1장
When the Dragon Awoke: Inside China's Economic Transformation
In 1997, a tall American banker walked nervously through Beijing's Zhongnanhai compound to meet Vice Premier Zhu Rongji, China's economic czar. The streets were eerily quiet-Deng Xiaoping, architect of China's economic rebirth, had died the previous week. That banker was Henry Paulson, then president of Goldman Sachs, who would go on to become U.S. Treasury Secretary and one of the West's most influential voices on China. His meeting that day would be the first of hundreds with Chinese leaders over a quarter-century of unprecedented economic transformation that would reshape the global order.
"Dealing with China" has become required reading in boardrooms and policy circles worldwide, praised by figures from Warren Buffett to former President Bill Clinton. Paulson's unique insider perspective-spanning high finance, government service, and environmental conservation-offers unparalleled insights into how China evolved from impoverished isolation to economic superpower, and what this means for the world's future. Through personal relationships with three generations of Chinese leadership, Paulson witnessed firsthand the nation's extraordinary rise and the complex challenges it continues to face.
2장
Banking on Reform: China's Economic Awakening
When Paulson first visited China in the early 1990s, the contrast between sophisticated Hong Kong and mainland China was stark. Beijing's old hutong neighborhoods were rapidly disappearing, replaced by massive government buildings and commercial complexes. The energy in places like Shenzhen was infectious-forests of cranes and fields of bulldozers ready to break ground on China's future.
This transformation had begun in 1978 when Deng Xiaoping set China on a new course, rejecting Mao's political obsessions to focus on economic development through market principles. His pragmatic approach-"It doesn't matter whether a cat is black or white, as long as it catches mice"-transformed agriculture first through the household responsibility system, which increased grain yields by 34% between 1978-1984. Urban reforms followed with industry restructuring, dual-track pricing systems, and special economic zones in strategic locations that enjoyed lower taxes and fewer restrictions.
Deng's message that "To get rich is no sin" unleashed the Chinese people's energy after years of privation. The economy boomed with 10% annual GDP growth in the early 1980s. Entrepreneurs like Liu Chuanzhi (Lenovo), Cao Dewang (Fuyao Glass), and Zong Qinghou (Wahaha) built empires from humble beginnings.
The reform path was uneven, marked by political conservatism, resource waste, pollution, and corruption. The economy overheated in 1988 when price control liberalization caused panic, and the 1989 Tiananmen crackdown halted reforms temporarily. By Paulson's first visit in 1991, Deng's 1992 Southern Tour had outmaneuvered hard-liners, restarting reforms with GDP surging 14% as the "socialist market economy" was endorsed.
Within Goldman Sachs, a vigorous debate raged about whether to focus on China or the "Asian Tigers." While Hong Kong, Singapore, South Korea, and Taiwan offered less volatile growth and more immediate business opportunities, Paulson advocated for China's potential based on simple math-these countries combined had only one-third of China's population. His conviction that China represented the future would prove prescient, though the path would be far from smooth.
3장
Real Gold and Silver: Creating China's Corporate Giants
The 15th National Congress of the Communist Party in September 1997 solidified China's economic reform path. Jiang Zemin countered concerns about private enterprise by declaring that a smaller state-owned sector wouldn't affect China's socialist nature. This stance encouraged private sector growth while setting up the next phase of reform-restructuring the inefficient state-owned enterprises that employed 110 million workers and represented nearly 30% of industrial GDP.
All attention was focused on China Telecom's unprecedented $4.22 billion initial public offering scheduled in Hong Kong and New York. The deal centered on mobile telecommunications assets from two coastal provinces but required building a marketable company from scratch due to China's complex telecom system. Vice Premier Zhu Rongji intended China Telecom to become the template for revamping other SOEs, using the IPO process to drive change and reorganize entire industries.
The team faced an unusual challenge: there was no actual company to underwrite. China Telecom (Hong Kong) was initially just a shell with no assets. Goldman had to help the Ministry of Posts and Telecommunications create a company that would appeal to investors-the opposite of a normal underwriting process. The solution was to focus on the mobile business, incorporating cellular assets from various provinces.
The celebration of Hong Kong's handover to China on July 1, 1997, was quickly overshadowed by market turmoil. On July 2, Thailand abandoned its defense of the baht, triggering the Asian financial crisis. The currency plunged nearly 20% against the dollar, and the contagion soon spread to other Southeast Asian economies.
Despite market volatility, the IPO was pushed to October 23, with shares sold in three tranches across U.S., Asia, and Europe. When Black Thursday hit on October 23, the Hang Seng dropped 10% and China Telecom opened sharply down, but the deal had raised $4.22 billion-what Wang Qishan called "zhen jin bai yin" (real gold and silver) when reporting to Zhu Rongji. By year-end, China Telecom shares were trading 13% above the offer price, marking a landmark success for state-owned enterprise reform.
4장
Oil's Special Place: Transforming China's Energy Giants
Oil wasn't merely an energy source for China but a symbol of independence and self-reliance-a literal wellspring of national pride. After Mao took power in 1949, he turned to the Soviet Union to break China's dependence on imports. Drilling began in 1958, and oil was discovered at Daqing ("Great Celebration") field the following year.
"Iron Man" Wang Jinxi and his drilling team became national heroes, laboring through temperatures as low as -30C before striking oil. Daqing became one of the most productive fields ever discovered, accounting for three-quarters of China's oil output in the 1960s-70s. By the late 1970s, China had become a net oil exporter, with leaders hoping surging revenues would fund modernization initiatives.
The explosive growth sparked by Deng's reforms placed ever-greater demands on China's energy resources. By the late 1980s, it became apparent China would need to import oil again. Even as demand boomed, reserves plateaued, partly because below-market domestic prices mandated by the government left little funding for exploration and production. By 1994, China was once again a net importer.
Getting CNPC (China National Petroleum Corporation) to market became Goldman's most difficult Chinese assignment during Paulson's tenure. The 2000 IPO of PetroChina (CNPC's listed subsidiary) faced multiple challenges: the dot-com bubble made investors uninterested in "old economy" companies, oil prices were historically low, and the offering inspired the first organized protests against a Chinese company listing in America.
Inside CNPC, the transformation was extraordinary. Like many state-owned enterprises, CNPC wasn't just a company but a self-contained city-state providing housing, schools, hospitals, mortuaries, and more for over a million workers. Disentangling these functions to create a modern corporation required over a thousand professionals-40 from Goldman, plus teams from CICC, McKinsey, seven law firms, and PriceWaterhouseCoopers.
The PetroChina restructuring, though difficult and painful, proved necessary for China. Fifteen years after its IPO, which raised $2.9 billion, PetroChina became the world's biggest listed oil producer, surpassing ExxonMobil in 2011. Its market capitalization briefly topped $1 trillion in 2007, making it the world's largest company by market cap.
The social consequences lingered for years. By 2002, laid-off workers whose severance had run out returned demanding more, triggering widespread protests and riots. Despite company packages, China still lacked a well-funded nationwide pension and social safety net-an urgent task remaining to be addressed.
5장
Cleaning the Stables: Financial Crisis and Recovery
In contrast to the West's perception of China's smooth entry into global capital markets, the journey was fraught with disasters as capitalism advanced without sufficient oversight. This dark side of China's economic miracle became apparent when Goldman Sachs agreed to help restructure Guangdong Enterprises (GDE), which owed nearly $6 billion to international creditors.
Wang Qishan, appointed executive vice governor of Guangdong Province in late 1997, approached Goldman Sachs to help resolve GDE's financial crisis. China's leadership had made a radical decision: unlike previous failing companies, GDE and Guangdong International Trust and Investment Corporation (GITIC) would not be bailed out. Their debts would not be treated as sovereign obligations-they would either be restructured or liquidated.
The crisis in Guangdong had been brewing for two decades. Following Deng's 1978 reforms, China had created investment trusts to borrow money overseas and spur domestic development. Over time, local politicians moved beyond infrastructure investments into real estate, construction, and various businesses, often outside their home provinces. These "red-chip" companies joined investment trusts in increasingly risky ventures, from property markets to volatile stocks.
The financial irregularities represented the ugly underbelly of China's economic rise-an inevitable result of rapidly shifting from a command economy to a market-oriented approach. China lacked both comprehensive laws and the institutions to enforce them. The Communist Party had staked its legitimacy on growth and prosperity, so it couldn't pause the economy while designing the ideal blueprint.
Despite his public confidence, Wang was deeply concerned about GDE's financial condition. Goldman's team uncovered a chaotic organization with over a dozen unfocused business lines. Working with accountants, they reconstructed each subsidiary's history from inadequate records and employee recollections. The discoveries ranged from comical to criminal-an eel farm whose eels allegedly washed away, a Paris hotel, periodically submerged Thai beachfront property, and rampant fraud at Guangnan Holdings where executives falsified profits and swindled banks.
When creditors initially resisted forming a committee, expecting government bailouts, Zhu Rongji and Wang Qishan demonstrated their resolve by liquidating GITIC-"killing the chicken to scare the monkey." After two years of negotiations, a restructuring agreement was reached that ultimately allowed creditors who held onto their securities to recover all their money. The successful resolution established crucial precedents for corporate failures, reset relationships with foreign investors, and began cleaning up China's banking system.
6장
Banking Reform: The World's Biggest Mattress
In Mao's China, commercial banks were largely unnecessary as the Ministry of Finance directly funded state enterprises in a closed loop. The People's Bank of China dominated finance, acting as both central bank and commercial lender. Reform and Opening Up in 1978 led to the creation of the "Big Four" commercial banks. However, these banks lacked discipline in lending, with local branches pressured by government officials to finance growth at all costs, resulting in massive bad loans.
By 1997, at least 25% of loans were non-performing (later revealed to be closer to 50%). The Asian financial crisis exposed these weaknesses, prompting Zhu Rongji to refuse devaluing the renminbi and instead inject 270 billion yuan into the banks, though this proved insufficient to solve the underlying problems.
To address the banking crisis, Zhou Xiaochuan, who was tasked by Premier Zhu Rongji with designing a bank restructuring plan, created a system to move bad loans off bank balance sheets into specially created asset management companies (AMCs). By 2000, the four AMCs had acquired $170 billion in bad loans-15.5% of China's GDP.
In fall 2004, a pivotal meeting with ICBC's Jiang Jianqing marked a shift from Goldman merely advising Chinese banks to potentially becoming financial partners. When Jiang unexpectedly asked if Goldman would consider becoming a strategic investor in ICBC before its IPO, Paulson hesitated, concerned about the bank's financial health.
When Goldman Sachs examined ICBC's numbers, they discovered an astonishing deposit base of $600 billion with new deposits flooding in at $225 million every business day. The government-set spread between loan and deposit rates ensured hefty returns, making ICBC "the world's biggest mattress" and a profit-making machine despite bad loans. With 150 million retail customers and 17% of China's banking assets, ICBC represented a perfect proxy for China's booming economy.
Goldman Sachs subjected the ICBC investment to rigorous internal vetting, recognizing it represented more than conventional number-crunching-it was fundamentally a bet on China itself. The $3.8 billion investment would become the single largest foreign direct investment since China's opening.
The Chinese banks, previously considered pariahs, had become highly desirable investments. By July, Goldman Sachs, Allianz, and American Express reached an agreement to purchase 8.45% of ICBC, though they still needed regulatory approvals.
The Goldman team successfully brought Bank of China public in June 2006, raising $11.2 billion in Hong Kong and an additional $2.5 billion in Shanghai. ICBC followed in October 2006, becoming the first bank to list simultaneously in Hong Kong and Shanghai, raising a record $21.9 billion. These transactions marked the high-water mark of financial reform in China.
7장
Strategic Economic Dialogue: Building Bridges
My first visit to China as U.S. Treasury secretary in September 2006 was markedly different from my previous 70 trips as a businessman. The motorcades and protocol weren't for me personally but represented my role representing America. I deliberately chose Hangzhou as my first stop rather than Beijing to signal the importance of economic reform and private sector activity. There I met with Xi Jinping, the rising Communist Party secretary of Zhejiang Province, who had impressed me earlier with his focus on entrepreneurship, innovation, and environmental protection.
I believed engaging China required recognizing their economic priorities-President Hu once told Bush his nightmare was creating 25 million jobs annually. With the Communist Party's legitimacy tied to economic prosperity, I reasoned getting our economic relationship right would improve all other issues.
That summer, Deborah Lehr and I developed the Strategic Economic Dialogue framework, focusing on three goals: improving U.S.-China economic cooperation, accelerating China's economic reforms, and encouraging China's responsible global economic participation through market opening, intellectual property protection, and currency reform. We designed a structure addressing China's complex decision-making-involving top officials to secure approvals while building consensus across ministries.
Wu Yi, a formidable 67-year-old vice premier known as China's "Iron Lady," was appointed to lead the Chinese side of the SED. During our first meeting, Wu Yi bluntly acknowledged my doubts about her appointment but promised to prove herself. In a private moment with President Hu, I suggested a 3% renminbi appreciation before our December SED meeting as a good-faith gesture-not making demands but offering a constructive suggestion that would help me convince Congress the dialogue was working.
The inaugural Strategic Economic Dialogue in Beijing featured an unprecedented 28-member U.S. delegation including six Cabinet members, Federal Reserve chairman Ben Bernanke, and Export-Import Bank head James Lambright. China matched with 14 ministry-level officials. The delegations met in the Great Hall of the People's Golden Hall, discussing China's economic strategy, trade, investment, energy, and environmental issues.
Despite some formality, frank exchanges emerged, particularly when Commerce's Bo Xilai challenged U.S. openness to Chinese investment by citing CNOOC's failed Unocal bid. The SED produced tangible results: agreements on export financing, allowing NYSE and Nasdaq to open China offices, restarting airline negotiations, and supporting China's entry into the Inter-American Development Bank.
8장
Environmental Challenges: Saving Shangri-La
Paulson had learned through years of close contact with China that its environmental challenges couldn't be separated from its rapid growth. The country's economic leap forward had taken a horrific toll on its environment, evident in the choking smog blanketing major cities, fetid rivers and lakes making water undrinkable for much of the population, and reports of basic foodstuffs like rice tainted by industrial heavy metals.
The World Bank estimated that pollution cost China 5.8 percent of GDP annually and caused 750,000 premature deaths each year, with 16 of the world's 20 most polluted cities located in China. The country's environmental problems weren't contained by its borders, with air pollution carried across the Pacific on westerly winds to the U.S., and China surpassing America as the largest emitter of CO2.
Despite misconceptions about China's triumph, their leaders know their vulnerabilities. With per-capita GDP ranking 80th globally (just ahead of Iraq and roughly one-eighth of America's), China faces enormous challenges: shifting from exports and inefficient government investment toward domestic consumption and high-end services, while addressing environmental disasters and entrenched interests resisting change.
In July 2007, Paulson visited Qinghai Lake in western China, 1,300 miles from Beijing and 10,000 feet above sea level. This trip to "China's water tower" was strategic-the region was home to seven of Asia's biggest rivers and played a key role in the Asian monsoon system affecting half the world's population. The lake was under severe threat from drought, desertification, and climate change, with 85% of its tributary rivers having disappeared.
Following his Qinghai visit, Paulson met with President Hu in Beijing. Hu was unusually enthusiastic about Paulson's western China trip, extending their scheduled 45-minute meeting to 90 minutes. Paulson emphasized that as the world's two largest energy consumers, the U.S. and China needed to exert joint leadership on climate change.
The third Strategic Economic Dialogue produced significant agreements, most notably on product safety protocols across eight areas from food to toys. Concerned about the SED's future after the Bush administration, Paulson proposed a ten-year framework for cooperation on energy and environment that would transcend administrations. Wu Yi immediately supported this initiative, which would later establish task forces on clean water, air, transportation, electricity, energy efficiency, and conservation.
9장
The Global Financial Crisis: A Reckoning
By June 2008, the fourth Strategic Economic Dialogue met amid soaring oil prices, food shortages, and the deepening U.S. financial crisis. The crisis profoundly shaped Chinese attitudes, exposing China's overdependence on exports while altering the relationship between the two countries. Wang Qishan, who had replaced Wu Yi as Paulson's counterpart, candidly told him: "You were my teacher, but now here I am in my teacher's domain, and look at your system, Hank. We aren't sure we should be learning from you anymore."
As the financial crisis deepened with Bear Stearns' collapse in March, China felt the reverberations through its investments in U.S. financial institutions and its own slowing economy. During Paulson's April visit to Beijing, Chinese leaders questioned him intensely about the U.S. economy and their money-losing investments.
At a breakfast meeting in Treasury's Cash Room, Wang Qishan impressed U.S. lawmakers with a thoughtful discourse on China's development paradox. When challenged on climate change, he pointed out that while China had the world's third-largest economy, it ranked 125th in per capita GDP. He highlighted the contradiction in U.S. demands for both increased Chinese consumption and environmental sustainability, noting the stark differences in American and Chinese lifestyles: "For exercise, ride your bikes to and from work."
The financial crisis had severely damaged Fannie Mae and Freddie Mac, which owned or guaranteed $4.4 trillion in U.S. mortgages. Though privately owned, investors assumed their securities carried government backing, creating moral hazard. Paulson requested emergency authority from Congress to increase credit lines and buy equity if necessary, using his now-infamous "bazooka" analogy during contentious hearings.
As the crisis spread through interconnected markets, money market funds began failing when their Lehman holdings became worthless. Investors fled to Treasury securities, freezing both commercial paper and Treasury repurchase markets. Chinese banks were withdrawing from money markets and shortening GSE holding maturities. Though Wang had promised China wouldn't sell U.S. government paper, somewhere in the bureaucracy these decisions were being made.
China began feeling economic pain with declining equity markets and slowing export growth. On November 9, just before the G20 summit, Beijing announced a massive $586 billion two-year stimulus program focused on infrastructure, along with credit easing that would enable state-owned banks to launch a trillion-dollar lending campaign.
10장
China's Future Challenges: The $10 Trillion Reboot
During our July 2014 meeting in the ornate Fujian Room of the Great Hall of the People, President Xi Jinping assured me that reform in China "is not an empty slogan but rather an enterprise" for which he personally takes responsibility. Xi's administration had unveiled the most ambitious economic reform agenda since the 1990s at the Third Plenum, declaring markets would play a "decisive role" in resource allocation.
The Xi administration is working to reduce bureaucratic interference while strengthening regulatory oversight-creating a system where "access is easy, but oversight is tight." Premier Li has targeted cutting administrative approvals by a third during his first term, already eliminating 300 requirements. Though the Third Plenum endorsed state ownership as a central economic pillar, it committed to reducing SOEs' number, diminishing their roles, exposing them to competition, and eliminating favoritism.
China's financial system urgently needs modernization. Despite having four of the world's ten biggest banks by tier-1 capital, China's system remains underdeveloped. Equity markets remain volatile and trade on government policy rather than fundamentals, while the bond market is undersized and inefficient. This stunted system limits options for companies and investors alike, with banks primarily lending to government entities and SOEs while private enterprises struggle for capital.
China's debt has surged from 130% of GDP in 2008 to 206% by mid-2014-dangerously high for an emerging economy and growing faster than GDP. Warning signs appeared in 2013 with interbank lending rate spikes, followed by near-defaults and actual defaults in 2014. A financial reckoning is inevitable, particularly among trust companies, with commercial banks facing mounting bad debts.
Despite the constraints of a statist economy, China's private sector has grown from near-extinction during Mao's era to roughly 60% of China's $10 trillion GDP today-enough to rank as the world's second-largest economy on its own. This remarkable achievement came despite limited access to credit, capital, and fair competition.
China now boasts more billionaires than any country except the U.S.-152 in 2014, up from 95 in 2012. These self-made success stories range from property developers like Zhang Xin and Pan Shiyi of Soho China to tech pioneers like Jack Ma, whose Alibaba raised $25 billion in history's largest IPO. Pony Ma's Tencent Holdings, with its WeChat platform claiming 470 million Chinese users, has grown into the world's fifth-largest internet company.
11장
The Way Forward: Competition Without Confrontation
In March 2014, while addressing financial executives in Boston, I was asked why I was helping China as "a patriot." This question reflects growing American apprehension as China emerges as our biggest economic competitor. But helping China reform serves America's interests. Every major global challenge-from economic and environmental issues to security threats-will be easier to solve if the world's two largest economies work together rather than at cross-purposes.
Some American complaints about China are legitimate, like intellectual property theft, while others are based on misunderstandings. Job losses in America stem more from technological advances than outsourcing to China. Chinese ownership of U.S. debt (about 10% of publicly held debt) benefits us by lowering funding costs, and they've been responsible investors. Trade with China, now our second-largest partner and third-largest export market, has grown dramatically since 2001, with U.S. exports to China quintupling to $104 billion by 2011.
With its $10 trillion economy, China now projects power more assertively, building up naval and air forces and engaging in territorial disputes in the East and South China Seas. These actions complicate U.S. relations and embolden confrontationists. While I believe China's primary objectives remain stability and economic development, their muscle-flexing risks jeopardizing economic interests through potential conflict.
The best path forward is turning shared interests into shared successes through concrete actions that build trust. Joint humanitarian missions, environmental initiatives, educational exchanges, and cross-investment create interdependence that discourages conflict. When America pushes for greater market liberalization and openness, we help Chinese reformers achieve their economic goals while benefiting ourselves.
We must base our dealings on facts, not wishes. China's opaque one-party system makes understanding its internal dynamics challenging. While many Chinese leaders have studied America, we generally lack similar familiarity with China. We need advisers who understand what's realistically achievable and can capitalize on shifting priorities.
Most importantly, we must deal with China from strength, which means addressing our own fiscal challenges and economic growth. With $18 trillion in national debt and persistently anemic growth, our ability to lead by example is diminished. Restoring our economic prowess will advance our cause far more effectively than focusing solely on China's rise.
