America and the World Economy: A Strategy for the Next Decade

Thursday, February 10, 2005

Council on Foreign Relations
New York, N.Y.

PETER PETERSON: I have exciting news for you. I want you to turn off your cell phones. You’re also supposed to do something with something called a BlackBerry, and if I knew what they were, I’d be glad to elaborate, but I won’t do that. [Laughter]

You know, it’s very rare in life, or relatively rare, that you see genuine visionaries in building something. And Fred had the conception, that was a very broad one, that economic policy was moving rapidly to the vortex of foreign policy, and there was no institution in the United States that really focused on international economics. But what is more remarkable about Fred, in my view—and I’ve been there since the creation—is to combine this vision with the capacity to execute and implement it, and actually build an organization that includes, in my view, and I think in [Council President] Richard Haass’s view, the single-best group of economists perhaps in the world. If you look at the people on their staff, I think you’ll be enormously impressed with the group that he has attracted. Now, when I say he sustained the institution, I have a deep need to put my hands in my pockets, because he is the most gifted person in reaching into other people’s pockets of anyone I know. [Laughter] But he’s done it for a very, very good cause.

The occasion today is the publication of a book called, “The United States and the World Economy: Foreign Economic Policy for the Next Decade.” Dick Gardner was telling me that he likes it enough that he’s actually using it as a text for one of his courses. But it’s quite an extraordinary book, covering the entire horizon. And that’s going to be our subject today. And I’ve been asked to ask him a few friendly questions. He may not think they’re friendly—we’ll wait and see. And then, of course, we’ll turn it over to you.

Fred, it was I guess a little over a year ago, or nearly a year ago, when at one of your board meetings [Harvard President and former Treasury Secretary] Larry Summers wondered if you and your staff could come up with a single number that captured the overall impact of globalization in the United States—that’s quite a project—including what its costs were. And I noted with great interest as I read your book that one of the centerpieces of this book is your analysis of what that estimate is. I’d like to know what the number is and what does it imply for our economy, and if you could do it without anesthetizing all of us, I’d be interested in [laughter] how you went about making such a grand calculation. So let’s talk about the impact of globalization on the U.S. economy, both plus and minus, and how did you arrive at that, and what is it?

FRED BERGSTEN: Well, I’m happy to do that. With respect to anesthesia, I don’t know how this topic compares with Social Security reform, [laughter] but I’ll try to keep them awake relative to that discussion.

PETERSON: Do you think that’s an approach to fundraising?

BERGSTEN: Speaking of which, I can only respond to the prefatory comments by saying in terms of reaching into other’s pockets, I had a masterful mentor, the chairman of my own board, without whom, incidentally, nothing that we’ve accomplished at our institute would have been possible. So everything Pete said about me is returned, cubed—he made it all possible, and I am forever devoted to him for having done that.

On the substance, we wanted to take a comprehensive and fresh look at the international economic policy of the United States, partly because we were going to have a new administration, new Congress—both could have been newer, but they are nevertheless new—and because of a series of fundamental changes in both the domestic and international environment for an economic policy that we lay out in the book. But we thought as a center point for that, we really should step back and ask: What has been the impact of the open foreign economic policy that the United States has more or less carried out for the least 50 or 60 years? Was it a winner, what were the results, and could we quantify them?

So we put our best team together—four or five of our best economists, and we came up with four numbers that I think are striking. The first number was, as Larry Summers suggested we seek, a single comprehensive manifestation of the impact of globalization on the U.S. economy. We used four different methodologies. I’m happy to talk about all that with the econometricians in the audience, if you’d like to do that.

PETERSON: No, I’d suggest not. [Laughter]

BERGSTEN: OK. Actuarial tables on Social Security are probably more interesting. In any event, the number was about $1 trillion per year of increased U.S. national income from our integration with the world economy over the last 50 years. That takes into account both the technology changes that have taken place—the shrinking of the planet—and the policy liberalization, the dramatic reduction of trade and investment barriers. And when you put it together and adopt the different approaches, which writes different numbers in precise detail, but they all clustered around a gain of roughly $1 trillion per year from the globalization process to the United States. That works out to a little less than $10,000 per household. It’s about 8 [percent] to 10 percent of GDP [gross domestic product]. It’s a big number—not overwhelming, as a share of our total economy of $11 trillion now, but it’s big, and it’s obviously been worthwhile.

The second question we asked was, “Suppose you kept going. We know we’re still far away from any ideal of global free trade. Suppose you went all the way to free trade, the U.S. got rid of the rest of its barriers—of which there are still a lot—but, even more importantly, the other countries got rid of their barriers, particularly the rapidly growing developing countries—China, India, Brazil, et cetera.” And the answer there was that a means to truly global free trade would enhance the U.S. standard of living by another half trillion dollars a year, another 500 billion [dollars] per year. In short, we’re kind of two thirds of the way down the road, but there’s a lot more to go, and it’s worthwhile—and that’s the thesis of the book: to keep moving toward opening the world economy further.

But then, of course, as we know from the globalization to date, there are costs. Like anything else in economics, [there is] no free lunch. You have to pay a price. There are losers. How big are those? So we also quantified those as best we could. I should say we were probably conservative on the gain side, and we tried to go high on the cost side, just to avoid charges of bias. But on the cost side, we take into account things like temporary unemployment costs, when workers are dislocated by trade, lower lifetime earnings that some trade-dislocated workers have to experience when they take lower-paying jobs throughout their careers. And the answer there was an annual loss of about $50 billion. Something like 5 percent of the trillion-dollar gain was offset by losses, particularly to displaced workers, both in the short-transition run and the longer run, with some low income.

And then we said there’s an important fourth number: [a] huge beneficial cost-benefit ratio, 20 to 1. How much are we spending as a country to try to protect those gains, deal with the cost and losers, and thereby, in addition, to handling the real economic and social downsides of globalization try to shore up the political foundation for resisting the backlash and maintaining an open policy? And the answer there is a shockingly low one to two billion dollars per year. That’s what we spend on trade-adjustment assistance. Now, you could argue, as [U.S. Trade Representative and Deputy Secretary of State-designate] Bob Zoellick did with me, that some other worker-training programs and such ought to be counted—might take it up to five or six billion—but the point is that we spend an abysmally low amount of money—a tiny share of the benefits to the society as a whole—to protect those gains and provide a base for achieving the additional huge gains, the additional half trillion or so a year that are potentially available.

And so one of the themes running throughout the book is that we need to do a much better job in our domestic policies, budget policies, other things we’ll talk about, but in terms of adjustments to the dislocations that do take place in globalization, like any economic phenomenon. We need to do a much better job of providing safety nets to cushion the transition when people are dislocated; and, more importantly, we need to do more to enhance the capability of our economy, particularly our work force, to take advantage of globalization rather than feel victimized by it as so many of our workers do.

We lay out in a full chapter in the book a menu of approaches to do that. It is not very expensive. Take the current 1 billion [dollars] up to 3 billion [dollars] a year, and you go a long way down the road. We lay out a number of qualitative improvements. You may be shocked to learn that services workers are not even included under the current trade-adjustment program. So when we have a fear about outsourcing of people in the services sector—computer programmers, [inaudible]—they can’t even qualify to get the trade-adjustment assistance, though their job has been lost to a trade flow or an international investment flow—things like that, which are low-hanging fruit [that] need to be changed. And so one of the themes of the book is to work hard on domestic measures to enable us to maintain and expand an outward-oriented, successful foreign economic policy to save the huge gains we already get, and to reap the additional benefits that are out there.

PETERSON: Thank you. I think, Fred, you’d agree virtually all economists these days believe that the current account deficit is unprecedented in size, racing towards 6 percent—and according to your experts perhaps substantially higher—are unsustainable. Some see the risk of a hard landing that is obviously to be avoided. What do you think the risks are? How do you assess the risks? And this is a leading question: What do you think of the administration’s plan, given whatever you think the fragility of the dollar is, borrowing quite a few trillions of dollars to quote/unquote “fund” the Social Security accounts? If you can’t handle that softball, you’re in real trouble. That’s all I can say. [Laughter]

BERGSTEN: In the book, we divide up the challenges facing foreign economic policy in two parts. One is longer-run structural problems—the rise of China, the advent of a European economic superpower, [and], more broadly, the advent of large emerging markets around the globe, which we think require the U.S. to reorient its whole foreign economic policy away from the traditional emphasis on the rich countries and the G-7 [Group of Seven industrialized democracies], [and] much more in the direction of those emerging market economies, the G-20 [Group of 20] to replace the G-7—things like that we can talk about if you want later.

But we focus also on a series of immediate problems, to which we would attach a great degree of urgency, of which two are at the forefront: one which you mentioned, the current account deficit, and a possible sharp fall of the dollar; and the other of the new sharp rise in energy prices. We think energy prices can easily go back up to 60 [dollars] or 70 dollars a barrel. If that combines with the sharp fall of the dollar, you could have a vicious scenario of a sharp spike in inflation, a rapid rise in interest rates, and a sharp turndown in the economy. It was a combination of those two things—and you will remember it well—higher oil prices and a falling dollar—that led to the term “stagflation” in the 1970s, and in the late 1970s, produced the worst period for the American economy since the 1930s: double-digit inflation, 20 percent interest rates, sharpest recession since the Great Depression. I hasten to say I don’t think things will get that bad this time, but the combination of those two immediate risks implies moving in that direction, which we saw not so long ago, and clearly do not want to repeat. The most urgent of the problems, I think, is the one you address: the risk of a sharp fall in the dollar. The latest numbers suggest the U.S. current account deficit has now risen to about 7 percent of our GDP, well over $700 billion a year at an annual rate.

PETERSON: It was about half that in the Reagan years, right?

BERGSTEN: The previous peak, which led to a decline of the dollar by 50 percent in two years in the middle ‘80s, was just under 4 percent of GDP. Now we’re at 7 [percent]. And, even more importantly than the level, [the current account deficit is] rising by about $100 billion a year. We are on a trajectory that is not only in unsustainable and unprecedented territory now, but is rising even more into terra incognita. Catherine Mann in our institute, who has been very accurate on this and she wrote the book on it five years ago, has recently updated her projections, and suggests another $100 billion per year into the foreseeable future. In short, when [Federal Reserve Board] Chairman [Alan] Greenspan tried to paint a rosier picture on this last Friday—I understand why he did it—do not believe it. The outlook is not for a turnaround or even a leveling off; it’s for getting worse.

As a result of that huge external deficit, the United States has to borrow $5 billion every working day from the rest of the world. That’s to finance the current account deficit and our own foreign investments. And if we don’t get that $5 billion inflow every working day—happily invested by foreigners here at existing interest rates, exchange rates and other prices—then something has to adjust. And the main thing that adjusts is, of course, the exchange rate of the dollar goes down.

When the dollar hit its peak three years ago, we at the institute calculated it would have to come down by at least 30 percent on a trade-weighted average in order to restore at least a semblance of sustainability of the U.S. external position—not meaning elimination of the current account deficit—that would be implausible and impossible—but cutting it in half, cutting it from the current level to maybe 3 percent of GDP. That would take something like a 30 percent fall of the dollar from its peak three years ago. Over that period, the dollar has come down about 15 percent. So it’s gone about halfway.

Now, I hasten to say to our European friends in the room it is devoutly to be hoped that the next wave of the dollar decline occurs against a whole different set of countries. The first phase of the dollar decline has been against the euro, the [British] pound, the Swiss franc, Canadian dollar—countries with floating currencies—and it has occurred virtually not at all against the Asians, who are the big surplus countries, the big accumulators of foreign exchange, the rapid growers who could afford it. But they have blocked the increase in the value of their currency, depressing the dollar’s correction, and throwing all of the correction that has occurred onto the Europeans and those with floating currencies.

So in figuring out how to remedy the problem in an orderly way, there are really three parts to the solution. One is a continued substantial and hopefully orderly decline of the dollar—but that’s going to require the Chinese to stop blocking it, the Japanese to stop intervening heavily, and the other Asians to get into the act, which they devoutly should for internal reasons, as well as to speed the international adjustment. It’s also going to require the countries whose currencies are strengthening—notably the Europeans—to take action to offset the subsequent decline in their trade surpluses, which measures to expand their domestic demand. In the case of Europe, in my view, it requires much lower interest rates by the European Central Bank.

But the third thing—a long way around to your final part of the question, Pete—is U.S. action here at home. The U.S. external deficit is essentially a reflection of the fact that we save virtually nothing in this economy. Household saving has disappeared—literally gone to zero; the federal government dissaves—it’s in deficit. So to keep our economy going, we have to borrow that $5 billion from the rest of the world every working day. If we didn’t get it, we’d have no investment, we’d have no growth, we’d have no productivity, we’d have no nothing. And so we are dependent on the rest of the world to finance our economy. That inflow of foreign capital pushes the exchange rate of the dollar up, prices up, companies and workers out of world markets, and generates the huge trade deficit.

So the underlying issue is to raise U.S. savings. Enter the [President] Bush proposal on Social Security reform. The Bush proposal on Social Security reform, in my view, makes the problem worse. It clearly takes money out of government revenues and substantially increases the government budget deficit, and it’s dissaving. Now, the defenders of the plan would say, “Ah, yes, but the people who now no longer put that money into Social Security put it into private savings, so at worst, it’s a wash.” Unfortunately, not true, because we know from the history of the last 20 years—and 401Ks and IRAs and all that have been coming into play—that the main effect of tax incentives for savings accounts is to induce higher income Americans, like in this room, to take their money out of their taxable savings plans and put it in tax-free savings plans. Look at the last 20 years. [Inaudible] of Roth IRAs, other IRAs, 401Ks, and the private savings rate has gone from 8 [percent] to zero—hardly a stunning success for the saving incentives of the past. The Bush Social Security plan would make it worse.

By contrast, however, let’s tweak the plan. Let’s say, go ahead and create private Social Security accounts, if you want to call them that. But instead of funding them by deflecting money out of current Social Security into those accounts, require those accounts be funded by additional contributions by the people doing the saving. There would still be some substitutions, but there would at least be some increase in savings that would help deal with the external problem as well as the internal budget. Go one step further: If we’re serious about increasing savings, let’s make those additional savings accounts mandatory—specifically require people to contribute to their Social Security plan. Let’s say you are also required to put 1 [percent], 2 [percent], 3 percent of income, maybe depending on your income level, into a private saving account. Again, there’d be some substitutions, but then you’d begin to get some real increase in national saving. It’s interesting. I’ve talked to several senators this week, other congressmen, including Republicans on the House side, [who] are beginning to think in this direction, driven of course, by our chairman’s fervor and I must say incredibly compelling work on this over the years. I think the message is beginning to get through that this has to be done in a serious way.

My point here is simply [that] there is an acute relationship between Social Security reform and international trade. People don’t make that linkage. The senators I talked to this week have not made that linkage. I’m suggesting they do so to buttress their case, because everybody now recognizes the trade deficit and the dollar are problems. But when we do something like Social Security reform, or Medicare reform, or any other of the big budget steps, it has to be remembered that the outcome of those debates will critically affect our international economic and financial position, our competitiveness in world markets at an industry by industry level, almost as much as it affects the budget and the more obvious linkages. And that is something that this Council, my institute, try to promote, realizing we have a seamless web these days between domestic and international issues.

PETERSON: Because the purpose of my leading question was to lead you to the right answer. [Laughter] I assume I can conclude from that, that your enthusiasm for borrowing another $10 trillion is somewhat restrained—is that right? [Laughter]

BERGSTEN: My enthusiasm for borrowing a penny more is zero, and I think we have to get back to the budget position that this president inherited only four years ago, a modest surplus as a share in the economy.

PETERSON: OK. Fred, I was intrigued. There was a section in your book that talked about, quote, “market manipulation” by key foreign countries on some of the central problems facing us. Can you explain and elaborate, and how serious is it, and what do we do about it, whatever you’re talking about?

BERGSTEN: Yes. As we did this analysis of this whole array of issues, it increasingly struck us how the two big immediate problems—the dollar problem, the energy problem—have been severely distorted and made incredibly worse by blatant market manipulation by major countries around the world. On the exchange rate issue, I already mentioned it: China last year intervened in the exchange markets to block the rise of its currency against the dollar to the tune of $200 billion. That’s 14 percent of their entire GDP. In the first quarter of last year alone, Japan intervened to the tune of $150 billion. In one quarter they more than financed the entire global U.S. trade and budget deficits. These are countries intervening against market forces to keep their country currencies under value, to subsidize their export positions in world trade, to export their unemployment problems to the rest of the world, notably to the United States, through flagrant violation of all the international rules—in this case, both in the IMF [International Monetary Fund] and the World Trade Organization [WTO].

The U.S. Treasury, the IMF, the WTO, and the global system have done an absolutely miserable job—indeed a practically negligible job—of trying to defend the rules of the game. And therefore, this intervention, which is market manipulation literally in the words of the IMF Articles, is distorting and blocking the entire adjustment process. I mentioned before our friends in Europe and Canada—the countries whose exchange rates have gone up because the Asians won’t let theirs go up—[that they] should in fact be in the front of the queue in Beijing, right along with the U.S., to try to overcome that element of market manipulation.

In the energy markets, it’s even more blatant, because for 30 years you’ve got a producer cartel which has restricted supply, blocked investments coming in to the most productive potential sources of additional output—therefore props prices way above anything market levels would have suggested, and an enormous volatility to the market. And, as Greenspan always reminds us, the three big recessions of the last 50 years have been triggered by oil price spikes—in short, hugely anti-market intervention by governments of a number of countries, treated with impunity by the rest of the world. That kind of cartel behavior would of course be a pro se violation of every antitrust law in the world. Had it took place within national borders, [it] would never last a week, but because it’s international, we have been unable to find ways to deal with it.

In the book, we propose a series of responses. They will be controversial, they would be difficult to achieve, but the stakes are enormous. For every dollar increase in the world oil price, the world economy grows by $25 billion less the next year. And if you get a run-up of $10 to $20 a barrel, as we have over the last year or so, you are taking a huge amount of growth off the world economy—not as much as in the 1970s when we were much more dependent on the oil price, but still huge amounts.

And so, a major area where we simply have to find ways to block this market intervention and manipulation is in the energy sector. In talking, as we did the last month or two in briefing officials at the Bush administration and the Fed [Federal Reserve Board] and others, the Congress, about this, I made the simple point that our current administration—most administrations around the world—claim a real devotion to market forces, underlying economic trends, and sort of abhor the thought of intervening in markets. Frequently, when you suggest to them what economists call a “second-best” intervention to come in with something to counter the other guy’s intervention, they say, “Oh, it’s terrible. That would be distorting the market,” to which my reaction is, “What market?”

In the case of the dollar-renminbi exchange rate, I can assure you there is no market. In the case of the oil price as determined by the Saudis and OPEC [Organization of Petroleum-Exporting Countries], there is no market. So, if we’re going to get serious about some of these problems, we have to recognize that not only is there a national interest—I would suggest a big global interest in reforming those situations—but it would conform to every standard textbook model of what good market economists—who believe in Adam Smith and all that—would adhere to in their fondest wishes. And so there is no contradiction between ideology and practice, if we get the analysis of the problems right.

PETERSON: Fred, you’ve been needling me for 30 years for something I did in the White House. I assume that the statute of limitations would begin to apply. But you’ll recall that one of the things you needled me about is our decision to close the [inaudible] and put on an import surcharge, the idea being that we had to get their attention to move to the negotiation table. You don’t like import surcharges. What would you do to get the Chinese and the Japanese and the others to cooperate and not manipulating and intervening, and remarkably hesitant to do so up till now?

BERGSTEN: Well, you’re right, I don’t like import surcharges, but something along the lines of what you did in 1971 may turn out to be necessary. I met with [Chinese] Premier Wen Jiabao a year ago when he was here, and I tried to think what I could possibly say to the Chinese premier that would get him to change their policies in this area. So after explaining what I’ve gone through here on the exchange rates and trade and all that, I said, “And, Mr. Premier, please avoid making the same mistake that the Japanese made for 25 years.” I thought if anything would appeal to the premier of China, it would be tell him don’t replicate the errors of Japan. Well, he’s still replicating.

The point being that, if you maintain a grossly undervalued currency, to which the Japanese did, to which you had to respond in ‘71, and the Chinese are doing now, one inexorable result is huge trade protection against that country. It’s a result. And you can see it in Washington right now. Almost every week, new U.S. import barriers are being raised against Chinese products right now. It’s not theory—it’s happening. Practically every textiles and apparel product, color TVs, semiconductors, wood furniture, shrimp—every week, virtually every week there’s a new product. The Chinese are being hit, reflecting the fact that, of our $700 billion global trade deficit, almost $200 billion is now bilateral with China, and all that’s driven by this grossly undervalued Chinese currency, which is adding to their already very strong competitive position to make them even more competitive. So, they’re going to get more and more trade control. If that’s the counterfactual, if you’re going to wind up with more and more trade controls anyway, maybe it makes sense to simply point out to them explicitly that, you know, maybe a 50 percent import surcharge—if their currency is undervalued 25 [percent] and the import side only deals with one half the balance, then you say 50 percent import surcharge.

PETERSON: As I was to find out, several months after proposing this, in the interest of economic history, these sticks that one uses to get other people to behave in the way you wish are not without some dangers. I had proposed the use of these import surcharges, as you may recall, as a negotiating lever to bring everybody to the table and arrive at agreements on a variety of issues. Much to my dismay in the Oval Office—I assume this is on the tape somewhere—John Bowden Connally, who is not my favorite Treasury secretary in American history, said something like this to the president: “Mr. President, this import surcharge is really selling in Peoria [Illinois]. People don’t understand much about the dollar and all that stuff, but they sure understand that import surcharge. Why don’t we keep it on until after the election.” [Laughter] And I almost shrieked in horror at the—so, I don’t suggest using sticks lightly. They’re a very dangerous thing to get started, because they can result in retaliation and so forth.

BERGSTEN: I absolutely agree. But tell the end of the story. The import surcharge succeeded. You got, at that time, the recalcitrant countries—Japan and the Europeans—to agree to a significant exchange rate change that then removed the underlying problem, and headed off protectionism more generally. Mention the other point—and I know one reason you did the import surcharge was you could see the Congress charging down the road to more import barriers already.

PETERSON: Absolutely.

BERGSTEN: And, incidentally, so did the Reagan administration. When people say to me [that] the kind of things I’m talking about are kind of inconceivable because the Bush administration would never do it, I remind them of the history of the Reagan administration. The first Reagan administration, you may recall, was the quintessential example of “benign neglect” of trade, the exchange rate, everything else—the huge Reagan tax cuts, massive budget deficits, massive trade deficits, overvalued dollar. And in 1985, the leadership of the House Ways and Means Committee said if the [1930] Smoot-Hawley tariff itself came to the floor of the House, it would pass overwhelming.

Enter [former Secretary of State] Jim Baker and [inaudible] in the Treasury, realizing that the world trading system, as well as the dollar, were about to explode, did the [1985] Plaza Agreement [between the United Staes, France, Germany, Japan, and the United Kingdom to jointly influence exchange rates] and negotiated a 50 percent decline of the dollar over the next two years, which had its desired effect of cooling the international financial risks and cooling the domestic political protectionism. It’s only when you get to dire situations like that, absolutely right, that you would even contemplate—or an internationalist like I would ever contemplate the kind of things you had to do in ‘71, and that I just suggested. But I believe, and our book shows, I think, that we are getting to that point of risk in terms of a crash in the dollar, U.S. interest rates to double digits, interaction with energy the way I talked, risk of stagflation. Protection is already expanding exponentially. Those are the risks that need to be dealt with. And if it requires breaking a little crockery to head them off, I’m afraid it might have to happen.

PETERSON: All right, on that happy note let’s turn to the questions. Please identify who you are. And this meeting, incidentally, is on the record. Yes, sir? That’s you, sir.

QUESTIONER: I’m not going to ask—I’m Stanley Arkin—I’m not going to ask you which currency you most favor, but I will ask you whether there’s any country or economic union in the world which has an economic policy which you admire. [Laughter]

BERGSTEN: There are a lot of countries that have policies that I admire to a substantial degree. Canada has had an extremely good economic record the last few years. It’s had the highest growth in the G-7. It has a responsible fiscal and monopoly policy. It’s a little shaken now by the sharp rise in its currency, but it’s had a very good record.

Japan, after it’s lost decade, I think has turned the corner. I may surprise you by praising Japan, led by my good friend [Japanese Economics Minister] Heizo Takenaka, who spent a year at our institute, they have gotten their banking system at least well back on the track to solvency and efficiency. They’ve avoided the big policy mistakes they made in the late 1980s and late 1990s, and I think they’re in a period of catch-up and growth.

I may really shock you when I tell you that I have huge praise for China. I’ve been very critical of their exchange rate policy, but I have huge admiration for Chinese policy. They’ve not only grown at a 10 percent average for 25 years; they have done it in a way that has integrated them into the world economy to an unprecedented degree. China has now replaced the United States as the main locomotive of the world economy, accounting for over 20 percent of world trade growth in the last four years. And the reason is because they’re such an open economy. That may shock you too—lots of complaints about Chinese trade barriers, yes they have to do more to fulfill their WTO obligations. But the ratio of exports and imports in China to GDP exceeds 60 percent. It’s more than double ours. It’s triple Japan’s. It’s risen like a rocket. And the reason is that Chinese leadership explicitly adopted a strategy of integrating with the world economy to overcome domestic resistance to reform within China.

The most statesmanlike vision I have ever heard from a foreign leader is the following. I was in a very small group meeting with former Chinese President Jiang Zemin just after he had personally been heavily involved in a negotiation for China’s entry into the WTO. And he said in perfect English, and with great pride, “I want you to know that I view China’s entry into the WTO as intimately related to my country’s deep sleep during our feudal period, while the West was growing smartly after the Renaissance.” What did he mean by that? The famous story of when the British ambassador went to the emperor in 1793 and said, “We’re ready to trade.” And the emperor said, “Go away, young man—you have nothing we want.” The point being, China rejected the first era of globalization in the 19th century. As a result, 100 years later they were the poorest country on Earth, they were carved up by the colonial powers, they disintegrated into a bunch of warlords, and the communists took over. The communists learned a lesson, and they said, “Never again. We will participate in globalization—we’ll do it as best we can on our terms, to be sure—and we’ve got a lot of leverage because of our size—but we’re going to be big parts of that activity.” They joined the WTO, and then they sent their top team all around the country, visiting the provincial governors, the Communist Party chieftains, the vice mayors of the cities—saying, “Well, here are the new rules, and you have to conform to those—sorry—whether you like it or not.” Well, doesn’t always work perfectly, but they’ve used it constantly to overcome domestic resistance to internal reform. And here is a country which in my view has another 25 years of 10 percent growth in front of it, because of superb economic policy. So just get the exchange rate right and avoid Peterson and I hitting them with some import surcharge, they’ll be in the clover.

PETERSON: Other questions? Over here please.

QUESTIONER: Thank you. Charles Ferguson. As you might know, Nouriel Roubini of NYU [New York University] just wrote a paper about prospects for a hard landing as a result of the macroeconomic imbalances of which you spoke. Nouriel’s argument is that Chinese accumulation of dollars is on a rapidly, quickly unsustainable path. And he also argues that even a 20 percent reevaluation would have very little effect; his point being that only the United States can forestall such a hard landing. I wonder what your comments might be.

BERGSTEN: Nouriel did a superb book for us about a year ago, called “Bail-Ins or Bail-Outs.” He’s terrific. He’s a visiting fellow at our institute, and I think very highly of him. As I said before, I agree with the conclusion that there’s a real risk of a hard landing. So on that we’re exactly on the same wavelength.

On his point about China maybe being ready to start selling dollars—I wish it were true. As I said before, a big part of the problem is that China keeps buying dollars and keeping its currency from going up, and thereby blocking not only its own adjustment against the U.S., but blocking all of Asia’s adjustments.

QUESTIONER: But Nouriel’s point was that they couldn’t keep buying dollars at the current rate—they won’t have enough.

BERGSTEN: No, they can buy dollars forever, because they’re buying them with local currency. They can create local currency forever. Now, he may argue that that that may increase their domestic money supply and so cause inflation pressure and all that. But as I said, they bought $200 billion worth last year. They didn’t sterilize all of that effectively, but to a fair extent. And their inflation rate actually came down over the last year.

I know that, more important than what you or I or Nouriel think, the Chinese think they can buy infinitely. And so do the Japanese. And my fear is not Nouriel’s, that they’ll start not buying; it’s that they’ll continue to buy, because that will block the adjustment process.

One fallacy that often occurs in rooms like this is you say, “Well, how can the Chinese and the Japanese and the others keep piling up all those dollars when they know they’re going to drop in value—20, 30, 50 percent?” And the answer of course is they do not view it in financial terms. It’s an export subsidy. It’s an off-balance, off-budget export subsidy that they can get away with in the world. If they did a direct subsidy to their auto industry, they’d get hauled in to the WTO. They could do it through the exchange-rate system and, given the frailties of the U.S. Treasury and the IMF and the G-7, they’d get away with it. But they view it as an export subsidy, part of their job development program. They realize they’re going to take big losses, but they don’t mark to market—they will never mark to market—and they don’t care.

You may be amused. I talked to the Japanese vice minister for finance about it a month ago, and he actually went out of his way to say to me, “You know, we really like the exchange market intervention we’re doing.” He said, “We borrow money from the Bank of Japan at zero interest, and we buy dollars and put it into your Treasuries, and they don’t pay much, but they pay 2 [percent]—and that’s better than zero—we’re making lots of money.” [Laughter] And I said, “But you’ve got a lot of unrealized capital losses.” And he just laughed and said, “We don’t mark to market. We’ll never mark to market. Besides, 20 years from now the yen may be back at 130—who knows? We may get big capital gains.” In short—and that’s part of the problem—that’s where Nouriel’s got it wrong. It can go on for a very, very long time, blocking the adjustment process.

The simple point: the other Asians won’t let their currencies go up against the dollar, because with the renminbi pegged to the dollar, that would mean going up against the renminbi and losing the competitive edge against the toughest competitor they face, which is China. So China’s intervention takes all of Asia, even Japan to some extent, all the way around to India, out of the adjustment process. And that’s what’s blocking an orderly and constructive correction of the type that’s needed.

PETERSON: Richard—[inaudible]—

QUESTIONER: Fred, your excellent overview chapter in the book has some important things to say about trade policy. In your judgment, what are the chances of a successful conclusion of the [WTO] Doha Round [of trade talks] in the next two years, particularly in view of these currency misalignments and global imbalances? If we cure the misalignments by getting the dollar much lower, we make it less likely that some of our competitors will want to make the deep cuts we’re seeking. If we don’t change the misalignments, we’ll have resistance at home. How do we get out of that box?

BERGSTEN: It’s obviously a very good question. And since Dick mentioned my chapter, and was kind enough to plug it to Pete before, I’ll simply note by way of advertisement that you can buy the book on your way out—[laughter]—there’s a nice table set up, and I know there will be a rush—don’t stampede each other getting to the table, but I urge you to take that step.

PETERSON: If you can get by with only buying the book, you’re going to be in much better shape than some of the rest of us. So—[laughter]—

BERGSTEN: That’s a loss leader, buying the book. [Laughter] I think, Dick, as you know, the answer is to get an exchange rate outcome from this current imbalance that is roughly in equilibrium for everybody concerned. The euro, for example, to quote [Frence central bank chief] Jean-Claude Trichet, with whom I talked about it 10 days ago—the euro has gone up 65 percent against the dollar from its low. The euro has done its bit. It should level off in the $1.30 or so range. But again, if the Asians block, the euro is going to go to $1.40, $1.50, and then the problem you mention is going to occur. So again, for trade policy as well as currency market reasons, it is absolutely crucial to broaden this adjustment, bringing Asians in, get it in a balanced direction that’s headed towards equilibrium both here and abroad.

On your broader question, the outlook for the Doha Round, it is very worrisome. The Doha Round was launched over three years ago. It was revived procedurally last summer, but the truth is three and a half years after it was launched there is virtually yet not substantive agreement on anything. So there’s been a lot of marching of time. The real deadline is, and always was, when the U.S. trade negotiating authority expires, in the middle of 2007. So they’ve got another year and a half to two, but an enormous amount of work yet to do to get it on track. At a minimum, the U.S. is only going to play if our big dollar overvaluation and current account deficits start coming down. And, I would add, going back to what I said before, if we would move domestically to put better defenses in place for people who will be dislocated by the further liberalization implied by the Doha Round. Every time I’ve talked to Bob Zoellick about this, I have said the Achilles’ heel of your trade policy—which I generally applaud—wrote an article in Foreign Affairs defending him only two years ago—but the Achilles’ heel is their failure to put in place significant domestic adjustment policies, even when the Congress gave them new tools in the Trade Act of 2002.

At our institute we invented some new ideas—wage insurance, health care tax credits—which help deal with the adjustment of these displaced workers. The Congress voted those in 2002, but the current Department of Labor, to put it bluntly, has not implemented them. And, as a result, when the administration goes to the Congress with trade legislation now, the first question they will be asked is, “What are you doing to implement the tools we gave you to deal with the domestic downsides of all this?” The same thing happened in the Clinton administration. The Congress gave them new tools in the NAFTA [North American Free Trade Agreement] legislation to deal with the losers. When [former Treasury Secretary] Bob Rubin went to testify in 1997 to get new trade authority, the first question from the Congress was: “What have you done to implement NAFTA trade adjustments?” Well, they hadn’t made a single loan out of the new [inaudible], they had no answer, and they didn’t get any new authority. And the Clinton administration never got any new authority. And the same thing is going to happen if we don’t shore up the domestic flank of the international trade problem.

On top of that, the Doha Round has got a lot of international problems. When the Europeans liberalize their agricultural policy, will the rapidly emerging developing countries—Brazil, India, South Africa, China after—will they reduce theirs? At the end of the day, I think there will be a Doha Round outcome, but my guess is it’ll be quite modest. The governments will declare victory, they’ll claim they succeeded, but in fact they won’t have done much. Therefore—and that’s another theme of the book, and I just wedge it in now to mention it—therefore the proliferation of bilateral regional and sub-regional trade agreements will accelerate.

The failure of the Doha Round or the [inaudible] outcome of the Doha Round will not stop the process of trade liberalization. Lots of countries want it. Lots of countries want to pursue negotiated trade liberalization to mobilize their exporters to overcome their domestic protectionists, so they can keep reforming their internal policies. I mentioned that for China. That’s how Mexico used NAFTA. That’s why Egypt now wants a free trade agreement with the United States. Trade liberalization will continue, but it will take a different form and format. Some people worry that that will undermine the global system. I observe that historically it has strengthened and catalyzed the global system. But it has to be managed in that direction. And if the Doha Round falters badly, we will face a real question about the role of the World Trade Organization and whether the multilateral trade regime will continue at anything like the dominant role that it has played for the last 60 years.

PETERSON: Other questions? Over here, please.

QUESTIONER: David Nowakowski from the Rohatyn Group. If you’re arguing that the Asian currencies are weak, and so a de facto not de jure subsidy, why is that so bad for the U.S.? I think [economist] Milton Friedman once had an argument with a now-forgotten Keynesian saying that if someone is offering you a subsidy, take it. The only thing you should do is not fight back with subsidies of your own. And, second of all, if the Asian currencies are so undervalued and they keep intervening, why aren’t they experiencing inflation and so appreciating in real terms?

BERGSTEN: On the first question, I’ll have to get [inaudible] here to support me, because he was a student of Milton Friedman—and colleague. Milton always said exchange rates should be permitted to float and respond to market forces. That’s what I’m advocating. I’m not always a devotee of Milton, but in this case he certainly had it right. He would be—he is totally opposed to what the Chinese and the other Asian countries are doing now to block the effect of market forces in promoting adjustment of currency values.

Now, you say—but isn’t that a good deal for us? We get all those cheap imports, and Wal-Mart can sell all that cheap stuff to our consumers. And the answer is, absolutely right. And as long as it exists, and as long as it can be sustained, it’s great. It’s just like living on your credit card, as long as the credit card company never collects. And in the U.S., given its size, given the international role of the dollar, given our power, has a pretty long reach. And so we’ve been able to go, as I said at the outset, into terra incognita. The Fed, the OECD [Organization for Economic Cooperation and Development], our institute, everybody who studied this thing—whenever industrial countries have run current account deficits 4 or 5 percent of GDP in the past, they get into big trouble. As Pete said, the U.S. has never even gotten to 4 percent, and the dollar had to come down 50 percent in the mid 1980s. But we’re now in terrain of Mexico ‘94, Thailand ‘97—current account deficits, 7, 8 percent. That ‘s the league we’re in now. So unless you’re really a super optimist, I would say Pollyanna, it’s hard to imagine that we’re going to have any kind of sustainability of this for much longer.

Now, you asked a good analytical question: Why don’t they get inflation? Well, China has. Two years ago we were talking about deflation in China. Now on the latest numbers, the inter-corporate price index in China, which is better than their CPI [consumer price index], has gotten as high as 8 or 9 percent of annual rates. And, you’re right, that is an alternative for currency revaluation. And in fact, when the Chinese defend themselves against the kind of criticism I’m making, they say, “Well, you’re getting real appreciation through our inflation,” to which our response is, “It’s a pretty crazy policy.” It’s pretty crazy to deliberately inflate your economy instead of letting your exchange rate move.

In my view, a revaluation of the Chinese currency is exactly what they need for internal reasons. Their leadership has said they want to slow the economy down because it’s overheating; revaluation would do that very modestly. They’ve got an inflation problem now. Revaluation would counter that. They’ve got a big problem of exploding money supply, because of all the speculative capital coming in anticipating revaluation. A substantial one-shot revaluation would cut that off. All that on top of countering the trade protection that’s breaking out against them every week, as I mentioned before.

It seems to me there’s a pretty powerful case for China doing it. I understand I think why they don’t do it, but I regard it as just a huge mistake.

PETERSON: I’d call on Ted Sorensen, but I urge you not to ask him to comment on your book. You all know his old line about my earlier book—once you put it down, you won’t be able to pick it up. [Laughter] But his comment about my latest one is even more devastating. He said, “When I read your title, ‘Running on Empty,’ I had assumed it was an autobiography.” [Laughter] So, Ted, please, he is our guest here.

QUESTIONER: Fred, it’s very good to have you back at the Council.

BERGSTEN: Good to be here.

QUESTIONER: I’m not an economist, and my other habits are good also. [Laughter] So therefore I don’t always understand what I read on this subject, but I thought I read today that the United States may discontinue its membership in the WTO. Is that possible? And, if so, why? And what would be its impact on the United States?

BERGSTEN: No, it’s not possible, and I didn’t read the story you mentioned, but I suspect I know what triggered it. Back when the Congress was passing the last big trade round, the Uruguay Round in 1994, then Senate Majority Leader [Robert] Dole [R-Kan.], contemplating a run for the presidency, put an amendment in that required the Congress to take a vote every five years on continued U.S. membership in the WTO. And it provides kind of a point of departure for a debate about U.S. trade policy, including U.S. membership in the organization. The first of those was held five years ago, and about 50 members of the House voted against, but it of course sailed through, and we retained our membership. There’s no doubt that we’ll continue our membership. But there will be a debate. There will be another debate, incidentally, on continuing the trade negotiating authority that the administration got through the Congress by one vote in 2002. There will be votes on some of the free trade agreements that have been negotiated, most notably the one with Central America, which has attracted a firestorm of opposition, both in the labor unions over labor standards, and over some agricultural groups because a tiny little bit of sugar and other things were included.

So one of the themes in our new book is not only is there a risk of protectionism in the [inaudible] for the reasons we mentioned before, but that there is a series of votes coming up in the Congress literally over the next three to six months which could badly throw U.S. trade policy off course. And that vote on the WTO, though it won’t succeed in pulling the U.S. out of the organization, is certainly part of that mosaic. And so there will be a big debate about trade policy. One of the reasons that we try to remind people that globalization is a big winner for the United States and there’s lots more benefits out there to be garnered, is to try to add some fuel to those debate, because those could get very nasty.

If the Congress, for example, votes down the Central American Free Trade Agreement, it could torpedo the entire trade negotiating program of the administration. It would certainly torpedo other bilateral and regional free trade agreements, because others would say, “Well, if the Congress is going to vote it down, even when the president negotiates, sends it up under the fast-track procedure and all that, we’re certainly not going to go through all the domestic political pain of making concessions and putting our own necks on the line.” It could even undermine the Doha Round that Dick Gardner asked about earlier. It would, in short, significantly undermine U.S. credibility in its negotiations in the international trading system, with I think incalculable implications for our overall foreign policy, world role, pretensions to leadership and the like. So this is big stuff, and I’m glad you raised the question, because unfolding in the Congress over these next few months will be some big tests of everything we’re talking about, and what I suspect most people in this room, certainly at our institute, think are very important for the country, need to be defended, but are in jeopardy.

Again, just to underline the gravity of the issue, we’ve done a series of studies on globalization in the United States and its effects. And we did one study on its politics. We looked at all the polls, surveys, focus groups—all the efforts to assess American public attitude about globalization and free trade. And the results were really quite stunning. The results showed that the American public is split almost down the middle, 50/50, on whether globalization is a good or bad thing for the United States. That is of course directly contrary to the numbers I gave you at the outset. It’s one reason we’ve done the adjustment, to try to tilt that outcome. But the public’s perception are an even split.

And then we said, “What motivates that difference in views?” And the answer was again fascinating. It had nothing to do with the industry in which people worked. Aerospace workers who were employed by Boeing were in the streets in Seattle demonstrating against globalization—has nothing to do with the industry here. One, and only one variable: Your level of education. Anybody who has attended a couple years of college, level of a college graduate, loves globalization. It’s an opportunity. Anybody who is a high school graduate or less, which is still the average American worker, is terrified by globalization. They’ve seen the others having lost jobs—I mentioned before there are some, not a lot—couple hundred thousand a year take lower wages—that’s a small share of our labor force—but others see it and say, “There but for the grace of God go I.” And so there is a resistance to globalization in a very large part of the country.

The congressional votes, which are almost always split right down the middle—Clinton lost four times, Bush won by one vote in the House—those votes are not something unique in the Congress. They are actively reflecting the underlying ambivalence in the country about globalization.

Now, if you change the question and say, are you for or against globalization if the U.S. government is significantly assisting the losers?, you get a 70 to 30 majority in favor of globalization. But the fact is we can’t honestly say that now.

The other variable, as I mentioned, is education. For every increase of one year in the average education level of the public, you get an increase of 10 percentage points in the support for globalization. So if we could convert the average American worker from a high school graduate even to a community college graduate, we’d have a working majority. But that’s a long-term solution. But those are the underlying politics that make what seems to probably most of us in this room, and on the numbers I gave you at the outset, seeming to be a slam-dunk—it’s 20-to-1 benefit/cost ratio, clearly we ought to be for it and help the losers. In part because we don’t help the losers, the whole game is at risk. And that again is one of the major themes of this book, and why we feel organizations like the Council on Foreign Relations and our Institute for International Economics has to be hammering on domestic policy reform and change in order to link the two things and provide a sustainable foundation for a sensible policy.

PETERSON: Fred, the hour has come. I think you now see why I think this fellow is a rare combination of a gifted visionary and a gifted professional practitioner. Thank you, Fred. [Applause]







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