Stephen C. Freidheim Symposium on Global Economics

Description

8:00 to 8:30 AM Breakfast Reception

8:30 to 9:45 AM Session One
Currency Wars, Capital Controls, and the Outlook for the International Monetary System
Ajay Shah, Professor, National Institute for Public Finance and Policy, New Delhi
Benn Steil
, Senior Fellow and Director of Interntional Economics, Council on Foreign Relations; Author, Money, Markets, and Sovereignty
Alan M. Taylor, Senior Advisor, Morgan Stanley; Professor of Economics and Director of the Center for the Evolution of the Global Economy, University of California, Davis
Presider: Sebastian Mallaby, Director, Maurice R. Greenberg Center for Geoeconomic Studies, and Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; Author, More Money Than God: Hedge Funds and the Making of a New Elite

10:00 to 11:00 AM Session Two Keynote
Lawrence Summers, Director, National Economic Council; Former Secretary of the Treasury, U.S. Department of the Treasury
Presider: Tim W. Ferguson, Editor, Forbes Asia

11:15 AM to 12:30 PM Session Three
Trade Tensions: Challenges and Opportunities After the Midterm Elections
Charlene Barshefsky
, Senior International Partner, WilmerHale; Former U.S. Trade Representative
Jagdish Bhagwati, Senior Fellow for International Economics, Council on Foreign Relations; Professor of Economics and Law, Columbia University; Author, In Defense of Globalization and Termites in the Trading System: How Preferential Agreements Undermine Free Trade
Douglas A. Irwin
, Robert E. Maxwell '23 Professor of Arts and Sciences, Department of Economics, Dartmouth College; Author, Free Trade Under Fire
Presider: Edward Alden, Bernard L. Schwartz Senior Fellow, Council on Foreign Relations; Former Washington Bureau Chief, Financial Times


Audio
Transcript

RICHARD HAASS (president, Council on Foreign Relations): Well, good morning. I'm Richard Haass, president of the Council on Foreign Relations, and I want to give a warm welcome -- and it is warm today -- to everyone here and thank you all for coming to what is the second annual Stephen C. Freidheim Symposium on Global Economics.

Let me begin by thanking Stephen for his support, without which this would not be possible, as well also -- and not -- let's be honest -- not simply for his generosity but also for his ideas. Steve is -- there are certain people who are generous enough -- and I'm happy with that -- to support what we do here. Steve, however, isn't content with that, and also is truly an intellectual participant. And you see the fruits of it today, which is going to be an extraordinarily rich day. So thank you.

I also want to thank the Council -- the Council on Foreign Relations' Maurice R. Greenberg Center for Geoeconomic Studies, led by the gentleman to my left here, Sebastian Mallaby, for all that they do as well and all the work they put into this symposium.

And subjects such as the ones we're going to be discussing this morning that focus on economic and political forces and how they interact and affect the world are at the heart of what we're trying to do both in this center and at the council. The interplay of the policy and the economic is what we call "geoeconomic," and what we are trying to do is mirror the world. Universities may have departments and silos; the world does not. And we do our best to approximate the world.

We've got an impressive lineup today, as you can see from your program. We start off with a panel on currency issues, followed by a conversation with Larry Summers, and we end with a panel on trade. And in the between the panels are breaks, to give you a chance to speak to one another, take in some calories, and there is a lunch afterwards.

Timing is a lot in life, and I think our timing is good. As the G-20 meeting in Seoul demonstrated all too clearly, the world as yet has no mechanism for solving currency issues. And the G-20 meeting came against the backdrop of charges -- or actually a near-consensus, I would suggest -- that China was manipulating its currency. Much less agreed upon was what the consequences were and what to do about it. But before the meeting was over, criticism of the Federal Reserve's decision to resume quantitative easing filled a lot of the political space. So all of this means we've got more than a little bit to discuss this morning.

The third panel -- the third session today, the second panel, is on free trade agreements and trade more broadly, and given, again, what happened in Seoul, what for many was the unexpected inability to come to closure on the U.S.-South Korea Free Trade Agreement forms the backdrop.

And obviously trade is a growing issue of both domestic and international concern. Lots of people are asking the question of what, if any, consequences the new Congress in this country will have. And as recent Wall Street Journal and Pew polls have shown, there are fundamental issues of what can be done to resurrect a consensus in this country that would support free trade. Indeed it's for that reason that one of the things we have started up here at the Council in Foreign Relations is a task force on exactly that issue: What should be American policy in this -- in this realm?

And again, all of this is against the backdrop of a moribund -- I think that's a fair word -- Doha process or lack thereof. So I think there's also the question of what, if anything, can be done to resurrect not simply the three languishing free trade agreements, but what can be done to resurrect global trade talks.

We'll discuss all these issues and more today, and I think the "more" is whatever Larry wants to talk about in between. The context could not be better in another sense. We've already had the brief -- well, the draft of the chairs of the deficit commission come out. Then I think today you've got the Rivlin commission's report that she and former Senator Domenici have put out.

So the air is filled with things economic and geoeconomic. And as a result, we couldn't do better than to turn things over to Sebastian Mallaby. Sebastian is the director of the Maurice R. Greenberg Center for Geoeconomic Studies here at the council, but he's also the Paul A. Volcker senior fellow for international economics, which makes him the person at the Council on Foreign Relations with the largest title and the largest business card. Sebastian is also the author of a recent book, "More Money than God: Hedge Funds and the Making of a New Elite," which is not only important, but it is truly interesting and readable.

So with that, Sebastian, over to you, sir.

SEBASTIAN MALLABY: Okay. Thank you very much, Richard. We'll get started right away on this first session about capital controls, currency wars, et cetera. We've got a great panel here to speak about this. I'll just quickly introduce Ajay Shah at the end, who is a professor at the National Institute for Public Finance and Policy in New Delhi and also visiting at the IMF research department right now.

In the center is my colleague over here at the council, Benn Steil, who wrote the book "Money, Markets, and Sovereignty," and is working on another book, which we'll get to in a second.

Then Alan Taylor, who is a senior adviser this year at Morgan Stanley, but also director for the Center for the Evolution of the Global Economy at the University of California, Davis.

So I'd like to start -- I mean, as Richard said, we've got a lot of stuff in the news, whether it's the European tensions, whether it's the controversy over the Chimerica deal and how sustainable that might be, questions in the background about the sustainability of the dollar as a reserve currency. All of this stuff is in the mix, but I want to start with some historical perspectives here because Benn is working on a book on the creation of the postwar monetary order, the 1944 Bretton Woods conference.

And I want to start with you, Benn, and ask if you could explain a bit, you know, when the framers, as it were, got together and thought about what they were trying to achieve in the monetary system, what were the objectives they were trying to satisfy, and what part of their thinking resonates today?

BENN STEIL: Well, today, of course, the phrase "currency wars" is much in the news, and the framers of the Bretton Woods system, the Americans and the British, were looking to create a new international monetary architecture that would address the problems that emerged from the so-called currency wars of the 1930s. The view was that it would be impossible to reestablish any sort of open international multilateral trading system without dealing with that issue, without providing some mechanism for stabilizing exchange rates.

The American and the British plans were actually quite different. The American plan was built around the idea of establishing the dollar as a unique surrogate for gold. All countries would be pegged to the U.S. dollar; the dollar would be THE international reserve currency, and countries would be offered inducements to maintain a fixed, pegged price for their currencies with the dollar. Now obviously that stands in marked contrast to today, where we're trying to get countries to de-peg from the dollar.

But where you stand depends upon where you sit. And in the 1940s, we were the world's largest creditor country. So we had a strong incentive to enforce fixed exchange rate, because it stopped others from devaluing against us, very unlike the situation today when we're the world's largest debtor nation.

The Keynes plan was entirely different. The Keynes plan wanted to replace both gold and the U.S. dollar with a new fiat international reserve currency. Keynes called it "Bancor." Actually, most countries at Bretton Woods at least quietly massively preferred the Keynes plan, but they were in no position to challenge the United States. So the so-called White plan, the U.S. plan, became the foundation of Bretton Woods.

And there's a lot of nostalgia today for Bretton Woods. But it's important to realize that the system as such, with convertible currency as it was envisioned by Harry White, only started in 1959. And by the mid-1960s it was already fraying, and by 1971 it was finished when Nixon closed the gold window.

And if I could just describe very briefly what the problem was, because this problem still exists today. Under the so-called classical gold standard that we had before 1914, if we were trading with China, if we sent a dollar to China, China would redeem the dollar (in ?) the United States for gold; U.S gold stocks would decline; we would raise interest rates; credit would tighten; prices would fall; U.S. goods would become more competitive and that would ease imbalances. And this system worked pretty well in the pre-1914 era. There were financial crises around the world, but they tended to be very short-lived and shallow by comparison to modern crises.

How did the system work under Bretton Woods? Well, the same way it works today. We would send a dollar to China. China would not redeem the dollar for anything; they would hand it back to us immediately in the form of a very low-interest rate loan. That dollar would get recycled through the U.S. financial system, creating more credit. And in the 1920s this turned up in the -- in various asset markets, like the stock market in the 1960s. It turned up in inflation. And of course, in the past decade, it turned up in places like the housing market. So it's a -- it's a problematic system.

Now, only two coherent responses to those fundamental flaws have ever been put forward, in my view.

One is the French response in the 1960s; that is, we should go back to the classical gold standard, which for all sorts of reasons is not likely, despite the fact that Bob Zoellick appears to have put it back on the -- at least on the international discussion level. Even Jean-Claude Trichet was forced to respond to this idea.

And the second is to adopt some sort of Keynes plan, a legitimate new international reserve currency. And in fact, the governor of the Bank of China, Governor Zhou, last year said that we -- perhaps we did make a mistake at Bretton Woods and that we should not have gone forward with the White plan and we should have gone forward with the Keynes plan.

MALLABY: Alan, do you want to add something to that?

ALAN M. TAYLOR: Yeah. I'm -- first I want to say I'm really looking forward to Benn's book, which I think is going to be very insightful.

But my one -- the one thought that resonated with me is that we know how the Bretton Woods framers thought about it. They thought that currency instability caused bad economic outcomes.

Now, even if that's the way they thought about it, and many people have thought about it since, that doesn't necessarily mean to say that was actually true causally, as an economist would say, you know, looking at the data or trying to assess the evidence. So there's an alternative interpretation out there of what was going on in the '20s and '30s, which is that economic instability were the real or financial causes -- currency instability. Right? And that puts a very different spin on how you look back at those events or later events -- so one can say about the collapse of Bretton Woods in the '60s and '70s, whether it was currency instability that caused real economic problems or the other way around.

Same thing today. We didn't have talk of currency wars until we had the worst economic depression since the 1930s. So economic historians and economists are very careful to try and sort out that causality. And it's not by any means a slam dunk. So if you look at, you know, is there any major difference between how economies perform under different exchange rate regimes, in terms of growth, in terms of crises, all kinds of other metrics, it's very hard to detect a problem there. So I think this sort of currency war, currency instability theme as, like, oh, no, we must try and avert that or put that genie back in the bottle at all costs, maybe that was a characteristic of Bretton Woods, though we should be careful about thinking that that's really the way things are being driven.

And, you know, I guess we might come back to this (theme ?) later, but a currency war isn't the -- or you know, currency movements aren't the worst thing in the world if they relieve other kinds of economic pressures. They are a substitute for a trade war, in some sense. And economic research on the 1930s by someone who's here today, Doug Irwin, who we might hear from later, supports the idea that if you can use the exchange rate as a release valve, it can help you avert more extreme measures of protectionism.

MALLABY: Well, that's a good connection to the third session today. Maybe we'd rather have currency wars than trade wars. But can you pick up also on this issue about what kind of reserves countries should be accumulating? Benn talked about the French idea of gold; you know, the bank or Keynes' idea of some kind of commodity-linked instrument. Right now, you don't have either of those, and you've got a world in which, since 1995, central banking reserves have gone from 5 percent of GDP to 14 percent. Is this sensible? Is it -- I mean, this brings us back up to the debate right today. In other words, the problems identified in '44 are at the core of what's going on in the last 15 years: huge reserve accumulation. Is this justifiable?

TAYLOR: So I think there were a number of questions embedded in that, which is a good way of framing it. So why have the emerging countries started down this track? Why are they accumulating what they're accumulating, and when will they stop? Or what is enough, right?

So I think we all know why they started. If you look at the trends in the data since the 1970s, it was kind of flat. Industrial countries, developing countries, they had, you know, a certain ratio of reserves to GDP, and it was kind of flat-lining; nothing much happened. Then we hit the sort of era of financial globalization and also commercial globalization in the '90s, and the emerging markets started to ramp up their reserve accumulation. And that only accelerated. In fact, it accelerated dramatically after the Asian crisis of '97.

So, you know, at some simple level, what's going on there, it's sort of political economy. Etched on the mind of all emerging-market policymakers, and etched on my mind, is that photograph of Suharto with Camdessus leaning over him, and he's signing away Indonesia's economic life and his political life. Right? And no emerging-market policymaker wants to be in that kind of photograph or that kind of position ever again.

So the message that they took from those events was: We must self-insure. It's not enough to rely on market access, being able to go into debt or borrow when you're in a pinch; or even go to a multilateral, which might come with nasty economic conditions or not supply you with enough credit on enough terms or whatever. Instead, instead of trying to run our wealth down into negative territory, we'll start with our wealth in really positive territory, and then we can draw it down when we need it. And it's kind of hard to argue with that, in terms of, like, countries pursuing their self interest and perhaps interpreting those events of the '90s as a caution. So I don't think there's anything surprising, or indeed anything wrong about that.

So how should you interpret the last 10 or 15 years when they ramped up this reserve accumulation? One temptation is just to panic and say, oh, no, this is global imbalances forever. That could be true and, you know, I'm not going to attempt to forecast it. It's hard enough to do economic history; I think forecasting is really beyond my pay grade. (Laughter.) But I think one way to look at it is we're in a bit of a step change. They knew they were under-provisioned, or under-reserved, in the 1990s, and so they had to take steps if financial globalization and integration and maybe the risks of a growing financial sector in their own countries and globally was going to pose more of a threat to them. So it made sense.

But maybe that step change is going to taper off, and so the public flows toward the -- you know, toward the rich world, driven by their accumulation of reserves, could taper down. So I think, you know, that's an optimistic view of how, you know, a more benign rebalancing could take shape in the years ahead: less of a reserve accumulation as they feel they've got into a sort of safe territory. And going in the opposite direction, I think part of the benign rebalancing will also be increased private capital flows towards them, so -- but that's maybe a separate issue.

As to what -- you know, what they're accumulating, you know, we're back to the Triffin dilemma which -- you know, bringing up Bretton Woods themes again, a hundred years ago, we had one real reserve asset, and that was gold. The problem was, it's in finite supply, or very inelastic supply. And we kept on making more stuff -- which is good; we had economic growth. But economic growth outpaced the stocks of gold, which would mean either inherent deflation if you kept the backing ratio and the price of gold the same, or you'd have to be constantly tampering around with how much backing and what the price of gold was -- which is basically like saying, "Let's float," or "Let's have a fiat system," which we kind of got to by various misdirections.

But along the way then we had a dollar system. And the dollar has this reserve currency status now, which is also kind of a path-dependent accident of history. The good news is: Dollar reserve assets are in seemingly infinite supply. (Laughter.)

But unfortunately that comes with other problems. It's -- you know, it's their reserves, but our problem. And we need to think about, you know, how we manage that. You'd think, you know, getting trillions of dollars at low-interest rates would be a wonderful position to be in, but it -- you know, it depends on an assumption that we have wise and efficient financial markets and households and governments and funds to allocate all of that.

MALLABY: And actually, let's get back to one thing Adam said, which, I mean, maybe I'll -- (inaudible) -- put words in your mouth, but you were saying that with reserve accumulation over the last 15 years, whilst enormous, has been natural and precautionary, and not about buying -- you know, not about managing the value of your currency. Do you agree with that, Ajay? Do you think that most reserve accumulation in the last 15 years can be explained in those terms?

AJAY SHAH: Right after the Asian crisis, it seemed like reserves accumulation was very strongly motivated by that iconic photograph of Suharto. But I think fairly quickly the motivations changed. There used to be this great debate, how much reserves should a man have, a bit like Abraham Lincoln's question of how long should a man's legs be. And different people used to have different views about how big the reserves needed to be. And the top experiment that you would have asked for is, let's have a really big flood, and then we'll see how much reserves you need. Well, we did have a nice, big flood.

And you get two camps, you get two stories. One kind of story is a country that will tell you no amount of reserves would have helped, that in 2008, you know, this was really not something that any reasonable, central bank would -- any unreasonable amount of reserves could have particularly made a difference to.

And then on the other hand, you have data of some countries where the amount of reserves actually used in intervention through the crisis is actually remarkably small. You get numbers like 2 (percent), 3 (percent), 4 percent of GDP. You don't get a very large amount of usable reserves.

So it seems like there are some countries where the amount of reserves required to have dramatically changed outcome was essentially infinite. And there were other countries where the reserves were pretty small. So I find myself hard -- I find it difficult to support the simple reserves as safety storage, certainly after around 2002. There I think it was more about -- (inaudible) -- mercantilism.

Many countries would say that because the Chinese are doing it, we have to do it, too. Maybe the story runs that because the Chinese are doing it, you get a domestic political economy where funds in your own country start pressurizing the politicians, saying because you are doing it, we need to do it, and you start sounding a bit like competitive argument in trade protectionism.

MALLABY: Yeah, you also get a Lockean process, right, where if China is running one type of exchange rate policy that favors its exporters, the exporters grow, they do better, they become more powerful, they have more political say. And then that becomes a political economy, sort of Lockean. Benn, you look as if you want to --

STEIL: You know, China is an interesting case because they've pursued essentially the same policy in terms of fixing their exchange rates since 1994. But their motivations have changed entirely. During the Asia crisis in 1998, there was enormous pressure on China to get rid of its currency peg and to devalue, and the U.S. Treasury showered enormous praise on China for maintaining its fixed exchange rate during the -- during the crisis. So China started this policy with very different motivations than it has now to maintain it. Clearly, its reserves are well beyond what it could possibly need for prudential purposes for dealing with a crisis like the one we've just gone through.

MALLABY: Ajay, let me get back to you since you're at the IMF at the moment. So, I mean, one could argue that even if a decent chunk of this reserve accumulation is understandable for precautionary reasons -- we have a world of big capital flow, so you need big self insurance -- that there are externalities from this reserve accumulation because as you do it, you are pushing capital into other economies, they don't want to necessarily absorb this stuff. And so therefore it would make sense to shift from countries self-insuring to collective insurance through the IMF.

You're sitting there in the IMF, but you're not owned by it since you're only visiting. So you're in the perfect position to tell us, you know, how plausible it is that some better-designed, larger, reformed, whatever IMF could remove this incentive to self-insurance, to get over that Suharto, Indonesia iconic photograph problem, and return countries to viewing the IMF as its friend?

MR.: It could be done.

MALLABY: Alan's even laughing at the mere suggestion of it.

MR.: Yeah. I think it could -- it could be done. But I really disagree on the extent to which that is the question we face today. I think the size of reserves in most emerging markets are way past precautionary motives today. So on -- it could be done, it should be done, and it will help one day. But I don't think it's going to make any difference today. Today we are in a world of exchange-rate mercantilism. I don't think the precautionary motive (binds ?).

MALLABY: Alan, do you want come back on this?

MR.: (So tell us what ?) -- and relate your argument earlier, specifically to China. I mean, before you said, in general, (this reserve ?) accumulation is precautionary. Do you believe that for China specifically?

TAYLOR: Okay. So, you know, frankly those -- the questions --separate.

So I think, you know, we can sort of sit here, and we can have a theoretical model or we could maybe construct some empirical model of do we think exchange rates are on target, above target, below target. And I think one of the problems there is just that there's a range of either theoretical parameters or the standard area you get there is so large that it's very hard to say meaningfully, well, that country has too many or too few reserves. So I'm not sure that's an edifying route to go.

I mean, I agree that we're in a second-best world. There must be better ways to insure. I'd like to, you know, sit here; we can link arms or we can wish for unicorns and the IMF to be nice. But we have to deal with the world as it is, and I think that's my sort of main point about the last 15 years. There were -- there were a lot of nasty threats that these emerging economies saw unfold and they reacted to. But yes, it would be better if there were -- there were alternative insurance mechanisms.

But, you know, it's hard. You've gone through the last, you know, two or three years. You take an example like Chile and its finance minister, Andreas Velasco, who's a friend of mine. And, you know, before the crisis he's being excoriated. He's got the worst, you know, approval rating of any politician and people are like, you know, insulting him on the street as he's taking his kids to school and, you know, it's all very unpleasant.

And then the crisis unfolds and he gets out the check book and spends the reserves on their social programs and things to support the economy, and people love him, right? And if you -- everyone suddenly understands there's a reason we did all of that savings, so that in a time of crisis we would have the flexibility to be able to support our economy. And his approval rates and that of Bachelet shot up to the highest levels ever.

And as someone who studies, you know, Latin American and Southern Cone economic history, I thought, wow, a countercyclical approval rating of a finance minister in Latin America. (Laughs.) Has that ever happened before? So, I -- you know, I just think it's a very powerful story both economically and politically as to why we're seeing this unfold. But I completely agree that there may be countries well above where they need to be in terms of reserve holding.

But in terms of motivation, some of it is planned; some of it is almost accidental; and -- but, you know, some of it may have intent. But I think it's loading too much on intent to sort of say, you know, you're a manipulator and this is mercantilism.

And I think the other thing that makes me a little bit uncomfortable there is an awful lot -- I mean, in the case of China, to bring it back to China -- an awful lot of this accumulation of reserves in the last six years has been through sterilization, so the issue of sterilization bond(s) that (require/acquire ?) reserves. So it's not really -- you know, it's not alternating the monetary base or monetary conditions in any significant way.

And I sort of look at that, and I can sort of separate their monetary conditions from their reserves. It's almost like they've got a separate policy. You know, the exchange rate peg, as you said, was -- it was set, you know, 16, 17 years ago. It's been fixed but adjustable, you know, that wonderful oxymoron we got from Bretton Woods, which is like "military intelligence" or something. (Soft laughter.) It's moving, but we think it's really fixed, okay?

MALLABY (?): (Inaudible) -- Council on Foreign Relations. Don't (make jokes ?) -- (inaudible).

TAYLOR: Sorry, I -- (laughter).

So that was -- (inaudible) -- ago, and then they kind of got into this task. But I just want to make the point that they got, whatever, you know, 120 percent backing for (N zero ?). They've got reserves of 3 trillion (dollars). Does anyone, you know, really think that suppose they got an extra 500 billion (dollars) of reserves tomorrow or they reduced reserves by 500 billion (dollars) -- which they could do very quickly through sterilization or other means just by moving the (leaders ?) -- does anyone really think that would change their ability to peg? You know, would it be so hard to peg with only 100 percent backing, as opposed to 120 percent backing? They're still so far beyond. I mean, they're really two separable issues.

And I think they could quite safely back with perhaps half the level of the reserves they have now. You know, think back to the gold standard, when countries were backing the gold standard with, like, you know, 10 (percent) or 20 percent backing in emerging countries, maybe a bit more, 50, 60, 70. So I really think that we ought to separate the currency and exchange rate question from the reserves, because I think mechanically and practically they are separate.

MR. : (Inaudible) -- and I just point out that Keynes did not believe that it was possible to have a nice, friendly, helpful International Monetary Fund. He was very concerned about White's plan. His idea of an international clearing bank was going to be completely passive. And throughout the Bretton Woods process -- the British emphasized this with the Americans -- we want a passive institution. We don't want it interfering with national autonomy.

We just want it to be a mechanism to produce this international reserve currency that would have a very elastic supply. So it was more a mechanism than an actual fund with technocrats that were going to make the sort of decisions that would produce the Suharto photo.

TAYLOR: I mean, I think, again, this is like (first best ?): If we could have a way for both surplus and deficit countries to coordinate and cooperate and adjust in those ways, the world would be, you know, a much happier place, and we'd all be -- we'd all be very happy with that.

But can we make it work? I think, you know, we need -- we need a guinea pig and a sort of controlled experiment, a small region which claims to have political cohesion where we could try out such an experiment. Umm -- oh, well, Europe. (Laughter.)

I don't want to divert our discussion, but I think, you know, that's obviously a question that's in the air as to can countries that are -- you know, when you have a group of countries with asymmetric shocks, surplus and deficit, and they want to get along -- I don't know. I'm -- at the moment, I'm not getting such positive vibes out of that. But it could be --

MALLABY: Right. I mean, the Ireland reaction to the prospect of a European bailout is only a little bit different to the Indonesian one. I mean, they don't seem to want the money, just like Suharto didn't want it.

TAYLOR: I mean, right, it comes with conditions, saying, oh, it might come with some very unpleasant conditions, some that might even threaten the development model, such as, you know, the corporate tax structure and so forth. And they want to sort of hold on for the best deal possible, which is understandable. And they know that the moment they sign it that it's almost irreversible, and it'll be politically something hanging round their neck for a long, long time. So yeah, I can understand why they -- why they are balking at it, yeah.

MALLABY: Well, Benn, or actually whoever wants to get this -- but I mean, you know, you could say -- there's a lot of criticism right now about the global monetary regime, a lot of disquiet about it, because this combination of fixed and floating, open and not open seems to create a lot of tension. Europe is another model, as Alan said. Right now it seems to be in a mess. Should we draw from this the lesson that even in a fairly politically cohesive bloc of countries, fixing is just too difficult and is not the way to go? I mean -- Benn, actually, whoever wants to --

STEIL: Well, let me start on Greece. There's this myth out there now that somehow if Greece had not joined the euro zone they never would have gotten into this problem. I find this storyline rather remarkable, since a few -- just a few years ago, when Iceland went into crisis, everybody was drawing the opposite conclusion, that clearly if Iceland had euroized, they wouldn't have gotten into this problem.

It's important to remember that, if you go back to 2000, right before Greece joined the euro zone, already 80 percent of their total debt stock was denominated in euros. Irrespective of whether they joined the euro zone, they were going to issue debt in euros because it was cheap. So had they not actually joined the euro zone, they just would have gotten into this crisis sooner.

So it's far from clear to me that this is -- this is a problem created by joining the euro zone. You can make an argument that it's a problem created by the creation of the euro itself, because it induced countries to borrow in this country when -- in this currency when the rates were cheap.

But I don't think we should draw the conclusion that joining the euro zone was a mistake. I don't think you will see countries having any real incentive to consider leaving the euro zone, because once you've actually defaulted on your debt, the whole logic of leaving the euro zone in order to alleviate the pressure goes away. You don't need to do that anymore.

MALLABY: Ajay, on -- let's switch topic a little bit to capital controls. So one response to a world of abundant capital flowing out of reserve-accumulating countries has been for the recipients of these inflows to try to erect barriers. So Brazil, Taiwan, Thailand, all these countries that have -- you know, there's been a kind of return of the fashion towards capital controls. The IMF, which used to be extremely hostile to controls, is now willing to say that they're a good idea in some cases. You know, maybe from the Indian perspective, you've had a long tradition of using controls. Do they work? Are they a good idea? Is it -- is it a sustainable swing of the pendulum of fashion that capital controls are now being smiled upon?

SHAH: There used to be an old wisdom, mostly rooted in the Latin-American experience in the '70s and the '80s, that controls were messy and controls did not work, and you give it enough time, the lawyers and the financial engineers will show you how to get past any controls. I think we are going to rediscover the wisdom of that in a painful way.

So I continue to be skeptical about the usefulness of controls. Controls are far less effective than many policymakers think. I think people have just spent too many years away from those experiences of the '70s and '80s to get to the point where you feel that controls will actually deliver the goods.

There is only one class of situations where I think there is a case for doing something different: It is a country where there's a very low level of development and the country really does not have much of a financial system, the country really does not have financial supervision or the human capability to put together some kind of financial supervision. Maybe an autarchic (ph) approach is more appropriate there, but for most significant countries participating in the global system, I really find myself skeptical about controls.

STEIL: I'd point out that just at Bretton Woods, both under the American and the British plans, capital controls were absolutely fundamental. In fact, the Americans were much more hard-line than the British about it. White insisted not only that countries should have the right to implement capital controls, but countries should have the obligation to assist those countries in preventing inflows into their markets from those countries.

MALLABY: But, Benn, the question, surely, about that is that it's one thing to argue that in 1944. And now we have a world of, you know, hugely expanded trade flows, hugely expanded global supply chains; multinational corporations, which raise capital in different jurisdictions and can move capital internally through their networks by under-invoicing, over-invoicing, all these tricks. Surely it would be plausible to say that capital controls were a useful policy option 66 years ago, but they're not anymore.

And, I mean, India, as I understand it, Ajay, I mean, is a -- is a case study in this, where theoretically the bond market is closed to foreigners, but in practice, after Lehman Brothers went down, India -- Indian interest rates reacted rather dramatically. Isn't that right?

SHAH: Yeah, I -- I've written a lot about this, but on that weekend when Lehman failed, I have to confess that I was more curiously looking at the world, that oh, what a spectacle, rather than thinking that something interesting is going to happen in India. But lo and behold, on that Monday morning, the money market in India opened before London and before New York, and that money market had choked right there in the morning of Monday morning. So it was a lesson for me on financial globalization.

In theory, the rules say that Indian funds cannot borrow abroad with a maturity of less than three years. So in theory, there was supposed to be no money-market borrowing going on. But in practice, that didn't work, so I think we really should question the extent to which capital controls make a difference.

MALLABY: Alan, what do you think? Do you think capital controls can be useful policy tools?

TAYLOR: Well, I think the discussion so far -- I just want to back up what's been said. Fifty, 60 years ago, we were in a different world after World War II, given that this, you know, fundamental trilemma: You can't have fixed exchange rates, capital mobility and autonomous monetary policy. Countries wanted their autonomous policies, but they wanted to sort of stick with the barbarous relic of the gold standard, or the dollar standard, as it became. And so they had to give up capital mobility. Everybody was on board with that. The Washington consensus of 1945 was, you know, kill finance, basically, and restrict financial globalization. It was a very different world.

Why did it unravel? For reasons you were pointing to, in part. As world trade grew and commercial ties between countries grew, there were ways around. The controls were leaky, the countries could mess around with their invoicing of exports and imports to move capital surreptitiously, and there were other ways in which leaks developed over time. So Ajay's point is that, you know, you can't really make controls absolutely watertight, and they can be evaded.

So I think we have to be just pragmatic here and understand that we're not going back all the way. On a continuum from zero to 100 percent, we're not going to back to the 100 percent, sort of early 1950s way of the world here. And that's -- I don't think that's what's being talked about. Just as, you know, when people talk about currency war, they're really talking about actually quite small currency movements. It's nothing like, you know, Zimbabwe or even the 1930s.

So what we're likely to see is some movement from zero and, you know, complete freedom of capital movement towards some restrictions. Perhaps the most important ones we will see. And to, again, bring the great example of Chile to bear, I think like the Chilean "encaje," where there's a tax on short-term flows. And I think studies at the IMF and elsewhere have shown that won't necessarily significantly damp down the total volume of capital flowing in your country, but it might change the composition more towards long-term FDI and away from the kind of hot portfolio flows.

And on the margin, that's maybe something that gives you a little bit of a breathing space and takes away some of the downside risk with these countries looking back at, you know, recent experiences where they were subject to capital outflows or runs. And you know, that's something we can cope with. Even the IMF came out this year and said, you know, maybe capital control's all right. You know, everyone probably fell over and said: What did they just say?

And I think we can sort of live with a world like that, but it won't change the fundamental, deep, you know, real forces that drive the capital flows in the long run but force countries to have adjust their real exchange rates and, you know, cope with living in a globalized world.

So you know, I think pragmatically we'll just follow a fairly moderate course here.

MALLABY: Ajay, we've been talking mainly about reserves in terms of just the extraordinary pace of accumulation. There's also of course the issue of, you know, the currency that it's denominated in, and 60 percent of reserves are denominated into our dollars, but the U.S. economy is 24 percent of global GDP. Do you think that, you know, emerging markets such as India -- are the central banks going to move to something else? When Zoellick talks about gold as a reference point at the World Bank, is there something behind that? Is there -- you know, could you see central banks moving towards some alternative to the dollar on a five- to 10-year horizon?

SHAH: Well, in two parts:

First is, you can act actually be very separate and distinct in your decisions about how to peg the exchange rate and what reserves portfolio you to own. So in principle, a central bank could say that I'm going to peg to the euro, and its investments could all be in hedge funds. So the currency composition of reserves, a large part of it, can be in something that's very different from your pegging strategy. So we don't have to think that the two go together.

In principle, the whole world could choose to peg to the dollar, but that doesn't mean you have to hold all your assets in U.S. government bonds. You could diversify. There's just a small liquid portion that you need to keep in dollars. Large parts of the $3 trillion could go into something else.

The second point I do want to emphasize is that we should not phrase the choices that the world faces as between that (Barbados relic ?) or the U.S. dollar, because there are very nice alternatives as well. Let's not lose sight of the fact you could choose to float the exchange rate; that here is another anchor other than gold -- that is, the CPI basket, so to speak -- so inflation targeting is an alternative system in which any country can create fiat money. And it actually works very well. It -- Andy Rose at UC Berkeley has emphasized that it is actually the best-performing system in many ways; it is durable, it adjusts to shocks and so on. And it's a nice framework, a mechanism through which we can create fiat money.

It does need a little bit of an institutional capability in the country, and Benn Steil and Robert Litan have emphasized that in many countries you don't have that kind of institutional capability. So I respect the difficulties in a certain class of countries where you could not do it.

But for a large part of the world, we actually have a very clean, well-posed alternative, which is inflation targeting plus floating exchange rates.

MALLABY: Well, I want to bring members and guests in, in a second, but I want to give Benn and Alan just a chance now to wrap up this part of the conversation. If -- so, you know, Ajay is saying that after all is said and done, fiat currencies perform better than the alternative of -- I mean, Benn, do you agree with that and, I mean -- and also, as you think about this discussion, do you regard this period of tension over currencies, capital controls, et cetera, as something that we'll just get through and it won't seem significant in five years' time? Or do you think this is the beginning of some tipping point in the system?

STEIL: I think it is the beginning of a tipping point. Alan brought up the problem with the so-called Triffin dilemma earlier. Robert Triffin in 1960 gave very famous congressional testimony where he said: Well, look, this system that we're operating in -- under right now is inherently unstable. The United Sates will always create one of two problems. Given that the U.S. dollar, our national currency, is THE international reserve currency, the U.S. will either produce too little liquidity for the world, which will cause a crisis, or they'll produce too much of it, which will cause a crisis.

But the regime would always oscillate between the two crises until you changed it. And Triffin's solution was to go to the Keynes idea of having an international fiat currency. His chief intellectual nemesis at the time was the French economist Jacques Rueff, who said: No, nonsense. The whole idea of a Bancor he described as nothingness dressed up as currency. We had to go back to the classical gold standard.

And both those concepts are indeed extremely radical, but I don't believe that anybody's ever identified a coherent system that lies somewhere in between. So I think there are ways that we, as the issuer of the international reserve currency, can mitigate the likelihood of crises, like we're going through now, in the future. But I think the system is inherently prone to the sort of problems that we're experiencing.

MALLABY: So we've -- we're living in an incoherent world, but it's been 50 years since the incoherence was pronounced in (Congress ?). Will we carry on, Alan, or will it -- are we reaching a tipping point on the system?

TAYLOR: I'm thinking very deeply. And my wife is a medievalist, so I'm always reminded that it's been an incoherent world for, like, a millennium or more. (Laughter.)

But, I mean, there's a -- there's a serious point here, which is, you know, is there a system? Should there be a system? Can there be a system? You know, we like to teach our courses to undergrads saying, you know, this -- the gold standard system, Bretton Woods and, you know, the idea that someone or -- you know, someone's in charge, whether they have a black helicopter or not. It's the lifeblood of, you know, our courses, (mainly ?) at the Council on Foreign Relations.

But in some sense, you know, countries will pursue self-interest. And it might be difficult, as we see from Europe and other instances, to actually make some kind of coherent system work. What we really want, though, is, like, something that's stable and durable, isn't prone to crises and permits, you know, exchange and trade and other good things to happen.

And the present, quote, "system," i.e. nonsystem, has done a decent job of doing that for the last 30 or 40 years. People thought, when Bretton Woods collapsed: Oh, no! Floating exchange rates. It's going to be the 1930s. We're going to have another Great Depression. And then, you know, life went on and trade kept on growing, maybe even accelerated, and economic growth resumed and we have the new industrializing economies and -- (inaudible). Maybe that was overblown.

So, you know, I think we need to be cautious about thinking we absolutely have to solve this and this is some great crisis. Clearly there are tensions. The -- if -- the main tension is if the emerging markets want to go on, you know, accumulating infinite dollars and -- the Triffin dilemma is there, is sort of behind that -- we may have a problem. Those imbalances may continue in a way -- in a way that's problematic.

But I -- but I do see, you know, trends pushing in the other direction. We don't really know how countries will graduate from emerging (states ?) to developed. Another factor pushing in the direction of fear of floating and lots of reserves 10 or 20 years ago was that they couldn't issue bonds in their own currency. And they had a huge mismatch in terms of the currency, the liabilities and assets. Well, the currency mismatch is moderated, partly because of the accumulation (of/on ?) official reserves, which, you know, creates other issues. The reserves are mostly in the public sector, while a lot of the liabilities are still in the private sector.

But another thing that's ameliorating the problem is that many countries can issue domestic currency bonds now in international markets. And, you know, every morning I'll go to meetings at Morgan Stanley and we're hearing -- Peru has just issued, you know, a domestic currency -- Peru has issued a domestic currency bond, with overwhelming demand for that bond, right? And that's helping these countries get away from needing quite so much in terms of precautions. Just like a few weeks ago, you -- it wasn't -- it wasn't a peso bond, but you had Mexico issuing a 100-year bond -- 100-year bond. You know, I -- my head starting spinning as I thought back over Mexico's 200-year history and what Reinhart and Rogoff and others have pointed out.

But, you know, in some sense that's progress, right? And so we're taking away some of the roll-over risk and other problems. So, you know, one can be optimistic and think some of these countries are graduating; that to some extent they're taking responsibility for their own problems through self-insurance. They've learned from their mistakes of the past just as we did. We're now -- we're all -- we're all emerging countries, right? We just had a massive financial crisis and learned -- you know, we got -- we got some sort of comeuppance and learned that history doesn't -- that it doesn't sort of go away.

So, you know, I'm kind of optimistic there, that we'll just -- that we'll just progress down this track and the imbalances will ameliorate and our system, such as it is, will continue to function without massive intervention. We'll just have the sort of, you know, amusing moments when people panic and say "currency war." And it's entertaining to get the newspapers going, but that's just, you know, part of the great rich tapestry of economic life.

MALLABY: Okay. Well, so we're going to muddle through happily.

At this time, we'll open it up to members and guests. I should have said at the beginning that this is on the record, so sorry I didn't say that before. So if you have a question, please put your hand up and wait for the microphone, speak directly into it.

Do we have any questions? We have one right here in the front, I think.

QUESTIONER: Thank you. Marcus Mabry from The New York Times. So I suppose I could be accused of being one of those newspapers that benefitted from it all. (Laughter.)

I'd like for you to take the opposite view, though, and tell us what do you see, though, as the genuine shocks here in the short term -- because obviously, we do make some money talking about those. (Laughter.) But which ones do you think are really valid? Because I assume there are some you do find valid -- valid risks in the short term.

MALLABY: Well, if it bleeds, it leads. Please provide some blood. (Laughter.)

No, seriously, what -- if you had to predict what the flashpoints might be in the next six months of monetary diplomacy, I mean, how do you see -- how do you see the Financial Times headlines?

TAYLOR: For me, the main downside risks are the European problems are not contained in a -- in a sensible way, and a trade war. I would say those are the two major downside risks. They're hard to quantify, but I think they're definitely there.

MALLABY: Let's go over there.

QUESTIONER: Steve Robert.

I'm intrigued by Alan's somewhat sanguine outlook toward -- to all this, in that we might just sort of muddle through it without needing too much change. But the one country that's become the poster child for currency manipulation, and takes an enormous beating in the press and in other places, is China. So to what extent do you think this is a valid criticism and to what extent do you think the rest of the world should put more pressure on China to let their currency adjust?

MALLABY: Do you -- Ajay, do you want to take a crack at that, and then --

SHAH: I think China matters more than meets the eye, not just because of the size of the Chinese current account deficit, but because there's a whole bunch of political responses across the world that are being shaped by the Chinese exchange rate. Exporters in lots of countries turn around to their governments and say, "Look at those guys. We need you to do the same." So I think that's the real significance of China; that if we could see some important changes in China, it would change the politics of exchange rates and trade protectionism in lots of places, and that's important.

MALLABY: That, by the way, is an issue which I think comes into the third session as well, where, you know, if the Chinese government is assisting Chinese companies in exporting, with key credit or near-free infrastructure support, tax breaks and so forth -- you know, they decide they want to take over the soda industry, and so there's huge government backing for soda companies; it does change the dynamic internationally, where other soda companies are going to their governments and saying, "Hey, you help us, too." And so you get a sort of -- but that -- so I think there's a linkage across our sessions there.

Did you want to say something, Alan?

TAYLOR: Yeah, I think the criticism of China is a little unfair, and I -- you know, they've had a fixed exchange rate for 16 years, and we didn't criticize them for much of that period. And we -- the criticism seems to go up when we've got problems of our own. So some of that is endogenous and reflects other features.

And I think going forward, you know, they are letting the currency appreciate -- not as fast as other people might wish. They do have inflation pressures. We know when a developing country grows, its price level in dollars will rise. That means either domestic inflation in their own currency, or an appreciation. And, you know, the Chinese leadership and economic advisers are aware of the laws of economics and that this is an almost ironclad rule and that it will happen. And I'm sure they want to contain inflation, and they will find a mix.

But I don't -- I don't think it's, you know, beneficial or wise from a sort of economic or financial statecraft point of view, if I can use that term, to really browbeat them about it. I think -- I think it's -- you know, that they have their place on the world stage, and we need to deal with it diplomatically. And I'm not sure we've always accomplished that, especially in recent weeks, heading up to the G-20.

And, I mean, there's sensitivity there, when other world powers -- you know, there's a perceived slight -- or even former world powers. I remember when the British delegation was there last week. It was Remembrance Day, and the Conservative ministers were wearing poppies. And this was taken as a huge insult by the Chinese that some -- you know, that -- (laughter) -- so, you know, if that's going to cause trouble, you know, then saying a few harsh words about their currency is going to lead to explosions.

But my sense is, if cool heads would just prevail, I think the adjustments are taking place in the right direction, and QE2 is part of that. And, you know, there'll be a letting off of steam from various quarters, but eventually the reconfiguration, you know, will occur.

QUESTIONER: But if you go back 15 years ago, China was a very -- if you go back to 15 years ago, China was a very small economy. Today it's the second-biggest economy in the world.

MR. : Yes.

QUESTIONER: So --

TAYLOR: Ajay's point about the macro weight is important. It's --

QUESTIONER: Yeah, so isn't that -- isn't that a great imbalance, to have the second-biggest economy in the world with 3 trillion (dollars) of reserves, I think he said, manipulating their currency, not letting it basically float like all the rest of the big countries are doing?

MALLABY: Benn, do you want to attempt --

STEIL: Yeah. Bringing up Keynes again, Keynes -- Keynes's biggest gripe about the international monetary system was that there was never any fundamental pressure on a creditor nation to adjust. I think he unfairly tarred the gold standard in that regard, because under the gold standard the creditor nation was supposed to adjust, but the point was that they never HAD to adjust. And if he were here today, there's no doubt that he would support some mechanism to force China to adjust. Under his plan, for example, creditor nations would actually be fined by his version of the IMF for building up excessive credit.

Now, as a matter of financial statecraft, I don't think we're ever going to get to a world where we can -- we will have that sort of institutional pressure on a creditor nation to adjust. The pressures in the financial markets are always on debtors to adjust.

TAYLOR: Just think -- I mean, in Europe, are we going to get a system where Germany taxes itself for running a surplus? Or is it just going to be we must tax and have penalties like in the Stability and Growth Pact for the naughty deficit countries? Is there going to be any sense that the surplus countries have some role to play?

And I think if you can't achieve that kind of Keynes-type plan within the superstructure of the -- of the EU or the euro zone, to imagine it at the global level is --

QUESTIONER: (Off mike) -- deficit on -- (off mike) -- countries. That's different than getting -- (off mike).

MALLABY: Well, let's -- I want to move to another question, but let's just give Ajay one chance on that, because he said something before we walked onto the stage about, you know, is it true that 10 percent or 20 percent misalignment in a currency really has a big effect on trade outcomes?

SHAH: I don't work in that field. But the people who are very closely studying the trade data and asking questions about aggregates and (stabilities ?) of trade through exchange rates are really not finding a whole lot there. The effects are remarkably small. So I see a certain gap between the evidence and the political rhetoric. I think the politics is very real. In any country you go to, you will have a bunch of people screaming at the politicians that, oh, this exchange rate is not good for me. But the evidence over a large number of countries for large numbers of years shows fairly modest effects. So I think that the magnitude of the impact of exchange rates on trade is a bit overstated.

STEIL: In fact, I'd just throw in that Keynes actually agreed with that. He argued in the 1940s that, given the so-called "terms of trade" effect, that Britain would get virtually nothing, if anything, out of devaluing. So he was not in favor of a floating-exchange-rate system. He was in favor of a fixed-exchange-rate system, with adjustments when there was a quote-unquote "fundamental disequilibrium." Would he have declared the current status quo in the world as a fundamental disequilibrium? Absolutely yes, he would have. But he would not have supported floating exchange rates on that basis.

MALLABY: We have a question over there.

QUESTIONER: Deryck Maughan, KKR. Is it China's fault that we've only had a current-accounts surplus once in the last 30 years? Is it China's fault that we have deficits with more than 60 countries, not just one? Is it China's fault that we're on a fiscally unsustainable path and critically dependent on capital inflows to keep the economy going? Do we owe a vote of thanks to the world's central banks, who now own more than half of the U.S. Treasury debt, recognizing that they'll -- they will very likely take very large capital losses simply to keep us afloat? Would you agree that the United States is the largest systemic threat and it's time to stop blaming China?

MALLABY: Okay, so we've talked enough about China, but that is a -- (laughter) -- cue to talk about QE2. I mean, I take the question to be really about quantitative easing, which we have not addressed. In other words, is the U.S. to be blamed for -- more than China for any potential instability to the U.S. economy, I guess is what the question -- (inaudible).

MR. : I love the way you turned that question around. (Laughter.)

(Cross talk.)

TAYLOR (?): Yeah. And in terms of truth in advertising, to directly answer the question, yeah, it takes two to tango. But QE2 -- I mean, Ajay's point is absolutely valid. And I was talking to Dick Burnham, my colleague at Morgan Stanley, and, you know, people have run the various models.

If you think about just the magnitude of depreciation that people would like to ask China to do, it's probably outside the realm of reality, and then you crank it through the models, how much of a change in trade balances or current accounts is that really going to deliver, it's not that huge. So QE2, you know, it's going to work through various channels, and it's kind of the last, best hope, because what's happening in terms of fiscal and other policies that can turn around the United States economy right now; not so much. Even the Fed is now coming under attack, which is obviously very worrying, for someone like me, at least.

So, you know, we have still a broken financial transmission mechanism. Banks are not lending. Many of them are still repairing their balance sheets. Households are repairing their balance sheets. You can ease financial conditions a bit more. You can move the yield curve at the long end a little bit more. Maybe that's partly signalling just saying I really am committed to low interest rates for been longer than you thought. And then you can hope for help from the rest oF the world. It is marginally going to weaken the dollar. I guess that's the hope. but it's the unintended, or at least unspoken, consequences, as Bill Dudley (sp) pointed out in remarks this week.

So there's a direction. However the U.S. is just issuing very conventional monetary policy like in the textbook. You know, you have an asymmetric shock, you're in a worse position than other countries, you're going to have more expansionary monetary policy; and as a, quote, "side effect," the currency will weaken, and you hope that will stimulate aggregate demand. It's just unfortunate we're in a position where many of the transmission mechanisms through which that will work are just somewhat impaired. but it may be the only game in town.

STEIL: There is another perspective. Certainly that's the one that's shared by the Fed and the administration, but there's another perspective that I would characterize through this analogy. Say you turn on your shower in the morning and there's very little water coming out. You call the plumber and he says, well, the problem is you have a hole in your pipe. And you say, well, how much will it cost to repair it? And he says, $10,000. And you say, well, forget about the hole, then; just turn up the water pressure.

And that's what we're doing. We have, in my view, a broken credit transmission mechanism. The problem is not that the Fed is not providing too much liquidity; it's that it's not translating into credit for the businesses that need it. Small and medium-size enterprises in the United States are overwhelmingly dependent on small and medium-size banks for their lending. These banks still have very seriously impaired balance sheets.

So the fact that in principle they can borrow from the Fed at virtually zero interest rates is not, for them, an incentive to expand their balance sheets by making loans. And until we address that problem, we are going to be dealing with all the side effects from turning up the water pressure.

What are those side effects? Well, bubbles. And we're seeing the possible emergence of some serious bubbles now, for example in various commodities markets and in emerging markets.

I agree with you, Alan, in principle that it's a good thing if Peru can legitimately and sustainably issue bonds in their own domestic currency, but I would suggest that this is an effect of yield chasing because of the fact that credit is so cheap now and yield is so low on conventional assets, and that this is probably not sustainable.

And so that's the potential downside of QE2, in my view.

MALLABY: Another question. Anybody else. Okay, one over here.

QUESTIONER: Jorge Mariscal (ph) from the Royalton Group. I think maybe parts of this question have been answered, but if the final mix for U.S. recovery entails a weaker dollar, and if this is -- the final mix is required, then the world will just have to adjust to that, and the tensions we're living today are part of that adjustment.

I figure that if there is no weaker dollar, what is you're going to see is deflation in the United States. Real wages and the price of things are going to go down anyway, so they either go down nominally or they're going to go down really. And so the fight here is to prevent or to smooth out that path. But I guess my question is, concretely, do you see a weaker dollar as part of the solution, in the end, despite all the screaming and kicking that you're hearing from other nations?

MR.: Ajay, do you want to take a crack at it?

SHAH: So, I think that the dollar's -- I think that the weaker dollar is a part of the solution and that a weaker dollar is the way we are headed. And I guess the interesting feature of the Chinese question is how that weaker dollar is played out in respect of the counterparties. So how much will happen at the euro? How much will happen in the Korean won? How much will happen in the Chinese renminbi? I think that is the interesting dimension.

So that's a story that is being played out in the currency wars.

MALLABY: To some extent, you could get this adjustment by having not deflation here but low inflation, but then really quite considerable inflation in emerging markets, which you're -- which you're seeing. And you're nodding on that.

TAYLOR: Yeah, I mean, in the long term, we know, just as a, like, ironclad law, that when countries develop, their price level goes up in dollars. So in real -- in terms of real exchange rates relative to the emerging markets, we're going to see the dollar weaken. Relative to other developed markets, not so clear to me.

In the short term, though, because the U.S. is -- economy is in a weaker position, I'd expect that a weaker dollar in real and nominal terms in the short term to be part of the likely recovery strategy. But as was pointed out, whether that plays out through the price level or nominal exchange rates, I don't know. There's considerable uncertainty around any of these forecasts because a lot depends on, can the Fed pull out an exit strategy from this large balance sheet without igniting inflation? I personally don't think we're going to see double digit or anything scary, but it will have to manage it, possibly, within a wider range than would have been previously, you know, anticipated.

But there are similar issues like for the euro zone, right? It's bought a lot of Greek and Irish and other countries' debt. Is it going to have a hole on its balance sheet? It's been supplying a lot of liquidity to Irish banks. There are all kinds of facilities there that might need to be unwound. Some of them have been sterilized, but still, they've got to manage a big balance sheet. The Bank of England has pursued QE. Japan has been trying, you know, all manner of things for 20 years, to variegated effects.

So I think in terms of nominal exchange-rate movements, all of the G-4 and the big countries have, like, question marks over them in terms of what kind of volatility you will see, but I'm pretty sure we'll see volatility.

MALLABY: Any more questions? Yes, Steve.

QUESTIONER: Steve Fried (sp) -- (inaudible) -- Capital. You touched on the euro and the potential risk there. To the extent that you do have some players in the euro who have not been able to meet their mandated deficits, to the extent that it doesn't look like they're going -- it's going to be possible, to the extent that they've misrepresented their current position, what do you think should be done with these players, and what do you think will be done, and how will this ultimately unravel?

TAYLOR: Sir, I mean, I think the great conundrum or problem for the euro zone right now is that they've set up a common currency and also wanted to have a no-default zone. And the realization in recent weeks has been that we can't have a no-default zone. And one can imagine the political economy behind that, which is we want to be taken seriously as a new currency, have credibility; can't we just get everyone to play by sensible rules and not have bad outcomes?

But unfortunately, given both public- and private-sector behavior -- the public sector in Greece, Portugal; private-sector bubble in Ireland and Spain in housing and so forth -- they ended up with countries that, you know, went off the rails a bit in terms of sustainability and borrowing.

So I think that's one of the big unknowns about Europe, is how will that be resolved? There's talk of this crisis-resolution mechanism. They went far down the road in terms of wanting to have haircuts. They're backing off a bit now and thinking about how they will restructure some rules about how a country can go into some kind of structured or organized default.

But I think, eventually, you know, history says occasionally, you know, debtors default, and that's like life, and we have to come up with a way to just manage that in a reasonable way. And I think that's where the euro zone will end up, and you know, that'll be okay. I mean, we talk about the Peru bond. You know, it'll have risk. All credits have risk, and just because we're living in a savings glut world doesn't mean that everyone's chasing yield now in the naive -- the naive view that yield is always safe. It comes with risks. And, you know, we've just grown up a bit, or maybe we learned a lesson we should never have forgotten. And those same lessons will apply to the euro zone too.

MALLABY: Benn, you wrote a nice piece about the lessons from the financial crisis in terms of domestic regulation. And it strikes me there's a parallel here, which is that orderly resolution mechanisms are extraordinarily hard to implement, because in a time of panic, the systemic risk consequences -- that the risk of contagion from actually making people take a haircut, take a loss, is so big that people often just blink.

And so you can have an orderly resolution mechanism; in the case of American deposit-taking banks, it's called the FDIC. But whether the Treasury in the moment of truth was willing to actually use that mechanism after Lehman went down with WaMu and actually make the bondholders of WaMu take a haircut, the truth is we know that they were ready to flinch and to have public money go in to facilitate the rescue. So that was an example where you had a resolution mechanism but you didn't have the guts to implement it.

In other cases you don't have a resolution mechanism. For example, in Long-Term Capital Management in 1998, there was no resolution mechanism for hedge funds. But, you know, the government didn't put public money on the line because it was an environment where they actually did resolve it by convening people at the New York Fed. Without there being a mechanism to do it, they did it.

And aren't we seeing the same thing now in Europe, where, you know, you can talk about a resolution mechanism, you can theorize about it, but when you actually are confronted with Ireland and you try to use it, everybody panics, the Portuguese start screaming, and you can't -- you don't have the guts to do it?

STEIL: Absolutely. In fact, the EU is trying to have its cake and eat it too on this particular issue. They're saying, "Right now don't worry; we're not going to let anybody fail. But just you wait: In the future, in a few years' time, private investors are going to have to take a haircut." And of course that caused a panic in the market, because investors say, well, those countries are asking us to buy their bonds now, which they're planning to pay back in the future, and you're saying that we're going to be at risk in the future. So we're not going to buy the stuff now. So creating an orderly restructuring mechanism -- it can -- exceptionally difficult to do.

My personal view is that you've got to have what we economists call a corner solution. You can't -- you either have to say that the public -- the private sector is at risk and caveat emptor, or you have to say that we're not going to allow any failures. Why? Well, consider the Northern Rock bank run in the U.K. The U.K. had deposit insurance, I believe, on, what, 90 percent of the deposit(s)? Well, depositors are going to run for their 10 percent. So if you're going to have deposit insurance as a mechanism to stop bank runs, it has to be a hundred percent, at least up to a certain deposit amount. Otherwise you may -- you might -- may as well not have it at all, because it doesn't achieve the purpose.

So the -- what the EU is trying to do now in my view is exactly parallel to the U.K. deposit insurance scheme before this crisis. And they're going to be forced to revisit it.

MALLABY: Let's take one last question. I think there was one right here.

QUESTIONER: Thank you. I'm Vincent Lauerman from Energy Intelligence. I've heard a lot about economics today, but not a lot about politics. I'm just kind of curious: The House of Representatives passed a bill before the midterm elections in which a countervailing duty would be imposed on countries that were perceived to have a(n) undervalued currency. I guess, really, this is a two-part question. The first part is, is it likely that the Senate will pass a similar bill? And if so, would it be veto-proof? And at the same time, what would that -- and this -- the second question's for Alan, and that is, what would that do to this gradual improvement in global imbalances if the Senate did pass such a bill?

MALLABY: Okay, well, on the -- on the political thing, I think the Senate prediction is that they would not pass it, although the corollary to that is that after the tea party -- I mean, the tea party's views on foreign policy, including trade policy, are pretty obscure.

So I think it's -- but you want to give a last comment? I mean, it sort of dovetails to what you were saying earlier about would we rather have a currency war than a trade war. Maybe the currency war would lead to the trade war. That's a good thing to end the session on.

TAYLOR: Yeah, I hope we don't get to a trade war, and I think the -- as I understand it, the political equilibrium at the moment suggests that it won't clear all the hurdles, which, you know, I think would be a good thing. But if we start going down the route of imposing those kinds of protectionist measures, it will just open up a big can of worms.

Even, I mean, the Brazilian finance minister himself -- you know, he's quite a media star. He got on the front page once saying it's going to -- that we're in the middle of a currency war. Then he got to come back the next day to sort of explain himself. And in the -- in the second press conference, he said: Well, what I really meant to say was the currency war is bad, but what would be really bad would be a trade war.

So everyone understands that that's like where we don't want to go. And I think at the -- at the international level, we're kind of fortunate that, unlike in the 1930s, it can't really be such an unrestrained free-for-all, because now we do have the WTO, we have mechanisms and institutions in place that will try and protect, you know, the status quo and try to prevent countries departing and just doing unilateral stuff.

But, you know, Washington is Washington, and anything could happen.

MALLABY: Okay. Ajay and Alan, thank you very much. We're going to stop you there.

We're coming back at 10:00 a.m., for the Lawrence Summers session. Thank you. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

EDWARD ALDEN: (In progress) -- bilateral trade agreements which have been sitting out there for several years now. He set a deadline for trying to get the outstanding issues resolved with Korea. I must admit, I was a bit surprised. And our panelists may be able to shed some light on this, on why the administration would set a deadline and then failed to get a deal and even looked like they failed to make really serious efforts to get a deal. But the Korea deal, as a result, is still out there.

And then, finally, of course, we had a midterm election, which appears to have strengthened congressional support for trade liberalization, at least in the House, which is historically where trade has been most problematic. Trade is being talked about as an area where the administration and a Republican House might find some common ground.

So I want to start with you, Doug.

Doug has been working on two books about trade policy in the Great Depression, which are out next year, and wrote a fine intellectual history of free trade which a number of you may have seen.

Doug, to start, how would you assess the current state of the U.S. trade policy? If we, say, have it at a positive extreme, the leadership that led to the inclusion of the Uruguay Round -- at the other extreme, Smoot-Hawley and the various other Depression-era measures -- where do we stand currently?

DOUGLAS A. IRWIN: Well, currently I'd say that U.S. trade policy is sort of in hibernation. And I think one of the consolations of history is that that's actually normal. So we tend to think about sort of the history of post-World War II liberalization as being this very linear process where you have GATT round after successful GATT round, that's beating down the barriers to trade. But I think when you look at the history, it's much more punctuated than that.

So I think about the postwar liberalization as being sort of the founding of the GATT in 1947, then a 20-year hiatus, then the Kennedy round in the '60s, not finishing up till 20 years after that; that's '67; then another hiatus, and with due respect to anyone who negotiated the Tokyo Round, wasn't all that consequential a round; and then the Uruguay Round.

So these are three big initiatives, but they're sort of filled with this period of relative inactivity, no big initiatives. Then you have to ask the question, so we're in one of those periods where we're sort of waiting what the next step is.

What generated those three sort of bursts of U.S. trade activism? Why did the U.S. sort of become much more of leader in just those three instances? And I think one common element is that the U.S. was reacting to perceived discrimination against its exports on the part of foreign countries. So in 1947, the major concern of policymakers was imperial preferences and breaking into the British colonial trade bloc, including Canada and other countries.

In 1962, the reason why President Kennedy pushed for the Trade Expansion Act is because of the formation of the European Economic Community and the perception that that would lead to diversion of exports away from the United States; and then, in the Uruguay Round, the importance of the sort of fortress Europe, the 1992 initiative in Europe, and expansion of the European community. That was one factor that the U.S. wanted to overcome.

So I think if we're looking for another big U.S. trade initiative, we have to think about where will U.S. commercial interests have a stake in trying to open up markets in a big way, as against some sort of perceived discrimination against us? And I think that's an open question at the moment.

ALDEN: And how would you assess on the protectionist side? We've seen some measures around the world to try to protect markets in the face of the economic downturn, but certainly nothing like we saw in the Great Depression. How would you assess the levels of protectionist response we've seen in the face of the crisis?

IRWIN: Well, there's a very interesting comparison between sort of the 1930s response and the current response in terms of trade policy. And I think the major change there has been that policymakers have so many more policy instruments with which they can address the economic downturn now as opposed to the 1930s.

So the problem in the 1930s was most governments were on -- countries were on the gold standard, so they didn't have an independent monetary policy. Most of them had what was known as the treasury view of fiscal orthodoxy; you should balance budgets even in downturns, so if receipts go down, you have to cut expenditures to keep the budget balanced. So fiscal policy was off the table. And so that naturally led policymakers to turn to trade-policy measures.

And now, of course, we have fiscal and monetary policy, as well as many other instruments, to address a downturn. And then, therefore, trade policy is less important as a mechanism of trying to get the economy moving again.

ALDEN: So you would say that some of these other tools have enabled us to avoid the traditional protectionist response.

IRWIN: Absolutely.

ALDEN: Interesting.

Charlene, I want to talk to you a bit about the politics of trade. You know, I've watched this as a reporter through that period of great activity with NAFTA and the Uruguay Round negotiations that brought China into the WTO, and have also watched it in a great period of inactivity, as Doug described. And some of that certainly has to do with the domestic politics of the issue in the United States.

Why has it become so hard for any administration, Democrat or Republican, to carry out an ambitious trade policy of the sort we've seen in the past?

CHARLENE BARSHEFSKY: Well, I think there are four factors in particular that weigh very heavily now on the politics of trade and globalization. And you can see these factors creeping along from NAFTA forward. So the first has to do with the pace of globalization, particularly since 1950, and then again almost immediately post-NAFTA, where you have, because of a variety of -- for a variety of reasons, whether capital flows or financial flows, whether trade flows, the advent of technology and so on, you have a global economy that is larger. It is growing faster, at least pre-crisis, under the pressures of financial flows and technology than ever before. And the result is competition is extremely intense. That'd be the first factor.

I think the second that bears on the politics is the re-emergence of China, the integration of Asia around China as a productive hub, China's growth rate, its increasing muscularity, which countries perceive and read differently, and a China that has conducted a trade policy that is heavily export-oriented and a currency policy that is largely linked to the dollar. And the result is massive imbalances.

I think the third factor has to do with the period that the United States finds itself in, and that is a profound period of weakness as the global economy is more integrated and as China has re-emerged. That weakness was evident before the financial crisis. But with the financial crisis came an extraordinary synchronous contraction, with the result that consumer confidence plummeted, demand plummeted in the developed world. These large imbalances became more and more a target of apprehension, all while our competition has gotten tougher.

And the last factor, I think, is jobs -- jobs, jobs, jobs. We've been losing manufacturing jobs since the 1950s. We have not been losing white-collar jobs until more recently. That's one area of concern. The other, of course, is with the financial crisis came a crash to job growth, obviously extraordinary layoffs. And job growth today is tepid.

So all of those factors bear now on the politics of what will go forward, plus the fact that you have a more populist Congress. I think the jury's still very much out on what the House will be able to do. The jury is less out than on -- with respect to the Senate. You have, in general, a declining popularity in trade agreements since NAFTA. It's a clear trend; agreements pass by fewer and fewer votes with each iteration. The one exception was PNTR for China, which passed by a pretty comfortable margin in the House.

And I think, last, you have this overall concern about the position of the United States making all of the anxieties that I've already mentioned all the greater. So those are the politics that I think will bear heavily on this next push by the administration with respect to trade.

ALDEN: Just to bring in Doug's larger historical scope, do you see any of this as immutable? I mean, if you look back to the early 1980s, some similarities: High unemployment, challenge from Japan, worries about U.S. weakness and decline, and yet a remarkable resurgence from that.

BARSHEFSKY: Right. I don't think it's immutable. And whatever the perceived or real decline of the U.S., I don't think that's immutable either. And I don't think China's re-emergence is immutable -- an immutable fact necessarily; certainly not linear, necessarily.

But I do think that there is increased sensitivity now, in part greater than at the NAFTA junction, simply because of the flow of information, the awareness the public has of a world that seems to be much smaller, an awareness of job dislocation in a manner that is quite pointed.

And I think, with that and with the rhetoric that's gotten worse and worse every year about trade imbalances and unfairness, as though trade deficits were a function entirely of unfairness, which, of course, is not at all right, I think you have a tougher environment now.

ALDEN: I want to turn to Jagdish, who has recently been named by Angela Merkel and David Cameron to co-lead an experts' group, along with former WTO Director General Peter Sutherland, that will look at, among other things, ways of reviving the stalled Doha Round of trade talks.

Jagdish, with the U.S. hampered politically and weaker economically, as we've heard from Charlene, can you see trade leadership emerging from elsewhere in the world? Are the Chinas or the Indias or the Brazils or the other emerging market countries prepared to play a bigger role than they have in the past in fostering liberalization or are we still in a situation where there's no real alternative to U.S., and to a lesser extent European, leadership of the trading system?

JAGDISH N. BHAGWATI: That is a good question but I think we are still -- the United States is still the biggest Rottweiler on the block. It is true that these other countries have risen, but please look at President Obama's visit to India. Because the sensitivity by the president, because of reasons mentioned by Charlene, the Indians were strictly under, you know, instruction not to raise the trade issue at all except to talk about jobs in the United States. So we were a bit like the Japanese who don't provide leadership, even now. They used to be strong, silent men. Now they're weak, silent men. (Laughs.) But I think this is basically a kind of (blighting ?) us. And apropos of that, let me also say that when, after the Indian election and after the American presidential election, the situation changed dramatically for the U.S. and for India.

In India, the communists were put out of the coalition. So the Indian prime minister was much freer to actually move to his trade liberalization than before because the communists were hostile to trade. But in our case, it went the other way because our unions basically financed a whole lot of Democrats for the election. So people like Sherrod Brown and really lots and lots of others were elected by the unions that were fearful of trade. And here I actually have a point which I could probably be lynched by Democrats, my fellow Democrats. But just as the president -- our president, Obama is hamstrung by the fact that George W. Bush left behind an enormous debt burden and a flow deficit that was an act of commission, I think he also faces from President Clinton an act of omission, meaning President Clinton never really -- you know, personally to the unions.

I don't remember a single one ever being asked to go sit down with George Meany and his troops and say, look, is your fear of trade justified. Maybe there were a few others but all the other Democrats I know, including Paul Krugman at the time, none of us were ever asked to do that. It was all a political issue. We're getting pollsters and so on and so forth. But basically President Clinton found religion and he vanquished the unions -- right ? -- over the NAFTA vote and the Uruguay Round vote. But he did convert them. Now, it was assumed that there were finished, right? Now, they've come back and they've become a huge problem for the United States and you can't expect -- I mean, how much time does poor old President Obama have. So if only President Clinton had done the job, it would have been somewhat easier for President Obama to placate them.

So I think the point I want to make is that basically if the rest of the countries have to do the job, then we have a problem. They are still not large enough to be able to say, look, to President Obama, look, we're going to play this. I think when this group was appointed, also, which you mentioned, the attention of everybody was not to isolate, embarrass the United States but basically to compliment them and say, look, you can't play right now. (Laughs.) But the work has to be done because in the end, the U.S. cannot -- (inaudible) -- for trade. Right? This is the biggest open economy in the world. So that is where I think the idea is to try and see (that homework has been done ?) in terms of how you extend incentives against protectionism, because there are loopholes we have discovered, you know, things to fix. And then what are the different ways in which we can move forward? And there are ideas which are -- you know, which can be put forward. But I think this is important.

One thing which Charlene touched on, which I think is important, and I think this is where the China-U.S. situation, which really is also playing a big role, comes in. China basically I think we have provoked unnecessarily. I mean, it is true we were first focused on the exchange rate and as, you know, anybody who has studied macroeconomics knows, to a large extent it's the hands on the clock, it's the underlying fundamentals that are important. Like if Greece suddenly became totally -- you know, left the euro. It would still not -- it would still have the same problems, no matter what the exchange rate was, as long as there was excess spending. It would just simply, you know, make a little difference but not a great deal; same thing for China.

China was moving to its internal spending on infrastructure and so on. We should have simply said -- well, talked behind the scenes and said, look, here, do more of it, we need you to do this. Instead, we -- you know, Schumer and all these people and continuously bashing China is bound to put their back up, okay? So I think that has really been part of the problem. What we are doing now is basically essentially doing QE2 which is actually, you know, in a way we could say correctly that there's a lack of world demand. We've asked you to spend more. You're not doing it. So we're having to do it ourselves. One is sensitive to this as the exchange rate goes down, which is very different from changing the exchange rate down, which we allege China is doing, with a view to diverting a certain amount of inadequate world demand to your own goods. So there's no parallel. But why do they talk as if there is a parallel between the two? Because we really put their backs up, I think.

ALDEN: I mean, a number of issues raised here that I actually want to give Charlene and Doug a chance to respond to it. With respect to China, Charlene, do you agree with the assessment that the U.S. has been overly provocative in various ways? Is China moving in the directions we want it to move on its own or does it need more of a push and a shove?

BARSHEFSKY: I think China will do first and foremost what's in China's interest to do. This is one of the -- of its most fundamental facts. That's point one. Point two, I think the U.S. doesn't actually have a strategy with respect to China. Or if it does, it's not entirely clear to me what it is. Number three, I don't see any reason the U.S. should be shy about insisting that China play by the rules. China insists that of us all the time. I think we should return the favor. And fourth, I do think, however, that if you want to make progress with China, sometimes quieter is better and sometimes discussion of a reasonable sort is better than over very heated rhetoric.

So I think the administration now needs to sort out how it wants to deal with China. I think eventually China will move on the exchange rate because it's going to have to. This is absolutely clear. The only issue is when and by how much. And my own view, and I've said this for a long time, but for various financial crises and the European crisis, China would have already moved. It was already at that point, I believe. So it'll get there and I think the U.S., because China will get there on its own terms regardless, I think the U.S. ought to be looking at other areas where Chinese trade behavior ought to come under some greater scrutiny and focus on those areas, at least as much, if not more now more than the exchange rate per se.

ALDEN: Doug, let me ask you because Jagdish mentioned the QE2 at the end, which certainly in terms of the optics of the G20 put the U.S. very much on the back foot, to use my old British expression from my days at the FT. It's a cricket expression I learned. But if we read the fine piece you had in The Wall Street Journal a while back, which is out there for members here to pick up, you seem to indicate in that that to some extent the alternative to monetary easing and devaluation well be trade protection, and if that's your choice, you would prefer monetary easing and devaluation. Talk about that a little more. How do you see the interplay of currency and trade tools in the sort of economic situation we find ourselves?

IRWIN: Well, I think I certainly agree with what's been said about China's exchange rate and how it's sort of been overplayed as (sort of being an ?) important (goal ?). And I think I'd come back to what Larry Summers said, that it's much more important to get China to improve its domestic demand. With consumption being 35 percent of GDP, very clearly a huge outlier, emphasizing potential domestic change that they can make there rather than the exchange rate per se is very important.

But I think in terms of what the U.S. can do, I mean, there's a huge debate, obviously, about whether QE2 is, you know, the right thing to do or not, including domestically. It's not just the international ramifications. Of course, it comes back to other countries not wanting their currencies to appreciate and potentially put a dent into their export growth because of that.

But I think one of the benefits -- potential benefits of QE2 is if it can restart the U.S. economy, we'll actually start growing again and we'll actually be able to bring in imports. So one of the things we saw in the 1930s, for example, is those countries that went off the gold standard and devalued, they actually were more imports rather than fewer, because they got domestic growth going.

And I think the danger is that if we don't do something like QE2, then we're going to face a Japan-type scenario. And I know a lot of people say, well, we ought to have a hard -- strong currency. Well, Japan has a very strong currency and they're not growing and they still have financial problems.

So I think that it's sort of insurance for the U.S. in terms of trying to move in that direction. The alternative, once again, is if we don't act and the U.S. economy continues to stagnate, I think there's going to be a tendency to blame foreign countries.

And I think that's -- that's from the -- it's monetary stimulus versus trade protectionism. If we do nothing, then I think we just lend ourselves open -- open to the door to blame the other countries for our problems.

ALDEN: Jagdish, let me ask you, in the -- along the same line, in effect, to explain not the surplus of protectionism we've seen in the last couple of years, but actually the lack of it. I mean, if you look at the WTO studies that have been done, there have been new protectionist measures, but they've been pretty small, certainly compared to the size of the crisis.

I would have anticipated that in a crisis like this we would have seen far more trade protectionism than we have. Doug points to one factor -- the variety of economic tools that governments have that I think does a lot of explaining that.

How important has the WTO been? How important has the rule system been? And in that regard, how important is it to keep moving forward on the WTO front to keep that system alive and healthy and not just have a series of, you know, proliferating bilateral agreements, which you've been quite critical of.

But what role has the WTO, you think, played here?

BHAGWATI: Well, I mean, there are three "I"s which I talk about, which have really prevented protectionism from breaking out in a big way: ideas, interests and institutions.

The institutions is the WTO. I mean, when the GATT came up, it put up a whole lot of roadblocks so you couldn't have a free-for-all raising of trade barriers like in the 1930s. And that has really helped, because you could freely just -- you know, there loopholes, which are going to be fixed, which we are aware of now and more so, but that has certainly helped a bit.

The idea that somehow you could use trade barriers with the view to diverting demand from other people to your own goods -- the sort of thing we think the Chinese are doing -- that is subject to retaliation and all sorts of things.

So I think the idea has -- the ideas of change also. And the interests of change, meaning interests with -- political scientists call lobbies interest, basically. And those interests -- today, many more people are involved in international trade. I think one of the things which I'm working on is to see how from each state you have -- not just people like Caterpillar, G.E., et cetera, but all kinds of little people who are involved in export business. So if you take their input, there's large numbers of people actually in the country in different states who are actually interested in international trade. They provide the counterweight and the pulse, basically, to people who want to close markets in a more traditional -- so all three have played a role.

But WTO is essential. That's why a lot of us are worried that if Doha really doesn't get concluded in some way or the other, that in fact it'll weaken the WTO and we need that -- WTO is a functioning discipline. And you know, we really ought to look upon it as as precious as the example of Smoot-Hawley, which is a negative example to show that trade is important.

ALDEN: Just so the audience and members and guests don't think we did a bait and switch, I want to talk a bit about the midterm elections. The topic here was supposed to focus very much on challenges and opportunities after the midterms.

Charlene, what do you see as the prospects? Did the outcome of the midterm change anything fundamental in terms of the likelihood of positive progress on the trade agenda going forward?

BARSHEFSKY: I think it's a question mark. The concern on trade agreements is almost never the Senate. The concern, since NAFTA -- including NAFTA -- is the House.

And the House is a little bit hard to divine at the moment. From the Democratic side, the caucus that took the hardest hit in the midterms were the blue dogs who are pro-trade, fiscally conservative Democrat. They took the hardest hit.

On the Republican side, the big winners were the tea partiers, who in terms of campaign rhetoric, there's a question mark there -- and we have to wait and see -- could not be viewed to be globalist in temperament.

So if you look at any given trade agreement, trade agreements since NAFTA have been passed by Republican votes, largely. On the Democratic side that means you usually need between 50 and 65 votes. That's a tall order when you don't have half the blue dogs anymore and when those who were elected were elected on a further-left, more populist basis.

On the Republican side, because of the question mark about the tea partiers, the traditional reliance on Republican votes in high numbers is also a question mark.

My own view is that the Korea FTA, for example, were to be concluded substantively, thought to be doable still, but I think there are two factors that are a must. And without either one of them, don't even start. One is presidential leadership and constant support. And this is -- this is a heavy lift. And if the president wants the Korea agreement or Colombia or Panama -- but it looks he'll go for Korea first, that seems to be the preference -- it's going to take a lot of political capital on his personal part to get it.

And the second factor is exceptionally strong business community support. The rhetoric today is we're going to support this agreement, but the proof is boots on the ground and we'll have to see.

Without those two elements, I don't believe trade agreements' passage will be possible for the next two years.

ALDEN: And I want to press just a little more on the Korea FTA, because it was -- it was quite an interesting set of developments leading up to the G-20. I mean, the U.S. appears to have demanded some pretty fundamental changes to an agreement that was concluded. I mean, you know, not to get too much in the weeds, but in effect, it's a violation of it's U.S. commitment under fast track to its trading partners.

The idea was that you negotiate deals, they would come back to Congress for an up or down vote. Now, we've gone back to -- Korea demanded some pretty significant changes in the auto provisions of that agreement. And the U.S. clearly failed to get a deal at the summit. And what was the response from Congress? The incoming chairman on the Ways and Means Committee, Dave Camp, Republican of Michigan, and the outgoing chairman, Sander Levin, Democrat of Michigan -- some of them said, hurrah! Hooray for you! Way to stand up for the auto industry.

How do you get a Korea FTA through with that kind of political lineup?

BARSHEFSKY: I think it will depend what the agreement looks like and the reasons why an agreement wasn't concluded at the G-20. I don't know what those reasons were. One could take some guesses. I don't know what those reasons were.

But I do think that if the agreement will conclude substantively, it will conclude on the basis that the president believes he can sell it. If he believes he can't sell it, it either will stay unconcluded or will conclude, but he won't bring it to the Congress.

And I think on that basis, I would say it would remain an open series of issues.

ALDEN: Jagdish?

BHAGWATI: I'm not a political scientist. I'm an amateur observer of Washington. But it seems to me --

BARSHEFSKY: That's more than enough.

BHAGWATI: -- that in the auto industry, surely we've bailed out the wretched Detroit industry, right?

Chrysler has had two bailouts so this is for Chapter 22 rather than Chapter 11 -- (laughter) -- and they're doing well. So it should be possible for the person to lean on them, in my opinion, on this issue.

Beef is the harder one, okay? Because agriculture is always a hard one. But that's -- it's hard to think of that one thing holding it up.

As far as labor standards, environmental standards are concerned, I mean, those are issues which arise with other FTAs -- in particular -- (inaudible) -- recently Colombia. There's no such issues with South Korea. So if the president wants to make a -- you know, put his shoulder to the wheel, he could do it, I think. It's more doable than the Colombian one, because there, Human Rights Watch and everybody is geared up to fight like hell. And so that's going to be a tougher one.

So I think it was a good idea, if he wanted the FTAs, is to go first for -- for the South Korean one. And I think that might build up a little momentum. But we've got to -- you're absolutely right. You've got to lean on these --

ALDEN: I will --

BHAGWATI: -- friends.

ALDEN: I will say that the beef issue, though, shows how strange the politics of trade have become, because you had a beef industry that was saying, our sales have never been better in Korea; let's just finish this deal. And you had Max Baucus in the Senate Finance Committee saying, no. Unless you rewrite the rules to allow all American beef exports, I'm not going to support the deal.

So trade has been even stranger than it used to be in Washington, which is saying something.

At this time, I'd like to open it up and invite our members and their guests to join our conversation with their questions. As usual, please wait for the microphone and speak directly into it. Stand and state your name and affiliation and keep your questions short so we have lots of time for everyone.

Laurie, why don't we start up here at the front.

QUESTIONER: Hi. It's Laurie Garrett from the council. Thank you very much for your wisdom.

I'm having a very, very hard time grappling with what 21st century protectionism would actually look like concretely, absent the politics. Just, how does it play out?

Pre-World War II protectionism, American cars were made in America, steel beams were made in America, so you had control of your resources. But now with globalization, name an industry that isn't multinational in its production chain or its distribution chain or what have you. So protectionism looks sort of suicidal industrially. I don't understand, concretely, how it could play out.

The only example I see of it that helps me a little bit to understand this is how China responded with the rare earth elements, but that's an extraction industry, essentially.

So help me understand: What is 21st century protectionism?

ALDEN: Doug, do you want to take that one?

IRWIN: Actually, you're putting finger on something very important, which is I'm a relative pessimist on whether we're going to have future liberalization or -- this can be difficult to achieve, but I'm very optimistic that we can maintain the system we have.

And one of the main reasons is because of multinational investment, cross-ownership across borders and what have you.

The trade politics in the United States have changed dramatically from the 1980s. So once again, early 1980s, we had a recession, high unemployment, not a financial crisis, but very difficult times.

We had a domestic auto industry, a domestic semiconductor industry, a domestic steel industry, all wanting protection against imports. And now those industries are multinational. U.S. industry have ownership stakes abroad; foreign producers are here. And so there's not that domestic constituency in favor of raising the barriers at the border anymore. And it becomes much more subtle what protectionism is from specific bailouts or tax policy or what have you.

So I think globalization is good in the sense that it will help keep borders open, because there are fewer domestic producer interests that are in favor of raising trade barriers.

And when you add in supply chains and all of the others, that just reinforces it.

ALDEN: Can I ask along the same line to any of our speakers, should we abolish from the press the use of the term "trade war?" You know, every time there's a trade action now we talk about, is this going to trigger a trade war? And I honestly don't know what that means anymore. And has it become a completely meaningless phrase?

BARSHEFSKY: I think it's meaningless phrase, it's a silly phrase.

BHAGWATI: It's a trade skirmish. (Laughter.)

ALDEN: Because "trade war" does imply this sort of 1930-style tit-for-tat retaliation and we all go down the road to Armageddon. And it's not clear that that's --

BARSHEFSKY: I think what you have is a world where governments tolerate trade friction much better than they used to. And that's in part because there are a lot of mechanisms to resolving trade frictions, which keep those frictions, if you will, compartmentalized from other areas, typically, of international relations. So countries go well along being quite friendly, but having all sorts of lawsuits pending on trade-related issues, and most countries are perfectly happy to have it just that way.

So I think the notion of a war every time such an action is filed, when countries fully expect such actions to be filed, is kind of a silly use of the phrase.

BHAGWATI: There's one qualification or supplement to what Doug said, which is that, while producers are not going to be very keen to be wanting protection, the fact of intensified competition which you have today, which Charlene had referred to, that creates need for adjustment assistance in a very big way. Because when workers get laid off -- because workers are here. They're now. I mean, you know, for them, this argument doesn't apply.

And that's where I think China is important. I mean, we've been focused so much on imbalances and so on, but they come and go. I mean, look at how the dollar was a scarce currency, and, you know, it soon disappears.

So I think this whole focus has been terribly counterproductive. The really important thing, I think, which is about China, is that it's such a large country and such an open country -- (inaudible) -- reliant on trade that we have essentially -- it's like the image I use of Gulliver in a Lilliputian world economy. It creates tsunami waves for lots of special industries, just the way the Japanese did in the 1930s when you had $1 blouses and lots of labor-intensive goods coming out, and then we wound up worrying. That's when the phrase "yellow peril" came in.

So I think what you need to do is worry about China actually creating waves, not overall waves for us, but for specific sectors where they happen to be competitive. They're also creating waves on the import side because they use raw materials which then become scarce and affect our user industries. So it's like double Gulliver compared to the one Gulliver in the 1930s of Japan.

And I think the main thing, which is going to stay for a while, is the need for adjustment assistance to (accomodate ?) China in the world economy.

ALDEN: So it's interesting that a colleague of mine has been working on a paper about one hard-hit region in the Midwest, and the major form of adjustments is not trade adjustments, it's disability insurance. People ending up -- you know, claiming disability because it's the only program they can find that -- support them.

Further question, we'll go right to the back here and then we'll --

QUESTIONER: I'd like to go back to the question of the prospects of the FTAs in the new Congress. Charlene, you said what's always been the orthodoxy, which is, you can only get this done when you have strong presidential leadership. And we certainly saw that in the Clinton administration.

But in the situation we're going to be faced next year, where you have a new Congress, the Republicans have already said their number-one objective is to defeat the president every time they can, doesn't his standing up and making this a really important thing lessen its prospects? And is there another way to get this done? (Laughter.)

BARSHEFSKY: Well, it would lessen its prospects if you thought Republicans did not have an independent interest to see something get done. But Republicans, I would argue, have an independent interest for seeing trade agreements pass, and that is to shore up business support in the face of an insurgent tea party and concerns the business community has about that and the sway of the tea party within the Republican Party.

So I think for the Republicans who are traditionally open-trade-oriented, and who traditionally have wanted to distinguish their brand of economic growth and theory from that of trade unions, have an independent interest for seeing something get done. I think that's one of the reasons you see people saying that trade may be, ironically, one of the areas which the administration and a Republican-dominated House might be able to agree on.

Look, I still think it's a very, very heavy lift, and the way the Republicans will play this, in part, is to insist that a number of Democrats walk the plank, on the theory that, come two years from now, that walking of the plank will hurt the Democrats more than it will ever hurt a Republican.

And so that's why I say the number of Democratic votes, you know, somewhere between 50 to 65, at a minimum, because part of the price of moving forward will be, I think, Republican insistence for more Democratic votes than they reasonably believe exists.

ALDEN: Next question. Right here.

QUESTIONER: (Inaudible) -- from NIPFP. Many years ago when economists used to think about trade, the argument was that the bang for the buck in agricultural liberalization is relatively small because agriculture is a small part of world GDP and there are lots of workers. So the great focus was on manufacturing, trade liberalization.

Now, if you fast forward into 2010, services GDP has come to dominate world GDP. And in some sense, maybe we are fighting the wrong war. We're continuing to fight on problems of manufacturing liberalization. We're continuing to take interests in agriculture liberalization. But the real front here is services trade liberalization.

The Europeans have got some very interesting things going. You could be a German producer of mutual fund paper, and you could sell it anywhere in Europe, and so on. So the Europeans are trying to build a lab for globalization with an unprecedented level of competition and trade in services.

So I wonder where all this fits into our future thinking about the WTO.

BARSHEFSKY: If I could just start at least by saying that I agree with you fully. I think one of the reasons Doha holds almost no interest for the American business community is, first of all, it is heavily agriculture focused, again. Second, the manufacturing issues have not been sorted out. But in any event, there are very few businesses that will tell you manufacturing tariffs are of any concern whatsoever anymore. And third, that there's nothing in the deal on services that's meaningful, and that's where the growth of U.S. trade has been.

So certainly, I've said for some time that the next free trade agreement that the U.S. does should not be with a country, it should be cross-cutting, and that is, an FTA on services with other major services-supplying countries. And that would then be an agreement that could be taken to the WTO with the hope of further expansion by the addition of other members.

This is exactly how we did financial services liberalization in the '90s in the WTO and telecom liberalization and removed tariffs on technology goods. And that is, you start with a small core of the countries who actually trade heavily in the particular sector or area. You open up that core agreement to anyone who wants to join in under the auspices of the WTO. And in the case of telecom and financial services, you can't get in the WTO unless you join on.

So I agree with you. We're not fighting the last war. That wouldn't be so bad. We're fighting the war from a number of years ago.

On the other hand, agriculture liberalization is very critical to the developing countries. And in that regard, the U.S. and Europe ought to do the right thing. And inasmuch as we can't afford the subsidies we provide -- nor can Europe, to be frank -- those subsidies ought to be sharply, sharply reduced and curtailed.

ALDEN: Charlene, what would be part of such a negotiation on services? What would be the very sectors that would fall under that umbrella?

BARSHEFSKY: All. It would be a services negotiation.

ALDEN: So insurance, financial services --

BARSHEFSKY: You'd start with what you have in the GATTs. You'd throw in the telecom agreement and the financial services agreement, which has to be updated in any event. You sit down with Europe and Japan, one or two other countries, and you hammer out what would be a reasonable services agreement. Almost doing anything would be beyond what you're going to get out of the WTO.

ALDEN: Yeah. And you can certainly imagine the possibility of exciting business a bit more. I mean, the contrast would --

BARSHEFSKY: Oh, no, that would be very exciting.

ALDEN: -- with the end of the '80s when there were, you know, the pharmaceutical industry and the motion picture industry and financial services groups, Americans thought there was such interest in the trade liberalization agenda that you just don't see in the current agenda anymore.

Further questions? Right here. Sorry. Behind you first, and then --

QUESTIONER: (Inaudible.) I want to touch upon two disconnects that I see, given the effect of technology, number one, on the liberalization of global flow of technology, capital goods, free capital flow, it's in emerging markets, emerging countries, India, China and developing countries. The pace by which the price of commodities, raw materials and the currencies are going up and down and the volatility, on the one hand, and on the other hand, the pace by which policies are being decided by especially Democratic countries.

And to your points, comparing it to the pace by which China makes a decision, supposedly in a market economy, but three days ago, they come out with a decision, okay, we're going to cut down inflation. Raw materials collapse in three days; in four days dollar goes up like crazy. There is a bit of a disconnect of pace and timing between policy and market-driven pricing. Can you comment on how that affects their policies?

ALDEN: Jagdish, you want to tackle that one?

BHAGWATI: I mean, this is something which, outside of the trade policy framework, we all know that currency flows essentially are far more quick and volatile and so on. So I think this is one of the reasons why I think the idea that we should extend to services the notion of liberalization fully, when we are embracing financial sector liberalization, I think it's going to run into a roadblock.

Mike Moore, who was here the other day, he's now -- not the mad one, but the former director-general of the WTO -- (laughter) -- he now represents -- he's an ambassador of New Zealand. And he was saying, you know, we are going in the -- (inaudible) -- to full liberalization of services. And I said, look, you haven't lived in this country long enough, you don't know. But I mean, you start talking about opening up the financial sector to free flows, it means you haven't lived through a crisis at all, you don't have a clue.

So I said, you know, take financial services out, bring them in later. But anything like UPS, DHL, whatever you want to, non-financial services is something we can negotiate.

And I would just add one more point to what Charlene was saying, that already in fact there are lots of things which have actually been done, which have not been accounted for. Like in India, lots of things have opened up, like Credit Suisse finally opened up a full branch of its own, which was unthinkable before.

So you could actually package a lot of these things which have actually happened, and then work for a deal, right, rather than start at the telecom kind of end. So I think there's more give, but not on the financial side. Forget it. I mean, that will kill whatever you want to do, at least in this country, unless I'm reading the things that --

BARSHEFSKY: No, I think -- look, I think you could -- well, financial services has been done once, and there was quite a bit of liberalization. That needs to be updated just because prudential rules are very different now and so on.

But I do think -- and I think that can be done. And the services sectors of course encompass an extraordinary array of things. And it just seems to me that's where the growth is, that's where countries really have not liberalized in accord with any plan for convergence along the way.

All the Uruguay round did in services was basically a fancy standstill. Just don't do anything worse than what you're doing now. But that didn't bring services regimes in concordance.

And so I think there's a lot to be done there, which would be much more productive, a more productive use of time than manufacturing tariffs which are really not the issue.

ALDEN: And might be politically easier, because services liberalization is so complex that nobody can begin to understand it. So probably good to have -- (laughs).

BARSHEFSKY: Well, it's complex, and it may be easier in general because you tend to have -- and this is a gross generalization, but I think this is right -- you tend to have substantial leadership on the services sector side through various trade associations and so on, that are quite pro-trade and want the opportunity to be able to export or operate cross-border in some fashion.

BHAGWATI: With the views you have, Charlene, on manufacturers, you wouldn't get a job with Jeff Immelt, I'm sure. (Laughter.)

BARSHEFSKY: Good thing I'm not looking.

ALDEN: Do you still have a question, sir? Wait for the microphone.

QUESTIONER: Yes. In discussing the --

ALDEN: I'm sorry, could you just identify yourself quickly.

QUESTIONER: Abe Katz, former president of the U.S. Council for International Business. In talking about the politics of trade, Charlene, I think we have to spend more time understanding the role of the trade unions in all this. It's not because they got the wrong idea. They're in a quandary. They've lost members because the whole character of industrialization in the United States has changed. They won't get -- they need members. They won't get card check, so this is the only thing that they have, is stopping all trade.

My experience has been unfortunately they don't want any -- they'll fight any move to liberalize trade. There isn't a way that you can convince them that trade will be good.

And I really wonder, when you said, Charlene, depends on whether the president can work with them, whether this president will want to override the union. This is a question, his own ideology and (conscience ?).

But as far as trade unions are concerned, I have a question for Jagdish. You're going to try to resuscitate the Doha round. We always believed that in order to have a multilateral trade negotiation, you need fast track. The one thing that the unions will be absolutely opposed to is fast track. They'll try to kill it in a number of ways.

What's the strategy? Wait for a Republican president or a president who will squelch the unions? I'm curious as to how you see the future?

BHAGWATI: Charlene is the expert there.

BARSHEFSKY: Well, thanks a lot. (Laughter.)

ALDEN: And I'm actually going to put Doug on the spot afterwards, just on the history, because the unions used to be a lot more supportive of trade liberalization.

Go ahead, Charlene.

BARSHEFSKY: (Inaudible.)

ALDEN: Well, why don't we start that, and then we'll put you on the spot on what the president should do.

BARSHEFSKY: Okay.

IRWIN: Actually, unions were typically neutral prior to World War II. So the AFL conventions in the 19th century and early 20th century, they took no position on trade, because they were an umbrella organization for so many individual unions, and each individual union had its own interest depending on the export orientation or the import-competing nature of the business they were in.

But really, you know, it did change in the late '60s, because that's when, you know, there's sort of this delay in terms of we had the GATT in '47, Europe was still recovering, Japan was still recovering. It was until late '60s, early '70s that major industries began to be really adversely affected by foreign competition. And that's of course when the unions stepped right up and came in.

And once again, the timing of when the unions changed their positions very much to avoid import competition, so the United Auto Workers was very late in the mid to late '70s, whereas the steelworkers in actually the late '50s were already complaining about trade. So it's very individual specific.

ALDEN: And what are the prospects now, Charlene? I was reading this morning, and it may just be a dodge, but Richard Trumka was leaving open the possibility that they might not oppose the Korea deal. (Didn't say ?) they'd support it, but said they might not oppose it. What --

BARSHEFSKY: Right. Yeah, look, the key, in terms of Democratic votes, the key is not union support. The key is simply that a vote for the agreement will not be counted by the union as among the key votes against which the union will measure whether you should be supportive or not.

So neutrality by the union isn't even needed. It's just not actively opposing. So that's a lower threshold, obviously, than having the unions decide that trade is a good thing. That's the first point.

Second point is, I think that the union movement has to consider whether it's in their interest to weaken the president if the president decides he wants to do this. And -- yeah, the Korean deal, especially.

And third, I think there are a number of arguments, particularly pertaining to the Korean deal, that are quite effective, including with respect to the union, having to do with national security, having to do with reinvigorating U.S. relationships and alliances in Asia, particularly now. Those are also very effecting arguments particularly to union members and more liberal Democrats.

So the threshold isn't as high as might be suspected. Having said that, it is really tough. And the president does have to decide whether this is how he wants to use a large portion of his political capital.

ALDEN: Further questions? Right here.

QUESTIONER: This -- I'm not sure -- (Inaudible) -- International.

ALDEN: Thank you.

QUESTIONER: I noted that there is much, I guess, view that the financial sector, you know, should be left out because it's going to be politically difficult. And I agree with that assessment. But it seems to me it's a very important sector, and there is much going on there in other fora, the BIS, all the industry associations on bond markets. And it's quite crucial to how competitive advantage of financial sector companies evolves.

There's a great fear that the regulation that's done at national levels in response to the financial crisis, that there will be a destruction of the level playing field. So I would just wonder if you have any comments or thoughts on how to try to move this to a more balanced, sort of level field.

ALDEN: I guess the question is whether this falls inside the trade system or whether it's just better to handle it in other forums.

BHAGWATI: I think it -- I mean, it should be left to other fora. This is like the, you know, the issue in the GATT's agreement on trade and services, what we call Mode Four, meaning provision of services, movement of natural persons. By "natural" they didn't mean ruling out Frankenstein and other unnatural persons. (Laughter.) They're just excluding forums, actually -- (inaudible).

But that is something where even liberal Democrats like Dianne Feinstein have the view that the flip-side of that is immigrational, temporary or permanent, so it should be dealt with in immigration debates rather than this part of trade. So that's exactly the, you know -- which is a perfect forum where it's just more important, more likely you'll get something accomplished, right?

BARSHEFSKY: Agreed, totally.

ALDEN: Yeah, and it's certainly true that the Uruguay Round put a number of issues out there on the trade negotiating table. And it's not clear we can move on all of them. I think the reach, in some ways, probably exceeded the grasp.

We probably have time for one or two more questions before we break for lunch.

We've silenced the audience.

BARSHEFSKY: There you go.

ALDEN: We've solved the entire -- (laughs) -- Sebastian, you've been integral to this whole event, so a good final question.

SEBASTIAN MALLABY: Sebastian Mallaby from the council. So one issue which might come up in future, you know, in this debate about 21st century protection, is raised by Charlene's comments to The Wall Street Journal in the story they ran yesterday about China, where you were talking about the way that the government was backing Chinese companies with cheap financing and so forth. And this came up in Larry Summers' comments, too.

And so I guess maybe a set of disciplines around government subsidies, implicit and explicit, might be a new frontier, particularly -- and of course, they bleed into questions about national security when you're dealing with the government that's doing the subsidizing being a potential rival, not just economically, but strategically.

So perhaps you could elaborate a bit on that. And I'd love to hear also what the others are thinking, too, about whether this is a proper part of the trade debate, this question of state capitalism.

ALDEN: And the issue has been raised of competition policy. How far should trade get into the realm of domestic competition rules?

Charlene.

BARSHEFSKY: Well, look, the issue of governments heavily subsidizing industrial sectors, indeed, going so far as to create them, is dealt with very well under existing trade rules. This is the case against Airbus which is an entity created and then financed by certain European governments.

It's the situation with respect to steel, particularly in Europe, but also Korea, where industries were financed heavily by their governments.

And so, too, in the case of China or any other country, including the U.S., that heavily subsidizes industries or creates industries that weren't there. These are already practices very well dealt with under WTO rules.

The rules process ought to be -- the dispute settlement rules process ought to be enhanced, in my view, by providing for injunctive relief, so that if a case is pending, a government is forced to stop doing what it's doing. And this is, I think, an unfortunate gap in the rules that needs to be corrected.

But having said that, I don't think new disciplines on subsidies are needed so much as governments acting on the subsidies they do find, and taking these issues to the WTO for appropriate resolution.

ALDEN: Doug, have you --

(Cross talk.)

Yeah, please.

BHAGWATI: The whole point about this is the green subsidies.

BARSHEFSKY: Yeah.

BHAGWATI: They actually were not actionable until '92, and then they were removed from that. And so I think we'll have a problem to get back to it, because I think everybody's really wanting to subsidize, you know, green technology. So we probably should put it back into a non-actionable box. Because I think --

BARSHEFSKY: Well, I'm not --

BHAGWATI: -- there's universal agreement on that, I would say.

BARSHEFSKY: Yeah. On that, I'm not sure about, because you have a situation where there's already a concentration of productive and other capacity; in the case of solar, for example, most notably with respect to China.

That in and of itself will squeeze out other competitors because, you know, solar panels and so on, it's a scale business. That's all. It's a scale business. If you don't have the scale, you aren't going to make it unless you're a highly innovative or a highly particularized product.

But for basic stuff, scale is everything, and scale will be largely located in China.

And so for industries here that are then forced to source offshore, or who would like to have gotten into the business, the issue becomes, I think, one that's appropriately subject to WTO rules.

ALDEN: Doug, maybe I'll give you the last comment. Are there any kind of historical precedents for the sort of challenges that the U.S. and Europe and others face in dealing with Chinese state capitalism? Is there any way to help us sort --

IRWIN: Well, I just want to make two points. One is that there's a subsidy agreement through the OECD in the 1970s, because exactly the same issue came up. But the major issue -- so it was just the OECD countries. But the major difference is that then the subsidies were on the books, they were explicit government subsidies, they were identifiable and actionable.

The problem with China, I think, is a lot of these subsidies are implicit through the banking credit system and the state-owned banks. And who you channel credit to and what the price of that is, that's very hidden, very hard to see, very hard to identify, and it can be a source of friction, because the allegation will be very much like against Japan in the 1980s as to allocation of credit, that you build up surplus capacity that depresses prices.

And how you actually, you know, quantify, what is the magnitude of the subsidy, very, very difficult thing to do. So it could be an issue, whether there's going to be growing friction in the future.

ALDEN: Very good. On that note, let's thank our panelists for an excellent discussion. (Applause.)

And you are all invited to join us for lunch until 1:00. Thanks again.

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

TIM FERGUSON: (In progress) -- the Stephen Freidheim Symposium on Global Economics.

This is -- this is a privilege, to have this gentleman with me, who needs very little introduction, but I will do that sparingly in a moment.

First, some housekeeping: This is an on-the-record session of the council. It is being teleconferenced to members outside of New York. That makes it all the more important that you turn off your portable devices, as that will interfere with the sound.

We will have a conversation up here for a few minutes, and then turn it over to members and guests. I'm sure you are well prepared with questions for our guest today.

Lawrence Summers, as I say, is -- needs no introduction to this group: 20 years in public life, or the public eye; most particularly of note today, his service at the Treasury Department in the Clinton administration, ultimately as Treasury secretary; and now as director of President Obama's National Economic Council. The two are perhaps relevant in comparative context that may come up in today's discussion.

Dr. Summers, the first session dealt with a backdrop of exchange rates and capital controls, various factors that are ever more present in the economic discussion. After a period of rather benign economic indicators in 2010 -- post the crash -- we're now seeing considerable volatility in things like commodity prices, rates, to some degree in currency and such. What is your take on why the last couple of months may have shown a greater jumpiness in some of these areas of the markets?

LAWRENCE SUMMERS: Well, let me first just say that on the subject of the exchange rates, I have learned to follow the lead of J.P. Morgan, who was famously asked what his prediction was for the bond market. And he leaned forward, he paused, he lowered his voice. His audience waited to see what the great man would say. And he allowed that, in his judgment, based on a lifetime of experience in the markets, going forward, bond prices would fluctuate. (Laughter.) And I have a similar degree of confidence and a similar forecast with respect to -- with respect to exchange rates.

Look, I think that you have seen a number of developments. Relative to any sensible set of concerns that one would have had when the G-20 came together in London in the early spring of 2009, the world is incomparably more stable, secure and prospering than anyone could have expected. The Stock Market, after all, had fallen more between October of 2008 and March of 2009 than it did between October of 1929 and March of 1930. Similar things could be said about the levels of global trade. Similar things could be said about loss of employment.

The collapse was averted. The emerging markets re-attained what I've earlier called escape velocity: self-sustaining growth, not driven by unusual policy, but driven by the virtuous cycles that characterize successful economies -- rising incomes, rising spending, rising spending, rising incomes, greater capital investment embodying progress, spurring larger markets, that spur still greater investments and so forth.

That process appeared to be -- appeared with -- very far from certainty but with significant probability -- to be engaging in the industrialized world last spring.

The extent of the dislocations within the European system both were jarring to the European economies, and coming so soon on the -- in the wake of the traumatic events of 2008, were jarring on a broader basis -- that along with a judgment that one can make in retrospect that -- that more of the growth was inventories and was the result of macroeconomic policy, rather than natural organic growth. And I think most people guessed in the spring, contributed to performance that was somewhat below par. And those two -- those two things, along perhaps with some rising uncertainty about what was going to happen in China, have led to an outlook that is somewhat more uncertain right now.

The other hand, if you look at the VECs or other measures of implied volatility, if you look at credit -- if you look at how much most credit spreads have widened, you have to say that it is a remarkable thing that anybody would be talking about the increases in volatility over the last month or so as a significant event, because they are at best the Appalachians compared to the Himalayas of the increases in risk and volatility that took place in 2007 and 2008, that took place in 1998, that took place at a variety of other moments.

I had a tennis coach who told me when I was a kid that you're never as good as you think you are when you think you're good, and you're never as bad as you think you are when you think you're bad. And that has always seemed to me to be a useful thing to keep in mind in looking at economies and in making judgments.

The late Rudi Dornbusch, who spoke here many, many times, used to say something that I think is also helpful, frequently in making sense of economic events. Paraphrasing him slightly, he said: Things in economics take longer to happen than you think they will, and then they happen faster than you thought they could. And that is on the one hand sobering with respect to imbalances and crises, but it is also relevant with respect to recoveries and take-offs. And so I think those two perspectives also operate in the direction of diminishing the extent to which one allows one's pulse to be overly influenced by what's happened in the last month or two.

FERGUSON: Granted that I have a hill to -- a hill to climb here, as you suggest, let me -- let me posit that in addition to the nervousness in Europe that you referred to and which continues to be acute, that now in Asia, in several of the emerging economies, there does seem to be an acute concern about inflationary conditions and such that may prompt some of these exercises of capital controls and the like.

Do you grant that there's anything more than a temporal anxiety to the situation in these emerging giants?

SUMMERS: I think I'd say three things.

First, having an involved around the world in one way or another with problems that involve excessive capital outflows and problems that involve excessive capital inflows, it would be a very serious mistake to treat them as symmetric.

The problems associated with excessive capital outflows are far more serious. Any one of us would much rather live in a nation that too much capital was trying to get into than a nation that too much capital was trying to get -- was trying -- was trying to get out of.

Second thing I would say is, it is the natural economic force that when capital is trying to get into some place, when there is a demand for investment in a place that exceeds the local supply of savings or when the balance moves that way, the way that happens is that the relative price of the goods in that place goes up. That's why when the financial sector is doing well, prices in New York rise relative to prices in other parts of the country. That is a very fundamental mechanism.

It can manifest itself in different ways. With a flexible exchange rate, it can manifest itself in an exchange-rate appreciation. With a fixed or managed exchange rate, it can manage -- it can manifest -- it can manifest itself in a rising rate of -- rising rate of inflation. Either way, there is an impact on real exchange rates.

There is a(n) understandable urge at such times, particularly when there's the -- there's the -- there are concerns associated with that process, if it is perceived as temporary, it can be dislocative of real economic activity. And if it is way, way temporary, it can create situations of easy-in-easy-out that can, on the other side, create very difficult problems of capital-outflow management.

Therefore, I think there has been a change in global financial thinking relative to what would have been the case 15 or 20 years ago towards much more acceptance of the notion of various kinds of fiscal measures or regulatory measures directed at influencing the pace and character of capital -- of capital inflows. The somewhat doctrinaire views that prevailed in the late '80s or early -- or early '90s -- I think there has been a shift, and I think it's to be debated just how efficacious such controls are. It's to be debated just what the best ways to administer them. I suspect at the end of this episode we'll know much more about the subject than we do right now.

I don't myself see a strong case for the rest of the world resisting controls on capital -- on -- (or ?) taxes on capital inflows when -- if countries judge them to be in their interest. You know, I think in a way there's a(n) imperfect but not entirely unwarranted analogy with similar things with respect to flows of people. We tend to think that a country that won't allow people to emigrate is really doing a sort of totalitarian and problematic thing. We tend to accept as a given that countries may prudentially limit the immigration into their country. And in the same way, when capital controls are directed at encouraging expropriation without consequence, which is the root of a great deal of capital control that took place decades ago in emerging markets, that's a rather different thing than appropriate limits on capital -- on capital inflows.

FERGUSON: As you say, one adjustment mechanism for these shifts in capital flows is the exchange rate. The earlier discussion today dealt considerably with the Chinese situation, the amassing of considerable foreign reserves.

Are we approaching a situation with regard to China where the proper adjustment of exchange rates could be on the scale of, for example, what was done at the Plaza Accord with Japan in the 1980s?

SUMMERS: Well, I mean, what took place in the -- what took place in the Plaza Accord was a communique got issued that used the word "orderly appreciation." That's what actually took place in the Plaza Accord, that there was no sudden -- there was no sudden movement. There were -- in the period after that, there were rather substantial market moves over a long -- over a long time period, not particularly driven with actually levels of intervention that would look extremely low by today's standards.

And so economic experts debate the extent to which the Plaza Accord was the -- was the driving force and the extent to which a variety of market conditions were the driving force. And you could find fair-sized -- you could find market moves ahead of the Plaza Accord in the relevant currencies.

So I don't think that's an especially -- but obviously, it involved movement -- it involved international discussions of exchange rates. And there's a feeling that there should be international discussion now around imbalances. But beyond that, I think there's a certain naivete in the attempt to carry that -- to carry that kind of analogy too far.

FERGUSON: You don't think that the consequences associated with that adjustment in exchange rate, which included the buildup of serious bubbles in the Japanese economy -- you don't think that that is weighing on Chinese policymakers, as some say?

SUMMERS: That's a rather -- that's a -- that's a -- that's a rather different -- that's a -- that's a rather different question in terms of what Japanese -- what the lessons -- what, if any, were -- are the lessons for Chinese policy of what took place in Japan. You know, while I'm a public official, there's going to be a certain vagueness to my comments in this -- in this area. So if you're not entirely certain what I'm saying, that's somewhat -- that's rather intentional. (Laughter.)

But I guess I would make two points. One is that the experience of Germany and the Deutschmark, which followed a very similar -- which was essentially symmetric with respect to whatever exchange-rate policy was in the '80s, has none of the elements that were present in Japan. And so that would tend to lead one away from a simple version of the analogy.

I think a closer reading of the macroeconomic history of the 1980s would suggest that there was, as you suggest, a period between -- largely in 1985 and 1986 that had some of the elements that you referred to, and there was a period that began in early 1987, where the dominant -- where the dominant preoccupation was easier money in Japan to promote lower interest rates to avoid appreciation.

And so if one was looking -- and again, I'm not especially big on the premise of the exercise -- but if one was looking to lessons of Japan's experience that might have bearing on other countries today, I think the argument would be at least as compelling that the post- Louvre easy money to avoid appreciation was bubble-creating as the opposite argument would be.

And Mr. Kuroda, the current president of the Asian Development Bank -- has actually lived through this period as a Japanese official -- has actually written about that period in some detail as -- and its lessons, and has also written, drawing a kind of parallel lesson about the dangers of suppressing appreciation from the experience that I'm not old enough to remember closely, in the early mid-'70s after the Smithsonian Agreement.

FERGUSON: Let me ask you about capital flows in a very different way. We're in a rather extraordinary situation in which the emerging or what used to be the poorer countries of the world are building up significant capital stocks, reserves and such, and are in the process of more or less repatriating those reserves to the industrialized developed countries.

Would you agree this is a rather extraordinary situation, and what are the implications of it?

SUMMERS: I've said often that if you lived on Mars and you studied economic theory and then you were asked: You have a world with two major parts -- an industrialized core in which growth is relatively slow, populations are aging rapidly, there is essentially -- there's very -- there's very low labor force growth, and a rapidly growing, younger -- rapid labor force growth as well as productivity growth -- and technological conversions periphery. And then you asked: Which way would you expect the net flow of capital to be, we wouldn't pass a student who expected it to be other than from the -- from the industrial core to the -- to the emerging periphery. So I think it is a very important phenomenon to understand.

And it has multiple aspects. As MIT's Ricardo Caballero has suggested, there are elements of who has capacity in producing legal certainty and safety for those who want to have liquid assets that are very safe. And that kind of capacity may affect the ability to attract investment.

There are issues of who is newer on the scene and therefore has more need for liquid reserves that may affect the pattern. And there is centrally, as any number of authors have emphasized in different ways, the question of vendor finance as an economic development strategy. And if one believes that export-led growth, for a variety of reasons, is likely to be particularly rapid growth, particularly conducive to the import of technical change, particularly conducive to the discipline of competition from those who are further -- who are further developed, particularly conducive to various kinds of industrialization, the management of real -- the management of real exchange rates may be a way of achieving that kind of export-led growth. And one concomitant of that is a pattern of capital exports which is seen most clearly in a sense in financing the current-account deficits of those with whom one runs a current-account surplus.

There are examples that go in both directions, and I'm not -- you know, people are much closer to this -- to this history than I. The experience of Britain from the Civil War to World War I would fit the story that you have in mind or that would be taught in Mars. The experience of the United States at the very beginning of the 20th century would be one of some net exports -- despite the frontier, despite the West, all of that -- some net exports, and some concerns in other parts of the world about being under-sold by an excessively competitive exchange rate.

So I think the answer is that it is at first paradoxical. It does raise questions of sustainability, but it doesn't rise all the way to inexplicable.

FERGUSON: All right. Well, on a certain level, investment interests from the Chinas of the world to the United States and other industrialized countries is a -- is a pure positive. On the other hand, it does seem to add in many quarters to a sense of anxiety about a long-term American decline.

Do you see what is happening in the broad scope of capital flows in the world to speak at all to that point? And what, if anything, can government officials such as you do in policy-making to address that?

SUMMERS: I've lived my life on the Eastern Seaboard of the United States: Philadelphia, Boston and Washington, with frequent visits to New York. Over the course of my life, the fraction of both American GDP, and of any professional sports league, that takes place in that Eastern Seaboard has declined quite substantially. It has declined as the rest of the country has, in a variety of ways, caught up; the most important development being air conditioning in the South, which changed fundamentally the economic geography of the country, but there are a whole set of other developments.

If there is -- the proposition can be debated, but in the fullness of it all, life on the Eastern Seaboard of the United States is better because of the progress and the convergence that has taken place. In the same way, U.S. GDP was half of world GDP in 1947, and it's on the order of a quarter of world GDP today. So you could call that 60 years of decline, or you could call that the basic success of building and integrating rising -- more increasingly prosperous global system. And I -- there's lots of things you can question and there's lots of senses in which history's not continuous, but I think a thoughtful person would tend to say that the second view was probably the right view of that.

So if you say what's my forecast of the share of world GDP that will be American GDP in 2030, will it be greater today -- greater than it is today or less than it is today, I think all forecasts have a way of going wrong -- (chuckles) -- but I would guess that it would probably be less. Does that constitute decline, or does that -- or does that constitute successful evolution and success? I don't think you -- I think that we have learned painfully again and again that the economic success of others and increasing global integration in no way guarantee that good things will happen; and a sort of crude determinism that says prosperity will mean that everything works out is, I think, badly wrong.

On the other hand, I think that it would be a mistake to somehow overdo the consequences.

I also think it's instructive to look back at aspects of the history. There's a sort of powerful concept which is the opposite of Robert Merton's. Robert Merton the Elder talked about self-fulfilling prophecies. There's also a notion of self-denying prophecies. John Kennedy believed that Russia would have a larger GDP than the United States did in 1985. That was his -- that was the firm belief of the elite of that time, and a reading of the Samuelson textbook of that era would have been supportive of that view. That did arouse concern, and that concern aroused a whole set of things we did as a country that were enormously constructive and contributed to making that prophecy be wrong.

If -- every time the Council on Foreign Relations had a panel of broadly this kind between 1988 and 1992 -- 1989 and 1992, somebody found it clever to observe that the Cold War was over and Germany and Japan had won. It was an absolutely -- bit of conventional wisdom, and it was part of a process that led to a variety of kinds of renewal that were very healthy for the United States.

So I don't mean to dismiss the current wave of declinism, but I think these types of concerns are best channeled into a whole set of constructive efforts directed at renewal. And I am quite -- I don't minimize the problems we have at all, but I am quite optimistic about our future, and as I look around the world and ask whose hand I would want to be playing, I think our hand, in a whole set of ways, actually, looks very good.

FERGUSON: Before I turn it over to our members and guests, just to follow on that point on domestic policy for a moment, as you say, there are things that you would see that need to be done, and others very much have their own views. What -- could you identify, maybe -- as you're approaching your last 40 days or so, two months in office, what would you identify as the most urgent actions that the American body politic could address?

SUMMERS: Look, I think the single most important test of the success of our -- success of the policies of a public and the private sector will be, does the growth rate pick up significantly in the next three years? I think if it does, large numbers of problems will fade away, and I think if it doesn't, they will be close to -- they will be close to unaddressable.

Second, even with -- even on an optimistic judgment about the resumption of growth, we are not currently on a path where the public sector's revenues and public sector's spending assumptions are properly reconciled, and putting in place an appropriate framework for doing that is terribly, terribly important.

Third, we do not -- we are not doing what we could be doing, especially at a moment when -- think about it -- federal government can borrow nominally for 30 years at 4 percent.

At such a moment, we are not doing what we should be to renew the nation's infrastructure, broadly defined, its physical infrastructure. Look at airports here. Look at the airports you fly from here, and the airports you fly to across oceans. Look at the quality of mass- transit infrastructure. Look at degrees of congestion, incidence of -- incidence of potholes, even incidence of water-quality issues. That's the tangible, classic infrastructure.

There is a broader infrastructure that is less public: the infrastructure that supports the virtual economy at a time when more -- less and less is going to be physical and more and more is going to be information. Why should -- why should we not be in the top 10 on any measure of connectivity? Why should it be the case that 7-Elevens use information technology much more intensively than doctors' offices do? Why should it be the case that we don't apply IT, in which we're a leader, when doing so would save 75,000 lives a year by preventing medical errors?

You know, there's a broad debate about education in the country and, you know, it's kind of in the same -- on one level, we've made a lot of progress and a lot of positive things that have happened; but, you know, some of it's kind of the same. People on the right say there should be more standards, and if there isn't more standards nothing else matters. And people on the left say there should be more money, and that's what's really important. And, you know, we can have the debate back and forth, or we can actually decide that there's merit in both positions -- (chuckles) -- and that we need -- we need both reasonable physical infrastructures and reasonable infrastructures of support for accountability in terms of data and all of that.

And I would say the fourth and final thing I would -- I would highlight is that I think we do -- I say this to audiences like this one -- we do need to think about obligations of citizenship as well as privileges of citizenship. That's true of an impatient and demanding electorate. It's also true of its elites. And I think it would be a mistake not to recognize that some of what is going on in the country is a concern that too many in its elites seem like citizens of Davos as much or more than citizens of America; that there was a time when George Eastman had a fantastic set of ideas about photography, and the result was that the city of Rochester had a prosperous and healthy middle class for a generation-and-a-half. And Americans still have equally good ideas, but it doesn't tend to be the case that there are large, prosperous middle classes created in America in the wake of those ideas.

And how that's going to be addressed in a way that is healthy for the long run of the global system is something I don't think we've fully figured out, but need to.

FERGUSON: Well, we have a good deal of upstanding citizens right in this room. Dr. Summers has agreed to stay a bit over our allotted time, so if you can raise your hand for any questions, and we'll bring a microphone to you.

I see one here in the back. Please identify yourself.

And please ask a one-part question. (Scattered laughter.)

QUESTIONER: My name is Richard Tillman (ph). Hi, Larry. How are you?

SUMMERS: Hi, Rick.

QUESTIONER: I want to just ask you about the issue of how this administration deals with the private sector going forward to produce jobs and growth. That's something that's been quite a lot talked about in the press. But I also want you to address a second part of what I would call a twin leadership deficit.

Is the private sector, particularly the CEOs in the private sector capable of leadership the same way that you observed in the Clinton administration or have they pulled back their horns for a whole series of reasons? And so in a sense we don't simply have a(n) administration leadership deficit with the private sector; we have a twin leadership deficit.

So I'd like you to comment on both of those aspects.

Thank you.

SUMMERS: I think -- I think my remarks about citizenship were intended to be a call to the kind of leadership in the private sector that you were -- that you were referring to.

Confidence is the cheapest form of stimulus and I think we in government need to be attentive to that in a world where there is very substantial uncertainty.

At the same time, I do think it is worth observing that S&P 500 profits are up by approximately 60 percent since the fourth quarter of 2008, and that is a rather stunning increase in two years. And so as one thinks about how times have been in the corporate sector, I think that perspective could usefully inform some of the commentary.

Now, of course, the fourth quarter of 2008 was an isolated and particularly difficult period. But even if you look at various kinds of trend lines and so forth with all the challenges, profitability has been quite robust, capital costs are quite low. And so I think in an odd moment, in an odd sense, the largest challenge is actually -- the largest short run challenge, I think, is probably seen in quite similar ways in government and in the private sector. If there were more customers walking through the door and there was more demand, then a lot of good things would be -- would be happening.

And so I have to say that I think that a lot of the constraints on various kinds of business activity that are sometimes ascribed to uncertainty, we do need to work to minimize that. I think have a lot to do with the fundamental fact of demand being less robust than many would hope.

FERGUSON: Question in the far back, please.

QUESTIONER: Is this working? Andrew Grummer (ph) from Arnold, Bligh Schroder (ph). You mentioned West Germany and their model of transitioning from weak currency of the '60s, '70s to the stronger currencies of today. It didn't create the greatest spending population. And I'm curious from the Chinese perspective, is the German model and the American model of transitioning from an export to a consumer society -- are there -- are they the only two models that the Chinese can follow? And -- or is China going to be its own exception and create its own rules?

And I'm just trying to get your thinking if you were in the Chinese position, what model would you look to, what are the positives and negatives and -- or is this going to be a totally different path which would put a -- obviously, a lot of pressure on our fiscal policy and trade policies to transition through this?

SUMMERS: I've got enough problems with American economic policy without trying to put myself in China's place. I'll say this. The share of consumption in GDP in the United States is about 70 percent. In Japan in its highest savings years was somewhere in the mid-high 50s. In China, 10 to 15 years ago was 45 percent and in -- a couple years ago it was 35 percent.

And of course, that would likely be associated with significant increases in domestic demand.

FERGUSON: We have a question from Randolph Baxter of the U.S. Bankruptcy Court in Cleveland about the Euro and the volatility among -- with the European Union and such, to which I will add the possibility of even a fragmenting of that Euro bloc.

"What will be the effect on capital markets in the United States?", Mr. Baxter asks.

SUMMERS: Oh, I think I'll leave that to the investments -- to the investment analysts. But I think we have observed last spring to some extent, have observed in the last several weeks that uncertainty regarding the European situation tends to have consequences for markets that go beyond Europe.

So the failure to resolve -- the failure to resolve difficulties in Europe is unlikely to be constructive for other parts of the world.

FERGUSON: Question around here.

QUESTIONER: Thank you. Mr. Secretary, my name is Roland Paul (sp). I'm a lawyer. I ask this question with due respect and considerable personal admiration.

As you know --

SUMMERS: Uh oh. (Laughter.)

FERGUSON: That's the only way to respond.

SUMMERS: With due respect, that's different from respect, you'll notice.

QUESTIONER: You can strike the due. But as you know, there's a movie making the rounds in the theaters called "Inside Job," in which it's pointed out that in the Clinton administration, you vigorously opposed the regulation of derivatives. I wondered in light of hindsight whether your position may have changed?

SUMMERS: With respect to my current position, I worked very hard to support the president and Secretary Geithner on the financial regulation bill that passed the Congress that involves at a number of levels by far the most sweeping derivatives regulation in terms of forcing large parts of trading to exchanges in clearinghouses, in terms of forcing things to be consolidated into institutions that are supervised in consolidated ways that represent by far the most serious regulation that it ever existed in this country and which go far beyond regulation anywhere else in the world.

That's the position -- that's the position that I support.

With respect to the Clinton administration's record on this and with respect to what took place in the intervening eight years, obviously, one would do some things differently with hindsight than at the instant. But I would caution you that this is an enormously complicated story that if you want to pursue it, you should read the rather comprehensive sets of recommendations that the Clinton administration put forward in this area and that the Congress was unwilling to pass at that time, and make some effort to avoid rushing to judgment based on -- based on films that have a point of view.

FERGUSON: Steve Friedheim, please.

QUESTIONER: Steve Friedheim, Cyrus Capital.

JP Morgan has set the price, one of the largest IPOs in U.S. history today, General Motors. As far as we understand it, the book is very, very strong, 60-plus billion (dollars). The price talk is going up, and you know, 18 months ago, the administration, your team was faced with a very, very different situation.

If you could talk a little bit about the GM experience and what lessons learned were there? And specifically, is there a place for government intervention in the private sector?

And if so, is GM a model or is it very specific to an individual case and can't be used?

SUMMERS: No comment I make has any bearing on any of the remaining uncertainties surrounding the IPO, which prices at the -- prices at the end of the day and such.

Look, I think you have to judge this, at least my judgment as a person who co-chaired the auto task force for the president; I wouldn't pretend to be an objective observer -- but I think you have to judge that the core decisions -- one, that the government couldn't stand by and allow the automobile industry to collapse with the consequent unemployment in the millions and costs imposed on the public sector in the tens of billions. I think in light of where we are today, that judgment has to look like it was a pretty good one.

Two, the judgment that was highly controversial at the time, that in order to do it, it was necessary to go through a formal bankruptcy process with the provisions for adjustment that that required -- painful as it would be for many of the creditors, many of the other kinds of stakeholders in the process -- the fact that we were able to go in and out of bankruptcy in less than 90 days on something of that scale, is I think a tribute to the skill with which our automobile -- with which the automobile working group chaired by Steve Ratner, Harry Wilson and others, the quality of the job they did.

But I think the president's core judgment that, support, yes, with real bankruptcy, I think that was the right -- I think that second judgment was the right judgment.

Third, I think the judgment that we were going to force restructuring, but that it wasn't going to be Government Motors; that we weren't going to be setting regulation with a view to their competitiveness, that we weren't going to be using it to achieve nineteen different objectives, that we were basically going to force a real restructuring, force a change in management, but then we were going to let the company run itself with a view to, as rapid as possible, reprivatization, that core strategic judgment was correct.

I think the fourth judgment, that we were not going to try to take on all the concerns of all the companies that were associated with what had happened, but were going to regard the automobile -- the large automobile companies as central -- we're going to provide additional support as necessary to make that support work, but we're not going to engage in a broader effort to override market forces -- I think that was the correct judgment.

Is this a -- is this a model? I think it depends on it.

Every half century, when there is an epic financial crisis and potentially major disruption and the DIP financing market has collapsed, should the government consider a carefully constrained role in DIP financing? Yes. And the view that it's yes I think is supported by this success.

Should the lesson of this be that failing large companies should as a matter of national industrial policy be bailed out even in non- extraordinary circumstances? I think that would be a very dangerous lesson to learn from this -- from this experience.

FERGUSON: Well, with that, Dr. Summers, I will say the council would be delighted to have you back when you are fully at liberty after the turn of the year, but -- (laughter) -- but I think we can appreciate your candor under the circumstances today, which has been remarkable.

So thank you very much for joining us. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

RICHARD HAASS (president, Council on Foreign Relations): Well, good morning. I'm Richard Haass, president of the Council on Foreign Relations, and I want to give a warm welcome -- and it is warm today -- to everyone here and thank you all for coming to what is the second annual Stephen C. Freidheim Symposium on Global Economics.

Let me begin by thanking Stephen for his support, without which this would not be possible, as well also -- and not -- let's be honest -- not simply for his generosity but also for his ideas. Steve is -- there are certain people who are generous enough -- and I'm happy with that -- to support what we do here. Steve, however, isn't content with that, and also is truly an intellectual participant. And you see the fruits of it today, which is going to be an extraordinarily rich day. So thank you.

I also want to thank the Council -- the Council on Foreign Relations' Maurice R. Greenberg Center for Geoeconomic Studies, led by the gentleman to my left here, Sebastian Mallaby, for all that they do as well and all the work they put into this symposium.

And subjects such as the ones we're going to be discussing this morning that focus on economic and political forces and how they interact and affect the world are at the heart of what we're trying to do both in this center and at the council. The interplay of the policy and the economic is what we call "geoeconomic," and what we are trying to do is mirror the world. Universities may have departments and silos; the world does not. And we do our best to approximate the world.

We've got an impressive lineup today, as you can see from your program. We start off with a panel on currency issues, followed by a conversation with Larry Summers, and we end with a panel on trade. And in the between the panels are breaks, to give you a chance to speak to one another, take in some calories, and there is a lunch afterwards.

Timing is a lot in life, and I think our timing is good. As the G-20 meeting in Seoul demonstrated all too clearly, the world as yet has no mechanism for solving currency issues. And the G-20 meeting came against the backdrop of charges -- or actually a near-consensus, I would suggest -- that China was manipulating its currency. Much less agreed upon was what the consequences were and what to do about it. But before the meeting was over, criticism of the Federal Reserve's decision to resume quantitative easing filled a lot of the political space. So all of this means we've got more than a little bit to discuss this morning.

The third panel -- the third session today, the second panel, is on free trade agreements and trade more broadly, and given, again, what happened in Seoul, what for many was the unexpected inability to come to closure on the U.S.-South Korea Free Trade Agreement forms the backdrop.

And obviously trade is a growing issue of both domestic and international concern. Lots of people are asking the question of what, if any, consequences the new Congress in this country will have. And as recent Wall Street Journal and Pew polls have shown, there are fundamental issues of what can be done to resurrect a consensus in this country that would support free trade. Indeed it's for that reason that one of the things we have started up here at the Council in Foreign Relations is a task force on exactly that issue: What should be American policy in this -- in this realm?

And again, all of this is against the backdrop of a moribund -- I think that's a fair word -- Doha process or lack thereof. So I think there's also the question of what, if anything, can be done to resurrect not simply the three languishing free trade agreements, but what can be done to resurrect global trade talks.

We'll discuss all these issues and more today, and I think the "more" is whatever Larry wants to talk about in between. The context could not be better in another sense. We've already had the brief -- well, the draft of the chairs of the deficit commission come out. Then I think today you've got the Rivlin commission's report that she and former Senator Domenici have put out.

So the air is filled with things economic and geoeconomic. And as a result, we couldn't do better than to turn things over to Sebastian Mallaby. Sebastian is the director of the Maurice R. Greenberg Center for Geoeconomic Studies here at the council, but he's also the Paul A. Volcker senior fellow for international economics, which makes him the person at the Council on Foreign Relations with the largest title and the largest business card. Sebastian is also the author of a recent book, "More Money than God: Hedge Funds and the Making of a New Elite," which is not only important, but it is truly interesting and readable.

So with that, Sebastian, over to you, sir.

SEBASTIAN MALLABY: Okay. Thank you very much, Richard. We'll get started right away on this first session about capital controls, currency wars, et cetera. We've got a great panel here to speak about this. I'll just quickly introduce Ajay Shah at the end, who is a professor at the National Institute for Public Finance and Policy in New Delhi and also visiting at the IMF research department right now.

In the center is my colleague over here at the council, Benn Steil, who wrote the book "Money, Markets, and Sovereignty," and is working on another book, which we'll get to in a second.

Then Alan Taylor, who is a senior adviser this year at Morgan Stanley, but also director for the Center for the Evolution of the Global Economy at the University of California, Davis.

So I'd like to start -- I mean, as Richard said, we've got a lot of stuff in the news, whether it's the European tensions, whether it's the controversy over the Chimerica deal and how sustainable that might be, questions in the background about the sustainability of the dollar as a reserve currency. All of this stuff is in the mix, but I want to start with some historical perspectives here because Benn is working on a book on the creation of the postwar monetary order, the 1944 Bretton Woods conference.

And I want to start with you, Benn, and ask if you could explain a bit, you know, when the framers, as it were, got together and thought about what they were trying to achieve in the monetary system, what were the objectives they were trying to satisfy, and what part of their thinking resonates today?

BENN STEIL: Well, today, of course, the phrase "currency wars" is much in the news, and the framers of the Bretton Woods system, the Americans and the British, were looking to create a new international monetary architecture that would address the problems that emerged from the so-called currency wars of the 1930s. The view was that it would be impossible to reestablish any sort of open international multilateral trading system without dealing with that issue, without providing some mechanism for stabilizing exchange rates.

The American and the British plans were actually quite different. The American plan was built around the idea of establishing the dollar as a unique surrogate for gold. All countries would be pegged to the U.S. dollar; the dollar would be THE international reserve currency, and countries would be offered inducements to maintain a fixed, pegged price for their currencies with the dollar. Now obviously that stands in marked contrast to today, where we're trying to get countries to de-peg from the dollar.

But where you stand depends upon where you sit. And in the 1940s, we were the world's largest creditor country. So we had a strong incentive to enforce fixed exchange rate, because it stopped others from devaluing against us, very unlike the situation today when we're the world's largest debtor nation.

The Keynes plan was entirely different. The Keynes plan wanted to replace both gold and the U.S. dollar with a new fiat international reserve currency. Keynes called it "Bancor." Actually, most countries at Bretton Woods at least quietly massively preferred the Keynes plan, but they were in no position to challenge the United States. So the so-called White plan, the U.S. plan, became the foundation of Bretton Woods.

And there's a lot of nostalgia today for Bretton Woods. But it's important to realize that the system as such, with convertible currency as it was envisioned by Harry White, only started in 1959. And by the mid-1960s it was already fraying, and by 1971 it was finished when Nixon closed the gold window.

And if I could just describe very briefly what the problem was, because this problem still exists today. Under the so-called classical gold standard that we had before 1914, if we were trading with China, if we sent a dollar to China, China would redeem the dollar (in ?) the United States for gold; U.S gold stocks would decline; we would raise interest rates; credit would tighten; prices would fall; U.S. goods would become more competitive and that would ease imbalances. And this system worked pretty well in the pre-1914 era. There were financial crises around the world, but they tended to be very short-lived and shallow by comparison to modern crises.

How did the system work under Bretton Woods? Well, the same way it works today. We would send a dollar to China. China would not redeem the dollar for anything; they would hand it back to us immediately in the form of a very low-interest rate loan. That dollar would get recycled through the U.S. financial system, creating more credit. And in the 1920s this turned up in the -- in various asset markets, like the stock market in the 1960s. It turned up in inflation. And of course, in the past decade, it turned up in places like the housing market. So it's a -- it's a problematic system.

Now, only two coherent responses to those fundamental flaws have ever been put forward, in my view.

One is the French response in the 1960s; that is, we should go back to the classical gold standard, which for all sorts of reasons is not likely, despite the fact that Bob Zoellick appears to have put it back on the -- at least on the international discussion level. Even Jean-Claude Trichet was forced to respond to this idea.

And the second is to adopt some sort of Keynes plan, a legitimate new international reserve currency. And in fact, the governor of the Bank of China, Governor Zhou, last year said that we -- perhaps we did make a mistake at Bretton Woods and that we should not have gone forward with the White plan and we should have gone forward with the Keynes plan.

MALLABY: Alan, do you want to add something to that?

ALAN M. TAYLOR: Yeah. I'm -- first I want to say I'm really looking forward to Benn's book, which I think is going to be very insightful.

But my one -- the one thought that resonated with me is that we know how the Bretton Woods framers thought about it. They thought that currency instability caused bad economic outcomes.

Now, even if that's the way they thought about it, and many people have thought about it since, that doesn't necessarily mean to say that was actually true causally, as an economist would say, you know, looking at the data or trying to assess the evidence. So there's an alternative interpretation out there of what was going on in the '20s and '30s, which is that economic instability were the real or financial causes -- currency instability. Right? And that puts a very different spin on how you look back at those events or later events -- so one can say about the collapse of Bretton Woods in the '60s and '70s, whether it was currency instability that caused real economic problems or the other way around.

Same thing today. We didn't have talk of currency wars until we had the worst economic depression since the 1930s. So economic historians and economists are very careful to try and sort out that causality. And it's not by any means a slam dunk. So if you look at, you know, is there any major difference between how economies perform under different exchange rate regimes, in terms of growth, in terms of crises, all kinds of other metrics, it's very hard to detect a problem there. So I think this sort of currency war, currency instability theme as, like, oh, no, we must try and avert that or put that genie back in the bottle at all costs, maybe that was a characteristic of Bretton Woods, though we should be careful about thinking that that's really the way things are being driven.

And, you know, I guess we might come back to this (theme ?) later, but a currency war isn't the -- or you know, currency movements aren't the worst thing in the world if they relieve other kinds of economic pressures. They are a substitute for a trade war, in some sense. And economic research on the 1930s by someone who's here today, Doug Irwin, who we might hear from later, supports the idea that if you can use the exchange rate as a release valve, it can help you avert more extreme measures of protectionism.

MALLABY: Well, that's a good connection to the third session today. Maybe we'd rather have currency wars than trade wars. But can you pick up also on this issue about what kind of reserves countries should be accumulating? Benn talked about the French idea of gold; you know, the bank or Keynes' idea of some kind of commodity-linked instrument. Right now, you don't have either of those, and you've got a world in which, since 1995, central banking reserves have gone from 5 percent of GDP to 14 percent. Is this sensible? Is it -- I mean, this brings us back up to the debate right today. In other words, the problems identified in '44 are at the core of what's going on in the last 15 years: huge reserve accumulation. Is this justifiable?

TAYLOR: So I think there were a number of questions embedded in that, which is a good way of framing it. So why have the emerging countries started down this track? Why are they accumulating what they're accumulating, and when will they stop? Or what is enough, right?

So I think we all know why they started. If you look at the trends in the data since the 1970s, it was kind of flat. Industrial countries, developing countries, they had, you know, a certain ratio of reserves to GDP, and it was kind of flat-lining; nothing much happened. Then we hit the sort of era of financial globalization and also commercial globalization in the '90s, and the emerging markets started to ramp up their reserve accumulation. And that only accelerated. In fact, it accelerated dramatically after the Asian crisis of '97.

So, you know, at some simple level, what's going on there, it's sort of political economy. Etched on the mind of all emerging-market policymakers, and etched on my mind, is that photograph of Suharto with Camdessus leaning over him, and he's signing away Indonesia's economic life and his political life. Right? And no emerging-market policymaker wants to be in that kind of photograph or that kind of position ever again.

So the message that they took from those events was: We must self-insure. It's not enough to rely on market access, being able to go into debt or borrow when you're in a pinch; or even go to a multilateral, which might come with nasty economic conditions or not supply you with enough credit on enough terms or whatever. Instead, instead of trying to run our wealth down into negative territory, we'll start with our wealth in really positive territory, and then we can draw it down when we need it. And it's kind of hard to argue with that, in terms of, like, countries pursuing their self interest and perhaps interpreting those events of the '90s as a caution. So I don't think there's anything surprising, or indeed anything wrong about that.

So how should you interpret the last 10 or 15 years when they ramped up this reserve accumulation? One temptation is just to panic and say, oh, no, this is global imbalances forever. That could be true and, you know, I'm not going to attempt to forecast it. It's hard enough to do economic history; I think forecasting is really beyond my pay grade. (Laughter.) But I think one way to look at it is we're in a bit of a step change. They knew they were under-provisioned, or under-reserved, in the 1990s, and so they had to take steps if financial globalization and integration and maybe the risks of a growing financial sector in their own countries and globally was going to pose more of a threat to them. So it made sense.

But maybe that step change is going to taper off, and so the public flows toward the -- you know, toward the rich world, driven by their accumulation of reserves, could taper down. So I think, you know, that's an optimistic view of how, you know, a more benign rebalancing could take shape in the years ahead: less of a reserve accumulation as they feel they've got into a sort of safe territory. And going in the opposite direction, I think part of the benign rebalancing will also be increased private capital flows towards them, so -- but that's maybe a separate issue.

As to what -- you know, what they're accumulating, you know, we're back to the Triffin dilemma which -- you know, bringing up Bretton Woods themes again, a hundred years ago, we had one real reserve asset, and that was gold. The problem was, it's in finite supply, or very inelastic supply. And we kept on making more stuff -- which is good; we had economic growth. But economic growth outpaced the stocks of gold, which would mean either inherent deflation if you kept the backing ratio and the price of gold the same, or you'd have to be constantly tampering around with how much backing and what the price of gold was -- which is basically like saying, "Let's float," or "Let's have a fiat system," which we kind of got to by various misdirections.

But along the way then we had a dollar system. And the dollar has this reserve currency status now, which is also kind of a path-dependent accident of history. The good news is: Dollar reserve assets are in seemingly infinite supply. (Laughter.)

But unfortunately that comes with other problems. It's -- you know, it's their reserves, but our problem. And we need to think about, you know, how we manage that. You'd think, you know, getting trillions of dollars at low-interest rates would be a wonderful position to be in, but it -- you know, it depends on an assumption that we have wise and efficient financial markets and households and governments and funds to allocate all of that.

MALLABY: And actually, let's get back to one thing Adam said, which, I mean, maybe I'll -- (inaudible) -- put words in your mouth, but you were saying that with reserve accumulation over the last 15 years, whilst enormous, has been natural and precautionary, and not about buying -- you know, not about managing the value of your currency. Do you agree with that, Ajay? Do you think that most reserve accumulation in the last 15 years can be explained in those terms?

AJAY SHAH: Right after the Asian crisis, it seemed like reserves accumulation was very strongly motivated by that iconic photograph of Suharto. But I think fairly quickly the motivations changed. There used to be this great debate, how much reserves should a man have, a bit like Abraham Lincoln's question of how long should a man's legs be. And different people used to have different views about how big the reserves needed to be. And the top experiment that you would have asked for is, let's have a really big flood, and then we'll see how much reserves you need. Well, we did have a nice, big flood.

And you get two camps, you get two stories. One kind of story is a country that will tell you no amount of reserves would have helped, that in 2008, you know, this was really not something that any reasonable, central bank would -- any unreasonable amount of reserves could have particularly made a difference to.

And then on the other hand, you have data of some countries where the amount of reserves actually used in intervention through the crisis is actually remarkably small. You get numbers like 2 (percent), 3 (percent), 4 percent of GDP. You don't get a very large amount of usable reserves.

So it seems like there are some countries where the amount of reserves required to have dramatically changed outcome was essentially infinite. And there were other countries where the reserves were pretty small. So I find myself hard -- I find it difficult to support the simple reserves as safety storage, certainly after around 2002. There I think it was more about -- (inaudible) -- mercantilism.

Many countries would say that because the Chinese are doing it, we have to do it, too. Maybe the story runs that because the Chinese are doing it, you get a domestic political economy where funds in your own country start pressurizing the politicians, saying because you are doing it, we need to do it, and you start sounding a bit like competitive argument in trade protectionism.

MALLABY: Yeah, you also get a Lockean process, right, where if China is running one type of exchange rate policy that favors its exporters, the exporters grow, they do better, they become more powerful, they have more political say. And then that becomes a political economy, sort of Lockean. Benn, you look as if you want to --

STEIL: You know, China is an interesting case because they've pursued essentially the same policy in terms of fixing their exchange rates since 1994. But their motivations have changed entirely. During the Asia crisis in 1998, there was enormous pressure on China to get rid of its currency peg and to devalue, and the U.S. Treasury showered enormous praise on China for maintaining its fixed exchange rate during the -- during the crisis. So China started this policy with very different motivations than it has now to maintain it. Clearly, its reserves are well beyond what it could possibly need for prudential purposes for dealing with a crisis like the one we've just gone through.

MALLABY: Ajay, let me get back to you since you're at the IMF at the moment. So, I mean, one could argue that even if a decent chunk of this reserve accumulation is understandable for precautionary reasons -- we have a world of big capital flow, so you need big self insurance -- that there are externalities from this reserve accumulation because as you do it, you are pushing capital into other economies, they don't want to necessarily absorb this stuff. And so therefore it would make sense to shift from countries self-insuring to collective insurance through the IMF.

You're sitting there in the IMF, but you're not owned by it since you're only visiting. So you're in the perfect position to tell us, you know, how plausible it is that some better-designed, larger, reformed, whatever IMF could remove this incentive to self-insurance, to get over that Suharto, Indonesia iconic photograph problem, and return countries to viewing the IMF as its friend?

MR.: It could be done.

MALLABY: Alan's even laughing at the mere suggestion of it.

MR.: Yeah. I think it could -- it could be done. But I really disagree on the extent to which that is the question we face today. I think the size of reserves in most emerging markets are way past precautionary motives today. So on -- it could be done, it should be done, and it will help one day. But I don't think it's going to make any difference today. Today we are in a world of exchange-rate mercantilism. I don't think the precautionary motive (binds ?).

MALLABY: Alan, do you want come back on this?

MR.: (So tell us what ?) -- and relate your argument earlier, specifically to China. I mean, before you said, in general, (this reserve ?) accumulation is precautionary. Do you believe that for China specifically?

TAYLOR: Okay. So, you know, frankly those -- the questions --separate.

So I think, you know, we can sort of sit here, and we can have a theoretical model or we could maybe construct some empirical model of do we think exchange rates are on target, above target, below target. And I think one of the problems there is just that there's a range of either theoretical parameters or the standard area you get there is so large that it's very hard to say meaningfully, well, that country has too many or too few reserves. So I'm not sure that's an edifying route to go.

I mean, I agree that we're in a second-best world. There must be better ways to insure. I'd like to, you know, sit here; we can link arms or we can wish for unicorns and the IMF to be nice. But we have to deal with the world as it is, and I think that's my sort of main point about the last 15 years. There were -- there were a lot of nasty threats that these emerging economies saw unfold and they reacted to. But yes, it would be better if there were -- there were alternative insurance mechanisms.

But, you know, it's hard. You've gone through the last, you know, two or three years. You take an example like Chile and its finance minister, Andreas Velasco, who's a friend of mine. And, you know, before the crisis he's being excoriated. He's got the worst, you know, approval rating of any politician and people are like, you know, insulting him on the street as he's taking his kids to school and, you know, it's all very unpleasant.

And then the crisis unfolds and he gets out the check book and spends the reserves on their social programs and things to support the economy, and people love him, right? And if you -- everyone suddenly understands there's a reason we did all of that savings, so that in a time of crisis we would have the flexibility to be able to support our economy. And his approval rates and that of Bachelet shot up to the highest levels ever.

And as someone who studies, you know, Latin American and Southern Cone economic history, I thought, wow, a countercyclical approval rating of a finance minister in Latin America. (Laughs.) Has that ever happened before? So, I -- you know, I just think it's a very powerful story both economically and politically as to why we're seeing this unfold. But I completely agree that there may be countries well above where they need to be in terms of reserve holding.

But in terms of motivation, some of it is planned; some of it is almost accidental; and -- but, you know, some of it may have intent. But I think it's loading too much on intent to sort of say, you know, you're a manipulator and this is mercantilism.

And I think the other thing that makes me a little bit uncomfortable there is an awful lot -- I mean, in the case of China, to bring it back to China -- an awful lot of this accumulation of reserves in the last six years has been through sterilization, so the issue of sterilization bond(s) that (require/acquire ?) reserves. So it's not really -- you know, it's not alternating the monetary base or monetary conditions in any significant way.

And I sort of look at that, and I can sort of separate their monetary conditions from their reserves. It's almost like they've got a separate policy. You know, the exchange rate peg, as you said, was -- it was set, you know, 16, 17 years ago. It's been fixed but adjustable, you know, that wonderful oxymoron we got from Bretton Woods, which is like "military intelligence" or something. (Soft laughter.) It's moving, but we think it's really fixed, okay?

MALLABY (?): (Inaudible) -- Council on Foreign Relations. Don't (make jokes ?) -- (inaudible).

TAYLOR: Sorry, I -- (laughter).

So that was -- (inaudible) -- ago, and then they kind of got into this task. But I just want to make the point that they got, whatever, you know, 120 percent backing for (N zero ?). They've got reserves of 3 trillion (dollars). Does anyone, you know, really think that suppose they got an extra 500 billion (dollars) of reserves tomorrow or they reduced reserves by 500 billion (dollars) -- which they could do very quickly through sterilization or other means just by moving the (leaders ?) -- does anyone really think that would change their ability to peg? You know, would it be so hard to peg with only 100 percent backing, as opposed to 120 percent backing? They're still so far beyond. I mean, they're really two separable issues.

And I think they could quite safely back with perhaps half the level of the reserves they have now. You know, think back to the gold standard, when countries were backing the gold standard with, like, you know, 10 (percent) or 20 percent backing in emerging countries, maybe a bit more, 50, 60, 70. So I really think that we ought to separate the currency and exchange rate question from the reserves, because I think mechanically and practically they are separate.

MR. : (Inaudible) -- and I just point out that Keynes did not believe that it was possible to have a nice, friendly, helpful International Monetary Fund. He was very concerned about White's plan. His idea of an international clearing bank was going to be completely passive. And throughout the Bretton Woods process -- the British emphasized this with the Americans -- we want a passive institution. We don't want it interfering with national autonomy.

We just want it to be a mechanism to produce this international reserve currency that would have a very elastic supply. So it was more a mechanism than an actual fund with technocrats that were going to make the sort of decisions that would produce the Suharto photo.

TAYLOR: I mean, I think, again, this is like (first best ?): If we could have a way for both surplus and deficit countries to coordinate and cooperate and adjust in those ways, the world would be, you know, a much happier place, and we'd all be -- we'd all be very happy with that.

But can we make it work? I think, you know, we need -- we need a guinea pig and a sort of controlled experiment, a small region which claims to have political cohesion where we could try out such an experiment. Umm -- oh, well, Europe. (Laughter.)

I don't want to divert our discussion, but I think, you know, that's obviously a question that's in the air as to can countries that are -- you know, when you have a group of countries with asymmetric shocks, surplus and deficit, and they want to get along -- I don't know. I'm -- at the moment, I'm not getting such positive vibes out of that. But it could be --

MALLABY: Right. I mean, the Ireland reaction to the prospect of a European bailout is only a little bit different to the Indonesian one. I mean, they don't seem to want the money, just like Suharto didn't want it.

TAYLOR: I mean, right, it comes with conditions, saying, oh, it might come with some very unpleasant conditions, some that might even threaten the development model, such as, you know, the corporate tax structure and so forth. And they want to sort of hold on for the best deal possible, which is understandable. And they know that the moment they sign it that it's almost irreversible, and it'll be politically something hanging round their neck for a long, long time. So yeah, I can understand why they -- why they are balking at it, yeah.

MALLABY: Well, Benn, or actually whoever wants to get this -- but I mean, you know, you could say -- there's a lot of criticism right now about the global monetary regime, a lot of disquiet about it, because this combination of fixed and floating, open and not open seems to create a lot of tension. Europe is another model, as Alan said. Right now it seems to be in a mess. Should we draw from this the lesson that even in a fairly politically cohesive bloc of countries, fixing is just too difficult and is not the way to go? I mean -- Benn, actually, whoever wants to --

STEIL: Well, let me start on Greece. There's this myth out there now that somehow if Greece had not joined the euro zone they never would have gotten into this problem. I find this storyline rather remarkable, since a few -- just a few years ago, when Iceland went into crisis, everybody was drawing the opposite conclusion, that clearly if Iceland had euroized, they wouldn't have gotten into this problem.

It's important to remember that, if you go back to 2000, right before Greece joined the euro zone, already 80 percent of their total debt stock was denominated in euros. Irrespective of whether they joined the euro zone, they were going to issue debt in euros because it was cheap. So had they not actually joined the euro zone, they just would have gotten into this crisis sooner.

So it's far from clear to me that this is -- this is a problem created by joining the euro zone. You can make an argument that it's a problem created by the creation of the euro itself, because it induced countries to borrow in this country when -- in this currency when the rates were cheap.

But I don't think we should draw the conclusion that joining the euro zone was a mistake. I don't think you will see countries having any real incentive to consider leaving the euro zone, because once you've actually defaulted on your debt, the whole logic of leaving the euro zone in order to alleviate the pressure goes away. You don't need to do that anymore.

MALLABY: Ajay, on -- let's switch topic a little bit to capital controls. So one response to a world of abundant capital flowing out of reserve-accumulating countries has been for the recipients of these inflows to try to erect barriers. So Brazil, Taiwan, Thailand, all these countries that have -- you know, there's been a kind of return of the fashion towards capital controls. The IMF, which used to be extremely hostile to controls, is now willing to say that they're a good idea in some cases. You know, maybe from the Indian perspective, you've had a long tradition of using controls. Do they work? Are they a good idea? Is it -- is it a sustainable swing of the pendulum of fashion that capital controls are now being smiled upon?

SHAH: There used to be an old wisdom, mostly rooted in the Latin-American experience in the '70s and the '80s, that controls were messy and controls did not work, and you give it enough time, the lawyers and the financial engineers will show you how to get past any controls. I think we are going to rediscover the wisdom of that in a painful way.

So I continue to be skeptical about the usefulness of controls. Controls are far less effective than many policymakers think. I think people have just spent too many years away from those experiences of the '70s and '80s to get to the point where you feel that controls will actually deliver the goods.

There is only one class of situations where I think there is a case for doing something different: It is a country where there's a very low level of development and the country really does not have much of a financial system, the country really does not have financial supervision or the human capability to put together some kind of financial supervision. Maybe an autarchic (ph) approach is more appropriate there, but for most significant countries participating in the global system, I really find myself skeptical about controls.

STEIL: I'd point out that just at Bretton Woods, both under the American and the British plans, capital controls were absolutely fundamental. In fact, the Americans were much more hard-line than the British about it. White insisted not only that countries should have the right to implement capital controls, but countries should have the obligation to assist those countries in preventing inflows into their markets from those countries.

MALLABY: But, Benn, the question, surely, about that is that it's one thing to argue that in 1944. And now we have a world of, you know, hugely expanded trade flows, hugely expanded global supply chains; multinational corporations, which raise capital in different jurisdictions and can move capital internally through their networks by under-invoicing, over-invoicing, all these tricks. Surely it would be plausible to say that capital controls were a useful policy option 66 years ago, but they're not anymore.

And, I mean, India, as I understand it, Ajay, I mean, is a -- is a case study in this, where theoretically the bond market is closed to foreigners, but in practice, after Lehman Brothers went down, India -- Indian interest rates reacted rather dramatically. Isn't that right?

SHAH: Yeah, I -- I've written a lot about this, but on that weekend when Lehman failed, I have to confess that I was more curiously looking at the world, that oh, what a spectacle, rather than thinking that something interesting is going to happen in India. But lo and behold, on that Monday morning, the money market in India opened before London and before New York, and that money market had choked right there in the morning of Monday morning. So it was a lesson for me on financial globalization.

In theory, the rules say that Indian funds cannot borrow abroad with a maturity of less than three years. So in theory, there was supposed to be no money-market borrowing going on. But in practice, that didn't work, so I think we really should question the extent to which capital controls make a difference.

MALLABY: Alan, what do you think? Do you think capital controls can be useful policy tools?

TAYLOR: Well, I think the discussion so far -- I just want to back up what's been said. Fifty, 60 years ago, we were in a different world after World War II, given that this, you know, fundamental trilemma: You can't have fixed exchange rates, capital mobility and autonomous monetary policy. Countries wanted their autonomous policies, but they wanted to sort of stick with the barbarous relic of the gold standard, or the dollar standard, as it became. And so they had to give up capital mobility. Everybody was on board with that. The Washington consensus of 1945 was, you know, kill finance, basically, and restrict financial globalization. It was a very different world.

Why did it unravel? For reasons you were pointing to, in part. As world trade grew and commercial ties between countries grew, there were ways around. The controls were leaky, the countries could mess around with their invoicing of exports and imports to move capital surreptitiously, and there were other ways in which leaks developed over time. So Ajay's point is that, you know, you can't really make controls absolutely watertight, and they can be evaded.

So I think we have to be just pragmatic here and understand that we're not going back all the way. On a continuum from zero to 100 percent, we're not going to back to the 100 percent, sort of early 1950s way of the world here. And that's -- I don't think that's what's being talked about. Just as, you know, when people talk about currency war, they're really talking about actually quite small currency movements. It's nothing like, you know, Zimbabwe or even the 1930s.

So what we're likely to see is some movement from zero and, you know, complete freedom of capital movement towards some restrictions. Perhaps the most important ones we will see. And to, again, bring the great example of Chile to bear, I think like the Chilean "encaje," where there's a tax on short-term flows. And I think studies at the IMF and elsewhere have shown that won't necessarily significantly damp down the total volume of capital flowing in your country, but it might change the composition more towards long-term FDI and away from the kind of hot portfolio flows.

And on the margin, that's maybe something that gives you a little bit of a breathing space and takes away some of the downside risk with these countries looking back at, you know, recent experiences where they were subject to capital outflows or runs. And you know, that's something we can cope with. Even the IMF came out this year and said, you know, maybe capital control's all right. You know, everyone probably fell over and said: What did they just say?

And I think we can sort of live with a world like that, but it won't change the fundamental, deep, you know, real forces that drive the capital flows in the long run but force countries to have adjust their real exchange rates and, you know, cope with living in a globalized world.

So you know, I think pragmatically we'll just follow a fairly moderate course here.

MALLABY: Ajay, we've been talking mainly about reserves in terms of just the extraordinary pace of accumulation. There's also of course the issue of, you know, the currency that it's denominated in, and 60 percent of reserves are denominated into our dollars, but the U.S. economy is 24 percent of global GDP. Do you think that, you know, emerging markets such as India -- are the central banks going to move to something else? When Zoellick talks about gold as a reference point at the World Bank, is there something behind that? Is there -- you know, could you see central banks moving towards some alternative to the dollar on a five- to 10-year horizon?

SHAH: Well, in two parts:

First is, you can act actually be very separate and distinct in your decisions about how to peg the exchange rate and what reserves portfolio you to own. So in principle, a central bank could say that I'm going to peg to the euro, and its investments could all be in hedge funds. So the currency composition of reserves, a large part of it, can be in something that's very different from your pegging strategy. So we don't have to think that the two go together.

In principle, the whole world could choose to peg to the dollar, but that doesn't mean you have to hold all your assets in U.S. government bonds. You could diversify. There's just a small liquid portion that you need to keep in dollars. Large parts of the $3 trillion could go into something else.

The second point I do want to emphasize is that we should not phrase the choices that the world faces as between that (Barbados relic ?) or the U.S. dollar, because there are very nice alternatives as well. Let's not lose sight of the fact you could choose to float the exchange rate; that here is another anchor other than gold -- that is, the CPI basket, so to speak -- so inflation targeting is an alternative system in which any country can create fiat money. And it actually works very well. It -- Andy Rose at UC Berkeley has emphasized that it is actually the best-performing system in many ways; it is durable, it adjusts to shocks and so on. And it's a nice framework, a mechanism through which we can create fiat money.

It does need a little bit of an institutional capability in the country, and Benn Steil and Robert Litan have emphasized that in many countries you don't have that kind of institutional capability. So I respect the difficulties in a certain class of countries where you could not do it.

But for a large part of the world, we actually have a very clean, well-posed alternative, which is inflation targeting plus floating exchange rates.

MALLABY: Well, I want to bring members and guests in, in a second, but I want to give Benn and Alan just a chance now to wrap up this part of the conversation. If -- so, you know, Ajay is saying that after all is said and done, fiat currencies perform better than the alternative of -- I mean, Benn, do you agree with that and, I mean -- and also, as you think about this discussion, do you regard this period of tension over currencies, capital controls, et cetera, as something that we'll just get through and it won't seem significant in five years' time? Or do you think this is the beginning of some tipping point in the system?

STEIL: I think it is the beginning of a tipping point. Alan brought up the problem with the so-called Triffin dilemma earlier. Robert Triffin in 1960 gave very famous congressional testimony where he said: Well, look, this system that we're operating in -- under right now is inherently unstable. The United Sates will always create one of two problems. Given that the U.S. dollar, our national currency, is THE international reserve currency, the U.S. will either produce too little liquidity for the world, which will cause a crisis, or they'll produce too much of it, which will cause a crisis.

But the regime would always oscillate between the two crises until you changed it. And Triffin's solution was to go to the Keynes idea of having an international fiat currency. His chief intellectual nemesis at the time was the French economist Jacques Rueff, who said: No, nonsense. The whole idea of a Bancor he described as nothingness dressed up as currency. We had to go back to the classical gold standard.

And both those concepts are indeed extremely radical, but I don't believe that anybody's ever identified a coherent system that lies somewhere in between. So I think there are ways that we, as the issuer of the international reserve currency, can mitigate the likelihood of crises, like we're going through now, in the future. But I think the system is inherently prone to the sort of problems that we're experiencing.

MALLABY: So we've -- we're living in an incoherent world, but it's been 50 years since the incoherence was pronounced in (Congress ?). Will we carry on, Alan, or will it -- are we reaching a tipping point on the system?

TAYLOR: I'm thinking very deeply. And my wife is a medievalist, so I'm always reminded that it's been an incoherent world for, like, a millennium or more. (Laughter.)

But, I mean, there's a -- there's a serious point here, which is, you know, is there a system? Should there be a system? Can there be a system? You know, we like to teach our courses to undergrads saying, you know, this -- the gold standard system, Bretton Woods and, you know, the idea that someone or -- you know, someone's in charge, whether they have a black helicopter or not. It's the lifeblood of, you know, our courses, (mainly ?) at the Council on Foreign Relations.

But in some sense, you know, countries will pursue self-interest. And it might be difficult, as we see from Europe and other instances, to actually make some kind of coherent system work. What we really want, though, is, like, something that's stable and durable, isn't prone to crises and permits, you know, exchange and trade and other good things to happen.

And the present, quote, "system," i.e. nonsystem, has done a decent job of doing that for the last 30 or 40 years. People thought, when Bretton Woods collapsed: Oh, no! Floating exchange rates. It's going to be the 1930s. We're going to have another Great Depression. And then, you know, life went on and trade kept on growing, maybe even accelerated, and economic growth resumed and we have the new industrializing economies and -- (inaudible). Maybe that was overblown.

So, you know, I think we need to be cautious about thinking we absolutely have to solve this and this is some great crisis. Clearly there are tensions. The -- if -- the main tension is if the emerging markets want to go on, you know, accumulating infinite dollars and -- the Triffin dilemma is there, is sort of behind that -- we may have a problem. Those imbalances may continue in a way -- in a way that's problematic.

But I -- but I do see, you know, trends pushing in the other direction. We don't really know how countries will graduate from emerging (states ?) to developed. Another factor pushing in the direction of fear of floating and lots of reserves 10 or 20 years ago was that they couldn't issue bonds in their own currency. And they had a huge mismatch in terms of the currency, the liabilities and assets. Well, the currency mismatch is moderated, partly because of the accumulation (of/on ?) official reserves, which, you know, creates other issues. The reserves are mostly in the public sector, while a lot of the liabilities are still in the private sector.

But another thing that's ameliorating the problem is that many countries can issue domestic currency bonds now in international markets. And, you know, every morning I'll go to meetings at Morgan Stanley and we're hearing -- Peru has just issued, you know, a domestic currency -- Peru has issued a domestic currency bond, with overwhelming demand for that bond, right? And that's helping these countries get away from needing quite so much in terms of precautions. Just like a few weeks ago, you -- it wasn't -- it wasn't a peso bond, but you had Mexico issuing a 100-year bond -- 100-year bond. You know, I -- my head starting spinning as I thought back over Mexico's 200-year history and what Reinhart and Rogoff and others have pointed out.

But, you know, in some sense that's progress, right? And so we're taking away some of the roll-over risk and other problems. So, you know, one can be optimistic and think some of these countries are graduating; that to some extent they're taking responsibility for their own problems through self-insurance. They've learned from their mistakes of the past just as we did. We're now -- we're all -- we're all emerging countries, right? We just had a massive financial crisis and learned -- you know, we got -- we got some sort of comeuppance and learned that history doesn't -- that it doesn't sort of go away.

So, you know, I'm kind of optimistic there, that we'll just -- that we'll just progress down this track and the imbalances will ameliorate and our system, such as it is, will continue to function without massive intervention. We'll just have the sort of, you know, amusing moments when people panic and say "currency war." And it's entertaining to get the newspapers going, but that's just, you know, part of the great rich tapestry of economic life.

MALLABY: Okay. Well, so we're going to muddle through happily.

At this time, we'll open it up to members and guests. I should have said at the beginning that this is on the record, so sorry I didn't say that before. So if you have a question, please put your hand up and wait for the microphone, speak directly into it.

Do we have any questions? We have one right here in the front, I think.

QUESTIONER: Thank you. Marcus Mabry from The New York Times. So I suppose I could be accused of being one of those newspapers that benefitted from it all. (Laughter.)

I'd like for you to take the opposite view, though, and tell us what do you see, though, as the genuine shocks here in the short term -- because obviously, we do make some money talking about those. (Laughter.) But which ones do you think are really valid? Because I assume there are some you do find valid -- valid risks in the short term.

MALLABY: Well, if it bleeds, it leads. Please provide some blood. (Laughter.)

No, seriously, what -- if you had to predict what the flashpoints might be in the next six months of monetary diplomacy, I mean, how do you see -- how do you see the Financial Times headlines?

TAYLOR: For me, the main downside risks are the European problems are not contained in a -- in a sensible way, and a trade war. I would say those are the two major downside risks. They're hard to quantify, but I think they're definitely there.

MALLABY: Let's go over there.

QUESTIONER: Steve Robert.

I'm intrigued by Alan's somewhat sanguine outlook toward -- to all this, in that we might just sort of muddle through it without needing too much change. But the one country that's become the poster child for currency manipulation, and takes an enormous beating in the press and in other places, is China. So to what extent do you think this is a valid criticism and to what extent do you think the rest of the world should put more pressure on China to let their currency adjust?

MALLABY: Do you -- Ajay, do you want to take a crack at that, and then --

SHAH: I think China matters more than meets the eye, not just because of the size of the Chinese current account deficit, but because there's a whole bunch of political responses across the world that are being shaped by the Chinese exchange rate. Exporters in lots of countries turn around to their governments and say, "Look at those guys. We need you to do the same." So I think that's the real significance of China; that if we could see some important changes in China, it would change the politics of exchange rates and trade protectionism in lots of places, and that's important.

MALLABY: That, by the way, is an issue which I think comes into the third session as well, where, you know, if the Chinese government is assisting Chinese companies in exporting, with key credit or near-free infrastructure support, tax breaks and so forth -- you know, they decide they want to take over the soda industry, and so there's huge government backing for soda companies; it does change the dynamic internationally, where other soda companies are going to their governments and saying, "Hey, you help us, too." And so you get a sort of -- but that -- so I think there's a linkage across our sessions there.

Did you want to say something, Alan?

TAYLOR: Yeah, I think the criticism of China is a little unfair, and I -- you know, they've had a fixed exchange rate for 16 years, and we didn't criticize them for much of that period. And we -- the criticism seems to go up when we've got problems of our own. So some of that is endogenous and reflects other features.

And I think going forward, you know, they are letting the currency appreciate -- not as fast as other people might wish. They do have inflation pressures. We know when a developing country grows, its price level in dollars will rise. That means either domestic inflation in their own currency, or an appreciation. And, you know, the Chinese leadership and economic advisers are aware of the laws of economics and that this is an almost ironclad rule and that it will happen. And I'm sure they want to contain inflation, and they will find a mix.

But I don't -- I don't think it's, you know, beneficial or wise from a sort of economic or financial statecraft point of view, if I can use that term, to really browbeat them about it. I think -- I think it's -- you know, that they have their place on the world stage, and we need to deal with it diplomatically. And I'm not sure we've always accomplished that, especially in recent weeks, heading up to the G-20.

And, I mean, there's sensitivity there, when other world powers -- you know, there's a perceived slight -- or even former world powers. I remember when the British delegation was there last week. It was Remembrance Day, and the Conservative ministers were wearing poppies. And this was taken as a huge insult by the Chinese that some -- you know, that -- (laughter) -- so, you know, if that's going to cause trouble, you know, then saying a few harsh words about their currency is going to lead to explosions.

But my sense is, if cool heads would just prevail, I think the adjustments are taking place in the right direction, and QE2 is part of that. And, you know, there'll be a letting off of steam from various quarters, but eventually the reconfiguration, you know, will occur.

QUESTIONER: But if you go back 15 years ago, China was a very -- if you go back to 15 years ago, China was a very small economy. Today it's the second-biggest economy in the world.

MR. : Yes.

QUESTIONER: So --

TAYLOR: Ajay's point about the macro weight is important. It's --

QUESTIONER: Yeah, so isn't that -- isn't that a great imbalance, to have the second-biggest economy in the world with 3 trillion (dollars) of reserves, I think he said, manipulating their currency, not letting it basically float like all the rest of the big countries are doing?

MALLABY: Benn, do you want to attempt --

STEIL: Yeah. Bringing up Keynes again, Keynes -- Keynes's biggest gripe about the international monetary system was that there was never any fundamental pressure on a creditor nation to adjust. I think he unfairly tarred the gold standard in that regard, because under the gold standard the creditor nation was supposed to adjust, but the point was that they never HAD to adjust. And if he were here today, there's no doubt that he would support some mechanism to force China to adjust. Under his plan, for example, creditor nations would actually be fined by his version of the IMF for building up excessive credit.

Now, as a matter of financial statecraft, I don't think we're ever going to get to a world where we can -- we will have that sort of institutional pressure on a creditor nation to adjust. The pressures in the financial markets are always on debtors to adjust.

TAYLOR: Just think -- I mean, in Europe, are we going to get a system where Germany taxes itself for running a surplus? Or is it just going to be we must tax and have penalties like in the Stability and Growth Pact for the naughty deficit countries? Is there going to be any sense that the surplus countries have some role to play?

And I think if you can't achieve that kind of Keynes-type plan within the superstructure of the -- of the EU or the euro zone, to imagine it at the global level is --

QUESTIONER: (Off mike) -- deficit on -- (off mike) -- countries. That's different than getting -- (off mike).

MALLABY: Well, let's -- I want to move to another question, but let's just give Ajay one chance on that, because he said something before we walked onto the stage about, you know, is it true that 10 percent or 20 percent misalignment in a currency really has a big effect on trade outcomes?

SHAH: I don't work in that field. But the people who are very closely studying the trade data and asking questions about aggregates and (stabilities ?) of trade through exchange rates are really not finding a whole lot there. The effects are remarkably small. So I see a certain gap between the evidence and the political rhetoric. I think the politics is very real. In any country you go to, you will have a bunch of people screaming at the politicians that, oh, this exchange rate is not good for me. But the evidence over a large number of countries for large numbers of years shows fairly modest effects. So I think that the magnitude of the impact of exchange rates on trade is a bit overstated.

STEIL: In fact, I'd just throw in that Keynes actually agreed with that. He argued in the 1940s that, given the so-called "terms of trade" effect, that Britain would get virtually nothing, if anything, out of devaluing. So he was not in favor of a floating-exchange-rate system. He was in favor of a fixed-exchange-rate system, with adjustments when there was a quote-unquote "fundamental disequilibrium." Would he have declared the current status quo in the world as a fundamental disequilibrium? Absolutely yes, he would have. But he would not have supported floating exchange rates on that basis.

MALLABY: We have a question over there.

QUESTIONER: Deryck Maughan, KKR. Is it China's fault that we've only had a current-accounts surplus once in the last 30 years? Is it China's fault that we have deficits with more than 60 countries, not just one? Is it China's fault that we're on a fiscally unsustainable path and critically dependent on capital inflows to keep the economy going? Do we owe a vote of thanks to the world's central banks, who now own more than half of the U.S. Treasury debt, recognizing that they'll -- they will very likely take very large capital losses simply to keep us afloat? Would you agree that the United States is the largest systemic threat and it's time to stop blaming China?

MALLABY: Okay, so we've talked enough about China, but that is a -- (laughter) -- cue to talk about QE2. I mean, I take the question to be really about quantitative easing, which we have not addressed. In other words, is the U.S. to be blamed for -- more than China for any potential instability to the U.S. economy, I guess is what the question -- (inaudible).

MR. : I love the way you turned that question around. (Laughter.)

(Cross talk.)

TAYLOR (?): Yeah. And in terms of truth in advertising, to directly answer the question, yeah, it takes two to tango. But QE2 -- I mean, Ajay's point is absolutely valid. And I was talking to Dick Burnham, my colleague at Morgan Stanley, and, you know, people have run the various models.

If you think about just the magnitude of depreciation that people would like to ask China to do, it's probably outside the realm of reality, and then you crank it through the models, how much of a change in trade balances or current accounts is that really going to deliver, it's not that huge. So QE2, you know, it's going to work through various channels, and it's kind of the last, best hope, because what's happening in terms of fiscal and other policies that can turn around the United States economy right now; not so much. Even the Fed is now coming under attack, which is obviously very worrying, for someone like me, at least.

So, you know, we have still a broken financial transmission mechanism. Banks are not lending. Many of them are still repairing their balance sheets. Households are repairing their balance sheets. You can ease financial conditions a bit more. You can move the yield curve at the long end a little bit more. Maybe that's partly signalling just saying I really am committed to low interest rates for been longer than you thought. And then you can hope for help from the rest oF the world. It is marginally going to weaken the dollar. I guess that's the hope. but it's the unintended, or at least unspoken, consequences, as Bill Dudley (sp) pointed out in remarks this week.

So there's a direction. However the U.S. is just issuing very conventional monetary policy like in the textbook. You know, you have an asymmetric shock, you're in a worse position than other countries, you're going to have more expansionary monetary policy; and as a, quote, "side effect," the currency will weaken, and you hope that will stimulate aggregate demand. It's just unfortunate we're in a position where many of the transmission mechanisms through which that will work are just somewhat impaired. but it may be the only game in town.

STEIL: There is another perspective. Certainly that's the one that's shared by the Fed and the administration, but there's another perspective that I would characterize through this analogy. Say you turn on your shower in the morning and there's very little water coming out. You call the plumber and he says, well, the problem is you have a hole in your pipe. And you say, well, how much will it cost to repair it? And he says, $10,000. And you say, well, forget about the hole, then; just turn up the water pressure.

And that's what we're doing. We have, in my view, a broken credit transmission mechanism. The problem is not that the Fed is not providing too much liquidity; it's that it's not translating into credit for the businesses that need it. Small and medium-size enterprises in the United States are overwhelmingly dependent on small and medium-size banks for their lending. These banks still have very seriously impaired balance sheets.

So the fact that in principle they can borrow from the Fed at virtually zero interest rates is not, for them, an incentive to expand their balance sheets by making loans. And until we address that problem, we are going to be dealing with all the side effects from turning up the water pressure.

What are those side effects? Well, bubbles. And we're seeing the possible emergence of some serious bubbles now, for example in various commodities markets and in emerging markets.

I agree with you, Alan, in principle that it's a good thing if Peru can legitimately and sustainably issue bonds in their own domestic currency, but I would suggest that this is an effect of yield chasing because of the fact that credit is so cheap now and yield is so low on conventional assets, and that this is probably not sustainable.

And so that's the potential downside of QE2, in my view.

MALLABY: Another question. Anybody else. Okay, one over here.

QUESTIONER: Jorge Mariscal (ph) from the Royalton Group. I think maybe parts of this question have been answered, but if the final mix for U.S. recovery entails a weaker dollar, and if this is -- the final mix is required, then the world will just have to adjust to that, and the tensions we're living today are part of that adjustment.

I figure that if there is no weaker dollar, what is you're going to see is deflation in the United States. Real wages and the price of things are going to go down anyway, so they either go down nominally or they're going to go down really. And so the fight here is to prevent or to smooth out that path. But I guess my question is, concretely, do you see a weaker dollar as part of the solution, in the end, despite all the screaming and kicking that you're hearing from other nations?

MR.: Ajay, do you want to take a crack at it?

SHAH: So, I think that the dollar's -- I think that the weaker dollar is a part of the solution and that a weaker dollar is the way we are headed. And I guess the interesting feature of the Chinese question is how that weaker dollar is played out in respect of the counterparties. So how much will happen at the euro? How much will happen in the Korean won? How much will happen in the Chinese renminbi? I think that is the interesting dimension.

So that's a story that is being played out in the currency wars.

MALLABY: To some extent, you could get this adjustment by having not deflation here but low inflation, but then really quite considerable inflation in emerging markets, which you're -- which you're seeing. And you're nodding on that.

TAYLOR: Yeah, I mean, in the long term, we know, just as a, like, ironclad law, that when countries develop, their price level goes up in dollars. So in real -- in terms of real exchange rates relative to the emerging markets, we're going to see the dollar weaken. Relative to other developed markets, not so clear to me.

In the short term, though, because the U.S. is -- economy is in a weaker position, I'd expect that a weaker dollar in real and nominal terms in the short term to be part of the likely recovery strategy. But as was pointed out, whether that plays out through the price level or nominal exchange rates, I don't know. There's considerable uncertainty around any of these forecasts because a lot depends on, can the Fed pull out an exit strategy from this large balance sheet without igniting inflation? I personally don't think we're going to see double digit or anything scary, but it will have to manage it, possibly, within a wider range than would have been previously, you know, anticipated.

But there are similar issues like for the euro zone, right? It's bought a lot of Greek and Irish and other countries' debt. Is it going to have a hole on its balance sheet? It's been supplying a lot of liquidity to Irish banks. There are all kinds of facilities there that might need to be unwound. Some of them have been sterilized, but still, they've got to manage a big balance sheet. The Bank of England has pursued QE. Japan has been trying, you know, all manner of things for 20 years, to variegated effects.

So I think in terms of nominal exchange-rate movements, all of the G-4 and the big countries have, like, question marks over them in terms of what kind of volatility you will see, but I'm pretty sure we'll see volatility.

MALLABY: Any more questions? Yes, Steve.

QUESTIONER: Steve Fried (sp) -- (inaudible) -- Capital. You touched on the euro and the potential risk there. To the extent that you do have some players in the euro who have not been able to meet their mandated deficits, to the extent that it doesn't look like they're going -- it's going to be possible, to the extent that they've misrepresented their current position, what do you think should be done with these players, and what do you think will be done, and how will this ultimately unravel?

TAYLOR: Sir, I mean, I think the great conundrum or problem for the euro zone right now is that they've set up a common currency and also wanted to have a no-default zone. And the realization in recent weeks has been that we can't have a no-default zone. And one can imagine the political economy behind that, which is we want to be taken seriously as a new currency, have credibility; can't we just get everyone to play by sensible rules and not have bad outcomes?

But unfortunately, given both public- and private-sector behavior -- the public sector in Greece, Portugal; private-sector bubble in Ireland and Spain in housing and so forth -- they ended up with countries that, you know, went off the rails a bit in terms of sustainability and borrowing.

So I think that's one of the big unknowns about Europe, is how will that be resolved? There's talk of this crisis-resolution mechanism. They went far down the road in terms of wanting to have haircuts. They're backing off a bit now and thinking about how they will restructure some rules about how a country can go into some kind of structured or organized default.

But I think, eventually, you know, history says occasionally, you know, debtors default, and that's like life, and we have to come up with a way to just manage that in a reasonable way. And I think that's where the euro zone will end up, and you know, that'll be okay. I mean, we talk about the Peru bond. You know, it'll have risk. All credits have risk, and just because we're living in a savings glut world doesn't mean that everyone's chasing yield now in the naive -- the naive view that yield is always safe. It comes with risks. And, you know, we've just grown up a bit, or maybe we learned a lesson we should never have forgotten. And those same lessons will apply to the euro zone too.

MALLABY: Benn, you wrote a nice piece about the lessons from the financial crisis in terms of domestic regulation. And it strikes me there's a parallel here, which is that orderly resolution mechanisms are extraordinarily hard to implement, because in a time of panic, the systemic risk consequences -- that the risk of contagion from actually making people take a haircut, take a loss, is so big that people often just blink.

And so you can have an orderly resolution mechanism; in the case of American deposit-taking banks, it's called the FDIC. But whether the Treasury in the moment of truth was willing to actually use that mechanism after Lehman went down with WaMu and actually make the bondholders of WaMu take a haircut, the truth is we know that they were ready to flinch and to have public money go in to facilitate the rescue. So that was an example where you had a resolution mechanism but you didn't have the guts to implement it.

In other cases you don't have a resolution mechanism. For example, in Long-Term Capital Management in 1998, there was no resolution mechanism for hedge funds. But, you know, the government didn't put public money on the line because it was an environment where they actually did resolve it by convening people at the New York Fed. Without there being a mechanism to do it, they did it.

And aren't we seeing the same thing now in Europe, where, you know, you can talk about a resolution mechanism, you can theorize about it, but when you actually are confronted with Ireland and you try to use it, everybody panics, the Portuguese start screaming, and you can't -- you don't have the guts to do it?

STEIL: Absolutely. In fact, the EU is trying to have its cake and eat it too on this particular issue. They're saying, "Right now don't worry; we're not going to let anybody fail. But just you wait: In the future, in a few years' time, private investors are going to have to take a haircut." And of course that caused a panic in the market, because investors say, well, those countries are asking us to buy their bonds now, which they're planning to pay back in the future, and you're saying that we're going to be at risk in the future. So we're not going to buy the stuff now. So creating an orderly restructuring mechanism -- it can -- exceptionally difficult to do.

My personal view is that you've got to have what we economists call a corner solution. You can't -- you either have to say that the public -- the private sector is at risk and caveat emptor, or you have to say that we're not going to allow any failures. Why? Well, consider the Northern Rock bank run in the U.K. The U.K. had deposit insurance, I believe, on, what, 90 percent of the deposit(s)? Well, depositors are going to run for their 10 percent. So if you're going to have deposit insurance as a mechanism to stop bank runs, it has to be a hundred percent, at least up to a certain deposit amount. Otherwise you may -- you might -- may as well not have it at all, because it doesn't achieve the purpose.

So the -- what the EU is trying to do now in my view is exactly parallel to the U.K. deposit insurance scheme before this crisis. And they're going to be forced to revisit it.

MALLABY: Let's take one last question. I think there was one right here.

QUESTIONER: Thank you. I'm Vincent Lauerman from Energy Intelligence. I've heard a lot about economics today, but not a lot about politics. I'm just kind of curious: The House of Representatives passed a bill before the midterm elections in which a countervailing duty would be imposed on countries that were perceived to have a(n) undervalued currency. I guess, really, this is a two-part question. The first part is, is it likely that the Senate will pass a similar bill? And if so, would it be veto-proof? And at the same time, what would that -- and this -- the second question's for Alan, and that is, what would that do to this gradual improvement in global imbalances if the Senate did pass such a bill?

MALLABY: Okay, well, on the -- on the political thing, I think the Senate prediction is that they would not pass it, although the corollary to that is that after the tea party -- I mean, the tea party's views on foreign policy, including trade policy, are pretty obscure.

So I think it's -- but you want to give a last comment? I mean, it sort of dovetails to what you were saying earlier about would we rather have a currency war than a trade war. Maybe the currency war would lead to the trade war. That's a good thing to end the session on.

TAYLOR: Yeah, I hope we don't get to a trade war, and I think the -- as I understand it, the political equilibrium at the moment suggests that it won't clear all the hurdles, which, you know, I think would be a good thing. But if we start going down the route of imposing those kinds of protectionist measures, it will just open up a big can of worms.

Even, I mean, the Brazilian finance minister himself -- you know, he's quite a media star. He got on the front page once saying it's going to -- that we're in the middle of a currency war. Then he got to come back the next day to sort of explain himself. And in the -- in the second press conference, he said: Well, what I really meant to say was the currency war is bad, but what would be really bad would be a trade war.

So everyone understands that that's like where we don't want to go. And I think at the -- at the international level, we're kind of fortunate that, unlike in the 1930s, it can't really be such an unrestrained free-for-all, because now we do have the WTO, we have mechanisms and institutions in place that will try and protect, you know, the status quo and try to prevent countries departing and just doing unilateral stuff.

But, you know, Washington is Washington, and anything could happen.

MALLABY: Okay. Ajay and Alan, thank you very much. We're going to stop you there.

We're coming back at 10:00 a.m., for the Lawrence Summers session. Thank you. (Applause.)

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THIS IS A RUSH TRANSCRIPT.

EDWARD ALDEN: (In progress) -- bilateral trade agreements which have been sitting out there for several years now. He set a deadline for trying to get the outstanding issues resolved with Korea. I must admit, I was a bit surprised. And our panelists may be able to shed some light on this, on why the administration would set a deadline and then failed to get a deal and even looked like they failed to make really serious efforts to get a deal. But the Korea deal, as a result, is still out there.

And then, finally, of course, we had a midterm election, which appears to have strengthened congressional support for trade liberalization, at least in the House, which is historically where trade has been most problematic. Trade is being talked about as an area where the administration and a Republican House might find some common ground.

So I want to start with you, Doug.

Doug has been working on two books about trade policy in the Great Depression, which are out next year, and wrote a fine intellectual history of free trade which a number of you may have seen.

Doug, to start, how would you assess the current state of the U.S. trade policy? If we, say, have it at a positive extreme, the leadership that led to the inclusion of the Uruguay Round -- at the other extreme, Smoot-Hawley and the various other Depression-era measures -- where do we stand currently?

DOUGLAS A. IRWIN: Well, currently I'd say that U.S. trade policy is sort of in hibernation. And I think one of the consolations of history is that that's actually normal. So we tend to think about sort of the history of post-World War II liberalization as being this very linear process where you have GATT round after successful GATT round, that's beating down the barriers to trade. But I think when you look at the history, it's much more punctuated than that.

So I think about the postwar liberalization as being sort of the founding of the GATT in 1947, then a 20-year hiatus, then the Kennedy round in the '60s, not finishing up till 20 years after that; that's '67; then another hiatus, and with due respect to anyone who negotiated the Tokyo Round, wasn't all that consequential a round; and then the Uruguay Round.

So these are three big initiatives, but they're sort of filled with this period of relative inactivity, no big initiatives. Then you have to ask the question, so we're in one of those periods where we're sort of waiting what the next step is.

What generated those three sort of bursts of U.S. trade activism? Why did the U.S. sort of become much more of leader in just those three instances? And I think one common element is that the U.S. was reacting to perceived discrimination against its exports on the part of foreign countries. So in 1947, the major concern of policymakers was imperial preferences and breaking into the British colonial trade bloc, including Canada and other countries.

In 1962, the reason why President Kennedy pushed for the Trade Expansion Act is because of the formation of the European Economic Community and the perception that that would lead to diversion of exports away from the United States; and then, in the Uruguay Round, the importance of the sort of fortress Europe, the 1992 initiative in Europe, and expansion of the European community. That was one factor that the U.S. wanted to overcome.

So I think if we're looking for another big U.S. trade initiative, we have to think about where will U.S. commercial interests have a stake in trying to open up markets in a big way, as against some sort of perceived discrimination against us? And I think that's an open question at the moment.

ALDEN: And how would you assess on the protectionist side? We've seen some measures around the world to try to protect markets in the face of the economic downturn, but certainly nothing like we saw in the Great Depression. How would you assess the levels of protectionist response we've seen in the face of the crisis?

IRWIN: Well, there's a very interesting comparison between sort of the 1930s response and the current response in terms of trade policy. And I think the major change there has been that policymakers have so many more policy instruments with which they can address the economic downturn now as opposed to the 1930s.

So the problem in the 1930s was most governments were on -- countries were on the gold standard, so they didn't have an independent monetary policy. Most of them had what was known as the treasury view of fiscal orthodoxy; you should balance budgets even in downturns, so if receipts go down, you have to cut expenditures to keep the budget balanced. So fiscal policy was off the table. And so that naturally led policymakers to turn to trade-policy measures.

And now, of course, we have fiscal and monetary policy, as well as many other instruments, to address a downturn. And then, therefore, trade policy is less important as a mechanism of trying to get the economy moving again.

ALDEN: So you would say that some of these other tools have enabled us to avoid the traditional protectionist response.

IRWIN: Absolutely.

ALDEN: Interesting.

Charlene, I want to talk to you a bit about the politics of trade. You know, I've watched this as a reporter through that period of great activity with NAFTA and the Uruguay Round negotiations that brought China into the WTO, and have also watched it in a great period of inactivity, as Doug described. And some of that certainly has to do with the domestic politics of the issue in the United States.

Why has it become so hard for any administration, Democrat or Republican, to carry out an ambitious trade policy of the sort we've seen in the past?

CHARLENE BARSHEFSKY: Well, I think there are four factors in particular that weigh very heavily now on the politics of trade and globalization. And you can see these factors creeping along from NAFTA forward. So the first has to do with the pace of globalization, particularly since 1950, and then again almost immediately post-NAFTA, where you have, because of a variety of -- for a variety of reasons, whether capital flows or financial flows, whether trade flows, the advent of technology and so on, you have a global economy that is larger. It is growing faster, at least pre-crisis, under the pressures of financial flows and technology than ever before. And the result is competition is extremely intense. That'd be the first factor.

I think the second that bears on the politics is the re-emergence of China, the integration of Asia around China as a productive hub, China's growth rate, its increasing muscularity, which countries perceive and read differently, and a China that has conducted a trade policy that is heavily export-oriented and a currency policy that is largely linked to the dollar. And the result is massive imbalances.

I think the third factor has to do with the period that the United States finds itself in, and that is a profound period of weakness as the global economy is more integrated and as China has re-emerged. That weakness was evident before the financial crisis. But with the financial crisis came an extraordinary synchronous contraction, with the result that consumer confidence plummeted, demand plummeted in the developed world. These large imbalances became more and more a target of apprehension, all while our competition has gotten tougher.

And the last factor, I think, is jobs -- jobs, jobs, jobs. We've been losing manufacturing jobs since the 1950s. We have not been losing white-collar jobs until more recently. That's one area of concern. The other, of course, is with the financial crisis came a crash to job growth, obviously extraordinary layoffs. And job growth today is tepid.

So all of those factors bear now on the politics of what will go forward, plus the fact that you have a more populist Congress. I think the jury's still very much out on what the House will be able to do. The jury is less out than on -- with respect to the Senate. You have, in general, a declining popularity in trade agreements since NAFTA. It's a clear trend; agreements pass by fewer and fewer votes with each iteration. The one exception was PNTR for China, which passed by a pretty comfortable margin in the House.

And I think, last, you have this overall concern about the position of the United States making all of the anxieties that I've already mentioned all the greater. So those are the politics that I think will bear heavily on this next push by the administration with respect to trade.

ALDEN: Just to bring in Doug's larger historical scope, do you see any of this as immutable? I mean, if you look back to the early 1980s, some similarities: High unemployment, challenge from Japan, worries about U.S. weakness and decline, and yet a remarkable resurgence from that.

BARSHEFSKY: Right. I don't think it's immutable. And whatever the perceived or real decline of the U.S., I don't think that's immutable either. And I don't think China's re-emergence is immutable -- an immutable fact necessarily; certainly not linear, necessarily.

But I do think that there is increased sensitivity now, in part greater than at the NAFTA junction, simply because of the flow of information, the awareness the public has of a world that seems to be much smaller, an awareness of job dislocation in a manner that is quite pointed.

And I think, with that and with the rhetoric that's gotten worse and worse every year about trade imbalances and unfairness, as though trade deficits were a function entirely of unfairness, which, of course, is not at all right, I think you have a tougher environment now.

ALDEN: I want to turn to Jagdish, who has recently been named by Angela Merkel and David Cameron to co-lead an experts' group, along with former WTO Director General Peter Sutherland, that will look at, among other things, ways of reviving the stalled Doha Round of trade talks.

Jagdish, with the U.S. hampered politically and weaker economically, as we've heard from Charlene, can you see trade leadership emerging from elsewhere in the world? Are the Chinas or the Indias or the Brazils or the other emerging market countries prepared to play a bigger role than they have in the past in fostering liberalization or are we still in a situation where there's no real alternative to U.S., and to a lesser extent European, leadership of the trading system?

JAGDISH N. BHAGWATI: That is a good question but I think we are still -- the United States is still the biggest Rottweiler on the block. It is true that these other countries have risen, but please look at President Obama's visit to India. Because the sensitivity by the president, because of reasons mentioned by Charlene, the Indians were strictly under, you know, instruction not to raise the trade issue at all except to talk about jobs in the United States. So we were a bit like the Japanese who don't provide leadership, even now. They used to be strong, silent men. Now they're weak, silent men. (Laughs.) But I think this is basically a kind of (blighting ?) us. And apropos of that, let me also say that when, after the Indian election and after the American presidential election, the situation changed dramatically for the U.S. and for India.

In India, the communists were put out of the coalition. So the Indian prime minister was much freer to actually move to his trade liberalization than before because the communists were hostile to trade. But in our case, it went the other way because our unions basically financed a whole lot of Democrats for the election. So people like Sherrod Brown and really lots and lots of others were elected by the unions that were fearful of trade. And here I actually have a point which I could probably be lynched by Democrats, my fellow Democrats. But just as the president -- our president, Obama is hamstrung by the fact that George W. Bush left behind an enormous debt burden and a flow deficit that was an act of commission, I think he also faces from President Clinton an act of omission, meaning President Clinton never really -- you know, personally to the unions.

I don't remember a single one ever being asked to go sit down with George Meany and his troops and say, look, is your fear of trade justified. Maybe there were a few others but all the other Democrats I know, including Paul Krugman at the time, none of us were ever asked to do that. It was all a political issue. We're getting pollsters and so on and so forth. But basically President Clinton found religion and he vanquished the unions -- right ? -- over the NAFTA vote and the Uruguay Round vote. But he did convert them. Now, it was assumed that there were finished, right? Now, they've come back and they've become a huge problem for the United States and you can't expect -- I mean, how much time does poor old President Obama have. So if only President Clinton had done the job, it would have been somewhat easier for President Obama to placate them.

So I think the point I want to make is that basically if the rest of the countries have to do the job, then we have a problem. They are still not large enough to be able to say, look, to President Obama, look, we're going to play this. I think when this group was appointed, also, which you mentioned, the attention of everybody was not to isolate, embarrass the United States but basically to compliment them and say, look, you can't play right now. (Laughs.) But the work has to be done because in the end, the U.S. cannot -- (inaudible) -- for trade. Right? This is the biggest open economy in the world. So that is where I think the idea is to try and see (that homework has been done ?) in terms of how you extend incentives against protectionism, because there are loopholes we have discovered, you know, things to fix. And then what are the different ways in which we can move forward? And there are ideas which are -- you know, which can be put forward. But I think this is important.

One thing which Charlene touched on, which I think is important, and I think this is where the China-U.S. situation, which really is also playing a big role, comes in. China basically I think we have provoked unnecessarily. I mean, it is true we were first focused on the exchange rate and as, you know, anybody who has studied macroeconomics knows, to a large extent it's the hands on the clock, it's the underlying fundamentals that are important. Like if Greece suddenly became totally -- you know, left the euro. It would still not -- it would still have the same problems, no matter what the exchange rate was, as long as there was excess spending. It would just simply, you know, make a little difference but not a great deal; same thing for China.

China was moving to its internal spending on infrastructure and so on. We should have simply said -- well, talked behind the scenes and said, look, here, do more of it, we need you to do this. Instead, we -- you know, Schumer and all these people and continuously bashing China is bound to put their back up, okay? So I think that has really been part of the problem. What we are doing now is basically essentially doing QE2 which is actually, you know, in a way we could say correctly that there's a lack of world demand. We've asked you to spend more. You're not doing it. So we're having to do it ourselves. One is sensitive to this as the exchange rate goes down, which is very different from changing the exchange rate down, which we allege China is doing, with a view to diverting a certain amount of inadequate world demand to your own goods. So there's no parallel. But why do they talk as if there is a parallel between the two? Because we really put their backs up, I think.

ALDEN: I mean, a number of issues raised here that I actually want to give Charlene and Doug a chance to respond to it. With respect to China, Charlene, do you agree with the assessment that the U.S. has been overly provocative in various ways? Is China moving in the directions we want it to move on its own or does it need more of a push and a shove?

BARSHEFSKY: I think China will do first and foremost what's in China's interest to do. This is one of the -- of its most fundamental facts. That's point one. Point two, I think the U.S. doesn't actually have a strategy with respect to China. Or if it does, it's not entirely clear to me what it is. Number three, I don't see any reason the U.S. should be shy about insisting that China play by the rules. China insists that of us all the time. I think we should return the favor. And fourth, I do think, however, that if you want to make progress with China, sometimes quieter is better and sometimes discussion of a reasonable sort is better than over very heated rhetoric.

So I think the administration now needs to sort out how it wants to deal with China. I think eventually China will move on the exchange rate because it's going to have to. This is absolutely clear. The only issue is when and by how much. And my own view, and I've said this for a long time, but for various financial crises and the European crisis, China would have already moved. It was already at that point, I believe. So it'll get there and I think the U.S., because China will get there on its own terms regardless, I think the U.S. ought to be looking at other areas where Chinese trade behavior ought to come under some greater scrutiny and focus on those areas, at least as much, if not more now more than the exchange rate per se.

ALDEN: Doug, let me ask you because Jagdish mentioned the QE2 at the end, which certainly in terms of the optics of the G20 put the U.S. very much on the back foot, to use my old British expression from my days at the FT. It's a cricket expression I learned. But if we read the fine piece you had in The Wall Street Journal a while back, which is out there for members here to pick up, you seem to indicate in that that to some extent the alternative to monetary easing and devaluation well be trade protection, and if that's your choice, you would prefer monetary easing and devaluation. Talk about that a little more. How do you see the interplay of currency and trade tools in the sort of economic situation we find ourselves?

IRWIN: Well, I think I certainly agree with what's been said about China's exchange rate and how it's sort of been overplayed as (sort of being an ?) important (goal ?). And I think I'd come back to what Larry Summers said, that it's much more important to get China to improve its domestic demand. With consumption being 35 percent of GDP, very clearly a huge outlier, emphasizing potential domestic change that they can make there rather than the exchange rate per se is very important.

But I think in terms of what the U.S. can do, I mean, there's a huge debate, obviously, about whether QE2 is, you know, the right thing to do or not, including domestically. It's not just the international ramifications. Of course, it comes back to other countries not wanting their currencies to appreciate and potentially put a dent into their export growth because of that.

But I think one of the benefits -- potential benefits of QE2 is if it can restart the U.S. economy, we'll actually start growing again and we'll actually be able to bring in imports. So one of the things we saw in the 1930s, for example, is those countries that went off the gold standard and devalued, they actually were more imports rather than fewer, because they got domestic growth going.

And I think the danger is that if we don't do something like QE2, then we're going to face a Japan-type scenario. And I know a lot of people say, well, we ought to have a hard -- strong currency. Well, Japan has a very strong currency and they're not growing and they still have financial problems.

So I think that it's sort of insurance for the U.S. in terms of trying to move in that direction. The alternative, once again, is if we don't act and the U.S. economy continues to stagnate, I think there's going to be a tendency to blame foreign countries.

And I think that's -- that's from the -- it's monetary stimulus versus trade protectionism. If we do nothing, then I think we just lend ourselves open -- open to the door to blame the other countries for our problems.

ALDEN: Jagdish, let me ask you, in the -- along the same line, in effect, to explain not the surplus of protectionism we've seen in the last couple of years, but actually the lack of it. I mean, if you look at the WTO studies that have been done, there have been new protectionist measures, but they've been pretty small, certainly compared to the size of the crisis.

I would have anticipated that in a crisis like this we would have seen far more trade protectionism than we have. Doug points to one factor -- the variety of economic tools that governments have that I think does a lot of explaining that.

How important has the WTO been? How important has the rule system been? And in that regard, how important is it to keep moving forward on the WTO front to keep that system alive and healthy and not just have a series of, you know, proliferating bilateral agreements, which you've been quite critical of.

But what role has the WTO, you think, played here?

BHAGWATI: Well, I mean, there are three "I"s which I talk about, which have really prevented protectionism from breaking out in a big way: ideas, interests and institutions.

The institutions is the WTO. I mean, when the GATT came up, it put up a whole lot of roadblocks so you couldn't have a free-for-all raising of trade barriers like in the 1930s. And that has really helped, because you could freely just -- you know, there loopholes, which are going to be fixed, which we are aware of now and more so, but that has certainly helped a bit.

The idea that somehow you could use trade barriers with the view to diverting demand from other people to your own goods -- the sort of thing we think the Chinese are doing -- that is subject to retaliation and all sorts of things.

So I think the idea has -- the ideas of change also. And the interests of change, meaning interests with -- political scientists call lobbies interest, basically. And those interests -- today, many more people are involved in international trade. I think one of the things which I'm working on is to see how from each state you have -- not just people like Caterpillar, G.E., et cetera, but all kinds of little people who are involved in export business. So if you take their input, there's large numbers of people actually in the country in different states who are actually interested in international trade. They provide the counterweight and the pulse, basically, to people who want to close markets in a more traditional -- so all three have played a role.

But WTO is essential. That's why a lot of us are worried that if Doha really doesn't get concluded in some way or the other, that in fact it'll weaken the WTO and we need that -- WTO is a functioning discipline. And you know, we really ought to look upon it as as precious as the example of Smoot-Hawley, which is a negative example to show that trade is important.

ALDEN: Just so the audience and members and guests don't think we did a bait and switch, I want to talk a bit about the midterm elections. The topic here was supposed to focus very much on challenges and opportunities after the midterms.

Charlene, what do you see as the prospects? Did the outcome of the midterm change anything fundamental in terms of the likelihood of positive progress on the trade agenda going forward?

BARSHEFSKY: I think it's a question mark. The concern on trade agreements is almost never the Senate. The concern, since NAFTA -- including NAFTA -- is the House.

And the House is a little bit hard to divine at the moment. From the Democratic side, the caucus that took the hardest hit in the midterms were the blue dogs who are pro-trade, fiscally conservative Democrat. They took the hardest hit.

On the Republican side, the big winners were the tea partiers, who in terms of campaign rhetoric, there's a question mark there -- and we have to wait and see -- could not be viewed to be globalist in temperament.

So if you look at any given trade agreement, trade agreements since NAFTA have been passed by Republican votes, largely. On the Democratic side that means you usually need between 50 and 65 votes. That's a tall order when you don't have half the blue dogs anymore and when those who were elected were elected on a further-left, more populist basis.

On the Republican side, because of the question mark about the tea partiers, the traditional reliance on Republican votes in high numbers is also a question mark.

My own view is that the Korea FTA, for example, were to be concluded substantively, thought to be doable still, but I think there are two factors that are a must. And without either one of them, don't even start. One is presidential leadership and constant support. And this is -- this is a heavy lift. And if the president wants the Korea agreement or Colombia or Panama -- but it looks he'll go for Korea first, that seems to be the preference -- it's going to take a lot of political capital on his personal part to get it.

And the second factor is exceptionally strong business community support. The rhetoric today is we're going to support this agreement, but the proof is boots on the ground and we'll have to see.

Without those two elements, I don't believe trade agreements' passage will be possible for the next two years.

ALDEN: And I want to press just a little more on the Korea FTA, because it was -- it was quite an interesting set of developments leading up to the G-20. I mean, the U.S. appears to have demanded some pretty fundamental changes to an agreement that was concluded. I mean, you know, not to get too much in the weeds, but in effect, it's a violation of it's U.S. commitment under fast track to its trading partners.

The idea was that you negotiate deals, they would come back to Congress for an up or down vote. Now, we've gone back to -- Korea demanded some pretty significant changes in the auto provisions of that agreement. And the U.S. clearly failed to get a deal at the summit. And what was the response from Congress? The incoming chairman on the Ways and Means Committee, Dave Camp, Republican of Michigan, and the outgoing chairman, Sander Levin, Democrat of Michigan -- some of them said, hurrah! Hooray for you! Way to stand up for the auto industry.

How do you get a Korea FTA through with that kind of political lineup?

BARSHEFSKY: I think it will depend what the agreement looks like and the reasons why an agreement wasn't concluded at the G-20. I don't know what those reasons were. One could take some guesses. I don't know what those reasons were.

But I do think that if the agreement will conclude substantively, it will conclude on the basis that the president believes he can sell it. If he believes he can't sell it, it either will stay unconcluded or will conclude, but he won't bring it to the Congress.

And I think on that basis, I would say it would remain an open series of issues.

ALDEN: Jagdish?

BHAGWATI: I'm not a political scientist. I'm an amateur observer of Washington. But it seems to me --

BARSHEFSKY: That's more than enough.

BHAGWATI: -- that in the auto industry, surely we've bailed out the wretched Detroit industry, right?

Chrysler has had two bailouts so this is for Chapter 22 rather than Chapter 11 -- (laughter) -- and they're doing well. So it should be possible for the person to lean on them, in my opinion, on this issue.

Beef is the harder one, okay? Because agriculture is always a hard one. But that's -- it's hard to think of that one thing holding it up.

As far as labor standards, environmental standards are concerned, I mean, those are issues which arise with other FTAs -- in particular -- (inaudible) -- recently Colombia. There's no such issues with South Korea. So if the president wants to make a -- you know, put his shoulder to the wheel, he could do it, I think. It's more doable than the Colombian one, because there, Human Rights Watch and everybody is geared up to fight like hell. And so that's going to be a tougher one.

So I think it was a good idea, if he wanted the FTAs, is to go first for -- for the South Korean one. And I think that might build up a little momentum. But we've got to -- you're absolutely right. You've got to lean on these --

ALDEN: I will --

BHAGWATI: -- friends.

ALDEN: I will say that the beef issue, though, shows how strange the politics of trade have become, because you had a beef industry that was saying, our sales have never been better in Korea; let's just finish this deal. And you had Max Baucus in the Senate Finance Committee saying, no. Unless you rewrite the rules to allow all American beef exports, I'm not going to support the deal.

So trade has been even stranger than it used to be in Washington, which is saying something.

At this time, I'd like to open it up and invite our members and their guests to join our conversation with their questions. As usual, please wait for the microphone and speak directly into it. Stand and state your name and affiliation and keep your questions short so we have lots of time for everyone.

Laurie, why don't we start up here at the front.

QUESTIONER: Hi. It's Laurie Garrett from the council. Thank you very much for your wisdom.

I'm having a very, very hard time grappling with what 21st century protectionism would actually look like concretely, absent the politics. Just, how does it play out?

Pre-World War II protectionism, American cars were made in America, steel beams were made in America, so you had control of your resources. But now with globalization, name an industry that isn't multinational in its production chain or its distribution chain or what have you. So protectionism looks sort of suicidal industrially. I don't understand, concretely, how it could play out.

The only example I see of it that helps me a little bit to understand this is how China responded with the rare earth elements, but that's an extraction industry, essentially.

So help me understand: What is 21st century protectionism?

ALDEN: Doug, do you want to take that one?

IRWIN: Actually, you're putting finger on something very important, which is I'm a relative pessimist on whether we're going to have future liberalization or -- this can be difficult to achieve, but I'm very optimistic that we can maintain the system we have.

And one of the main reasons is because of multinational investment, cross-ownership across borders and what have you.

The trade politics in the United States have changed dramatically from the 1980s. So once again, early 1980s, we had a recession, high unemployment, not a financial crisis, but very difficult times.

We had a domestic auto industry, a domestic semiconductor industry, a domestic steel industry, all wanting protection against imports. And now those industries are multinational. U.S. industry have ownership stakes abroad; foreign producers are here. And so there's not that domestic constituency in favor of raising the barriers at the border anymore. And it becomes much more subtle what protectionism is from specific bailouts or tax policy or what have you.

So I think globalization is good in the sense that it will help keep borders open, because there are fewer domestic producer interests that are in favor of raising trade barriers.

And when you add in supply chains and all of the others, that just reinforces it.

ALDEN: Can I ask along the same line to any of our speakers, should we abolish from the press the use of the term "trade war?" You know, every time there's a trade action now we talk about, is this going to trigger a trade war? And I honestly don't know what that means anymore. And has it become a completely meaningless phrase?

BARSHEFSKY: I think it's meaningless phrase, it's a silly phrase.

BHAGWATI: It's a trade skirmish. (Laughter.)

ALDEN: Because "trade war" does imply this sort of 1930-style tit-for-tat retaliation and we all go down the road to Armageddon. And it's not clear that that's --

BARSHEFSKY: I think what you have is a world where governments tolerate trade friction much better than they used to. And that's in part because there are a lot of mechanisms to resolving trade frictions, which keep those frictions, if you will, compartmentalized from other areas, typically, of international relations. So countries go well along being quite friendly, but having all sorts of lawsuits pending on trade-related issues, and most countries are perfectly happy to have it just that way.

So I think the notion of a war every time such an action is filed, when countries fully expect such actions to be filed, is kind of a silly use of the phrase.

BHAGWATI: There's one qualification or supplement to what Doug said, which is that, while producers are not going to be very keen to be wanting protection, the fact of intensified competition which you have today, which Charlene had referred to, that creates need for adjustment assistance in a very big way. Because when workers get laid off -- because workers are here. They're now. I mean, you know, for them, this argument doesn't apply.

And that's where I think China is important. I mean, we've been focused so much on imbalances and so on, but they come and go. I mean, look at how the dollar was a scarce currency, and, you know, it soon disappears.

So I think this whole focus has been terribly counterproductive. The really important thing, I think, which is about China, is that it's such a large country and such an open country -- (inaudible) -- reliant on trade that we have essentially -- it's like the image I use of Gulliver in a Lilliputian world economy. It creates tsunami waves for lots of special industries, just the way the Japanese did in the 1930s when you had $1 blouses and lots of labor-intensive goods coming out, and then we wound up worrying. That's when the phrase "yellow peril" came in.

So I think what you need to do is worry about China actually creating waves, not overall waves for us, but for specific sectors where they happen to be competitive. They're also creating waves on the import side because they use raw materials which then become scarce and affect our user industries. So it's like double Gulliver compared to the one Gulliver in the 1930s of Japan.

And I think the main thing, which is going to stay for a while, is the need for adjustment assistance to (accomodate ?) China in the world economy.

ALDEN: So it's interesting that a colleague of mine has been working on a paper about one hard-hit region in the Midwest, and the major form of adjustments is not trade adjustments, it's disability insurance. People ending up -- you know, claiming disability because it's the only program they can find that -- support them.

Further question, we'll go right to the back here and then we'll --

QUESTIONER: I'd like to go back to the question of the prospects of the FTAs in the new Congress. Charlene, you said what's always been the orthodoxy, which is, you can only get this done when you have strong presidential leadership. And we certainly saw that in the Clinton administration.

But in the situation we're going to be faced next year, where you have a new Congress, the Republicans have already said their number-one objective is to defeat the president every time they can, doesn't his standing up and making this a really important thing lessen its prospects? And is there another way to get this done? (Laughter.)

BARSHEFSKY: Well, it would lessen its prospects if you thought Republicans did not have an independent interest to see something get done. But Republicans, I would argue, have an independent interest for seeing trade agreements pass, and that is to shore up business support in the face of an insurgent tea party and concerns the business community has about that and the sway of the tea party within the Republican Party.

So I think for the Republicans who are traditionally open-trade-oriented, and who traditionally have wanted to distinguish their brand of economic growth and theory from that of trade unions, have an independent interest for seeing something get done. I think that's one of the reasons you see people saying that trade may be, ironically, one of the areas which the administration and a Republican-dominated House might be able to agree on.

Look, I still think it's a very, very heavy lift, and the way the Republicans will play this, in part, is to insist that a number of Democrats walk the plank, on the theory that, come two years from now, that walking of the plank will hurt the Democrats more than it will ever hurt a Republican.

And so that's why I say the number of Democratic votes, you know, somewhere between 50 to 65, at a minimum, because part of the price of moving forward will be, I think, Republican insistence for more Democratic votes than they reasonably believe exists.

ALDEN: Next question. Right here.

QUESTIONER: (Inaudible) -- from NIPFP. Many years ago when economists used to think about trade, the argument was that the bang for the buck in agricultural liberalization is relatively small because agriculture is a small part of world GDP and there are lots of workers. So the great focus was on manufacturing, trade liberalization.

Now, if you fast forward into 2010, services GDP has come to dominate world GDP. And in some sense, maybe we are fighting the wrong war. We're continuing to fight on problems of manufacturing liberalization. We're continuing to take interests in agriculture liberalization. But the real front here is services trade liberalization.

The Europeans have got some very interesting things going. You could be a German producer of mutual fund paper, and you could sell it anywhere in Europe, and so on. So the Europeans are trying to build a lab for globalization with an unprecedented level of competition and trade in services.

So I wonder where all this fits into our future thinking about the WTO.

BARSHEFSKY: If I could just start at least by saying that I agree with you fully. I think one of the reasons Doha holds almost no interest for the American business community is, first of all, it is heavily agriculture focused, again. Second, the manufacturing issues have not been sorted out. But in any event, there are very few businesses that will tell you manufacturing tariffs are of any concern whatsoever anymore. And third, that there's nothing in the deal on services that's meaningful, and that's where the growth of U.S. trade has been.

So certainly, I've said for some time that the next free trade agreement that the U.S. does should not be with a country, it should be cross-cutting, and that is, an FTA on services with other major services-supplying countries. And that would then be an agreement that could be taken to the WTO with the hope of further expansion by the addition of other members.

This is exactly how we did financial services liberalization in the '90s in the WTO and telecom liberalization and removed tariffs on technology goods. And that is, you start with a small core of the countries who actually trade heavily in the particular sector or area. You open up that core agreement to anyone who wants to join in under the auspices of the WTO. And in the case of telecom and financial services, you can't get in the WTO unless you join on.

So I agree with you. We're not fighting the last war. That wouldn't be so bad. We're fighting the war from a number of years ago.

On the other hand, agriculture liberalization is very critical to the developing countries. And in that regard, the U.S. and Europe ought to do the right thing. And inasmuch as we can't afford the subsidies we provide -- nor can Europe, to be frank -- those subsidies ought to be sharply, sharply reduced and curtailed.

ALDEN: Charlene, what would be part of such a negotiation on services? What would be the very sectors that would fall under that umbrella?

BARSHEFSKY: All. It would be a services negotiation.

ALDEN: So insurance, financial services --

BARSHEFSKY: You'd start with what you have in the GATTs. You'd throw in the telecom agreement and the financial services agreement, which has to be updated in any event. You sit down with Europe and Japan, one or two other countries, and you hammer out what would be a reasonable services agreement. Almost doing anything would be beyond what you're going to get out of the WTO.

ALDEN: Yeah. And you can certainly imagine the possibility of exciting business a bit more. I mean, the contrast would --

BARSHEFSKY: Oh, no, that would be very exciting.

ALDEN: -- with the end of the '80s when there were, you know, the pharmaceutical industry and the motion picture industry and financial services groups, Americans thought there was such interest in the trade liberalization agenda that you just don't see in the current agenda anymore.

Further questions? Right here. Sorry. Behind you first, and then --

QUESTIONER: (Inaudible.) I want to touch upon two disconnects that I see, given the effect of technology, number one, on the liberalization of global flow of technology, capital goods, free capital flow, it's in emerging markets, emerging countries, India, China and developing countries. The pace by which the price of commodities, raw materials and the currencies are going up and down and the volatility, on the one hand, and on the other hand, the pace by which policies are being decided by especially Democratic countries.

And to your points, comparing it to the pace by which China makes a decision, supposedly in a market economy, but three days ago, they come out with a decision, okay, we're going to cut down inflation. Raw materials collapse in three days; in four days dollar goes up like crazy. There is a bit of a disconnect of pace and timing between policy and market-driven pricing. Can you comment on how that affects their policies?

ALDEN: Jagdish, you want to tackle that one?

BHAGWATI: I mean, this is something which, outside of the trade policy framework, we all know that currency flows essentially are far more quick and volatile and so on. So I think this is one of the reasons why I think the idea that we should extend to services the notion of liberalization fully, when we are embracing financial sector liberalization, I think it's going to run into a roadblock.

Mike Moore, who was here the other day, he's now -- not the mad one, but the former director-general of the WTO -- (laughter) -- he now represents -- he's an ambassador of New Zealand. And he was saying, you know, we are going in the -- (inaudible) -- to full liberalization of services. And I said, look, you haven't lived in this country long enough, you don't know. But I mean, you start talking about opening up the financial sector to free flows, it means you haven't lived through a crisis at all, you don't have a clue.

So I said, you know, take financial services out, bring them in later. But anything like UPS, DHL, whatever you want to, non-financial services is something we can negotiate.

And I would just add one more point to what Charlene was saying, that already in fact there are lots of things which have actually been done, which have not been accounted for. Like in India, lots of things have opened up, like Credit Suisse finally opened up a full branch of its own, which was unthinkable before.

So you could actually package a lot of these things which have actually happened, and then work for a deal, right, rather than start at the telecom kind of end. So I think there's more give, but not on the financial side. Forget it. I mean, that will kill whatever you want to do, at least in this country, unless I'm reading the things that --

BARSHEFSKY: No, I think -- look, I think you could -- well, financial services has been done once, and there was quite a bit of liberalization. That needs to be updated just because prudential rules are very different now and so on.

But I do think -- and I think that can be done. And the services sectors of course encompass an extraordinary array of things. And it just seems to me that's where the growth is, that's where countries really have not liberalized in accord with any plan for convergence along the way.

All the Uruguay round did in services was basically a fancy standstill. Just don't do anything worse than what you're doing now. But that didn't bring services regimes in concordance.

And so I think there's a lot to be done there, which would be much more productive, a more productive use of time than manufacturing tariffs which are really not the issue.

ALDEN: And might be politically easier, because services liberalization is so complex that nobody can begin to understand it. So probably good to have -- (laughs).

BARSHEFSKY: Well, it's complex, and it may be easier in general because you tend to have -- and this is a gross generalization, but I think this is right -- you tend to have substantial leadership on the services sector side through various trade associations and so on, that are quite pro-trade and want the opportunity to be able to export or operate cross-border in some fashion.

BHAGWATI: With the views you have, Charlene, on manufacturers, you wouldn't get a job with Jeff Immelt, I'm sure. (Laughter.)

BARSHEFSKY: Good thing I'm not looking.

ALDEN: Do you still have a question, sir? Wait for the microphone.

QUESTIONER: Yes. In discussing the --

ALDEN: I'm sorry, could you just identify yourself quickly.

QUESTIONER: Abe Katz, former president of the U.S. Council for International Business. In talking about the politics of trade, Charlene, I think we have to spend more time understanding the role of the trade unions in all this. It's not because they got the wrong idea. They're in a quandary. They've lost members because the whole character of industrialization in the United States has changed. They won't get -- they need members. They won't get card check, so this is the only thing that they have, is stopping all trade.

My experience has been unfortunately they don't want any -- they'll fight any move to liberalize trade. There isn't a way that you can convince them that trade will be good.

And I really wonder, when you said, Charlene, depends on whether the president can work with them, whether this president will want to override the union. This is a question, his own ideology and (conscience ?).

But as far as trade unions are concerned, I have a question for Jagdish. You're going to try to resuscitate the Doha round. We always believed that in order to have a multilateral trade negotiation, you need fast track. The one thing that the unions will be absolutely opposed to is fast track. They'll try to kill it in a number of ways.

What's the strategy? Wait for a Republican president or a president who will squelch the unions? I'm curious as to how you see the future?

BHAGWATI: Charlene is the expert there.

BARSHEFSKY: Well, thanks a lot. (Laughter.)

ALDEN: And I'm actually going to put Doug on the spot afterwards, just on the history, because the unions used to be a lot more supportive of trade liberalization.

Go ahead, Charlene.

BARSHEFSKY: (Inaudible.)

ALDEN: Well, why don't we start that, and then we'll put you on the spot on what the president should do.

BARSHEFSKY: Okay.

IRWIN: Actually, unions were typically neutral prior to World War II. So the AFL conventions in the 19th century and early 20th century, they took no position on trade, because they were an umbrella organization for so many individual unions, and each individual union had its own interest depending on the export orientation or the import-competing nature of the business they were in.

But really, you know, it did change in the late '60s, because that's when, you know, there's sort of this delay in terms of we had the GATT in '47, Europe was still recovering, Japan was still recovering. It was until late '60s, early '70s that major industries began to be really adversely affected by foreign competition. And that's of course when the unions stepped right up and came in.

And once again, the timing of when the unions changed their positions very much to avoid import competition, so the United Auto Workers was very late in the mid to late '70s, whereas the steelworkers in actually the late '50s were already complaining about trade. So it's very individual specific.

ALDEN: And what are the prospects now, Charlene? I was reading this morning, and it may just be a dodge, but Richard Trumka was leaving open the possibility that they might not oppose the Korea deal. (Didn't say ?) they'd support it, but said they might not oppose it. What --

BARSHEFSKY: Right. Yeah, look, the key, in terms of Democratic votes, the key is not union support. The key is simply that a vote for the agreement will not be counted by the union as among the key votes against which the union will measure whether you should be supportive or not.

So neutrality by the union isn't even needed. It's just not actively opposing. So that's a lower threshold, obviously, than having the unions decide that trade is a good thing. That's the first point.

Second point is, I think that the union movement has to consider whether it's in their interest to weaken the president if the president decides he wants to do this. And -- yeah, the Korean deal, especially.

And third, I think there are a number of arguments, particularly pertaining to the Korean deal, that are quite effective, including with respect to the union, having to do with national security, having to do with reinvigorating U.S. relationships and alliances in Asia, particularly now. Those are also very effecting arguments particularly to union members and more liberal Democrats.

So the threshold isn't as high as might be suspected. Having said that, it is really tough. And the president does have to decide whether this is how he wants to use a large portion of his political capital.

ALDEN: Further questions? Right here.

QUESTIONER: This -- I'm not sure -- (Inaudible) -- International.

ALDEN: Thank you.

QUESTIONER: I noted that there is much, I guess, view that the financial sector, you know, should be left out because it's going to be politically difficult. And I agree with that assessment. But it seems to me it's a very important sector, and there is much going on there in other fora, the BIS, all the industry associations on bond markets. And it's quite crucial to how competitive advantage of financial sector companies evolves.

There's a great fear that the regulation that's done at national levels in response to the financial crisis, that there will be a destruction of the level playing field. So I would just wonder if you have any comments or thoughts on how to try to move this to a more balanced, sort of level field.

ALDEN: I guess the question is whether this falls inside the trade system or whether it's just better to handle it in other forums.

BHAGWATI: I think it -- I mean, it should be left to other fora. This is like the, you know, the issue in the GATT's agreement on trade and services, what we call Mode Four, meaning provision of services, movement of natural persons. By "natural" they didn't mean ruling out Frankenstein and other unnatural persons. (Laughter.) They're just excluding forums, actually -- (inaudible).

But that is something where even liberal Democrats like Dianne Feinstein have the view that the flip-side of that is immigrational, temporary or permanent, so it should be dealt with in immigration debates rather than this part of trade. So that's exactly the, you know -- which is a perfect forum where it's just more important, more likely you'll get something accomplished, right?

BARSHEFSKY: Agreed, totally.

ALDEN: Yeah, and it's certainly true that the Uruguay Round put a number of issues out there on the trade negotiating table. And it's not clear we can move on all of them. I think the reach, in some ways, probably exceeded the grasp.

We probably have time for one or two more questions before we break for lunch.

We've silenced the audience.

BARSHEFSKY: There you go.

ALDEN: We've solved the entire -- (laughs) -- Sebastian, you've been integral to this whole event, so a good final question.

SEBASTIAN MALLABY: Sebastian Mallaby from the council. So one issue which might come up in future, you know, in this debate about 21st century protection, is raised by Charlene's comments to The Wall Street Journal in the story they ran yesterday about China, where you were talking about the way that the government was backing Chinese companies with cheap financing and so forth. And this came up in Larry Summers' comments, too.

And so I guess maybe a set of disciplines around government subsidies, implicit and explicit, might be a new frontier, particularly -- and of course, they bleed into questions about national security when you're dealing with the government that's doing the subsidizing being a potential rival, not just economically, but strategically.

So perhaps you could elaborate a bit on that. And I'd love to hear also what the others are thinking, too, about whether this is a proper part of the trade debate, this question of state capitalism.

ALDEN: And the issue has been raised of competition policy. How far should trade get into the realm of domestic competition rules?

Charlene.

BARSHEFSKY: Well, look, the issue of governments heavily subsidizing industrial sectors, indeed, going so far as to create them, is dealt with very well under existing trade rules. This is the case against Airbus which is an entity created and then financed by certain European governments.

It's the situation with respect to steel, particularly in Europe, but also Korea, where industries were financed heavily by their governments.

And so, too, in the case of China or any other country, including the U.S., that heavily subsidizes industries or creates industries that weren't there. These are already practices very well dealt with under WTO rules.

The rules process ought to be -- the dispute settlement rules process ought to be enhanced, in my view, by providing for injunctive relief, so that if a case is pending, a government is forced to stop doing what it's doing. And this is, I think, an unfortunate gap in the rules that needs to be corrected.

But having said that, I don't think new disciplines on subsidies are needed so much as governments acting on the subsidies they do find, and taking these issues to the WTO for appropriate resolution.

ALDEN: Doug, have you --

(Cross talk.)

Yeah, please.

BHAGWATI: The whole point about this is the green subsidies.

BARSHEFSKY: Yeah.

BHAGWATI: They actually were not actionable until '92, and then they were removed from that. And so I think we'll have a problem to get back to it, because I think everybody's really wanting to subsidize, you know, green technology. So we probably should put it back into a non-actionable box. Because I think --

BARSHEFSKY: Well, I'm not --

BHAGWATI: -- there's universal agreement on that, I would say.

BARSHEFSKY: Yeah. On that, I'm not sure about, because you have a situation where there's already a concentration of productive and other capacity; in the case of solar, for example, most notably with respect to China.

That in and of itself will squeeze out other competitors because, you know, solar panels and so on, it's a scale business. That's all. It's a scale business. If you don't have the scale, you aren't going to make it unless you're a highly innovative or a highly particularized product.

But for basic stuff, scale is everything, and scale will be largely located in China.

And so for industries here that are then forced to source offshore, or who would like to have gotten into the business, the issue becomes, I think, one that's appropriately subject to WTO rules.

ALDEN: Doug, maybe I'll give you the last comment. Are there any kind of historical precedents for the sort of challenges that the U.S. and Europe and others face in dealing with Chinese state capitalism? Is there any way to help us sort --

IRWIN: Well, I just want to make two points. One is that there's a subsidy agreement through the OECD in the 1970s, because exactly the same issue came up. But the major issue -- so it was just the OECD countries. But the major difference is that then the subsidies were on the books, they were explicit government subsidies, they were identifiable and actionable.

The problem with China, I think, is a lot of these subsidies are implicit through the banking credit system and the state-owned banks. And who you channel credit to and what the price of that is, that's very hidden, very hard to see, very hard to identify, and it can be a source of friction, because the allegation will be very much like against Japan in the 1980s as to allocation of credit, that you build up surplus capacity that depresses prices.

And how you actually, you know, quantify, what is the magnitude of the subsidy, very, very difficult thing to do. So it could be an issue, whether there's going to be growing friction in the future.

ALDEN: Very good. On that note, let's thank our panelists for an excellent discussion. (Applause.)

And you are all invited to join us for lunch until 1:00. Thanks again.

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