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Hearing of the Subcommittee on Terrorism, Nonproliferation and Trade of the House Committee on Foreign Affairs - U.S. Foreign Economic Policy in the Global Crisis

HEARING OF THE SUBCOMMITTEE ON TERRORISM, NONPROLIFERATION AND TRADE OF THE HOUSE COMMITTEE ON FOREIGN AFFAIRS

SUBJECT: U.S. FOREIGN ECONOMIC POLICY IN THE GLOBAL CRISIS

CHAIRED BY: REP. BRAD SHERMAN (D-CA)

WITNESSES: SIMON JOHNSON, PH.D., RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, GLOBAL ECONOMICS AND MANAGEMENT (GEM), MIT SLOAN SCHOOL OF MANAGEMENT; PETER MORICI, PH.D., PROFESSOR OF LOGISTICS, BUSINESS AND PUBLIC POLICY, ROBERT H. SMITH SCHOOL OF BUSINESS, UNIVERSITY OF MARYLAND; C. FRED BERGSTEN, PH.D., DIRECTOR, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS; PHILIP I. LEVY, PH.D., RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE; LORI WALLACH, ESQ., DIRECTOR, GLOBAL TRADE WATCH

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REP. SHERMAN: We'll now bring the subcommittee to order. And we'll start, of course, with opening statements. I thank the witnesses for being here.

But I especially want to thank President Barack Obama for taking note of the timing of this hearing and coordinating the release of his international economic plan with the timing of this hearing. I just can't voice my appreciation for that strongly enough.

Today's hearing aims to examine the effects of the global economic crisis on how the U.S. and international trading partners may adjust their economic policies in response. We know that early next month our president will be attending the G-20 summit in London. The administration has released an international plan, the provisions of which are just now coming into view. It involves the G-20 countries committing to a stimulus package of 2 percent of GDP, that the countries should spend significant additional amounts on export promotion through their export credit agencies. In our case that would be the Export-Import Bank.

While we don't have all the details of the president's plan, we have checked with Treasury. They are not going to be seeking budget authority for this effort. And the export financing will be short term using the existing Ex-Im bank facilities. OPIC, over which this subcommittee has legislative jurisdiction, is not anticipated to be involved in this plan. The countries are going to be urged to put in matching amounts to the World Bank and also on the other multilateral banks to help less developed countries finance exports.

And I do want to put -- make a note about the use of the World Bank. The World Bank lends money to Iran. It is helping to keep the mullahs in power. It is helping indirectly to finance nuclear weapons that will threaten the United States. The World Bank either needs to adopt a policy not only of not making additional loans to Iran but also of not making further disbursements on loans previously approved if it is to be regarded as a healthy agency with which the United States should continue to do business and to make additional investments.

Also under the Obama proposal, the U.S. would increase its line of credit to the IMF from ($)10 billion to ($)100 billion with a view to increasing other countries to do likewise so that the total increase would be $500 billion.

Now, obviously we need to see the president's full proposal. I want to work with the administration to ensure an aid package is crafted that maximizes support for American economic and foreign policy goals, and this hearing is the beginning of that process.

I do think that two things need to be more clear, first how we're going to plan for the -- for dealing with the trade deficit. You just can't sweep half a trillion to three-quarters of a trillion dollars under the rug year after year after year. And the second thing that remains unclear is whether our commitment to increase a line of credit to the IMF is contingent upon similar commitments from Europe, of Saudi Arabia and China, or whether it is something we are going to do in the hopes that it encourages these other nations to act. I would point out that it appears that Japan is already acting consistent with President Obama's plan.

This hearing will also focus on the big brouhaha of the buy- American provisions in the stimulus package and compare them to the buy-France and buy-China provisions stated explicitly and implicitly in the stimulus packages of other countries.

The extent of the crisis is well known to all. On March 8th the World Bank announced that the world economy will actually shrink for the first time since the end of World War II. The International Labor Organization expects global unemployment to increase between 18 and 30 million workers and may increase by 50 million workers if this situation continues to deteriorate. By some estimates, as much as 40 percent of the world's wealth has evaporated.

Most of those focusing on how we got here focus on the non- regulation of derivatives and absurd mortgage lending standards in the United States. But we cannot forget that the trade deficit of the United States has spiraled out of control, reaching $800 billion in 2007. This is a symbiotic malignancy in which the rest of the world becomes economically dependent on a malignant trade relationship with the United States. And Americans become dependent upon living a lifestyle where we consume far more than we produce. Things that cannot go on forever don't, and one would expect that the U.S. trade deficit will either be straightened out by the current economic calamity or will result in the next economic calamity.

Our trade deficit (spends ?) I believe comes from our faith-based trade policy. We have faith that if we open our markets others will do the same thing. And we have faith that since we are a country that believes in the rule of law, because we believe that the only way government can affect, should affect or ever does affect private sector and economic decisions is through written regulations, that other countries follow the same rule of law and that if we can simply get those countries to adjust their written regulations we have thereby eliminated any governmental pressure or interference in decisions of private actors seeking to maximize their own utility by, in many cases, purchasing American goods. A faith-based trade policy works well as long as one doesn't look at the results.

Now, those who became rich and powerful in a system that led to our trade deficit are not going to roll over and move to any other system. They are using every technique possible to either avoid discussion of our trade deficit or to attack those who dare to mention it. Their favorite tactic is to talk about the Smoot-Hawley Tariff Act of the 1930s while failing to mention that when that act was adopted the United States had a trade surplus and continued to have a trade surplus in all of the years relevant after it was adopted as well. So you can't have a less similar circumstance to today and -- when comparing today with the days of Smoot-Hawley.

Second, Smoot-Hawley involved tariffs of 100 and 200 percent on various goods. It is radically different from anything that even Lori Wallach would propose.

And accordingly, when you mention Smoot-Hawley therefore you're talking about the proposal radically different from anything anybody is proposing today and you're talking about circumstances radically different from those that pertain today. But aside from those things, it's directly relevant to the discussion of today's trade policy.

When the House set steel and iron procurement standards for federal funds for mass transit and highway projects, there were cries that we had -- were going to start a trade war. There were a number of ironies in this, the least of which is the fact that the U.S. specifically exempted those types of projects from -- that were subject to our procurement obligations under the WTO agreement on government procurement. Who is crying most loudly? It was the Europeans and the Canadians. The EU ambassador to the U.S. called the buy-American language a dangerous precedent. The Canadian ambassador said the buy-American provisions would fuel the economic crisis.

This is particularly ironic because both Canada and Europe have retained essentially the same or greater procurement restrictions in their WTO commitments. Canada retains restrictive domestic procurement rights for its transportation sector, including systems and components and not just iron and steel. The EU has retained the right to restrict procurement for transportation, water, energy, telecommunications in its WTO procurement commitments.

Now, to comfort these critics, the Senate included language that clarified what was already I think well understood that the provision would be carried out consistent with the U.S. trade obligations. And the Senate simultaneously expanded the buy-American provisions to include U.S. manufactured goods.

So this expanded version of buy America became law. Did the world come to the end? No. In fact, after the bill became law, its critics have been relatively silent.

This is -- the importance of the subject of this hearing is illustrated by the fact that my statement has already gone on too long. But I will use my time during the questioning period to illustrate how the government procurement and stimulus efforts of our trading partners are far more restrictive to U.S. competition than anything imagined in the United States stimulus bill.

I look forward to hearing from our witnesses. And I look forward with even greater anticipation to the opening statement of our ranking member, Mr. Royce, and our other colleagues.

REP. EDWARD ROYCE (R-CA): Thank you, Mr. Chairman, very much. I look forward to working with you and cooperating as we did in the 111th -- or as we did in the prior Congress here in this Congress.

I wanted to just make a few observations. One is that the world is changing ever more rapidly and, unfortunately, not for the better. Our director of national intelligence calls the global economic and financial crisis, today's subject, our greatest threat. It's certainly near the top.

As the U.S. economy sinks, so is the world's. All over growth is down, unemployment is up and markets are sagging. Trade is a big concern. World trade, Mr. Chairman, has quadrupled since 1982. The USTR -- President Obama's USTR testified last week that the world trading system has expanded the economic pie.

This winning streak, unfortunately, is over. Trade is now declining for the first time since 1982 and it is declining very rapidly. Some have warned that the golden era of trade is over, and that depends upon whether protectionism gains the upper hand in this argument because ideas have consequences.

The policies that sparked trade's growth were under attack well before economic -- before this economic crisis began. U.S. exports were the biggest contributor, frankly, to economic growth last year, yet the last Congress blocked trade deals with Korea, with Colombia, with Panama and with others.

This Congress appears set to do the same. A key House Democrat reportedly warned colleagues this week not to refer to trade agreements as win-wins; don't call them that. These agreements, though, amount to billions in stimulus that wouldn't cost a dime.

Now there's been a discussion of blocking trade in the 1930s with the Smoot-Hawley law. And of course, the Smoot-Hawley law, you know, with the 200 percent increases in tariffs, you can point to the fact that the Smoot-Hawley law is not identical to some of the initiatives being pushed today. But what we're talking about when we're talking about the Smoot-Hawley law is the blowback from the Smoot-Hawley law, the reaction of our trade partners in Europe in terms of the trade barriers that went up, the reaction in Latin America, in Chile and other countries that then imposed trade barriers, and the fact that once that happened economic decline put a very severe recession into a great national depression worldwide.

And I guess one difference is that when President Herbert Hoover signed that bill, reportedly beforehand he said, you know, I know better. He said, I think the economic consequences of these are great, but let's be honest; it was the most popular legislation that Congress probably ever passed. And certainly it was just as easy for the Canadians and the Europeans to follow in the footsteps of Smoot and Hawley, and it as just as easy today for those parliamentarians in Canada and in France to push for protectionist measures.

I guarantee you it is a popular, popular argument to make in those countries. But I also guarantee you that if we are successful in undoing liberalized trade and if those forces in Canada and France who would like to do the same are just as successful as some would like to be here, the consequences will most assuredly not be a economic benefit to the people of the world in my opinion, because there are very real trends that indicate we're heading back that way.

The World Bank reports that 17 of the G-20 countries have implemented trade restrictions. As the world's largest exporter, many high-paying U.S. manufacturing and service jobs are at risk. Protectionism combined with collapsed commodity prices threatens to throw hundreds of millions into poverty worldwide. And the implications of this for our national security are frankly beyond comprehension. Protectionism will affect other issues requiring international cooperation. It will be harder to work together on counterterrorism, on financial sector reform or nuclear nonproliferation if you are treating trade as a zero-sum game.

One focus of this committee will be foreign aid reform. Nearly everyone agrees that our aid program is dysfunctional, incoherent with its hundreds of goals. The administration's budget aims to double foreign aid. There is no justification for that given our aid program's sorry state, never mind our dire economy. Many types of aid are simply harmful. I saw that certainly with the impact that it had -- (laughs) -- on Mobutu's Zaire or Congo today.

The administration's plan announced yesterday to multiply U.S. spending through the IMF is ill conceived. Where did this come from? Many Europeans are right to balk about this. Calls to increase development aid make no sense while we're denying developing countries market access, the most powerful developmental tool. That is the most powerful thing that can be used for development. The African Growth and Opportunity Act doubled trade between the United States and Africa.

Encouraging is the administration's indication that it will move against agricultural subsidies which punish American consumers and the world's poorest.

Pakistan is of great concern. The country's a powder keg with a nuclear arsenal. Radicalism is spreading. And the economic crisis will weaken the remaining forces of moderation in that country. There is no reason to believe that the very large aid package for Pakistan being proposed will turn this around.

Closer to home, some have discussed Mexico as a failed state. Economic pressures are intensifying there. The Mexican government's battle with the drug cartels is a death match spilling into the U.S. More so than ever, border security is national security. And yesterday I wrote President Obama asking that he resume Operation Jump Start, which deployed National Guard troops along the Mexican border to great benefit.

Authoritarian governments in Russia, China, Venezuela and elsewhere already have blamed the U.S., deflecting the tension from their own shortcomings. But as Venezuela and others nationalize companies and embrace statism, their economic demise will intensify.

The idea that a nation's business can be well managed by its government, that politicians and government bureaucrats have the ability or inclination to manage business is a conceit and power grab that has made people poorer again and again. I hope that we understand that here at home.

Thank you, Mr. Chairman.

REP. SHERMAN: I thank the ranking member. And just one brief comment. There are I think three groups in trade at least that are protectionists associated with Smoot-Hawley; there are those who support generally our present policies, and there are those of us who believe in open markets with a sledgehammer. And so I'm sure when he was talking about Smoot-Hawley he knew I was in that third group and not in the first group.

And I now yield to our vice-chairman, Mr. Scott.

REP. DAVID SCOTT (D-GA): Thank you, Mr. Chairman.

We have five very distinguished guests before us. And I want to move this along so we can get to their hearings -- to their comments -- very important.

I think quite honestly that between you and Mr. Royce you've basically covered the waterfront. However, I do want to say that fear is just not an option for us. The world is in a state of uncertainty with many other countries' economies in dire shape. And we need to be very, very careful how we approach this. We need to do it with a calmness and a confidence and be very careful about how we view and how are viewed in terms of isolationism. It hasn't worked in the past.

We've been at our greatest as a country when we have shown the way without fear, without trepidation, and we have in many ways set the standards in terms of using our trade diplomatically, fairly and understanding that that is the main way that we keep avenues open to countries by having economic relationships with them. And I come down on the side of wanting to keep those opportunities of trade open and not close our borders.

With that, I will reserve for the rest of the questions so we can get to the -- our panelists. Thank you.

REP. SHERMAN: I now recognize the gentleman from Texas for any opening statement he may have.

REP. TED POE (R-TX): Thank you, Mr. Chairman.

Thank you for being here.

I'm concerned about four countries, China, Russia, Iran and Mexico, and our relationship with each of those. China: Are they going to take advantage of this situation worldwide to expand their political influence through their economic programs, concerned about the debt that the United States owes China and that growing interest on that debt. And Russia: Are they going to use their global influence during this crisis to move into more former Soviet states like they did in Georgia. Is Ukraine next, or who's next? Is the Russian bear going to come out of hibernation or are they just going to be complacent? I don't know, but maybe you do. And, of course, Iran, with the energy prices being what they are, is that affecting the stability of the Iranian government or has no effect?

I'm mostly concerned about our neighbor to the south. I think that as -- the United States needs to have a better neighborly relationship with Mexico. And the economic crisis there and the drug war in Mexico has led some to warn that some of the ungoverned areas in that country may become sanctuaries for terrorists. Is that a valid concern or is that just some concern or fear? Is it time to renegotiate NAFTA or is it time to reinforce NAFTA? And, of course, the answer to the question, the question being what is -- what should the United States do to stabilize Mexico economically so that it's stabilized politically?

And lastly, I too am concerned about our foreign aid policy. We just write the check every year and maybe we need to figure out why we do that to so many countries all over the world.

So with that, Mr. Chairman, I will yield back my time.

REP. SHERMAN: Thank the gentleman from Texas.

Recognize the ambassador and congresswoman from California.

REP. DIANE WATSON (D-CA): Thank you so much, Mr. Chairman. And thank you for holding today's very important hearing to examine the effects of the U.S. foreign economic policy and trade effects in this global financial crisis.

It is important that the U.S. continue to work with our friends around the globe to carefully craft, manage and redirect this crisis in order to restore confidence in the capital markets, consumers and developing nations.

As the recession began in December of 2007, many foreign leaders around the world believed the economic downturn was isolated to the United States. (Laughs.) However, as the situation snowballed into a global financial crisis, the most severe since the Great Depression, many people around the world began to fall into poverty.

In November of 2008, the World Bank reported that with each one- point percentage drop 20 million people could be trapped into poverty. We know from past recessions that when people lose their jobs, no matter which country one lives in, that desperation often leads to increased crime rates. We see it here in our country. In emerging and developing nations, desperation among unemployed youth can turn into acts of terrorism and retaliation against their own governments. In some cases this activity was spawned -- have spawned uprising and has been the cause of coup d'etat in several states.

It is my hope today that we can learn from our most distinguished panelists and take away some information that will help us as the policymakers so we can continue to navigate our way through this global financial crisis in a very positive and effective direction.

So Mr. Chairman, thank you, and I look forward to today's testimony and yield back my time.

REP. SHERMAN: I now recognize the gentleman from New York.

REP. MICHAEL E. MCMAHON (D-NY): Thank you, Chairman Sherman, and to your staff for putting together this very important hearing.

Recently I met with the German ambassador and members of the German Bundestag and representatives of common transatlantic businesses to celebrate the achievements of the transatlantic community. But we are faced with the unfortunate fact that the transatlantic community has fallen into what could be perhaps its deepest recession since World War II, and this weighed heavily on everyone's mind.

But during our conversation the delegation did not take aim at the United States and instead proceeded to discuss how the global economic crisis should be credited to the greed that crossed international borders and infiltrated the practices of many worldwide businesses. There are many who blame the United States for initiating this crisis, and many in our own country prefer to look inward for solutions to this crisis. But these seemingly divergent notions are actually one and the same. Although there can be no recovery in the global economy without recovery in national economies, the current crisis is not a uniquely American phenomenon, and that's why this discussion today is so important.

The United States must continue to look outward and look for ways to not only maintain but increase its credibility on the world stage. With that in mind, I would like to hear the suggestions from our distinguished witnesses on how to do just that while also successfully focusing on our crucial domestic responsibilities. And I look forward to your testimony.

And I yield the remainder of my time. Thank you, Mr. Chairman.

REP. SHERMAN: Thank the gentleman from New York.

And now we'll introduce our five witnesses. First I want to welcome Simon Johnson. He is the Kurtz professor of entrepreneurship at MIT's Sloan School of Management. He is co-founder of website on global economic and financial crisis, baselinescenario.com.

From March 2007 through August 2008, he was the chief economist for the International Monetary Fund.

Second, we are honored to have Lori Wallach, who is director of the Public Citizen Global Trade Watch. She is also founder of the Citizens Trade Campaign, a national coalition of consumer, labor, environmental, family farm, religious, civil rights and left-handed Americans representing over 11 million Americans.

I also welcome Philip Levy, a resident scholar at the American Enterprise Institute. Dr. Levy studies international trade and development. Before joining AEI, he was senior economist for trade on the president's Council of Economic Advisers.

Next, we have C. Fred Bergsten, who is the director of the Peterson Institute of International Economics since its creation in 1981. He has also served as the assistant secretary for international affairs at the U.S. Department of Treasury, 1977 through 1981. I hear they've got some empty space for you there or for anybody who knows their ways around the halls of the Treasury.

And finally I want to welcome Peter Morici, a professor of international business at the University of Maryland. Prior to joining that university he served as director of economics at the U.S. International Trade Commission.

With that let's hear from Mr. Johnson.

MR. JOHNSON: Thank you, Mr. Chairman.

I would like to start by saying a few things about the global economic outlook, which was the subject of my written testimony and then link some of the broader points to the latest statements and policy strategy laid out by Secretary Geithner yesterday.

First of all, in terms of the global outlook, I took note of your -- all your opening statements, and I think that you are right to be concerned about the latest developments around the world. I would suggest the situation is actually worse and considerably more dangerous than you currently think. And let me explain that briefly, if I can.

My view of the global economy in the short term is not very different from what appears to be coming out of the international official organizations. They will release their full revised forecasts in April. I think that the globally output will decline as the World Bank, said in its March 8th statement for 2009.

I'm much more worried about 2010 and what happens after that because I think we're entering not into a V-shaped recovery or even a U-shaped slow recovery but much more of an L-shaped situation where the world economy goes down and then it stays down for quite a long time. And I think that's because at the global level, again, we face very similar problems to those faced by Japan during the 1990s, the so-called balance sheet recession.

When consumers, firms and governments around the world have taken on a lot of debt and when you have the kind of shock to our financial system that we've witnessed over the past two years, and particularly over the past six months, you have problems with consumer confidence almost everywhere. You have firms that are trying to pay down their debt and save cash and be very cautious almost everywhere. And you have governments that unfortunately and quite inappropriate for the moment find themselves pressed towards austerity rather than being in the position of what we would wish and what we would try and press on them, which would be to do some sort of stimulus like in the United States. And I'll come back to some specific places in a moment.

I do think in this context the relatively good news is the U.S. can recover quicker than most other parts of the world. I think we have a debt of technology creation and commercialization that will fill the gap left by the decline of financial services. And I think we also have a financial system which, while it has very deep problems, particularly in and around large banks -- and I don't think those are going to be resolved any time soon -- we also have a variety of sources of financing, a much broader, deeper system of intermediation than most other countries.

So I think the U.S. can pull out of this within three to five years. The rest of the world I think is really going to struggle. And by struggling I mean the kinds of pressures that I think you were flagging in some of your opening statements. In the best case that they try to -- in the best case you have the alternatives, you see increasing pressures towards protectionism. Certainly we see this in Europe and we will start to see it more and more in emerging markets. I think we will see instability of governments and of regimes. And I think what Ms. Watson said about people being pushed down into poverty is absolutely right, and I would emphasize how hard it is to predict the consequences of that.

Mr. Poe raised the questions of what will happen to a number of countries. I think most of these countries will get weaker and be hurt by the economic situation, but exactly how that plays out politically I think is incredibly hard to predict.

The particular -- the problems particularly that I would stress right now that are evident are around Eastern Europe, east central Europe, and I'll come on to that in just -- in a moment. And I would emphasize the importance, obviously, of Russia in that dynamic as an incredible wild card.

Let me close by linking this view of the world to the statement issued by Mr. Geithner yesterday and the U.S.'s strategy towards the G-20. And let me say three things about regulation on Europe and about the fiscal issue.

On regulation I am sympathetic to the U.S. administration's position. These are longer-term issues that need to be dealt with. But I would also stress there are bombs in our global financial system that need to be defused. I don't think our European partners are focused on that, and I think we need to push them much harder.

And that leads into my second point, which is what we are facing now is -- some politicians like to say it's a global problem, it needs global solutions. Well, it's not actually that much of a global problem. Right now it's a problem of the U.S. financial system and in Europe, throughout Europe, and the inability of Western Europe in particular to take care of its weaker members and weaker members of the euro zone. And in that context I support the moves towards greater resources for the IMF. I'd be happy to elaborate on that later. This is a very serious, dangerous situation in the emerging markets and the industrial countries of Europe, and this is a tsunami of new problems heading our way.

Finally, on the fiscal point, I support calls for greater fiscal stimulus, where appropriate, around the world. But I would emphasize that with these kinds of problems mounting, there is very limited room for this and we should be pushing much harder towards monetary expansion particularly on the part of the European Central Bank.

Thank you.

REP. SHERMAN: I thank the witness. We enjoy hearing him here and we'll enjoy watching him on "The Colbert Report" tonight. That will be interesting.

And because it's relevant to Dr. Johnson's statement, I'll ask unanimous consent to put in the record my op-ed for The Christian Science Monitor that urges much larger stimulus now in the United States but also statutorily required austerity to go into effect when the unemployment rate comes down.

With that, let us move on to Lori Wallach, our next witness.

MS. WALLACH: On behalf of Public Citizen and its 100,000 members I'd like to thank the chairman and the committee members for the opportunity to testify.

And unlike my co-panelists the economists, I am a lawyer and an author of books on the WTO and the global trade regime.

The devastation being caused by the global economic crisis to the lives and livelihoods of millions of people around the world is not merely the result of bad practices by a handful of mega financial service firms but the foreseeable outcome of one particular system of global governance or, and perhaps more accurately, anti-governance.

Over the last decade the United States foreign economic policy has been systematically the implementation worldwide of a package of deregulation, liberalization, privatization and new limits on government policy space, often dubbed the Washington consensus or the neoliberal agenda. Trade agreements such as those enforced by the World Trade Organization and international agencies such as the IMF and the World Bank have been the delivery mechanism for this global experiment.

I am no fan of tariffs, but I am of fan of policy space. The issue here is not trade rules but rather the other rules to regulate finance and other elements of our economies. The current regime of deregulation was put into place with intentionality, and now the evidence is pretty clear this system is a failure and it needs to be replaced. Thus, for instance, while the U.S. has a responsibility to help those countries that are not responsible for the crisis get out of it, more funds for the IMF must be, for instance, conditioned on changes in that agency's rules -- the rights for other countries to stimulate their economies versus the IMF's typical budget austerity; the ability to do currency controls to avoid raids on currency; the ability, for instance, to regulate foreign investors.

Congress is increasingly becoming aware of the overreach of so- called trade agreements such as the WTO when you're being told that auto industry rescues by America conditions in stimulus packages, the TARP system, unless it's made available also to foreign banks, are all violations of trade agreements.

Some of this is true, some of it's exaggerated. In the body of my testimony, which I request be put into the record, I go into detail about one little known aspect of the current failed economic governance system. That's the radical financial service deregulation program of the WTO's financial service agreement. That aspect of the WTO, which has gotten very little attention but it is at the core of the problem, exports worldwide, the extreme financial service deregulation that triggered this crisis. And, more urgently, it imposes barriers on the re-regulation of financial services domestically and globally that many agree is key to remedy the crisis.

Agreeing to review and renegotiate these WTO financial service deregulation terms must be a key element of the G-20 process aimed at addressing the crisis. Simply putting more stimulus money into operation under the current rules is not the solution. But even as Congress and the G-20 and other international configurations are struggling to figure out how to re-regulate finance, many of the same people in government are currently pushing for expansion of the WTO financial service deregulation regime.

For instance, the G-20 summit in D.C. in November of last year was supposedly convened to lay out a coordinated response and re- regulation. Instead, the communique called for completion of the WTO's Doha round. Yet the Doha round has one of its three pillars -- further financial service deregulation. Let me repeat: The current Doha round agenda has as one of its three main elements more financial service deregulation. Calling for completion of that agenda has no place in the G-20 agenda.

Again, I am not discussing passing tariffs, I am not discussing trade but, rather, undoing a system that limits Congress's and other legislatures' policy space to put into place the array of policies needed. This is a practical matter. It's not an ideological assertion. In addition to these financial service issues, we have the limits that the chairman discussed on buy America, made more egregious by the fact that the United States in scheduling its trade commitments has (stringently ?) focused on ideology and not the national interest. As a result, we have taken on more responsibilities under the current model than other countries. So the EU and Canada wisely chose to exclude some of their procurements, given it has nothing to do with trade but, rather, how governments can spend their tax dollars to stimulate their economies.

To conclude, for a few years a few brave economists reviewed the massive persistent U.S. trade deficit the chairman mentioned as it began to exceed 5 percent of GDP, and they warned that such imbalances were not sustainable. And they called for an array of urgent policy responses so as to avoid a devastating and painful market correction, a massive contraction in trade. The absence of the policy responses has resulted in the undesirable outcome.

Remedying the current crisis and avoiding future such crisis and achieving economic stability at home and abroad will require a new system of global economic governance that harnesses the benefits of trade while restoring the many non-trade -- removing the many non- trade policy constraints that are now obstacles to ensuring markets operate in a stable and productive manner.

Thank you.

REP. SHERMAN: Thank you.

Now we'll move on to Philip Levy.

MR. LEVY: Chairman Sherman and members of the subcommittee, thank you very much for the opportunity to testify today on the international economic policy challenges facing the U.S. in this time of global crisis. You're to be applauded for holding this hearing and recognizing that, in this time of domestic distress, our foreign economic policies will have important and long-lasting ramifications.

Mr. Chairman, with your permission, I'd like to offer just a brief summary of some of the key elements in my testimony, particularly with the focus on international trade, and submit the extended version of the testimony for the record. I also hope to just say a word about some of the important points that you have raised on the trade deficit.

First point I would like to make is that the trading system is less sturdy than it appears, and it's heavily dependent on U.S. leadership. It may not survive a sledgehammer. The propensity to turn inwards at a time of economic crisis is not new. One of the perpetual challenges for trade globalization is that the benefits tend to be diffuse -- lower prices for consumers, market access for exporters -- while the costs of import competition tend to be concentrated. These costs are felt even more acutely in times of economic distress.

As you've already mentioned, the misguided attempts to protect domestic producers by raising trade barriers in the '30s were a major motivation -- were a major problem and then served as the motivation for the creation of the postwar trading system.

Despite the creation of the World Trade Organization in the last completed trade round, the global trading system is more feeble than it appears. The WTO has no real enforcement power. Contrary to some of the testimony today, the WTO does not force anyone to do anything; it cannot. Instead, dispute settlement panels determine whether a member country has reneged on a commitment. The trading system largely relies upon the willingness of its major members to honor the letter and spirit of agreements. If they do not, there is little to hold the system together.

The United States plays a special role at the WTO. It has pushed for liberalization and it has led by example. Even if the United States continues its vigorous support of liberalization of the WTO, the system faces tremendous challenges. Without such support, progress is hard to imagine and the prospect of decay is very real.

Even before the recent economic shocks hit, the WTO was suffering a crisis of its own. It repeatedly failed to conclude the last round of talks begun in 2001 in Doha, which leads me to my next point which is that litigation without negotiation will do great harm to the global trading system.

A failure of the trade talks threatens to drive members to enforcement actions in lieu of bargaining just at the moment when the willingness to honor past agreements may be at a low ebb. The extent the United States forsakes constructive engagement of the WTO in favor of enforcement actions, it will be adding strain that the system is ill-equipped to bear.

The leading governments of the world seem to have recognized the twin perils of faltering negotiations and protectionist temptations. At the G-20 meeting in Washington in November, leaders warned against protectionism and called for progress in the trade talks. That progress never came.

My third point: U.S. moves toward protectionism even if they honor existing obligations can have a devastating impact.

You chided critics for being silent on buy American, so I will follow your lead. It was against this backdrop that the buy-American provision of the recent American Recovery and Reinvestment Act was so ill-received.

I understand there are any number of arguments that have been made in defense of this provision. It addresses spending not trade barriers. There are similar provisions in U.S. law. It was amended so as to honor U.S. obligations under international agreements. Yet the signal it sent to the world was that the United States was turning towards protectionism.

Even in the early days of a much-heralded new administration, this provision drew strong complaints from major trading allies such as Europe and Canada, as you mentioned, but also Japan and Australia. The intent of the provision -- to divert demand away from foreign producers and protect domestic producers from competition -- was an old and familiar one. The sentiment is by no means unique to the United States, as you know, but by succumbing to it, we seemed to be abdicating our long-held position of global leadership in international trade.

If I may also then take a moment, you -- I would applaud your remarks about the trade deficit and your focus on the trade deficit -- the multilateral trade deficit. And in particular, I would note the very interesting developments that we've had in recent months, which -- where we've seen major movements in trade balances or the current account balances around the world. Those movements are very, very difficult to explain if we have the hypothesis that it is trade policy that's the primary driver of trade balances. And they make much more sense under widely accepted economic approaches which link trade balances to macroeconomic factors such as nations' spending and investment. In that light, I would say that your suggestion that you mentioned about after the crisis turning towards fiscal responsibility and national savings is exactly on point and I would applaud you for it. And I think this is the appropriate means to address current account deficits which, as you rightly note, are unsustainable.

As my last point, please let me state there is conflict between playing a global leadership role on trade and helping average Americans. Public concerns about growing inequality are perfectly legitimate. Economic studies have shown, though, that the primary drivers of inequality and wage stagnation are differing returns to education and the changes wrought by new technology. We do the country a disservice if we ignore the economic evidence and falsely attribute all of these ills to international trade.

If the United States leads the way toward open markets in goods and services through its words and its actions, it will help restore confidence in the global economy and it will help create future prosperity at home.

Thank you again for the opportunity to speak. I'll look forward to answering questions.

REP. SHERMAN: Thank you, Mr. Levy.

In order to lead by example, when you have a $700 billion trade deficit, it's hard to know how many would follow you except the country of Lemming. With the exception of that one country, I don't know of any others that want to follow our trade results.

With that, let's go to C. Fred Bergsten.

MR. BERGSTEN: Let me start by congratulating you, Mr. Chairman. You were absolutely correct at the start. The administration obviously did lay out its foreign economic policy to preempt your hearing today and/or to give us something to talk about. I appreciate the opportunity to do that.

I want to make one conceptual point which I think is central to this whole debate and then three operational issues surrounding the upcoming G-20 summit in London in early April.

The conceptual point is to argue that this is a global economic crisis. Virtually every country is being affected by it, some to greater or lesser degrees, but everybody is hit. And that being the case, we really do have to conceptualize our response as a global economic strategy. So when we talk about getting others to join the fiscal stimulus program or avoiding restrictions on trade or adding trade finance or helping finance developing countries through the IMF, that's all part of the global macroeconomic strategic program. And only if we think of it in that context, I think, will we come to correct answers in terms of individual policy responses. It's not just the U.S. operating within our own national boundaries. We do have to see ourselves as part of a global strategy. I want to stress that at the outset because I think it's very important for all the specifics that we talk about.

Let me talk about three specifics. First, on fiscal stimulus, there has been a consensus that -- a consensus; it's not been agreed by the countries but it's been pushed by the IMF and others -- that all of the major countries should undertake fiscal stimulus programs equal to about 2 percent of their GDP for each of the next two years.

Again, Mr. Chairman, I'm with you; that's not enough. That goal was set several months ago. And as my colleague Dr. Johnson laid out, the global outlook is much worse than we thought at that time. If 2 percent stimulus was right three to six months ago, we clearly need more now.

My proposal is that that G-20 countries at London in two weeks commit to adopt fiscal stimulus programs equal to about 3 percent each of their GDPs for each of the next two years. And there obviously have to be national variants on that theme. Some maybe can't afford it because of their budget situations. But on the whole, that should be the strategy. That would require additional stimulus measures even here in the United States and China, which have so far taken the lead. It would require lots more in Europe and some of the other key emerging markets. But I think without that we're not going to get anything like the needed recovery and we may be in Dr. Johnson's L- shaped problem for a long time.

Second, on trade policy and the discussion of buy America and others that you have led -- and I won't get into its details, but I want to make one broad point. I think there's an important distinction between countries' legal obligations and proper policy in the face of a global recession or worse. Lori Wallach and you and others are correct; there is lots of scope for government procurement preferences within the current rules. But I think to increase our use of those buy-national provisions is a policy mistake because it can lead to emulation and retaliation by other countries.

I think the last thing we want to do with my concept of a global recovery strategy is to encourage others to raise barriers to trade, even though lots of other countries can also do it within their legal rights within the WTO. All of the big emerging markets can double their tariffs from where they are now within the WTO rules. And we don't want to encourage that; it would dampen our exports, hurt our recovery strategy.

On the trade deficit, I'm also with you, but I want to make an important point just to make sure you and your colleagues are aware of it. The U.S. trade deficit this year will be less than half what it was at its peak in 2006. A lot of that is the reduction in the world oil price cutting our oil import costs, but a lot of it is the strong improvement in U.S. competitive position. The exchange rate of the dollar came down 25 percent over the last six years. Our exports boomed over the year 2008, as Mr. Royce said. It was the main driver of our economic growth.

You're absolutely right. We don't want to let that deficit to go back up. But keep in mind it is now a lot lower than it was even two or three years ago. We certainly want to keep it there, but it's not the big bogey that it was in the recent past. In order to help keep it there, we do want to expand our export finance capability. We want to expand and strengthen the programs of the Export-Import Bank in order to support in any way we can our export opportunities.

Finally, on the IMF, I'm delighted that Secretary Geithner adopted my proposal in my testimony to you of seeking the expansion of $500 billion for IMF programs. I think they need to do that in his way through the new arrangements to borrow. They also need to create special drawing rights. They also need to increase their quotas.

The point I want to (fly ?) for you is -- and you're probably aware of this -- you will face legislation on that this year. The Treasury has now indicated that it will be submitting legislation to the Congress to authorize increased U.S. participation in these various IMF programs. One's obviously going to have to look at the details. You'll have to study that carefully.

But I think the broad strategic point is that these IMF programs to help deal with the one-half of the world economy, which is now emerging in developing countries, has to be viewed as part of the global recovery strategy. It's critically important for our own economy. It's critically important for this global recovery approach. The international institutions surely are not perfect -- I've criticized them lots myself -- but they do play an absolutely vital role. And I'll hope when you get to that hearing we can talk about that in more detail.

REP. SHERMAN: Thank you for your testimony.

Without objection, the full opening statements of all witnesses will be put into the record. And the full opening statements of members who submit them for the record will be included in the record of the hearing.

We'll now go on to our last but certainly not least witness, Peter Morici.

MR. MORICI: Thank you, Mr. Chairman, and the members of the committee for the opportunity to be with you today.

In my mind, the global economic crisis has two origins. One is in imbalances in production and consumption, which you've heard about.

REP. SHERMAN: You want to turn on your mike?

MR. MORICI: Oh, I thought --

REP. SHERMAN: See a green light?

MR. MORICI: All right, start again?

REP. SHERMAN: Yes.

MR. MORICI: Okay. Thank you for the opportunity to be with you today.

And in any case, in my view, the global economic crisis has two sets of origins. One is the imbalance in trade, or in production and consumption between China and other countries in Asia and Western nations and also the oil nations, and the banks of the -- which have to do with changes that took place in our banking system over the last several decades, beginning with the end of regulation Q and ending with the end of Glass-Steagall, which gave rise to lots of interesting opportunities for creative financial engineers.

In the United States the current trading situation gives rise to a very huge trade deficit when our economy is operating at anywhere near full employment. I don't view the recent reduction in our trade deficit as particularly comforting. That gives rise to huge capital flows into the United States, which somehow or other have to be accommodated, and they have been accommodated by frankly less than prudent borrowing and lending decisions. They distort capital markets, and they gave rise to a consumption-led expansion that caused us to increase our debt to the rest of the world rather dramatically.

There really is no solution to this mess short of fixing those structural problems. A stimulus package is helpful; it's nice. But we're going to need ever larger stimulus packages to keep our economy going, because if you stimulate the economy with 2 or 3 or 11 percent of GDP, or whatever Fred wants -- I mean, you can mortgage the whole universe if you like -- once you stop spending the money, you'll come back down, but while you're spending it your trade deficit will go all the way up again.

REP. SHERMAN: Would you repeat that last phrase?

MR. MORICI: Your trade deficit will go all the way up again.

MR. BERGSTEN: Not (if ?) other new spending.

MR. MORICI: I don't agree with you, Fred. You had your turn; let me have mine.

REP. SHERMAN: (Laughs.)

MR. MORICI: Now, in order to fix the problem -- in order to fix the problem we're going to have to fix our domestic energy policy and our trade policy. Our domestic oil imports net and our trade with China are 90 to 95 percent of the trade deficit, so you don't have to look far for the problem.

We can and should dramatically reduce our imports of oil by dramatically changing the cars that we drive. We have that within our grasp and have chosen not to do it, and we should.

With regard to trade, we already are in a trade war, gentlemen and ladies. China's manipulation of its currency, its export subsidies -- do you realize its frozen its currency more or less since last July? In response to the recession, it's increasing its export subsidies. All of us that have studied economics and those of us that have only been spending time with economists over recent years would know that an export subsidy is as protectionist as a tariff.

You're in the middle of a trade war, and China is undertaking Smoot-Hawley already. And what the advocates of no protectionism please, no trade policy please are telling you is unilateral disarmament so the Chinese can export their recession to the rest of the world. If you stimulate the global economy, China's exports will grow, unless something fundamental is happening inside of China right now that we are not aware of.

To resolve the problem with China I simply think we should recognize we're not dealing with a market economy as we know it. And we should basically tell the Chinese you fix your trade surplus so we can fix our trade deficit. If you don't fix it, we will fix it for you.

The current imbalance of trade with China and on oil has created such destabilization in global financial markets as so to eradicate the benefits of free trade. If we're going to go to 10, 11, 12 percent unemployment, it's hard to imagine that free trade is doing us much good.

However, I don't believe we should repeal a hundred years of (neoclassical ?) economics. If we can get the Chinese trading reasonably and allow them -- have them adjust their currency so they're not engaged in continuous one-way intervention in times of full employment, then I believe that a program of open trade and competition best serves us and it would give rise to the most efficient allocation of resources.

With regard to the banks, I'll just leave it to you to look at that in my written submission. Essentially, we do need some major restructuring. We don't need a return to the days of Glass-Steagall, but we need something, and I think I've outlined it adequately there.

And I'll quit at that point, with 13 seconds remaining.

REP. SHERMAN: Amazing. Let's see if I can be equally brief in my questions.

First is kind of a question for the whole panel. I'd like you to just -- it's a simple yes/no question. I'll ask you to raise your hands. China has an economic stimulus package of close to $600 billion in progress now. Raise your hands if you think that U.S. workers will get 1 percent of that money.

MR. BERGSTEN: One percent?

REP. SHERMAN: One percent.

MR. BERGSTEN: Six billion?

REP. SHERMAN: Six billion.

MR. BERGSTEN: Over two years?

REP. SHERMAN: Yep. Now, I'm not talking about U.S. firms -- and Dr. Levy as well. So you think that -- and I'm not talking about the secondary economic impact. I'm saying the government buys -- apples and oranges.

You could have a 100 percent buy-America stimulus and say not one penny could be spent on anything built abroad, no matter what it is, and the foreign countries would still benefit because my sister would get a job and she'd buy some -- she'd buy a flat-screen TV. But we're going to spend ($)800 billion and some of it will go abroad, some of it stays here.

The Chinese government's going to spend $600 billion. Are they -- in terms of contracts to be performed by American workers, of that 600 (billion dollars), not multiplier effect, anybody think we're going to get 1 percent?

MR. BERGSTEN: I honestly don't know, because -- I honestly don't know, and no one can, because they haven't announced how they're going to spend the money. But I really think you --

REP. SHERMAN: Come on. China isn't going to give us a -- if they give us a penny, it'll be a mistake. Every billion people are entitled to one or two mistakes. But clearly, the Chinese stimulus package is designed to go exclusively to Chinese workers and not to go to American workers.

MR. BERGSTEN: No, but I think the important point, Mr. Chairman, with all due respect, is your premise. They're trying to stimulate their overall growth rate by 2 to 4 percentage points per year. (Inaudible) -- 5 or 6 (percent); they want to get it at least back to 8; they might do better.

Out of that increased Chinese growth, we will clearly get much more than $6 billion of exports.

REP. SHERMAN: Doctor, I'm trying to compare apples to apples. You didn't have the European Union ambassador praising the American stimulus package on the theory that it would increase our growth rate and thereby benefit the entire world. Instead, we had Dr. Levy particularly attacking the buy-America provisions.

My question is to illustrate that if you compare apples to apples, they've got a buy China 100 percent stimulus package; we have some buy-America provisions.

Let me go to Dr. Morici.

MR. MORICI: (Off mike) -- encourage you not to take Canadian ambassadors too seriously.

Having been director of Canadian studies at the University of Maine in my prior life and before that director of the Canadian- American Committee, and having written the Council on Foreign Relations book on the Canada-U.S. Free Trade Agreement, I have some credentials.

And I would say to you that the Canadians read the same book of economics that the French do, and that is that the Americans cause all of the economic problems. And forgive me for saying this to you, but when the Republicans are in, then they cause nothing but problems.

So right now, you've only caused 80 percent of the problems of the world, so I really wouldn't take that very -- it's quite disingenuous for them to say things like that, and I think you've raised a valid point.

I wouldn't have raised the question as 1 percent; we probably -- we might get 1 percent, but who cares? The point of the matter is we're not going to get very much out of their stimulus package and it's absolutely absurd in a world where the Chinese are so manipulating trade and causing so many disruptions in the world, financially, to not pursue a policy that requires them to give us some measure of reciprocity.

REP. SHERMAN: I'm going to go on to one more question -- that is, Warren Buffett has suggested a cap and trade system. That is to say if you want to import a dollar's worth of goods you need a voucher from somebody who has exported a dollar's worth of goods.

That would be a results-oriented free trade system. Instead, we have a process-oriented system where we negotiate with other countries as to what they put in their written regulations on the basis that anybody in China feels that the sole influence on decision makers is what's in the written regulations. And we spend endless discussions about what is or is not in the written regulations and was of a country that is not a rule of law society.

Dr. Morici, what do you think of the idea -- and I'm going to apply it just to China -- that we can reach, if we choose to, and we'd want to phase this in -- a balanced trade relationship, a non- malignant trade relationship with China, with a cap and trade system?

MR. MORICI: I don't believe that we can. I think it's ludicrous for the United States either to have cap and trade or a CO2 tax in the absence of a --

REP. SHERMAN: No, I'm talking cap and trade for exports; this has nothing to do with carbon.

MR. MORICI: I think it's -- wait, I'm sorry, do I fully -- when you say cap and trade --

REP. SHERMAN: What I mean cap and trade is a voucher system where if you want to import $1 million worth of tennis shoes from China, you have to go to somebody who exported $1 million worth of goods to China, get their vouchers, and then and only then you're allowed to bring in the goods.

MR. MORICI: I would prefer an alternative approach to China which is equally radical, and that is that the Chinese don't want to find a way to balance the trade on their own because of this highly managed economy, then we put a tax on their exports equal to the value of their currency market and divide it by the value of their exports, and we'll see how that works out for a while. And if they want to reduce their intervention, then we'll reduce the tax.

REP. SHERMAN: I think your approach is slightly less radical, but perhaps better than Warren Buffett's. It's interesting to see at least two radical ideas out there.

MR. MORICI: Well, the thing about it is if you think about it, if we were to do that -- you know, you have stimulus and you get the economy going, you know, you spend 11 percent of GDP or whatever it takes to get yourself there and your deficit goes up and the Chinese are intervening, then by us taxing that intervention, the benefit of higher prices on Chinese exports to the United States or our imports would go to the U.S. Treasury, whereas if they stopped their intervention, then the benefits of a higher price for Chinese exports would go to their businesses, so they would have a strong incentive to capture that rent.

So my feeling is while that might violate half a dozen laws -- I don't know that it would, but people argue that it does and have called me a protectionist for recommending that -- I think it might help China reconsider its regime and move in a direction that was more oriented towards free trade.

REP. SHERMAN: I've gone a little bit over, but I do want to hear from Ms. Wallach.

MS. WALLACH: I think that one of the benefits of that Warren Buffett proposal is -- which would create a secondary market for those permits -- is it lets the market decide, versus picking out winners and losers, what's worth importing and what value in that secondary market is worth obtaining that certificate.

And the way he does it is to phase it in over five to 10 years so that it's not an abrupt disaster in the supply chain but that rather it forces a balance and also it creates incentives for exporting while simultaneously creating a balance.

REP. SHERMAN: I think my time is expired. We'll go on to our ranking member, Mr. Royce. It is my intention to do a second round, and I know that a number of the other witnesses are anxious to make their comments.

REP. ROYCE: Thank you, Mr. Chairman.

Ms. Wallach, I'd ask you -- you strongly reject the CAFTA model, and from what I've seen, some might say it's shown itself to be a pretty good deal for the American worker in the sense that since its implementation in 2005 I think then the U.S. trade deficit for the region was over 1.2 -- ($)1.2 billion.

Since its implementation, the U.S. has swung to a surplus and it's grown every year, and I'll just add that an analysis by the USITC says passing the three pending FTAs would spur at least ($)12 billion in new exports.

Let me ask you another question here in concert with that. You severely criticized the World Bank and the IMF, which have distributed trillions of dollars made over the years. If these institutions can't be reformed, as you recommended, should they be closed? Because if the answer is yes to that, you might have an ally here in terms of what I've seen in a lot of that spending.

I assume you oppose the plan announced yesterday by the Obama administration to funnel some half trillion dollars through the IMF; the U.S. contribution of that would be another ($)100 billion. Let me ask you about that proposal.

MS. WALLACH: I'll try to answer all three questions.

On the CAFTA issue, the matter that I find most concerning is when you look across all of our FTAs and look at export growth -- the balance I'll get to, but the export growth issue, if you look across all of our FTAs, which are premised largely on the same model as NAFTA and CAFTA -- our export growth with our FTA partners is 6 percent, but our export growth with our non-FTA trade partners is 14.4 percent. There's something deeply wrong --

REP. ROYCE: That's China, I guess, principally.

MS. WALLACH: Not exclusively.

REP. ROYCE: Non-FTA partner.

MS. WALLACH: It's everyone else. Everyone who --

REP. ROYCE: Yeah, but that's the weighted balance.

MS. WALLACH: It's all 153 WTO partners, minus the 14 FTA countries.

REP. ROYCE: Right. The lion's share of it, though, in terms of the weight of it --

MS. WALLACH: No, export-wise, actually, we have larger exports to, obviously, other parts of the world, so if you do a weighted share it's our exports to countries such as the European Union countries, et cetera. Our export growth is doing better to countries we haven't made special FTA arrangements with than with the countries with whom we have, which is a serious incitement of the underlying model.

Now, the fact that we've gone from a $1.2 billion deficit with all the CAFTA countries to a $3 billion surplus is more or less a rounding error in the trade deficit that we have. Though it's a trend in the right direction, our export growth to those countries still lags behind the countries with whom we don't have FTAs.

So it'll be interesting to see over time what happens with the CAFTA balances, but the trend of export growth -- and then when you look at the larger FTAs, such as NAFTA, or you look at our trade balance even with Israel, we have enormous deficits with all of our large FTA trade partners, so that overall, the entire body of the 14 FTAs, we have about a $60 billion net with the whole package of them, not exactly -- (inaudible) -- right direction.

REP. ROYCE: And let's go to the issue of the World Bank and IMF, your thoughts on that that I asked.

MS. WALLACH: My expertise is in the structures and operations of the WTO. From the scholars who I've read regarding the IMF and World Bank reforms, my support is with various scholars who have noted that absent major reforms those organizations should be shut down. But I think where we might differ is that other institutions who play similar functions in global governance are needed, and the rules of the current regime of IMF and World Bank are so off that that's the issue, not the existence of global economic governance.

REP. ROYCE: Let me ask you: You reject trade agreements with allied countries -- Colombia, South Korea. How will this impact other areas in which we might want international cooperation, should we reject?

MS. WALLACH: Well, I think there are a lot of different ways to cooperate with countries. For instance, I'm a supporter of the Andean Trade Preference Drug Eradication Act. So to the extent we want to actually have relationships with some of the countries that we're having troubled relationships with in the region, including Bolivia and Ecuador, I think that that's an interesting piece of leverage and partnership to offer them.

The free trade agreements set up a set of foreign investor rights that allows right of new privileges and rights by companies operating in those countries so that the model of those agreements is extremely problematic and needs to be altered. It's the same model question I was discussing vis-a-vis the WTO.

REP. ROYCE: Colombians, though, want the agreement.

And let me ask you, can trade have national security implications? You know, for example further opening U.S. textile markets with respect to Pakistan to fight an economic collapse in that country, which is rather critical. I mean, there are ties between trade liberalization where it occurs and the economic growth that is a consequence of that in stabilizing some of these countries -- Colombia comes to mind.

MS. WALLACH: I think trade agreements can have economic security implications and so I was extremely worried by the report by the department of agriculture of Colombia that described the Colombia free trade agreement's agriculture provisions as destabilizing the rural society by displacing so many farmers and thus resulting in three options and only three options: the extreme growth of paramilitaries, more undocumented immigration to the U.S. -- you'll note after NAFTA, immigration from Mexico has increased 60 percent because of this displacement -- and three, more cultivation of illegal crops, i.e., narcotics.

So yes, having a free trade agreement like the one posed with Colombia can be extremely hazardous to our national security.

REP. ROYCE: And trade liberalization with Pakistan, which is rather critical in terms of some of our concerns on the committee right now -- allowing textile imports and creating more employment, let's say, as a result of the synergy between trade between the U.S. and Pakistan?

MS. WALLACH: I think the model there -- for instance, the Cambodia-U.S. textile agreement is a very promising one. That was an agreement that set out various democratic governance requirements, helped set up labor unions, had a role for the International Labor Organization to make sure that the benefits actually went broadly to the people -- which is the goal in this case -- to build people who have some wealth and security in a democratic market system.

And so that kind of a model for other countries, including Pakistan, I think is a promising one.

REP. ROYCE: Let me ask Dr. Morici a question, because you testified that 96 percent of the trade deficit is oil imports and imbalanced trade with China, which you find, you know, very problematic, as we do. Does this observation suggest that you find our trading relationship with other countries than China, and oil producers, generally satisfactory?

MR. MORICI: That's the sort of thing you view on a continuum, you know, from one to --

REP. ROYCE: Well, yeah, but you said 96 percent, so that --

MR. MORICI: No, I understand. But whether our trading relationship with Canada is satisfactory or with Europe is satisfactory or with Uruguay or with Panama or whatever, just because we don't have a trade surplus or trade -- we have trade surpluses and deficits around the world. That doesn't mean our trading relationships are satisfactory or unsatisfactory.

Our trade problem with oil is largely something we have done to ourself. We have pursued a flawed energy policy. With regard to China, that is something China has done to us. We've opened our markets to them, they have not done the same in reverse, and we have this problem on our hands.

With regard to other countries in the world, I think that by and large we can work those problems through through the normal processes that we have -- not all, but many. I don't know that we can work them through, for example, with India through normal processes, but I think we can with the Canadians, as much as they blame even their cold weather on us. You know, I think we can always work with them.

REP. SHERMAN: I think the time of the gentleman is expired.

We'll move on to our vice chairman, Mr. Scott.

REP. SCOTT: Thank you, Mr. Chairman.

I'd like for us to focus for a moment, if we may, on this issue of buy American. And it's especially timely, because next month the president will attend the G-20 summit. It will be his first global opportunity on the world stage to set the vision for the United States' position as well, and there's been some thought that the buy America and buy-American provisions fall out of the normal scope of our international trade and there's been some thoughts that it could trigger a trade war, and I'd like to get each of your thoughts on that right quick, please.

Yes, sir, Mr. Bergsten.

MR. BERGSTEN: There's a distinction between our legal obligations and what I would think is correct policy. In terms of legal obligations there's a government procurement agreement as part of the World Trade Organization. That is not adhered to by all members of the World Trade Organization; only about 40 member countries have participated.

So we, as a signatory, and in fact the proponent of it, have obligations in our government procurement policy only toward other countries that are part of that agreement. China is not part of that agreement. India is not. We have no legal obligation under our government procurement rules toward China, India or other countries that are not members of that agreement. Repeat: no obligations.

Likewise, back to what the chairman said, they have no legal obligations to us. China does not have to give us a penny of procurement under its government procurement rules, because it's not a signatory to that agreement.

The only add-on to what I just said is where we have particular trade agreements with countries, like NAFTA, where then our obligations, and theirs to us, go beyond the general procurement agreements in the WTO.

So that's the legality of it. We can do anything we want to China and India; we're constrained to some extent with Canada, Mexico and other trade agreement partners. But even where there are those agreements, there are lots of exceptions.

Somebody mentioned earlier that China's exempted all sorts of things, Europe's exempted, the U.S. is exempted -- lots of sectors of our own government, including lots of state and local government spending, that are not subject to those legal requirements.

So there are lots of areas where we can prefer American producers. That's the legality of it. If you want to do that, you can do it. My argument, to just add one sentence, is that for us to increase our buy-national preferences at this point in time would be a policy mistake because it would for sure encourage others to do the same thing, not only, incidentally, under their government procurement apples to apples but in their trade policies more broadly where there's lots of pressure to move in that direction, and I think it would be a mistake to encourage global movement in that direction at this time. But under the law of the land and the law of the universe, there's lots you can do.

REP. SCOTT: Okay. Let me just follow up that with do you feel that Congress should require that no additional procurement commitments be offered in future trade negotiations?

MR. BERGSTEN: No. I think our interest is in maximizing the commitments we can get from other countries in those kinds of negotiations. We should do it on a fully reciprocal basis. We should offer to open up additional parts of U.S. procurement only where we can get them to open up under theirs.

But if we could get -- back to what the chairman said -- if we could get China to commit to open to us under its $600 billion procurement program, I assure you we would gain lots more than we would lose to them by opening up to them.

REP. SCOTT: And the -- yes, Mr. Morici?

MR. MORICI: (Off mike.)

REP. SCOTT: You please go.

MR. MORICI: All right. First of all, the procurement code lists the entities that you will participate in national treatment, not those -- am I on?

The procurement code lists those entities for which there will be national treatment, not the exceptions, to be correct. The second is, given the current tenor of international trade, I don't see a particular problem with the buy-America provisions that were included in the stimulus package.

If we expect to ever obtain reciprocity from the bad actors in the system, unilateral free trade, it has been shown by practical experience, doesn't work. So my feeling is that I guess while I support free trade as much as Fred does, in the present context of policy, we have to deal with the world as we find it, not as we think it should be on our blackboards.

MR. BERGSTEN: Just to be clear -- a factual point. We now give buy-American preferences under all of our government procurement programs -- nothing new. And as Peter said, we only commit under that WTO agreement to those components of government procurement that we explicitly specify.

We've exempted mass transit and a lot of other things, so nothing new about this. The policy question is whether you increase protection in the teeth of a global recession headed toward depression, which can encourage others to go down the route and spiral the whole thing downward.

MR. MORICI: I take exception. It's not increasing protection, it's whether you liberalize further without an adequate response from your trading partners. I am perfectly happy to increase our commitments under the procurement code as soon as China signs up and actually lives with those commitments. But I'm not willing to give them access to our procurement as long as they behave as they do.

Fred, you're not talking about increasing protection, you're talking about liberalizing further. We are already in a trade war. Do you deny that China's mercantilist policies are a source of disruption in the global trading system and one of the reasons we're seeing the reactions that we're having?

(Cross talk.)

REP. SHERMAN: Usually we -- the question -- you know, you got to work hard to get elected to Congress to be allowed to ask questions to panelists here.

MR. MORICI: Could I say one thing?

REP. SHERMAN: But the --

MS. WALLACH: May --

REP. SHERMAN: I will let the gentleman from Georgia allocate as he will the next 40 seconds, and then we'll move on to the next --

REP. SCOTT: All right I'll give 20 to you and 20 to you. (Laughter.)

MR. BERGSTEN: I was one of the first people in 2003 to call attention to China's currency manipulation, substantial undervaluation of its currency and need to take very strong reactions to that, and I continue to take that view and I'm delighted that Secretary Geithner did so in his confirmation hearing.

REP. SCOTT: All right.

Ms. Wallach.

MS. WALLACH: Congressman, in regard to your question about the procurements provision being in future agreements and also relating back to what you said about isolationism and the U.S. relationship of countries, most of the world's governments do not consider procurement to be an appropriate topic in a trade agreement.

So originally the Doha round had procurements in it and the developing countries, but also some of the developed countries, walked away from that provision, and that was one of the main causes of the breakup of the entire round in Cancun. It got chucked off the wagon it is so objectionable.

Also, procurement being in the free trade agreement is the reason South Africa and Malaysia explicitly walked away from our free trade negotiations. We said basically it's either the NAFTA/CAFTA model or nothing, and they said if it has the procurement rules, forget it, because those governments see procurements as a matter of government appropriations policy or government stimulus policy, totally separate from trade.

REP. SCOTT: Thank you very much.

REP. SHERMAN: Thank you.

We'll now move on to the gentleman from Virginia.

And I promise you, Dr. Johnson, if my colleagues don't ask you questions, we haven't forgotten you're here. If they don't, I will.

REP. GERALD E. CONNOLLY (D-VA): Well, you took the words right out of my mouth, Mr. Chairman.

I've got a limited amount of time so I'm going to ask a question and ask you to try each to be concise, and I'm putting two questions to the entire panel.

The first one is, as Mr. Scott indicated, this is, in a sense, President Obama's first stepping out onto the international stage in a major way in attending the G-20 meeting. What is a success for him? What do we come out of G-20 with?

Dr. Johnson?

MR. JOHNSON: I think he needs and I think he's aiming to re- establish American leadership in terms of fighting the recession.

Immediate policy responses -- and I think Secretary Geithner wants to pursue a fiscal stimulus -- I would suggest that that be also framed in terms of the Europeans putting together a stabilization fund for their weaker members. That's really very important. And as a backup to that, I think Mr. Geithner is outlining $500 billion to the IMF.

That's a huge amount of money if you think the IMF is only going to lend to emerging markets. If you think the IMF is going to have to step in to weaker European countries because the Europeans are going to drop the ball, then ($)500 billion makes a lot of sense.

So I think both of these measures, particularly the ($)500 billion, is signaling the administration is taking this very seriously and they're going to I think shake up the Europeans and tell them that they have to really act to deal with their own problems, and if they don't then it will fall with the IMF, and that's not a good outcome for anyone. I don't advise any country ever to go to the IMF if they have an option.

REP. CONNOLLY: Ms. Wallach, what's a success for the United States coming out of the G-20 meeting?

MS. WALLACH: To have a commitment amongst the countries to review and repair the existing WTO and other international economic governance rules so that we, for instance, have the policy space to be able to re-regulate financial services, that the WTO is not promoting further financial service deregulation, given there are 105 countries now signed up to an agreement that requires that, and then finally to figure out what structural changes are needed in the institutions such as the IMF and the World Bank to allow for those policy flexibilities so that we're able to re-establish domestically but also internationally global governance rules that actually promote productive investment and stability as compared to promote this casino economy we're living with.

REP. CONNOLLY: Dr. Levy.

MR. LEVY: Congressman, I think a success would be for the U.S. to persuade the rest of the world that we're committed to taking our traditional leadership role, that we're committed to fixing our financial sector and working with others to do the same, and to preserving open markets.

If I may beg your indulgence for one point, and this is on the repeated attacks on the financial services agreement, let me just note that the WTO financial services agreement has an unusually strong carve-out for prudential regulation. This can be done for all manner of excuses, including "to ensure the integrity and stability of the financial system, regardless of any other provisions of the GATS." That's the General Agreement on Trade and Services, and I'm citing paragraph two there.

So I know time is short and I won't beg further, but I wanted to put that on the record.

REP. CONNOLLY: Thank you.

Dr. Bergsten.

MR. BERGSTEN: (Off mike) -- your previous incarnations as well as your --

REP. CONNOLLY: And Fred, it's great to see you again, because if you remember, 30 years ago I was on the other side of the Capitol, and it was great to see you again here today.

MR. BERGSTEN: Absolutely.

I think the big win for President Obama will be if he can get the rest of the G-20 to get with his program, which is stimulating an economic recovery, creating jobs, getting that done in a way that will inspire confidence in markets and around the world rather than undermine it.

It's unfortunate that central banks are independent and are not participating in this meeting, so you can't really do much in terms of monetary policy or increasing their support for financial restructuring in this context.

That being the case, fiscal stimulus is it. I suggested at my hearing upping the ante, seeking countries to commit to expand by 3 percent of their respective GDPs each year. That would require additional stimulus here. I think we're going to need it. I think if we can get the rest of the world to join it, we could get a compelling and confidence-inspiring global recovery strategy, without which this situation may continue to spiral downward.

REP. CONNOLLY: Dr. Morici.

MR. MORICI: Well, I'm hoping that we get something like that.

REP. CONNOLLY: Can you press your button?

MR. MORICI: I did -- (off mike).

I'm hoping that we get something on stimulus. I think Fred is correct that we need more of that. We need the Europeans to pull along, and I think we can get that.

However, that's really a big Band-Aid. I would like to see recognition of the fact that the imbalances in production and consumption between the Asian nations and the oil nations versus the West are a source of instability and must be corrected if we're going to permanently pull out, and I would like to see more reasonable expectations about the notion of global financial regulation.

I think those solutions still lie predominantly in domestic solutions with cooperation.

The Europeans continue to obfuscate issues in that matter. We're not going to regulate our banks through some sort of international entity.

REP. CONNOLLY: Thank you.

Mr. Chairman, my time is up, but I just want to note that what's struck me about the answers here is that there's a real opportunity for the United States at the G-20 to re-instill some confidence in the global system, and I hope we'll take advantage of it.

Thank you, Mr. Chairman.

REP. SHERMAN: And I thank you. Thank you for your excellent questions and for sticking to the time limit, as a few of us have not. (Laughter.)

And I now recognize the gentlewoman from California.

REP. WATSON: Thank you so much, Mr. Chairman.

And this is a question for all of you. While the First World countries have been hit hard by the crisis, poor countries and poor people are suffering as much or more, and according to the IMF's most recent forecast, low income country growth in 2009 is projected at just over 4 percent -- more than 2 percentage points lower than expected a year ago with high risk that the situation could get worse. In per-capita terms this means that many of the world's poorest countries will at best see incomes stagnate this year and possibly even contracts.

And this is of critical importance to us here in America. The national intelligence director, Admiral Blair, has told Congress that the primary near-term security concern of the United States is the global economic crisis and its geopolitical implications, yet we are stuck confronting this 21st-century poverty challenge with a foreign assistance apparatus that was designed for the Cold War.

So to all of you, what do you think are some of the key challenges to the United States government being able to address how this crisis impacts the poorest countries and people around the world?

And let's just start over with Dr. Johnson.

MR. JOHNSON: Thank you, Ms. Watson.

I think you're putting your finger on an incredibly important and difficult issue. I absolutely agree that this is going to impact the poorest people in a terrible way, and I think you're right that our mechanisms for dealing with this are outmoded and probably far too small in scale.

First and foremost, I think we have to get the global economy back on some reasonable trajectory and so that's why that should be the emphasis -- the right emphasis -- of the G-20 meeting, and I think and I believe that President Obama and Secretary Geithner are going to focus on that. And that has big effects on everyone else.

In terms of additional assistance for the poorest people, as you know, that's a complicated question. It's not an easy thing to provide additional financing in a way that's effective and that really reaches poor people. Too much of it can get siphoned off one way or another.

But I think that's something that's worth a considerable amount of attention and hopefully further resources from rich countries to the extent that it's possible in this difficult environment, because it will come back to haunt us one way or another if we neglect these people.

REP. WATSON: Ms. Wallach?

MS. WALLACH: Thank you for your question.

The crisis is exacerbating what were already very troubling trends in that the countries in the developing world who most closely followed the package of policies the IMF, World Bank and World Trade Organization have actually seen their growth rates declining, and the countries who haven't, like, for instance, China and Vietnam, have seen their growth rates expand much more quickly.

And so in a variety of regions you've seen since the adoption of the current global economic governance regime dropped in per capita income growth in sub-Saharan Africa -- also with other issues such as the AIDS epidemic -- you've actually seen literally net declines ,versus in Latin America slowdowns in growth rates relative to the period before these policies were adopted.

And so now with the crisis exacerbating that, the policy space having been removed for those countries to respond, part of the overall remedy is to fix the underlying rules. The majority of the developing countries were against the Doha round agenda. It was cynically dubbed the development agenda by then-USTR Zoellick, but actually the developing countries had a different agenda.

It was called the implementation agenda and it was a review and repair agenda for the existing WTO rules, and that is what I'm arguing is also part of the response that's needed and appropriate in this crisis. And I apologize for having no expertise in foreign aid issues.

REP. WATSON: Dr. Levy.

MR. LEVY: Thank you, Congresswoman.

I would agree with Dr. Johnson that first and foremost it would be very difficult for these countries to prosper in a world economy that's having the kind of difficulties that it is, so there's those measures.

I think we can do far better than we do with foreign assistance. This is an issue I spent a year and a half working on when I was at the State Department. I think it's important to work through multilateral organizations despite some of their failings, but I think that we can also be much more focused and effective in our foreign assistance policy by trying to set goals and be very clear in what we're doing and try to get better management and implementation from the executive branch.

MR. BERGSTEN: Let me give you a slightly dissonant answer. You mentioned the developing countries are looking at 4 percent growth this year. In today's global economy, 4 percent growth looks very good. There is no industrial country -- repeat, no industrial country -- that is expecting positive growth of any number this year.

We've done an analysis at my institute that looks at each of the G-20 countries to see what is their relative decline, and it may surprise you the smallest relative declines by far are the developing countries in the G-20 -- Brazil, China, India.

They've all suffered substantial reductions in growth in absolute terms, but relative to where they started, not so bad. And that's important for your question, because remember, the largest cohorts of poor people in the world are still in China, India, Brazil, Mexico -- big developing countries that we think of as advancing -- and indeed they are; they're in the G-20 -- but they still house by far the biggest cohorts of poor people, and since they're doing less bad, their situation, relatively speaking, is not so dire.

Having said that, I fully agree with my colleague -- those individuals within those countries are going to be hurt badly by the world downturn. The answer is to get global economic growth back up, keep global trade open as a couple of your colleagues on the panel have said, because it's still true, no country has achieved sustained economic development without integrating into the world economy.

REP. WATSON: Thank you.

MR. MORICI: I would like to build on and align myself with what Fred has just said. Most of the poor people are in countries that are doing relatively well and they don't require any particular special assistance from us. That said, I think it's important for us to remember that many of the poorest people are in very small countries who are really swept up by the events of the heavyweights.

And I think that we need to be cautious about how we deal with those very small countries who are caught in the great sea of combat between the United States and China and the intellectual combat between the United States and the EU and all the rest of that stuff.

So I do believe that if we could find some way to assist them, that would be appropriate, but I'm skeptical how you get that done without just getting the engine going again.

REP. WATSON: Thank you.

REP. SHERMAN: Thank you. The time of the gentlelady from California has expired.

We'll now recognize the gentlelady from Texas.

REP. SHEILA JACKSON-LEE (D-TX): Mr. Chairman, thank you very much for this hearing and particularly I'm delighted to be on a committee that gets it -- Terrorism, Nonproliferation and Trade. And I think there was some mind-set that understood that these are all interrelated.

It seems that I am following this track today. I started out with a border security hearing on the crisis of drug cartels at the Southern border and the enormity and the fierceness of what I think really has slipped the minds of members of Congress. And obviously we're just beginning in the new leadership, but it's a wake-up call.

And the reason why I mention that, of course, is we're in the question of trade, but also the falling economy lends itself to the crisis in the social fabric. And so my questions will be along those lines, and I want to go to Dr. Bergsten and Dr. Morici.

Those huge numbers of impoverished -- and I've just come back from Pakistan and India -- are there. I think the question we have to ask, are they doing anything about it, even though they have certainly much sizeable poverty in India, even though they may have the resources.

So I want us to continue to believe that it is important to fight against world poverty and to -- and even in this economic crisis be part of the warriors to extinguish some of the huge depths of poverty that really fuel terrorism and dissent. So that should not be off the table for the G-20.

But what I'd like to ask both is as we move to the G-20 I think Dr. Morici has mentioned -- and forgive me for not hearing all of your testimony -- the awkwardness of our relationship with China. I'd like you to comment on that further.

But Dr. Bergsten, I'd like you to tell us how pushy our president should be at the G-20. My understanding is that we're making our own sacrifices and our heads are getting battered on the stimulus -- all the talk shows that build up their credits on bashing Washington is all about how much money we're wasting. Maybe the G-20 is listening to Rush Limbaugh and has indicated that they don't want to do any stimulus. So where does that put us?

So if I could ask the question to Dr. Bergsten.

And I'm glad Ms. Wallach is here. I just want her to be satisfied that what her organization had spoken about maybe years ago, dereg, is now falling on top of our heads and we're smothered up, and she might want to just comment on how we get out of that, if you will, debris of dereg.

So let me go to Dr. Bergsten.

MR. BERGSTEN: I think President Obama should be very aggressive at the London summit. I think he comes with a strong hand because you in the Congress have voted a major stimulus program. I hope nobody's listening to Rush Limbaugh's appraisal of it.

There are sure flaws -- you all know it -- but it has put the U.S. out front in leading the concerted policy effort to get the world economy back on track. We may need another stimulus; I think we probably will have to do more, but right now, we're out front.

Now it may shock you when I tell you the other country that I think is out front that we should join arms with in leading that at London, and that's China, because China has also taken a huge stimulus program.

The chairman and I had a little debate about how you count it in terms of U.S. effects; I think it's going to help the U.S. as well as help the world economy. I think the U.S. and China, on that front -- the fiscal stimulus, the macroeconomic impulse -- lead the league, and President Obama should certainly be aggressive in pushing particularly the Europeans but also some of the other emerging markets who have not yet gotten with the program who are not the Germans, the French, for all their talk have done very little.

They in fact have tried to deflect the agenda. They say let's worry about financial regulation. Very important, but at a time we were trying to get the banks to lend more money and start unfreezing the financial system it's unhelpful, to put it mildly, to talk about increased financial regulation. It confuses the public, it confuses the banks. It's a bad idea.

The focus has got to be on avoiding a global depression, and I think on that the president needs to be quite aggressive and is in a strong position to assert leadership to do so.

REP. JACKSON-LEE: Dr. Morici, Dr. Bergsten has just put my hair on fire. He's got some good points, but he's talked about China.

REP. SHERMAN: If he puts your hair on fire, you may end up looking like me.

REP. JACKSON-LEE: (Laughs.) Mr. Chairman, I'm going to ask for your indulgence -- maybe I'll ask unanimous consent for a minute so that Ms. Wallach can finish her answer; Dr. Morici on the response on the China issue.

But I would also say that if our president is not aggressive, it impacts trade. Americans are not interested in sort of a trading situation if they can't get their pocketbooks back together.

Dr. Morici, what about China and what about some of the ills or problems that they have?

MR. MORICI: Well, I think there's a tendency with regard to China for policymakers to view it as a tactical problem. You know, if we get them to reform their financial markets, then everything will be fine.

In reality, this is an issue of systemic competition. We offer the world the notion that democracy and markets best serve the progress of mankind and that best can help people fulfill their dreams.

The Chinese offer the world a very different model and are pursuing tactics which abuse the international trading system and there are opportunities within it to make us look foolish. It's very difficult for us to tell the world they should adopt our prescriptions; rather, they offer people order and stability with an autocratic government.

So I think that we need to start to see China for what it is and to start to craft our trade policy in an appropriate way rather than one that views them with as sympathetic an eye as we have.

That doesn't mean at the G-20 that we can't pursue what Fred just described. We want to get the Europeans to stimulate their economies. But I think at some point we're going to have to reckon with what China really means for the West, and I don't believe that this administration or the last administration has been ready for that question except when they're trying to get confirmed in the Senate or running for president in Ohio. Once those goals are accomplished, they seem to fall back.

Vice President Biden quickly said right after Mr. Geithner was confirmed we need to determine whether China's manipulating its currency. I don't want to just say in this chamber what I thought of that statement. (Laughter.) But I will say it on the Lou Dobbs show tonight if I'm given the opportunity, if Lou gives it to me.

REP. JACKSON-LEE: But you will say that we're all interested in working through your issues and that we are too as concerned.

REP. SHERMAN: The time of the gentlelady from Texas has expired.

REP. JACKSON-LEE: Ms. Wallach, does she have a simple answer?

REP. SHERMAN: If she has a simple answer, out of respect for her we will give her some time.

REP. JACKSON-LEE: And Mr. Chairman, I thank you and I will yield back as Ms. Wallach answers the question.

Thank you, witnesses, very much for your answers.

MS. WALLACH: Thank you, Congresswoman. The short-term answer regarding the G-20 communique next month -- one, it should not include a commitment to push for the completion of the current WTO Doha round agenda because that explicitly contains as one of its three main pillars further financial service deregulation. Number two, it should contain a commitment for the G-20 countries to review the existing constraints imposed worldwide through the WTO on an array of different regulatory and non-trade policies that undermine the policy space that Congress and other legislatures and different world configurations need to create the policies of global governance to re-stabilize our economy.

And given the WTO is strongly enforced, given there have been 150 cases and 90 percent of the cases the domestic laws have been ruled against, and every single one has been changed but for one, where Europe is paying $100 million in sanctions a year, we need to strongly enforce global governance of a balanced sort, not the current system.

Thank you.

REP. LEE: Thank you.

REP. SHERMAN: Thank you, Ms. Wallach.

At this point I'll start the second round. I will have to leave for a few minutes after my questioning and our vice chair will take over. I'll try to return before the end of the hearing.

Dr. Bergsten, you're correct to point out that even if not one penny of China's stimulus money goes to a U.S. contractor that Americans will benefit to some degree by the general acceleration of the Chinese economy, just as I would point out that if we had provided that not one penny of our stimulus package had gone to China that they would get an enormous benefit because the goal here is to get people back in the malls, and whose products are sold in those malls?

The fact, though, is that China will get both the direct and the indirect benefit of our stimulus package because a lot of the money that we spend on manufactured goods as part of that will come from China.

I think we've made the case that most of you agree with, that we need more stimulus worldwide, and the president goes to London leading by example, leading by force of personality, leading with great oratorical skill.

What can he do other than encourage, what can he do in terms of bargaining, in terms of demanding, in terms of saying we're not going to do this unless you do that, to encourage other countries to have a stimulus package hopefully above but at least at a 2 percent level?

Dr. Johnson, our forgotten but very eloquent witness.

MR. JOHNSON: This is a problem with fiscal stimulus -- it encourages free riding. If you do a bigger fiscal stimulus, maybe I'll just sit back and I'll -- you build the roads, I'll sell you the BMWs and the construction equipment to build those roads. Honestly, this is the problem.

The main answer in terms of global policy coordination is to push harder with easy monetary policy, which of course is limited in terms of cutting interest rates. But moving towards quantitative easing and expressing support for the kinds of policies now being used by the Bank of England, for example, which is trying to expand the money supply in a way that Mr. Bernanke has talked about in the past but hasn't actually got to.

That will focus the Europeans' attention because if they have the prospect before them of the dollar potentially depreciating, right, and therefore you can't sell BMWs to the United States because the euro is appreciating, they will be much more likely to take the calls for financial stimulus seriously.

REP. SHERMAN: So we should seek stimulus measures that coincidentally bring the dollar down in value versus other currencies. I know that's an anathema to many Americans, of course.

Can you name a single country in the world that doesn't -- well, major industrialized country in the world that doesn't try often to have a lower currency so it can compete? I mean, we live in this world where testosterone and strong dollar are our pride, and then we run up the biggest trade deficit. What do other countries think of having a strong versus a weak currency?

MR. JOHNSON: Well, every country has the same sort of testosterone issues that you're discussing; no one else quite goes as far as the United States. And it's interesting right now in Europe, in the euro zone, where the interest rate and the monetary policy is controlled by the European Central Bank, they're rather tending towards a tighter monetary policy than many people would suggest is appropriate, given the economic circumstances, and that will tend to push the euro towards appreciating.

But you're right, most other industrial countries, leading industrial countries -- for example, the U.K., for example, the Canadians, for example, the Australians -- have a tendency to depreciate --

REP. SHERMAN: And the Asian giants Japan and China I think work very explicitly to lower their currencies, don't they?

MR. JOHNSON: Well, as has already been discussed, China manages exchange rate and that's a particular issue, and that absolutely needs to be addressed; I couldn't agree more with that topic. Japan's exchange rate obviously has been undervalued for a considerable period of time, and there it's a little bit more complex. It's the aftermath of the fact they had this massive bubble that burst 20 years ago and they never properly dealt with it. It's caused all kinds of other pathologies.

REP. SHERMAN: One last question, I don't know who will indicate an interest to answer it. In October of 2008 we helped the Swiss with a relatively routine currency swap. Now we find out that the Swiss are hiding 50,000 American tax evaders. What can we do to make the Swiss uncomfortable enough that they tell us who these 50,000 tax evaders are? Does anybody have a strategy?

Mr. Bergsten.

MR. BERGSTEN: Well, I can tell you what makes the Swiss uncomfortable would be the threat of abrogating the bilateral tax treaty between the United States and Switzerland.

REP. SHERMAN: So that would be interesting -- having a policy toward our tax treaties that was relevant to collecting tax revenue. Good idea.

Finally, Ms. Wallach, we've had this idea that we'll lead by example, that our markets will be open -- more open than any other country's -- and more importantly, perhaps, that we will be a rule of law society so that the degree to which our markets are opened or closed can be read in the statute books, that we won't have commissars call businesspeople and tell them to buy domestic goods.

How's that working out for us, and have other countries looked at the results of our trading policy and said, "By god, we want to do it just like Uncle Sam?"

MS. WALLACH: Well, I think you've answered your own question. It's rather evident that in fact the countries that are doing well under the current regime are not following the current rules and in fact are baffled, probably, by why we have so unilaterally signed up by example on an ideological basis versus made our negotiations on the basis of national interest.

And I think in the procurement area is one of the most stark examples.

I know it's an issue of special interest to the chairman, and in fact there are not many carve-outs that the U.S. has. There are now, of the U.S. states, 12 states that haven't signed on to the agreement, but otherwise the U.S. has signed on its entire service sector and all goods but for some of which are taken for exception, such as iron and steel in transit projects -- we didn't carve out all transit projects.

So, for instance, right now, while the rest of the world -- not just Europe and the EU but all the countries of the WTO but for the 39 who signed on to that extremely controversial agreement that most countries wanted nothing to do with have the right to set their procurement policies and their stimulus policies according to their best needs. The United States, for instance, we just put $20 billion into that electronic medical records-keeping business? Almost all of that's certainly going to go offshore.

We're not allowed to have contracts on services that have buy America because of our crazed, expansive, no-one-else-did-it-like- this-in-the-WTO lack of exceptions for services. That's a service contract that's for transcription of medical records. We can't say that work must be done by U.S. workers.

REP. SHERMAN: I thank you for your answer.

My time is expired, and when facts don't fit our theory, by god, we've got to change the facts.

MR. : (Off mike.)

REP. SHERMAN: My time is so expired that I'm going to see whether one of my colleagues allows you to bring up your fact.

We'll now yield to our ranking member, Mr. Royce.

REP. ROYCE: Thank you, Mr. Chairman.

Mr. Chairman, I want to go to Dr. Johnson.

You commented about the Japanese troubles and, you know, probably half of that equation or more is not dealing with those toxic assets, but part of it might be the age-separate stimulus bills passed which double-GPD -- a double debt to GDP in the country over that lost decade.

Also, you warn of the danger of the European push to re-regulate, suggesting that it could lead to potentially dangerous pro-cyclical policies that can exacerbate the downturn and prolong the recovery. I'd just like your commentary on that. And would you elaborate on your observation that governments have only a limited ability to offset increased private demand through fiscal stimulus? I think that's what we're hearing from the Europeans and I'd like your view on that as well.

MR. JOHNSON: I'm happy to take those points in order.

Look, I think on the experience -- my reading of the experience from Japan is that you need -- not that fiscal stimulus is irrelevant or unhelpful and not that the financial stimulus is the entire story, but you need to address both problems together, and if the root of the issue is in housing, as it was for them and commercial real estate and housing, obviously, here that you need to have some direct measures to take that on.

And to my way of looking at it, if you just pursue fiscal stimulus or if you over-weight the strategy towards fiscal stimulus, you'll end up running up more debt and it'll take you longer to get out of it.

REP. ROYCE: Until you get rid of the toxic assets.

MR. JOHNSON: Well, you have to address the problems in the financial system which are involved -- a strategy for re- capitalization that enables you to keep the financial sector private. In fact, I would say privatize it, given the extent of state control you now have over U.S. banks, and also clean up the balance sheets one way or another.

This is an expensive proposition; it's not politically popular. And major bankers, powerful bankers in Japan opposed it. They've opposed it in every single country where these kinds of issues have come up. They always want a way of dealing with this that's better for them and much more expensive for the taxpayer, and perhaps no surprise, the U.S. finds itself in a remarkably similar position.

On the pro-cyclicality of regulation, I do think there's an important point which has been lost in the broader discussion. If you go to banks or you go to regulators and you say you've got to really tighten up on credit standards, you will get a great depression, okay? You will further have contractions in credit. This is a very tough problem.

We want banks to be careful in their lending. We have to recognize that there was excessive credit and so some de-leveraging or reduction in credit around the world should be expected. And also, many creditworthy people, both individuals, families and firms, don't particularly want to borrow right now because it's too darn scary. We should save cash, we should hunker down, spend less, and see what happens, and that's happening globally; that's happening in a very synchronized way.

So I don't think piling on in terms of the kinds of regulations the Europeans have in mind is particularly helpful. I do think defusing the bombs in the financial system, which is the (fruit ?) of the point about the toxic assets and the lack of capital -- that's absolutely critically important. And I do think down the road to forestall the next bubble, we have to think hard about proper regulatory structure. In particular, I would emphasize any big bank that's too big to fail is too big to exist.

We have a problem in the United States with banks that are 10, 20 percent of GDP. In Europe, they have banks that are two times GDP in terms of bank assets to GDP. That's an order of magnitude bigger problem than we have here, and if we don't fix our problems, we're going to be looking at the kinds of issues Europe's going to grapple with this year, which are absolutely terrible and terrifying. Some of their banks are too big to rescue, let alone too big to fail, so it becomes a fiscal issue of the first order.

REP. ROYCE: And governments have only a limited ability to offset decreased private demand through --

MR. JOHNSON: This is the problem of limited debt capacity, even though in the United States we're relatively in a good position compared to other industrialized countries -- we start the whole crisis with debt-to-GDP around 40 percent. You have to expect, given the experience of obviously in other countries that the total increase in debt to GDP -- privately held debts to GDP -- will be at least 30 percentage points, and could well be 50 percentage points, so we'll end up with 70 to 80 -- 70, 90 percentage points, and that's with the kind of limited fiscal stimulus that you've already implemented and that's assuming that there's sort of a couple more tries in that same way.

That's a high level of debt. You can go further -- you can go as far as Japan and you can go to 150 percent GDP or 180 percent, but that's not a good idea. That becomes very expensive, and if you start to undermine the credibility of the U.S. government, and people around the world start to worry about the creditworthiness of the U.S. government -- which I would emphasize is not the current situation; I don't see that in the immediate future, but if you get there, then it's a whole different kind of global economy you're looking at. It will be no longer an issue the reason of currency when we no longer have the kind of position with regard to power around the world.

REP. ROYCE: Last question, to Dr. Levy: You make the point that the WTO is more feeble than it appears, lacking any enforcement powers. In Ms. Wallach's view, it's all-powerful. And would you just care to comment on that, Dr. Levy?

MR. LEVY: Yes, sir. I think it's often been very useful for governments around the world when they've abrogated an agreement or done something that's inconsistent with an agreement to point to the WTO and say -- you could say this here. It's like our Supreme Court -- they made us do it; they issued an edict. But there is no federal marshal service for the WTO in the same way. We've seen countries -- what happens is, you have two countries that reach an agreement, but (every ?) WTO settlement panel simply renders a judgment that says you've either acted in accord with your agreements or you haven't. After that, a country can retaliate or not retaliate. If it does, it's essentially an unwinding of the agreement.

There is no marshal service that forces you to act.

REP. SCOTT: Thank you. Thank you very much.

Let me just shift for a second, because this G-20 economic summit presents our country with an extraordinary opportunity, and we talked about having this happen as our president is being placed at least in a relative position of strength, given the fact that we passed the economic stimulus and are providing leadership.

But there are some sobering things out here as well that we need to examine, particularly as it relates to three problematic areas that I think are certainly problems. One, China, the other Russia, and of course the situation in Pakistan, which certainly involve with taking another look at our trade issues.

And if we undergird all of this with the fact that that economic stimulus money is based upon money we're borrowing from China, for some Russia, from these very same countries that we're having a problem with, grappling with.

Secondly, of the 15 major manufacturing nations that account for 80 percent of the world's manufacturing, the United States ranks the lowest for the proportion of production goods that are exported, and I think that I'd like to get your response from these two basic phenomena. We are leveraged beyond our debt. We've got -- how strength of a position are we in to bow up to China to tell them what they should and should not do when they're holding over a trillion dollars of our debt, and I think that puts us in a very vulnerable position.

Dr. Levy and Dr. Bergsten?

DR. LEVY: Thank you, Congressman. You raise an excellent question, and I guess I don't think the concern that's sometimes expressed that China's got this stock and they're going to use it as a cudgel to beat us into something is our concern. I do think that we have think very carefully about attacking China over issues of just trade balances, because it is fundamentally inconsistent with trying to borrow a great deal from them. If we are going a borrow a great deal -- to slip into jargon, a current account surplus in a capital account deficit -- these things are related. You simply cannot be borrowing a great deal from the rest of world and say, "And we also want to run a current account surplus" or even balanced traded.

So this will -- we saw this with Secretary Clinton's trip to China most recently. We can say "thou shalt not manipulate your currency," but we cannot at the same time say "and also please buy lots and lots of treasury bonds."

REP. SCOTT: Dr. Bergsten and then Dr. Morici.

MR. BERGSTEN: Actually, I slightly disagree with that. I think we can and should take a much tougher line toward China on the currency manipulation, and we're probably within our rights to do that. They are violating the most fundamental rules of the international economic system -- the IMF has very clear strictures against competitive undervaluation. We're perfectly within our rights to hit them.

Even if we succeed beyond our wildest dreams and get them to let the currency go up 20, 30 percent, which I think it still needs to do, they will still be running trade surpluses. They will still be adding to their reserves, and for their own reasons, they will continue to put most of that into dollar assets, so I really don't worry about that too much. They're not going to dump the dollar.

However, there's a more fundamental reason that your concern is correct. China is the second largest economy in the world. It's now the biggest exporter in the world. It's got 1.3 billion people. We are not going to order China around, and it's much more fundamental than whether they hold treasury bills. So we have to get used to the fact -- I've actually published two books on this topic in the last three years; I've studied it very carefully. We have to find new ways that we can work with China, hitting them -- hitting them hard where they are violating the rules of the game, like on currency, but working with them where they are with the program, like on fiscal stimulus.

Could I say one word about Pakistan? It's come up two or three times. As I think Mr. Royce said at the outset, the best thing we could do for Pakistan is to reduce our barriers to their exports to the United States, particularly of textile products.

We did a study at my institute of a possible free trade agreement between the United States and Pakistan. We showed how that would actually support the U.S. economy, not hurt it. It's just as a marker -- if you want to do something serious on Pakistan, we've done a very comprehensive analysis of how that could be done through the trade instruments.

REP. SCOTT: So you agree then -- because while you're on Pakistan, I want to get to that, and then I'll get to you, Dr. Morici -- that right now, all of our trade basically with Pakistan is military -- military equipment, military procurement.

Are you saying that our trade should be more balanced by decreasing the military --

MR. BERGSTEN: No, increasing the civilian. Increasing is very --

REP. SCOTT: Economic.

MR. BERGSTEN: Yeah. You and some of the other members have asked about how to stabilize Pakistan. An essential part of that has got to be to create jobs in Pakistan so people aren't out on the streets and becoming jihadists. And again, no country has ever been able to achieve sustainable development without integrating into the world economy and expanding their trade. We have it within our power to support Pakistan moving in that direction, and I think we should take a very, very hard look at that.

REP. SCOTT: Now, let me ask you -- number one, you definitely feel that they are keeping their currency artificially low?

MR. BERGSTEN: Absolutely.

REP. SCOTT: Do you also agree that they are depressing their domestic consumption?

MR. BERGSTEN: Yes, through a bunch of policy errors. I don't think it's quite as devious as Dr. Morici does. I think they'd actually like to get their consumption up, but they've moved painfully slowly to do so. I'm very critical of that too.

REP. SCOTT: And do you believe that this is a consciously concerted effort for them to grow their economy by exploiting -- exporting to targeted markets in the United States and Europe?

MR. BERGSTEN: I think that's a part of their development strategy. But remember that 80 to 90 percent of their growth over this 30-year period -- including the last five years -- has come from the domestic economy. Ninety percent of their investment is domestic. Ninety percent of the growth in demand in the economy is domestic demand. It should be 110 percent because their trade surplus should go down.

So it's not the bulk of their economic success story, but it is an element that disrupts internationally and, yes, we have to worry about it very, very greatly.

REP. SCOTT: All right, thank you.

I'm going to go Dr. Watson.

I think you wanted to make one comment on this, and we'll move right to you.

MR. MORICI: Yes, it's important to recognize that we have two distinct sets of problems -- the problems with the banks, which we could discuss how to fix, and a deficit in aggregate demands, a structural deficit. If we reflate the economy with a stimulus package we will get back to the point where if -- because we have a large trade deficit we have a deficit in aggregate demand, unless we encourage people to borrow out against their homes, and have another bubble, or the federal government keeps having more and more stimulus packages.

The only way in the end that can be redressed is by changing the trade deficit so that you are not spending 5 percent of what you earn abroad.

And the only way in the end that can be changed is through oil and through your trade to China.

With regard to China, while we cannot bully them and determine what they will do -- if they don't do what we suggest, just as it is a sovereign nation, it can set its exchange rate wherever it wants -- since its doing so in a way that violates international law, then the thing that we -- we can't reset the exchange rate because we're the reserve currency.

But we can tax dollar/yuan on conversion to the point to provide the same relative prices within the economy that an equilibrium exchange rate -- as thought about my international economists -- would be. So we have that with them.

And if we keep going down the path we're going -- instead we keep borrowing and the problem that you worried about gets worse and worse. The rest of the world -- we've borrowed about $7 trillion, as near as I can figure, or sold off stuff at -- you know, securities. And that's about what all this publicly traded stock in the United States is worth right now. So we've gotten ourselves to the point where we could get bought up.

REP. SCOTT: That's right.

MR. MORICI: It's not very smart.

REP. SCOTT: Thank you.

Dr. Watson?

REP. WATSON: I could see if we could come to some agreement. When our president goes to the G-20 -- and they have been discussing this creation of a new framework for regulating and several of you have mentioned regulating the international financial system so that we can prevent and anticipate a crisis like this from reoccurring -- what would a new super, super international institution -- a framework be like to stop or to shorten a future global recession? What would you suggest?

And anyone that wants to take a bite of that apple, please do.

Dr. Johnson.

MR. JOHNSON: I think pursuing such an international structure is an illusion. I think it's a distraction put forward by politicians who want to hide the fact that their domestic regulatory structures failed completely. And I think they failed for a very simple reason -- the banks became too big and too powerful.

I think that's true in the United States, regrettably, and it's much more true in other countries. I mentioned before, in Europe the banks are much larger relative to the size of the economy and they're actually more powerful -- if you can believe that -- than in the United States.

And I think unless and until you address that issue -- the power of the big banks -- you'll -- any regulatory structure is always going to be overwhelmed. Maybe it will look good for a while, but the next time the bubble or a boom comes along, you'll have repetition of the same problems in a slightly different format.

I think the key issue is breaking up the big banks. The banks that are too big to fail -- and some of them are too big to rescue -- are too big to --

REP. WATSON: They're creating the failure, right?

MR. JOHNSON: Absolutely. They're holding the entire world economy hostage right now. They're saying if you take measures that are contrary to our interests and we're the only ones who know what -- we're the only ones who know, you know, what could go wrong because they're the only ones who understand the complexity of our banks -- I think, by the way, they don't understand it; that's how we got into this mess, but leave that to one side -- they're saying unless you do what we say, unless you hand over a large amount of taxpayer money, there will be a major problem for the financial system and for the global economy. And, you know, I think they're right, unfortunately. I think we got ourselves into a situation where they're right and we can't allow that to continue into the future.

I think you have to consider ways to break up these banks and so that you have to consider size restrictions on them -- which is a very crude way to do it. But I can't think of any other way you're going to prevent this problem from recurring, perhaps in an even worse and more spectacular fashion.

REP. WATSON: Dr. Bergsten?

MR. BERGSTEN: I just want to put one caveat on the question you raised about the role of international participation in financial regulation. It's clear that serious regulation has to occur at the national level. I fully agree with Dr. Johnson on that. But I think there is a role for international cooperation, that is, in trying to set consistent internationally agreed standards against which to benchmark national financial regulation.

This was done with great success after the Asian crisis 10 years ago, one root cause of which was weak banking systems throughout those emerging markets. Out of the crisis came agreement on an international banking standard which was worked out by regulators of the national governments working together. It was then, kind of, embodied in IMF surveillance of national systems.

So what you got was international agreement on, kind of, a best practices template. National governments then tried to approximate that as best they could. And then the international system monitored -- kind of, pushed and prodded to get the standards up to snuff. And it's been a big success over the last 10 years.

One reason the Asians have not been hurt more by the current crisis -- their banking systems are enormously better than they were 10 years ago.

It's tougher now because we, the U.S., who thought our financial regulation was the gold standard -- turned out not to be the case -- we have to be subjected to that now. But I think trying to get international agreement on what should be the objectives of financial regulation and then, as national governments implement that, monitoring it internationally and trying to bring everybody up to speed is a useful part of the process, though the regulation still takes place almost totally at the national level.

REP. WATSON: Dr. Morici.

MR. MORICI: Yeah, I think that we need to revisit -- first of all, I agree with -- I did it again, I'm sorry.

To begin again, I agree largely with what's been said about international regulation. The Europeans, for cultural reasons, are inclined to always recommend an international body. And I think that it should be accepted as for what it is.

The real problem lies in the domestic regulation. We need to revisit some of the things that we have done. For example, permitting large financial supermarkets to emerge and for commercial banks to be part of investment banks has created a lot of cultural compensation and incentive problems.

There are things constructively that we could do in the derivatives market without creating the nightmare of over-regulating the system. Simply providing that derivatives have adequate posted collateral by the ultimate party that's going to have to pay out when the value of the asset goes down and that requiring that if those guarantees are provided by international entities that their central banking authorities guarantee that those writers of the swaps can pay out just as well as ours can -- things of that nature.

There's other things that we should look at, but it's largely a problem of domestic regulation and the fact that, frankly, the bankers view regulation the way most of us view the tax code. And they are very good at it and so we're going to have to start to consider whether there needs to be changes enforced, you know, in the way the bankers view lobbying and regulatory structures and things of that nature.

MS. WALLACH: Regarding what structure, I have no expertise.

But as regards the actual rules that need to be in such a system of regulation, on the point of the importance of having domestic rules correct and having banks broken up, part of the issue for the G-20, again, is to review the existing WTO rules regarding financial services, because, for instance, the market access obligations now in those agreements, the limits -- the stand-still on new regulations, for instance -- make -- create obstacles to those kind of domestic policy goals. And just to make it very concrete, for instance, in the U.S. commitment to this particular agreement, one of the things we agreed to do to meet these obligations was to get rid of Glass- Steagall.

It's actually in the footnote of the U.S. GATS commitments because the market access rules don't allow you to have firewalls between the different kinds of businesses within the bank. You're not allowed to limit the size of a bank, quite explicitly in the Article 16 GATS market access rules. So these are very concrete changes that need to be put into place.

And the carve-out that Dr. Levy mentions doesn't really fix the problem because the carve-out says you can only -- shall not be used as a means of avoiding the members' commitments or obligations under the agreement, which is to say you can only use the exception as long as the exception doesn't apply to things that violate the agreement -- which is the only reason you'd need the exception.

REP. SHERMAN: I thank the gentlelady from California.

Since the discussion of waterboarding, President Obama announced that America does not torture. He was wrong. We're going to do a third round of questioning. (Laughter.) There may be only one person doing the torturing.

And I know, Dr. Johnson, you have to catch a train pretty soon.

Now, one quick comment about Glass-Steagall, and that is, the big investment houses -- Bear Sterns, Lehman Brothers, Merrill Lynch and Goldman Sachs -- did not engage in commercial banking until very recently, and their nonregulation is much a part of the problem. The fact that we have repealed Glass-Steagall is the only reason why we were able to walk away from Merrill Lynch without a huge amount of taxpayer money.

So speaking as a member of the Financial Services Committee, it is not the fact that we reduced some of the 1930s regulations. The problem is that we failed to create any new regulation for the new financial instruments. It's as if somebody said there was a spike in automobile accidents and it's because we abolished some of the 1910 buggy whip rules. It's not whether you kept the buggy whip rules or repealed them. If you don't have a vehicle code for automobiles, you cannot run a transportation system based on them.

Dr. Johnson, you intrigued me a bit on how we could stimulate our economy without a freeloader problem. Were you basically talking about the TALF program where the Fed goes out and buys various debt instruments? Or perhaps you could just add to your ideas on how we could accomplish that goal.

MR. JOHNSON: Certainly. The TALF program is, of course, designed to support the credit market problem, as you know very well, is the breakdown of securitization distribution. And the Fed is essentially stepping in and becoming part of the commercial funding for that market. I think that that's, you know, regrettable, but probably unavoidable under these circumstances, and I support it.

But it's not enough -- or it's not the complete part of what I was talking about, which is quantitative easing. Quantitative easing is when central banks actually go out and, for example, in the case of the Bank of England right now, they buy long treasuries. So instead of limiting their operations to short-term government obligations, which is their bread and butter, they actually try and operate further down the yield curve.

And basically -- they don't like to use this term -- that in the vernacular they're printing money. They're issuing money. They're trying to fight off deflation. They're trying to push inflation back up toward 2 percent, which is informally what they were aiming for before. And this kind of action, and demonstrating this, would tend to cause the U.S. dollar to depreciate just like the British pound has depreciated by 20 to 30 percent since these kinds of policies were put into place. And that concentrates the minds of your trading partners considerably.

REP. SHERMAN: Now, why is it printing money to issue currency to buy long-term treasuries if it's not also printing money to issue currency to buy short-term treasuries? Why is one, quote, "printing money" -- I guess a third way to go -- I mean, the Fed can do three things. You can print money for long-term treasuries. You could print money in return for short-term treasuries. Or you can just print money and go buy whatever you want to buy with it. Now, that's really printing money and is not being seriously discussed, except by crazy bald members of Congress.

Now, why is it that you would -- why is it considered more printing money to buy the long-term treasuries?

MR. JOHNSON: That's a mechanism of -- (inaudible) -- policy. But you're actually right, they could print money to buy things in your basement that you no longer want, for example.

REP. SHERMAN: Or if when -- because as I understand the TALF program, they're going to use cash to buy these various debt instruments, but they're going to get the cash by selling treasuries. So the private market is getting all the cash that the federal government is -- that the Fed is spending on the student loan paper and the Small Business Administration paper and the credit card paper.

But the private sector is giving the Fed a bunch of greenbacks for the treasuries that it's selling. Instead of doing that, they could just do half of it. That is to say, buy the paper by printing paper money and not selling any of their treasuries.

But going back to my question, why is it considered more printing money for the Fed to sell treasuries -- rather, buy long-term treasuries versus short-term treasuries? Why is one thought to be more inflationary than the other?

MR. JOHNSON: Well, I don't think we actually know enough about quantitative easing to make that determination since it's a relatively new program and a relatively new idea. Chairman Bernanke actually flagged it as a possibility back in 2002 in a speech and he was regarded -- he earned the reputation of a name as Helicopter Ben -- the nickname of Helicopter Ben after that speech for having even floated this possibility.

REP. SHERMAN: Helicopter, meaning an allusion to the idea of dropping currency from a helicopter?

MR. JOHNSON: No. He said that ultimately what you might need to do is tax cuts that are financed by printing money.

REP. SHERMAN: Tax cuts -- what?

MR. JOHNSON: Tax cuts that are financed by printing money. So you basically cut people's taxes and you send everybody a check and that check is -- obviously you're drawing on the Federal Reserve; that's an issue of money.

Now, that's a fairly drastic step to take and this -- the kind of program that the Bank of England has right now is a step in that direction. The central banks, I think, are rightly -- don't want to go crazy with the printing of money because you don't want inflation expectation. You don't want people to suddenly start expecting 20 or 30 percent inflation next year. You want them to go back to expecting 2 percent inflation next year -- which is what they were expecting, more or less, for a long time. And now those inflation expectations have come down --

REP. SHERMAN: I would rather them anticipate 4 percent inflation than anticipate 4 percent deflation.

MR. JOHNSON: Well, that's, I think, also my position. And I think that's where the central -- the central banks would never, of course, say that in public. But I think that's increasingly where they're leaning with this too. That is, to err on the side of a little bit too much inflation and then deal with that -- those consequences, than to have 4 percent, or even 1 percent deflation, which would be absolutely devastating given the debt levels and the structure of debt in this country.

REP. SHERMAN: Yes?

MR. MORICI: I would point out to you that there is a parallel issue with regard to whether you buy short-term paper versus long. And that is, by buying long-term paper you can -- or selling it or whatever -- you can reassert your sovereignty over your monetary policy.

We've lost the ability of the Fed to influence long-term rates because of China's, you know, investing in our capital markets and so forth, which we've had decoupling. And if the Fed had an active policy of not just targeting the federal funds rate, but with targeting the 10-year, you know, treasury rate, the 20-year treasury rate -- that sort of thing -- that would give it an ability to determine the slope of the yield curve in a very nice way which would be very useful for regulating the economy.

REP. SHERMAN: Because right now long-term treasuries are yielding 50 times the interest rate of short-term treasuries because -- (laughs) --

MR. MORICI: Well, it's not hard. I mean, if we take it to zero we can get it infinite, okay.

REP. SHERMAN: Right.

MR. MORICI: But the point is if we raise them back up again, the long rates aren't going to change very much -- we've established that -- because we essentially have a fixed-rate exchange rate system with China and it, you know, buys -- it fixes the exchange rates. And as a consequence --

REP. SHERMAN: Also, if we buy the long-term treasuries, the Fed gets a better yield --

MR. MORICI: Yeah.

REP. SHERMAN: -- and turns that money back over to us. When you can borrow short term at zero, why would -- borrowing long term doesn't seem like such a good deal. And then, of course, you get the quantitative -- yeah.

So the slightly radical approach is buy long-term treasuries. The truly radical approach is just print money and do something with it that the federal government wants to buy.

MR. MORICI: Where would you like to create your jobs? If you just print money and give it to the federal government, you'll create your jobs in very different places than if you buy long-term bonds, because that'll put money into the capital market where it might actually get used to build houses and things of that nature. So the money will go to different places. It's important to recognize that who gets the first round of money, just like whether or not we have buy America or not, you know, you have to look at where the benefits go.

REP. SHERMAN: Yes. I mean, you can buy that commercial paper which we're being told is worth 100 cents on the dollar; you can buy the long-term -- you really can't buy the short-term treasuries and affect much because the interest rate's already zero.

MR. MORICI: Right.

REP. SHERMAN: Let see, you know, I could keep you guys here for a long time. I'm not going to run out of questions, but I think we've run out of time. And the president is right, there's a limit to the amount of torture America will engage in.

Thank you very much for coming.

END.


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