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Hearing of the Senate Foreign Relations Committee – Foreign Policy and the Global Economic Crisis

Location: Washington, DC

Hearing of the Senate Foreign Relations Committee - Foreign Policy and the Global Economic Crisis



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SEN. KERRY: The hearing will come to order. Thank you all for joining us this afternoon. Just when we think things may settle down for a moment, the markets have a way of deciding otherwise and sending a different message. I noticed today that the British bond sale failed for the first time since 2002. And so even today the implications of the current economic downturn are being felt globally, which is what we're here to talk about today.

The United States is not alone in confronting economic crisis at this time. And what started here has now gone global and continues to reverberate beyond our financial systems into the daily economic lives of people everywhere. The reality is we don't quite know yet where the bottom is or where the end is. Today's hearing grows out of a roundtable discussion last month, which the committee held on this, where we began to scratch the surface of the global implications of the financial challenges that we face. I'm glad to do this before the full committee today.

Dennis Blair, the Director of National Intelligence, recently told Congress, and I quote him, "the primary near-term security concern of the United States is the global economic crisis and its geopolitical implications." That's an amazing statement given the ongoing risks that we face from terrorism, two wars, rogue nuclear programs in Iran and elsewhere. Blair warned that, quote, "time is probably our greatest threat. The longer it takes for the recovery to begin, the greater the likelihood of serious damage to U.S. strategic interests."

He also warned of "regime threatening instability," and today's economic crisis has already brought down governments in Iceland and Latvia and helped spark riots in Europe. Just this week the Prime Minister of Hungary offered his resignation over the economic situation there. So the crisis is likely to be a driving geopolitical force for some time to come, and the political ramifications could well become even more serious. If there is one lesson we should take away from the experience of a number of these countries, it is to not underestimate the severity of these economic challenges or the urgency of tackling them head-on rather than deferring tough decisions.

Last week, several of us had the opportunity to speak with Dominique Strauss-Kahn, the Managing Director of the International Monetary Fund, and Bob Zoellick, President of the World Bank. We spoke about the snowballing financial crisis brewing in Central and Eastern Europe. That made it clear that if we don't act quickly, we risk replacing an era of promise and progress with one of soaring unemployment, instability, and a rollback of the influence and ideals that we have spent decades building.

We also spoke about the need to strengthen our international financial defenses, particularly the IMF. And I'm pleased to join with Senator Lugar in supporting a dramatic increase in the IMF's capacity to respond to this crisis, just as Treasury Secretary Geithner has proposed. The IMF, along with the World Bank, is the best channel that we have to bolster emerging and developing markets as the economies, and the banking systems and the political systems are all strained around them.

The upcoming G20 meeting in London is an important opportunity to enlist global support for decisive action on this issue. Strengthening the IMF, however, is only one component of a much larger challenge. We have to fix our banking systems, not just in America but in every major financial center.

To be sure, our economy and the global economy have reached this moment of crisis. But as bad as the news has been, it is clear that if we come up with the right solutions, if we move together, if we move with a certainty and confidence in the choices that we make, then there will be great opportunities going forward. There is a great advantage to being the first to move in global finance. Washington has waited too long already while our financial institutions remain frozen. Lending will not happen until banks have removed their toxic assets, and we hope that the Treasury plan announced this week will help us do just that.

As we put our own banking system in order, there will also be new challenges waiting for us abroad. We're going to have to confront the potential for increased political instability; large-scale failures of other countries' financial systems; escalating financial protectionism; economic nationalism; or trade wars that could help to deepen the crisis; increased poverty and hunger in the developing world; and competitors exploiting financial instability in ways that diminish our influence. And these problems are not confined to traditionally unstable corners of the globe. Europe is facing some deep financial challenges. Turkey, Indonesia, and Pakistan, three of our most important partners in the Muslim world, all face acute balance of payments crises.

We also need to confront the fact that there's a great deal of anger out there among people who blame the model that we exported. Even as we restore confidence in our markets, we will also need to find a strategy to project leadership, share burdens, and spread stability as the problems reverberate on a global basis. And as we balance the domestic and global demands of this crisis, we need to be warned that in cutting corners for short-term savings, we risk creating far greater costs down the road.

We are pleased with the panel that we have here today. The witnesses that we have here today are a superb collection of innovative thinkers, all of whom think about, work in and around this sector on a daily and lifetime basis. And they will help us paint a fuller picture of the new foreign policy dynamics that these challenges create. Martin Wolf is the Associate Editor and Chief Economics Commentator at the Financial Times; and George Soros is the Chairman of Soros Fund Management and Open Society; and Lawrence Lindsey is President and CEO of The Lindsey Group and Former Director of the National Economic Council. Senator Lugar.

SEN. RICHARD LUGAR (R-IN): Well, thank you, Mr. Chairman. And I join you in welcoming a very distinguished panel who will offer insights into the global financial crisis and recommendations for a United States policy. As you pointed out, if it stays, no one knows for certain how long or how deep this economic downturn will be. With the administration's announcement of a plan to manage the so-called bad assets on the balance sheets of banks and corporations we're at a critical moment in the resolution of our banking crisis. The fundamental strengthening of our banking system is a necessary precondition to the return to solid economic growth.

I'm hopeful that as this plan is implemented the United States government will be judicious about sinking taxpayer money into banks and corporations that are insolvent. As many experts have suggested, we need a careful triage of financial entities to determine which ones can stand on their own, which could become healthy with a reasonable infusion of additional capital, and which are insolvent beyond repair. Banks that are insolvent should be either liquidated or, in some cases, merged with other banks. Depositors should be protected, but shareholders may have to take their losses. U.S. taxpayer funds should only be used for recapitalization of troubled banks in limited cases and the terms for government assistance should be uniform and transparent.

The goals must be to restore discipline to the banking sector, reestablish investor confidence in healthy banks, and ensure that banks have the capacity to contribute to economic growth. Actions to address our own economy are vital, but given the linkages between our financial sector and that of other countries, we cannot achieve economic recovery in isolation from the rest of the world. The United States must provide leadership in restoring the health of the international financial system.

In particular, the lending capacity of the IMF must be increased. The Obama administration has proposed increasing this capacity by $500 billion, in which the United States' commitment would be $100 billion. I will be very interested to learn from the witnesses' views of this proposal and whether they believe it's appropriately sized for the problems. As we work with other nations, our government must pay attention to how the global economy and our role in it can be rebalanced.

Some level of deficit spending is appropriate at this stage of the crisis, but the United States budget deficits that are projected cannot be sustained without extreme risk to both Americans and the international community. We cannot depend indefinitely on China investing heavily in the United States government debt. Some thought must be given to how we work with China and other nations to establish a more sensible global balance that depends less on demand by American consumers.

We also must be cognizant of the incredible pressures this global financial crisis will place on stability and peace. We have to expect additional political, economic, or even national security shocks. We know from history that societies under severe economic stress often do not make good political choices. In the face of job losses, wealth evaporation, homelessness, hunger, and other outcomes, the fabric of many nations will be tested. The crisis is likely to stimulate nationalism that could lead to demagogic policies or governments.

And under such conditions some nations might experience a retreat from democracy. This, in turn, increases the possibility of violent conflict within and between nations. Consequently, maintaining international cooperation and addressing the economic crisis affects more than our own prosperity. The upcoming G20 meeting must be a success, not just in the proposals that are adopted but also in the tone that is established for subsequent cooperation. The meeting should offer a clear message that the major economies will cooperate on financial restructuring and resist protectionism.

The United States must prepare itself for changes in its international role. We should ask ourselves what will be the basis of the United States' national influence in the future. Why will nations continue to listen to us? What leverage over rivals can we preserve, and how can we ensure that we will still be able to rally friends behind vital United States objectives.

The global crisis has increased the skepticism in emerging economies about American style capitalism and is likely to reduce enthusiasm within the United States and beyond for liberalized trade measures that would greatly benefit our country. I do not believe that we are facing a precipitous collapse of United States influence, but we have to be far more deliberate in executing a rational plan that gets the most out of the United States strengths and compensates for our new weaknesses. I thank the chairman for calling this hearing and very much look forward to the testimony of our witnesses.

SEN. KERRY: Thank you very much, Senator Lugar. Mr. Wolf, would you lead off, Mr. Soros next, and then Mr. Lindsey? And we're glad you were able to arrange to be here, Mr. Wolf. I know it's not a normal role within your sphere. But we admire your voice and perceptions and must say your home base is an important document for all us to read these days, and we appreciate its quality.

MARTIN WOLF: Thank you, Mr. Chairman and members of the committee. It is a very great honor to be here to discuss --

SEN. KERRY: Would you press your mike. I think there's a button there.

MR. WOLF: Okay. I apologize.

SEN. KERRY: There you go.

MR. WOLF: Thank you, Mr. Chairman and members of the committee. It is my great honor to be here to discuss the current economic crisis and its impact on American foreign policy. (Inaudible) -- but as a British citizen, and so as a grateful foreigner, I am particularly honored and well aware of the extraordinary role of the U.S. in promoting freedom and democracy across the globe over the past seven decades.

Yet, it is clear that we are experiencing the most dangerous financial and economic crisis since the 1930s. It is also a crisis for foreign policy, as you have noted. A deep recession, and that is sure, will shake political stability across the globe, and as important, it threatens the very long standing U.S. goal of sustaining and creating an open and dynamic global economy. And perhaps most important, the U.S., rightly or wrongly, is currently seen as the source of the problem more than of the solution across the globe.

The crisis is, therefore, a devastating blow to U.S. credibility and legitimacy as a world leader. If the U.S. cannot manage free market capitalism, it is asked, who can? If free market capitalism can bring such damage even here, why adopt it? If openness to the world economy brings such dangers, why risk it? As shock turns to anger, not just in the U.S. but across the world, these questions are unquestionably being asked. If the U.S. wishes to obtain the right answers, it must not only address the crisis at home, as is of course widely understood, but also do what it can to rescue innocent victims abroad. And this is not just a matter of charity; it is a matter of the highest enlightened self interest, as American policymakers have understood for many decades. The decisions taken in the next year will, I believe, shape our world for decades.

So what -- (inaudible) -- has to be done. I'm going to make a few suggestions, in the limited time available to me, focusing above all on the G20 and on the International Monetary Fund. First of all, we must realize that this is, indeed, a crisis of the global economy that the U.S. played a dominant role in creating. If that achievement, with all the promise it offers is to survive, the crisis will also, by definition, have to be solved globally.

Second, the meeting of the G20 heads of government in London is a recognition of the global nature of this crisis. Management of the world economy can no longer be achieved by the leaders of advanced economies alone. While not all the countries there present are systematically important, all systemically important countries will be there. The world looks for achievement at this summit; it must not be disappointed.

Third, the immediate priorities for this summit are to agree on how to sustain demand, fix the global financial system, and avoid a collapse into global protectionism. The longer term aim must be to reconsider the regulation and structure of the global financial system and reform the system of the international, economic, and financial governance. Some progress has already been made on these fronts, but it is not nearly enough.

Fourth, there is a very good chance that this crisis will lead to a much deeper decline in the world economy than is even now expected and thereafter, no more than a slow and limping recovery. This risk of extreme outcomes has to be eliminated, if at all possible. Fifth, if emerging economies are to trust themselves to the world economy in the future, it is essential to offer generous assistance now. At the moment, as I remarked, they blame the West for what has happened to them. It has been helpful that the Federal Reserve and other central banks have advanced loans to a few selected central banks, but much more than that is needed.

But sixth, the current lending capacity of the IMF is only about $250 billion, which, as I think everybody knows, is grossly inadequate. The U.S. administration has proposed that this be raised to $750 billion, and that is the very least that is now needed. It is important to remember that global foreign exchange reserves overwhelmingly held by emerging economies rose from about $1.5 trillion to $7 trillion between January 1999, that is shortly after the Asian financial crisis, and the peak they reached last year. And this is surely, at least in part, an indication of the extent of the demand for the reserves around the world. It would be far more efficient if reserves were pooled than if every country tried to ensure itself in this extremely expensive way. And that is what the IMF exists to do, and it should be used for this purpose.

Seventh, in addition to increasing its resources, the government of the IMF must be changed. Asian countries in particular still remember with bitterness the humiliation they received a decade ago at the hands of the IMF and, in their view, the U.S. Treasury. They will want a bigger say in the running of the fund if they are to trust it. An important step is a huge reduction in Europe's voting weights, now about a third of the total, and also important is an end to the traditional practice of always having an American head of the World Bank and European head of the IMF.

Eighth, serious thought must be given to making an annual allocation of SDRs, that is Special Drawing Rights, that the IMF's own reserve asset. This could satisfy the world demands for reserves at no cost in resources, and I have noted the recent remarks by the government of the Peoples' Bank of China on exactly this point. Traditional, the U.S. has regarded the SDR as a rival to the dollar as a reserve asset and treasured the ability to finance its external deficits through simple expansion of its own money supply. Bu the economic developments of the past decayed, and particularly the final consequences of the global imbalances should have shaken this complacency. The ability to run very large current account deficits has turned out, in my view, to be a calamity, since it offers at least a part of the explanation for the current financial crisis in the U.S. and the world.

Furthermore, the U.S. needs to be able to export its way out of its current recession. Otherwise, it is likely to be stuck with these terrible fiscal deficits for the indefinite future to offset the higher domestic private saving and current account deficit. Increasing the purchasing power of emerging countries through an annual allocation of even as much as a trillion SDRs, a little less than 2 percent of the world's GDP, would go a long towards solving this problem. I fear that if this does not happen, a return to generalized protection becomes likely as a way for deficit countries, even the U.S., to strengthen demand for domestic output and employment.

What I have outlined above is only a small part of the agenda, but it is a vital part. The more imaginative and energetic the U.S. now is, the better able it will be to restore its reputation and influence across the globe. This is unquestionably a time of decision. The U.S. has a choice of either doing everything in its power to restore and strengthen the global economic system it itself worked so hard to create or fails to do so. Choices must be made between outward looking and inward looking solutions. As we all know, we tried the former in the '30s, and this time, as we know, we must try the latter. Thank you.

SEN. KERRY: Very good. Thank you, sir, very helpful, and we appreciate it. Mr. Soros, welcome, glad to have you here. As a personal friend, it's good to see you, and also we have enormous respect for your thinking in these areas, so have at it.

GEORGE SOROS: Thank you, Mr. Chairman.

SEN. KERRY: Can you push your mike? There's a button there, yeah. Thanks. Why don't you just leave them all on, and then you guys can intervene when you want.

MR. SOROS: Thank you for the opportunity to testify today on the global financial crisis. I shall try to summarize briefly the main points of the argument I presented at a greater length in my written testimony. As you'll see, my points are very similar to those of Martin Wolf.

First, the current financial crisis is more severe and more widespread than any we have experienced since the 1930s. The International Finance System has actually broken down, and had to be put on artificial life support. Second, the countries on the periphery of the International Financial System are even more severely affected than those at the center. The rich countries could effectively guarantee their financial institutions against default, but the less developed countries, ranging from Eastern Europe to Africa, could not extend similarly convincing guarantees. As a result, capital is fleeing the periphery, and it is difficult to roll over maturing loans; $1.45 trillion of bank loans are coming due in 2009 alone.

Third, to stop the capital flight, the International Financial Institutions, particularly the IMF, must be reinforced and reinvigorated. The primary responsibility lies with the United States, both as the originator of the crisis and as the dominant financial power. If we fail to live up to our responsibility, we shall cease to be the dominant financial power. If the multilateral system falls apart, every country will pursue its own interests unilaterally, and China is liable to come out ahead. As things stand at present, China and the United States have a common interest in assisting the periphery countries. We must seize the opportunity, even as we address our own recession.

Fourth, the upcoming G20 meeting on April 2nd is a make or break event. Unless it comes up with practical measures to support the countries of the periphery, markets are going to suffer another sinking spell (ph), just as they did on February 10 when the authorities failed to produce practical measures to recapitalize the U.S. banking system. In the preparations for the G20 meeting, profound attitudinal differences have surfaced between the United States and Europe, particularly Germany. To put it in an oversimplified and exaggerated form, the United States wants to reinflate; Germany and Europe want to regulate. Actually, we need to do both, but the reinflation is urgent, and regulatory reforms will take time. Therefore, it should be possible to overcome the differences and find common ground in the need to protect the periphery countries from a calamity that is not of their own making.

As things stand now, the G20 meeting will, in fact, produce some concrete results. The resources of the IMF are likely to be doubled, mainly by using the mechanism of new arrangements to borrow, which will require congressional approval. The capital increase will be sufficient to enable the IMF to come to the aid of specific countries in difficulties, but it will not provide a systemic solution for the developing world.

Fifth, and this is the most important point I want to make, a systemic solution is readily available in the form of Special Drawing Rights, or SDRs. The mechanism exists and has already been used on a small scale. SDRs are highly complicated and difficult to understand, but they boil down to the international creation of money. The United States, Europe, and Japan are in a position to create their own money, and they are actively engaged in doing so in order to offset the collapse of credit. Less developed countries can't create money that is internationally accepted. They are the ones who need the Special Drawing Rights. Rich countries should therefore lend their allocations to the countries in need. They could so without incurring any costs or deficits. The recipient countries would have to pay the IMF interest at a very low rate, the composite average Treasury bill rate of all convertible currencies. They would have free use of their own allocations, but the spending of the borrowed allocations would be appropriately supervised. This should ensure that the moneys are well spent.

It's difficult to think of a scheme where the cost benefit ratio is so favorable. Therefore, in addition to the one-time increase in the IMF resources, through the use of the new arrangements to borrow, there ought to be substantial annual SDR issues in the range of $250 billion annually, as long as the global recession lasts. To make this scheme counter cyclical, the SDR issues could be made callable when the global economy overheats.

It's too late to agree on issuing SDRs at the G20 meeting on April 2nd, but if it were raised by President Obama and endorsed by others, it would be sufficient to give heart to the markets and turn the meeting into a resounding success. I very much hope that you will embrace the idea and encourage President Obama to propose it. It would make a tremendous difference to the world, and it would help the United States to resume its leadership position in the world.

While this is the main message I want to deliver, I also want to endorse President Obama's request for increased international assistance.

The items included in the budget are well thought out. I would particularly comment, the increased support of the Global Fund to Fight AIDS, Tuberculosis, and Malaria, where our contribution mobilizes twice the amount from other donors, it would be a shame to cut it. And I'll be happy to answer your questions.

SEN. KERRY: Thank you very much, Mr. Soros. Mr. Lindsey.

LAWRENCE LINDSEY: Thank you, Mr. Chairman, Senator Lugar, and members of the Committee. I am grateful for this opportunity to be here today.

I associate myself with the perceptions that were stated in your opening statements. I also associate myself with the bulk of the comments of my colleague on the table. My comments have mostly a difference of nuance. I think that America is a cause as well as a country and we represent the concept of economic and political freedom and, actually, our security as a nation is inextricably linked with the survival and success of liberty around the world. That's why I think policymakers must be particularly careful not to take actions that undermine those causes when they deal with current crisis.

In my testimony, which I ask to be included in the record, I point that there are a number of ways we can do a service to our cause and thereby to our country and, listening to my colleagues comments, would like to briefly comment on a third.

First, although it is very common to think that this crisis was created by America, I think that the data do not actually support this conclusion. Obviously, we are the largest economy on the planet and we, therefore, have a disproportionate share of any financial crisis that may exist. On the other hand, I included in my testimony two charges, one on the global housing bubble which shows that, in fact, the bubble in the rest of the world was actually greater than it was in the United States and, secondly, in the amount of leverage in the real estate market which shows essentially that there is no difference around the world between the amount of leverage we extend and the amount of leverage everyone did.

The causes of this crisis were global in nature. They were miscalculations by the global economics profession, by miscalculation in the consensus view of global central bankers and in the private sector. I don't think it was uniquely United States in cause of this crisis.

The second, I think that there are many calls today to reverse some of the policies that create greater economic and political liberty around the world and, because it was the expansion of liberty that led both to an unprecedented advance in global prosperity and the improvements in security in America over the last twenty-five years, I think it would be foolish for us to reverse it. In fact, the biggest threat to our security today derives from that part of the world in which political and economic liberty have made the smallest advances in the last twenty-five years, particularly the Middle East. I think we, therefore, do ourselves a disservice both economically and to our long-term security as a nation when we undermine liberty either by our own actions or by failing to set an example in these areas.

The third point that I would like to make today that is not in my written testimony but was raised by my colleagues is the strain that the United States is placing on total global resources today by our large and historically unprecedented proposed budget deficit. We are proposing a budget deficit, a public sector borrowing requirement, in the President's budget along of 16 percent of our GDP. On top of that, not in that budget where the borrowing will be undertaken by various institutions such as the TALF, the new PPIP, and the PPIF, which are all budget borrowers.

I am not a critic of budget deficits. I've been called a Keynesian and I probably am, but I'm a Keynesian who believes in using a sharp pencil. And when you start with 18 percent of GDP or you start thinking about how one would finance it, obviously, you can only get there through placing enormous strengths on global resources or directly resorting to the printing press. Last Wednesday, the Fed announced that it was seeing the same problems and would actually start using the printing press. I think we need to take the budget deficit, therefore, that we are contemplated, particularly in the long-term, into account and its effects on global economic recovery and our claim on global resources.

These are the general principles I have in mind. I look forward to answering any specific questions the Committee might have and, again, I thank you for the opportunity to be here today.

SEN. LUGAR: Thank you very much, Mr. Lindsey. Let me, on behalf of the Chairman, call for a short recess. We have a roll call vote preceding. That is why the Chairman left, hoping that he would be back by the time your testimony was concluded, I suspect, but in any event, I know that we all want to raise questions of the three of you.

So if you'll forgive us for a moment, I will call for a short recess, go vote, the Chairman will arrive shortly, and we'll proceed with the hearing.

We thank you for your indulgence.


SEN. KERRY: The hearing will come back to order. Thank you and sorry, folks, about the vote. I apologize to Mr. Lindsey for having to run out on you, but I did read your thing so I'm not wholly unprepared here.

Let me ask all of you, Mr. Lindsey, you begin your testimony by saying, you know, America is a cause as well as a country and that is true. Is it important for us to make any acknowledgements here? Is it important for us to have stated a truth about how this began in order to have credibility in the fixing and can we avoid some of the downsides that some people see if we don't do that? I wonder. Do you want to first respond to that, Mr. Lindsey?

MR. LINDSEY: (Off Mike.)

SEN. KERRY: With the mike, again.

MR. SOROS: I think one needs to understand what has happened that, basically, in the last twenty-five years or so, the international financial system has been developed on false premises and it has collapsed. We do have a very serious--

SEN. KERRY: When you say on 'false premises,' can you fill that out?

MR. SOROS: Yes. Basically, the assumption was that markets are self-correcting and should be left to their own devices.

SEN. KERRY: Is that fair to say that Alan Greenspan acknowledged that in public testimony in front of the Congress?

MR. SOROS: I'm sorry?

SEN. KERRY: Well, Alan Greenspan came before the Congress a month or so ago and said, "I didn't realize the degree to which the markets would not regulate themselves."

MR. SOROS: That's right.

SEN. KERRY: I mean, that was an open statement.

MR. SOROS: Yes. Yes. And I respect the fact that he has acknowledged this. Now, we have to -- we actually have two problems. One is that the system has collapsed and we have to rebuild it on sounder grounds. We must rebuild it. We do want an open trading system, we want global financial markets, but we have to put them on sounder grounds. More urgent is to arrest the collapse. We're just having devastating human consequences.

The first task is to stop the collapse, to reinflate, in fact, in order to keep the financial system afloat, and the second, then, is to reconstruct it. As Marvin King of the Bank of England, who also acknowledged the mistakes of the past, has very wisely stated, "What we need to do in the short term, actually, is directly opposed to what we need to do in the long term." In other words, right now, we have to compensate for the collapse of credit by increasing the money supply which we are doing to expanding the balance sheet of the Federal Reserve. In the longer term, of course, we must avoid doing what we did in the past which was to build up a chronic current account deficit and spending up to 6.5 percent more than we were producing. That's the longer term. But we can get back to a balanced position.

SEN. KERRY: What's the 1-2-3 of arresting the collapse?

MR. SOROS: Basically, we have to increase the money supply to compensate for the decline in credit, we have to recapitalize the banking system, and we have to deal with the crisis in the housing industry and prevent housing pricing from overshooting at the downside the way they overshot on the upside. Those are the three domestic. And then the fourth, we mustn't forget it, and that is, in fact, the subject today is we have to also look after and help those countries which are affected by the global economic recession and are not in the position without international assistance to do what we are doing which is to reinflating And we need to do that in our enlightened self-interest because reinflating the economy is a global task and we need the less developed world to stimulate domestic demand and the issue of SDRs would help them to do that.

SEN. KERRY: What do you think of that, Mr. Lindsey? I was wondering if Mr. Lindsey had a response?

MR. LINDSEY: I think you will find very little disagreements on the overall strategy we should be following on this panel. I've known both gentlemen for a long time. I do think there might be a small difference in the nuance with which we approach different tasks.

The first challenge, I think, that we have to keep in mind here is the importance of fixing the banking system first. That is going to require an enormous strain on capital, global capital markets, to fill a hole. The hole is here. The hole is in Europe, it's even bigger in Europe. The hole is even bigger in Asia as a share of their total banking capital.

SEN. KERRY: Effectively, you're talking about a lot of banks that are insolvent?


SEN. KERRY: I mean, that's the bottom line?

MR. LINDSEY: Yes. We probably -- I mean, there are a variety of estimates that are out there and the answer is no one knows for sure, but in the U.S., the number is between one and two trillion, that's the size of the hole. And I think it's important that we fill that hole as efficiently as possible because, when we do it in an efficient way, we put, like, two dollars straight into the capital markets in order to fill one dollar's worth of hole, and I think that that's a mistake because--

SEN. KERRY: Well, it's fair to say that TARP probably fell into the inefficient category?

MR. LINDSEY: The TARP has fallen, yes, the TARP is in the inefficient category and I've felt that a long time.

SEN. KERRY: Yes. Now, I don't want to make this into the banking committee, but I do want to understand sort of how we're proceeding forward here to restore our continence. The plan that's currently on the table offers a public/private partnership to buy a certain number of assets. It seems to me, I mean, that is going to help with liquidity, but I'm not sure that it addresses insolvency.

MR. LINDSEY: Yes, Senator, and I think that the Congress should take a closer look at the approach. I think the Secretary misspoke yesterday when he said that the public sector and the private sector share equally on the upside and downside. That is true for very small changes, but in fact, on the downside, the public sector will carry about 92 percent of the losses and the private sector just 8 percent whereas both share 50/50 on the upside. And I do think that, you know, before we proceed, discover that's the case, and then try and do a claw back like what happened with AIG which would destroy what credibility we have left, that we take a sharp pencil to it now, know that's where it's headed and realize that that may not be the most effective way or efficient way of injecting money into the banking system.

SEN. KERRY: I'm not going to go down that road right now because I want to keep the hearing moving on the international piece a little bit, but there is a lot to talk about with respect to that. My time is almost up.

On the international piece, Mr. Wolf, going back to what Mr. Soros laid out as of 1-through-4, we have increased the money slide, we have done a significant chunk on the housing, we've put a very significant stimulus up as has China, we have now put forward a mechanism for at least removing some of the toxic assets. Let's not worry about cost for the moment--I'm worried about it, but for the purpose of this discussion--so the question now is on the recapitalization. Is that fair? Is that the big hanging out there issue in terms of the global sort of sense of confidence?

MR. WOLF: In terms of the confidence people have in the U.S., specifically, rather than the global solution, I would agree that the question of whether the U.S. has a credible policy overall to fix its banking system over the next 12 months or so, ideally sooner, is certainly an extremely important one.

SEN. KERRY: In the case of fixing our banking system?

MR. WOLF: In the case of fixing your banking system; however, I would go along very much with what Mr. Lindsey said. It is clear that in all the respects that you listed, policies in other western countries and, in this context, I'm actually including Japan for this purpose, is behind on all those fronts. So, while I think in every respect, U.S. policy is far from having resolved the problems it faces and is creating some new ones as we discussed in the fiscal and monetary areas, it is clear that the U.S. is ahead of most other places in addressing these problems. I think the reason for that is that the crisis became evident when we discussed its origins at the time in the U.S. before most other developed countries and most other developed countries have corresponding been relatively tardy in responding.

SEN. KERRY: Well, is there, in your judgment, Mr. Soros, you deal in the market in this way, is it your judgment that people are holding back with a kind of reserve wish that somehow, because of the things already done--the increase in the money supply, the reinflation to some degree through the stimulus and other things--that those assets that are currently toxic and, if you mark the market today, you take a big haircut, may somehow reappreciate also? And if they can avoid a crunch, has that calculated a sense of delay or is it just that this is such a big chunk of money that people are having a hard time wrapping their hands around it? I mean, certainly, the response from Congress so far would indicate a real reluctance up here for people to deal with reality.

MR. SOROS: No, I'm afraid that this will not be sufficient to recapitalize the banks or remove enough toxic assets to enable them to resume vending.

SEN. KERRY: Do you think that is the calculation?

MR. SOROS: That is--it's not sufficient for that. It may turn out to be useful in conjunction with the stress tests that are currently contacted which may result in the need for the banks to accept lower valuations for the toxic assets, in which case, the two prices being asked may actually come together. As it is, I think that will only happen in the very high class assets by actually proving liquidity to the buyer does improve their ability to bid. So, yeah, I could see AAA assets bidden now coming together and actually thereby providing some liquidity to the banks, but it does not solve the problem when it comes to the toxic assets. I think there is more work to be done and this is just one step along the way.

SEN. KERRY: Well, let me say in fairness without letting the cat out of the bag and I actually asked the President this at the caucus luncheon that we had today and he made it very clear that he understands there is more to be done and there are next steps, so I think the stress test is a very important measuring point so that people can get a handle on exactly what the pricing might be and what the levels of toxicity are. Senator Lugar?

SEN. LUGAR: Mr. Lindsey, you mentioned your opposition to the size of the President's budget request and I, along with the Chairman, do not want to get into a domestic quarrel today, but clearly, one of the dilemmas that it presents in whatever size, at least some of our staff came up with the thought that $3.1 trillion dollars or 53 percent of the United State's debt is now held by foreign investors and foreign governments.

This is up from $1.5 trillion since the end of 2003, not five years ago. It is apparent, depending upon how the budget goes, but even more importantly, the appropriations that follow this budget formula, where we obtain the money. Presumably, much will be borrowed in the United States, but I think there's a presumption that much of it will be borrowed abroad.

What are the problems posed by that without getting into specific detail? The Chinese are often mentioned because they have mentioned themselves a couple of times recently pointing out that they would like for the dollar to be pretty solid. We want to make certain we're doing the right things in our economy so that all of their money that's in dollars would not be depreciated. Likewise, just two days ago, mentioning a potential international fund or currency or some equivalent other than the dollar in which they and other people in international finance might decide to put as a diversification maybe of their portfolio. At least there were hints that there might be a worry in due course about the Chinese loaning us money.

But the fact that this has come up a couple of times from the Chinese themselves presents another worry that perhaps the best bet is for everybody still to go to the dollar in terms of safety for reserves, for sovereign funds, for everybody else, but what is your own judgment about the parameters of this problem? And should this influence our domestic debate quite apart from our international debate?

MR. LINDSEY: Senator Lugar, I think you've identified it correctly. Our budget is not just a domestic issue. It is very much a foreign issue and simply because of the way the numbers are. If you go to the back of the President's budget, there is a page that's hard to fiddle with and it has to do with the total expected borrowing requirement. In the current year, the number in the President's budget is $2.65 trillion dollars of borrowing that the CBO would estimate is a little low, but why don't we work with it?

SEN. LUGAR: We were at $5.9 according to my figures at the end of 2008, so $2.75 on top of the $5.9?

MR. LINDSEY: Yes. Now, we have six months left to the year and we have borrowed about $700 of that $2,650, which leaves us with $1.950 billion more to borrow in the next six months by the President's budget. On top of that, any borrow you have for PPIP, PPIF, TALF, whatever it may be will be on top of all that. Let's just focus on that $1.95 trillion.

Now, personal savings rates are going up, the use of some of it will be financed domestically over that period. If we're lucky, I guess, U.S. household savings, including paying off those credit cards and everything else, all of it, would be about $300 billion dollars.

Now we're down to $1.650 billion to raise in the next six months.

Well, there are exactly two--there are three sources left. One, you can crowd out domestic investment and that's not good for the economy. Two, you can borrow it from abroad. And, three, the Fed can print it.

Last Wednesday, the Fed did the same math I just did and said, "Ooops, we're going to have to be printing some of it because we're never going to get there." The Fed said, "We're going to buy $300 billion," so that takes the $1.950 billion down to $1.650 billion over the next six months. To put that into perspective, that is 100 percent of the GDP of China over the next six months, so even if the Chinese didn't eat anything, didn't buy a car, didn't build a building, threw everything into lending it to us, we would just cover our borrowing requirement.

SEN. LUGAR: In the next six months?

MR. LINDSEY: Over the next six months. So it is very much a foreign policy issue and the mention was, well, yes, these other countries need money, right? Iceland is failing and Hungary and the Czech government fell and what have you. Well, when we borrow from the rest of the world, we are crowding out those other countries, so the only two answers are borrowing and global money creation. I think we should just concede we're going to have money creation and both of my colleagues had, but believe me, this is very, very much a foreign policy issue and the President's budget is, I believe, destabilizing to the global financial system, not because I'm against budget deficits; I've got no problem with it. As I mentioned, I'm a Keynesian, but I am a Keynesian with a sharp pencil and, when you take a sharp pencil to it, it doesn't add up.

SEN. LUGAR: Explain to us what it means if the Treasury prints money or creates money. How is this done? What is the effect upon our economy of that kind of creation?

MR. LINDSEY: The Treasury doesn't create money, my former colleagues at the Fed, that's their job, and what they do is they, well, we used to say 'run the printing presses,' it's now done with electrons instead of paper, most of it, but they hit the button and the electrons happen and they generate $300 billion and they buy $300 billion Treasury debt in the process. Because I'm right here and I'm thinking of it as printing the money and that's basically what happens. We expand our money supply in order to buy the Treasury debt.

SEN. LUGAR: What are the implications, then, for us in doing that?

MR. LINDSEY: Well, I have no problem with the $300, I'm worried about the other $1.650 billion, and I think the amount of money creation that would be necessary to cover the budget demands would be very troubling for the price level in the United States.

SEN. LUGAR: And that's just for the next six months, not the next year or the next two?


SEN. LUGAR: And you're back in the same predicament presumably?

MR. LINDSEY: We're back in the soup. It's a little bit, under current numbers, it's not quite as bad, but it's still bad enough that, yes, there is a problem.

SEN. LUGAR: Thank you.

SEN. KERRY: Just to expand the dialogue, do either you or Mr. Soros or Mr. Wolf want to respond a bit to that?

MR. WOLF: I would like to add something. The concern is a completely legitimate one and we certainly cannot imagine the world's market have an infinite taste for either the U.S. dollar or the U.S. government debt. It is striking, however, and it is particularly striking to many of us, for instance, people living in Britain, that here we have a country that appears to be in the throes of a very severe financial crisis and its currency is strengthened and its government's long term interest rate has been more than satisfactory by any standards.

So it appears, at least at the moment, maybe surprisingly so, that world markets--and we are talking about integrated world's markets; we cannot separate American from foreign, they're all in the same markets--are perhaps extraordinarily complacent about this situation and seem to be quite happy about accepting this amount of paper. And I really wish to conclude from that that won't necessarily be true in the future because of costs, as we have perceived well in recent years, markets can change their minds and, when they change their minds, they can change their mind very brutally.

But it is important to remember that the U.S. dollar and the U.S. government have a number of very substantial advantages in terms of credibility, liquidity, a long record of unquestioned survival which other competing currencies or bond markets do not have.

Other governments are going to have very large fiscal deficits. There is clearly very substantial money creation in other countries because, indeed, they're affected by similar crisis.

The question of the survival of the Euro is at least -- I'm not saying it won't -- will disappear, but, certainly, it's a more natural question than the survival of the dollar.

So for all these reasons, I am actually somewhat more relaxed in the short run, by which I mean the next two or three years, about the ability of the United States to sell all this paper and to sell these dollars and for the rest of the world to hold it.

There is an extraordinary demand for safe assets out there in the world, and there will be, without question, an extraordinary increase in desired savings across the whole world, because that's what this sort of recession means. So I'm not panic stricken in the short run.

The crucial thing, however, is that this doesn't go on for many years, because, then, the question of credibility will unquestionably come into play. And that is why having a global solution, which allows the U.S. partly to export its way out of this, have a stronger world economy, as part of the solution, and a credible fiscal profile or TARP out of this does, indeed, become essential.

SEN. KERRY: With the indulgence of my colleagues, I just want to -- because this is an important point to be making here, your agreement -- and I think, Mr. Lindsey, you agree -- I mean, there's been pretty near unanimity that we've got to spend some money to get out of this hole.

MR. LINDSEY: Absolutely.

SEN. KERRY: We've got to spend some money to stem the housing. We've got to spend some money to put people back to work and turn the confidence around. We've got to spend some money to recap the banks. We've got to spend some money to strengthen the IMF and keep some of these Eastern European and other countries afloat. There's almost unanimity on that.

So you've got to be a little careful about holding out this great big debt as something that -- we're forced into this situation. A lot of us are really unhappy about it, because, for the last few years, we've actually been fighting against some of the policies that have helped to put us here, but we're here. And the issue now -- I mean, the president has made it clear. His budget in the out years is clear, focused on reducing the deficit. But you've got to grow the revenues to be able to begin to get there.

Go ahead, Mr. Lindsey.

MR. LINDSEY: Senator Kerry, I agree. I have no problem spending money. I would simply point out that if you're in this bind, it is essential to spend money as efficiently as possible. And, therefore, if you have a -- why don't we call it a $1-1/2 trillion hole in the banking system to sell, it would be imprudent to borrow $3 trillion to have some jerry-rigged system --

SEN. KERRY: Do it the right way.

MR. LINDSEY: -- filling up the $1-1/2 trillion.

SEN. KERRY: I agree with you. That's a good point.

MR. LINDSEY: And that's where I would start. And that was my comment on the --

SEN. KERRY: Let me cut myself off here, because I know some colleagues are time sensitive.

Senator Kaufman, do you mind if Senator Corker were to go and then we come back to you?

SEN. CORKER: I really don't want to jump in front --

SEN. KERRY: Okay. All right. Senator Kaufman.

SEN. KAUFMAN (DE): Thank you.

I'd like to talk about kind of some of the political implications of this economic crisis. Mr. Soros, I think it's fair to say that Russia and China have done everything they can to avoid an open society. And the general consensus is that that's okay kind of because the people of Russia and China thought they were doing better economically. They had hope. They had the idea they were going to do better, their children were going to do better. What do you think the implications are in Russia and China of this economic crisis in terms of politically?

MR. SOROS: Well, I think that China, of course, is also in a crisis. Exports have fallen very sharply. And China is not a democracy. And the rulers know that their hold on power depends on their ability to keep the economy growing. So for them, the top priority is to assure or to do everything possible to stimulate the economy and maintain their target eight-percent growth -- well, it may be only six percent, but something of that nature. And they are in a position to accomplish this. And they did respond with a very large stimulus package. And they maybe fear that if that's not enough they're going to do more.

They also have large currency reserves. And they are liable to use those reserves also to finance their exports, just as they did in the past, lend out the money to buy their goods. They might do the same for others as well. So I think that they will, in fact, be able to recover faster than we will. And if they don't, you may have political and social unrest, and you could even have a breakdown, which would have a very negative effect for the rest of the world. So it's not a desirable outcome in any way.


MR. SOROS: So that's as far as China is concerned. And it's very important, since we have common interests with them, that we should find the proper way to work together to restart the world's economy. And that's why I think using the IMF is a very important foreign-policy objective for us and why I think the SDR issue would be really a major accomplishment for the United States.

Russia is a somewhat different situation, because there's tremendous resentment in Russia. Putin has been popular because he has actually, through the booming oil and gas, been able to provide both security and stability and economic improvement.

Now, you have a very severe financial crisis, a collapse of the Russian stock market and a debt crisis and a severe economic decline. And he is no longer so popular. And there's a real danger that he will become increasingly repressive, and perhaps also aggressive to divert attention from the troubles at home.

So I'm afraid that, from a foreign-policy perspective, Russia is a possible source of disturbance of peace. Tensions with Georgia, for instance, could easily escalate again to military action. Russia has used gas as a geopolitical power tool, may do that again. Russia is eager to reestablish control over Ukraine. Ukraine is in a very serious both financial and political crisis. So I see that as a major trouble spot in the world.

SEN. KAUFMAN: So if that occurs, what are the implications for the United States in terms of both the Russian leaders and the Chinese leaders in the past have used us kind of as a villain, someone to turn to when things are bad to explain why things are bad in their country. You think there's much chance of that happening? And how would it impact on U.S.-Chinese and U.S.-Russian relations?

MR. SOROS: Well, I think it's a very, very -- it's a difficult task, because, on the one hand, Russia has become aggressive, and we must resist aggression, because, otherwise, we reinforce it. So, on the one hand, we have to support Georgia, Ukraine, et cetera. On the other hand, we do have common interests, many common interests with Russia.

So we must really have a two-pronged approach. On the one hand, resist potential aggression, but, at the same time, try to develop the common interests and have a change of heart perhaps in the Russian leadership, which there is some possibility of achieving.

SEN. KAUFMAN: Thank you.

Mr. Wolf.

MR. WOLF: I'd just like to add a couple of comments, because I think it's very important, and I think George Soros brought this out very clearly. There are obvious similarities. As you pointed out, these are not democracies, and they are very different cases, and it's really important to understand this, particularly in relationship to this crisis.

China has, in some very deep sense, invested its whole future to a degree that most of us would have regarded as unbelievable 15 years ago, in opening up to the world economy. Astonishingly, this giant country has the highest trade ratios of any big country in world history. There are three ratios of trade for GDP in China, three times those of the U.S. It's quite extraordinary how far they've bet themselves on the world economy.

Of course, they didn't have a completely liberalized capital market, we know this, but they have accepted a vast amount of inward foreign direct investment, and a large number of investors that by any means are all very happy with their treatment here.

China is riding the sort of tiger of development. They see the future as moving in their direction. They are largely stability oriented. And I think they view this crisis, I suspect, not so much as an opportunity as something that they have to ride through.

But, actually, let me be quite clear, China wants the U.S. to succeed. There's no doubt in my mind that China wants the U.S. to succeed and manage this, because the alternative for them is domestically very destabilizing. And I should stress, by the way, I'm quite convinced that the choice for us is not between the democratic China and the authoritarian China, but an open authoritarian China and a closed and hostile one. So that's a very --

Russia is genuinely revanchist. It is not truly integrating the world economy, except in commodities. It is essentially a commodity exporter, as, of course, you know, and it's suffered huge losses as a result. The government is, in some ways, quite frightening and unstable -- not unstable internally. That's a different matter, but unstable in its attitudes to us, and much more inclined to make difficulties on principle, because it seems to me the Russians still view their relationship with the West in general and the U.S. in particular as a zero sum one. If the U.S. is doing badly, they're doing well. I think that's how they see it, pretty primitive.

I'm absolutely certain -- I've spent a lot of time in China talking to Chinese leaders -- that they do not view their relationships in the same way. Though while I accept the similarity -- it's a very important similarity, of course -- I think we have to view our relations to these countries in very different ways, and also to recognize, of course, that, in the long run, China is going to be a great power with which we will have to form reasonably productive relations over centuries.

MR. LINDSEY: I agree completely.

The one caution I would add to this committee with regard to China, I think their perception -- Martin used the word "ride through." I think of it more as building a bridge to the other side. And on the other side of the river, they expect to be able to continue or resume their large exports to us, and, if that is not possible, then I think in 2011 or so China will find that its bridge has not reached the other bank of the river and then we're going to have the problems that Martin was talking about.

SEN. KAUFMAN: Thank you. The only thing that -- compare anything is they're both non-open societies which are going to go through an economic crisis and that's the implication I want to make.

Thank you, Mr. Chairman.

SEN. KERRY: Senator Corker.

SEN. CORKER (R-TN): Mr. Chairman, thank you. And I know you hesitate to turn this into a banking meeting, but I just want to say that I think this is a very, very important issue and I hope we'll have more hearings on this topic. I don't know of anything more important. I thank you for having this hearing and certainly appreciate these three distinguished witnesses that certainly carry a great deal of clout and many people in the world listen to.

I think, at the same time, it's actually important for us to be very honest about where we are financially regardless of how we got here. And I hope that we'll focus on that in an important way. And, with that, I've had a lot of time with Mr. Lindsey in the past and certainly appreciate his contributions. I'm going to focus on Mr. Soros and Mr. Wolf.

We had a gentleman come into our office, Mr. Soros -- and I know that you've had tremendous experience as a financier around the world -- who made a presentation -- it's from Hamon Advisors, a man named Mr. Bass -- looking at where Europe is today. Okay? And I know we've talked about the relative differences as far as how we progressed on focusing on the financial institutions.

But he laid out some pretty alarming information -- if it's true -- would say that there's a calamity coming in Europe regardless of what policies occur, and it's based on the fact that there's huge amounts of sovereign debt there already. The monetary financial institution assets, as it relates to the size of the GDP of the countries, is very large, in some cases, similar to an Iceland-like situation before, in some cases. Okay?

There's huge structural deficits that are in place, and the interesting problem in those countries, as opposed to here, there are already high tax rates. So, in essence, while we don't want to use the ability we have here to tax higher, they're already at levels that are very difficult to go above in some cases.

You add to that the fact that their financial institutions are leveraged as a group at 37 to one assets to tangible common equity, which is a huge amount of leverage, and then when you have a down side, it's even more problematic. And then many of their loans are to countries outside of their own, meaning they have no control over the assets.

And the picture that you would paint is that, in many of those countries, there's a calamity coming that cannot be averted. And I know that you invest in countries around the world. I wondered if you had any response to that or have looked at that in any way?

MR. SOROS: No, I think, senator, you're right in saying that Europe faces very serious problems. Some of those problems are, let's say, within the Eurogroup, tensions within the Eurogroup, and some of it are outside. And, of course, Eastern Europe, the new members' states are at the focal point of the crisis, because their banking systems are largely owned by Western European banks. And the households have borrowed in foreign currency, strangely, more in Swiss francs, for instance, in Hungary than in euros, but, in other countries, euros. But most of the household debt is in foreign currencies.

And as the banks redraw and pull money out of Eastern Europe, currencies have come under pressure -- they are not part of the euro -- and the households find themselves in a much deeper indebtedness than they thought they were, because most of the loans went to finance real estate. So there is a very serious problem there, and it's very important for them to hold together.

They are, of course, guaranteeing their banking systems, but, since you have got national banking authorities, they tend to -- there is this what you might call financial nationalism within Europe developing, which is a big danger to the European Union. So that is the situation. I think you assess it correctly, and I'm very hopeful that Europe will actually pull together and pull through. But one should acknowledge the difficulties that they are facing.

SEN. CORKER: And so far that hasn't happened, I know.

Mr. Wolf, do you have any comments?

MR. WOLF: Yes. Obviously, I didn't see this particular presentation, so I don't know precisely the numbers involved. Some of them that you've given me, I certainly recognize, particularly the leverage ratio in the banking system. And, in my view, that looks worse than it is, because you have to allow for the fact that there was an extremely large non-bank financial system in the U.S. which performed much of the function that was in the banking system in Europe, and that was more or less completely uncapitalized.

So I think if you look at the leverage in the total financial system, they're very similar, and I think the needs for recapitalization, the numbers that Mr. Lindsey's given, will be very similar in Europe.

Is Europe unable to meet these obligations? Actually, if you look at it, in fact, it's already implicit in what you said, it's quite clear that the biggest fiscal challenge -- again, one shared with the United States -- is the long-term contingent liabilities associated with aging, very broadly defined. They're actually not dissimilar in scale. And the big advantage the U.S. has is -- one you mentioned is it starts with a lower tax level, though whether it'll be easier to raise taxes here will be interesting to see.

SEN. CORKER: -- it'll be very difficult --

MR. WOLF: And, of course, more important, the demography of the United States is more favorable, and that means underlying growth trends are more favorable. That should make it a bit easier to manage this.

Bu the point I would stress, which I think is more important for this purpose, is one aspect of what you said, which is this is a collection of countries and their debt and deficit positions are very different.

SEN. CORKER: That's right.

MR. WOLF: There are a few countries, by no means all and not the biggest -- with the one exception, namely, my own -- which have extraordinarily large banking systems relative to their economies. The UK is the only big country to fall into that category. I am reliably informed, my friends in the UK government, this is all under control. (Laughter.)

It is a very interesting aspect of this crisis and central to your considerations, because it's the border between financial and foreign policy, that we have global financial institutions that are guaranteed by host countries which may be very reluctant or unable to meet all international obligations.

I would like to point out the extreme difficulty created for the United States by the discovery that monies going through AIG ended up in foreign banks. This is a problem for Britain multiplied almost by an order of magnitude. And it's a political problem as much as an economic problem, quite central.

Apart from that, which is mainly the UK, otherwise, the other cases -- Switzerland, which is not, I think, a concern at this level. The really big problem is there are a number of member states in the Eurozone, a number of member states in the European Union that are not members of the Eurozone, which are quite likely to get into sovereign debt problems simply because of this crisis.

I don't believe that will include the biggest countries of the European Union, but there are some less than large ones, and even quite sizable ones, that could be seriously challenged. And, ultimately, the question there is not whether the big countries are able to rescue them, because I believe they are -- we can discuss that in greater detail if you wish to -- but whether they will be willing to.

Ultimately, this is not a federal entity. It doesn't have a federal tax structure. There is no federal government, and so, ultimately, if there were to be a very serious difficulty in the debt markets for particular countries' debt, you might find that some member countries -- big member countries, like Germany, for example -- would be reluctant to rescue them.

The rhetoric we have at the moment suggests they would help them, and, of course, George Soros has proposed the creation of a European bond market partly to deal with these problems. But we do have to recognize, in my view, the fundamental issue is not so much the scale of the problem in aggregate, but its distribution across countries and the less than perfect certainty -- much less than perfect certainty -- that strong countries would, in fact, rescue weak ones in a difficulty. We could well find a test of this within the next year or two.

SEN. CORKER: May I ask one more question based on -- I'd love to, by the way, give you this information. I didn't call out specific countries, because I don't have any way of validating this information, but I'd love give this to you and see if you would consider responding to some of the factual information that's here. You'll do that?

Mr. Soros, I met yesterday with the IMF and Mr. Lipsky, and I notice whenever here in America we talk about China and our debt and then people raising currency issues that obviously gets everybody -- rightfully so -- up in great concerns, and I realize that, right now, that's just talk and what we really need to focus on is making sure we keep our house in order, short and long term.

But, from your perspective, what is the reality of taking the SDR component or some other component, but using that as a potential building block to the IMF for a reserve currency that is, in effect, the one that becomes our world currency and not, in essence, using the U.S. dollar, what is the reality of that? Is that just talk or is that something that might well become a reality in the future?

MR. SOROS: I think it is much more than talk. It exists. In other words, SDRs actually exist. They are on the books of the IMF. It's not a new invention. It's very fortunate because it would take quite a long time to put it in effect. It took a long time to devise it, and it was devised exactly for this contingency of a global shortage of liquidity, forgetting now about the solvency problem as well where it can be helpful also.

So this is the moment when using SDRs on a large scale could, in fact, make a major positive contribution in helping to resolve the problems of the world. You drew attention to the problems that confront Europe. You are fully aware, of course, of the problems that confront us and also the problems that are confronting Eastern Europe are even greater than those that confront Western Europe, and, of course, the developing world is the most vulnerable of all.

And the SDR issue could help particularly the developing world, including, of course, Eastern Europe. And, therefore, it would make a positive contribution, and I think it is an opportunity for the United States to exercise leadership by proposing it.

SEN. CORKER: Of course, it would be very detrimental to the United States in proposing that, would it not?

MR. SOROS: No, I don't think it would be detrimental, frankly. You could -- as an alternative to the dollar, but I'm sure that the dollar will remain the world currency even with the issue of the SDRs. The SDRs are a different kettle of fish. They are a reserve on the books of the IMF. They have to be converted into a currency to be used. So they have to be converted into dollars or sterling or euros or -- (inaudible) -- for that matter, in order to be used for actual trading. So I don't think they represent, in any way, a threat to the dominance of the dollar in the world.

SEN. CORKER: (Inaudible) -- ask questions. I want to thank you all -- all three of you for being here and for your input. I wish we had longer time to be with you, and I hope there's a chance for you to come back in the future. Thank you very much.

SEN. : Thank you, Mr. Chairman. Actually, I just spent three days in Brussels at the Brussels Forum and sat through three days of economists debating these issues, and, frankly, I think I've had all the fun I can take. So I'm going to pass. Thank you very much. (Laughter.)

SEN. LUGAR: Let me take advantage of that and raise one more question. You've all talked a little bit about the dangers of protectionism, but isn't it already the case that many countries, taking a look at their own problems in terms of jobs, including our own, become more protectionist and that, to the degree that that continues, this is not fatal to the scheme, but it certainly is a body blow.

But in terms of common sense, why will countries come to some -- maybe the G20 discusses this or maybe others, the dangers to all of us, but, in the meanwhile, domestic politics being what it is, Mexican trucks can hardly get across our border. We're still trying to keep sugar out of the South from Latin America. All the same old things, literally.

And so crisis or not, people are saying first things first. These are things engrained in our policies in the past and are not easily expunged by summits or by other things. Other countries have similar difficulties.

Is there something about this crisis that is likely to change that ethos? And how might that come about? Yes, sir.

MR. WOLF: This is a subject I've thought about for about three decades and very interested in. I'm, as it were, pretty relaxed. I know free traders like me aren't supposed to say this, but I'm pretty relaxed about the sort of protection we're seeing.

We have experienced protectionism like this in every significant downturn in the last 50 years. It was very bad in the '70s and early '80s, and provided -- we must --have to accept that politicians meeting together in international meetings say one thing and, and behave a little bit differently at home. This is just the reality of the world. And the system we have, the rules-governed system, does in fact allow measures to be taken to protect industries in exceptional cases. And it will be very surprising if opportunities of that kind were not taken in this case.

So I don't think that anything that has happened so far is devastating as it were to the survival of the world -- of the world trading system, nor that anything that has happened should in itself be very, very surprising. So, could it be more dangerous than that? Yes, I think it could be more dangerous than that, and that's what I've been trying to stress in my recent writings.

Protectionism has not been used as a macro-economic policy tool, that is to say as a tool for dealing with general unemployment in any major country since the 30's. It's always been used to deal with the specific problems of specific industries, sometimes important, as in the case, for instance, of automobile production, or in this case, the financial sector, obviously where it's most significant.

Those, I think, are real changes, and if this recession becomes very long and very deep, that the other methods we've talked about, fiscal, for example, or monetary, seem to be no longer effective or dangerous, the policy makers in this situation will turn to the idea of general protection as a way of achieving the holy grail, as it were, of ensuring demand remains at home. And it is for this reason it's so important that demand policies, expansionary policies be agreed across the world, and in my view, particularly so, a subject we haven't discussed here, in surplus countries which have more room for expanding demand to increase their absorption of tradable goods and services. And that's relieving to some significant extent the problems of deficit countries, like the US, the UK, and others.

So my concern is that in that context, of course, people would even be willing to throw aside the rules that were agreed in the GATT and in the WTO, and we would then move from a series of, as it were, from a snowfall to an avalanche. We're not there, there is no sign of it. But if we don't fix this by orthodox macro-economic policy means, and this is very much, I think, the thinking of some of the people of the 30's, that that will happen. And that seems to me the danger we really have to focus on. It's not happened, there's not much of this around, but I think it is where we could be three or four years from now if we haven't fixed this.

SEN. LUGAR: Mr. Wolf, you've mentioned earlier on, as we discussed China the importance of China's willingness to open up to have, not a grand bargain, but at least for us to understand that we need to accept exports from China, that the production, the growth and what have you implies that market is here, elsewhere, but certainly the United States, and on the other side, not expressly, but implicitly, the Chinese have been interested in buying our bonds for safety reasons, but also because this is something that keeps the demand going.

So this is a very important flow, and it's something were to disrupt that, that is the Chinese opening up to the rest of the world and so forth, in terms of our policies, closing it off, we have these debates -- or we used to, a great deal about the value of the Chinese currency, and all sorts of ways of telling the Chinese what to do and so forth. Now, there's less of that, fortunately, in congressional debate, but I counsel us a little bit about China's situation, since it's extremely important to us and to them, and the fact, as you say, it's not a zero sum game. There is a possibility here of seeing mutual advantage.

MR. WOLF: Well, I agree completely with your description of the current situation, the trade between pieces of paper and real goods and services, and it must seem in many ways rather favorable to the United States. But in the longer run, and by the longer run, I don't mean the next ten years. I mean the next three or four or five, I do think, particularly in the context of a general deficiency of demand of the kind we are now experiencing and associated dangers, that we should be expecting. And I think that's the focus of the discussion, at least on macro-economic policy, that the Chinese pursue policies, which start reducing their current account surplus significantly.

I think it is really hard to stabilize the world economy, it's a view I have expressed in a recent book, if a major emerging country like this is running a current account surplus of $400 billion dollars a year or so, which might inconceivably in the long run rise further. I think it is desirable that we discuss with them ways in which this could be reduced. This will of course reduce their capital outflow, but it will also increase export opportunities from the rest of the world. In other words, the rebalancing of global surpluses and deficits in my view, I think it's a view that Keynes would have had in this context, in this sort of crisis, is a central part of the discussion we must be having with other countries around the world, and China is a particularly important one.

SEN. LUGAR: Thank you.

SEN. KERRY: Mr. Soros, fill out for us on the SDRs. A lot of people don't know what they are, the special drawing rights. They're the fourth amendment. There is an amendment to the IMF articles. Is that what you're limiting your comments to, or are you talking about the SDRs in the broader context that some people have talked about with respect to a full blown currency concept under the IMF? Where are you on that? Just fourth amendment, limited one-time draw, or are you talking broader?

MR. SOROS: No, I'm suggesting an annual issue of SDRs. While the recession, global recession is in place. Now, there is an existing pending issue. It's called the fourth amendment, and it's for 21.6 or 23 point -- some billion -- SDRs. And it is actually approved by a large majority of the countries and is only actually pending US approval to be over the 85 percent approval that is needed. That could be used as a -- sort of a -- trial run of how this would work. So it's a very practical proposition. There are some special difficulties or particularities with regard to that issue, because that was conceived 10 years ago to make up for the relative underrepresentation of Russia and Eastern Europe. So it has a more than proportional increase for those countries. So I'm not actually necessarily advocating that we should use that right away. It could be used, but I think it could be perhaps only after a better understanding has been reached with Russia.

SEN. KERRY: Fair enough. Mr. Wolf and Mr. Lindsey, I want to try to resolve in my own mind, and perhaps it's good to have the public discussion, about the degree to which the European experience right now is the result of mistakes that they made on their own, or the result of their having sort of bought in to the so-called Washington consensus about reforms of the last 20 years and practices.

For instance, many of our folks urged them in the privatizing of banking structures and so forth to open it up and allow the purchase of banks. And indeed, Western European countries have bought a significant component of the Eastern European banks. To such a degree that some of those countries are now holding, are holding assets, you know, greater than their own GDP, but also leaving some of those other countries almost without a banking system. So that if they withdraw to themselves now, and sort of take care of business at home, those Eastern European countries are in triple trouble.

Is that a fair -- I mean, where, sort of, how do you assess -- Mr. Wolf, maybe you go first -- how did they wind up where they are today? Was it the credit default swaps? The rapid purchasing? The entry into our housing bubble that created their bubble? How do you, you know, as we work our way through the anger that exists, and you acknowledge in your own testimony, and I mentioned in my opening, we got to have some sense of some sort of, you know, how we got here, I think.

MR. WOLF: Can I (stop ?) this --

SEN. KERRY: Go ahead. Yes.

MR. WOLF: The source in Central Eastern Europe of course is very complicated and but each of us countries concerned always remind us that we're different.

Nonetheless, there is a common element which is obvious enough. And I think we have to start with, not so much with what they were told but with what they, themselves, wanted. After the fall of the Soviet Union, a very important and blessed event, they were encouraged and above all, themselves determined to join Europe and in the same way join the West. It's -- (inaudible) -- clear there's a common desire. George Soros, of course knows much more about this than I did and played a very large role in promoting this.

The -- this was both economic and political and joining the European Union and the European structure was an important part of that. In the process, they committed themselves to opening up and liberalizing their economies and trying to become as much like ours as they -- as they could and did so to a very substantial degree. They integrated in trade to an incredibly high degree, foreign direct investment, open capital accounts and all the rest of it. And in general, looking back on this experience, if we leave aside where we are from now, and we can still get through this, I think, I've no doubt about it, it's been a big success. I think it's important, that you know, with all the things that has happened it the world, I think the opening of Europe and the integration of Europe is one of the great triumphs of Western policy in the broadest sense, and to the American policy.

Now, there are however, it's clear, a few vulnerabilities. First, this became the only region of the emerging world, and truly the emerging only region because of their commitment to this and their will to this to become a very, very large net importer of capital. After the Asian financial crisis, no other region was. All the other regions accumulated reserves and to some extent, therefore, shielded themselves against the shock. These were -- became very dependent on continuing inflows of foreign capital. They run large current account deficits, not all enormous, Poland's is relatively small, but some are gigantic.

So if all the capital is cut off, by definition, they immediately go into a depression because the capital that supported their activity, some cases very small countries have current account deficits of 20 percent of GDP. You can see what happens if that's cut off. So they became vulnerable on that point. They became vulnerable as you rightly pointed out because their banking system (in because ?) in order to introduce high grade Western banks as it would seem, banking became part -- they became part of Western groups and nobody thought this will be dangerous. I mean, truth, I don't remember anybody ever saying we could get into a crisis in which the major banks in Italy, Austria, or Germany might start thinking we should actually have to serve our domestic interest rather than the interest in these countries. By the way, I don't think it's come to that yet, but that was something that we didn't think about. It is the most worrying aspect of this crisis from the protectionist point of view and that's something we didn't think about.

The third thing they became vulnerable to inevitably was Western European demands. They export an enormous proportion of their output to Western Europe and the Western Europeans have plunged into a very deep recession. These are the (prices ?) openness. Now for very small open -- very small countries or countries in which a -- (inaudible) -- with small economies, and Poland still has a very small economy, this integration in the world is inescapable. There's no other way they could have become prosperous. But it is clear now that there were risks associated with that which we didn't fully understand and some which they took to willingly, like borrowing a large amount in foreign currency and therefore the risk of currency mismatches. So they made mistakes and we made mistakes. There's no doubt, and by we, I mean particularly Western Europeans in the advice that was given to them but also, I think, the IMF, the Americans, and so forth.

That's how we got here. But I would stress that despite these mistakes and they were, they made the region more vulnerable than it needed to be, that process by enlarge has been very positive. That means that if we can deal with the problems they now confront, and I believe they're all perfectly manageable with suitable support with insistence that the banks that went and bought their banks continue to operate effectively throughout the region with assistance to make sure that currencies don't collapse too much from the IMF, Western Europe, and so forth by successful policies to re-launch demand in Western Europe which is essential and for which Germany is crucial, I think we can get through this. Mistakes were made but I would not -- and they're clear that there were mistakes and I've indicated some of them, but I don't think that we should start saying that because of those mistakes that something fundamentally was wrong with the effort. This has actually been in many ways one of the greatest successes in both economics and foreign policy of the West in the last 25 years.

SEN. KERRY: Thank you. Very good.

MR. LINDSEY: Yes, if I could echo the point Martin made and not just for respect to Eastern Europe, but the hundreds of millions of people around the globe who join the global middle class thanks to these policies. This is a step back, but it is a step back after two steps forward. It's not three steps back. We are still ahead of the game. Senator, I understood your question to be a little different in that it was sort of a, do the Europeans have their own blame or did they simply get it all from us? And there I would -- I really don't think that -- I think we have an excess of self flagellation on this side of the Atlantic. If one goes back to the '90s, and looks at the creation of the ECB, the American economics profession was virtually unanimous in recommending that this was a dysfunctional setup. I testified before the British Parliament to that effect.

They put themselves in a situation where they created an optimal currency zone -- excuse me they created a currency zone that was not an optimal currency zone. They had no fiscal authority, they had very limited immigration, etcetera. And so a lot of the problems and the dysfunctionality that's now in Europe was really the result of a political decision they made 15 years ago with which we not only had no involvement but, as Americans, tended to recommend against. In addition, we Americans didn't tell the Irish to become a financial center and follow the policies that they did. We didn't tell the Austrians and the Italians to do all the investing in Eastern Europe that they did. We didn't tell the Spanish to invest in Latin America to the extent they did. They did that without our help or participation.

It's more that Europe and America made the same mistake than we exported our mistakes to Europe. The world financial system is global in its precepts. London is at least as creative a place as New York is, and monetary policies on both sides of the Atlantic were very accommodative of a bubble for reasons that, you know, have causes to defend. So, I really don't think that we should blame ourselves. We are part of the problem but they're grownups and they made their own mistakes along with us.

SEN. KERRY: Well, thank you all very much. Mr. Soros, I want to ask you if you want to summarize, have the last word here with respect to the foreign policy component of this and the challenge we face. If you just want to sort of leave the committee with some last thoughts pulling the afternoon together, that'd be terrific.

MR. SOROS: Well, all I'd like to say about what I think we've been, I think, saying going along, the situation is very serious, that it is a genuine collapse of the financial system the likes of which we have not seen since the 1930's. But we have the experience of the 1930's to learn from and we, I think we are trying not to make the same mistakes as we did then. So, the lessons of the 1930s were summed up in John Maynard Keynes journal theory which was published in 1936. We have the advantage that that book is now available. We can take it out of the drawer and dust it off and use it.

SEN. KERRY: There's another interesting book, incidentally, which I just reread the other day which is John Kenneth Galbraith's The Crash -- (cross talk) -- 29, which is well worth the wisdom in it particularly with respect to some of the -- (inaudible.)

MR. SOROS: And just in summary, I just would like to once again emphasize how we do have this special drawing rights which again, is in existence, is real, and it can be used and could make a major contribution to alleviating the problem.

SEN. KERRY: Last question Mr. Wolf. What's the most important thing that has to come out of the G-20?

MR. WOLF: I think the single most important thing, given where we are now, there has to be a really big demand commitment from the surplus countries otherwise the U.S. ends up with this nightmare fiscal proposition. They are the mirror image of each other. I think that's absolutely central and there must be clear and credible ways forward for the fund IMF system of which the SDRs are part. Those are the two absolutely essential elements in my opinion.

SEN. KERRY: Demand piece means?

MR. WOLF: Demand piece means that I think that the Germans, Japanese, and Chinese have to have a target for the domestic demand which clearly means they start reabsorbing their surpluses at home.

SEN. KERRY: Fair enough. This has been excellent. We really appreciate it. It scratches the surface of complicated issues but it is a terrific outline and we're very, very grateful to all three of you for being with us today. Thank you. We stand adjourned.


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