C. Peter McColough Roundtable Series on International Economics: Developments in the Global Economy and Implications for the United States

Thursday, January 11, 2007
Timothy F. Geithner
President and CEO, Federal Reserve Bank of New York
E. Gerald Corrigan
Chairman, International Advisors, The Goldman Sachs Group, Inc.

Council on Foreign Relations, New York City, New York

January 11, 2007

E. GERALD CORRIGAN:  Good morning, ladies and gentlemen.  As I think most of you know, the Council on Foreign Relations has a very rich tradition of making the trains run on time and we're going to try and stick to that tradition here this morning.

I'm Gerry Corrigan.  I'm delighted to be associated with this program this evening -- or this morning, rather.

I should just make a couple of very quick introductory remarks, which will not include a formal introduction of President Geithner; that is not necessary.  But I think for the record, I would like to say that this meeting at the council is sponsored the council's corporate program and the Maurice R. Greenberg Center for Geoeconomic Studies, and it is part of the Peter McColough Series on International Economics.  As I think all of you know, these programs are on the record.  I'm sure Mr. Geithner knows that. 

And without any further ado whatsoever, I'm going to ask Tim to come up and make a few general remarks at the opening.  Tim and I will then have a two-way conversation for 15 minutes or so, and at 8:30 promptly, we will open the discussion to the audience and adjourn at 9:00 promptly.  So Tim, go to it.

TIMOTHY F. GEITHNER:  Thanks, Gerry.  It's nice to be here at the council.  Particularly -- (inaudible).  I'm of course lucky in my predecessors at the New York Fed, at least in Gerry, you know, who's sort of a combination of Benjamin Strong and John Madden -- (laughter) -- that's hard act to follow.  I want to say a few things about the global economy, both at sort of real and financial dimensions, to provide a basis for our conversation. 

2006 marked the fourth year of a global expansion that's been remarkable -- remarkable for its strength, for its breadth, for how broad based it is, and for its stability and its resilience in the face of a number of economic shocks and a substantial degree of uncertainty in the strategic or the geopolitical realm.

And this period of very broad-based growth in incomes has been supported by some very important fundamental forces, and I want to just review these usual suspects because they're important.  They are, of course, a sustained period of very rapid technological innovation and this acceleration in the pace of global economic integration.  And those two things, technology and integration, lay at the heart of this substantial acceleration in productivity growth you saw in the United States in the second half of the '90s.

And I would say on the basis of the available evidence, we believe that that acceleration and trend in structural productivity growth remains largely intact in the United States.  And of course we're seeing growth -- productivity growth accelerating outside of the United States as well, not yet in the major economies, but strikingly in many of the large, emerging market economies.

Financial innovation and the integration of national financial systems have also made a very substantial contribution to the strength of this expansion -- the strength of real activity -- by of course improving the allocation of resources within countries and across countries.  And improvements in risk management and capital cushions and a variety of other changes to the system have, we think, made the system more stable and more resilient than it's been in the past.  And that's played an important role in this foundation for growth.

And of course policy -- macroeconomic policy is really substantially better around the world.  The increase in monetary policy credibility that's occurred in a very broad range of countries -- that of course Paul Volcker, Gerry Corrigan, Alan Greenspan helped bring about -- have produced lower rates of inflation globally and much more stability in long-term inflation expectations.  And this greater public confidence in monetary policy was very important in laying the foundation for the improvements in real economic performance we've seen by, of course, providing this kind of stable, long-term foundation for long-term investment decisions.

And in emerging markets we've seen not just better monetary policy, but more disciplined, more conservative fiscal policy and a range of other actions that have substantially reduced -- not eliminated, but substantially reduced -- the vulnerability of those countries to changes in confidence, capital flows, exchange rate movements.

These things are very important, and of course they're all interrelated.  The policies that delivered better inflation outcomes, more openness, more competition, stronger financial systems were very important in fostering the environment that led to this productivity growth acceleration, first in the United States and now more broadly. 

But the expansion's also been very notable for the financial conditions that have prevailed over the last several years.  Long-term interest rates have remained very -- have remained quite low in both nominal and real terms globally.  Equity and other asset prices have moved higher.  Credit spreads have declined to really quite low levels.  Market participants, of course, continue to report very exceptional levels -- exceptionally high levels of liquidity.  And volatility, both realized and expected future volatility, has remained very low across a very broad range of financial assets -- asset classes, markets and even economies.

And this constellation of market conditions and asset prices is really quite unusual, at least in comparison to what we've seen over the past several decades.  And this has been a very important distinguishing feature of the expansion, but it's not something we fully understand and we can't be that confident today in judgments about how durable it'll prove to be.

To a significant extent, these financial developments reflect fundamental real, durable things that have improved confidence in the future macroeconomic and financial stability -- reinforced, of course by the improvements in inflation performance and financial resilience.  Again, better monetary policy has lowered expectations about future inflation and inflation volatility and helped contribute to lower risk premiums.  And changes in financial intermediation -- the structure of the credit process -- seemed to have reinforced the contributions for monetary policy to greater stability and growth outcomes.

And this exceptionally rapid growth we're seeing in the major emerging market economies, together with a substantial increase in earnings that the energy producers, commodity exporters have enjoyed, have produced this very large increase in wealth and in savings in those economies -- relative to perceived investment opportunities there.  And in a world in which capital can flow much more freely across national borders, a significant share of those savings have, of course, moved outside those countries.

These forces are quite powerful and fundamental and they do help explain part of -- maybe a substantial part of this broad reduction in risk premium and the substantial increase in demand for credit risk and for financial assets.  But there are other factors at work as well, and some of these factors are more complex in their implications and perhaps less favorable in their implications.

Part of this dynamic in financial markets we've seen in this expansion is a consequence of what you might call the present state of the international monetary system.  This is a system, of course, in which a substantial part of the world economy still runs exchange rate regimes tied in some ways to the dollar, or directed at minimizing changes relative to the dollar.  And this has entailed or required a sustained period of very substantial official accumulation of dollar reserves, which in turn has put downward pressure on U.S. interest rates and upward pressure on asset prices globally.

These forces are almost certainly transitory, but their impact on capital flows and interest rates and asset prices are likely quite important, not just, of course, in what they've done to short-run growth prospects.  If they're large enough, they have the potential to alter or distort current decisions about investment and consumption in ways that could have meaningful effect for future growth prospects.  And they're important, also, because they work to mask or dampen the effects on risk premium in financial markets that we might otherwise expect to be associated with the expected trajectory of fiscal deficits and external imbalances in the United States.

Now with that broad context, I wanted just to say a few things about some of the broader policy issues that will likely be important to economic performance here and globally.  And of course, despite the favorable performance of the last several years, we face -- economies around the world still face a number of quite daunting longer-term challenges. 

The improvements we've seen globally in monetary policy were very important to the, as I said, the improvements in productivity and growth.  And of course, monetary policy will continue to be critical in the future.  But monetary policy alone can't provide -- can't carry the full burden of providing the elements or the framework necessary to provide that environment for innovation, long-term investment decisions that were so critical in the past and will be so important in the future.

And I would say economic policy in general -- look across the universe of the things that are at the center of economic policy in countries.  Economic policy in general needs to be more forward-looking in trying to provide a longer-term framework for stability.

On the fiscal front, briefly -- demographic changes around the world will confront governments with exceptionally difficult choices.  For the United States, these demographic challenges are less acute than they are for many of the other major economies, but they are still formidable in their scale and their complexity.  And even for the near term -- for those years between now and the period when the substantial increase in retirees will start to have a major impact on Social Security and Medicare expenditures, we are running an unsustainably large fiscal deficit.  And despite the recent improvement in revenues that have come with this expansion in the U.S., the expected trajectory for the fiscal deficit in the United States will mean that federal government debt to GDP continues to rise, and will continue to rise as a share of our economy.

The restoration of fiscal rules -- rules that require, for example, new tax cuts or expenditure programs to be funded with offsetting policy measures -- will help reduce the risk of further deterioration from this baseline.  But they can -- but they can only do that -- of course they can only reduce the risk of further deterioration from this trajectory, and they need to be complemented by a consensus on policy changes that will produce smaller future deficits.

Now restoring confidence in U.S. fiscal management would be important, independent of the broader context we see in the global economy today.  But it's more important, given the size of our external imbalance, which of course is now running at roughly 7 percent of GDP a year. 

The trade balance -- the U.S. trade balance in real terms has been broadly stable over the last two years, but our net income payments have shifted into deficit.  And the size of that part of our current account and balance, unreasonable expectations about the future is likely to continue to expand. 

And these large global imbalances -- both our current account deficit and the surpluses that are the counterpart of that deficit will have to come down over time.  And how that process of adjustment unfolds is going to depend on a complex and uncertain mix of factors around the world.  But confidence that the U.S. political system will act to generate a more sustainable fiscal trajectory here is important to raising the probably that this process of adjustment globally unfolds with less risk.

A few things about trade:  Of course, a successful conclusion of the Doha Round -- these latest multilateral trade negotiations -- would provide important insurance against the risk that this process of integration globally will be interrupted or reversed.  And despite the very favorable average income gains we've seen over the past few years here and globally, I think a common feature of the political context in economies around the world is the fragility or weakness of public support for openness and integration.

This political challenge of sustaining support for the process of integration may be the most important, and it may be one of the most difficult economic policy challenges of our time.  To paraphrase Larry Summers, it's not enough to explain to people that globalization is inevitable, and that policies that look politically attractive as a response to economic anxiety will only hurt the economy as whole; nor is it a politically effective strategy to state simply that economic integration is a necessary and powerful force in raising average incomes; or to simply explain or state that technological change may be more important than trade or immigration as an explanation for slower growth in real wages for many Americans.

Raising the quality of education and exploring ways to improve the safety net are probably a necessary part of the solution to this political challenge.  But these reforms are going to have a very long fuse and they may not yield the hoped-for increase in political support.  Trade doesn't appear to be more popular in countries with more generous safety nets, with universal health care, with highly subsidized higher education than it is today in the United States.

This political challenge of sustaining support for global economic integration and for fiscal sustainability will be more difficult in the United States because of what's happened to the broader distribution of income and to economic insecurity.  The very long -- this long-term -- and it is a long-term increase in economic inequality.  The slow pace in growth in real wages for the middle quintile of the population of the United States, the increase in the volatility of income that's come with the increased flexibility of the U.S. economy, and the greater exposure of households to the risk in financing retirement, and the burden of paying for health care -- these broad forces substantially complicate what would already be a daunting set of political challenges, economic challenges.

More generally, the global financial system and the monetary arrangements that underpin it are in the process of a delicate and consequential transition as the major merging market economies, particularly in Asia, move towards more mature monetary policy frameworks, more flexible exchange rate regimes and more open capital markets.  This transition will require very careful management.  And the economic dimensions of getting it right would be very complicated, even without the political pressures those governments face.

Just a final note on the financial system.  The global financial system is obviously in the process of very dramatic change.  And even the changes of just the past five years are extraordinary both in terms of changes in the size and the strength and the scope of the major global firms, in the role of private leveraged funds, in the extent of risk transfer and the increase in the size of the derivatives market; changes in the structure of the credit market; increase and changes in the structure of pattern of cross-border financial flows.

And these changes, and a range of others in the structure of the system, we believe on the available evidence seem likely to have made the system more effective both in moving capital to its most productive use in matching savings to ideas, capital to ideas, but also in making the system more stable and resilient over time.  But they don't mean, of course, the end of systemic risk in financial markets or the end of volatility in markets.  And these developments could in some circumstances work to magnify, rather than mitigate stress.

And for this reason, central banks and supervisors and those running the major financial institutions need to continue to work to ensure that what Gerry Corrigan calls the shock absorbers of the financial system -- the cushions of capital and liquidity, the robustness, the strength of the operational infrastructure -- are sufficiently strong to withstand economic and financial conditions that are more adverse than we've seen in the recent past.

Thank you. 

So with that, I will submit to your interrogation.  (Laughter, applause.)

CORRIGAN:  As I mentioned before, Tim and I are going to have a little informal chat here and then open the floor for observations and questions from you.

But to put this little chat in perspective, it was, Tim, I think three years ago this past November that Tim assumed the helm as the ninth president of the Federal Reserve Bank of New York.  And I can say as number seventh looks at number nine, number nine is doing a terrific job.  We're all very fortunate indeed to have you where you are, Tim.  So congratulations on your first three years.

GEITHNER:  That sort of makes up for the lack of introduction.

CORRIGAN:  (Laughs.)  You have to decide, though, whether what I just said was John Madden or Benjamin Strong.  (Laughs.)  It makes a difference which one it is. 

But seriously, as you reflect on your three years plus at Liberty Street, what kind of runs through your mind in terms of looking back?  What if anything surprised you?  How does it feel?  Tell us a little bit about three years at the helm.

GEITHNER:  Hard question -- complicated question.

I guess I am struck by the fact that we live in a financial system that's got these really terrific strengths.  I mean, if you look at how competitive, how profitable financial activity is today, if you look at how dynamic, you look at the pace of innovation, you look at how resilient our system's looked over time, if you look at how effective we are at providing opportunities for people to, again, raise capital to finance business innovation, we have a system that has just terrific strengths.

And yet I think if you look at the broader regulatory framework that surrounds that system, I think it's hard to know whether those strengths we see today in our system are the result of that framework, or have they persisted in spite of that framework.  And I think this broad regulatory framework that exists today, you know, was really, you know, it was designed a long time ago.  And if you look at it today, it's hard to believe that if we were going to create it from scratch and have the opportunity, we'd create something that looked like this.

And I think we need to begin -- and I think we are at the beginning stage of a broad consideration of how that system should evolve over time.  And I think that's an important thing for us to do.  And it's more important in part because, you know, the rest of the world is just getting substantially better at running a financial system than a capital market.  We lived for decades and decades with a world with really no credible alternative to the United States -- a place with the depth in liquidity and range of choices you had for running a financial business in some sense.

The rest of the world's getting much better at doing that. They're getting richer faster than we are.  And they are at the early stage of something we've gone through a long time ago, which is to transform bank-dominated financial systems and systems where the capital markets were a much larger piece of their financial system.  And those changes will -- are good for the world, they're good for the United States fundamentally, but they provide additional motivation for us to sort of try to begin the process in the United States -- a process like the one we began almost two decades ago that led to the broader reforms in the financial system of the late '90s.

We're at the beginning of a process, I think, of trying to think about how that system should evolve over time.  And I guess one thing I'd say, Gerry, about what I'm struck by is that imperative.  And I think if you look more broadly in the global system as a whole, you can see a similar basic imperative, because of course, there too the basic framework that was put in place for multilateral cooperation in the international financial systems after the war -- it's just going to have to evolve substantially further if it's going to be viewed as a legitimate place for building consensus on the future evolution of the system. 

And it'll just -- it's going to require substantially more change.  And I think for the United States we have to figure out a way to be supportive of that and still preserve, I think, what is very important to us, which is the capacity to play a central role in the evolution of those institutions in a world where we are small in relative terms, and a range of countries that are very important to the United States in terms of strategically, economically, financially, need to have a bigger stake, a bigger voice in how that system is run.

So I think -- I would say the thing I'm struck by most, again, is that imperative we face domestically to begin that broader process of evolution in our overall framework that surrounds the financial system.  And this parallel imperative globally of trying to bring about more evolution more quickly in the international financial institutions -- that basic framework for cooperation that was designed, really, for a different era, has been remarkably successful, but it's going to have to change a lot.

CORRIGAN:  And as a rather logical following question here, and then we'll turn to the audience, because the logical following question seems to me is that, you know, when you discuss, as you have, this collection of powerful, powerful market and global forces that are pushing, clearly, in the direction that you've described, the obvious question is, is that direction compatible with an inherently more or less stable global financial system?  And does it mean that when we have the next financial train wreck, which as we agree, will certainly happen, does it mean that the potential damage associated with that next financial train wreck may be greater than earlier train wrecks?

GEITHNER:  I think you framed it exactly right.  I think that, again, if you look at everything we know about the structure of the financial -- if you look at all the celebrated changes in the financial system, you have a system that's really much stronger, more able to withstand a broader range of shocks than was true in the past.  And of course, that's the result of lots of, again, these celebrated changes in the system, both much larger financial strength and capital cushion of the core of the system, more robust financial infrastructure, much greater opportunity for risk transformation and sophistication quality of risk management.  You know, all those things are almost certainly likely to mean the system is going to be more resilient across a broader range of circumstances.

But it also means -- and this is a necessary complement of those changes -- that if you face a shock that is sort of in the extreme tail of the distribution, large enough to be meaningful for a major firm, that shock may be greater, more complicated to manage, more difficult, maybe more consequential in its result.  And it's that combination of lower probability of future events, but of course the possibility that extreme shocks could more damage, be more complicated to manage, that should, you know, preoccupy everybody at the center of this world.

And I think that intuitively the way to explain that is to say -- is not just to say that, you know, if you have more concentration and more size at the core of the system, then the consequence of distress at the core of the system will be greater than was true in the past.  But part of this also just relates to the changes in the broader hedge fund leveraged, private fund world and the pace of innovation in derivatives (conflux ?) structure products. 

That activity, that big increase in leveraged arbitrage activity in both hedge funds and in the major institutions, economists believe -- and there's a lot of evidence to support that -- believe that that compresses volatility, suppresses volatility in relatively normal conditions.  But because of the financial constraints those institutions face, it can also amplify volatility or shock, if you have a shock large enough, again, to threaten the financial viability of those institutions.  And that's another reason why you might have this combination of lower probability, greater resilience, but some concern that if you're in the tail it might be more complicated to manage.

And of course, you know, this huge increase in structured credit derivatives in instruments that allow for a lot more embedded leverage, you know, that revolution in credit markets and finance, because it's taken place in a relatively benign economic environment in a long period of very low volatility, we necessarily know less about how those exposures are going to behave and how those markets are going to behave in, again, a less -- a more adverse economic condition.  That's another reason why you want to be -- you want to worry a little bit about this.

But that doesn't, I think -- shouldn't qualify too much the basic proposition that by many measures is the core of the system in the major markets, and really in emerging markets too.  It's really substantially stronger than it was five, 10, 15, 20 years ago.

CORRIGAN:  And I think that most of us would agree to that this time around, even though the sun is still shining brightly, there's an enormous amount of effort and attention being focused on these kinds of issues and how they might play out in the kind of tail event type situation that you've described.

I don't know about you, but I certainly take some comfort from just that alone -- the sheer amount of attention and effort that is being devoted to these questions.

So on that note, let me turn to the audience and see if we can get a question or a comment or two from any of you.

Okay.  Chuck, let's start with you, okay. 

QUESTIONER:  You mentioned a number of times in your remarks the need for confidence in the ability of the United States to generate good economic growth, fiscal discipline and so forth.

Recognizing that I would guess the vast majority of people would not only agree with that, but would feel a sense of unease about the current situation -- high or low -- and recognizing that the political environment -- the politicians -- don't seem to be leading in the direction of that, and perhaps they reflect rather than lead public opinion, what can be done practically to help to change public opinion or the political environment?  And specifically, does the Fed have any role in that effort?

GEITHNER:  The Fed and central banks everywhere, you know, they can do the constructive thing in trying to paint broadly the consequences of fiscal policy situations and things like this over time.

But I don't think it's likely that the central bank here, or in other countries with similar situations, can be a substantial part of the solution to that problem. 

I think that's just going to have to come from the political system itself and from the executive, and it has to come in part from how compelling the financial community -- the business community can be in trying to make the case that -- that you need to start to see now actions that can provide that kind of confidence in longer term sustainability that's going to be important to the U.S. economy. 

     I think that it has to come from the political system and it's going to come from the -- the business community and the financial community.  I -- I don't see a better alternative to that.  Of course -- of course, the Fed will be persuasive in private and compelling in public about the broader costs, and we'll work carefully in that -- in that end.  But I think it's going to come -- have to come from the political system and you -- you may be seeing the beginning of that consensus reestablish itself and it is not my -- my place in the world but I think the -- the center of the political system in the United States that -- that come -- has -- needs to exist to command greater conservativism on the fiscal side going forward, looks like it's getting some traction again but it's early days.

     CORRIGAN:  I'd just add a comment on my own that, Chuck.  Now Tim talked a little bit about -- (inaudible) -- trade a few minutes ago, and when one looks at the state of public opinion in the United States on trade issues, it's pretty sad.  It is really pretty sad.  And I certainly agree with what Tim was saying and that is, how you go about trying to move the needle even a little bit in terms of public understanding and support of the progressive policies in the trade arena is -- is a huge challenge and I -- I don't know but I think you would agree with this that the business community itself frankly I don't think has been nearly as progressive if not aggressive as it could and should be in trying to help make that case and educate the American public on that kind of an issue.  You had a couple of questions -- Annie (ph)?

QUESTIONER:  I'd like to ask you about the lessons of Amaranth. 

QUESTIONER:  Microphone.

QUESTIONER:  Thanks.  I'd like to ask a question about the lessons of Amaranth.  I think the ability of the system to absorb the implosion of Amaranth is ample testimony to everything you've said.  But I wondered if it has led to any sort of concerns in your mind about the assumption that counter parties are the best way to deal with potential shocks of hedge funds.  And particularly, you know, the situation with J.P. Morgan Chase which wasn't a counter party but it was the futures commission merchant there.  And I wondered if you could address concerns about that.  And also your point about the incredible asymmetric leverage, which means that counter parties' exposures may not be amply covered by the margin in these new products.  Thank you.

GEITHNER:  I personally don't find Amaranth particularly reassuring as an example or as -- as the -- as a compelling case to illustrate the more resilient properties of our system today.  I think Amaranth was very interesting but very special.  Most of their exposures that were proved sort of consequential to them were in exchange period instruments where there's an established margin regime.  They had a principal relationship with one counter party, one futures commission merchant. 

Those positions were in a -- in markets where there's an established regime for reporting designed to capture large positions.  There are a lot of things that were special about Amaranth that probably mean it doesn't really tell you much about how resilient markets are going to be in -- in other contexts.  And so I guess I would still say that the most effective way we have to try to mitigate the broader consequences for the -- for financial stability might come from distress in the hedge fund sector are to try to make sure that the core of the financial system has strong cushions of capital and liquidity against distress in the periphery. 

You know, we can't -- we shouldn't run a system designed to reduce the probability of failure in the hedge fund community.  We should try to run a system that's better able to withstand the likelihood -- inevitable likelihood of broader distress in that context.  And I think that that basic approach is probably the more effective way to deal with the systemic consequences. 

But, you know, these are complicated questions and people should come with them with a pragmatic view, and if there's a sensible approach that goes beyond that that offers some promise of return, that's feasible, that you can actually make work, then we should be open to thinking about that.  We haven't found it yet though.

CORRIGAN:  Tim, if I could just piggyback on Annie's question again.  The Fed and the SEC and the FSA, I think, thanks to your leadership, are taking kind of a systematic look at this whole question of margin collateral and so on as it pertains to not necessarily an Amaranth-type situation but the relationship between hedge funds in particular and their prime brokers and major regulated financial institution counter parties.  I know that's a work in progress but is there anything you'd like to say about that effort?

GEITHNER:  Well, as you said we are -- we are working with the other primary supervisors of the largest global financial institutions, banks and investments banks, U.S., non-U.S. -- to look at the -- in some sense the state of the art and the credit discipline that -- that exists in the relationship with hedge funds and in over-the-counter derivatives more generally.  And of course what you see when you do that of course is that there -- there really has been just a huge improvement in the strength of the risk management discipline in those areas relative to what -- (inaudible) -- in '98. 

But of course you also see as -- as often happens the competitive pressures that exist in these markets are pushing credit terms down, pushing margin levels lower, and although these arrangements are collateralized arrangements -- there are variation margins that exist in some sense -- they're in some relationships and in some products a lot of pressure on initial margins. 

If you look at the overall exposure -- direct credit exposure of the major firms to the hedge fund universe as a whole and you try to measure that, you know, reasonably -- through reasonably conservative prisms, that -- that total credit exposure does not look that large relative to capital.  But that doesn't really capture the broader risks to the system of the kind of shock to asset prices that might cause distress in hedge funds and lead to the kind of trend-amplifying behavior you saw in '98, and '87 in some broader sense.  And so, you know, we -- what we're doing is -- we've been talking about is just trying to look at ways in which we can try to induce the market as a whole to a slightly more conservative place in the terms of those relationships.

MR.CORRIGAN:  Other questions?  Mickey?

QUESTIONER:  With the globalization -- Mickey Siebert (sp) -- Muriel Siebert -- with the globalization of the securities markets should we have global securities regulations as we have in banking?

GEITHNER:  Well, you know, we -- we've been living for some time and we'll live I think for the -- for the foreseeable future with this reality of much more globally integrated capital markets, financial systems but sovereign states -- sovereign states that are going to want to have the national capacity and discretion to set the terms in which intermediation happens in their markets or how investors are protected, et cetera. 

And I don't think it's realistic to envision or necessary to try to work towards a kind of super national authority that would apply uniform terms to the way securities markets work.  But I do think -- sort of sounds pedestrian to say it -- but I do think that regulators everywhere in banking and in -- in the securities  market just -- they have to work much harder to kind of bring about a somewhat more integrated framework that underpin these markets better match the globalization of these markets.  And that is very important to do -- very hard to do.  It's particularly hard to do because the, you know, the pace of change means that the regulatory framework supervisor has to evolve much more quickly than it has in the past to keep abreast of this stuff.  And those two imperatives -- the need to -- that they need to have much more cooperation towards a more integrative framework globally for these things and the need to evolve more quickly is difficult -- is a difficult challenge. 

But I don't think you need to envision or will work towards a -- a kind -- a world in which we would cede to some super national authority that basic -- that basic authority over the terms of finance and our country has yet to -- to come up with a viable solution.  And of course, you know, Gerry was the center of efforts several decades ago -- I don't know, eight or nine decades ago, Gerry (Laughter.)?

CORRIGAN:  Now wait a minute.

GEITHNER:  Nothing new in that basic observation.  It's been happening for some time.

CORRIGAN:  Let me reach back into the audience.  Yes, sir?

QUESTIONER:  John Beatty (sp) from UBS.  The current Federal Reserve chairman has indicated a likely move towards an inflation-targeting policy.  I wonder how you would reconcile this with the explicit Federal Reserve mandate to ensure price stability as well as economic growth.  And I ask this specifically in light of the fact that the current Senate Banking Committee chairman has indicated a very likely increased oversight on the -- on the Federal Reserve.

GEITHNER:  Well, I'm going to give you some Fed-speak in response to that (Laughter.).  The FO&C (ph) is in the process --

CORRIGAN:  You want to see -- (cross talk) -- in three years?  (Laughter.)

GEITHNER:  FO&C is in the process of examining whether and how that basic framework of monetary policy in the United States might evolve in the future.  We're in the process of that exploration and -- but I would say though there's no conflict necessarily between the legislative mandate we have now in the -- in the United States first that governs the Central Bank, and the range of possible variance of the inflation targeting framework other countries have adopted  There's no necessary conflict between that and the chairman's been very clear in his confirmation hearings and since that we wouldn't consider changes that would call into question the need for changes that brought legislative mandate -- the dual – the broad dual mandate.

CORRIGAN:  Yes, back there.

QUESTIONER:  Thank you.  Could you comment on the fact --

CORRIGAN:  Would you -- would you identify yourself, please?

QUESTIONER:  Yes, of course.  Sergio Galvez (sp), Sullivan and Cromwell.  Could you identify the factors that might affect the status of the dollar as a reserve currency?  The likelihood that those factors could come into play and what the consequence would be of a change?

GEITHNER:  Excellent question.  I remember reading a terrific paper that a colleague of mine at the Fed wrote when I was at the Treasury I would say maybe 15 years ago, which was really a paper about the consequences of European monetary integration for the dollar's role as reserve currency, and the basic dominant role of the U.S. in the monetary system. 

As you -- as you recall at that point there was a lot of speculation that that would be a -- it would mean the -- the gradual but sort of consequential diminution or fading in the dollar's role.  And I -- and I -- I think the last line of that paper said the risks of the dollar's role in the system probably come from us, not from broader changes in the world in the sense that, you know, the world is in the process of substantial evolution in the broader balance of power, of course, and that of course will inevitably have consequences for the monetary system -- for the relative role of the U.S. in that context. 

But that process itself should be good for the United States and should be -- should be benign for the world provided we do a good job both as a central bank and as a government in sustaining confidence in this place as a place to bring your capital and invest it.  And of course that requires over time not just that we sustain confidence in our capacity to deliver price stability over time, but we sustain confidence that we're going to provide that broader economic policy framework that's going to make this a place where you're going to see innovation -- future productivity enhancements over time. 

So the end of that paper was focus on us and credibility in the United States, and don't view these broader changes in the world that may bring about over time some broader evolution in the monetary system as itself particularly threatening to stability more generally.

CORRIGAN:  (Inaudible) -- about seven or eight decades but I've been wrestling with that very question for four decades and the basic answer doesn't change as you've just stated it.  Yes?  Over here please.

QUESTIONER:  John Hartzell (sp), KWR International.  You talked about the increasing competitiveness of foreign economies -- capacities in their financial systems, and there was an earlier question about securities regulation.  About six weeks ago there was a report from a group called the Committee on Capital Market Regulation which acknowledged those trends -- nevertheless concluded essentially that at least in the IPO markets the U.S. was over-regulated, which was driving away foreign business and suppressing domestic IPO business. 

When the report came out a number of people also criticized it in various ways.  One hedge fund manager said it was very elegant whining.  He was also a former -- former -- he was a former SEC chairman but I just wonder where you stand on this.  Do you think we're over-regulated at least in that part of our capital markets?  Are others under-regulated?  Is there a new balance that has to be found?

GEITHNER:  Well, I -- again I think -- I think most of what you're seeing happening globally is -- is that the world is getting better at providing a place where it's attractive to raise equity and -- and debt too.  And -- and that process itself will create the dynamic we're seeing where you're going to look -- if you can look at the numbers about share in these areas and see in what is probably a pretty healthy and benign trend things that will cause some concern and reflection about the balance and regulation in the United States. 

But I think even -- even though most of what's happening is substantially positive things about again better -- about financial reform and -- and wealth and debts outside of the United States, it doesn't mean we should take a -- we should take a careful look at the full compliment of things that we've developed over time and imposed on our financial markets -- (inaudible). 

And I think that it is as many of these reports have pointed out and then the ones that are forthcoming will say this is a very complex network of things.  It's -- it's not just 404 in Sarbanes-Oxley, it's not just the dual accounting regime and the difficulties that presents for people that want to be public company.  It's not just the litigation environment and the whole enforcement environment around the securities law of the United States. 

It's about other things that are politically very difficult to deal with.  It's about the ease with which you can come to the United States and work, or as a client come and visit -- things like immigration -- and it's about the ability of companies to find exceptionally high-skilled talent and what's happened to the relative advantage of the United States -- there's other places for those things. 

You know, it's just abroad and it's about the complexity in the regulatory framework, and it is -- even though those are daunting things and it's hard to know whether you're going to find in the near term the political capacity to bring about meaningful change in those things, it's -- it's the right thing to worry about and the right thing to care about looking at it.  And these things, because they have such a long fuse politically, you got to start somewhere and you got to start even -- even if you don't see the horizon and don't know if you're going to be able to find the political -- (inaudible) -- and terms that are going to produce a better system than we have today.

CORRIGAN:  And Tim, just -- could you back one further comment on that?  If you look for example at listing requirements in, say, Hong Kong and Shanghai -- I say this as someone who deals with this on a day-to-day basis -- you can make a pretty good argument that if anything the listing requirements in those two regimes are much more demanding and strenuous than they are in New York.  So again it's -- what you see is not always what you get.

GEITHNER:  Get your attention -- (inaudible) -- this stuff?  And this is a little -- I'm not sure I can frame this right.  But I don't think what's happened to the U.S. share of public equity offerings is the most valuable prism to look at this broader question of what's happened to the strength of the U.S. financial system more generally.  And -- but even though you can't see it in a bunch of those numbers and, you know, there are many things about our system that still look very strong and very compelling against any other model in the world, I still think it's important that we sort of begin the process -- (background noise) -- about how our system can evolve.

CORRIGAN:  Go over here this time.

QUESTIONER:  Phil Gates (ph), a lawyer.  I'm constantly asked by clients all over the world about our excessive corporate pay -- payouts for our CEOs.  Do good jobs or bad jobs -- they get $400 million when they leave.  They have -- they think this is a very -- they feel also that we are lying about our inflation.  I've taught in economics that we get our inflation figures from the Bureau of Labor Statistics.  I don't know whether the Fed still does but the Fed is supposed to have a sort of handle on inflation. 

But I heard Mr. Goodfrin (ph) here a couple years ago say every single item of his expenditures -- of his life has tripled, and I can tell you if you ask your wives it has tripled.  The last -- what -- I don't believe the Bureau of Labor Statistics but I'd like to know what -- do you? (Laughter.)  And what -- what if anything the Fed can be doing about this scandal -- which is part two -- about our -- our treatment of our -- when people are struggling with minimum wages that these high -- high flyers in the corporate world get all this money.

GEITHNER:  I wish --

QUESTIONER:  Can you do anything about it (Laughter.)?

GEITHNER:  I wish I did but I -- and I really wish I could say something interesting about your broader question about what's happened to compensation.  But I have no useful insight to offer you about what we should think about it really, or what you should do about it. It's -- fortunately for me I think something substantially outside the day-to-day preoccupation (laughter) of my world. 

But I -- but I would say that -- but I -- as I said in my remarks I do think that this combination of this long-term trend in income inequality, you know, the sort of -- it's a -- it's you might say a perception of somewhat diminished opportunity where you're seeing in real rates -- real wage trends generally in the middle of the spectrum -- this increase in volatility of income.  You know, this combination of things is very important politically, and I think they -- they remind us in some sense the difficult things you face in the world that look like they're about economics are really about politics and the -- the biggest risks we face and the biggest challenges you face everywhere this -- economies face everywhere -- is really the capacity of the political system to find ways to deal with what are very compelling formidable long-term economic problems.  

But they're really essentially political.  They're not technically that difficult to figure out how to solve.  They're really about finding that political consensus where a lot of forces are -- are creating more divisive -- eroding the center of the political spectrum. 

I didn't answer your inflation question, but maybe I would just say that, you know, what -- what central banks -- central banks are accountable for what happens to overall inflation over time, and so we are measured really about what we do to overall inflation over time by its broadest measures.  But in the United States -- (inaudible) -- is the general view.  To do that what we try to do is try to figure out by looking a variety of different measures of -- of inflation.  Look at what's happening to underlying inflation today. 

And so when people talk about various measures of core inflation or different components -- (inaudible) -- what they're trying to do is to capture what's happening to underlying inflation, because by affecting that we can have the biggest effect over time -- what happens to overall prices.  But it will always be true that what you experience in your day-to-day life in terms of what's actually happening to inflation -- stuff you buy -- will differ a lot from what Gerry experiences or what I might experience or somebody else. 

And the challenge of trying to capture what's happening to underlying inflation is -- is a -- is a difficult challenge and that challenges -- the measures of core have been pretty -- pretty reliable in the United States over -- over time as a basic guide to monetary policy, and they probably look pretty good today still.  But we have to be very careful not to take too much comfort in those selective prisms of what's happening to inflation, because again overall ultimately we're accountable to what happens to overall inflation over the longer term.

CORRIGAN:  Unfortunately the clock is rapidly ticking by here and I'm going to take one more brief question with the emphasis on brief.  Yes, sir?  Brief.

QUESTIONER:  Herbert Levin (sp).  Thank you for your presentation.  Fred Bergstin's (ph) shop has turned out a number of studies as to what the change in the value of Remnant B would mean for the trade imbalance and always concludes that there's a great deal to be done on the U.S. side as well as the Chinese side.  Could you evaluate -- disaggregate some of these factors that he deals with on this subject?

GEITHNER:  Just to be crisp, no (Laughter.).  I spent much of my youth writing the index cards for the incoming secretary of the Treasury which says, no matter how you get the question asked about the exchange rate -- what's driving it, what the future is, what you think about it, what it's implications are -- don't say anything. (Laughter.)  And I -- and I -- but I should say that in your question you failed to acknowledge that the Bergstin Institute is really the Peterson Institute (laughter) for international economic policy.  That's not to associate Pete with Fred's long-term views on (laughter) exchange rate questions and policy implications.

CORRIGAN:  Unfortunately we're going to have to wrap this up in a minute.  Before we actually do that (applause) I want to again acknowledge that this morning's program is part of the Peter McLaughlin Series on International Economics.  Peter, as I think many of you know, passed away some months ago but he was kind of a -- a giant in the industry as head of Xerox for many, many years.  But he is the source of arrangements that make these kinds of programs possible and I do think we should again acknowledge that.  But in concluding, Tim, I want to acknowledge the terrific job that you've done here this morning and repeat what I said before.  In the eyes of number seven, number nine looks pretty good.  Thank you very much. (Applause.)






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