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ROBERT HORMATS:  First of all, thank you all for coming tonight. Two points, Council rules right at the outset. One, please turn off your cell phone. And, two, this is on the record, so those of you who are in the press or from other parts of our greater New York audience, I just wanted to mention that at the outset. That’s different from normal Council rules, as many of you know.

I’d like to welcome all of you to what promises to be an extremely interesting conversation; but, even more importantly, an opportunity to address an issue of enormous public consequence. The magnitude and the long-term importance of the issues that Pete Peterson has addressed in this very thoughtful and powerfully written book are enormous. These are issues of profound impact for our generation, but even more so on future generations who will bear the burden if we fail to act responsibly in the next several years.

I won’t take a lot of your time with a long introduction of Pete Peterson here at the Council. It would be similar to trying to introduce Tiger Woods at the U.S. Open. [Laughter.]  But let me simply say that Pete has thought deeply about some of the most pressing and important economic issues of our times, and has written a superb book about a critical issue for our society and for the global society.

I’d just like to start out by raising three sets of issues that Pete has focused his attention on, and focused our attention on, and that should energize our conversation. I’d like to begin with the following quote:  “The nation was unprepared. How did this happen?  The institutions charged with protecting our borders, civil aviation, and national security did not understand how grave this threat could be, and did not adjust their policies, plans, and practices to deter or defeat it. We learned of the pervasive problems of managing and sharing information across a large and unwieldy government that had been built in a different era to confront different dangers.”  This, as many of you will recognize, is from the 9/11 report.

Before us as a nation today lays another grave threat of a different nature, an enormous financial threat, with the potential to undermine our economy, social harmony, and our national security. This time, thanks to Pete Peterson, [Chairman of the Federal Reserve Board] Alan Greenspan, and others, we cannot say we were not warned, that we did not understand how grave the threat could be. And yet, we as a country do not seem able to adjust our policies, plans, and practices to avert it or to refocus our institutions to deal with it.

So the first question we need to ask is: Why not?  Don’t we accept these predictions?  Do politicians not have the will to take bold actions?  Do we as a nation think time and growth will cause the problem to miraculously go away?  Are we capable only of focusing on immediate crises, but incapable of confronting what you, Pete, so eloquently refer to as silent, slow-motion, and long-term threats?

Second, is the current political campaign making matters better or worse?  After all the vitriol, the flashing polemics, and the lancing personal attacks, will we be able to forge a consensus needed to produce bold reform?  Or will each side use proposals for reform by the other to vilify the other side in a perpetual extension of a mutually hostile environment?  And how do we get out of the conundrum that you have described so well in your book, Pete, in which interest groups are more fixated on pursuing and financing their own agendas than on safeguarding the common good of the nation?

Finally, in your book you propose a number of very thoughtful solutions to the problems that you describe so eloquently. As you share those with us in this conversation, we as concerned citizens need to think more about your notion of a lobby for the future, how to get engaged in the process of informing ourselves and others about the stakes involved, and engaging in a candid national debate on the perils that you have described.

A 9/11 Commission before we confront a financial crisis, to avert one rather than having to respond to one, is one way, an opportunity to look unflinchingly at the stakes, consequences of inaction, and the various policy alternatives. Mobilizing the rising generation as you’ve described it, Pete, is another. So I hope that, before we leave this evening, we will engage in a spirited discussion of what we can do and what the country can do to respond to the challenges that Pete has so well laid out in his compelling and thoughtful book. Pete, thanks very much for this terrific book, and thanks for taking the time to share your thoughts with us. [Applause.]

PETER PETERSON:  Bob, I’m going to honor our agreement that we have that if you gave me a sufficiently generous introduction, I would deliver some Blackstone business to Goldman Sachs, and I want you to know I intend to do that. [Laughter.]

I’m often asked, “Why did you write this book?”  Frankly, I’m kind of a confirmed masochist. For some sick reason, I thoroughly enjoy being bashed by my best friends. And of course the most gifted roaster in America is here, Ted Sorensen [adviser to President John F. Kennedy and senior counsel, Paul, Weiss, Rifkind, Wharton, & Garrison.]  You may recall that in this very room about my last book he delivered the infamous and now famous line that once you’ve put the book down you’ll never be able to pick it up. [Laughter.]  So I was eagerly awaiting his comments about this book, and I didn’t have to wait long. He called one day to say, “Pete, once I saw the title of your book, ‘Running on Empty,’ I had assumed it was an autobiography.”  [Laughter.]  And, as I told you, I paid for this microphone, and you don’t get equal time. OK?  [Laughter.]

The second reason why I’ve written this book—and I know it sounds sanctimonious and self-righteous and so forth—but it does have the virtue of being true. I have five children, nine grandchildren, and I’m lucky enough to have carved out a life that permits me to spend a lot of quality time, as the cliché goes, with them. And I read a comment by Dietrich Bonhoeffer, the German philosopher, that rings in my ears:  “The ultimate test of a moral society,” he said, “is the kind of world it leaves to its children.”  And as we quietly pass on huge, and indeed unthinkable, debts and taxes, as we quietly slip to our kids and grandkids the check for our free lunch, I say that we are failing that moral test.

So I suggest in this book a new political question—not the Ronald Reagan question, are we better off than we were four years ago, but: Is the future going to be better off and are our children going to be better off than they are today?  Now, when I make these comments, people say, “Are you suggesting that parents don’t care about their kids?”  Absolutely not. But I do argue that parents and grandparents are grossly uninformed, misinformed, and disinformed by an unhealthy combination of political and bureaucratic amnesia and anesthesia.

I once talked to [former British Prime Minister Margaret] Thatcher, who is the only developed-country leader to tackle these politically explosive entitlement programs—I said, “Lady Thatcher, what do you people talk about at the G-7 meetings? Are they aware of the problems?”  She said, “Oh, my yes, Mr. Peterson, they’re aware of them, but their theory is it’s going to hit on somebody else’s watch, and, ‘Why should I take the pain for somebody else’s gain?’”

So permit me to give you just a few examples of the political hijinks, hypocrisy, and chutzpah. Let me start with the unfunded, off-the-books liabilities or, if you prefer, the liabilities hidden from public view. Official sources, and many unofficial, put the number of unfunded liabilities between $45 trillion and $74 trillion, depending on the timeframe. That’s more than the entire collective net worth of the country.

Now for some hypocrisy and chutzpah. The Congress, in its wisdom, passed unanimously the [2002] Sarbanes-Oxley law that makes it a crime for corporate CEOs [chief executive officers] not to accurately report liabilities. They passed ERISA laws [Employee Retirement Income Security Act of 1974] that require corporations to fund pensions on no more than 30 years. Now, were the ERISA and Sarbanes-Oxley provisions to apply to the government, it would only add over $1.5 trillion to the annual budget. Now, while I suggest a number of reforms in my book, the most fanciful is that the Congress should apply the Sarbanes-Oxley standards to public accounting. Now, why is that fanciful?  I think I can safely assume that their enthusiasm for that reform would be, shall we say, restrained.

Now, the second example of political hijinks, hypocrisy, and so forth are the Social Security and Medicare trust funds. When I was secretary of commerce [in 1972-73], for a reason that was totally unclear to me, Time magazine referred to me as the most powerful secretary of commerce since Herbert Hoover [secretary of commerce, 1920-28], whatever that means. [Laughter.] I burst out laughing, because anybody that’s had that job knows that there’s never been a powerful secretary of commerce. So it started me on a career of collecting oxymorons: powerful secretary of commerce would be one. But I think the Social Security trust fund belongs in the upper tier. It should neither be trusted nor is it funded. [Laughter.] And while we anesthetize the public with the seductive statement the trust funds are quote–unquote, solvent for decades, otherwise congenital tax-cutters do not tell the public that the payroll taxes of our kids would need to be doubled in order to cover the cost of Social Security and Medicare. Furthermore, whether there’s a trust fund or not, we face the same three hard choices:  we either increase taxes, cut benefits, or try to borrow the money. How much would we have to borrow?  I think we should think in cash-flow terms, because these programs are pay-as-you-go, as you know. The official numbers tell us that projected cash flow deficits go from $25 billion only in the year 2003 to $783 billion in 2020, and in trillions of dollars thereafter.

Then of course there are the benign euphemisms or dysphemisms that mislead the public. “We shall not pass on our problems to the next generation.”  One might reasonably ask, Who in hell are we passing them onto?”  Or, “It’s your money.”  Who does the debt belong to, the Asians, or what?

[Economist] Milton Friedman, who tried to educate me on economics at the University of Chicago, used to teach us that a long-term tax cut is not a tax cut at all, unless it’s accompanied by long-term spending. It’s essentially a deferred tax increase on the future, which is to say our kids.

Then there is that absurdity called the social contract, and because of that contract we must live up to our promises. When I went to business school, I took a course in commercial law where the one requirement of a contract was that there was a meeting of the minds of the parties involved. So to dramatize the absurdity at a book party some friends gave me recently, I invited up my adorable 7-year-old granddaughter Chloe, and I said, “Darling, I want to be sure you’ve signed on to $45 trillion of unfunded liabilities and a doubling of your payroll taxes.” This adorable little girl says, “Papa, is a trillion more than a billion?”  I said, “Darling, it’s a thousand times more.”  And she said, “Well, I’m going to have to sell a lot more lemonade, and you’re going to have to increase my allowance, Papa.” Point made.

Then in my relentless need to offend everyone, I attack what I call the theologies of both parties. I use the word theologies deliberately, because a lot of their policies seem faith-directed—more or less untouched by analysis, history, or evidence. [Laughter.]  And they are nearly always delivered with a kind of moral certitude. My party, the Republican Party, for example, has a tax-cut theology, and it’s morphed into any tax cut, anytime. It is joined by some big-spending, big-government Republicans—alas, a new oxymoron, the big-government Republicans. This isn’t just Pete Peterson the curmudgeon saying this. The highly conservative Cato Institute refers, quote, to the spending explosion. [Former House Majority Leader] Dick Armey [R-Texas] says, “We can’t pin this one on the Democrats—we’re in control of everything.”  And now [conservative political commentator] Patrick Buchanan in his new book [“Where the Right Went Wrong,”] states, and I quote, George W. Bush has compiled a fiscal record of startling recklessness.  Now, finally, these Republicans are joined by their fellow starve-the-beasters. Paradoxically, the starve-the-beasters’ argument is in sharp contrast to the supply-side argument. They say, “If you cut taxes, of course revenues will go down, and that’s what we want to happen so we can get rid of these government deficits and government benefits.”

Now, I say to the starve-the-beasters, you better be careful what you wish for. Have you considered certain melancholy facts?  Seventy-seven million [baby-]boomers, twice the number of elderly as we have now, will start retiring in five years. A third of the people at age 65 have no—no –- net financial savings. According to the Social Security Administration, Social Security benefits and other benefits account for 91 percent of the total cash benefits of the bottom fifth of the elderly. So I say to the “beasters,” as we call them in debates, I want you to picture this scene:  77 million boomers, 25 or 30 million of them, or some number, are in very serious need of support. And you are going to say them, “Sorry, folks, we’re going to give you a big cut in benefits, and there aren’t going to be any social or political or moral effects,” and then presume they’re going to say, “Thanks, I needed that. I deserve that for my [inaudible].” By the way, the star of the starve-the-beasters, I say to them, “If you’re so concerned about reducing government, where are your specific proposals now to reduce the spending of government?”  And, by the way, again, when in a crisis did government ever get smaller?  And if I may suggest one more by the way, it might not be unfair to say to the president, “By the way, sir, in the face of this spending explosion, how is it that you are the first full-term president since John Quincy Adams not to veto a single bill?”  So, in sum, my party has done LBJ [Lyndon Baines Johnson] one better:  We have guns, butter, and tax cuts

I now turn to my Democratic former friends. My party has not seen a tax cut it didn’t like. It might be charged many Democrats have hardly seen a universal entitlement program they did not like. They conveniently ignore the question, if we’re all on the wagon, who is going to pull it?  Now, viewed historically, I believe that it is fair to say that they have gotten some help from co-conspirators in my party. Consider the following rather startling trend:  over the last 40 years, federal benefits to individuals have gone up six times after inflation. Or if we view the current situation on the Medicare prescription drug benefit, in spite of the fact that most serious analysts say projected growth of Medicare are unsustainable, without saying a single word about controlling the cost of the current program, Democrats can claim that the Medicare prescription drug benefit does not go nearly far enough.

One might ask, “Peterson, you’ve been boring us relentlessly for some decades now about these entitlements. What’s new?”  Well, beyond the obvious reality that the first boomers retire in only five years, I suggest in this book there are three important new realities that we must deal with. All three are around the basic themes and profound disconnects between ends and means. All three are about our unwillingness to confront the long-term trade-offs between national security, economic security, retirement security, and critical human capital and investment needs in our New Economy country.

First of all, we have an unprecedented national security agenda to fight two wars—first the war on terror abroad and second the war on terror at home. While we say we will pay any price and we say we know these wars will go on for years to come, we have in fact seriously underestimated the cost; and, two, we are fighting these two wars without a war budget. Some seem to have forgotten that while our military is stunningly effective, it is also stunningly expensive. It’s very different form the good old days, World War II for example, which was a bit like organizing a federal jobs program:  quick training of inexpensive troops with inexpensive equipment. In today’s high-tech, high-cost military, the brute fact is that these fats have ballooned. For example, it costs us a billion dollars a week for just two divisions in Iraq conducting, quote, stability operations.

Some quick factoids. The Congressional Budget Office under Republican control tells us the following:  They say realistic defense budget estimates for the next decade should be 18 percent or higher, or a trillion dollars more than the official estimates. And they remind us that the official budgets include no provision for wars; also no provision for additional troops, even our 54 out of 61 members of the House Armed Services Committee oppose that; and were we to meet the criticism of having a 10-division Army to meet our 12-division priorities, the personnel-related expenses alone would come to about $40 billion annually.

Second, the war on terror at home. I hope you’re as proud as I am of the work that this institution has done on homeland defense, and in particular that of [Council Senior Fellow] Steve Flynn. In spite of all the rhetoric, there are critical holes in our homeland defense: cargo containers, first responders, health care systems, immigration control, protecting critical infrastructure such as energy resources, pipelines, refineries, and on and on. Just to cover only three of the obvious alternatives: equipping the first responders, expanding our medical facilities, and protecting our ports would cost $120 billion over the next five years.

The second new reality—and it’s receiving far too little attention in my mind—is not simply the budget deficits but the huge foreign or current account deficits, the twin deficits that Bob talked about. The previous record was 3.7 percent of the GDP [gross domestic product] in the ‘80s. The dollar fell by a third, and we experienced a stock market crash. Today it’s at 5.4 percent of the GDP, or over $600 billion, heading north by most accounts into utterly unthinkable territory. Currently we import $4 billion every day from abroad—every work day—one half to finance our deficits and one half for foreign investments. Now, even the IMF [International Monetary Fund] is giving us hell. They’re reminding us that 5 percent of the GDP current account deficit is typically a danger point, and 40 percent of the GOP external debt, as they put it, where we’ll be shortly, is, quote, an unprecedented level for a large industrial country.

So as part of this book, I interviewed a dozen experts who are much smarter about these things than I. Let me tell you what they told me. None of them believe that these current account deficits are sustainable. We had a Nixon humorist, which to some of you may be another oxymoron, Herb Stein [chairman of the council of economic advisers under President Richard Nixon], who I remind you said if something is unsustainable it tends to stop. [Laughter.]  He went on to say if your horse dies, I suggest you dismount. [Laughter.]  So the question before us is, how do we get off gently, or do we expect to be thrown off the horse?

Now, roughly half of these experts predicted—said we were taking a substantial risk of what they call a hard or a crash landing. Paul Volcker [chairman of the board of governors of the Federal Reserve, 1979–87], for example, says there is a 75 percent chance of a crisis, including a sharp fall in the dollar within five years. Bob Rubin [director at Citigroup and U.S. Treasury secretary, 1995-99] who speaks with his usual understated and constructive ambiguity, refers to a “day of serious reckoning.”

Now, what is a hard landing?  It envisions the following:  a sudden, big drop in the dollar; a big spike in interest rates; nasty effects on financial markets in the economy. The balance predicts a softer landing. But nearly all of these same phenomena take place, only on a more gradual basis. But make no mistake:  these are all landings. They are not takeoffs.

Now, in truth, no one knows when or how these deficits will be made lower and sustainable, but everybody agrees that they must be. The U.S. now, directly or indirectly, absorbs two thirds of the total current account surplus run by every nation in the world. This cannot continue. Redressing the unsustainable global imbalance will require some profound and perhaps even traumatic structural and indeed cultural changes of our own and other countries’ political economies. The U.S. must consume and import relatively less, export and save relatively more, and the rest of the world will need to do the opposite. Now, given the difficulties of these adjustments, our esteemed chairman of the Fed has said that nothing worries him more than the clouds of emerging protectionism as countries desperately search for a possible, quote, unquote solution.  Whatever the outcome, these are great risks that a great country should not be taking.

And I’m not simply talking about the domestic and economic risks, but in this hall the national security risks and the foreign-policy risks of betting on how long the biggest better and the biggest borrower in the world can also be a great leader and a superpower.

The third new reality is the rapidly aging world and the gargantuan fiscal demands that come with it. We in America say our 77 million boomer problem is a large problem. However, the problem in other developed countries is far more severe and will hit far sooner and harder. Why? Because birth rates are far lower than ours, and they confront a big drop in young tax-paying workers. In Italy and Spain, for example, the birth rate is 1.2 [babies per woman], where as you know it takes 2.1 babies per woman to sustain population. In Japan, they are going to experience in the next 10 years a drop of 25 percent in their young workers under the age of 30. Their benefits are much higher, their retirement is earlier. In France, only 34 percent of the workers between age 55 and 64 are employed. Only 7 percent in continental Europe have any pension plan. The unions are much more powerful. Their taxes are already much higher. In Europe they average on payroll taxes about 35 percent or 45 percent of the GDP overall.

Our friends at the Center for Strategic International Studies have projected that the public benefit spending demands for the elderly in Japan, France, Germany, and Italy are projected to grow from 15 to 28 percent of the GDP in the next 40 years. That’s unthinkable, it seems to me.

Speaking of Japan, let me tell you an anecdote that happened in this hall. I was sitting next to Mr. [Haruhiko] Kuroda who until recently was the vice minister of finance. I said to Mr. Kuroda, “Mr. Kuroda, does Japan have a big problem with aging and the senior benefit programs that go with it?”  Oh, yes, Mr. Peterson, very big problem.”  “Mr. Kuroda, how are you going to finance those big deficits?”  “Ah, Mr. Peterson, unlike you we have a big savings level and we have a big current account surplus. For while we can fund it that way.”  “But, Mr. Kuroda, you’re financing 25 percent of our current account deficit. Have you figured out a way of spending the same money twice?”  “Ah, Mr. Peterson, very serious problem.”

Now, remembering that one speech for me is one too many, permit me to say that I have suggested to [Council President] Richard Haass that the Council might well consider some major studies and task forces that the Council would undertake on the daunting implications on foreign policy, on national security and international development, as well as the domestic tradeoffs of these burgeoning and ultimately unsustainable domestic commitments.

Finally, I lay out some reforms in the book, and I shall quote this today—only the economic or fiscal ones, not the political ones. They build around the central theme that we must substantially increase our rate of national savings, which is now hovering near zero. But there are two obvious ways of doing that. We can reduce the huge dis-savings or the negative savings of budget deficits, but without expenditure reform this is a fool’s mission, and I’m delighted that Chairman Greenspan has recently emphasized this point.

The second thing I believe we must do is increase personal savings per se. As to reforming entitlements, clearly Social Security and Medicare require fundamental reform. However, I believe Medicare is not only the biggest problem, accounting for over 80 percent of the unfunded liabilities, but it is also the far more daunting problem in political and even moral and ethical terms.

Now, some say just drop the Bush tax cuts, at least on the wealthy. The Congressional Budget Office tells us that even if we repeal all of Bush’s tax cuts—and no one in either party is proposing that—they are only about 10 percent of the problem. We simply must confront the hard reality that reductions in benefits are absolutely essential in Social Security and Medicare.

Let’s start with Social Security. I proposed in time past a series of what you might call micro-changes, gradually increasing the retirement age and affluence test, a Diet COLA [cost of living adjustment] and so forth. I’ve decided that this multi-step approach tends to aggregate a consensus of negatives, and I searched for a simpler macro approach that I felt had much to say for it—not just simpler to execute, but simpler to explain to the parents and their young, which I consider crucial.

Now, it’s quite widely known that Social Security benefits are indexed to inflation, with 100 percent COLAs. But I find that it is not widely known that these benefits are also indexed to wages. This is precisely what makes it difficult to grow out of the problem, because as productivity goes up, wages go up, so do the costs. Now, if we were to eliminate the wage indexing, this would eliminate the unfunded liabilities of Social Security. And if we have time to discuss, I’ll explain why I believe parents and their children getting the same benefits in real terms is something that could be sold politically as fair and simple.

My second proposal that may surprise you is mandatory savings in personal retirement accounts of workers of 2 to 3 percent, with some subsidy for the poor, managed by a public/private board. Why mandatory?  Some years back I was asked by the Clinton administration, the Congress, to chair a committee on capital formation; in other words, savings. I asked the most distinguished group of savings economists I could find—left, right, and center—how effective are these tax incentives to increase net savings?  I was surprised to hear that most of them agreed they have limited effect and the results are quite ambiguous. So I said, “What are you saying?”  If we must increase savings, which I think we should and must, they’re saying you have to make it mandatory—the way Chile, Singapore, Australia have done.

How would these funds be invested?  I would put them in global index funds, equity, and fixed-income. Why index funds?  First, it would reduce administrative costs—and remember that many of these accounts that people keep talking about would be very small. Avoid the political issues of industries to invest in and not invest in.

Why a public/private board?  It’s essential in my view that we get these funds out of the hands of government, who have demonstrated beyond doubt that they will spend any surpluses, any funds that they can get their hands on, and get these savings invested in the private sector.

Now, what about Medicare?  It’s a much longer; it’s a much bigger and a much more formidable problem. Why is it more formidable?  Because it presents ethical life-and-death issues and who decides and how to decide who gets what treatment, because it confronts what Dan Yankelovich [chairman and co-founder of Public Agenda] calls a “maximum right” mentality, that Americans are, quote, entitled—not one of my favorite words—to all of the latest high-tech and high-cost treatments, a mentality that has led us to spend twice as much as the rest of the world as a percent of the GDP, with no measurable difference in health outcomes. In this book I present a half-dozen proposals for determining the—for reducing the cost of health care, and I hope they are some rational and humane proposals.

Finally, what are the possible scenarios?  I gave you two options with scenarios, one I vastly prefer, scenario A, that the public gets a massive dose of truth-telling. To help in that effort, I propose that, given the imminent impact of the 9/11 Commission, I recommend that the next president immediately appoint such a bipartisan twin deficit commission of trusted Americans of the unique quality of [9/11 Commission Chair] Tom Kean and [9/11 Commission Vice Chair] Lee Hamilton. I’m talking about the Paul Volckers, Rubins, [former Senator Warren] Rudmans, [former Senator] Bob Kerrey, [former Senator] Sam Nunn type of person—not the special-interest devotees. That will require bold leadership by a president who not only educates but leads Americans to take constructive action, but ideally creates a global consensus for other developed countries to take action. This is emphatically a global problem, if I ever saw one.

Also, perhaps the next president may realize that this time it—if I can refer to it in those terms—could hit on his watch, and what a legacy that would be. It will require a bipartisan setting. A partisan setting, Ted, reminds me of the turkey-shoot phenomenon or the pheasant-shoot phenomenon that you and I experienced in Nebraska:  The poor turkey that lifts its head with a proposal in a partisan setting gets his head shot off.

Scenario C has much to be deplored. It’s the crisis or what we might call the Pearl Harbor scenario. A lot of hard heads that I’ve talked to believe that this is what it will take. Let us pray this is not the case, because there are costs of all kinds that will be profound on all of us.

Thank you. And may I say that Ted Sorensen would be happy to remind you, if you pick this book up, don’t put it down—you won’t be able to pick it up. Thank you very much. [Applause.]

HORMATS:   Well, Pete, thank you very much for a very stimulating presentation. I think all of us who have had the pleasure of reading this book see in it a number of not only very powerful arguments, but some very compelling recommendations for dealing with the problems you’ve outlined.

On that note, we’re in the middle of a presidential campaign, and I think I’d be remiss in not asking you when you see what the candidates are saying about these subjects—or not saying about these subjects—how do you react?  How do you evaluate the various proposals?  Or, to put it another way, do you think the proposals are even close to sufficient to address it?

PETERSON:   As I said earlier, my enthusiasm for both sets of proposals was very restrained. I start with the Republican Party. We heard the president the other day propose some changes in Social Security in the health care area. The Social Security issue, which I would define, Bob, and you may or may not agree, as where are the funds going to come from, because we have to fund them, essentially proposes that we take 10 percent of payroll tax, then put it in individual retirement accounts. But in so doing we increase the debt and increase the deficits, and we don’t confront at least a trillion dollars of what we call transition costs from going from one system or the other. It’s a bit of a three-card monty quality, you know—which we can’t quite put our hands on what exactly is being proposed. But nowhere do you see a proposal to reduce the benefits, which is of course the key issue I’ve emphasized.

On health care the president proposes an expansion of the health savings accounts. There are many good aspects to the health savings accounts. There are large deductibles and co-payments, which I think are generally a good idea. They’re portable—they go with you. They encourage savings, which is a good idea. It’s good for younger people and pretty good for lower-income people. And again, however, it doesn’t touch the central issue. It’s the costs of Medicare that are unsustainable that need to be reformed. And all this does in a sense is add to the cost. Now, it may increase somewhat the number who are insured, which is a good thing, but it does not address the central issue. I think this is the Lady Thatcher syndrome, huh? Who wants to take the pain for somebody else’s gain?

In the case of [Democratic presidential nominee] Senator [John] Kerry], he’s essentially proposing universal health care, but again not a word about how we are going to reduce the cost of the current program. So I’m less than overwhelmed with the proposals I’ve heard.

On the other hand, let’s be realistic.  I have never thought that a political campaign is an optimum environment for serious discussion or practical proposals.

HORMATS:   Let me follow that up. How do we, subsequent to the campaign—once the election is over and hopefully tempers have cooled down—how do we begin to develop—some have used the word culture—a culture of unity on this issue?  The 9/11 Commission idea I think is a terrific one. But the problem is Social Security and Medicare become potent, vitriolic issues, even in years that are not election years, simply because each side tends to have mischaracterized the other to create alarmist notions in the minds of people that the other guy’s proposal is going to undermine Social Security or undermine Medicare or cause older people to become destitute. How do we change that political culture? You’ve written about this quite well, about the polarization. Could you comment briefly on this, because I do think your point about—

PETERSON:   I do strongly suggest—if I didn’t make it clear—I’m talking about what he does after he’s elected, not before he’s elected, because I can’t imagine a serious discussion of reform proposals taking place in the context of a political election, where the temptation to shoot down the other guy engaged in the turkey shoot would not be irresistible. So it has to happen later.

Longer-term, we have some very serious issues for the young people in this country, and I write a chapter on that subject. The attitude of the young people is characterized by the old joke you probably remember—Ted will tell you all my jokes are old—but in the philosophy class in which the professor asks, “Which is worse, ignorance or apathy?” And some kid from the back shouts, “I don’t know and I don’t care.”  [Laughter.]  We must create an environment and a setting in which young people begin to get educated because we’re talking about their future. And when I spent time in Washington, and I saw the magnitude of the gray lobby—35 million AARP [American Association of Retired Persons] people who vote nearly three times as much as the young people, and who probably write 10 times the letters that the young people do, and at least 10 times the telephone calls, we can’t really be surprised that they’re more responsive to their needs than the other. Though it’s a longer discussion than we can have here, but I think central to this issue is some way of getting the kids and the parents better educated about this problem. It should start in the school. Since it’s their economic future that we’re talking about, I propose a whole series of questions that ought to be included in a civics class. You know, we tend to talk about how our system is set up and formed and checks and balances, but we rarely teach young people about the economics of government.

HORMATS:   One of the things that’s interesting about this book—and I’ll refer back to Ted Sorensen on some of the earlier books—this has become a bestseller—lots of people are buying it. Does this give you some degree of hope that perhaps—just perhaps, because of the sales of this book and the interest are so substantial, that people are beginning to understand the gravity of the situation and it’s becoming a more important issue on the minds of people as opposed to “Gray Dawn” and others that were compelling books but not quite the bestseller as this one?

PETERSON:   Well, previously I’ve specialized in worst-sellers, so this is quite a shock to me, I must say. [Laughter.]  I think I should engage in some fuller disclosure. Ted Sorensen has so gotten to me with his assault, that I felt I had to respond in some concrete way. And how could I do that?

Now, another of his attacks on me that I found particularly devastating was I was on a high one day when someone sent me the London Times—you will remember this, Ted—and there was a half-page picture of Lady Thatcher, and the picture headline underneath it says Lady Thatcher is carrying this book, “Gray Dawn,” by the American writer Peter G. Peterson. Well, I was just thrilled by this, so I sent it to Sorensen and I said, “I just want you to have a picture of the global eclectic audience that my books have.”  Within micro-seconds I get back a typical nonpartisan observation of Mr. Sorensen. He says, “Referring to you as the American writer is roughly like referring to George W. Bush as the American orator.”  [Laughter.]  So I decided, Ted, that whatever it cost me, I was going to get a bestseller. Now, for those of you writing books, if you don’t care about the cost, go out and buy 25,000 of them in the first—[laughter]—and you’ll have a bestseller. [Laughter.]

Seriously, it seems to me—I like to hope this is the case—I would like to believe that two things explain the interest in this book. One is we are in the middle of a political campaign, which tends to concentrate the mind on issues. Secondly, I’m hopeful that a growing number of Americans sense that we’re living in a surreal and a Disneyland world. We are told we can fight these two wars we are talking about, we can fight them without sacrifice, unless you consider making a tax cut a permanent sacrifice, we can add debt, like no one in history has ever added debt, and somehow no one has to pay the bill. There are enough people out there like myself and Ted and David and others who remember the Second World War quite vividly. And the idea that we could be fighting wars that are life-and-death issues, both the war abroad and home, without anyone making a sacrifice of any kind I suspect doesn’t seem to compute in the American psyche. And I would like to believe that’s another reason, aside from my buying 25,000 copies, that this may have been a bestseller.

HORMATS:   I think we should now turn it over to the audience. Let me make one—

PETERSON:   Incidentally, I told Sorensen that I paid for this microphone, and he’s not going to get equal time at this occasion.

HORMATS:   Before I turn it over to the audience, I just wanted to add one historical comment, going back to World War II. It’s quite interesting—this is really the only war that we financed without cuts in domestic spending or increases in taxes. Lincoln in the Civil War, what was arguably an extremely unpopular war for a very long period of time—not only did he raise taxes, we didn’t have an income tax before the civil war. He instituted an income tax and raised it three times in the course of three years. And ever since World War I, World War II, the Korean War, we have cut domestic spending. In fact, Roosevelt cut programs that he himself had initiated in the New Deal to make room in the budget to pay for the war. So you’re absolutely right, this is without historical precedence and it’s something that we think is—

PETERSON:   You know, I spoke, Bob—your speaking of the war reminds me of my comment about the theology or faith-directed aspects of this tax cut business. I was on [“The Charlie Rose Show”] one night and asked to comment on Bob Bartley, the highly respected editorial director of The Wall Street Journal who is a confirmed supply-sider. And Mr. Bartley was going on at great length about how we should have seven fat years and we should do it again, and everything was wonderful. And I sat there and listened to him a while. And I said, “Mr. Bartley, it’s curious you mentioned everything but the debt that was built up during the decade of the ‘80s.”  “Why surely,” he said, “Mr. Peterson, you’re aware of the fact that debt as a percent of GDP is what matters.”  And I said, “Mr. Bartley, I think I’m aware of that fact. What’s your point?”  “Well,” he said, “It’s half as a percent of GDP of what it was 50 years ago.”  I said, “Oh, 50 years ago, that would be 1947, right after the Second World War, where we did build up debt, but we proceeded to bring it down, as you point out dramatically. I thought we were here to discuss Reaganomics, not to discuss what happened 50 years ago.”  I happen to know the numbers. Debt went up from 26 percent of the GDP to 43 percent of the GDP. Now, I’m not questioning the sincerity of these people—I think they believe this. But there is a moral certitude you know about this. But during the break—and I like Bob Bartley, incidentally—I said, “Bob, Bill Clinton put in pay-as-you-go spending rules that we’ve now gotten rid of, they did a lot to control spending, but they also increased taxes on people like you and me, and we had six very good years. Now, if the tax cuts are that essential, how do you explain the six good years we had?”  And the response was stunning, because 16 years earlier I was attacked by the editorial page of The Wall Street Journal for not understanding psychological expectational economics, and if we just got the tax cuts we’d have budget surpluses and trade surpluses, you may recall, by ‘84, in only two years. Forgetting that comment, Bob looks at me in a perfectly straight face:  “But, Pete, there’s a 15-year lag between the Reagan cuts and the prosperity we’re having now.”  [Laughter.]

So when I say that these discussions are faith directed, it’s very difficult at least in my form of dialogue to have a rational discussion of what we’re talking about.

HORMATS:   We have some time for some questions. It’s very hard to see with all the lights, so let me start out—yes, we’ll go one, two, and then three. Wait for the microphone, please, and please identify yourself.

PETERSON:   Please draw him out too, won’t you?  He knows a lot about it.

QUESTIONER:   I’m a professor at NYU [New York University] Law School. I’m interested in the international economy. I wanted to draw you out on the current account deficit. Are you suggesting that we turn our back on WTO [World Trade Organization] or subsidize exports or have another investment control as President Johnson did briefly?  Or do you have better ideas?

PETERSON:   No, I’m not suggesting controls. I’m suggesting that the most constructive thing America could do to avoid the hard landing is to get our fiscal affairs in order and to increase our net savings so we don’t depend so much on foreign savings.

QUESTIONER:   So you say the domestic deficit—

PETERSON:   Contributes.

QUESTIONER:   —you’ll cure the current account deficit?

PETERSON:   I’m saying that if you do two things—if you reduce the budget deficit and you increase personal savings, that combination will have a major impact on reducing the current account deficit. I believe that. I think most economists believe that.

HORMATS:   Yes, can you identify yourself, please?

QUESTIONER: Lesley Stahl, CBS—

PETERSON:   Uh-oh, “60 Minutes”—look out, look out.

QUESTIONER:   This is “60 Minutes.”  First of all, everyone should know that Pete Peterson had a piece on “60 Minutes” on the deficit, and that’s the first and last time there’s been a piece on the deficit on network news. [Laughter.]  But you do make it so interesting—I mean that sincerely. I have to say I don’t know what you meant by wage indexing on Social Security. I wonder if you would explain what the wage indexing is—

PETERSON:   Sure.

QUESTIONER:   —and how that will solve the problem. And don’t be afraid to talk down to us on this one. [Laughter.]

PETERSON:   Well, in your case that would be impossible. [Laughter.]  Let’s look at it this way:  At the present time, the benefits go up with inflation and they go up with wages, both factors. Now, one of the things that make it very difficult to grow out of them is that wages tend to go up with productivity and with growth of the economy. But, alas, so do the costs of these programs. However, if you eliminate the wage indexing and you simply say to the kids, “From now on we’re only going to index to inflation, we’re not going to index to wages,” the benefits only go up with inflation. So if, as we hope, the country gets more productive and it grows, the cost of these programs as a percent of the economy goes down very substantially, and it is that fact that eliminates the unfunded liabilities.

QUESTIONER: [Inaudible]

PETERSON:   Well, it stabilizes the benefits at the current level plus inflation. And then I’d like to visualize a discussion that parents and kids might have, because ultimately at the moral level the way we ought to be conceptualizing this problem is that parents, kids, and grandkids sitting there, they’ve all been told the truth, the awful truth, and suddenly everybody understands that they didn’t really intend to slip the check to their children in the form of huge taxes. And this is fundamentally unfair. But what are we going to do?  We’re not going to slash the benefits. We’re not going to present our kids with unthinkable taxes. What do we do?

Well, what this does then is the kids and the parents say, “OK, we goofed. We shouldn’t have spent the money. We were supposed to set it aside, but we didn’t, you know, blah, blah, blah”—and we dramatically increase the benefits. But we are where we are.

Under this formulation, Lesley, the kids and the parents would get the same benefit in real terms. The kids would not get the increased benefits that they’re currently being told they’re going to get, but I offer two comments about that. Most kids don’t think they’re going to get them anyway; and, secondly, this way they avoid the tax increases that go with those. So I—it just occurs to me that it might be a simpler concept to sell that parents and kids get the same benefit after inflation. It may be wrong, but that’s my judgment.

HORMATS:   We’ll take three more questions—if they’re quick. Yes, in the back, and then we’ll go to the other side. Yes, please?

QUESTIONER: Hi, Nancy Lieberman of the Skadden, Arps law firm. Could you tell us what reaction you’ve gotten from politicians you’ve spoken with since the book has come out? I’m sure you can’t give us any names, but without naming them, share it with us?

PETERSON:   Well, politicians don’t want to get into a dialogue with me or anyone else on this subject, because the first time you lay out the enormity of the problem that I’ve been trying to lay out the obvious next question is, what are you going to do about it?  And imagine, if I may, Ted, invoke the name of [former Vice President] Walter Mondale, who you may recall said we’re going to increase taxes, and the enthusiasm was really restrained for that notion. [Laughter.]  Imagine a politician making the Pete Peterson speech. Even if you got rid of all the Bush tax cuts, it’s only 10 percent of the problem. So, folks, we’re going to have to reduce the benefits. Now, just imagine the political response to that particular—imagine what the other side would say about that. “Oh, it’s not a problem. The trust funds will take care of everything. These guys are pessimists.” You know, on and on and on. So I don’t think it’s possible to have a dialogue at the present time with politicians. You get a lot of congratulations:  Thank God you had the guts or imprudence to speak the truth, even though you’re a Republican. But the politicians themselves in my opinion are not going to engage in anything approaching an honest dialogue at this time.

HORMATS:   Yes, in the back on this side. I think there was one. Yes, please?

QUESTIONER:   Thank you. John Moore, Morgan Stanley. A question on health care. Since we can’t change demographics, how should we be thinking about containing costs while preserving some of the value of health care?  From the bottom up?  Through wringing out inefficiencies from the top down?  Through rationing?  Both? Neither?  How do we think about that?

PETERSON:   Well, I think there’s a more toxic word in the American political dictionary than liberals—at least in some circles, Ted—and it’s rationing. But in effect what we’re talking about is we’re going to have to get by with less of what we have become accustomed to. And we spend enormous amounts in this country on very high-tech, high-cost methods. We have a system in which the differences within regions, between regions, are simply staggering for the same diseases. But we’re going to have to try a variety of things. I talk about installing managed competition. I talk about promoting cost-sharing. I talk about much more investment in what is called best medical practices. You can’t have a medical system in which the New York area adopts one method for treating a certain disease, and somebody else adopts one that’s five times more expensive.

I propose that we should seriously consider global caps, which is what the rest of the world, much of the rest of the world, does. Now, that is rationing. But this whole subject of rationing is so politically toxic that we can’t use the word. But we’re going to have to give up some treatments that have some benefits. The question is, what do they cost and what is the cost-benefit ratio?

Now, a number of years ago you may recall the state of Oregon decided that Medicaid was just going absolutely out of control—and as you know the states absorb half the costs of Medicaid—and they put together a communitarian approach, which I found very sensible—nurses, doctors, clergy, labor unions, et cetera said, “What is it we’re going to do to control costs?” And they come up with 715 what they call DRGs, diagnostic related groups. And this brave group of people got together and listed 715 diagnostic-type situations, and they actually ranked them in terms of priorities. So, for example, giving a second liver transplant to an alcoholic was considered a low priority—OK?—so forth. These people, nonetheless—Democrats, Republican, independents—got together and came up with this list. This went to the White House, and someone says, “Oh, my God, we’re talking about rationing.” I don’t know what euphemistic word you can use to describe what’s required, but we are going to have to get by with less medical care—and I hope we’re rational about choosing those things that are high cost and very marginal benefit. But it’s an extremely tough problem. We spend in this country very large amounts of money on the last months of life, as you probably know. In the course of writing these books, I visited intensive-care units in the United States, and I visited them in Europe and Great Britain for example. If you visit an intensive-care unit in the United States, I think you’ll be stunned by the average age as well as the treatments. There’s an immense amount of heroic intervention techniques, extremely costly techniques.

I once asked my good friend, Fred Plum, head of neurology at New York Hospital—perhaps the leading stroke expert in the United States—“What do they do in Great Britain, Fred, because their costs there and their intensive-care units are different than ours?”  He said, “In Great Britain, Pete, if someone has a severely disabling stroke and their quality of life is de minimis, they turn the patient over to the general practitioner, who sends them home, and that person dies what is called an old man’s death.”  Now, I’ve been responsible for more politicians losing elections than anybody in America, and I remember [former Colorado governor] Richard Lamm read some stuff I’d written in this area—and you may recall he ran for office in Colorado, and he suggested such things as living wills and so forth. He got roundly booed on the grounds that, as Yankelovich says in America, it’s maximum right. So don’t let me minimize the difficult problem that we’re going to face. It’s the health care reform issue ultimately and how we reduce costs, because it injects more and ethical and psychological and political issues of deep magnitude.

HORMATS:   One more.

QUESTIONER:   John—[inaudible]—the possibility of investing those in private securities, war equities. And presumably if they were bonds, those would be disbursements of the federal government, and at least you’d have an honest accounting and probably significantly better returns on the investments than on one-and-a-half-year government bonds. Could you comment on that?

PETERSON:   Well, I think it’s important to understand that what is in these trust funds so that there are no delusions about what we are talking about. It’s essentially a group of liabilities, is what it is. And these so-called bonds that people keep referring to have never been sold anywhere. They are simply a paper transfer, an accounting kind of fiction. So when it comes time to cash in the, quote, trust fund assets, you do exactly the same thing as if you didn’t have—you have to go out and borrow the money, or you have to cut the taxes, or whatever.

Now, I agree with you, John. One of the reasons I want the set-up as mandatory assistance of private accounts—and, incidentally, John knows much more about this than I do—I’m a little amused, John, and you may not agree with me—with these private retirement accounts that people keep talking about. Your friend and mine, Jack Bogle [chairman and founder, The Vanguard Group], has done a lot of work with what happens with greater returns due to the administrative costs of accounts. The accounts that are in the Bush proposal that they’re talking about—just think this through for the moment—are roughly 10 percent of the payroll tax, which is roughly 1.5 percent of pay. The average pay in America is $40,000. So we’re going to start out with a $600 account, and then we’re going to have a $1,300 account. Now, John, just imagine the administrative costs, not to mention the risks, of managing millions of small accounts and what that would do to the rate of return. That’s why I propose putting it in the private sector, putting it in index funds—and they ought to be global index funds in my opinion—so the returns would be much higher than anything the government could assume. But what’s most important:  the money would be invested in the private sector instead of in some accounting fiction that doesn’t amount to anything.

Don’t ask me about nuclear physics. [Laughter.]

QUESTIONER:    I’m Dick Garwin. Let’s say a reader is persuaded by this excellent argument, and also realizes that it’s going to be difficult to do something politically to solve the problem, and decides to benefit himself or herself by making investments. Have you thought what will happen in the 10 years or five years before remedies can be taken as individual investments go to handicap the system?  What will happen to the economy?  Is there some way that we can change the rules so that these investments themselves can help to improve the system?

PETERSON:   Well, the system will get improved, Dick, if we save more and invest more. Just the way you grow is to invest. And the trouble with most of these programs, Dick, is that they’re all consumption, aren’t they?  They’re about the past basically—they’re not about the future. And one of the things that has happened to our economy in the government budget, investment in human capital, investment in infrastructure, has gone from 6 percent of the GDP, where it used to be for years, down to 2 or 3 percent of the GDP. But the way you grow, according to my economics at least, is you save and invest more, and that’s the way you grow. And that’s why I want this money to go into the private sector. I don’t want the politicians to spend it, because they’ll not only spend it, but it will be for consumption rather than investments, you can be sure. That is the past and not the future.

HORMATS:   We’re out of time, but I just want to leave you with one quote and then one final response. And that is—it’s a quote from Alexander Hamilton. It goes back to 1790. It shows they were a little wiser in those days than perhaps we are today. Hamilton said he wanted to incorporate it as a fundamental maxim in the system of public credit of the United States that the creation of debt should always be accompanied by the means of extinguishment. We’re still looking for that means of extinguishment.

The second point I want to make in concluding is that you quoted Bonhoeffer early on—I think he would be very proud of you. Thank you very much. [Applause.]

PETERSON:   Thank you. [Applause.]

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