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World Economic Update [Rush Transcript; Federal News Service]

Panelists: Roger Ferguson, Glenn Hubbard, and Stephen S. Roach
Moderator: Daniel K. Tarullo, Professor of Law, Georgetown University Law Center
February 21, 2007

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DANIEL K. TARULLO: Good morning, everyone. We want to get started so we can get you out in a timely fashion.

Welcome to this session of the World Economic Update. I want to remind regular participants at Council meetings of a couple of idiosyncrasies of this one. First, it is on the record; secondly, this is being webcast over the Council's site around the world; and -- this is not idiosyncratic -- please turn off all cell phones, Blackberries and anything else which will make annoying noises in the course of the meeting.

So this morning, after a little bit of a hiatus, we're back and we're going to do one of the surveys of the world economy, the kind that we started this series off with. Maybe a little bit later in the spring, we'll move to something more focused and topical.

We have with us this morning as our panel very -- we always have good panels, this is a particularly good panel, I think. First time meeting with us, Roger Ferguson, former vice chair of the Fed, now the chairman and member of the executive committee at Swiss Re America; to my immediate left, Glenn Hubbard, former chairman of the Council of Economic Advisors and now back at Columbia as the dean of the Business School; and to -- I hesitate to say this -- to my far left -- (laughter) -- Steve Roach, chief economist, managing director at Morgan Stanley and formerly an optimist. (Laughter.) But once and future optimist is the way we want to put it.

So what we're going to try to do this morning, as I say, is to start with a look at the world economy. The way I framed it is for this year, identifying will are likely to go in both the upside and downside risks. Then we want to spend a little bit of time talking about the issue of whether Europe and potentially other areas of the world have de-coupled from the United States; that is, whether this metaphor of the world flying on the one engine of American consumption is no longer as an -- as accurate a metaphor. And I'm sure in the process, we're going to talk a bit about the continuing global imbalances and exchange rate policy.

So let's start off with the broadest question, and we'll put this to Steve and then Glenn and Roger add their comments as well.

So Steve, forecasts for this year, including, I think, yours at Morgan Stanley, have world growth still about 4 percent. By historical standards, looking quite good, even though a bit down from the last very good several years. Is -- is that still your view a couple of months after the forecast? And if so, what are the risks that the economy -- the world economy does face?

STEPHEN S. ROACH: Well, Dan -- first of all, it is great to be back here, I agree it's been too long. That is our baseline view at Morgan Stanley. This is a team of people who, believe it or not, report to me, and they don't agree with me. (Laughter.) So my sense is that, while we've had four terrific years of global growth -- in fact, the strongest four years since the early 1970s -- that the baseline view for the soft landing, which is maybe a slowing of about a half point from the average gains of 4.9 percent world growth on IMF basis over the preceding four years. The risks to that, I think, are very much on the downside, and I would cite two reasons for that, the American consumer and the Chinese producer.

We're all very smug about U.S. consumption -- it rebounded in the fourth quarter of last year after a couple of sluggish quarters -- and we're proud to declare that the consumer has withstood the pressures of the shakeout in the housing market. I think the jury's out on that one, right now. I think, number one, the housing downturn does have considerably further to go, maybe not in terms of housing starts and home sales, but in terms of the impacts of the construction sector itself. We've only had three quarters of sharp declines. The construction industry employment has unwound only about 14 percent of the gains that have occurred over the past five-and-a half years.

And consumers, as you know, Dan, with negative savings rates for the first time since the early 1930s, with record debt ratios, are not exactly well-positioned to keep plowing ahead if there was a shortfall in macro impacts from the housing sector. So I look for some reduction in consumption spending growth over the course of this year that will catch people by surprise.

And the second thing I'd point out is China. They do seem to be much more serious about slowing down an overheated investment sector than they've been in the past. Overnight, they raised their bank reserve requirements for the fifth time in nine months. They've raised their overnight lending rate a couple of times. So far it has had no impact on bank lending, but they're now, I think, at a point where they really do recognize the risk of allowing this overheated investment -- (audio difficulty) -- to continue. That's close to 50 percent of their economy. And if they -- if they slow -- if they succeed in slowing 50 percent of their economy down, the GDP and the industrial output has to follow.

And I guess the final thing I'd say on that is that at the start of 2006, investment spending in China was growing at a 30 percent rate. At the end of the year, it was growing at 14 (percent). So in fact, they have succeeded in slowing it down, and there's more to come. And then the final, final point I'll make -- because I know Roger wants to jump in -- is look, I've studied the psychology of pessimists and optimists for most of my life. And there's been a period in recorded history where optimists have been right for longer than five years. So they've had four good years -- (laughter) --

TARULLO: On any subject? (Cross talk, laughter.)

ROACH: -- they've had four good years. This is their last year. So enjoy it. (Laughter.)

ROGER W. FERGUSON, JR.: Let me jump in.

TARULLO: Roger, why don't you come in, and in particular, to the degree you think there are risks, are they on the downside?

FERGUSON: Right. First, I observed the anomaly of my sitting to Glenn's far right -- (laughter) -- which was, for those who know, the way things work, you understand the anomaly there.

Let me speak to the risk issue. I -- just to make this interesting, but also to tell you my real views -- firmly and totally disagree with Steve Roach. He is clearly out to lunch. (Laughter.) More seriously, I would say in my more serious sort of former Fed vice chairman role, that the risks to the global outlook I would describe as much more balanced than Steve's. The U.S. economy has done remarkably well, overcoming, clearly, some strong head winds from the housing sector. I agree with Steve there may be more left there. There's a little tail left, but I think I, at least, and many have been surprised at how well the U.S. economy has withstood the -- I think, the brunt of the housing market slowdown and house price slowdown. And that is partially because we are continuing to run quite well and create a large number of jobs, and it's a little hard to see dramatic slowing in the economy -- the global leader, which the U.S. is. You've even got unemployment, let's say, at about 4.5 percent.

If I look around the rest of the industrial world, I would say the same thing is true. Steve put a little weight on China. Yes, there are attempting to slow their economy from 10 percent to about 9 percent. That's not the stuff, I think, of which global slowdown is made. India continues to look quite good. We obviously are having a number of economies that are benefiting from relatively strong commodity prices, which I think will help a little bit. So I think there's actually much more balanced risk around this general outlook. And the final point I'd make as a formal central banker is I look at what central banks are doing, and they clearly are, I think, interested, but not yet in any sense aggressive. And so another 25 basis points across almost any of the major central banks, which perhaps is in the cards one way or another, globally, doesn't strike me as the kind of thing that throws the Earth's -- or the global economy off from this very, very positive and benign outlook. So I would disagree with Steve. I think the risks really are quite balanced around the global outlook, and if anything, there is, I think, a little more upside risk than Steve -- certainly more upside risk than Steve gives us credit for.

TARULLO: Okay. Glenn?

R. GLENN HUBBARD: Yeah, I certainly share that view. I think that if you look at what the world economy has been through in the past six or seven years, if you'd step back years ago and did your forecast, you never would have guessed where we would have been. To me, that says this isn't a fluke. There are some underlying sources of strength that I'll come back to in a second.

Just on the forecast, I think 4 percent for world growth's probably a tad optimistic, but I do think that all the major regions of the world are roughly growing at their potential, inflation pressures remain modest, so I think the outlook looks very good. I'm not so much worried about the risks Steve identified because they're well understood. I think they're priced in most forecasts. I actually worry about two kinds of downside risks that I don't think are as well understood. One are geopolitical risks that, because of their idiosyncratic nature, tend to be difficult for markets to price; one, I think, markets don't price well enough and people aren't worried about enough is protectionism. In this country and other major democracies, that, I think, is a clear and present danger.

On the upside, productivity growth remains very strong in the country, as does wealth. So for all those who think the consumer is just on a binge, remember the determinants of consumer spending have always been current and expected future income growth and wealth. Consumers, I think, could rightly be perceived as optimistic. I do think there are a lot of upside potentials in most of the world's regions, and I just don't think that this is the last year for optimism.

Sorry.

TARULLO: Yeah.

Steve, do you want to come back on any of these points?

ROACH: Yeah. How much time do we have? (Laughter.)

TARULLO: Take a few minutes.

ROACH: Well, I would say I would agree with Glenn's point on protectionism. That's, I think, a big issue, and I think it's not just the fact that we've had a political shift in the United States. It's a political shift that I think is grounded in some striking economic anomalies that have opened up in the U.S. and around the developed world. We talk about the win-win rubric of globalization. The win in a developed world has gone to the wealthy and to the owners of capital. The profit share of national income in the United States is at a record high, and the labor share is touching its record low. And this is true of most major countries in the industrial world. And, you know, I would challenge Glenn on the point that with labor income shares at record lows, how can you talk about the ongoing vigor of consumption other than for those who are lucky enough -- that's maybe the top 5 to 10 percent of the income stream -- to carry the weight for others.

And with respect to Roger, I'd be interested in his views now that he's -- he can come clean as a former central banker -- how much of this is just an outgrowth of an extraordinary aggressive monetary accommodation that has fueled the mother of all liquidity cycles that has driven spreads on every risky asset class in the world simultaneously down to record (types ?) And what happens if central banks actually do what we thought they were supposed to do back in the days of William McChesney Martin, and that's begin to take the punch bowl away when the party's getting good? This is a pretty good party, isn't it, Roger?

FERGUSON: Let me jump in. As a former central banker -- even as the central bank when I was doing it, I thought I was always clean, so let me continue -- (laughter) -- that process of being clean.

With respect to Steve's substantive point, it is absolutely true that we are living in what I would describe as a low-everything environment. There are low risk spreads just across the board. I agree that some of that is undoubtedly not going to be sustainable as things roll forward. However, I think where Steve's got it wrong is the reason that that is the case -- and it's not purely because of central bank action, but it's actually what's going on in the real economy. What we've got happening in the real economy is inflation is low and contained almost everywhere globally, expected to come down in the U.S. --where I will admit it's been tad high for sure, but expected to come down -- and we have had a dramatic sense of certainty, which perhaps will change. But all that is implied that you have, in technical terms, the risk premia are down broadly because there is less inflation uncertainty, because the level of inflation is somewhat lower, and because they have -- if you will, generally a lower macroeconomic volatility, which I think is then fed into prices, as you've seen, and certainly risk spreads. It has been quite a long time since we've seen, for example, an emerging market crisis. That is just one example.

Now Steve, I think, would come back and appropriately say that is not going to last forever, and I would certainly agree with him. Some of what we've seen is partially what's certainly going to be unwound at some point. But the challenge for markets is how do you price that in? Because there's really clearly not a gaining trade at this stage on betting against low volatility and very, very low risk spreads.

The final point Steve suggests is a dramatic ploy by central bankers. I would disagree on that point as well. As I look around the globe, I would say interest rates as set by monetary policy makers, I think, appropriately calibrated for trend growth pretty much globally, and inflation relatively low and contained. I think what is interesting is out at the longer end of the yield curve, and there I think what we've got is just fundamentally a recycling of savings from Asia in particular, and to some degree from the Middle East, back into safe assets with primarily U.S. dollar-denominated assets, and that's driving a relatively flat yield curve in the U.S., and consistently, I'd say globally.

HUBBARD: Could I pick up on that point, actually?

TARULLO: Yeah, sure.

HUBBARD: Because the -- I think it's very important. I do think that you're right that we're priced to perfection. But there's a difference between knowing that an equilibrium will change and having there be a trading strategy somewhere in between. I think we're likely to see over the next few years continued saving investment imbalances that are bringing large amounts of money. I would put the Middle East first, actually, not second, and then Asia. (Second ?) that I think will keep that happening. Yes, the spreads are very low, but it's hard to see what unwinds them, you know, in the very near-term.

TARULLO: But let me ask you about that, because there are lots of things, including geopolitical risk, which you mentioned earlier, which are difficult for traders to quantify and thus are difficult for them to devise an effective trading strategy for. But that doesn't diminish the risk, right? I mean, the risks are still out there, even if a rational trader says, "I don't know how I deal with these." So let me ask you on -- because I want to ask each of the three of you -- I want to ask the two of you where you think the downside risks are, and then I want to ask Steve where he thinks the upside risk is. Where do you think the downside risks are?

HUBBARD: Well, clearly there are geopolitical risks. Iran would be probably the largest single one. I think the continuation of the war in Iraq, while it has a lot of political consequences and military consequences, does not have significant economic consequences for the U.S. The -- a conflagration in Iran would certainly be very different. I'm not enough of an expert to talk about probabilities of that, but I would caution people that even after an event like 9/11 and the onset of Iraq where there were dislocations in markets, the recovery was actually quite smart.

You have to sort out political and military risks from actual effect on the U.S. economy, where, again, downside risks that I would see are as much as anything else potentially self-inflicted. They come from poor public policy choices. Protectionism would clearly be at the tope of the list. Looking around the world, a major tax increase in Japan would be another candidate, as well as a mistake in pressing on the brakes too fast in China.

TARULLO: Okay.

Downside?

FERGUSON: I would agree with Glenn. Geopolitical comes first to mind. I also agree it's little hard to figure out exactly how you'd build a trading strategy around those risks. I think, frankly, the markets are betting that those risks will not evolve. I think they are betting, for example, China will keep North Korea under control, Iraq will continue to sort of bubble in a relatively negative way, but not spill over economically. So I think the reality is it is really hard to figure out, other than a surprise on policy -- you know, a dramatic move one way or the other. There's also, obviously, the risk of an inflation surprise in some sense, and that would come, I suspect, from a dramatic bounceback in commodity prices.

And one that we haven't talked about at all is a longer-term risk that this productivity growth, which has been an important part of the U.S. story for more than a decade now -- if there's any change in that, Glenn picked up on it. But if there's any change in that at all, I think that is a bit of a risk as well on the inflation front. But all those things, I'd put relatively low probabilities on, which is why I'm buying in very much to a relatively nice consensus outlook.

TARULLO: And Steve, where do you see upside -- where might you see upside risks? (Laughter.)

ROACH: Look, the -- (laughter) -- the consumer -- the American consumer is not a sector, not a force that most forecasters want to bet against. And I am betting against the American consumer, and I've been doing it for the last few years, and I've been wrong. And yet, as I see the consumer today, saving-short, income-short, overly indebted at low interest rates, incredibly asset-dependent over the last several years, with the major prop to incremental consumption growth now being mark-to-market with a fairly sharp downturn in housing markets. And you saw the story today in The Realtors' Report that, you know, house prices are now declining in half of America's major metropolitan areas.

You know, I think, barring a spontaneous resurgence of labor income generation, I would challenge Roger on this point that that's what's happening in a strong, as he put it, strong job-growth environment. I don't think the numbers show that at all.

TARULLO: Steve's having trouble seeing the upside here. (Laughter.)

ROACH: I said, you know, the consumer is the place to look for the upside.

But let me just ask one other question, Dan, and that is --

HUBBARD: Can I --

TARULLO: Wait.

HUBBARD: I want to ask a question, and that is, Roger is -- and Dan, you made this point, too, that, well, the markets don't seem to be all that worried about these types of risks; look at spreads. Is that really the way to look at it here?

I mean, you've got institutional fund managers and individuals desperate for yield in a low-return environment, awash in liquidity, and they keep pushing out in the yield structure into riskier and riskier assets to seek yield. Isn't that just an example of an extraordinary buildup of complacency that is validated by irresponsible central bankers who have basically ensured the moral hazard that nothing bad will ever happen? Isn't that what happened, Roger, when you were there? (Laughter.)

FERGUSON: Let me jump in on this.

TARULLO: We'll let Glenn and then Roger briefly respond, and then I'm going to try to move the topic forward.

HUBBARD: Yeah, before Roger defends his manhood and that of other central bankers -- (laughter) -- let me weigh in on the consumer. Your description of consumers, on average, reminds me, at the beginning of my teaching career I taught at Northwestern. And you recruit economists in January, so I would inevitably tell recruits to consider average temperatures in Chicago when deciding on whether to move there.

The consumer is not an average. And if you look at the financial health among consumers, you certainly see, as you yourself said, you know, more affluent consumers are actually incredibly healthy, both in terms of their stock of wealth and income. And even among many households of modest income, there have been wealth gains. You're referring to flow savings, but certainly wealth gains.

And productivity growth will not always be in corporate profits in a competitive economy. So going forward, I think, consumers look pretty darn healthy. And I think that is an upside that you're missing.

FERGUSON: First, I think we should get the facts right. (Laughter.) That's always a nice place to start. I think Steve was right that early on in this recovery, without a doubt, much of it was going to capital and not labor. And the last part of last year, 2006, as I recall the data, real hourly compensation was rising around 3 percent or something like that on an annual rate.

TARULLO: Second half, right.

FERGUSON: So things -- I think Steve was right early on, but it looks to me as though we're starting to see a rebalance in this issue.

Let me also not worry about defending my manhood. It's obvious to all. (Laughter.) I think it's really -- I think Steve's other point is certainly, though, well-taken. We have to be cautious about assuming that these very, very low risk grids actually reflect the accurate pricing of risk indefinitely.

I would agree with Steve that at some point these spreads are going to change in many cases. There will be something that goes wrong. But at this stage, it is very, very hard to see, and therefore very, very hard to price in. And I do disagree with Steve, I think, if the consensus forecast comes true, which I believe is likely, these risk spreads will probably prove to be relatively justified. They do go into one other point which you haven't talked about, which is sort of global imbalances.

ROACH: Yeah, that's where I wanted to move.

FERGUSON: Right. And I think that's the other side of what's going on here for sure. And I think this is a point there in which Glenn has touched on, and I did as well. Part of what is happening here is there are global imbalances in a broad savings investment style, and what we are getting, frankly, is, with that, we're getting a lowering of the real equilibrium price of almost all risk, which is an obvious approach of supply and demand but is not necessarily a sign of great problems.

ROACH: Say a little bit more about that, Roger.

FERGUSON: Well, it's very -- Glenn touched on it; it's very straightforward. We have a very interesting circumstance now in which it's not sustainable indefinitely, but the U.S. is clearly consuming and not saving, which is, I will admit, a long-term risk.

We have China and a number of other economies providing those goods. In exchange for that, they are clearly then taking on our dollar-denominated assets, and they are then coming back and buying dollar-denominated assets with those dollars that we're sending them.

And so, in order to make all of this equilibrium work, what you end up having is just, frankly, lower real interest rates. And that's what's happened. That's not necessarily a sign of something that's good or bad. It is just simply the way markets work. And what markets are telling us right now is that there is plenty of liquidity -- I agree with Steve; searching for return -- yes, that's true; moving out on the yield curve -- absolutely correct. But that's just equilibrating activity.

TARULLO: Okay, good. So now this is the moment to turn to the imbalances, since Roger has raised them. This has been a continuing theme in our panels for how many years? Boy, a while. We keep identifying the global imbalances. Some people keep seeing high or near-term risk and others see it as a longer-term adjustment problem.

Since we last convened here, the U.S. current account deficit has gone above six-and-a-half percent of GDP. China's global current account surplus is growing as -- grew quite rapidly last year. So global imbalances, if anything, have gotten somewhat more skewed over the last couple of quarters. But, as I think everybody up here would agree, this is certainly not eliciting lots of nervousness within markets.

And so the question I want to put to people -- and Roger, I think, has begun to address it -- is whether the persistence of these imbalances suggests, A, that they're actually not as much of a risk as people thought, that this is a different circumstance in which 5 percent of current account deficit as a portion of GDP for the biggest economy in the world is not that big a deal; B, that they are actually a risk, and a growing risk, and the longer they -- it's kind of like a bubble; the longer they keep growing, the bigger the pop is going to be; or C, something else. And Glenn, why don't you start on that?

HUBBARD: Well, I guess I'd be probably somewhere in C. If you look at what's happening around the world, as Roger said, you've got a series of growth shocks in different regions of the world. And if all financial markets worked perfectly, this would be no big deal. We'd sort it out easily.

The U.S. financial system is a benchmark. It absorbs growth prospects very easily. There's talk that the world saving has increased. That's not really true. What has happened is that the incremental saving in the world is being done in countries and regions whose domestic financial systems simply don't work.

China is the poster boy, although the Middle East is the larger source of funds. So what happens in a situation like that is that excess saving goes to the international capital market and very open economies like the United States. So there's nothing pernicious particularly about the American economy that's doing that. It's not even pernicious in foreign economies.

The question is, how does it unwind? You know, Herb Stein said many years ago that things that grow too fast forever will stop. So the current account deficit won't be 50 percent of GDP. But frankly, it's probably going to be at this level or a little higher before it falls back down.

And what will bring it, I think, back down is gradual increases in saving in this country, which to me involve entitlement reform, and overseas a reform in their financial assistance. I mean, that's really the time-honored thing. So it's not something that I would worry about too much as a near-term problem, because these are long-term structural issues that are leading to it.

TARULLO: Okay, Steve.

ROACH: But Glenn, to that point, right now I think the U.S. requires at least, with an $875 billion current account deficit in the first three quarters of '06, roughly three-and-a-half billion dollars of capital inflows each business day of the year.

HUBBARD: Net. Net.

ROACH: -- net -- to fund it, so it's funded. And so we are very much dependent on -- I'm putting words in your mouth here -- but the sustainable disequilibrium. And then you have stressed here, though, that one of -- your biggest concern, if you had to put your finger on an issue, is the risk of protectionism.

We all spent time in Washington. I was there earlier this week. To me the drumbeat's getting louder and louder that there could well be a policy blunder in this regard aimed explicitly at China, which is a very large supplier of demand for U.S. treasuries. And again, this comes up repeatedly. It came up several times in Chairman Bernanke's testimony in front of the Congress the last couple of days.

If we were to do something along those lines, what worries me about this sustainable disequilibrium is that the bigger the imbalance gets, the more vulnerable it is to a shock. And I spend a lot of my time in China, and I guarantee you that if we impose some type of trade sanctions on China, that their willingness to show up at the next Treasury auction is going to be drawn into question. And this could be a very disruptive outcome for this buildup of global imbalances at a time when we have concluded, as Roger correctly says in other risk assessment exercises that there's nothing to worry about. So I do worry about it.

TARULLO: Yeah, but before the other two fellows come in, let me ask you about one thing you said, which is the willingness of China to show up at the next Treasury auction. The analysis that one hears is that the reason China is doing what it's doing is because it's pursuing what it regards as its own interests, which include keeping its currency about where it is now, with a very slow appreciation --

ROACH: Can I come in on that point?

TARULLO: Just a second -- slow appreciation. If that's the case, why would, you know, allowing subsidies, countervailing duty law to apply to Chinese imports, for example, why would something like that change fundamentally the Chinese calculus of what was in its best interest?

ROACH: Because we would have taken unilateral action to change the character and the nature of our bilateral relationship with China. The Congress goes first. And as is always the case in a retaliatory measure, the party that is perceived to have been wounded, especially a nation like China, which places a huge stake on the issue of national pride, I don't think they're going to take this sitting down. And look, I'm not saying the Chinese are going to dump --

TARULLO: But what does that mean?

ROACH: -- you know, their $1 trillion, 60 percent of which is (lodged in dollars ?), I'm saying that their incremental buying -- their accumulating about $200 billion of foreign exchange reserves -- they want to diversify that flow in any case. They're telling us that right now. But if we take unilateral trade sanctions against them, they will accelerate their process of diversifying the flow. And that has consequences for the dollar and for real long-term interest rates in the United States.

TARULLO: Yeah, and the -- I'm going to go to Glenn just in a second -- but the consequences for the dollar are something that they will feel as well, right? Go ahead.

ROACH: They will.

HUBBARD: Yeah. I mean, first of all, I agree with you on the fear of protectionism, as I said earlier. I would note you're shifting the debate from being structurally concerned about this to a policy matter, so it's a different point. But on China, you know, I think Dan is exactly right. The Chinese are pursuing a strategy. I think it's wrong, but their strategy is clear to them, which is they are willing to tolerate expected foreign exchange losses in the future in exchange for what they perceive is an economic development strategy. Their monetary policy is keyed on this. Their development strategy is keyed on this. It is wrong because their financial system is broken, but that's what they're doing.

It would take a very large shock to knock them off of that. That is their entire strategy. Dan is exactly right. The capital losses relative to their GDP, if any precipitous action, is something a rational person would hesitate for.

I also think, while I'm worried about protectionism in the U.S., I also believe -- maybe this is hope, but I'll state it as belief -- that the president of the United States will veto the China trade bill.

TARULLO: Roger.

FERGUSON: Let me jump in. I think, on these imbalances, first, we've got to recognize the result of what I would describe as mutual preferences. We act as though they're driven by things that are way beyond our control, and the reality is there's a preference for the U.S. to do what we're doing, which is to consume more than we save. There's a preference in the rest of the world to produce for us. And this is just the natural outcome.

We know it's not sustainable indefinitely, for reasons that Glenn and Steve have indicated, which is that at some point the rest of the world gets saturated with dollar-denominated assets. But I don't see that happening immediately because the U.S. is a very strong economy.

The risks, I think, are certainly towards protectionism. Frankly, I think protectionism is clearly bad for China, but it's also, frankly, quite bad for the U.S. One of the things that has helped us to continue to have solid growth from consumption is the ability to bring in relatively high-quality, relatively low-cost goods from overseas, including China.

Finally, the question that Glenn has raised of whether or not the Chinese are acting rationally or irrationally, it's hard for us to say, frankly. The reality is they need to create huge numbers of jobs. I've heard numbers as much as 20 million a year. They've decided to use an export-led strategy, which has got a long history in Asia and is mutually beneficial to us and to them. So I suspect that we're going to see this be sustained for some time, though it is not sustainable in the long run.

And finally, Dan, I fully agree with your point. The Chinese effort to rebalance their reserves, I do believe they'll undertake it, but it will be done very, very cautiously, for the reasons you talked about. The dramatic capital losses from their dollar-denominated assets, should they move away from the Treasury auction, the way Steve has indicated, is very, very large. And they are very, very practical people and don't want to tolerate that.

TARULLO: Just one point on the exchange rate issue. I think I know Steve's views on this, although, correct me if I'm wrong, Steve, but your position, I think, has been that a realignment or revaluation of the renminbi would not play a particularly robust role in rebalancing the structural imbalances.

ROACH: Absolutely.

I mean, Roger and Glenn have said -- and this is a point we all agree on -- that this is savings investment disequilibrium. And the relative price adjustments are not going alter that. The Congress believes -- and again, this is just an appallingly a poor macro -- that if we were to force China into a major reevaluation of the renminbi that we'd fix the multilateral trade issue.

And I pointed out, just the other day, to one of the leading advocates of this point of view that, you know, the sad thing is you'll wake up and you may have fixed the Chinese piece, but it'll show up somewhere else until we raise our national savings rate. And the Congress will not -- they don't care about that.

TARULLO: The administration's repeatedly stated view is that China should change -- it should move towards changing its exchange rate policy as well. Do you think that that is just a -- do you think that's misguided as well, or is that just an effort to hold --

ROACH: Well, I'd say, you know -- look, I have a lot of respect for Hank Paulson, because he does have a great understanding of the macro framework under which China operates under. And early on he seemed very determined to push the China debate away from the currency issue. And I think he's been, you know, unable to do that successfully, in large part because he feels tremendous political pressure from Capitol Hill. So as much as he would like to get away from that issue, politically it's been very difficult for him to do that.

And I think that's a disappointment in the administration's approach toward China right now is they're getting caught up in this currency debate.

TARULLO: One thing -- I think one thing to watch for is the next meeting in May, because the Paulson meetings to date have produced very little that has satisfied those who think that there needs to be at least a road map to change. And a lot of the things that all three of you have been talking about may come to a head if people don't see something more concrete in May.

Okay. Last question I want to put to the panel, before we turn to you, is the one that I mentioned in my introductory comments, which is the metaphor of the world economy flying on one engine, which is to say, U.S. consumption. Sometimes people would say one-and-a-half engines -- the second being Chinese investment.

About three, four, five months ago one began to hear a lot from European policymakers, analysts -- both in Europe and in the United States who watched Europe -- to the effect that Europe was successfully decoupling from the United States, which is to say that a slowdown in growth in the U.S., which some people were predicting then and some people are still predicting now, would not have particularly adverse consequences on Europe, as a result of which a recession in the United States might in the European view, not be a global recession, but instead a localized problem here, driven by -- as Mervyn King said -- the housing problems in the U.S.

The most frequently cited statistic to support this, the good news is that three quarters of European growth over the last five years have been accounted for by increased consumption in Europe -- domestic demand, that is. I always want to say, that's the good news. The bad news is the growth hasn't been too terrific over the five years, so how much are you supporting? But that is a figure.

They export, I think, what, 10 percent of their exports now go to the United States? Certainly not much more than that. So the question is, is there a decoupling taking place? Are there other parts of the world, beginning with Europe, that can now drive global growth, rather than just participate in the global growth that the U.S. is initiating.

Roger?

FERGUSON: I would say it is certainly true there is some decoupling that's taken place. It's taken place because the dollar has fallen against -- has risen against the euro. I'm sorry -- it's fallen against the euro recently. And that has led to, as you point out, much more domestic consumption in the euro zone.

I would be cautious about overstating it. And I think still the U.S. is the primary driver. Europe is certainly coming on, and it's actually a very nice thing to see more balanced growth broadly. But I would not get overly exuberant about Europe driving global growth.

HUBBARD: Yeah. I would agree that it's still an interdependent world. And when I said at the beginning that Europe was growing close to potential, that doesn't mean it's growing at the U.S. rate. It's growing a full percentage point lower because of the same structural problems that have plagued European economies for a long time. The notion of Europe leading global growth is to me farcical.

Europe would be connected, I think, to the United States in any event, because the kind of events that would lead to a recession of the U.S. -- we've already said -- two of the three of us said we don't think the housing situation in the U.S. is going to lead to a recession. The kinds of things that will lead to a recession here are global shocks. Europe will not be immune from those. So I think decoupling stories in a global economy don't hold water.

TARULLO: Well, they put it as decoupling which seems to me would lead to the critique that you just offered, Glenn.

But there's a -- I tried to recently frame it slightly which is, can we see sources of economic growth beginning in other parts of the world, rather than piggybacking on --

HUBBARD: Well, of course we can. But let's not confuse rates of change and levels. So China and India may be growing rapidly, but the absolute size of those economies in the world still pales in comparison to even small variations in this country. So again, I just don't think the decoupling is there.

TARULLO: Steve?

ROACH: Well, I think in Europe you have to get a little bit more granular. And in particular, I'm impressed by what's going on in Germany right now. Germany has really, I think, worked very hard in overcoming the headwinds imparted by German reunification, as well as by the price they've paid to take on the euro and give up the deutsche mark.

In the last several years I think a lot is made out of rigid, high-cost German labor markets. So Germany knows this and they've moved aggressively now to a much more flexible work force. I think about 40 percent of their total work force are temps and part-time employees. The German labor unions are not as powerful as they used to be, although they're trying to flex a little bit right now in this current wage round.

Corporate Germany -- and this is a big surprise -- they really lagged in the IT spending binge in the late '90s. And they're finally beginning to spend much more aggressively on new technologies. And finally, the financial restructuring -- the M&A activity, the other type of financial engineering that's going on within Germany -- the volumes of that have accelerated dramatically. So for the first time since the early 1990s, you can now see a market pick up in German productivity growth.

To Glenn's point, it's not as rapid as the productivity acceleration that the U.S. has experienced over the last decade. But you know, for an economy that was growing about 1 percent in productivity growth for about a dozen years, the number is now closer to 2 (percent.) and I think that's an encouraging development.

I wish I could say it's the same for all other members of the European Monetary Union. In some cases, like Spain, things are looking better, but in other places that's not the case. But Germany is still the dominant economy in continental Europe. And I think there are some encouraging developments there.

TARULLO: So just to try to draw what all three of you have said together. At least in the near to medium term, there's still not going to be, in the aggregate, adequate domestic demand-driven growth in other parts of the world to drive the global economy without, basically, relying fundamentally on U.S. consumption. True?

FERGUSON: Roughly true.

HUBBARD: That's a good State Department memo version of the -- (laughter) --

TARULLO: All right. Okay.

I think we're about -- yeah. We should turn to questions from the audience now. And -- well, let me get my little notes here so that I make sure that I do what Martina (sp) asks.

Okay, so Martina says please wait for the microphone and speak directly into it. And when I recognize you, please stand and state your name and affiliation. And I'm just going to put on my glasses so I can see.

Yes, ma'am.

QUESTIONER: My name is Nancy Lieberman. I'm at the Skadden, Arps Law Firm. And any of the panelists can answer.

Do you feel that the continued application of Sarbanes-Oxley in its present form is having a negative impact on the U.S. economy, and also capital formation in the United States? Do you think there's any probability of fixing it, or are we just going to have to learn to like it?

HUBBARD: I guess I'd be tempted to say, "Thanks, Mom" because I just wrote a 135-page report on the subject that you can get on the Web.

There's a committee on capital market regulation, which I had co-chaired, that addressed that among many other topics that are, frankly, more important than Sarbanes-Oxley. But I think the punch line on Sarbanes-Oxley is Section 404 needs work. The clarification of materiality, I think is very, very important. There's a confusion in the regulatory process between probabilities of things happening and the consequences of those things happening.

But I think this is an area that is ripe for reform. And frankly, that reform is happening. But I wouldn't tar all of Sarbanes-Oxley with that brush. I mean, that's really about Section 404.

TARULLO: Glenn, if I could just ask you -- Roger wants to weigh in on this. I want to ask you: When you talk about 404, are you talking about the way the SEC has implemented it through regs and enforcement --

HUBBARD: Correct.

TARULLO: -- not the statutory language itself?

HUBBARD: Well, the statutory language itself, of course, is vague. And that's where regulators --

TARULLO: (Cross talk.)

HUBBARD: And what we argued in this report is that there are ways for the SEC and the PCAOB to clarify things that would reduce costs. And part of the problem in all of this is the relative lack of cost benefit analysis in the U.S. financial regulatory system. I mean, the overarching theme of our report is that no other major economy does that. We have relatively good supply of economists in this country too and we can do better.

TARULLO: Roger.

FERGUSON: I would take a slightly more nuanced view on this. I think first, we should put this in a broad historical context. What we see now is a world of global capital. And by definition with global capitalism, you'll find pockets that start to emerge to challenge the dominate market.

Certainly, if you look at the IPO market, many of the biggest IPOs have been out of China, so by definition, Hong Kong would be the natural home. London has been working very hard to compete with New York and has done a reasonably good job. So put this in a broader context and don't try to find a single cause for these broad swings.

Secondly, on Glenn's point, I would agree 404 undoubtedly needs some work. I would say the SEC is quite aware of that and has been moving to think about how to do that. In the context of full disclosure -- there are chuckles in the room, because my wife is a commissioner of the SEC, so you should know that I have a strong view that the SEC is undoubtedly going to do the right thing. (Laughter.)

ROACH: Or you don't get dinner tonight. (Laughter.)

FERGUSON: But I would say, you know, this broader issue -- let's be aware of longer-term trends. There are things we can do, certainly, to make the U.S. continue to be a very, very attractive market. And by and large, the U.S. is still a very attractive market. And we shouldn't get overly excited about one year's movement, one-way or the other, where capital gets formed.

TARULLO: But Roger, is an implication of what you're saying that regardless of whether there is sensible streamlining of the regulatory process, that we are going to continue to see lots of financial activity migrating to other parts of the world, particularly Asia?

FERGUSON: I think that's an implication, because -- well, the point we made earlier on. If you had this global savings investment in balance, you will find that where pools of capital start to emerge, people will go there to raise their capital. Pools of capital are starting to emerge in Asia for a variety of good reasons -- some that's flowing back to the U.S. Some of that's being tapped locally. And I think there is sort of an inevitability. That is not a reason to avoid fixing regulatory issues in the U.S. -- streamlining where appropriate, et cetera -- but let's be cautious that we are dealing global pools.

HUBBARD: Yeah. I don't want to get too down and dirty into the data, but if you go to the studies in the Capital Markets Committee report, even if you control for growth in other regions -- particularly Asia and China -- there's something going on. And it's not the decline in IPOs that worries me, or the decline in listing premium in the time series. It's the fact that we're losing the listings for firms from countries with good corporate governance, which tells me all we have done is raise transactions' costs. And it's not so much whether we're discouraging the non-U.S. companies from coming here, but what we're doing to all the American companies who then have to comply with that. I don't think this is a red herring.

TARULLO: Okay.

Yes, right here. The mike should be coming from the left.

QUESTIONER: Rick Lazio, JP Morgan.

I noticed that when you talked about downside risk, you didn't mention the possibility of a major player having inadequate risk management. So a mismatched, highly leverage player, counterparty concentration, meltdown -- is that not on anybody's list?

FERGUSON: Rick, I think it is conceivable to see that it may be a mistake some institutions made. Possibly risk management has not been as good as one would like in an institutional setting. I think it's highly unlikely that would be systemic in the sense of bringing the U.S. economy -- you know, throwing it off of a trend growth.

And I also take a lot of comfort in the fact that former colleagues at the Fed, and also at the SEC, have worked very hard, as you know, with the private sector to deal with some of these counterparty issues. So my sense of it is there's always the possibility that something could go wrong. I don't think it's likely to be systemic. And the regulators seem to be very much focused on this, along with the private sector, which hopefully minimizes the probability of something very big happening.

TARULLO: Anything? Okay.

HUBBARD: I would agree with that.

TARULLO: Next question -- in the back. Yes?

QUESTIONER: (Off mike.)

TARULLO: I'm sorry, can you speak up a bit. I guess, turn the mike on.

QUESTIONER: (Off mike.)

TARULLO: Can you identify yourself, please?

QUESTIONER: (Off mike.)

TARULLO: (Laughs.) Before you execute your trades or -- commodity -- or?

(Laughter.)

ROACH: I'll throw something out there. I mean, you know, the view in the markets is that we're in midst of this super cycle where commodity prices -- the highs are higher and the lows are higher. And last year, actually, was a year that challenged that view significantly.

I think there has certainly been a significant underinvestment on the supply side of energy and most base metals commodities over the last 20 years -- an outgrowth of very low real prices of most of these commodities. And with the global economy picking up over the last four years, obviously the lack of supply has created a lot of pricing power.

The one thing that is critically important to note though, that is on the demand side of the equation the story's made in China. China is 5 percent of the nominal GDP in the world, but over the last five years has accounted for 50 percent -- that's 5-0 percent -- of the cumulative growth in world consumption of oil and most base metals. China is a very inefficient user of commodities, especially oil, where it uses about twice as much oil per unit of GDP as the rest of the world.

China cannot afford the implications of its own inefficient commodity consumption technology and is explicitly making an effort to reduce that. And I think with a macro slowing of investment growth in China as well, which is a very commodity intensive activity, I don't think you're going to see the type of growth in the demand side of commodity markets that you've seen in the last four years. So I think we'll have more two-way markets. I don't look for a collapse in oil prices.

But to the extent that some of these markets have been driven well in excess to the upside, not just by supply and demand, but also by the fact that many institutional investors are viewing commodities as a legitimate asset class, I think that the story will be much more even-handed over the next couple of years than most believe.

TARULLO: Okay. Other questions? Yes, sir. Right here.

QUESTIONER: Larry McQuade of River Capital. What are the implications of the expenditures on the war in Vietnam on the -- on our economy?

TARULLO: Iraq. (Laughter.)

FERGUSON: The war in Iraq?

QUESTIONER: In Iraq -- excuse me. (Laughter.)

TARULLO: The parallel has been noted. (Laughter.)

FERGUSON: Try to get Glenn to answer that.

TARULLO: We just finished paying for that one, didn't we? (Laughter.)

Glenn.

HUBBARD: You know, the question of the Iraq war is an interesting one because certainly we haven't seen any significant negative effect on the U.S. economy as opposed to whatever military or foreign policy views may -- one may have on the war in Iraq. And the question of judging the war in Iraq from an economic perspective, not geopolitical perspective, depends critically on what you think the counterfactual was. And so if the counterfactual was a regime that was a clear and present danger to the world economy, it's very hard to assess the economic impacts of wars in that sense because you don't really know what the counterfactual is.

U.S. spending on the war in Iraq is troubling but not nearly so troubling is the domestic spending that really is the whole country's fiscal imbalance. So I don't -- there are many reasons to be concerned about the war in Iraq, but I would not put the macro-economy as -- near the top of that list.

TARULLO: How about the opportunity costs, Glenn? Your colleague, Joe Stiglitz --

HUBBARD: No -- I mean, Joe's failure in this regard is the lack of -- and this is as nice as I've been because you're web-camming it -- (laughter) -- his failure in this regard is the lack of any counterfactual. So again, you know, if the counterfactual was that the regime in Iraq posed a clear and present danger, I'm not so sure how you quantify this. He takes indiscriminately long present values -- you know, any economist who chooses a low enough discount rate can, you know, make any number very large. But I don' think the issue with the war in Iraq is so much the cost as whether or not it was good policy, and there I won't offer an opinion. But in terms of the economy I don't see this as a particularly grave danger.

TARULLO: Any -- other views on that, Steve or Roger -- on the -- no? Okay.

Yeah, in the back.

QUESTIONER: Good morning. I am Hajime Matsuura from Nikkei. Could you touch on the yen market, please? This accumulated position of carry trade -- is it a risk for the global market -- if it exists?

TARULLO: Good. So carry trade, just -- for those of you who may not be familiar with it, basically the notion is that when you have an economy with very low interest rates where you don't expect rapid appreciation of the currency that it makes a lot of financial sense to borrow in that market and then invest your assets elsewhere where interest rates or other yields are higher, and then when it comes time to pay back the money that you've borrowed in yen, for example, it's a good deal because the interest rate has been low and the currency hasn't appreciated. And the issue gets raised every -- periodically, I would say, the issue gets raised. Is there a problem there because could things become unwound if, for example, the yen or the Swiss franc were to appreciate quite a bit or interest rates were to go quite high.

Roger.

FERGUSON: Dan has summarized the issue very well. I think the answer to the question that you've posed and sort of Dan has elaborated is, it depends very much on how things evolve in the Japanese economy. If the Bank of Japan was forced to dramatically raise interest rates, if there were a bit of an inflation scare in Japan that drove a dramatic reassessment of where the interest rate futures in Japan are likely to go, then yes, I think there's a risk to the carry trade.

The reality seems to be that the Japanese economy seems not to be confronting this sort of inflation scare or suggesting the Bank of Japan doesn't have to move dramatically, therefore suggesting -- unlikely you'll see the kind of dramatic reassessment of the interest rate outlook and an unwinding of the carry trade.

TARULLO: Other views on that point?

ROACH: Well, just the -- mainly a question to Roger in that regard -- the yen is what many would consider to be -- although it did strengthen a little bit yesterday -- near some fairly significant technical resistance points, and there's a concern that I've heard from a number of market practitioners that, you know, a yen dollar that goes through, say, 122.50 could continue to depreciate very sharply, which would, if anything, intensify the carry trade. The Japanese printed a surprisingly strong GDP report for the quarter just ended, but it really sort of offsets some of the surprising weakness in the quarter before that.

And we were talking earlier -- I mean, who knows where the revisions are going to end up in these numbers. But the Bank of Japan -- you know, maybe they'll surprise us and do what they said they were going to do last month and begin to tighten. But the odds are, it looks like, that they probably won't. So isn't this one of these, again, anomalies in the market that will continue to become a greater source of speculative activity until, you know, one of these days as we saw -- I mean, you were there Roger, it was in '98, when there was just a huge overnight move in the yen that caught a lot of major players off-sides and really destabilized world financial markets at that point.

FERGUSON: That's another way of saying my point, which is if there is an unexpected surprise out of Japan, then, yes, you can get that kind of activity. I think the reality is that most people see a relatively continuous movement in Japanese economic developments, implying, if you will, only gradual moves by the bank and no dramatic reassessment.

But yes, Steve, you're right: If there's a dramatic reassessment, then obviously you'd see it feed through into currency prices, exchanges rates, which could potentially be destabilizing. So I would put that into the risk category, but I'd put it in as, at this stage, it appears to my view, anyway, to be a relatively low probability risk.

ROACH: Do you agree that the yen is probably the most undervalued of the major currencies in the world today?

FERGUSON: This is a point where I -- I find it hard to ever agree with these sort of strong statements about --

ROACH: You're not a Central-Banker anymore. You can actually -- (laughter) -- you can do these things, Roger.

FERGUSON: Well, I'm being -- I'm trying to be prudent and responsible in front of this audience.

ROACH: Yeah. (Laughter.)

FERGUSON: Let me be very serious.

ROACH: Are you trying to break our pattern, Roger?

FERGUSON: Yeah, I'm trying to break the pattern. No, I think it's very, very important that we not -- that we recognize, when you have basically free-floating currencies, which the yen fundamentally is, they reflect the fundamentals of their home countries and the outlook for those home countries. And what we actually have right now is, yes, a relatively low interest rate environment in Japan, by definition leading to a yen that is relatively low. We talk about that as though in some sense that's an anomaly. It's not. It's just simply a reflection of what's going on in the Japanese economy.

And so I am -- the reason I'm reluctant to sort of be drawn into the language that you're using, Steve, is I think you -- it leaves the wrong impression that somehow or another, the exchange rate regime is totally disconnected from the economy and driven by irrational psychology. I think in fact the exchange rates and the major currencies, which are basically free-floating against each other, are reflecting fundamentals of their economies, and at this stage -- and interest rate regimes. And at this stage we've got pretty good growth in Japan, inflation seeming obviously really quite quiescent. The Bank of Japan perhaps is going to move another 25 basis points at some point, but all of that is leading to -- you know, the markets to give us an exchange rate of the yen that I think is reflective of those fundamentals.

TARULLO: Glenn?

HUBBARD: Yeah, I basically wanted to say what Roger just said, along with the observation, it's hard for me to see the expressions "inflation scare" and "Japan" in the same sentence.

TARULLO: (Laughs.)

FERGUSON: Right. I would agree with that.

HUBBARD: But this was a big issue in the G-7 meeting -- the recent G-7 meeting, because you accurately expressed, I think, the -- sort of the orthodox Washington point of view. The Europeans have a very different perception of at least the Euro-yen cross rate, and I think behind the scenes, tried to get something inserted into the communique --

ROACH: It wasn't so behind.

HUBBARD: -- and failed in doing so.

ROACH: Right.

HUBBARD: So there's a real difference of opinion on this issue depending on where you come from.

TARULLO: But Steve, do you credit the European view? Or is that -- I mean, you've been quite critical of Washington politicians -- what about Paris and Brussels and Bonn politicians on this point?

ROACH: Well, I think, you know, in these G-7 meetings, you know, they're always supposed to be meetings with finance ministers of the major economies looking out for the broader global economy. But in most respects, they're always -- they reflect points of view that are very much driven by self-interest. And in the case of Europe, I think there's great satisfaction with the recovery that has been -- at least that was evident in '06, and I think they feel that at current levels of Euro-yen, which are closing in on 1:60, that there may be some risk there to the downside of their own recovery that they're getting uncomfortable with. And they want to express that in a G-7 discussion where all the focus seems to be with respect to U.S. concerns over their renmimbi, and they're saying, "Wait a second. You know, there are more issues here than America's concerns over the Chinese currency."

TARULLO: Okay. I want to get -- this is, as I mentioned at the outset, being webcast, and we have a question from one of the national members who's watching it on the webcast: "One of the effects of integrating developing countries into the world economy seems to be suppression of wage growth in the developed countries with record corporate profits at the same time. How long do you expect this trend to continue, and what kinds of events could reverse it?"

Glenn?

HUBBARD: I actually just came back from India a couple of weeks ago doing a lot of events to promote management education, since that's what I do. And one of the biggest constraints that was expressed to me by business people all over India was rapidly rising wages in India and the fact that they were increasingly paying almost Western levels.

Now why am I saying this? What theory tells us is when we throw a lot of new potential workers into the labor market, i.e., the integration of China and India into the world economy over the past generation, we will see initially downward pressures on the wages of the low-skilled workers around the world, since that's what most of the Indian and Chinese workers are. But over time, we'll also see upward pressure in wages in those emerging economies and finally back to upward pressure in wages in the developed world as well. So these are things that play out. But I don't see any sort of permanent lowering of wages of American workers from this. In fact, as we see prosperity in the rest of the world, that is very good for this economy.

To the extent that we have issues with low-skilled workers in this country, it has much more to do with our own education and training system, I think, than with developments in New Delhi or Beijing.

TARULLO: Glenn, two questions on that: One, you've kind of got the eventually, or maybe lurking behind there is the economist's "in the long term." But how long a period of absorption of 1.2 billion workers into the economy before you see --

(cross talk) --

HUBBARD: Well, as I said, we're already seeing it. If you're look in India and China, we're already seeing China losing manufacturing to Vietnam. You're already seeing India facing wage pressures and bottlenecks in key sectors. You're already seeing it there.

In this country we have started to see some movement as well for low-skilled workers. Where we have not, I think, is primarily because of our own training and mismatch as much as anything else.

So yes, these things are there, but I think they're in the long run very healthy for the world economy.

TARULLO: And the second question is, you were referring to low-skilled workers, but I think one of the -- to be honest, I think one of the reasons why this issue has gained political salience in the United States is large swaths of the middle class now have anxiety that their jobs are at risk of being outsourced, precisely because China and India seem quite good at technical education of people. So isn't this something that potentially goes up the socioeconomic ladder rather than just kind of sit down?

HUBBARD: I think off-shoring is misunderstood in this regard. We're -- first of all, off-shoring is very small relative to the large growth (flows ?) of labor in the American economy. But off-shoring is a story about routine jobs. Now you're correct: Routine doesn't mean low-skilled. There are some jobs -- some accounting jobs, some elements of even the medical profession -- that are tradable in some sense. But America's prosperity in upper-middle class and upper-income jobs has always been about much more innovative jobs. I do not see the U.S. losing its edge.

TARULLO: Roger.

FERGUSON: Let me jump in and agree on that last point. Let me also put the fact on the table that the unemployment rate in the U.S. is around 4.5 percent. And there have been long periods of anxiety about foreign competition -- you know, Japan, Europe at some point as it was starting to turn around, now the emerging market economies. But the reality is that the unemployment rate in the U.S. has stayed within a relatively narrow band. And so from a macro standpoint, I think Glenn is absolutely right. The data clearly support the notion that we are creating new jobs just as we are losing others.

And don't lose track of Glenn's other point, which is that the natural churn within the U.S. economy is really quite dramatic. So I think I understand some of the anxieties that have emerged from headlines and other things -- the underlying facts suggest that the U.S. economy is really quite productive, capable of creating some new jobs. The challenge, obviously, is moving low-skilled people who are educated in one set of skills which may not be relevant much longer in the U.S. economy -- transitioning them to other kinds of jobs. And so I think it's really a domestic transition problem as opposed to an issue of trying to change what's going on in the rest of the world.

TARULLO: Though the questioner was I think -- not putting -- the questioner phrased his question in terms of wage levels rather than unemployment levels.

FERGUSON: Yeah, but I think --

ROACH: Yeah. No, I think that's a very important point, Dan, because again in the U.S., if you look at national income and break it into the labor shares and capital or profit shares, the divergences have never been higher. And you compare that, you know, with, say, the Japan-bashing of the late '80s -- back then both labor and capital shares were under pressure. This time around, 20 years later, capital's doing fine and so labor feels increasingly isolated.

And to Glenn's point, I think the thing that's missing in the model that you present is it's sort of a Ricardian model of, you know, we trade away a comparative advantage in manufacturing, but you know, we're high-skilled knowledge workers and we do brilliant things in non-tradable services. This globalization is about manufacturing and services. IT-enabled connectivity has changed both the breadth and the speed by which we are subjected to global competitive forces in a way that we really cannot comprehend. And I think, you know, five -- seven years ago when we first started talking about the off-shoring debate, you're entirely right -- it was low-skilled data processing call centers. But it has moved dramatically up the value chain, primarily on the wage effects, hitting workers in software programming, engineering design, the medical professionals, doctors, lawyers, financial analysts and the like.

So I think this is a very rapidly changing dynamic and is extremely unsettling to a much broader cross-section of the American public. And this is why the political forces are being galvanized in this country. I don't think the economists, with all -- you know, I'm certainly a card-carrying economist -- have done a particularly good job in understanding and in articulating this globalization in the new context that we're in today.

TARULLO: Okay, on that note, we've got -- in order to get people headed downtown right at 9:15, we want to close there but to say that this last question and this last colloquy has I think foreshadowed an hour-and-a-quarter debate I want to have at the next World Economic Update on the impact of globalization with specific attention to changes in the global labor market.

So I want to thank all three panelists and all of you.

(Applause.)

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