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The Global Consequences of the Crisis, Session One in the Stephen C. Freidheim Symposium on Global Economics on Financial Turbulence and U.S. Power

Speakers: Joseph S. Nye Jr., Distinguished Service Professor and Sultan of Oman Professor of International Relations, John F. Kennedy School of Government, Harvard University, and Philip D. Zelikow, White Burkett Miller Professor of History, University of Virginia
Introductory Speaker: Sebastian Mallaby, Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker Senior Fellow for International Economics Deputy Director of Studies, Council on Foreign Relations
Presider: Richard Medley, Chairman, Medley Capital Management
May 12, 2009, New York
Council on Foreign Relations

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This session was part of the Stephen C. Freidheim Symposium on Global Economics: Financial Turbulence and U.S. Power, which was made possible through the generous support of Stephen C. Freidheim.

SEBASTIAN MALLABY:† Welcome, everyone.† I think we can get started.† I'm Sebastian Mallaby.† I direct the Center for Geoeconomic Studies here at the council.† My role is, very briefly, to thank everyone for coming.† Welcome to the first of the Stephen C. Freidheim Symposium on Global Economics. †

I want to say thank you particular to Steve, who's been not only generous with his support, but also a great collaborator in brainstorming and setting this up.† He is also quite patient, because we were going to do this back around November, December, and there were one or two speakers who said they would come and then the demands of going into the new administration caused them to reconsider.† It turns out that the only thing more all-consuming than having a top administration position appears to be sort of getting ready to have a top administration position.† (Laughter.)† So Steve was great through all of that.† Thank you very much.

This symposium has three panels.† It sort of fits into the core idea of what the Center for Geoeconomic Studies is about, which is to bring together the geopolitics, the foreign policy on the one hand, and mix that international relations with international economics.† And so what you're going to see here today is three sessions, all of which take a look over the horizon about the effects of the financial crisis; this one on geopolitics, the next one on financial regulation and the third on sort of trend growth in the macroeconomy.

So with that, I'll hand over to our first moderator, Richard Medley.† And thank you, everyone, for being here.

RICHARD MEDLEY:† Thank you.† I want to introduce Joe Nye, who everyone knows, but, as you may not know, he's either going to be the ambassador to Japan, China or Yale.† (Laughter.)

JOSEPH S. NYE, JR.:† (Laughs.)† Or not.

MEDLEY:† But you will, right?† One of them.

NYE:† No.† I said I think all these things are 50-50, at best.† The Yale one might be a little higher.

MEDLEY:† I guess that's -- and Phil Zelikow, of course, who has the distinguishing characteristic of being so talented that Richard Haass asked him to be part of this symposium.

So let's just start talking.† Basically, the question that we have before us is the geopolitical effect of the economic crisis.† And it does seem to me that the U.S., China -- U.S. and China, at least, have reacted very strongly and positively to this.† And -- but you've got all of Eastern Europe and Central Europe and, in fact, most of Western Europe who seem not to have.† Does that -- is that -- does that change where we're going to go, where we're going to be in terms of geopolitics?† As you said in our conversation, there is a G-2 kind of idea coming, which the Japanese know about.† They want to kind of insert themselves into that as part of the G-3.† Where do you think this leaves us?

NYE:† Well, it -- let me take it short-run and long-run.† In the short run, meaning next year, two, three, there are going to be, I think, significant ramifications, geopolitical ramifications of the financial crisis.† For example, if Pakistan goes belly-up because of the economic effects, that's a huge geopolitical impact.† Let me leave that aside, because Phil's going to say a bit more about that, and focus more on the long run.

To what extent has this crisis changed our views of what will be the relationship between the major powers in 10 to 20 years time?† And when it first broke, the conventional wisdom -- Steinbrueck, the German finance minister, said this is the end of American dominance.† Putin -- not Putin, Medvedev followed suit.† Even my friend Michael Ignatieff, who's going, we hope, to become prime minister of Canada, said now that American power has reached high noon, Canada should be adjusting its policies elsewhere. †

I think all this is wrong-headed.† It's a big mistake to draw long-term conclusions from short run -- I mean, right now, you just project a linear projection of where we are, it looks bad.† In fact, even those short-run -- or those predictions that were made at the beginning of the crisis have already been falsified.† Decoupling -- remember decoupling?

MEDLEY:† Yes.

NYE:† Well, that got knocked on the head.† The crisis was supposed to be the crisis of the dollar.† Well, what happened to the dollar?† Up, not down.

And then you say, yes, but China's doing well -- 6 percent growth this year -- America, not.† We're somewhere in the negatives -- 3 percent, let's say, negative.† But, you know, what's interesting is the decline of China's growth rate from 10 percent to 6 percent is greater than the decline of our growth rate.† And that means the time when China would catch up with the United States in overall economic size doesn't get closer; it gets further out.† I mean, Goldman Sachs's famous 2040 when they catch up, then they shortened it to 2027 -- well, you know what?† It's going back to 2040. †

And so there's a lot of very foolish geopolitical extrapolation based on short-run situations, which, in fact, I think are not very well thought through.† We can talk about what Niall Ferguson called "Chimerica," whether that really is a G-2.† I think not.† I think it's a great mistake to think of this only as a G-2.† Three economies -- U.S., China, Japan -- out of four, with Europe treated as one, are over 2 percent stimulus and are sharing a pretty heavy load.† But it would be a huge mistake in (managing ?) the international (community ?) to leave out the Europeans.

So I think that -- beware of geopoliticians bearing long-term gifts based on short-term trends.

MEDLEY:† Let me just -- before we turn to Phil, one more question.† Japan seems to have really come to the fore in this, has really done a lot.† And, you know, after two decades of stagnation, they've really taken this, it seems to me, as a -- as a clarion call to become part of the world again and reenter.† I mean, do you feel that there's a possibility that Japan reemerges after all this talk of, you know, it disappearing from the world stage?

NYE:† Well, I think Japan learned from its own "Lost Decade."† And the Japanese stimulus package is not only ample, but it's also different.† Instead of building more bridges to nowhere, which was the traditional style of the Japanese infrastructure for the sake of the Liberal Democratic Party's local constituencies, they're now putting a lot of the stimulus package into services or technology.† I mean, it's a different kind of stimulus package.† And 2 percent is a significant number.

I think they are taking this role more seriously.† That's another reason why for us to treat and talk as though there's just a G-2 would be a mistake.† Remember, Japan is the second largest economy, not China.† People often take the trends of China and put it in second place.† Uh-uh.† Japan is still a much bigger factor, economically.

MEDLEY:† So, in terms of -- how do you see the impact of the economic downturn in terms of the geopolitics, as Joe was saying, of Pakistan and the problems we're going to face in there?

PHILIP D. ZELIKOW:† Well, let me come back to the Pakistan issue in a moment.† But first, I want to just urge the audience to regard this with a certain amount of humility.† But to make that banal point -- make it perhaps a little more concrete, let's imagine that instead of meeting here to discuss the long-term implications of the global economic crisis on May 12th, 2009, we are meeting here to discuss the long-term effects of the global financial crisis on May 12th, 1931 -- May 12th, 1931. †

The financial crisis has now clearly been upon the United States for about a year and a half.† It's well recognized.† Reverberations are felt everywhere, though it's hit the Americans especially hard and the Germans.† But it's not being felt the same way everywhere.† There are a lot of arguments going on about whether the crisis will persist.† Many people think that green shoots are noticeable and that actually the worst part of the crisis may already be behind us, but there are people who dispute that. †

For international implications, hard to say.† German politics is clearly rocked, but the civilian government of Chancellor Bruning in the Weimar Republic still seems to be holding together.† Widespread bank failures are not yet convulsing Europe.† In the Far East, there's turmoil in China, of course.† But Japan is still a firm part of the Western international political order, a full -- a full member of the Supreme Council of the league. †

So you've looked back and you'd say, well, what do wise statesmen think about this?† Well, Winston Churchill, one of the most eloquent statesmen of the age, only six months earlier said that he thought the prospects for peace have never been better than for 50 years. †

So you look out on the future and there are some dark clouds, to be sure, but, well you could -- you can imagine them, the way that council meeting would have gone in the wood-paneled suite they would have used on May 12th, 1931. †

So there are two things I want you to take away from that story.† The first is, is just this little concrete reminder about humility.† Okay, you got that.† The second one, which I think is actually -- is a big idea, but like all big ideas is also very simple, is the really important decisions about the crisis are not the decisions surrounding the onset of the crisis; they're decisions you make after you're well into the crisis.

We are accustomed to thinking about periods of world history by noting the points at which things began.† So there's huge literature about what caused the crash of 1929, or what caused the outbreak of war in August 1914 and so on.† My argument to you -- and I think it's sustained by the historiography, especially on the Depression -- is that the key things that created the lasting crisis of the '30s were not the crash itself.† The crash of '29 was not at all unique.† There had been a severe crisis right after World War I.† There have been other severe financial shocks later, even like 1987.† The decisions that actually turned the crisis, basically took it off the precipice to a much more dangerous stage, were actually made in 1931, 1932.† I think that's the view of Charles Kindleberger, Peter Temin, Ben Bernanke, when he was writing as a historian. †

So in other words, it's not -- rather than focus on what got us into the crisis, because, well, lots of things, hard to predict, the things that will shape world history are the decisions we're making right now.† And it's not clear to me what those decisions will be.† If it was clear to me, why would I be sitting here?† I'd be in the south of France, perhaps.

MEDLEY:† But so -- I mean, on that -- I mean, what do you think about the discussion?† Already, the central banks -- the ECB, the Fed, the Bank of Japan, Bank of England -- are discussing exit strategies already.

ZELIKOW:† They're already looking ahead to when they pull out of the crisis.† And they might be right.† I'm -- again, you know, I'm not the -- all of you here read Nouriel Roubini on the one hand or the Obama administration on the other.† And you can decide -- you've probably already decided who it is you think you believe.† And you actually are probably smarter about this than I am.

So my job is -- is to kind of think through what happens in either of these scenarios, and then what policies would you adopt that would be resilient enough to prepare for uncertainty.† But I'll -- what I'll call attention to are two big themes, let's put it this way, that are geopolitical. †

The first is there will be a -- there will be some key issues that will arise over the next year or two that will either validate the credibility and continuing influence of the United States and its allies, basically shows the Americans and their friends can still more or less manage stuff, they can still more or less manage big stuff.† I think actually if things in Pakistan or Afghanistan look up a bit, you know, the heroic efforts -- looks like the glass is beginning to fill, rather than drain -- Iran, especially.† But I'm not sure what the test will be.† It might be that.† But something will, in -- I think in the next year, will basically show we're still managing stuff or we're not.

The second big set of tests will be on the international political economy.† And the thing that I'm -- and what I'm especially focused on the international political economy is right now we're seeing an astonishing amount of continuing cohesiveness in basically the general premises we took into the crisis about the shape of the international political economy are still generally held among all the major economic powers.† And that's being tested now.† And I think the tests are going to become the more acute.† Where I see the tests as being most dire -- not in the United States; I'm -- there -- I'm especially concerned about Europe.† I actually think if Europe cracks, cracks in a big way, that will be important. †

But I'm looking for signs of a big divergence.† The divergence could go in a couple of different ways.† And one reason it could be very significant is because -- I don't understand the Obama administration's fiscal policy yet.† I listen patiently to it and I nod my head and I want to believe, but then I -- my -- but then my -- the rest of my body starts working and I start using my head and I just can't get the numbers to add up, and -- but they've got a plan.† But suppose the -- suppose if -- kind of play out what happens if the fiscal policy turns out to founder in some significant ways.† There, the issues of divergence may be very, very important.† If it looks like the United States, the -- kind of this -- a big aircraft begins to drop back out of formation -- you see what I mean.

MEDLEY:† Yeah. †

NYE:† But --

MEDLEY:† Go ahead -- go, Joe.

NYE:† Can I just comment on what Phil said, which I largely agree with?† I think it's extremely important not to think there's one future.† When I used to chair the National Intelligence Council, which does intelligence estimates for the president, I would say to the analysts, give your best scenarios with their best estimates on them, and then after you've done that, tell me what would make them all wrong.† And they'd say, oh, we've studied this for our lifetime.† You know, that's -- we don't need to do that.

You have to do that, because it tests your assumptions.† And so if you asked what I was saying a few minutes ago, which is, will this lead to the long-term American decline that some people projected, and I said no, I owe you that test of my assumptions, which is why Phil's analogy to the '30s is right.† If the shape of the recovery is a "V" -- you know, the kinds of things that we've heard from macroeconomists that you'll have maybe 2 (percent) or 3 percent growth by the first quarter of next year and so forth -- or even if it's a "W," since, as Phil pointed out, we saw -- you had really four years from '29 to '33 of downturn, and then you had beginnings of recovery, but you had many "Ws" on the way --

ZELIKOW:† Along the way, yeah.

NYE:† And if it's a "V" or a "W," then I would continue to hold the projection that I gave.† It's it's -- the shape is, in fact, a downward set -- a staircase downward or a long, long "L" like Japan in the '90s, then I think we ought to reanalyze this question of how American power will look at the end of it. †

So I think Phil's warning is very appropriate, that -- state your assumptions.† My assumptions are this is probably a "V" or a "W" but not a lost decade, a la Japan.† But if it is, then I think the damage to American power will be considerably greater, though perhaps not as great as the pessimists say.† One of the things that people forget is when you're looking at some dimensions of power, it's relative.† The United States has been hurt, but, ironically, other parts of the world have been hurt even more.† And that means in relative power terms, you have to keep that as your base for projection.

MEDLEY:† But I do think that -- but turning just for a moment from the economic side to the geopolitical side, there is -- I mean, the U.S. and the Obama administration -- and you're right.† I mean, I don't think the Obama administration could tell you accurately what their global fiscal policy is going to be three or four years from now, because they're running as fast as they can to keep up with this.† And as, you know, Bernanke has said many times, we'll worry about the next phase once we're through this phase, because you can't -- you know, you just can't let this thing collapse.

On the geopolitical side, the force projection of the United States, I think, between Obama's -- to me -- you guys probably knew this; I didn't -- surprisingly positive attitude toward FTAs and, as you said, the world order has knitted -- has stayed knitted together in a way that we didn't see, at least in the beginnings of the Great Depression.† It's really stayed together.† And the fact that we've gone, you know, from Iraq to Afghanistan and obviously Pakistan, although, you know, maybe we can't talk about that, but the idea is that the force projection of American power is very strong, whether it's -- whether it's economic policy or military policy.† It seems to have actually almost increased in its ability to project force.† I don't know what -- you want to --

ZELIKOW:† Well, no, actually I'm not too downbeat at the moment.† I'm not too upbeat, either, but I can -- on the plus side, you could make a pretty good argument that says the Bush administration left the Obama administration with Iraq actually heading in a much better place so that they could --

NYE:† Absolutely.

ZELIKOW:† -- basically afford to dial back and concentrate their attention on Afghanistan, Pakistan, without it looking like there was a catastrophic retreat of American power.† It doesn't feel like a big retreat.† It feels like there's retrenchment now that that actually after years of terrible trial and error, we actually -- but the result is that the American military, after trial and error, actually was able to prove its effectiveness in Iraq and now can somewhat pull back and let Iraqis pick up.† And so even if there are some big problems now, it may be, well, those are going to be Iraqi problems.

But in other words, the credibility of American power was renewed.† They're going to hit -- the Afghanistan-Pakistan problems hard.† If it looks like their efforts there at least seem to be well-guided, their credibility holds together there.† So in other words, the hard power side still looks relatively credible and robust, while now reinvigorated, I think, by a much stronger soft power effort.

Where did I ever get these words like "hard power" and "soft power" -- (laughter) -- these made-up words that press in my brain and I can't get them out?

NYE:† Poisonous.† (Laughter.)

ZELIKOW:† Someone has complained. †

The -- but now you've got all that additional reinforcement.† So then you -- that actually would then strengthen the point Joe kind of led with, which is, you know, by no means is this a picture in which you count America out.† But that would be kind of an upbeat story.† And then the downbeat side of this would be, then, the hypothesis, which I think is right, not that the Obama administration has failed, but that a couple of really very large tests are coming that have not arrived yet, and that those tests -- I think there will be some cluster of things that will become the geopolitical test. †

If you want to go back to my 1931 example, the great test of what people thought was then a new working collective security system was actually set to arrive in about a year, starting in September '31 and really reaching a crescendo in '32 with -- actually the Manchurian episode turns out to be very important as a precursor for all else that will follow, because of what it signaled to the world about how the world was really going to work.† And the same thing was happening on the economic side, so that by the time you get into 1933, most people in the world have kind of come to the conclusion -- one -- both militarily and economically, you know what?† It's every man for himself.† And if you want to secure resources, if you want to secure your future, you'd better secure it with your own might and main.† And that's a very different kind of world.† That's a very different kind of world than the one we live in today.

I'm not suggesting that the past is prelude to today's future.† Things will unfold in some very different way, but it suggests some questions that one can use in looking ahead about the geopolitical tests that they'll face, which I think Iran and Pakistan are very high on that list, since this is -- this is being managed credibly and with some coherence or not.† And then on the international political economy side, there are a cluster of things in which I actually think and somewhat fear that American fiscal policy and political debates in Europe could -- and Chinese reticence could combine in very unfortunate ways.† And perhaps we can develop that subject a little bit.

MEDLEY:† And let's follow up on that, Joe.† I mean, there is a really interesting development with China, Taiwan and Japan.† That triumvirate seems to be moving more toward cooperation than one would have predicted.† Again, as, you know -- as you said, Phil, it's hard to make, you know, 10-year predictions, because you always look like an idiot.

But there -- certainly right now, China, Taiwan, Japan, there seems to be an opening there or no?

NYE:† Well, we developed a strategy back in the '90s called the East Asian strategy, which basically said with the rise of China, is this necessarily going to lead to conflict between the two great powers, a la the rise of Kaiser's Germany in 1914.† And we said not necessarily.† What's interesting is Britain had actually been overtaken by Germany by 1900.† China is not going to overtake the United States, as I suggested, for another couple of decades.† So we've got a lot more room there.

The strategy we designed at that time was reaffirm the U.S.-Japan security treaty so that if a three-party game, China can't play a Japan card against us, that essentially we have the balance of power, and within that framework, open the door to China by joining the WTO and integrate them into the international economy, which -- Bob Zoellick properly put it when he was deputy secretary of State, asked China to become a responsible stakeholder.† That strategy was not rejected by the Bush administration, and it so far seems to be continued by the Obama administration.

And the main thing -- again, going back to my point when you say, "What could make it all wrong?" the main joker in that deck was Taiwan.† Under the previous president, Chen Shui-bian, there was an incipient independence movement, or the government was actually making incipient moves toward independence that drove Beijing crazy.† He's been replaced by Ma Ying-jeou, the current president, who has now launched a cross-straits dialogue.† And almost everybody I know who's been in Taiwan, in Beijing and so forth, says, "You know what?† This may be one of the rare problems which is getting better with time, rather than worse."† So the big joker in that deck which would have thrown our East Asian strategy off course seems to be, for now, at least, better.† But if it arose again, that could be a problem.

The Japanese-Chinese relationship is one which is quite interesting.† When I was renegotiating the U.S.-Japan security treaty in the '90s, the thing that always interested me is that when you talk with your Japanese counterparts across the table or in front of cameras, all they had were good words about China.† Then you went to a bar late at night to see what they really wanted to say, and they were scared as hell about the rise of China.† And the important thing is that Japan will be our ally, because the rise of China is a concern.† But it's important to reassure the Japanese.† So we don't want negative China-Japan relations.† That would have a bad effect.

I've always argued that what you want is a triangle of good relations between U.S., Japan and China to produce stability in East Asia, which is the basis on which markets can bring prosperity.† That has worked, and I think the important thing now is to keep that triangle stable in all three legs.† I think it looks better now then it did, say, a decade ago.

ZELIKOW:† Joe's points are very good.† And, of course, if you think about the East Asian geopolitical environment, all the countries in East Asia are very conscious about how they're going to play their relations with China.† But put yourself in their position.† All of you would answer the question, "Do you want friendly relations with China?" of course, you would say yes.† If I would ask you, "Would you put yourself in China's hands?" all of you would say no.† You would say no not because you necessarily dislike China or hate China, but because you cannot possibly trust it, precisely because of the way its own government works.† Indeed, many people who are very close to the Chinese government in China don't trust how their government is going to work, because their government is deeply opaque and it's extremely complicated in lots of ways that those of you who follow China understand very well.

So therefore, given a very large country ruled in such an opaque and mysterious way -- so pretty much all of its neighbors are going to want to have some powerful neighbor to be its -- some powerful country like us to be their friend.† And if we'll act in a more or less responsible way, our geopolitical position in East Asia could be very secure.† Then the problem is to make sure that that doesn't turn into some kind of arrangement where the Chinese think the world's trying to contain them and they're -- it's a zero-sum black-white game.† And in our different ways, both Joe and I have been trying to stress to people for more than 10 years that absolutely that doesn't need to be the case.† This can actually be a win-win situation in a world that accepts interdependence and common frameworks.

MEDLEY:† And I think that's the thing that we can really agree on, is that there's a real -- with the Taiwan thing in particular, with China behaving the way it has with their responsibility on the currency and everything like that, there is a chance for a win-win there.

One thing we haven't touched on -- and it's kind of always the -- you know, as Ross Perot used to say, the crazy aunt in the attic is Europe.† I mean, we're not as in tune with Europe, in an odd way, as we are with the Asian powers.† And I'd like to get your -- you know, your thoughts on that.† Where -- because there is real divergence in the way we're handling this, the way they think about markets versus the way we think about markets.† And --

ZELIKOW:† Let me jump on that and to -- make a really large fundamental point about the future of the international political economy. †

The basic international political economy that we're revisiting today was forged in the late 1970s and early 1980s.† And I want to remind some of you who took economics of the famous Mundell-Fleming impossibility theorem.† The Mundell-Fleming impossibility theorem, for which Robert Mundell, a Canadian economist, won a Nobel Prize, stated that there are three desirable things you might want to have.† You might want to have capital mobility, free movement of capital.† You might want to have stable exchange rates.† And you might want to have national autonomy in controlling your monetary policy, basically national economic autonomy.† Those are three desirable things.† Mundell argued you can never have all three of those things.† You can only have two of those three things; pick which two you want. †

The Bretton Woods system was liberal in many ways, on trade, especially.† It was not a liberal system for capital mobility.† Capital mobility was government-brokered and highly limited.† This began to erode in the 1960s, and it was a system beset by constant crises, the -- no need to go into details.† And therefore -- because what had happened is they resolved Mundell's theorem by saying, "We're going to sacrifice capital mobility to have stable exchange rates and national autonomy, because we're going to use national Keynesianism, and we want to have the freedom to do that."† And then that system broke down and collapsed in the early 1970s.

What replaced it?† What replaced it was a new solution to the Mundell theorem in which you sacrifice national autonomy to a very large degree.† You get more stable exchange rates -- somewhat stable exchange rates and a high degree of capital mobility.† That -- there were big crises that tested the formulation of that, bracketed by -- from the British IMF crisis of 1976 to the Third World debt crisis and Mitterrand's famous u-turn of 1982.† Now, that is important. †

The question is, today, are we going to revisit that solution to the Mundell theorem?† And the place where it is most likely to be revisited is not the United States, nor in East Asia, which relies on capital mobility.† It is in Europe.† It is in Europe where, actually, it was tested most severely in the late '70s and Mitterrand's France, and it is in Europe where it may be tested again.† Mitterrand made the u-turn in 1982 after he tried a national Keynesian approach.† He was broken, basically, by the Germans and the European monetary system, by the way, who had also disciplined the Americans during the Carter administration.† And finally the Americans gave in and appointed Paul Volcker in 1979 after they had bucked against Europe, for those of you who think the Americans always make the rules.† The Germans really had been the anchor throughout, partly because of their continuing coalitions that always had the Free Democrats as a critical partner playing a governing role in their economic policy.

Now, the Germans are still actually the anchor in the way Europe has been approaching it and† -- (inaudible) -- hard-money policy Europe has generally been adopting lately.† That's being tested right now in Germany and in European politics.† Not only are there the East European problems, which have gotten some attention.† In some ways, I'm more worried about Southern Europe over the -- over the near term.† But look at what's happening in German politics, per se.† Oskar Lafontaine and others are now joining hands with some of the old former East German communists and they're making a square assault on the whole fundamental premises of the social market economy that has governed the German economy for the last generation.† They're going after the Mundell theorem.

If Germany breaks, where does France go?† And indeed, France gave in before, because their European identity turned out to be more important than adopting their own independent economic path. †

So if Europe cracks in some really important way, then really the whole way the world regards the solution to the Mundell theorem then goes open to question, and the whole structure of the international political economy comes back into play.

MEDLEY:† I just want to say quickly, Joe -- and I want to turn it to one -- but the -- what you're alluding to is very important, because there is a fundamental concern in the markets that what are called derogatorily PIGS -- that Portugal, Italy, Greece and Spain will break off from Europe and that -- and that the ECB will not be able to save the southern region from breaking off because of debt and other issues.† Obviously, that would be -- that would just be a catastrophic development.† But short of that, there's still challenges that Europe faces versus the way they're handling things.

NYE:† Yeah, I'm somewhat less Europe-pessimistic than Philip is.† I think he's right to warn on this.† The pendulum is going to swing from the market orientation to state orientation -- swinging in this country as well as in Europe.† The question is, how far does it swing?† I don't think the German system's going to break.† You get about 10 percent for this left coalition that Phil mentioned.† And I think also that what's interesting is we all predict increased protectionism with economic downturn.† What's interesting is not that there's been some, but how little there's been -- much less than predicted.† And the European framework, while there is protectionism within it and with -- both internally and externally, what's interesting is how limited it's been.

So it's not nearly as bad as one -- I mean, you could make a case -- a scenario is still made.† I don't see that as the most likely scenario.† The -- one of my colleagues at Harvard has just done a projection arguing that Europe is going to come through this fine and that the Euro will be a reserve currency -- dominant reserve currency by 2020.† I don't agree with that, because I think they don't have a macroeconomic policy behind it.† But it's -- any case, I don't think you're going to see this swing going so far in Europe.

I worry a little bit less about Southern Europe than I do about Eastern Europe.† Europe essentially brought the center of Europe into the Brussels framework, which was extraordinarily important.†† It meant that instead of instability, you had stable democracies in the center of Europe -- lots of problems with all of them, but nonetheless a lot different from Europe in the 1930s, for example, in that region.† But go one tranche further east and look at Ukraine, look at Belarus, look at Moldova, look at the Caucasus and so forth; that's the area which is, I think, very problematic.† Ukraine down 20 percent GDP; lots of problems with internal cohesion; lots of problems with the Russians trying to get hold of the gas market.† That's an area where the EU had created an East Europe -- an Eastern Europe initiative, but it's now underfunded and under-attended-to, because of the problems inside the EU itself.† And they focused first on Poland and Hungary, rather than the further east.

So if I were asking for a geopolitical crisis area, the fact that the Russians want to exert their post-imperial space again and that the Europeans aren't paying enough attention, that would be the geopolitical belt that I would worry about, not the Southern Europe belt.

MEDLEY:† But again -- I mean, even there, in terms of the positive policy responses, as you said, that the lack of protection -- we were talking about the FTAs and things that -- really, lots of positive things have happened in this crisis.† One of them was when they couldn't, you know, focus the ECB and other resources on Eastern Europe, we brought in the IMF, which was, you know -- you know, a truly substantial commitment to kind of hold the border until we could get this --

NYE:† Right.

MEDLEY:† Until we could get this together.† It's -- I just thing the policy responses have been phenomenal relative to history.

NYE:† Yeah.† Much better than expected.† And --

MEDLEY:† And by the way, I have to say, the Bush administration, you know, started this a long -- you know, I may be a Democrat, but they did start this; they did get a lot of this right early on.

NYE:† Bringing in the IMF -- reviving the IMF, what have they -- year or so ago at a meeting of Sebastian's center here, we were talking about what were we learning about the crisis, and one of the comments was the irrelevance of the IMF.† Well, guess what?† They're relevant again.† I think that's important, because if you rely just on the EU to solve these eastern problems, you got to globalize it.† You got to get in into a broader context.

MEDLEY:† Exactly.

ZELIKOW:† Right, because, I mean, all this -- all of this tends to renew confidence that global frameworks for managing† interdependence work.

NYE:† Yes.

ZELIKOW:† And the crisis becomes truly ominous at the point people think they don't work anymore and that world in which we could rely on interdependence in global frameworks is passing from the scene.† It's worth, then, taking Joe's comment on Ukraine, which he's been -- he's dead right about that. †

I want to circle back to China again and to the role of China in all of this, as we think about the importance of global frameworks and the commitment to interdependence.† I'm not sure what China's going to do over the next five years.† It is -- I see -- I know where China wants to go over the next five months.† I think I see the short-term trajectory of the leadership.† You can just -- if you plot it out in a linear way, that sounds good.† And that if you talk to people who follow China -- how confident are you that the Chinese basically can just keep the tiller steady for the next several years to come? -- you begin to find some people who have some concerns.

And I want to underscore that a little bit by telling another little historical story, because if you -- if you follow the economic historians of the Great Depression like Peter Temin, a lot of them actually draw the basic shot that caused the Great Depression actually back to World War I.† That's Temin's argument.† And what really happens then is the burden of being the great world creditor and spreader of money shifted from Britain to America.† Britain had held a lot of the gold and had dispensed it liberally because of its firm belief in free trade.† Britain was the world's major creditor.† During the war, really, in 1916 and 1917, this turn -- and Britain is bankrupted by the war and the decision to continue the war in 1916 that both Britain and Germany make in their different ways.† But one reason is Britain is bankrupt by the end of 1916 and going into 1917 and they know it, and now they rely on American loans.

So basically, the burden of becoming the world's creditor shifts to the United States as the -- by the time the war ends.† And America, increasingly, has gathered the world's gold.† What America does right after the war is it passes a tariff that's much more important than Smoot-Hawley, that famous old tariff of 1930, which is the Fordney-McCumber tariff, in which they -- coming out of the war, they've got all of the world's gold.† Instead of adopting a policy of free trade and liberally dispensing the aggregate demand that all that gold represents, they build a huge set of trade walls.† And then -- that's what Washington does.† And Wall Street tries to help keep Europe afloat by lending dollars to Europe, which were then recycled to help keep things going in Europe.

But what that meant, then, from the economist's point of view, is a terrific shock from essentially the displacement of Britain's role -- this hegemonic role in the world economy, America doesn't take Britain's place.† America basically builds a fortress America relying on its domestic economy, primarily, through these tariff walls and other things, but then hides that a little bit through the way Wall Street was dispensing credit, a credit line that then completely dried up when the crash came.

Now -- think back, now the -- think about -- instead of thinking -- instead of Britain, think America, and instead of America, think China.† Think about the role that China now has in lubricating the dispersal of capital worldwide and in the way China manages its own economic demand as a way of keeping global economic demand up.† If China doesn't basically open the trading doors and allow its increases in demand and its economic growth to become an engine for global economic growth, China cannot take the -- cannot take the place that the United States is increasingly stepping back from, as it necessarily begins restraining its own domestic demand and trying to figure out how to repay the gigantic loans it is borrowing and will keep borrowing.

So the responsibility on China to be the responsible stakeholder, to borrow that phrase, really becomes important.† In the little historical story I just told, the impact of these choices do not become apparent for eight to 10 years.

NYE:† Could I just -- to add on Phil's nice historical comparison, one of the big differences, of course, is that China -- the renminbi is not about to replace the dollar as a reserve currency.† As Kindleberger shows, the problem in the 1930s was Britain was broke and the Americans didn't live up to their responsibilities.† China is not where -- yet in relation to the current world, where America was for the -- to the world economy and to Britain in the 1930s.† It's not that strong yet.

The interesting question is the Chinese have been complaining about having to hold dollars, and they've made noises about going toward SDRs globally.† The government -- Zhou, the president of the Chinese central bank has made that.† That's understandable.† It puts a shot across our bow.† But a more illustrative statement was by somebody else in that framework, Luo Ping, who said, "You know, we just don't know what else to do with our money except to buy dollars and hold dollars."† He said, "We hate you guys, but there's nothing we can do about it."† The hating us not in a literal sense, but in the sense that that's the only store of value at this time.

So I think the -- it's an interesting analogue, but the circumstance of China's not the circumstance of the U.S. in the '30s vis-a-vis Britain.† What is interesting is, will China change its growth model?† If they go back after this recession to pure export-led growth and accumulate these surpluses even further, that will put a lot of pressure on the system.

Now, the Chinese will tell you -- the 6 percent growth they expect this year, it's all internal demand.† Well, partly that's because of the stimulus.† And the interesting question is, will they begin to alter their growth model toward greater consumer spending and internal demand when the government component diminishes after the stimulus?† There are some signs that this is happening.† You know, you see consumer demand arising in some of the interior provinces, not just the coastal areas.† But if the Chinese don't alter their growth model, then the pressures of these imbalances, as Martin Wolf likes to point out, could create another kind of problem.

MEDLEY:† Okay, great.

Let's go to our questions from the audience.† Just remember -- when you ask a question, remember to identify yourself and wait for the microphone.

Stephen?

QUESTIONER:† Steve Freidheim, Cyrus Capital.† I want to pick up on this question -- the issue of the debt.† You know, Joe, you mentioned in your comments that the U.S. power, in part, was assumed on growth coming out.† And I guess the corollary to that is the debt side.† I mean, there -- and the question is, is there are a debt level in which the size of the debt becomes a problem?† And as you look out, in terms of the various stimulus packages that are being put together by various geopolitical belts, as you call them, you know, where -- as we come out of this, which areas are going to be areas where the levels of debt are going to be advantages and where are the debt levels going to be disadvantages?† And how important does that figure into the balance of power coming out?

NYE:† Well, clearly people's willingness to hold dollars will diminish at some point, when the -- you know, the number -- supply of dollars is too great.† It's interesting to remember that when people -- two years ago, many people predicting the current crisis based on our deficits -- twin deficits, which was going to lead to the hard landing of the dollar, that's not what caused the crisis.† It was totally different.† But it is conceivable that that could play out in the future.† We just -- if we just inflate our way out of the debt problem -- I mean, out of the fiscal problem by just spending without any upper limits, at some point, people are going to say, where else can I hold value, because I know my dollars are going to be devalued in the future?† And that could lead to a hard landing or something.

But generally, people say, you know, you have to be over a hundred percent of debt-to-GDP ratio before you begin to get that worry.† But it's worth -- and we're nowhere near that yet, even with the projections of the -- that Phil was worried about, we're not there.† And it's worth remembering that economies like Japan have passed that limit in the past.† So it's not -- it's not an absolute number, but many people say that hundred percent is just a salient point at which worrying increases.

So I think it -- I think it's crucial -- I mean, the assumptions that I would make are if you have real economic growth, it can allow you to grow your way out of this problem.† If you have what I described as not a "V" or "W" but this long, flat "L" for a decade, then you're not going to grow your way out of this, and that debt problem may get to ratios which lead to lack of confidence in the dollar.† I don't think we're there yet, but, I mean, it does go back to the point that Phil and I were making earlier that if you make those assumptions -- I mean, it depends on which of those assumptions you make, is the answer to your question.

ZELIKOW:† Well, I'm still uneasy.† I'm uneasy on a couple of levels. I'm uneasy because I just don't see a plan for medium-term fiscal sustainability and I'm -- smarter people than I am say that if you don't have the medium-term fiscal sustainability squared away, then you're likely to have to pay higher interest rates to borrow the money, and that's going to then produce the very economic profile that Joe just warned about.† And what I hear back from that is a little bit of complacency, which basically says they have no place else to put their money.

So yeah, we've seen a little -- the spreads have gone up some, but they're -- it's still not that bad.† One thing, though, that IMF economists have pointed out is that this can change on a dime.† So spreads can be pretty narrow and then people -- there's some point in which the market just comes to a conclusion.† They keep waiting to see and then they come to a -- this ain't going to happen or -- and some alternative ways of storing value emerge and things can happen.


QUESTIONER:† What are they?

ZELIKOW:† They find some other places to put their money, possibly even in their own economies, if their own economies are recovering, because we're borrowing at levels that we haven't seen since the Second World War.† But the big difference from the Second World War era is in the Second World War era we borrowed the money from ourselves.† Remember those war bond drives?† We're not borrowing the money from ourselves anymore.† Therefore, there -- when we borrow the money, there are opportunity costs to that.† That money is not doing other things.† And so the people who have that money have to -- basically, if they're foreigners, they're not going to invest it domestically because they'd rather buy T-bills with it.

Well, if they're -- if the world economy is recovering -- and we want it to recovery -- is this actually a good outcome for the world economy?† I mean, maybe when you look, the numbers involved just aren't enough at the margin to really make that much of a difference in the recovery of the world economy, but I listen to some of the things Mallaby over there says about his estimates of macro global demand and where that demand comes from, and it just all leaves me rather uneasy.

By the way, if I were the Chinese, I actually would be trying to create a reserve currency that's an alternative to both the dollar and the Euro, some kind of basket, some kind of invention.† I'd be working very hard at that.

MEDLEY:† Max?† Back there.

QUESTIONER:††† I'm -- (name inaudible).† I was struck by how sanguine you both sounded on avoiding the dangers of protectionism, but when you look at how world trade has plummeted in the last year or so, when you look at what Bob Zoellick warned about at the recent G-20, that 17 of the nations involved there had taken protectionist measures, and the growing pressure on politicians to save jobs -- as we saw recently even within the European Union, where Sarkozy ordered French automakers, we'll give you subsidies, but only if you create those jobs in France -- I just wonder whether there is such a snowball of momentum building that politicians won't be able to avoid it.† And I don't see anything on the horizon that looks positive, such as a world trade agreement.† Doha looks dead.† So I wonder if you'd elaborate a bit more on why you feel relatively upbeat on the dangers of protectionism.

NYE:† Well, I think what I meant to say was, yes, trade has declined drastically, but not because of protectionism.† The decline comes first, which may generate protectionism.

The proposition I was going on is that, other things being equal, when you have a decline in economic activity in a democracy, you should expect a rise in protectionism.† I mean, squeaky wheels will demand grease.† There has been, in all the countries mentioned, a rise in protectionism.† There -- I mean, and some of it is open; some of it is covert.† I mean, there's essentially a covert protectionism in terms of bailouts of banks, in terms of, you know, informal encouragement to invest locally rather than internationally. †

So, yes, there's been an increase in protectionism.† But compared to what would otherwise be predicted by the level of the economic decline, it's been much less than expected.† I mean, we are really not at a Smoot-Hawley moment.† If we get to my long "V" scenario -- my long "L" scenario, I would expect that to increase considerably.† So I'm not sanguine, but I'm just saying what's remarkable is that this dog hasn't barked louder so far.

ZELIKOW:† Let me just stress again, though, the point is when people work through these projections, the people who work conflicts tend to concentrate on what's going on in regional conflict† and geopolitics.† The people who work economics tend to work economic projections.† And so the big point I want to underscore for you is the synergy between the two. †

In other words, let's imagine that the economic crisis produces strains that cause actually political explosions in, say, Ukraine or Pakistan or both and that one or both of those situations and maybe Iran, too, goes south in some really important way over the next couple of years with possible violence involving -- violent crisis involving Russia and so on.† Now, that could have a whole causal chain in which economics are a background factor but aren't the primary driver.† But when that crisis plays out -- when those crises play out, those crises will then have a huge synergistic effect on the global economy, because those -- the political effects of those crises will than damage the operation of global frameworks of interdependence that are kind of taken as the background assumptions for the success of global economic recovery, the IMF as an effective debtor of last resort, the gradual assimilation of China into a role of greater global responsibility and so on.

So that's the thing that I most worry about, is that the global economic situation stays very tippy; there's some serious elements of instability remaining in the scenario; there are then some particular local effects that are severe in a few countries, and that those problems then catch fire in ways that produce first-rate political crises that don't seem to be handled effectively, and then you get a really toxic combination that can move world history into a quite different place.

MEDLEY:† Next question?† Right here in --

QUESTIONER:† (Name and affiliation inaudible.)† There seems to be no end of self-flagellation here in the United States at our profligacy and how we spent ourselves into this crisis and the rest of the world is quite happy to jump on that as well and point their fingers at the United States.† But as Joe pointed out before, the necessary condition for us to be the consumers of last resort was nobody else doing the consuming, and in particular, China.

And towards -- then in -- it worries me a lot that as we move out of this phase of the crisis that the rest of the world doesn't take up the slack to try and demand and consume more, and we go right back into the kind of imbalance that created the conditions of excess credit and sort of dumb things in the Untied States.† So I guess the first question is, do you see that as a risk?† And the second question is, if China doesn't step up to the plate by further stimulating domestic demand, are there other strategies that the U.S. and the world can think about to try and avoid those imbalances by us consuming and nobody else doing the same?

ZELIKOW : Well, another -- one other way in which you'll see signs of weakening interdependence is not just the rise of tariff barriers, but the rise of what others, including Sebastian, have talked about as "self insurance," where they basically just hoard money and then they do things to depress or artificially depress domestic demand so they can hoard more money.† And they're basically operating as predators in the world economy, getting what they can out of it so they can hoard more as insurance against potential reverses.† It's a different version of the old story of I'm going to myself acquire all the resources I need for solvency without really relying on an interdependent system.† This, too, though, will have large effects for the depression of overall global demand.

And I don't really see right now a good answer to that problem.† I -- there is a -- just as there is a free market ideology that may have been at work that basically says that -- that criticizes some of the actions that accelerated -- that were -- that didn't pay attention to the asset price inflation while they concentrated so much on consumer price inflation, there is also a kind of -- there is also kind of ideology at work now in the revival of belief in Keynesian stimulus, which is also an ideology, and that this is an effective way of providing demand.† And it also actually -- the science underneath that ideology is not great, rests on a few historical episodes that are susceptible to multiple interpretations.† And if you then begin over-relying on that to solve the problem, then you may find it harder and harder to sustain debt, which then increasingly turns you -- because the world won't lend you the money to sustain it, and then you're back into -- you're back into the "every man for himself" paradigm in another way, and which -- nations then will need to enact capital controls and others things in order to hold on to their money.

Joe?

NYE:† Yeah.† Martin Wolf is -- has written several interesting columns in the FT basically making the point that you were stressing, properly.† And it is a worry.† If all you do is the U.S. uses fiscal policy to get back into growth and it's ahead of everybody else and we go back to the world as it was before this and we just accumulate the same imbalances and then, in addition to that, you have the increased fiscal deficits that we talked about earlier, which reduces confidence in the dollar, you can see an unhappy scenario.† That's the bad news, and Wolf is right to point it out.

The good news is that the world's second largest economy is doing a major fiscal stimulus and trying to orient it more on the domestic side and that the -- leaving aside the Europeans for a minute -- the third largest economy, China, I think -- there's some signs that the Chinese may realize that their model -- that they can't go back to the old model.† They may know what I just said; they read Martin Wolf, too.† And they view -- (laughter) -- no, I mean, there are very sophisticated people in -- doing the banking and finance in China now.

And what's interesting there is from the top political leadership in China, their major concern, what drives them, is the prospect of domestic instability.† The legitimacy of their political leadership rests on high rates of economic growth.† And if they realize that, sorry, if you go back to business as usual just before all this, guess what?† You're going to wind up with protectionism, with barriers against you and so forth.† And what's that going to do to your model of political stability at home?† Then you start thinking of other paths.

So the argument would be that the Chinese won't go back just as they were, that they will do more, essentially, to increase domestic demand.† And they have programs now -- you know, subsidizing purchase of automobiles and other things and consumer durables and so forth to increase demand at home.

MEDLEY:† Well, one particular thing they just did hasn't gotten a lot of attention.† They actually allowed for the first time farmers in the west to take their land, which is still communally held, actually -- still held by the state -- but to use their land as collateral for loans.† And this is a -- this is a huge potential breakthrough and gives you a sense the Chinese really are thinking about an internal stimulus model rather than a -- I mean, sorry, an internal demand model rather than purely a --

NYE:† Those are the good news parts of the story.† To be fair, balance is -- there's a bad news part of the story, which was, again, put forward by the central bank governor, Zhou.† He said, "Culturally, we are locked into high savings rates."† Particularly, if you look at the demographics -- (inaudible) -- all these children to support you, in the absence of a social security system, you better save.† And so there is a cultural barrier as well as -- I mean, the politics may say do what you're just saying.† The innate conservatism of the culture about savings may run the other way.

ZELIKOW:† There's another -- there are two other danger signs I want to call attention to.† One is -- on the Chinese is when I was in government I was, like Joe, very impressed with the Chinese you would encounter especially on economic issues.† I mean, they're the new Mandarins, and they're terrific.† (Laughter.)

NYE:† That's a good phrase, Phil.

ZELIKOW:† So, then you assess how much do we lean on the future of -- those folks, they're definitely going to be in charge.† That is really the -- that's the face of China I can rely on seeing for the rest of my professional life.† I expect to ask, you know, other people who know China better, how much would you bet on that premise?† Because other Chinese that you might encounter in other settings have a very different strategic culture and outlook on the world.† So that's just -- that's just kind of an asterisk.† Mostly it's just a measurement of my own ignorance and unease.

The second thing, though, I want to call attention to, which we haven't mentioned at all so far today, is India.† One of the important ingredients of optimism about the general trajectory of the world economy was not just China but also the fact that beginning especially in the early '90s, India had joined in the full globalization of the world economy, and was increasingly participating in it with a lot of activity and energy that you can especially see in the Indian private sector.

And so one other interesting set of questions is, what does the trajectory look like for India?† And does that trajectory stay constant or does it change as India essentially, which -- there is a very strong strain in India's political culture that likes insularity.† I won't elaborate on it.† Those of you who know India know it -- understand this well.† And you can easily see that happening again.† If that happens again, that's another, again, potential drag on predictions for the general strength of the global economy and where that's going and another potential large source of instability in East Asia.

MEDLEY:† Another question, right there in the center.† Can we get a microphone?

QUESTIONER:† Matt Nimetz.† The goal is to get world demand up again to sustain the growth that we used to have.† But the way we're going about it is very much setting up the stage for what got us into trouble, that is, doing it through increasing debt.† And even the Chinese idea of letting peasants mortgage their land to consume is basically a subprime mortgage program for China.† And what we're doing in this country is encouraging people and banks to lend extensively to people, to get credit cards' rates down, to have the government driving that.† So aren't we -- aren't we getting ourselves into the exact same position where we were five, ten years ago, of increasing debt in -- both by governments and by consumers?† And we have no real solution to sustained growth outside of very, very risky policies which inevitably will be -- lead to great volatility in the future.† And so is there any sustained way of achieving growth?

NYE:† I think -- I mean, what we're betting on, greatly oversimplified, is that the real economy will bail out the financial system.† If the financial system is so broken that the real economy can't bail it out in time, you could either get a "W," in my earlier terms, or you can get this fall to the low "L."† So there is a -- I mean, there is a serious problem that you identified, Matt.

On the other hand, as you look at sources of real growth, you have to look at the sources of productivity.† There are parts -- I mean, if you look at Silicon Valley, as you look at biotechnology around Cambridge, I mean, there still is -- I have a son in each of those two markets, so I may be biased on this.† But, I mean, they're in the capital sector of those two markets.† But their view is that there's a lot of capital about ready; there are a lot of good ideas there.† So if all we're doing is building bridges to nowhere and throwing government money in things, yeah, then we're in the dilemma you say.† If you think that the entrepreneurial nature of our culture is not changed and the opportunities are there and that can lead to increase in productivity, that's the source of real growth.† And I think the danger is that we don't let the government pendulum swing so far that it nips that in the bud.

But I -- I mean, it's -- so we're using government if you want to have the real economy rescue the financial economy.† And that depends upon the government in doing that, using just the fiscal stimulus but not over-regulating in such a way that you nip that source of real long-term growth.† That's a very simplified version of the -- of a picture of the economy.† But I think there -- it's at least a -- it's at least a consistent story, if not the only story.

ZELIKOW:† Yeah, because I think we all sense somehow that the growth model has to represent more -- has to represent something more than just "I can find ways to spend money."† But we just know in our guts that somehow sustainable growth has something in it that has to do with productivity or industriousness or the ability to qualitatively change the economy so that people are doing new things that then create new areas of specialization, new markets, development of new products and so forth.

And so then you have to ask yourself, what is it about the global economy that's been so extraordinarily successful over the last half century in raising the material well-being, life expectancy, any number of measurements of human well-being in such an extraordinary way?† And it is this -- the creation of a global industrious revolution, not industrial revolution, of the globalizing of that, the enormous specialization that can be created through the creation of these global networks, the opening of new markets for products, the variegation of many, many kinds of demands and the like.

And you do have a sense that for this to continue you need to be able to sustain these broad frameworks of interdependence that I've described and that somehow just simply persuading governments to spend more money or borrow more money just isn't an answer, like the example -- you're worried about the Chinese farmers borrowing money.† It's, you know -- and then you -- the first thing that came to my mind was, yeah, I remember when American farmers were borrowing a lot of money and there's been some times when that didn't work out so well for the farmer, or at least they thought so.† And then again, then my second thought was, I tried -- I remembered my image of Chinese banks.† Now, this may be dated.† I used to have a bad impression of the way Chinese banks made their decisions.† But it may be much better now.

MEDLEY:† Another question?† Right in the -- oh, yes, sir.

QUESTIONER:† Hello.† Zachary Karabell.† On Phil's point of there may be bad things that will still happen in the coming years that we're still at the beginning or that we could be at the early stage of an ongoing systemic issue, my question would be why, given the rhetoric and the sense, at least, from the past nine months that this is the worst since the Great Depression, that we're on the edge of precipice, that the financial system is largely, if not completely, dysfunctional, why it is that we have seen almost no political instability or even murmurings that would lead you think to think that that's in the next six to 12 months?† And while the point is taken that all of this can change on a dime, it does bear asking, is there some disconnect between the sense either in New York or in the media or for those implicated within the financial system of this being catastrophic that is at odds with what is actually being evidenced in the real world?

ZELIKOW:† Yes.† And this is precisely the point I was trying to drive home, is it's this -- my May -- my homely May 1931 example.† In May 1931, it wasn't the end of the world, and it didn't have to be.† In other words, I don't regard everything that happened after May 1931 as deterministically set by what came before, and they just didn't see it, poor schmoes.† No.† In fact, there had been really severe shocks right after World War I of comparable scale.† There was -- they could have pulled out of it, and then this would have seemed like just one more severe panic and so on that people then got over.† The key decisions that drove it off the precipice weren't in '29; they were the decisions in '31 to '33.† In other words, the analogue is they're not the decisions that happen in '07; they're decisions we're going to be making now and in the next year or two that will determine whether or not this flattens out and pulls out or else we make some bad economic and financial choices that then probably combine with responses on some political fronts that are maybe only distantly connected that then combine to create a whole qualitative step change in the crisis.† We're not there yet and we don't have to get there and I hope we won't get there.

MEDLEY:† Joe, do you want a final word?

NYE:† No.† I mean, I think Zach has actually written on this.† What it --

MEDLEY:† What hasn't he written on?

NYE:† Well, he's written on everything and intelligently, so it's a -- but the -- I think the thing, again, you ought to say is the usual expectation when you have this degree of negative growth is a lot of political turmoil.† It's like the comment we made earlier about protectionism.† You would say, given this degree of decline, expect a lot of protectionism.† There has been protectionism.† There's been some political instability, you know, in some of the Baltic states, the Czech Republic and several -- but, you know, compared to what you would expect, much less than predicted. †

And that does raise an interesting point, which is always look for anomalies, things that aren't the way that predictions go.† And there are two anomalies:† Protectionism hasn't been as bad as it first looked and the political instability hasn't been as great as it first looks.† And that makes one think that -- be careful about your 1930s analogies.† I mean, Phil's right to remind us of this.† But just as it's a mistake to think that there's no relevance to the '30s, it's also a mistake to think that we're going to repeat ourselves, as Phil's and my friend Ernie May (sp) likes to quote Mark Twain about history doesn't repeat itself; at best, it† rhymes.† Well, we're right now in a rhyme and we're not quite clear how it's rhyming.

MEDLEY:† Okay.† Thank you.† We always have a rule of getting out on time.† It's 10:45 now.† Thank you very much.† (Applause.)

NYE:† Thank you.

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