Henry Paulson’s speech on the eve of his departure to the G7 Summit in Singapore should be compulsory reading for anyone interested in China’s growing role in the world economy.
Unlike previous bluster from the Treasury throne, Paulson takes the tone of a concerned parent. Yes, China is still growing, but it is old enough and big enough now to take responsibility for its actions. Those actions do affect the wider economy, and it is no longer immune from the repercussions of its actions.
Discarding the usual aggressive "revalue or face a backlash" stance of his predecessors, Paulson displays a nuanced understanding of the China miracle and, more importantly, the challenges that remain.
Sure China is now big and powerful, but it is also incredibly fragile. Its financial system is a mess, failing to fulfill its basic function of distributing savings to the most productive economic players, its social safety net is stretched so thin that Chinese consumers are scared to shop, undermining efforts to introduce balance to the country’s investment- and export- led growth trajectory, and its massive trade surplus is something the other kids in the playground are obviously not going to take lying down for long.
Where Paulson diverges from his predecessors – and the current China hawks filling up the airwaves with threats and ultimatums – is that he has dropped the "reform or we will launch a backlash" line and replaced it with "reform or we won’t be able to prevent a backlash" argument.
As Paulson knows, a protectionist backlash against China will benefit no-one. He also knows that a rapid appreciation of China’s currency will benefit no-one. The solution to the undeniable problems besetting China are much more subtle. But they are tied to reform, liberalization and a market-based exchange rate.
But China also knows this. Gentle reminders to take off the training wheels are the best way to encourage China to take the right path to reform. Who knows what path China will veer down if they are removed by force or threat.