The Untold Story of How George W. Bush Lost China

President George W. Bush Plays “Bushism or Not?”
President George W. Bush Plays “Bushism or Not?”

The U.S.-China relationship started veering wildly off track 15 years ago—but Washington stumbled badly in its response.

Paul Blustein

By the time he became treasury secretary in July 2006, Henry Paulson had traveled to China about 70 times in his capacity as a top Goldman Sachs executive. Blessed with an imposing stature—he starred as an offensive lineman for the Dartmouth College football team—Paulson became a familiar presence in the inner sanctums of Chinese power as he represented Goldman on deals such as the sale of shares in state-owned enterprises. Although not a speaker of Chinese, he gleaned a keen sense of how the country’s system worked, having met its top leaders on many occasions in their Beijing compound.

When he was summoned to the White House to be offered the Treasury post, therefore, Paulson sought approval from President George W. Bush to take command of the administration’s economic policy toward China. It seemed only logical for him to make the most of the deal-making skills and relationships he had developed with Chinese leaders, and Bush readily agreed to bestow his new Treasury chief with authority to oversee a coordinated strategy among the various U.S. agencies dealing with Chinese-American economic issues. This was understood to be a daunting challenge at the time. Myriad problems were plaguing trade, investment, and financial ties between the two countries.

In retrospect, however, Paulson’s assignment was even more consequential than anyone at the time understood. It was under the Bush administration’s watch that economic relations between the two powers began to go badly awry. The problems that Paulson, among others in the administration, confronted and the responses they crafted—or didn’t craft—lie at the heart of the trade war that rages today between Washington and Beijing.

Half a decade before Paulson became treasury secretary, China had joined the World Trade Organization (WTO), a historic integration into the global economy of the world’s most populous nation. To gain entry to the Geneva-based trade body, China had agreed after lengthy negotiations to open its markets in ways that exceeded the requirements imposed on other nations, and Beijing also accepted that its trading partners could use several unusual mechanisms that could restrict the inflow of Chinese products into their markets. The assumption of China’s trading partners was that economic liberalization would put Beijing on a gradual path toward true free enterprise—if not fully unbridled then at least a form similar to that in, say, South Korea. In a 2002 book that he co-wrote, then-WTO Director-General-designate Supachai Panitchpakdi enthused: “The agreement signaled China’s willingness to play by international trade rules and to bring its often opaque and cumbersome government apparatus into harmony with a world order that demands clarity and fairness.”

But such optimism was rooted in a failure to anticipate how China’s economic policies would evolve. Starting around 2003, and continuing for a number of years thereafter, China kept the exchange rate of its currency pegged at artificially low levels, bestowing significant competitive advantages on Chinese exporters. That exacerbated a phenomenon that has come to be known as the “China shock,” which refers to the decimation of manufacturing companies in a number of U.S. blue-collar communities that were disproportionately affected by Chinese imports.

Also in 2003, Beijing established institutions giving it tighter and more efficient control over the management of giant state-owned enterprises, allocation of subsidies, enforcement of regulations, and approval of investments. This was the inception of a new policy direction, variously dubbed “state capitalism,” “techno-nationalism,” and “China Inc.” Although the private sector was vibrant and flourishing, intervention by the government and the Communist Party would become far more pervasive than before. Foreign firms that had once been welcomed with open arms would increasingly fall victim to a bewildering array of obstacles and industrial policies aimed at promoting and protecting Chinese competitors favored by the party-state.

Looking back at the Bush administration’s handling of these problems, it is reasonable to wonder why a more forceful approach wasn’t taken.

The China shock, although not recognized by economists as a distinctive event until years later, spurred political sentiment especially among working-class Americans that their country’s trading partners had taken it for a ride—a view that Donald Trump exploited in his presidential campaign with his claim that China had committed “rape” of the U.S. economy. And Beijing’s alleged maltreatment of U.S. companies—which has become much more intense under Xi Jinping, China’s supreme leader since 2012—was the main basis for the Trump administration’s imposition of tariffs on Chinese goods in 2018.

Looking back at the Bush administration’s handling of these problems, it is reasonable to wonder why a more forceful approach wasn’t taken; the U.S. response can be fairly described as sluggish. Several reasons emerge from a granular look at the process. Among the most important is persistent optimism in Washington that China would continue to shed the vestiges of Maoism and open its markets. Also playing a part were fears of a U.S.-China economic rupture and what that would mean for the United States and its allies.

But perhaps most crucial of all was the outbreak of the global financial crisis, which brought glaring defects in the U.S. model to the fore and stymied efforts to modify China’s policies. It is a cruel historical irony that Paulson, the kingpin of the Bush administration’s efforts to change Chinese policy, stood at the nexus of the financial collapse that fatally undermined them.

Chinese President Hu Jintao (center) and his wife, Liu Yongqing, pose on the floor of the New York Stock Exchange before ringing the opening bell on April 29, 2002. With them are NYSE Chairman Richard Grasso (from left), American International Group CEO Maurice Greenberg, and Goldman Sachs CEO Henry Paulson.HENNY RAY ABRAMS/AFP/Getty Images

Few could have imagined such a turn of events when Hu Jintao became China’s president on Nov. 15, 2002, less than a year after the nation joined the WTO. Beijing insiders struggled to characterize the 59-year-old Hu as anything more than a bland, cautious enigma of strict loyalty to the Communist Party. Hu’s most salient trait was his disciplined discretion, especially in public. One of the most revealing comments about the new president came from his 88-year-old great-aunt, Liu Bingxia, who helped raise him after his mother died when he was young. Of her great-nephew, Liu said: “He never once interrupted his elders when they were speaking.”

Given Hu’s careful, consensus-building approach, the odds appeared to favor continuity in policy, including on economic matters, for which Hu delegated substantial responsibility to Premier Wen Jiabao. And in important respects, the Hu-Wen leadership duo did continue to pursue the market-opening path that had been blazed by their predecessors, Jiang Zemin and Zhu Rongji, during China’s entry into the WTO. Under Hu and Wen, Beijing implemented tariff cuts and eliminated import quotas along with many other policy measures and reforms promised during the WTO accession negotiations.

But in the early months of 2003, very soon after taking power, Hu and Wen laid the foundations for much greater economic intervention by Beijing than the United States and other WTO members had anticipated when they ushered China into the trade body. The importance of many of these actions would be recognized only in retrospect; the institutions created under Hu and Wen’s leadership garnered little notice abroad at the time.

But in the early months of 2003, very soon after taking power, Hu and Wen laid the foundations for much greater economic intervention by Beijing than the United States and other WTO members had anticipated.

One of these institutions was the State-owned Assets Supervision and Administration Commission (SASAC), which took centralized control over the national government’s shares of 196 of the biggest state-owned enterprises. These companies were corporate behemoths—PetroChina, China Mobile, Dongfeng Motors, and Sinopec, for example—that competed fiercely in private markets and issued much of their stock to global investors. But with the power to appoint (and remove) executives at many of these companies and a mandate to “maintain and improve the … competitive power of the State economy,” SASAC was a completely novel instrument of economic management, even in a world where such state enterprises exist in many countries. As Mark Wu, a Harvard Law School professor, has written:

“Imagine if one U.S. government agency controlled General Electric, General Motors, Ford, Boeing, U.S. Steel, DuPont, AT&T, Verizon, Honeywell, and United Technologies. Furthermore, imagine this agency were not simply a passive shareholder, but also behaved as a private equity fund would with its holding companies. It could hire and fire management, deploy and transfer resources across holding companies, and generate synergies across its holdings. … In many ways, SASAC operates as other controlling shareholders do. It is happy to grant management operational autonomy so long as it delivers along the agreed-upon metric. The difference is that the metric is not pure profit, but rather the Chinese state’s interest, broadly defined.”

Another entity that arose in 2003 came to be known as a “superministry” because of its coordinating power over others. It was dubbed the National Development and Reform Commission, and one of the main responsibilities assigned to its 30,000-strong bureaucracy was the design of China’s five-year plan. The clout of China’s planners had ebbed during the period of economic liberalization in the 1980s and 1990s, but with the new commission, China was bulking up the planners’ responsibilities, bestowing their goals with much greater force than mere guidelines. The prices of major commodities and inputs—in particular electricity, oil, gasoline, natural gas, and water—would be set by the commission, which also allocated state investment funds and held power of approval over many large projects, such as infrastructure and factories.

These institutions gave Beijing an array of new levers for manipulating and influencing the actions of enterprises, both public and private, across the entire Chinese economy. And behind them—or more precisely, above them—loomed the ultimate authority in how those levers would be manipulated, namely the Communist Party.

The most arresting symbol of this system was the red phones that sat atop the desks of several hundred of the nation’s most powerful individuals in government as well as the CEOs of the biggest state-owned enterprises. The phones, which connected only to other similar phones, were called “red machines” because anyone calling on them would be likely to rank high in the party apparatus. “When the ‘red machine’ rings,” a senior executive at a state bank told the author Richard McGregor, “you had better make sure you answer it.”

The red phones are emblematic of the party’s reach, which extends not only to all levels, branches, and agencies of national, provincial, and local government, but also to industry, finance, the media, and academia. Nearly every person holding ministerial or vice-ministerial rank at a government agency will be a party member; the same goes for top executives at state companies and banks as well as other institutions such as major universities, research institutes, and news organizations.

About three years after assuming leadership, the Hu-Wen regime took major steps toward deploying the powers of the party-state to influence economic, industrial, and corporate outcomes.

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All this command and control might have been used by China’s leaders purely for political reasons, to entrench their rule and stifle dissent. If that had been the case, the implications for the trading system might have been minor. But about three years after assuming leadership, the Hu-Wen regime took major steps toward deploying the powers of the party-state to influence economic, industrial, and corporate outcomes, a distinct course reversal from the market reforms of the Jiang-Zhu era.

In February 2006, the State Council issued a landmark document called the “National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020).” One phrase in its dense bureaucratese stuck in the craws of foreign business executives and trade officials: “zizhu chuangxin,” or “indigenous innovation.” That term implied that instead of importing goods from abroad or inducing foreign companies to invest and produce freely in China, the government was pivoting to a strategy of boosting Chinese enterprises, quite possibly to the detriment of foreign ones.

The plan listed a number of “priority” sectors “that are both critical to economic and social development and national security and in dire need of [science and technology] support.” These included high-speed rail, energy-efficient automobiles, “high performance, dependable computers,” flat-panel displays, advanced medical equipment, and renewable energy. Also specified were 16 “megaprojects,” which included high-end chips and software, super large-scale integrated circuit manufacturing, next-generation broadband wireless telecommunication, advanced numeric-controlled machinery, large aircraft, nuclear reactors, pharmaceuticals, and genetically modified organisms. State-owned enterprises were directed to obtain know-how from foreign partners through “co-innovation and re-innovation based on the assimilation of imported technologies.”

Innocuous as words such as “assimilation” and “co-innovation” might seem, they struck many foreigners as ominous. Intellectual property piracy of the old-fashioned sort (DVD copying, knockoffs of luxury-branded goods, and so on) was on the decline, but there was a potentially more vexing concern: the pressure to hand over proprietary know-how that certain foreign companies were subjected to if they wanted to tap the Chinese market. Although other countries, notably Japan, had employed similar strategies to their advantage in previous decades, official demands for technology transfer from foreign investors contravened WTO principles, and upon joining the organization, Beijing had pledged to halt the practice, which it had once imposed explicitly.

What were the practical implications of these developments for foreign firms active in the Chinese market? The outcome in one sector is revealing. The wind turbine industry illustrates how government regulations, subsidies, and other forms of support enabled Chinese companies to extract technological expertise from foreign investors and then, after capturing most of the domestic market, turn themselves into export powerhouses.

China was giving itself a leg up in global markets that went beyond the normal rough and tumble of global capitalism.

Gamesa, a Spanish firm that was the world’s No. 3 wind turbine maker, began shipping large numbers of turbines to China around the turn of the century and became the leader, with a 35 percent share of the Chinese market by 2005. But that year, the Chinese government decreed that wind farms could buy only turbines containing more than 70 percent Chinese-made parts; “wind farms not meeting the requirement of equipment localization rate shall not be allowed to be built,” the directive stated. Gamesa responded by sending engineers to Tianjin, where they helped build an assembly plant and trained Chinese suppliers to make components, such as steel forgings and electronic controls. Other multinational turbine makers took similar steps, and within five years, Chinese firms—backed by low-interest loans from state-owned banks and inexpensive land from municipal authorities—controlled 85 percent of the market; Gamesa’s share had dwindled to 3 percent. The biggest Chinese turbine makers held nearly half of the global market in 2010 and were gearing up to grab more.

The imposition of local content requirements on wind turbines sold in China clearly violated WTO rules. Even so, Gamesa was raising no fuss—the Chinese market had grown so large that even the company’s shrunken share was amply profitable. “If you plan to go into a country, you really need to commit to a country,” Jorge Calvet, Gamesa’s CEO at the time, told the New York Times in 2010. As the paper reported, “the Chinese government bet correctly that Gamesa, as well as G.E. and other multinationals, would not dare risk losing a piece of China’s booming wind farm business by complaining to trade officials in their home countries.”

It would be grossly unfair to credit such industrial policy schemes with fueling all of the spectacular growth China was enjoying during the years after WTO entry. A major factor driving the country’s export juggernaut, in addition to low labor costs, was the construction of infrastructure, such as coastal ports and highways, which allowed delivery of goods to the United States in as few as 18 days, compared with 28 to 45, for example, in Sri Lanka. Moreover, the reduction in China’s own tariffs made inputs—machinery, raw materials, and so on—cheaper for Chinese manufacturers, thereby enhancing their competitiveness on world markets. The Chinese industries with the largest growth in exports were those that had large reductions in their input tariffs, according to a study published by the Federal Reserve Bank of New York in 2017.

But hard work, investment, good infrastructure, leanness, and meanness did not tell the whole story. China was giving itself a leg up in global markets that went beyond the normal rough and tumble of global capitalism.

A woman sits behind the wheel of a new car in a lot in Beijing on June 20, 2003, during a boom in private car ownership in China.Natalie Behring-Chisholm/Getty Images

Among the U.S. companies that expected to reap a bonanza when China entered the WTO were auto parts manufacturers, and for a while after 2001, the profits materialized pretty much as anticipated. Every month, hundreds of thousands of Chinese were buying their first cars, many of which were full of U.S.-made components, as the country’s rapidly growing auto industry depended heavily on imported engines, transmissions, seating-control systems, and the like. Moreover, China was cutting tariffs sharply on auto parts in accordance with its accession commitments.

But by 2005, the tables were turning. That year, for the first time, China exported more auto parts than it bought from abroad, with shipments to the U.S. market leaping 39 percent to $5.4 billion. The influx of Chinese parts exacerbated the woes of a U.S. industry that was already struggling, as witnessed by the bankruptcy filing in October 2005 of Delphi Corp., the biggest U.S. auto parts maker. Even harder hit were U.S. furniture makers, which were reeling from an onslaught of imports, mainly from China. Between 2001 and 2005, at least 230 furniture plants were closed in the United States, with 55,000 jobs lost, as China’s share of the U.S. wood furniture market—a mere 3 percent in 1994—reached 42 percent in 2002 and 60 percent in 2005.

The China shock was in full swing. Although the low cost of Chinese labor was part of the explanation, the hypercompetitiveness of China’s exporters could be attributed to another key factor: the exchange rate of China’s currency, the renminbi.

Most of the world’s major countries allowed their currencies to float in value on international markets, in accord with supply and demand, during the latter decades of the 20th century. Not China, which used a different system that relied on strict controls over inflows and outflows of capital and kept the renminbi pegged at 8.28 per U.S. dollar, even during the years following WTO membership, when China’s exports soared and outpaced imports by a wide margin. The country’s current account surplus—the broadest measure of the surfeit of exports over imports—amounted to more than 7 percent of GDP in 2005, a higher percentage of its economy than either Japan or Germany had ever achieved. Instead of allowing its currency to appreciate, which would normally happen in a country with a huge surplus, China held it down by intervening on a massive scale in currency markets.

A hue and cry arose among U.S. companies, labor unions, and many economists, who saw the fixed-rate renminbi as a classic manipulation of market forces to benefit Chinese workers at the expense of U.S. workers—although American consumers enjoyed cheaper Chinese goods as a result. Indignant members of the U.S. Congress introduced a variety of bills aimed at remedying this injustice. The most popular bill—it garnered 67 Senate supporters at one point—was one introduced by Sens. Chuck Schumer, a Democrat, and Lindsey Graham, a Republican, which would have imposed 27.5 percent tariffs on Chinese goods, based on estimates by some analysts of the renminbi’s undervaluation.

Bush administration officials saw their options as extremely limited.

Noisy though such bombast may have been, Bush administration officials saw their options as extremely limited. Slapping tariffs unilaterally on Chinese goods would be an egregious violation of WTO rules and would surely lead to economic warfare between Washington and Beijing—a nightmare scenario under almost any sensible estimation. Interdependence bound the U.S. and Chinese economies together in an embrace popularly dubbed “Chimerica,” despite—or rather, because of—their vast differences. By shipping tons of merchandise to American consumers, China was accumulating hundreds of billions of dollars annually, which it plowed into U.S. securities of all kinds, including U.S. Treasury bonds and the bonds issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac. For its part, the United States, with its low savings rate, relied on that inflow of Chinese capital—and capital from other nations—to help keep interest rates down. Beijing got manufacturing jobs to lift its massive workforce out of poverty, while Americans got cheap electronic devices, clothing, and other imported goods, together with bargain-rate mortgages. A trade conflict that disrupted the extensive supply chains involved would endanger the Chimerica arrangement—and probably the global economy as well, U.S. officials believed. They therefore turned to diplomacy—the quieter the better, in their view, because China would want to avoid even the appearance of giving in to U.S. pressure.

An example came when Paulson, a couple of months after taking office, took his first trip to China as treasury secretary. In an indication of the esteem in which he was held, he managed a brief tête-à-tête with President Hu—just the two of them, plus an interpreter, an extraordinary courtesy considering Paulson wasn’t a head of state.

“In a way that could only be done in a truly ‘private’ meeting, I said something that I never divulged to members of the Congress or even to my fellow Cabinet members,” Paulson writes in his book Dealing with China (adding that he did report the exchange to Bush). “I gave him a number to work with. ‘Mr. President,’ I said, ‘if your currency appreciated 3 percent against the dollar before the end of … December, the result would be good for China and it would help me convince Congress that [diplomacy] is working.’” Hu’s response—“I understand”—was enough to convince Paulson that Beijing would allow the renminbi to appreciate more rapidly than before, and upon his return he called Schumer and Graham, who shelved their bill, at least for the time being.

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The renminbi did climb—although only by 1.3 percent in the last quarter of 2006, and 2.2 percent by the spring of 2007. Dissatisfaction remained strong in U.S. industry circles and on Capitol Hill about the still grossly undervalued renminbi. Frustrated Bush officials put greater emphasis on a new strategy, pressuring the International Monetary Fund to change its rules and use its authority as the voice of the international community to chastise countries with “fundamentally misaligned” exchange rates—China being the obvious target. The result, as shall be seen, was a debacle.

U.S. President George W. Bush waves during a group picture with Asia-Pacific Economic Cooperation leaders in Shanghai on Oct. 21, 2001. The summit focused on ways to boost trade to support the slumping global economy in the wake of the 9/11 attacks.STEPHEN JAFFE/AFP/Getty Images

Ask almost anyone who worked on China trade issues in the Bush administration during the first few years after China’s WTO accession and they’ll admit that their sanguine assumptions proved woefully off-base. Like the Clinton administration before it, the Bush administration was predominantly of the opinion that Beijing was progressing gradually but purposefully toward economic liberalization, thanks to the impetus of WTO membership. Although unhappy about China’s foreign exchange policy, U.S. officials were inclined toward shrugging off rather than raising alarms about developments such as the formation of SASAC or approval of the 2006 science and technology development plan.

“The general view was that we’re going to have bumps in the road with China, and they’ve just swallowed a huge elephant [i.e., WTO membership commitments], so we should be a little patient with them,” one high-ranking Bush administration policymaker told me. “Their policies will align with ours—not over months, but it’s going to happen. There was great confidence in that. And if you’re confident about the endpoint, it allows you to be more patient about missteps along the way.”

Nowhere was this forbearance toward China more consequential than in the matter of pedestal actuators—mechanisms that adjust the height of seats on motorized scooters used by the physically disabled.

In August 2002, a New Jersey maker of pedestal actuators that had lost a substantial amount of business to Chinese imports decided to strike back using the law. This was the first effort to use a special kind of safeguard tariff that applied only to China. Ordinary, plain vanilla safeguards apply to imports from all countries and can be imposed to provide temporary protection to an industry that is threatened by a surge of imports, as long as the imports can be shown to be “causing or threatening to cause serious injury” to domestic companies. But during the course of its negotiations for entry to the WTO, Beijing had reluctantly agreed that its trading partners could resort to a “China product-specific” safeguard, based on a relatively lax standard of evidence. American manufacturers could get temporary duties or other protective measures levied on competing Chinese goods alone if the U.S. International Trade Commission found that those imported goods were causing “market disruption” adversely affecting the U.S. industry.

In the pedestal actuators case, a finding of market disruption was forthcoming on Oct. 18, 2002, when the trade commission voted 3-2 in favor of imposing protective measures against Chinese imports. The “relief ” recommended was quotas limiting the number of imported Chinese pedestal actuators for three years.

Bush sent the message that the China product-specific safeguard wouldn’t be much use, at least while he was in office.

But three months later, the White House announced that Bush was exercising his right to reject the commission’s recommendation. That set a precedent followed in similar, subsequent cases: On April 25, 2003, the president refused to impose safeguard measures that the commission had recommended in a case involving imported Chinese wire hangers; he did it again in 2004, in a case involving imported Chinese “ductile iron waterworks fittings,” which are used to join pipes and valves; and again in 2005 in a case involving steel pipe. By consistently disallowing the measures favored by the commission—even when the commissioners voted unanimously, as they did in the hangers and waterworks fittings cases—Bush sent the message that the China product-specific safeguard wouldn’t be much use, at least while he was in office. U.S. companies stopped filing such cases for the remainder of Bush’s presidency, figuring that they would only waste time and money.

Explaining its decisions in these cases, the White House issued statements noting that under the law governing the China product-specific safeguard, the president is supposed to consider the overall impact on the U.S. economy, not just the industry competing with Chinese imports. Restricting Chinese imports would lead to price hikes on users of those items, the White House statements pointed out; in the case of pedestal actuators, for example, “a quota would negatively affect the many disabled and elderly purchasers of mobility scooters and electric wheelchairs, the primary ultimate consumers of pedestal actuators,” a presidential statement said. Furthermore, even if the government blocked imports from China, similar products would soon come into the U.S. market from elsewhere, rendering safeguards ineffective.

Omitted from these public statements were some of the deeper reasons for rejecting the use of the China safeguard. Bush’s advisors, led by U.S. Trade Representative Robert Zoellick, worried that if one industry got protection under the safeguard, virtually every U.S. manufacturer competing with Chinese imports would be clamoring for similar treatment. That would put the entire U.S.-China trade relationship at risk, and U.S. multinationals—which were reaping big profits in the Chinese market—lobbied heavily to avoid any major disruptions. Also tilting the scales was lobbying by Chinese officials, who strenuously argued against U.S. use of the discriminatory China safeguard. The White House had no choice but to listen, given foreign-policy considerations such as securing Chinese support for its anti-terrorism campaigns.

Bush resisted entreaties to come down harder on China—and he took considerable heat as a result.

It wasn’t that the Bush team adhered to ideological purity in its embrace of free trade. In March 2002, the president bowed to pressure from Rust Belt states by imposing tariffs ranging from 8 to 30 percent on imported steel, including Chinese steel, using the general safeguard rules. And following a pattern set during the Clinton administration, Bush’s Commerce Department imposed anti-dumping duties (for alleged sales at unfairly low prices) against imports from China far more often, and far more punitively, than imports from any other trading partner.

But Bush resisted entreaties to come down harder on China—and he took considerable heat as a result. Even during his 2004 reelection campaign, when he was getting pounded by Democratic candidate John Kerry for being soft on Beijing, the president forthrightly opposed demands by organized labor for sanctions against China’s treatment of workers. By remaining true to his convictions, Bush deserves credit for political courage. In hindsight, however, using the China safeguard—or just quietly threatening Beijing with its wide application—might have been effective at inducing a change in China’s foreign exchange policy. That, in turn, might have blunted the impact of the China shock.

Would such an approach have worked? That is an unanswerable question; in any event, the White House didn’t try.

U.S. Treasury Secretary Henry Paulson shakes hands with Chinese Finance Minister Jin Renqing before their meeting in Beijing on Sept. 21, 2006.Elizabeth Dalziel/Getty Images

In Bush’s second term, as troubling aspects of China’s economic policies became more evident, top U.S. officials began speaking more bluntly and acting more aggressively. “China has been more open than many developing countries, but there are increasing signs of mercantilism, with policies that seek to direct markets rather than opening them,” warned Zoellick, who had been named deputy secretary of state, in a widely acclaimed address on Sept. 21, 2005, which exhorted Beijing to become a “responsible stakeholder in the international system.”

Responding to intensified criticism in Congress, the new U.S. trade representative, Rob Portman, vowed to undertake a “top-to-bottom review” of the administration’s China trade policy. That review resulted in a February 2006 report citing, among other things, “continued Chinese barriers to some U.S. exports; failure to protect intellectual property rights; failure to protect labor rights and enforce labor laws and standards; [and] unreported and extensive government subsidies and preferences for [China’s] own industries.” The chief proposal, implemented soon thereafter, was a significant expansion of Washington’s capacity for investigating Chinese trade practices and cracking down on infractions.

And then, a few months after that report, Paulson arrived in Washington with the president’s blessing to try a new approach for U.S.-China economic engagement.

Paulson’s idea, which was named the “Strategic Economic Dialogue,” was hatched over the summer of 2006 during brainstorming sessions with Deborah Lehr, who had served in the Clinton administration as a top China trade negotiator and was married to Goldman’s chief of staff. Policymakers at senior levels would convene twice a year for give-and-take on all manner of economic issues—not just hot-button trade, currency, and investment topics but also financial market opening, energy, the environment, and food and product safety. Other Chinese-U.S. negotiating forums already existed—notably one initiated in 1983 called the Joint Commission on Commerce and Trade—but by choosing top economic priorities and putting maximum emphasis on them at the Strategic Economic Dialogue, the United States could convey more clearly to China what it wanted and what it was willing to give in return, Paulson contended. The Treasury chief wanted to include a large number of Chinese ministers and influential officials involved in economic matters, while also reserving time for brief engagement with the respective heads of state, Hu and Bush. That would be the most effective way of exploiting China’s “top-down yet consensus-driven decision making,” according to Paulson.

Paulson arrived in Washington with the president’s blessing to try a new approach for U.S.-China economic engagement.

The outcome can be described as incremental at best. The first session convened on Dec. 14 and 15, 2006, in the Great Hall of the People, with the two delegations facing each other across long tables and video screens placed at intervals for viewing PowerPoint slides. Paulson was in a “super cabinet” position, leading a 28-person team that included six of his fellow cabinet members plus agency heads, notably Federal Reserve Chairman Ben Bernanke. On the Chinese side, Vice Premier Wu Yi served as Paulson’s counterpart, with 14 ministry-level officials in attendance along with high-ranking aides. Despite hopes for a spirited discussion on agenda items that included China’s economic development strategy and specific energy and environmental issues, even Paulson had to admit in his book that “speakers relied too frequently on set pieces or talking points.” Four more gatherings were held during the remainder of Bush’s presidency—one in Washington, one in Annapolis, Maryland, and two more in Beijing.

Some specific so-called deliverables resulted, notably an agreement on air travel that more than doubled nonstop routes between the United States and China, a Chinese commitment on emissions trading, and a tourism promotion accord. But U.S. trade officials who participated generally found the talks not conducive to anything resembling breakthroughs on the issues that mattered to them. “It was interesting—there were these canned presentations, but absolutely nothing I could tell came out of it,” Warren Maruyama, the general counsel at the Office of the U.S. Trade Representative at that time, told me.

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In any event, the Strategic Economic Dialogues were overtaken by other developments—in U.S. financial markets.

The talks were supposed to be two-way, with China having reciprocal rights to air its concerns about U.S. policies, and Chinese officials had a lot to talk about following the collapse of Bear Stearns in March 2008. Amid the steady debilitation of other Wall Street firms, Paulson was peppered with questions from the Chinese about the health of U.S. banks, the adequacy of Washington’s response, and the safety of China’s holdings of U.S. securities. At the dialogue in Annapolis in June 2008, Wang Qishan, who had known Paulson for 15 years and succeeded Wu as the head of the Chinese delegation, pulled the treasury secretary aside. “He wanted me to know that the financial crisis in the U.S. had affected the way he and others in the senior ranks of the Party saw us,” recalled Paulson, who quotes Wang as saying: “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.”

The Strategic Economic Dialogues were overtaken by other developments—in U.S. financial markets.

Meanwhile, at the IMF, a battle over China’s currency policy was nearing a climax behind the scenes. The IMF staff was putting the finishing touches on a report that would have sharply rebuked China in the eyes of the international community by calling the renminbi “fundamentally misaligned” and calling for the fund’s top management to initiate special consultations with Beijing. Paulson and other Treasury officials were pressing hard, over vehement Chinese objections, for the report to be published and brought to the monetary fund’s executive board. A showdown loomed when a board meeting was scheduled for Sept. 22, 2008—which at the time no one knew would come exactly one week after the most catastrophic financial episode in generations.

The board meeting was never held. The staff report remained buried in the fund’s files until I received a copy and brought it to light years later. Indeed, the U.S. Treasury lost interest in prodding the IMF to denounce China’s currency policy. On Sept. 15, Lehman Brothers went bankrupt; the following day, the giant insurer AIG required an emergency $85 billion loan from the Fed to avoid Lehman’s fate. The staggeringly large financial gyrations that ensued for months thereafter shifted the balance of power again away from the United States and toward China—this time seismically, by several orders of magnitude greater than anything that had come earlier in the crisis.

Another of Paulson’s books, On the Brink, offers helpful insight regarding the reasons for that seismic shift. In his chapters about events immediately following the Lehman bankruptcy, the former treasury secretary recounts numerous phone calls to Beijing in which he and other Treasury officials were essentially imploring Chinese leaders to help keep the rest of the U.S. financial system afloat. On the Saturday after Lehman collapsed, for example, Paulson called Wang in the hopes that a Chinese state-owned company would invest in the investment banking giant Morgan Stanley, which was in desperate need of a cash infusion.

To the extent the U.S. economy had been admired as a model that China should strive to emulate, the global financial crisis shattered such perceptions.

Here, ironically, was where the Strategic Economic Dialogue may have had its most significant impact. Crediting Beijing with “play[ing] a big role in helping the West survive and emerge from the worst of the crisis,” Paulson concludes: “The relationships I had built in China, at Goldman and through the painstaking efforts of the SED, had paid off.”

The depths that the United States plumbed—and the crisis in Europe that followed—thoroughly discredited Western-style capitalism in the eyes of many Chinese. To the extent the U.S. economy had been admired as a model that China should strive to emulate, the global financial crisis shattered such perceptions.

The Chinese economy not only weathered the crisis, it also grew so robustly as to emerge as the single most potent source of support for global recovery. When overseas demand shriveled in the winter of 2008 to 2009, causing export orders to plunge and leaving millions of Chinese workers idle, Beijing responded with an emergency stimulus package that included spending of nearly $600 billion, or 12.5 percent of GDP, on priorities such as transportation, electrification, health care, education, and low-income housing. The People’s Bank of China, meanwhile, slashed interest rates and also used a policy tool available to few central banks elsewhere: It doubled the target for bank lending, which major banks were obliged to obey with a splurge in credit for state-owned and private Chinese businesses. The payoff was that output expanded at a pace of 9.1 percent in 2009, almost matching the previous year’s growth rate and far outstripping economies in the rest of the world.

In China, reformers who favored additional progress toward liberalizing markets and rolling back party-state control were thrown on the defensive. Statists were emboldened. Increasingly confident in the virtues of its own model, Beijing diverged from the economic approach its trading partners; in so doing, it undermined support for the rules-based WTO system abroad. And now the foundations of that system have been fractured by the capricious behavior and contempt for international rules of the current U.S. president. But the origins of the present destruction lie in the events of a previous U.S. presidency.

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