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This meeting is part of the McKinsey Executive Roundtable Series in International Economics, presented by the Maurice R. Greenberg Center for Geoeconomic Studies and the Corporate Program.

MICHAEL ELLIOTT:  Good morning, ladies and gentlemen.  Thank you.  Thank you so much for getting up early on this bright and cold December morning to join us at the Council.  There's been extraordinary interest and demand for this session, and we're delighted to see you all.

My name's Michael Elliott; I'm the editor of Time's international editions.  And we have a distinguished group of economists on the platform with us this morning, who I'll introduce in just a second.

We've all seen them: the arrogant Englishmen flying over, arriving at Kennedy airport with extra suitcases, wandering around New York buying all their Christmas shopping with impeccable taste, going back to London with 200 "I Heart New York" t-shirts, and bragging to their friends that they've done nothing but eat at the best restaurants in Little Italy. 

We've got used to the boastful and proud Canadians swarming across the border from Toronto to Detroit and Buffalo -- (mild laughter) -- saying, in that arrogant way that the Canadians have, that although five generations -- (laughter) -- that although five generations of MacKenzies have gone to McGill, Yale looks such a bargain this year that little Cameron might go to New Haven.  (Laughter.) 

And when we've traveled, we have ourselves felt the dollar's decline as we've got used to $10 macciatos in Rome and $10 kirs in Paris and theatre tickets in London that only Goldman partners can afford.  And as December stretches into January, you can hear a kind of worried rumble throughout New York: Will I really be able to afford to go to Davos next month?  (Laughter.)

To discuss these and other topics, we have a wonderfully distinguished panel.  On my immediate left --

STAFF (?):  (Off mike.)

ELLIOTT:  Oh, I should say.  Sorry.  That reminds me -- logistics.  Set cell phones on "stun" or whatever.  Actually -- switch them off, actually, and any other electronic devices that we have with you. 

We have an enormously distinguished panel to discuss "The Falling Dollar:  Should We Worry?"  On my immediate left, Richard Clarida, professor of economics at Columbia University and formerly assistant secretary of the Treasury for economic policy.  Next to Richard, the legendary Jim Grant, author of Grant's Interest Rate Observer, the modern-day heir and legatee of Walter Bagehot, editor of The Economist in the 19th century, author of Lombard Street, after whom I once wrote a column, actually, come to think of it.

Next to him is Benn Steil, who is senior fellow and director of international economics here at the Council.  Then on our far right, one of the world's most distinguished monetary and financial economists and, of course, former undersecretary in the Treasury, visiting us from the West Coast, professor at Stanford, senior fellow at the Hoover Institution, John Taylor.  Welcome.  Welcome to all of you.

We've been reading the front pages.  We've watched financial news dominate discourse from the summer right on through to the new year.  We've read about credit crunches and sub-prime crises.  We've watched the Fed and other central banks launch a rescue package or some sort of package, which I hope we talk about later.  We've seen currency fluctuations.  We worry that inflation might be being imported through weak currency.  We wonder whether competitiveness, on the other hand, is being enhanced, as the price of American goods becomes more competitive in world markets. 

Benn, what do you make of it all?

BENN STEIL:  Well, Michael, as you know, I've been in the concerned camp for quite a few years, but I think since September and the hundred basis points' worth of Fed rate cuts, I've moved into the pessimistic camp.

I think we're seeing a degree of foreign official concern about the role of the dollar as a reliable long-term standard of value that we haven't seen since the 1970s, in the wake of the United States' reneging on its commitment to back the dollar with a fixed amount of gold.

And the problem back then, as it is now, was identified as the Triffin dilemma.  The Triffin dilemma was named after famous Belgian American economist Robert Triffin, who testified before Congress in 1960 arguing that the world faced a fundamental problem when it used the national currency as an international currency.  That is, the United States, as the provider of the international currency, had to run persistent balance-of-payments deficits in order to supply the world with the dollars it needed.

But the buildup of these deficits over time, he argued, would inevitably undermine confidence in the dollar as a store of value, and would bring the system to an end.  And it did indeed come to an end in 1971.  And now that the dollar's no longer backed with gold, the Triffin dilemma still exists; it just takes a heck of a lot longer to play out.

And the reason I think we're seeing such concern right now is twofold.  First of all, over the past 10 years, we've seen an enormous buildup in foreign holdings, particularly foreign official holdings, of dollars.  That's been a good thing, a quite flattering thing for the United States that foreigners have wanted to accumulate dollars, but it's driven the current account deficit up to record levels.

And in September when the Fed started cutting rates quite aggressively, inflation was already at 3.5 percent.  Now it's up to 4.3 percent, and we are now exporting inflation worldwide, in particular to Asia and the Middle East, where most countries there have pegged their currencies to the dollar for decades.  And they've imported U.S. monetary policy over the decades, for very good reasons.  That is, that most of their trade is actually denominated in dollars, so it was a pretty smart thing, essentially, to take policy from the United States.  But that's no longer sustainable.

Inflation in some Gulf states is now pushing over 10 percent and, of course, these countries in the Middle East, in Asia, are our biggest creditors.  And when they begin to lose confidence in the dollar, I think we need to start showing some concern in terms of our conduct of monetary policy, in particular. 

ELLIOTT:  Thanks very much.  I should say, otherwise people from the Council will never invite me back, this is an on-the-record meeting.  This is not one of the Council's on-the-record meetings (sic).

Jim.  Concerned?  Bearish?  Worried?  Optimistic?

JAMES GRANT:  Yes, Michael.  (Laughter.)

The dollar is, when you step back and look at it with some perspective, it's kind of the -- I think it's the greatest achievement in the annals of money.  Here it is, this piece of paper of no intrinsic value, which is held as value, which is used as invoicing currency, as a store of value the world over.  And yet there is nothing behind this piece of paper except the bland assurances of the issuing government.  And, of course, the wisdom of Congress.  (Laughter.)

So there have been, since the late 19th century, currencies that have been, as they say in the economic quarterlies, the hegemonic currencies.  The pound sterling ruled the roost for much of the 19th century, indeed, much into a half of the 20th century, the dollar's taken over.

Unique in the annals of money is a reserve currency that is uncollateralized.  You can exchange the dollar into pennies, nickels, dimes, and quarters, but into nothing else.  And this historical anomaly is, I think, the thing that is now being tested.  The world has accepted this piece of paper as value.  I think the world is beginning to ask, in a still-inarticulate way, what there is, exactly, behind it.

And as Benn said, it's flattering that so many of our dollars wind up in the bank accounts of so many foreign creditors.  It would be more flattering if these foreign creditors were profit-seeking individuals who bought dollars because they were thunderstruck by the value that the United States offers in its investment markets.  Sadly, most of  these dollars are absorbed by foreign central banks, and of course, the way that a foreign central bank absorbs -- or any central bank absorbs any asset is to create the wherewithal to buy it.

So as Benn said, until 1971, there was the Bretton Woods system.  In this system currencies were exchangeable and the dollar was exchangeable into gold bullion at $35 per ounce.  Since 1971, we have had kind of a faith-based world in which currencies are not exactly defined.  Exchange rates may or may not float; some of them sink. 

But the characteristic feature of our system today is that these dollars are absorbed by central banks that print money with which to buy them.  So this is a kind of an awkward formulation, but our system today is the printing-money-with-which-to-buy-dollars system.  And doesn't it sound just a little bit inflationary?  (Laughter.)

ELLIOTT:  Very good. 

Richard, what do you think's happened in the last six months, but in particular in the last few months, that gives us a clue of what's likely to happen next year?

RICHARD CLARIDA:  Well, I'd like to take the other side before I answer your question.  I think the adjustment in the dollar to date is understandable.  I think it's appropriate.  I think, on balance, it's stabilizing for the global economy. 

You mentioned the current account deficit.  It has shrunk by about 2 percent of GDP.  The U.S., which was the engine of global growth from '01 to '05, is now the caboose.  The Fed is cutting interest rates, I think, appropriately, given the U.S. business cycle, and in that environment you're going to have a decline in the dollar.

I think the current monetary arrangement that the two previous speakers mentioned, with China and the Middle East countries accumulating reserves, I think that regime probably continues, but it is evolving.  And I think that evolution is appropriate.  Over time, there will be fewer dollars accumulated as reserves, and more euros.  And I would certainly hope and expect we'll see more currency flexibility in China and, following that, probably more in Asia. 

So I'm in the camp that thinks the adjustment of the dollar is appropriate, will continue.  And I don't see a fire sale or a crash landing, but I do see an evolution in the current system.

To get to your specific question, I think the last several months are quite understandable.  Again, the Fed was out of the gate, easing monetary policy more aggressively.  Recall, as recently as May there was a speculation that the next Fed move would be a hike, because of the booming U.S. economy.  And of course now we've had 100 basis points of easing, and more to follow.

Also, notwithstanding some flattering growth numbers in Q3 and Q4, the underlying momentum in the economy is substantially slowing.  And whether or not it's Feldstein, Greenspan, or esteemed Wall Street economists, we're all seeing slower U.S. growth.  So I think in that environment -- slow growth, the Fed easing -- you get an adjustment in the dollar. 

I'd finally like to say, and I think this is important for most of the folks in the audience who are not academic economists, which is a good thing.  (Chuckles.)  Because it's important to understand that currencies can adjust to achieve adjustments in relative prices, and I think that's what's going on now.  And a weaker dollar can also be evidence of bad monetary policy.

I think right now, the weaker dollar is in the first category.   It's an important adjustment to global relative prices that's helping to rebalance the global economy.  I have every faith that the Bernanke Fed, like the Greenspan Fed, ultimately will achieve low and stable inflation and, under that scenario, I don't see the dollar being displaced as a global reserve currency.

ELLIOTT:  John.  Bearish, bullish, optimistic, think the worst is over?

JOHN B. TAYLOR:  I think Jim Grant's answer, yes to all that, is a good one.  (Laughter.)  I think -- no, seriously.  Just as a former policymaker, with responsibility, so to speak, for our currency in the 2001-2005 period, I can say we should always be concerned about our currency.   As some of the speakers indicated, it's very much related to policy.

And a monetary policy that maintains the purchasing power of our currency is essential.  A fiscal policy that keeps the budget from expanding is essential.  I think a foreign policy more generally that makes America an open place welcomes investmentism.  All those are very important for our currency, and I hope we continue with those.

When I was on the job, we would frequently get either headlines or calls or messages about the dollar's going to collapse, there's going to be a crisis.  And of course that worries you all the time.  But I have to say, we've had a movement of the dollar against the euro, against other currencies, not so much against the Asian currencies. 

But it seems to me, as you look at it, this has been a fairly orderly movement of the currencies.  And I think that's because of the policies' trying not to talk down the dollar; never talking down the dollar -- that's a terrible policy -- but also not intervening, trying to avoid intervention, avoiding verbal intervention as much as possible.

With respect to recent events, last November, George Schultz and I wrote a piece for the FT.  We noticed some, we thought, some important changes.  Perhaps the current account, the most important, which we've seen in adjustment for over a year now, that's coming down. 

That used to be the big worry about the dollar.  Current account up, dollar down.  Well, we've had an improvement in the current account; that's to some extent a silver lining of the sub-prime prices, because investment is down, housing is down, therefore the gap between saving and investment is down and the current account is adjusting.  Other things equal that, so that means the dollar doesn't have to do as much work.  So we were cautiously optimistic about the dollar a month ago, and so far that's come about, I think.

And the other thing I think, very recently, is a recognition that, especially with the inflation numbers last Thursday and Friday, the retail sales numbers last Thursday, that the assumption that there was going to be major easing by our central bank is quickly diminishing, and I think that's right.  I think there are inflation issues, and that's why the Fed is unlikely to be in the business of major interest rate cuts.  And that's also bullish for the dollar.

ELLIOTT:  Just on the inflation point, to anticipate a question that we're bound to get from the floor, so I'll ask it, have we seen any signs of importing inflation through our weaker dollar yet, or has that worry, which has been a traditional worry about a decline in the external value of the currency, not really shown up in the figures?

TAYLOR:  Well, very little so far, fortunately.  You could say the last week, maybe there was a broader movement across.  But this is a major change.  It used to be the dollar would -- or other currencies' movements -- would affect the inflation rate a lot.  It hasn't happened much in recent years, not just in the United States, but other countries. 

And I think the reason for that is monetary policy.  It's focused on trying to keep inflation low, compared to the bad old days of the '70s where we had ups and downs and a real mess -- not only in the United States, in many other countries.  So this policy of focusing much more than in the past on price stability I think is one of the reasons we've seen less pass-through than in the past.

ELLIOTT:  John mentioned an orderly movement of the dollar, which I wrote down, and I wanted to come back to Benn and Jim, who are on the -- I don't want to kind of use simple bull-and-bear indicators here -- but on the, perhaps on the kind of slightly more worried, concerned end -- though everyone's probably concerned. 

Benn, do you see an orderly movement continuing, or do you think there is a risk of what the newspapers would call a collapse or a dollar run or what have you?

STEIL:  I think a lot depends on what the Fed does from now on.  If they continue to cut rates aggressively, I think we could see a disorderly adjustment of the dollar exchange rate.

I think the main reason to be concerned that the current account movement has not been sufficient over the past year is that private capital inflows into the United States have all but dried up in recent months.  If foreign official inflows should also begin to dry up, then we're at significant risk of a disorderly adjustment. 

Two brief points with regard to monetary policy, to explain why I'm concerned.  The Fed has not, in its official statements, pointed to any evidence of disinflationary effects, for example, of the credit crunch.  They've talked about growth risks.  There are many possible reasons why growth in an economy may slow down, one of which is that productive resources that have been dedicated to one sector or several sectors -- say, housing -- need to be reallocated to other sectors.  In other words, we've been allocating too many productive resources to one sector.  Needs to move to another sector.  In that particular case, printing more money never helps; in fact, it makes a situation worse by delaying the adjustment and making the adjustment in the future much sharper and much more severe.

Second, with regard to the credit crunch that we're experiencing right now, it's a very serious one.  I've got a piece coming out in the FT on Friday with a proposal for dealing with it, and it doesn't involve cutting interest rates.  I don't believe the provision of extra central bank liquidity in a case like this actually helps, because the problem in the markets right now is legitimately a credit risk problem. 

That is, ask yourself, if someone came to you and said, I'd like to borrow a million dollars to invest in a Ponzi scheme, you would almost certainly say no.  But if you learned that the Fed was going to cut interest rates by 50 basis points, that still would not affect your decision.  You would not be more likely to lend to such a person, because your concern is that you're not going to get your principal back.  That is the problem as a credit risk, and that's precisely what we're seeing in the markets now.

Banks are concerned about lending to other banks for more than a day or so, because they don't know about the health of their counterparties.  Until we resolve that problem, we're going to have extreme difficulties in the credit markets.

ELLIOTT:  Jim, in the grand thinking again about this orderly movement that John was talking about, in the grand sweep of history, what is it that turns orderly movements into disorderly movements for currency?

GRANT:  Well, if we're talking about a run, there must be something to run to.

ELLIOTT:  Right.

GRANT:  And in a world of currencies equally collateralized -- that is it say, equally with the promises of the issuing governments and the wisdom of the governing authorities -- it's not clear what the inherently sound alternative might be.  Now, this bit of gold bullion in the world's not nearly enough, if everyone took a shine to that, to accommodate all comers.  So you see a kind of a serial shuffling of assets from one denomination to the other.

The dollar is a bit of a puzzle for anyone who fancies himself or herself a seeker of investment value.  Objectively, as you noted with these hoards of arrogant Canadians, the dollar is, on its face, a (bye/buy ?).  And if -- and the CFR does not pack the house with people to talk about a problem (till ?) that problem has not been somewhat discounted.  So we can all agree that the dollar is, you know, is not the sale it was, say, five years ago.  But the dollar is, as they say, the world's reserve currency.  It is the top monetary brand in the world, and it's got nowhere to go in market share, really, except a little bit lower.

And, you know, it might just be that posterity, examining this era of our monetary history, might say that this was the conclusion of an experiment in paper money.  We had an experiment in paper money during the French Revolution; that didn't work out so well.  We had one in the American Civil War, similarly.  There was experiments -- there were experiments in the inter-war period in the 20th century with floating currencies and with monetary non-orthodoxy.  They, too, were deemed a failure.  Bretton Woods has been widely deemed a great success.  This might be that 35 or 40 years of the printing-money-with-which-to-buy-money era is going to be reckoned a time whose time has come.

ELLIOTT:  Richard. 

TAYLOR:  Can I just --

ELLIOTT:  Sorry.  John, yes.

TAYLOR:  (Inaudible.)

ELLIOTT:  Yeah.

TAYLOR:  I think this is a good way to think about it, because the currency really is determined by our government officials, and what -- incredible they are.  But let's remember, this -- we've had 25 years now, since November of 1982 through now, just one month and 25 years, of remarkable economic performance in the United States, and now it's spread around the world.  I call it the long boom -- 25 years, two minor recessions, three long expansions, and even if this one doesn't continue, it's a long expansion. 

And I think that's because of this effort to keep inflation in check.  A monetary policy that recognizes the importance of a strong currency, purchasing power being maintained.  And as long as we continue with that, and I think there's always reasons to worry about it and be skeptical about it, but that's an amazing accomplishment.  Twenty-five years.  I mean, that's longer than Bretton Woods.  So let's think about that.

ELLIOTT:  Richard.

CLARIDA:  Well, no, John said it well.  And I think it's also important to note that you can look at the price of oil, price of gold, but there are direct indicators that are available that indicate where the markets think inflation is going.  Inflation index security is -- I think one of the great contributions of the Rubin-Summers Treasury was to introduce those here.  But most countries have them, inflation swaps and derivatives.  And so you can see every day where the markets think inflation is going.

And just to follow up on John's point, since countries have pursued inflation targeting, this is not just the G-7, but now in many emerged or emerging economies.  And you see not only this performance, but you see very well anchored inflation expectations.  And it's important to note that even in this fall, when the Fed has eased 100 basis points and there have been headlines about the collapsing dollar, inflation expectations have been well anchored.  So I think so far, the evidence is certainly that this will continue.

I should say that t here's always a tail risk of a disorderly adjustment, and those of us who tend to not emphasize that as a baseline case, it's certainly -- I'd like to be understood that there is a scenario.  Certainly, in a case where China reverses course and decides to sell $1.5 trillion of reserves and convert those into euros, you do have a full-blown crisis. 

But certainly the Chinese have indicated publicly, and when I've chatted with them, that they have a longer-term development strategy that involves a very gradual -- perhaps, by my assessment, too gradual -- transition to a more open capital market and a more flexible rate.  I think the evidence indicates it would be in China's interest right now to allow a faster pace of currency appreciation, with the expansion in their trade surplus and in domestic inflation. 

So I think there are these pressures that the other speakers have alluded to, but I think that the path is not one of a collapse or crash; it's one of an evolution of the current system in which the dollar continues to play this role, but with a gradually diminished share in global financial assets.

ELLIOTT:  Jim.

GRANT:  You know, Michael, it just might be -- and Richard and John, it might just be that the difficulty we face is exactly the problem that stems from targeting inflation, as defined.  Inflation as a defined term.  All the central banks have a very sophisticated way of defining it, much -- with many of the people who go shopping every day.

But the world is a cornucopia.  This indeed has been a time of great abundance, of terrific advances in productivity, of the annexation of two formerly estranged and primitive economies into the world's productive scheme.  It's been a unique era in world economic history.

But then shouldn't we have expected prices to fall?  Prices fell throughout the late 19th century.  It was a time of great advances in technology, of opening up of new areas of the world to production.  Prices gently declined -- or not so gently, if you were a farmer.  But in any case, they subsided over the course of 40 or 50 years.  There were no central banks that were operating as our central banks do.

So fast-forward to another era of superabundance and productivity and technological wonders -- our own.  Now we have central banks.  The central banks, manned by MBAs, PhDs, and other sophisticates, target inflation.  They don't want to see too little inflation.  In our own case, the Federal Reserve in 2002 and '03 actually said we will not stand for too little inflation.  We want just enough.

So these sophists, if I may speak technically -- (laughter) -- targeted a measured rate of inflation of 1.974 percent.  They calibrated this.  And they suppressed interest rates until they got their desired rate of inflation.  So Alan Greenspan was forever prattling on about productivity growth, and -- we've seen it. 

In the context of the opening up of India and China, of the wonders of digital technology, of the advances in productivity growth, why shouldn't prices have subsided?  We wouldn't allow it.  We wanted them to go up; they did.  We created the bank credit to force them up -- hypothetically, I say -- and the result has been an inflation of unmeasured asset prices.  Of houses, for example.  Of the prices of fixed income securities that were actually not so fixed.  So there's been a huge inflation in things they didn't measure, and that inflation is now manifest in a terrific global credit crisis. 

So I say that the world monetary system is father to this crisis.  The macro is connected to the micro, and the shinbone to the thighbone.  (Laughter.)

ELLIOTT:  Thank you. 

Benn, you wanted to come in.  I want to -- in a second, I want to kind of shift off focus to outside the United States.  But Benn, you were trying to get my --

STEIL:  I wanted to piggyback on Jim's comment.  I think inflation targeting has been a tremendous innovation, given the monetary system that we've been working under since the end of the Bretton Woods system.  But the big problem is what exactly it is we're targeting. 

Just like, for example, you can believe, like Milton Friedman, that inflation is always a monetary phenomenon, but it's very difficult to target the money supply because we don't really know what money is in this complicated monetary environment any more.

The point I would emphasize is that excessively loose monetary policy that destabilizes an economy does not always show up right away in the consumer price index inflation figures.  For example, in the 1909s in developing countries, in Indonesia and Mexico, in South Korea, we saw huge run-ups in asset prices over many years before they experienced financial crises and then currency crises.  And inflation was remarkably subdued, right up until the time that the financial crisis hit.

What's been the story of this decade in the United States?  A huge run-up in property and housing prices, asset prices of all sorts.  I should emphasize that the gold price and the oil price in particular have reacted immediately to the Fed's decisions on rate cuts.  We've seen a huge run-up in art prices and, of course, we've seen a huge run-up in the price of alternative monetary instruments to the dollar, like the euro.

In other words, we're seeing clear evidence that monetary policy is too loose in the United States.  When will it show up in the CPI figures?  Well, I would argue, with 4.3 percent inflation, it's already there. 

But if you are unconvinced, once foreign official inflows into the United States start drying up and the dollar starts declining more sharply, then you will see it show up in the CPI figures.  And by that time, it might be too late because inflationary expectations will have already been ratcheted up.

ELLIOTT:  Painfully to say that the Canadians have got tons oil and gold, too.

John, you in the first term of this president were responsible for international economics at the Treasury.  Talk to us a little bit about what nations outside the United States expect from U.S. currency policy and what our leading partners are thinking about what's happened in the last year.

TAYLOR:  Well, with respect to the G7, it seems to me there's a lot of agreement about how to proceed on currencies. One is to, as I said, avoid intervention in the markets.  There hasn't been an intervention by the United States or the ECB, the Bank of England and the currency market since September of 2000.

ELLIOTT:  Right.

TAYLOR:  I think that's a good record. I think it's one of the reasons why things have been somewhat orderly. You know, a lot of speculation about whether they're going to -- whether the Treasury's going to be there or not.  That's actually reduced.  I -- when I was in charge, the traders used to say, "Can't you say something?"  I'd get a little volatility.  We are not making any money with this little volatility.  So I think that's part of the reason.  I think there's a general agreement that that's a good way to proceed in the G7. 

I think with respect to the Chinese currency, there's more of an effort to get more flexibility in China.  I think they want to do that, too, but the general multilateral approach to China, I think, has been good.  You know, we don't talk it about too much, but there is actually this three-pronged strategy that the G7 and others have put together.  One is to reduce the budget deficit in the U.S -- and by the way, it's come down remarkably, it's 1.2 percent of GDP -- it's a huge reduction; two, to have faster growth around the world compared to the U.S. -- well, that's happening; and three is to get some movement in the Chinese currency.  It's appreciated by a little -- about 11 percent since it's begun and they want to do more. 

So it seems to me that that basic strategy is working.  Not instantaneously -- it never does, but it's on the right track.

ELLIOTT:  Richard, you were suggesting earlier that we're seeing a gradual evolution to a new paradigm -- to a new structure.  What -- how are G7 and other partners playing a part in that?  I mean, how is policy coordination coming along?

CLARIDA:  Well, I've been away from it for several years.  But when I'm over -- I was just in Europe last week.  And when you speak to policymakers, I think they very much, in private, convey the message that John just did, which is there more or less is agreement among the G7.  There is frustration, I think, with the slow pace of currency movement in Asia.  But I'd actually like to jump on and actually agree with something that Jim said.  We are in a world -- international economics is always about relative evaluations.  So there really is no absolute.  There's comparative advantage, there -- relative inflation and so the issue about the euro supplanting the dollar is obviously one that has been discussed and thought about. 

But if you think about it right now in the current environment, it's not at all obvious that the Europeans would welcome a big valuation increase in their currency where it is now.  It's not clear the European financial markets are really geared up to handle those sorts of inflows.  And ironically -- and I'm not saying there's a good outcome, it's just the reality -- the reality is that even though subprime loans were originated in the U.S., they were sold around the world.  They're on the balance sheets of UK banks, they're one the balance sheets of German and French banks.  So even if you had a flight of quality away from the dollar, it's not obvious you want to go into the pound or the euro right on that basis. 

So I think in general, I have nothing really to add beyond what John said.  I think there's pretty broad agreement in the G7.  I think the real issue for the next decade, for the next president and the next set of policymakers is going to be the integration of these rapidly emerged growing economies, whether or not they're in Asia and the Middle East or in Latin America, in the global financial system, and on balance, that's a positive, but there are obviously going to be potentials for missteps and dislocations along the way. 

ELLIOTT:  Benn, you were in Europe as well last week.  Are they screaming or are they, as John and Richard suggest --

STEIL:  I'm just back from Paris and would point to some comments made by French President Sarkozy recently.  He said that if the dollar were not stabilized, it could lead to, quote-unquote, "economic war."  Now that may be a little bit of hyperbole, but I'd like to put a sort of darker spin on what Rich was saying. 

Let's consider what it would actually mean if the euro were to become a more significant reserve currency.  Two things immediately.  First of all, a very significant further appreciation of the euro against the dollar.  Secondly, the eurozone would have to start running persistent current account deficits to supply the euros that the world would be saying we want.  Is Europe willing to tolerate both those things? 

ELLIOTT:  Hmm.

STEIL: And when President Sarkozy refers to economic war, I think that's what he's getting at -- that the European policymakers would rebel against that sort of shift in the global monetary system.  How would they do it?  Rampant protectionism. 

ELLIOTT:  Right.

STEIL:  I think it could be a huge threat to the global trading system if we were to see a major rebalancing of reserve currencies.

ELLIOTT:  Richard, you're -- you've been nodding in agreement as Benn's --

(Cross talk.) 

CLARIDA:  I think -- I think that's a logically consistent scenario.  Again, to me it's a very low-probability event because I don't think it's in China's interest to cite one country to move away from the current regime.  After all, by all accounts it's really the Chinese who resist a faster appreciation in currency diversification.  But certainly, it logically follows that if we were to get it in that low-probability event, it would be very -- it would be disruptive for the reasons that Benn mentions, yeah.

ELLIOTT: What was it exactly that the central banks did last week in their coordinated intervention Wednesday and Thursday?  And what was it designed to do?

John, do you want -- do you want to have again?

TAYLOR:   Well, it's designed to try to deal with a lending problem in the -- a term interbank market where banks, as Benn was saying before, have been reluctant to lend to each other beyond a certain short maturity.  And it's not so much, I think, concern about their counterparty.  It's the concern about their own balance sheet.

ELLIOTT:  Right.

TAYLOR:  The traders --

ELLIOTT:  Right.

TAYLOR:  -- don't want to put a lot of money up there when they don't know what their own balance sheets look like.  So that's caused the LIBOR to be higher than normal and that, of course, has big impacts through all the derivative securities that are written on LIBOR, including a lot of subprime and other kinds of mortgages.  So this effort is to try to offset that by providing liquidity longer-term to a larger set of players in the market beyond the usual primary dealers the Fed deals with.  And that's the goal.

I think it actually is a good step.  I don't see it having a big impact because the ultimate source of the problem is the issues in interbank market and -- well, also, it'll affect the rate a bit, but I don't think it'll bring it back down.

ELLIOTT:  But it did speak to a certain -- if you like, kind of maturity of cooperation among international financial and lending --

TAYLOR:  Absolutely.

ELLIOTT:  -- institutions.

Jim, you wanted to comment on this?

GRANT:  Yeah.

I -- consider that about six months ago, credit risk was at the bottom of a long list of things that people would think about every other Sunday when they get around to it.  The world was perfectly sanguine with respect to counterparty risk.  A few months pass, August comes and followed, as usual, by September, but -- (laughter) -- more drama later in the year and suddenly credit risk is at the very top of everyone's list.  This ought to give us all humility about the so-called foreseeable future, which may be as long as 15 seconds. 

How can we talk about the probability or the certainty as some people not on this rostrum, but the -- you -- open the Wall Street Journal and you hear other people talking about -- you know, where the Fed's fundraiser's going to be 12 months.  How can you know that?  How can you possibly anticipate with any degree of certainty what the future holds when this whole subprime business scandalously came upon us like a thief in the night when, in fact, it had very loud footsteps creeping up?

ELLIOTT:  Which a number of people noticed.

We have half an hour to take your questions for this enormously distinguished panel.  We've had a great 45 minutes already.  Please say who you are as you ask your question.  Stand and state your name and affiliation.  I'm sure we've got microphones, Stephanie, haven't we?  So put your hand up, stand up and say who you are.

The gentleman in the front here, please.

QUESTIONER:  Roman Martinez.  I'm a private investor. 

Could you address the policy implications if we get into a stagflation --

ELLIOTT:  Uh-huh.

QUESTIONER:  -- environment?

ELLIOTT:  John and I were chatting over coffee -- (laughter) -- and both of us noticed --

TAYLOR:  Well, first of all --

ELLIOTT:  Sam Britton's (sp) column on that very point in the -- (inaudible).  John.

TAYLOR:  Well, first of all, from the -- from us old-timers, stagflation conveyed this idea of double-digit inflation and even double-digit unemployment, sort of a period where you get both together.  So right now we're seeing inflation of concerns again in a weakening economy.  So that sort of is a reminder of what that could be.  But the magnitudes to me are just much, much smaller than anything we saw, say, in the 1970s days of stagflation.  So I think you've got you put that into perspective.  But I think it's quite likely that -- going forward that central banks are going to have to do some extra effort to keep inflation in check and that's going to require some tightening policy, and it doesn't mean the economy will recover as rapidly as otherwise.  So it's there, but it's always been there, by the way.  You know, every single downturn is related to inflation picking up and central banks having to deal with it.  It's the boom-bust story we've always had.  We always will have it.  The fortunate thing, it's much smaller than it used to be.

GRANT:  John, I would say that the paradox of stability is that you no longer have to have inflation at 10 percent unemployment or 12 percent in order to generate a really, like, Old Testament-quality financial crisis.  When you have people ordering their balance sheets and their affairs for very low and steady and predictable rates of inflation, they pile on the debt -- that is to say, they leverage up their balance sheets and along comes, relatively speaking, the merest zephyr of a macroeconomic disturbance instead of a 3 percent inflation rate, a 4.3 percent inflation rate.  That seemingly minor inclement of inflation and the absolutely low level of inflation compared to the '70s could be enough to cause real trouble today, where it might not have been so important in the '70s. 

So I think that's -- I think that stagflation is a clear and present danger because the Fed has already asked to do more than most central banks are asked to do.  It is meant to be the regulator of the financial system as defined -- as historically defined -- inadequately defined -- it is asked to be the steward of a -- the stable dollar, of generating a stable price environment and it is furthermore asked and directed to attend to a good level of economic growth in this country.  Add to that now kind of the role that Mr. Greenspan adopted -- the federal first responder to the scenes of financial accidents. 

So you have in progress this anomalous crisis of credit in the context of a 4.7 percent unemployment rate -- whatever it is -- and a statistically prosperous GDP growth.  I mean, how wild is this that -- we did a search on Factiva, the Dow Jones News retrieval system, to find this -- maybe you've seen -- maybe you're struck, as I am, by the incredible conspicuous cropping up of references in the public press to the Great Depression.  Right in the context of this housing -- never since the Great Depression, never since -- not since the '30s.  This have been a time of -- the Great Depression is on the tip of the American tongue at the time of almost unrivaled global prosperity because people have gamed the stability to lend and borrow with almost unprecedented recklessness.  And that is generating the incredible stresses on the Fed, which may yet give us a 5 percent inflation rate or a 6 percent inflation rate as the Fed does the first thing it has to do, which is to forestall a bigger crisis.

ELLIOTT:  We have at least one distinguished former Central Bank governor in the room, Jacob Frankel.

QUESTIONER:  Jacob Frankel, AIG.

Those of us with long enough memory recall that about 23 years ago, we had a similar session here.  This session today is "The Falling Dollar: Should We Worry?"  The title of that session was "The Rising Dollar: Should We Worry?"  (Laughter.)  In -- during that year -- and I think that John and I participated in Jackson Hall --

TAYLOR:  Right.

QUESTIONER:  Their conclusion was the issue is not the falling dollar or the risning dollar, but what was described there in Jackson Hall -- the rocky dollar on the rocky mountains -- (laughter) -- or the bouncing dollar.  So this was the context there.  It terminated eventually and concluded in the Plaza Agreement, which focused exclusively on a currency issue.  And this was probably the last exercise that only dealt with currency.  And it's a good fact that it was the last one because subsequently, there was a switch to understand that currencies cannot be analyzed in isolation and we need to build the polices, et cetera, et cetera. 

So basically, my question for today is this.  If we did not have the housing crisis, the prime -- subprime issue and all of those kind of things, would we have discussed today that particular session here?  And given that I think that the overall environment, including the macroeconomic setting, is very much influenced by that show, aren't we going to fall into the danger of barking the wrong tree and coming back to a currency debate while the game is really in a different area? 

Let me just make one last footnote because you made a very profound remark.  If you're to ever run on a currency, you have to have a currency to which you run, which is correct -- musical chairs.  But there is one more general, dangerous issue, which is a run from all currencies into inflation as is real estate, et cetera.  That's the context of the global inflation.  We seem to have forgotten that was once the reality and we'd bette remember to avoid it.

ELLIOTT:  Richard, do you want to take it? 

CLARIDA:  Well, Jacob, as always, has some provocative questions.  I'll just address one of those and I'm sure other panelists will weigh in on the others.

I completely agree and certainly have written on this a number of times that it is both misleading and -- potentially very misleading to focus very narrowly on currencies when really, what you have is an incredible transformation of the global financial system.  So there are different pieces of these moving parts.  You've got the savings glut piece, you've the Bretton Woods 2 currency peg dimension of it, you've got the vast growth in financial derivatives.  So we're all touching on various pieces of these and I think Jacob is absolutely right that the dollar is a very -- is one symptom of all of these interactions in the global economy.  And it would certainly be, I think, very dangerous now to think about -- you know, replaying the Plaza meeting now 20-plus years later, although I guess you'd have to get a condo at the plaza since they're not renting hotel rooms anymore.

But I think the broader point about the -- you know, the breakout of inflation, I guess I'm in the "glass is half full" camp here.  There are stagflation pressures.  There are these issues that we're addressing.  But I think ultimately -- I think the world's central bankers -- you know, have gotten the message and, I think, ultimately we will not have a breakout of a great inflation, although we may have much tighter monetary policies than we have currently that are required to keep inflation in check.  But I would like to hear from others. 

ELLIOTT: Benn do you want to comment --

STEIL:  I agree with Jacob.  I don't think there's any reason for there to be a grand international statement on currencies.  The problem in the currency market has its roots elsewhere, and just making statements about where the dollar should be, I don't think would be particularly helpful.  I think you're absolutely right that we probably wouldn't be here today discussing this issue were it not for the subprime crisis, but the subprime mortgage crisis is part and parcel, in my view, on a long period of excessively loose monetary policy.  I think we need to deal directly with the subprime crisis.

I've got a proposal coming out shortly that involves the government specifically intervening for precisely the reasons that John had specified earlier.  Banks are not sure if they have sufficient regulatory capital anymore and they're not so sure whether their counterparts will have sufficient capital in the future, and that's because of the dispersion of these subprime mortgages throughout the financial sector and instruments that are --

QUESTIONER:  Sure.

STEIL:  -- intimately tied to them.

So this, I think, the government has to deal with directly.  What I'm concerned about is that we're trying to deal with it through monetary policy.  By aggressively lowering interest rates -- and your referred to the coordinated central bank action earlier -- this is supposed to be an alternative to the discount window because of the stigma attached to borrowing from the discount window.  Rather than surreptitiously bailing out the banking sector by creating new public debt on the books of our central banks -- which is very, very dangerous -- it can undermine the foundation of the economy, which is indeed our currency -- we should be dealing with the subprime crisis directly, in my view, through a transparent government intervention where people can see what's going on and they know precisely what the parameters of the intervention willbe.

ELLIOTT:  More questions.

The gentleman -- that's right.  Exactly

QUESTIONER:  I'm Hunter Smith with Bungie (ph).

Chinese loan growth has been very high for a number of years and the bulk of that loan growth has been pushed into fixed asset investment in China, as well as commercial and residential property.  Do you see -- like you've seen -- you're seeing a significant credit unwinding in the United States?  Do you see any potential for a similar unwinding of the credit system in China?

ELLIOTT:  Anyone want to have a go at China?  I was there two weeks ago, but anyone want to pick up? 

Jim?  John? 

TAYLOR:  I'm from Brooklyn.  (Laughter.)

CLARIDA:  Thirty --

ELLIOTT:  Richard, go ahead. 

CLARIDA:  Thirty seconds wouldn't pretend to be an expert, but I think -- you know, the observable macro data is very consistent with the view that there are substantial excesses now in China, whether or not it's in the administered lending restrictions that are being put on at the last part of the year in order to tamp down lending.  You've got the big buildup to the Olympics next year.  I'm pretty confident the Chinese won't allow anything to happen before that but yeah, I think certainly that there are excesses now in the Chinese economy and they're having difficulty sterilizing the interventions -- their substantial hot money inflows to China.  I estimated that this calendar year '07, you know, China accumulated about half a billion -- half a trillion dollars in reserve this year and probably half of that half a trillion was what we used to call hot money inflows not generated by the trade surplus or the FDI.  So obviously I think that is a challenge.  I don't have a crystal ball about how it will be resolved but it could create some dislocation.

ELLIOTT:  John?

TAYLOR:  I think the central bank of China is a bit behind the curve now in terms of adjusting and tightening because it is -- there is a significant inflationary boom down the road there.  It's a more general thing globally and they're a part of it but I think that adjustment has to be made and exchange rate fits into that quite well.  If I could just make a comment on Jacob's points -- I think the -- if we hadn't had the sub prime my guess is there would be something else similar in the sense that as Jim was saying we had such a benign view of risks and probably overdid it in terms of thinking risks were so low so some adjustment was most likely to happen. 

I don't know where it would but those -- mainly because of those very, very low interest rates in '03-'04.  As you know, last August did a piece for the Jackson Hole Fed which showed that the Fed conference which showed that the interest rate was way below the recommendations of the so-called Taylor rule and then calculated how much impact that had on the economy and it was large.  So I think that's a source of the problem.

ELLIOTT:  John, from your time in the Treasury from '01 to '05, just a small point on China that I think interests people -- do the Chinese authorities have the kind of technical capability and levers to fully be part of debates on the international economy?

TAYLOR:  Oh, yeah.  They're -- I mean, they're learning so rapidly and they're studying and any seminar we put on they packed it with really top-grade smart people.  The institutional development is still taking time in terms of the money markets and the currency markets and the price discovery, but they're there and they're learning and they're going to be really good.

ELLIOTT:  Very good.  Gentleman right here -- yeah.  Wait for the microphone.  Say who you are -- yeah.

QUESTIONER:  Thank you.  Mahesh Kotecha, Structured Credit International.  I wondered if the panel might say something about the extent to which foreign central banks are holders of the sub prime and agency paper and how that affects the potential -- you know, how that might impact the dollar because clearly there's lack of confidence in the holdings of almost a half a trillion dollars worth of agency paper that the central bank of China has.

ELLIOTT:  Anyone want to go on that?  It's a technical point.  Richard?

CLARIDA:  I'm not aware -- I don't think any central bank has raised his hand and admitted to holding this, but certainly we know in the case of Germany that there's some Londis banks which have implicit state guarantees that were holding these including in structured investment vehicles and that's creating a real challenge now for the Bundesbank.  So it's not directly on its balance sheet but indirectly these banks -- and again, I'm not an expert on the German banking system but had some implicit or perhaps even more explicit guarantees to the local governments and that's part of the problem they're working through now.

ELLIOTT:  Municipalities all over -- all over Europe who've invested heavily -- yeah.

CLARIDA:  Jacob, I think, wants to intervene.

ELLIOTT:  Jacob wants to come back? 

QUESTIONER:  Well, just a technical point on this.  I think that in quite a few central banks this is viewed as part of the solution rather than as part of the problem, namely even here in the U.S. in -- during the discussion of the discount window what assets are eligible to be purchased by the Fed and it was viewed as part of the solution.  Let the Fed be willing to hold also or get from the banks some of the lower quality assets and that's why basically saying let's remove it from the private sector.  We -- central banks have a longer time horizon.  We are not going to be faced with a short-term liquidity squeeze of the current bottleneck.  We'll be able to spread it out over time, et cetera.  So it is really viewed more as a solution and I don't think that markets' confidence or lack thereof in monetary policy in the stand of the central bank depends too much on the balance sheet of the central bank.

CLARIDA:  You know, one of the collateral items that the Fed will accept as collateral is collateralized debt obligations which are these mortgage contraptions at 85 cents on the dollar if these things are not quoted in the public marketplace and some of these AAA-rated collateralized debt obligations are quoted very close to zero when they're quoted at all.  So the Fed is seemingly most openhanded in the list of collateral that it disclosed last week in connection with the so-called TAF.

ELLIOTT:   Two -- three hands.  Gentleman on the far left -- yes.  Please state your name.

QUESTIONER:  Jeff Schoenfeld, Brown Brothers Harriman.   The discourse so far has suggested quite a bit of alarm about the rate of inflation -- published rates of inflation perhaps.  Inflation indexed bonds suggest that inflation expectations are incredibly well-anchored throughout what has been a recent rise in the rate of inflation.  Can some of you discuss how you think the Fed looks at inflation expectations as an input for policy setting relative to actual rates of inflation?

STEIL:  Well, those expectations are based on what they think the Fed is ultimately going to do, right?  So the presumption, which I think is correct, is that the Fed will do what it needs to do to bring inflation down from these headline numbers we're seeing at this point as it's done for the last, say, roughly 25 years.  So I think that's what's in the markets.  They could be wrong.  I mean, they could lose it but I don't think so.  I think it's -- I think those are the right forecasts but the presumption is the policy is going to be correct.

ELLIOTT:  Gentleman just here and then -- over here.  And then we need to -- I need to pick up some people on this side, who I've been ignoring.

QUESTIONER:  Gene Solomon (sp), Indus Capital.  When Fed Vice Chairman Kohn was in this room a couple of weeks ago and suggested he's prepared or the Fed is prepared to lower interest rates -- do what they have to to sort of offset the additional risks in the economy they see -- in the Q&A session just like this he was asked, "Well, if you lower interest rates is the dollar going to weaken dramatically?"  And some of you have suggested it would.  And his reply, which I thought was pretty sound -- he said that if the Fed can instill confidence in the economy by lowering rates that the dollar would be stable.  What do you think of that?  Do you think he's misguided and, you know, it's better to allow the economy to sink, you know, to prop up the dollar?

CLARIDA:  Well, I -- I'm actually surprised that Don Kohn actually answered your question since I thought the rule of thumb for a federal official is never to comment on the dollar.  I think the other point we should --

ELLIOTT:  Must have been off the record.

CLARIDA:  Yeah.  (Laughter.)  The other point --

ELLIOTT:  Good luck in a crowd like this.

CLARIDA:  The other point we should remember, of course, is that although the Fed was the first out of the gate in September you now have had the Bank of Canada and the Bank of England easing policy.  And again, as I mentioned a couple minutes ago in international economics everything's a relative valuation.  So yeah, U.S. interest rates are lower but the Canadians and the Brits have indicated they're going to lower rates as well.  And that's probably given the dollar some support in recent weeks. 

ELLIOTT:  Actually I want to take someone from this side and then I'll flip back.  Gentleman right here.

QUESTIONER:  Thank you.  Sergio Galvis, Sullivan & Cromwell.  Maybe a question for Dr. Taylor -- in talking about the role of the dollars of reserve currency the factor you focused on is not so much the relative interest rates at a given moment but confidence in the political system and Congress.  So what are the things in terms of political economy that an administration or a congress to do to really knock off the dollar as the reserve currency?

ELLIOTT:  That's a good question.  What are the real political rather than technical policy errors that could really move us into uncharted territory?  John?

TAYLOR:  Yeah, I'd say anything that reduces confidence in United States policy -- a flagrant effort to just spend.  Stop talking about reducing the budget deficit.  If we can't get these long-term entitlement things settled that'll also reduce confidence.  I think the international side is awfully important.  It's very important for the -- especially for the administration to be open about our foreign investment policy -- to welcome investment as much as we can. 

So that's -- those are signs of confidence but I think on the monetary side the --  you know, the Fed chairman has to go testify at the Congress and I think the notion that one of the goals of monetary policy is to maintain the purchasing power of our currency -- that's price stability -- is a very important element of confidence.  So those are the things that we have to happen.  I think -- you know, listen to the candidates -- which ones are speaking out most about a strong confident U.S. policy -- and those are the ones that'll be better for the dollar.

ELLIOTT:  Well, let me bring in Benn at this point because you mentioned in the context of the European nations 10 minutes ago the possibility of seeing protectionist sentiment really take root in 2008.  And I agree, I think there's a risk of that.  Is that one of the -- is that one of the political shocks that, here in the U.S., could --

STEIL:  I think that's one of them.  I think the one that concerns me most is a more domestic response, and that is what I will "further socialization of the mortgage market " in the United States.  If Congress should get particularly aggressive on that front, I think we could undermine the potency of monetary policy to deal with precisely these issues, because we're going to build up the potential for greater such mortgage crises in the future. 

ELLIOTT:  It is worth remembering -- I mean, we look back on 150 years of history and think that some of the things that we saw in the late 19th Century, or in the 1920s and '30s can't possibly happen again.  Britain just had a true, genuine run on a bank, with people lined up in the street, kind of around the block --

STEIL:  Politely, though. 

ELLIOTT:  -- politely.  Very politely.  Very politely.  (Laughter.)  But photographs -- truly, photographs, the likes of which one has not seen for 40 years, with people, kind of, queuing-up outside branches of Northern Rock, to take their money out. 

STEIL:  It was not '40, it was 1866 with Overend Guerney, wasn't it? 

ELLIOTT:  The thing that really went wrong with Northern Rock is that its chairman, and he's a very good friend of mine, was a former journalist at The Economist.  That's the -- (inaudible, laughter) -- that's the real problem.  There.

Yes, the gentleman right here. 

QUESTIONER:  Yves Rostell (sp) Rothschild.  I'd like to come back to the question of private capital flows for a minute.  There was discussion before of the fact that recently the deficits have been covered mostly by central intervention, than private.  But there was no discussion of the possibility that, over time, there would be a greater desire on the part of U.S. holders to have their holdings more diversified out of the dollar. 

And, of course, that amount of money is so much greater, even with a slight shift, than the amounts of the annual trade or balance -- the current balance of payments deficit, something that's always hung over, never really happened, even though there's been, of course, more purchases of non-U.S. securities.  Do you see this, over time, as a serious risk or not? 

ELLIOTT:  I think it's a very interesting question. 

Benn, do you --

STEIL:  It's an excellent question.  In fact, financial economists here have long been quite baffled by what they call, "the persistent home bias" in investment, which is particularly noticeable in the United States.  If American's portfolios of investments were evaluated through traditional financial economic techniques, you would conclude that Americans are four times under-diversified, relative to what they should be in terms of their foreign holdings. 

But today, of course, it's easier than ever to invest abroad.  We've got cross-border mergers of exchanges -- you could log onto e-Trade right now, provided they've maintained solvency -- (laughter) -- and buy currencies around the world online just as easily as you could buy U.S. currency.  So I think this is a wonderful question. 

Going forward, I think you will see Americans diversify their investments quite a bit.  And interestingly enough, that will make Americans much more sensitive to alternatives to the dollar -- for example, like the euro, as a long-term store of wealth.  In other words, assets denominated in other currencies.  Traditionally, Americans have not thought that way, but as these vehicles become more and more available to them, perhaps they will. 

ELLIOTT:  And you did see a bit of a fad in '05, '06, '07, for a Yuan Carry Trade, in particular, with, kind of, lots of, lots of, lots of -- I mean, I don't know how many people were actually doing it, but, I mean, it got written about, to an extent that it had not -- that it had not been in the past. 

Gentleman right in the back -- three from the back -- yep.  The microphone is coming over to you.  I think we've got time for one more after this. 

QUESTIONER:  Thank you.  Whitney Bower, 3i Group.  Curious of the panel's views of volatility going forward.  We've been in an environment where we've seen changes, but relative stability.  And I'm curious to see if some of the factors we've discussed this morning would lead to increased volatility over the coming years, or more stability? 

ELLIOTT:  John. 

TAYLOR:  Yeah, I mentioned the volatility issue -- well, quite frankly, I've been surprised, at least until recently, how much volatility has come down in many markets.  And probably they overdid it, so we're getting an adjustment back again. 

But I think the -- to me, the volatility, to some extent, is induced by uncertainty about what the government is going to do -- about policy, about intervention, about monetary policy, about communications.  So I think the better job that the policymakers can do about communicating their own policies, the better the situation will be on volatility. 

I think, with respect to monetary policies, it's becoming quite difficult, especially now, to communicate about what's actually going on because of the uncertainties that The Fed itself has.  But that's -- I think that's the key here. 

ELLIOTT:  One more question -- because I can see people starting to drift off.

Gentleman over here, yeah. 

QUESTIONER:  Tim Ferguson, with Forbes.  So many people believe that a heightened savings proclivity in United States is key to righting the economic wrongs of the world.  Is the environment you all have been discussing today, of a weakened dollar and a weakened economy, conducive to a high savings proclivity in the U.S., or not? 

ELLIOTT:  Jim? 

GRANT:  Tim, I don't know. 

(Laughter.)

GRANT:  I'm sorry, I -- it's a good question.  I will -- 

ELLIOTT:  It is a very good question. 

GRANT:  -- I will get back to you when -- in a week. 

(Laughter.)

ELLIOTT:  Rich? 

GRANT:  Quick response.  Economists don't have a good track record at explaining or forecasting saving, but one thing that we do think we know is that, over a long period of time, saving can't be negative.  And in recent years we had a negative saving rate in the U.S.  So I can confidently predict that eventually it will become positive at the household level.  The pace at which that occurs, I don't know.  I think it's a classic example of the Keynesian paradox of thrift.  In the long run, higher saving is probably very good for us; in the short-run, if the saving rate goes up a lot overnight, you're probably talking about a pretty deep recession. 

ELLIOTT:  We can squeeze one more in. 

I'm getting a -- I'm getting a signal.  Right to the back there -- yeah. 

QUESTIONER:  Just a theoretical question.  If The Fed keeps interest rates at one percent, and they print a lot of -- they print a lot of paper, it seems that, I guess you'd want to be long trees -- (laughs) -- I guess you'd want to be long.  But The Fed keeps --

ELLIOTT:  Canada's got a lot of them too. 

QUESTIONER:  -- If The Fed keeps interest rates too low for too long, and creates several bubbles -- just a theoretical question, what do you replace The Fed with?  (Laughter.)

ELLIOTT:  I think the panel's answer is that no Fed would dare. 

But, Jim, would you? 

GRANT:  There's a terrific iconoclastic economist at Northern Trust Company by the name of Paul Kasriel, who suggests that -- who observes that any regulatory body can either fix the price of the thing it is charged with regulating, or it can fix the quantity, but it can't do both.  So The Fed has chosen to enter the price-fixing industry, not a very reputable one, but it fixes -- it is in the price-fixing -- it fixes an interest rate, much like the New York City rent control apparatus fixes or fixed New York City rents, with about -- sometimes with the same effects.

So what Paul suggests is that, instead of fixing a rate -- The Fed ought to let the market discover the rate, but rather The Fed ought to simply enlarge its balance sheet at the rate of growth of the American population, which is certainly something to think about.  You know, the trouble with "The Fed" is that it is the central bank overlooking the U.S. dollar, so it makes monetary policy for the 50 states; whereas the dollar is the world's currency.  And that is the tension that, I guess, has drawn us all here this morning. 

CLARIDA:  The classic, of course, proposal to replace The Fed, is by Milton Friedman.  And that was simply to just grind out a certain percentage of increase in money, year after year after year.  There was always an attractive feature of that is that it reduced a lot of discretion, a lot of possibilities for mistakes.  But, of course, that has its own problems. 

So I think an alternative is to think about other rule-like procedures that we can agree for The Fed to do.  And, obviously, it's not setting interest rates exactly, but it's adjusting them.  So I don't think we need to replace it, but we need to think about how to remove the discretion which sometimes leads to problems. 

ELLIOTT:  Rules-based systems.  Benn, quickly. 

STEIL:  In the ultimate disaster scenario in which people did fatally lose confidence in The Fed and the dollar as a store of value.  I think people would move back to what they always moved back to throughout history, which is gold as a monetary base. 

I don't think a government-run gold standard is, in any way, feasible or, indeed, desirable, but we have seen, over the course of this decade, a huge growth in private gold banks.  These are banks that work very much like normal banks except that they have 100 percent reserves in which people can denominate their transactions in gold.  They can do them electronically, by a computer.  There's no reason why they can't do them by SMART card.  So you could go to Buenos Aires and buy your cappuccino with a flake of digital gold. 

I'm not saying that this would be a desirable scenario.  It would, in fact, be a very, very undesirable scenario if we wound up moving away from our current system.  But if people fatally lost confidence in it, I think that's a direction we'd move. 

ELLIOTT:  How satisfying that the very last contribution that we should have, on a terrific -- after a terrific morning on currency systems, at least for those of us like Jim and myself who are history buffs, is that we should end up talking about the gold standard.  (Laughter.) 

I'd like to thank, on your behalf, John Taylor, Benn Steil, Jim Grant and Rich Clarida, for an absolutely fabulous morning.  You're all leaving at 9:15, opening bell in 15 minutes time.  Thank you all. 

(Applause.)

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