll shoot. More precisely, it was a power play based on a bluff. Since the bluff was transparent, the Chinese called it. And when they did, the US side folded. The Chinese then completed the hand by giving back a few symbolic concessions, so that Paulson's team would not have to admit to the obvious fact, that the trip had accomplished nothing at all.

For Paulson, a business negotiator, it was pretty much routine stuff: sometimes you win and sometimes you don't. But Bernanke is an economist. Despite his high public position, he is at heart an academic. In other words, he has standards, and a certain amount of professional dignity to maintain.

And last week he had the sorry job of putting economic lipstick on Paulson's pig. More than that: Bernanke had to argue that it was in China's economic interests to go along with Paulson's plan. Worst of all, he had to talk past the Chinese officials, who somehow seemed to feel that they have a better understanding of their own interests. It must have been dreadfully embarrassing.

Bernanke gave it a good college try, with an impressively wonkish speech, replete with 22 footnotes, delivered to the Chinese Academy of Social Sciences. On no evidence at all, he argued that a higher RMB would help China maintain its economic growth. The trouble with this that current policy has given China world-beating economic growth for three decades. Bernanke knows this (and said so), so he couldn't press this argument very far.

Next, having credited Chinese growth partly to its high savings, Bernanke made his second argument: China should now bring its savings rate down. This he said should be achieved by improving China's social safety net, so that Chinese families would feel less need to squirrel away funds to cover health care and old age. Apart from the direct benefits, Bernanke argued that this would reduce China's trade surplus by increasing Chinese household consumption.

Finally, as the US delegation left town, Paulson rather gratuitously promised to try to increase private savings rates in the United States, which Paulson wants to do, of course, by cutting Social Security and Medicare.

So here's the Bernanke-Paulson position in brief summary:

1) China's currency strategy has helped produce rapid growth for 30 years; therefore it should be abandoned.

2) China's high savings rates have been a key to this success; therefore they should be reduced.

3) China, a country emerging from communism, should spend more on public health and social security, so that ordinary Chinese can save less. (This is actually a good point, as far as it goes.)

4) The United States, a capitalist country, should spend less on social security and public health, so that ordinary Americans will be forced to save more.

5) Somehow, all this will reduce the deficit in the US-China balance of trade, a goal whose importance everyone agrees on but that no one can actually explain.

Adam Smith wrote it; I only quote it:

"Such as they were, however, those arguments convinced the people to whom they were addressed. They were addressed by merchants to parliaments and to the councils of princes, to nobles and to country gentlemen, by those who were supposed to understand trade to those who were conscious to themselves that they knew nothing about the matter. ... Those arguments therefore produced the wished-for effect. ... The attention of government was turned from guarding against the exportation of gold and silver to watch over the balance of trade. ... From one fruitless care it was turned away to another care much more intricate, much more embarrassing, and just equally fruitless."


James K. Galbraith holds the Lloyd M. Bentsen Jr. chair of government/business relations at the Lyndon B. Johnson school of public affairs at the University of Texas at Austin. He is a senior scholar with the Levy Economics Institute and chair of the board of Economists for Peace and Security, an international association of professional economists. His new book is "Unbearable Cost: Bush, Greenspan, and the Economics of Empire" (Palgrave MacMillan, 2006).

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