C. Peter McColough Series On International Economics - Globalization and Monetary Policy (With A Tribute to Kipling's Six Honest Serving Men)

Tuesday, June 10, 2008
Richard W. Fisher
President and Chief Executive Officer, Federal Reserve Bank of Dallas
Karen Parker Feld
Managing Director, Harvard Management Company

KAREN PARKER FELD: Good morning, everybody. Welcome!

Welcome to the Council on Foreign Relations. Today's meeting is part of the C. Peter McColough series on international economics, presented by the Geoeconomics Center, the council's corporate program, the Maurice Greenberg Center.

Before I proceed, let me remind you to please turn off your cell phones, any other wireless devices you might have. And I would like to let you know that today's meeting will be on-the-record.

My name is Karen Parker Feld and I'm the director of Foreign Exchange at Harvard Management. It's my distinct pleasure to introduce Mr. Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas.

You can read Mr. Fisher's impressive biography in your meeting flier. Many of you will already know about his broad expertise in finance and public policy. Some of you may have heard of his fondness for baseball analogies. But only those who have listened to his speeches can fully appreciate Mr. Fisher's talent for expression. His metaphors are not only apt, but colorful. He has described inflation as a "caged beast" or unfunded entitlement programs as "catastrophic" -- Pete Pearson (sp) would be smiling if he were here -- and the violent response of financial markets to the re-pricing of structured mortgages last summer as a "gag reflex".

As is customary when public officials speak on matters of public policy, Mr. Fisher will probably offer the standard disclaimers that his views do not necessarily represent those of his colleagues at the Federal Reserve. But you could probably have discerned that from his voting record. A notable hawk, Mr. Fisher has dissented from recent decisions to lower the federal funds rate. He has expressed concerns about inflation early and often, and his concerns are now being echoed by colleagues not only at the Federal Reserve, but indeed at central banks around the world.

Today Mr. Fisher will enlighten us about the consequences of globalization for the conduct of monetary policy, and I'm sure he will address this exact inflation concern that seems to be uppermost on so many people's minds right now.

Mr. Fisher. (Applause.)

RICHARD W. FISHER: Well, gosh. I was going to issue the standard disclaimers. I don't have to do that now! Karen, thank you.

And I want to first say what a great honor it is to be in this room. You know, Richard, I sent you a copy sometime ago of a letter I received on June 4th, 1976. And it was signed by David Rockefeller. And it says, "It is with great pleasure that I write to tell you that the board of the Council on Foreign Relations has just voted unanimously to invite you to become a member."

Well, I was so naive then I sort of felt the way it was expressed -- so heartfelt, it was signed by David and Cy Vance -- that right after that meeting, David rushed up to the playhouse in Pocantico Hills and I'm going to write Richard Fisher a letter and tell him he was unanimously accepted into the council. And that's where this education of mine really began. So it's a great honor to be here.

It actually predates that. I worked for a man named Irving Pratt when I was at Harvard. I sailed his boats. I was the best-paid crewmember in the New York Yacht Club crews. You weren't allowed to pay anybody, but Irving was commodore and I was well paid.

He grew up in this house -- the Harold Pratt House. This was where this man grew up. And he said that you would one day, Richard, if you worked hard, have a house like this. (Laughter.) He lied! (Laughter.)

But he did give me a quote, which I've carried with me and I've thought about a lot in my current duties, which was a wonderful expression by a former prime minister of England -- I forget which one. But he said that "not even love had made such fools of men as contemplating the nature of money."

What do I do for a living? I contemplate the nature of money! And I hope not to be foolish in doing so. You were nice, Karen, to say what you just said.

I'm going to read to you what came out of the Daily Telegraph in London last night, after Ben Bernanke spoke and after Tim Guidner (sp) gave a very good speech yesterday, by the way, which I thought was thoroughly comprehensive and the standard bearing speech for a lot of what we have been doing and what we will be doing. I admire him enormously.

But here's what Ambrose Evans-Pritchard wrote yesterday in the Daily Telegraph -- perfectly British name -- it says, "Fetch your tin helmets once again. The European Community (sic/Central) Bank is opting for monetary purge. So too is the U.S. Federal Reserve, now ruled from Dallas" -- (laughter) -- "Uber-hawks and Cromwellians have gained the upper hand at the great fortress banks." And then he goes on to conclude, "slavish adherence to, quote, 'inflation-targeting', end of quote, and totemism and pseudoscience will ruin us all."

Well, with that background I'd like to talk to you about my perspectives on inflation and go back to the origins in this building, because it's my very firm view that we are being driven by the new gearing of a globalized world. We have set up within Dallas and the Federal Reserve of Dallas an Institute for Globalization and Monetary Policy. And the reason for that goes back to this little poem of Kipling that I hinted at in the title of the speech. You may remember it. It's one of the sweet ones that he wrote of many.

He said, "I have six loyal serving men. They taught me all I knew. Their names are What and Why and When and How and Where and Who." Something I've taught my children at each interval to try to focus on when they analyze any problem they're presented with.

And I think the what, why and when of globalization is pretty obvious to many -- particularly people that were tutored and trained and listened carefully in this building and elsewhere, but I'd like to repeat them very quickly to you to put them in context.

Beginning with 11/9 when the wall came down, beginning with the ascension of Deng Xiaoping -- and also what I would call the two Steves, that is the two people that invented the Apple Computer and brought it to market in 1975 and perfected it in 1977 -- we embarked upon an integration of the global economy which really had not been seen before. We've often talked historically about what happened before the First World War, but this is globalization multiplied manifold.

There are no national frontiers anymore. We not only have transcended physical space, we've transcended space itself. As a result of that, it was pretty clear to me and clear to my colleagues -- including Chairman Greenspan, and also let me say, especially Ben Bernanke -- that the way things are transmitted today are first, not well understood; and secondly, affect us all.

This is not a closed economy. And moreover, we are not a manufacturing or an agricultural nation. And let me just give you some statistic to put some things in perspective so that we're all on common ground: 1 percent of the GDP of the United States is agriculture; 5 percent is mining and oil and gas; 11 percent is manufacturing. The rest is services.

If you're an architect -- and this is a real case -- working in Corpus Christie, you do not price yourself according to what goes on in Corpus Christi or Texas. You price yourself through the Internet on what's going on in Dubai. If you're a lawyer -- and by the way, there are more people in the legal services industry in the United States than there are in the entire automobile manufacturing industry from parts to finished product. That always scares people, but it's true. Those lawyers produce twice as much GDP. If you're a prominent lawyer, you price yourself off of London -- not just off of New York or off of Dallas or off of Los Angeles. And we are a fully integrated economy. So the "what" is simple.

The "why" -- what I explained earlier, which is the net, the beauty of the ether of inner space, the enormous trade liberalization and other liberalization moves made by two great presidents -- Bush 41 and President Clinton. To me the first -- the two great trading presidents -- actually, the best free trading presidents since Grover Cleveland, and we can't bring Grover Cleveland back. And the when, I think, is pretty apparent -- the dates that I just mentioned.

The question is: How do we manage monetary policy from here? Where do we do it and who does it? And that's what you're hearing a bit of an expression of frustration about presently. We know through globalization that first we received an enormous boost in tailwinds in terms of the hard part of central banking, and that was controlling inflation.

We know that by adding almost 3 billion people to the game that we wanted to play, capitalism, that we were going to drive down the basic labor costs and we would have surges of productivity -- enhanced by the net, but provided by new labor sources.

When Deng Xiaoping said it doesn't matter if the cat is yellow or black -- by the way, he didn't say "white or black." I was in the room when he said it. It was "yellow or black" -- as long as it catches mice. That was the signal. And they have caught mice in droves. That's the easy part.

The reason we focus on globalization and inflation is now the hard part, which is when you reach a certain income level, the income elasticity of demand changes. For example, if China grows at 10 percent, given an income elasticity at their income levels for oil, which is greater than one, their oil consumption will grow by greater than 10 percent. We're seeing that now.

The income elasticity of food consumption when you reach a certain caloric intake becomes greater. They're now at about 0.7 by our measurement -- it's a very imperfect measurement, by the way -- at the Federal Reserve Bank of Dallas. But it's multiples of our own.

They want to be a shipbuilding power. Richard, I don't know what it is, but every nation wants to be a shipbuilding power. And they will build a fleet of Panamax ships, the big ones, that will eventually flood the market, but presently it's creating an enormous amount of demand for iron ore and steel. And so one is not surprised to see the Brazilians contract for a 65 percent increase in iron ore.

What does that mean to us? I'll give you a simple example. The other day, I went to my drycleaner in Dallas -- Mr. Faulkner has three units -- and he pulled me aside and said I'm going to have to raise my prices. Why? Because the cost of those little wire hangers -- those little white wire hangers that they put your shirts on -- just went up 65 percent. Including insolvents and everything else, he has no choice but to raise prices. And so now what we're seeing is this global integration is if not creating headwinds, it's creating crosswinds.

And yet we are a central bank commissioned by the United States Congress with a dual mandate, which is summarized in one sentence, and that is to create the monetary conditions for sustainable non-inflationary growth. The European Central Bank has a single bank. The Bank of England has a single mandate given by sovereign authorities. But we live in a globally interconnected world where in terms of money -- which is an electronic impulse, it flows at the click of a mouse -- and in terms of the transmission of tasks to perform services and produce products, there are no such sovereign frontiers, and it creates an enormous complexity.

So, in terms of going forward, what do we need to do? First of all, we have imperfect data. I mentioned that 1 percent of our output -- which is enormous, by the way, relative to the rest of the world -- is agriculture. We have more agricultural data points than you can shake a stick at. We know more about manufacturing statistically than you can imagine. We know almost nothing about the service sector; a few imperfect measurements. But worse, we don't have the data that we need to understand the forces that are acting us and regearing our economy from a globalized perspective. If you ask what the capacity utilization is of Chinese manufacturing plants, you'll get a blank stare; nobody knows. And, in fact, it's very hard to coordinate even between ourselves Europe because we measure them on different time intervals and we measure them by different orders of measurement.

In terms of the activity that's taking place now and the center of attention and this discussion that we're having as to whether or not we should hold rates steady or cut them further or raise them, there in, too, you are going to find a difference of opinion, and I think it's because of one simple fact: the Europe is an infant currency. It just celebrated its tenth anniversary. It's not just that they have a single mandate, but if I were Jean-Claude Trichet, I would do exactly what he's doing. The only way you establish the credibility of a currency -- and remember, the dollar and Euro is a faith-based currency -- nothing backs it but the good faith of the central bank and the fiscal rigor, hopefully, of the political authorities -- and in the meantime you must establish price stability to be credible. And I'm fully sympathetic to what Mr. Trichet is doing.

We have been torn by our dual mandate. We are in a period starting last August -- Henry, you know almost better than anybody else and most people in this room know it better than I do -- where our system froze. I use this simple analogy: we have the fed funds rate, that's the monetary faucet. If we turn it on too much, we flood our fertile garden of this enormous 13 (trillion dollar) or $14 trillion economy with too much water, which is inflation and we kill it. If we turn it too little or we're too sparing, it turns brown from starvation. That's the easy part about central banking, at least when we think in terms of a closed economy.

But we had a period of freezing up at the pipes, the sprinkler heads weren't working, the pipes were leading in totally the wrong direction, and we had to take the liquidity enhancement initiatives that we did. Tim Geithner spoke about this yesterday. I plan to say no more about it today. I think he summarized it extremely well. And we're still fine-tuning that system to make sure the pipes work and the sprinkler heads work. So now we're back to the faucet. Chairman Bernanke spoke about that last night. Tim referenced it yesterday. I speak about it constantly, as do my colleagues. And trying to do that in a globalized world is not an easy thing because, again, the forces that act upon us and the gearing of the United States economy has been totally transmogrified. And trying to get that right is a very, very difficult thing to do.

I will conclude with one last point before taking questions. I've been at the Council, as I said, since 1976. I realize that questions are really statements disguised as questions. I look forward to entertaining them.


But I do want to draw your attention and I will from now on to every audience I speak is something that I think is much more fearsome, even though it's a domestic issue, but it puts us in an international perspective, than anything we have encountered so far. And that is if you think of the trauma we just went through in terms of our financial system, to me it was a spring shower compared to the storm that's coming. And the storm, and this is in honor of Pete Peterson and Ross Perot, are our unfunded liabilities. And let me just give you some numbers to conclude with, depress you, and wrap up my conversation.

If you look at social security as a piece of cake, $13.6 trillion in unfunded liabilities; roughly the size of our GDP. I'm sure our political authorities can figure out a way to deal with that someway, somehow. If you look at Medicare on the other hand, it's $85.6 trillion by our calculation, present discounted value -- infinite horizon discounted value, as economists call it. If we paid it off today, 85.6 trillion (dollars) -- Karen, you'd better start worrying about this now. I'll tell you why. And just to break it down: A, which is hospitals, is 34-plus trillion (dollars), B, 34 trillion (dollars), and my favorite, prescription drug coverage, created by a Texan president, a Harvard MBA, a conservative Republican, is now amounting to $17.2 trillion in unfunded liabilities in today's value if we paid it off today. That's greater than all of Social Security, it's been in place for 29 months and we're in an election year. We need to do something about it. If we were to pay it off today, it would be 1.3 (million) for every family of four, $333,000 for every one at 304 million Americans. And it's just growing and growing and growing.

Why does the central banker worry about this and why is this relevant to what I want to discuss or what I'm here for? Because it's a standard political reflex and we've seen it since ancient Rome and we're seeing it today in modern Zimbabwe, which is if you can't solve a fiscal problem, you turn to the monetary authorities to turn that faucet and print their way out of it. And I'm here to tell you that neither I nor Ben Bernanke nor anybody who sits on the Federal Open Market Committee will countenance that kind of behavior. If we do, we're finished and you will suffer. And this great financial center of New York will be irrelevant as far as the rest of the world is concerned.

Now, mind you, we are non-political at the central bank of the United States. We are bipartisan and nonpartisan, and I'll conclude with my favorite story of George Shultz's. When he was the head of the Office of Management and Budget, he was very worried under President Nixon that they as Republicans were spending too much money, and he called in Sam Cohen, who was the encyclopedic source of all things budgetary. He'd been there since the beginning of the agency. And in the middle of the night, he's reported to have said, "Sam, tell me the truth: is there any difference between Republicans and Democrats when it comes to spending money?" And Mr. Cohen thought for a while and furrowed his brow, sat back, and said, "You know, Mr. Shultz, there's only one difference: Democrats enjoy it more."


Thank you very much.


Now, I know more important are the Q&As, so why don't we go ahead and do that.

All right, Karen.

FELD: (Laughs.) At this time, we would like to invite members of the Council to join our conversation with their questions. I'm going to ask two I hope you will see as genuine questions because they feel like genuine questions to me.

Vince Reinhart was here in New York a couple of months ago speaking at the Monetary Policy Forum, which is a very interesting gathering, and one of the great declarations that he made was an end to gradualism in monetary policy because we are now living in a world of more rapid shocks, non-linear shocks, including the financial sector events that we've seen. In that context, and given the Fed's, you know, heightened concern about inflation, should investors be anticipating a less gradual policy scenario going forward than we might have done in the last five years?

FISHER: You're going to do well with the Harvard Portfolio because that was a very subtle way of asking. (Laughter.)

FISHER: You're going to do well with the Harvard portfolio because that was a very subtle way of asking. (Laughter.) Are you likely to see the Federal Reserve likely to raise rates dramatically at some point?

FELD: No, is there a regime -- I don't mean -- (Laughter.) I don't -- I'm not referring to the immediate future. I'm saying is there -- there was a lot of talk about the need for transparency and gradualism, and many papers were written on this topic --

FISHER: Right.

FELD: -- five years ago. Has there been a new sort of way of thinking about that process --

FISHER: Well --

FELD: -- either here or globally?

FISHER: First of all, you don't want central bankers with trigger fingers. You want a deliberative, careful, cautious approach. It's one of the unique government institutions. And you don't want us to react with any emotion whatsoever. So one would expect gradualism by definition of the nature of the beast. Having said that, obviously we were not gradualistic in approaching these new liquidity facilities.

Now I hope you all understand -- and so many of you are so well-connected -- that this didn't just sort of spring out of Ben's head or the FOMC's head. We had begun asking questions very early on -- "What's in the tool kit?" And it was pretty clear that the simple faucet that I spoke of before -- and forgive me for -- I think analogies are helpful here. But it wasn't enough. Just playing with Fed funds wasn't going to do the trick. And this goes back, actually, to the very first meeting with Ben and actually meetings before, as Alan was finishing up. So a lot of thought went into these processes, and we did act very quickly, starting on March 10th with a $200 billion facility. And then we have created, of course, these -- that was a term lending facility and then the new facilities that everybody's familiar with in terms of lending to the primary dealers and expanding that accordion a little bit.

And all the things that we have recently had a lot of analysis on -- and again, I think Tim covered it very well yesterday. As to interest rates, there was also a theory that if needed, we could movie less than gradually if the force of inflation were threatening. Mind you, we have a dual manage I mentioned earlier. Mind you, all of us were quite worried -- everyone at the table -- that we were in a crisis situation starting well before August, leading up to August -- in that period August through March. And the so-called tail risk that we were encountering was severe; that is, we had a severe tail risk, a small probability but possibility of dramatic economic weakness. We seem to have navigated our way a little bit though those shoals. I think we're in much better shape on that front. Others have spoken about that as well.

One might have concluded -- and certainly academically, one could argue -- that if you needed to -- if you got past that risk -- if indeed the force to globalization were imposing upon us an inflation that we would have to deal with, we certainly wouldn't want to be viewed as accommodating that inflation, yet, we could move quite radically to counter that. Personally, I don't subscribe to that thesis. This is the disclaimer. I'm speaking for myself, not on behalf of my colleagues and not on behalf of the Open Market Committee.

The reason I find that argument, which was beginning to leak into the marketplace, less effective -- and I may be wrong. Remember, I'm a non-Ph.D. I'm an MBA. I'm very proud of that, by the way. I'm one of the few non-Ph.Ds on the FOMC. If you look at it from a microeconomic standpoint or a market perspective, the more you talk about, the more markets discount it. And therefore your cuts become ineffective because the market begins to count and expect a discount -- in the long term, a reversal of policy, which is why personally, I drew the line at 3-and-a-half percent, and we're now at 2 (percent). The wisdom of the group prevailed.

I hope I'm wrong, but I do think that it is very central banker-like to, except for under duress, to be deliberate and to be gradual. And I would rather have seen us personally stop where we stopped, if we had to, under the tail risk prevailing, cut a little bit further. But now we need to proceed in a very deliberate manner, and I expect us to do so.

FELD: Thank you. One --

FISHER: Jimmy's got a question.

FELD: Sorry. Did we see a hand up there?

FISHER: Jimmy?

QUESTIONER: (Off mike) -- going through a massive de-leveraging in this country --

FISHER: Mm-hmm.

QUESTIONER: -- and you're seeing something on the order of 8 (trillion dollars) -- $10 trillion coming out of the credit systems. That itself is putting a major drag on the economy.

FISHER: Mm-hmm.

QUESTIONER: How does an increase -- potential increase in interest rate help stem inflation as opposed to piling on to the cost of doing business?

FISHER: Well, first of all, I'm not advocating at this point -- sitting here in front of you today -- an increase in interest rates. That's not what I said. What I said was that I drew the line personally at 3-and-a-half percent. We're now at 2 (percent). We'll have to determine, based on what we see and feel and smell and hear and see in the data going forward when we next meet, how we proceed in future meetings. And I'm not going to show my or -- my hand and I can't speak for the others.

As to your point as to the constriction that's taking place, there's no doubt that it's taking place. We see it in our bank surveys. We also see what's happening here in terms of the so-called shadow banking system. We're fully aware that there are enormous pools of liquidity elsewhere, by the way. I hope whatever we do doesn't do anything to have them shy away, either new regulation or new taxation or whatever the new treatment may be from fiscal as well as monetary authorities. And this is one of the reasons we've been trying to be very deliberate in the way we conduct ourselves. We want to attract as much capital as possible. Remember, we're net consumers from the rest of the world.

So I don't -- Jimmy, I don't necessarily buy your argument that there's a liquidity shortage per se. I do accept the thesis that we will have a slowdown. I refuse personally to use the word "recession." I prefer the word "anemia" because I think we're going to have anemic economic growth for a longer cycle. I'm not sure how long. I will pay that price personally if the price of that is that we don't increase inflation because the worst thing that can happen is the following. We come out -- instead of a saucer-like recovery, which is what I expect, slow, anemic growth for a period but American dynamism prevailing in the end and correcting itself. If we came out very sharply and we're running an inflation rate as we are currently running and we start at that point, then we will have a problem on our hands. And that's what I've been the most worried about.

So I take your thesis, which is we're likely to have a slow period because the credit availability, particularly those that don't have access to globalized markets -- my dry cleaner, for example -- the people that actually create jobs in America, which are small businesswomen and businessmen, are going to feel this monetary tightness, this financial tightness as we go though a period of correction. But let's not kid ourselves. We needed to go through a period of correction.

My favorite line from the musical "Evita" is when she says, "All I want's a little bit of excess." We had -- there is no such thing as a little bit of excess, and what we have contracted is what -- one of the horrible puns of this, which is an STD, which is a Securitized -- (scattered laughter) -- and Trading Disease. And we somehow must bring that under control, and I think we are. We're beginning to treat it. And that's the price we have to pay.

Now, I want to make sure you understand -- and remember, I'm from a state that created 31 percent of all the jobs in America last year, Texas. I'm an American. I don't doubt for a second the ability of us to repair ourselves, and I'm not one of these Eeyores who believes that America is finished or is second -- or runs second to Europe. No one can compete with us dynamically if we do our job as a central bank and get it right, and our political authorities don't screw it up.

FELD: Right there. Yes. And if you could state your name and affiliation.

QUESTIONER: Thank you. I'd like to stand up, but I think -- (inaudible, laughter.) Bal Das from InsCap Management. I would appreciate your view on a matter that has been bothering me for some time. When I look at the market and look at the Fed as the minders at the -- (audio break) -- a huge segment of the market which has to do with the financial techniques, whether we have to --

FISHER: Mm-hmm.

QUESTIONER: -- talk about derivatives or others. How much of it and how interconnected it is is something that the minders at the post are aware of when they are making some fairly fundamental decisions as the most recent one that we saw as compared to a group of men and women sitting around a table, effectively the blind's feeling different parts of the elephant and coming to a decision as to the consequences and taking thereafter action. For some time now, it seems to me in the absence of a framework to make the data transparent that you're looking at a black box and making your best guesses about it. I'd appreciate your views on that.

FISHER: Well, thank you for coming back to Kipling's elephant, by the way, where that little essay I quoted comes from, his essay.

Very mindful. And this is that there's not just this theoretical and practical mandate of creating the monetary conditions under the dual mandate for sustainable non-inflationary growth, the single sentence that summarize the two. But to do that, you have to have a working financial system. And Bill Gross wasn't the only one that thought of the fact we had a shadow banking system. One of the reasons we focus so heavily on these liquidity measurements, expanding what I call the tool kit of the federal reserve, was precisely because of what you just mentioned, which is you can turn the faucet all you want. If the pipes don't work or they're clogged up with hairs and other detritus of excess, you're not going to accomplish your objective. And we have to have a working financial system. We spent an enormous amount of time on this.

Again, I want to give credit to Bernanke because he personally was ahead of the game on this thing from the moment he sat at the table. What's our toolkit? What can we reach into? It turns out, incidentally -- interestingly, a lot of the toolkit was already there, we just hadn't used it. The key facility that we put together, and actually the ability to deal with Bear Stearns, came from an act of 1929 that Herbert Hoover had vetoed and was hidden in the Highway Construction Bill which allowed us to lend under quote, "exigent," end of quote, circumstances, even to an individual if we had to. It was there on the books. We hadn't used it.

And I hope you will find that the open market committee -- and again, I don't think Ben gets enough credit for it -- but all the committee, including Tim and others, have pressed to figure out a way to use the toolkit to the best of our ability without crossing the line of moral hazard, and that's a great debate; we're in the business of moral hazard, by the way. That's what a central banker does. But to focus on the plumbing, which is your reference. Because again, we can turn the faucet on and off all we want, if it doesn't get to where it's supposed to go, the sprinkler heads don't work, we're not accomplishing our job. So the answer to your question is we spend an enormous amount of time discussing them.

QUESTIONER: : (Off mike.) My question is on the moral hazard. Would you mind speaking to that -- (inaudible) -- whether or not we should see a significant bank failure?

FISHER: You don't expect a central banker to sit here and say, "Yes, we need to see a central -- " (Scattered laughter.) I think this debate on moral hazard is a healthy debate. I do think -- I referenced earlier in my answer to Mr. Robinson's question, my admiration for the flexibility of American capitalism in our financial markets. I do believe lessons can be learned. I'm not sure anybody wants to get up to that point where Bear was, people working awfully hard to raise capital. You incur moral hazard but you don't want to encourage moral hazard. And you work your very hardest to make sure the signal is sent, but the best repair of all is the repair of self. So I would be uncomfortable in having anybody assume that -- we are the lender of last resort obviously -- but having anybody assume that we're just there and available.

The important thing is that they heal thyself. And I believe that's taking place. I think it will be painful, as you mentioned earlier. And it will take time. And hopefully we've created some general facilities that will facilitate the process just to kill my hydraulic reference. In a way we've built what we used to call an aqueduct. It's a bridge until the system repairs itself. It's a temporary -- most of these facilities, most of them will be temporary as the system repairs itself and as the regulators figure out a way to get around this regulatory morass that we've created. And, very importantly, and this gets to the point of the argument, that we figure out a way to operate on a globalized basis given our sovereign mandates. That's going to be the hard part. And coordinate with others. And we're just beginning to get a vision internally of what that might be. Each us thinking about it individually and beginning to articulate what we think it might be. And you saw that first expression, at least from a New York fed perspective yesterday. We've been doing that for a while in Dallas.

QUESTIONER: Hi. Dan Rosen, the Rhodium Group in the Peterson Institute. You attributed the productivity growth 90's early parts of this decade and low inflation to the addition of billions of Chinese and other workers to the world economy. Inasmuch as Chinese labor costs are rising dramatically, environmental compliance costs, land costs and other costs of production as well, is this a structural built-in exogenous inflation shock that there's really nothing we can do about domestically except get ready to deal with the reality of it?

FISHER: First of all, we need to understand it. One of the points I made in my perhaps not very clear comments is that we don't understand it well. Nobody understands it well. The BIS doesn't understand it, securities analysts don't understand it. We're attempting using the resources of the federal reserve system and we have an enormous emphasis as I said at the Bank of Dallas of trying to wrap our arms around what this means for the gearing of our economy, point number one. Point number two is that at a minimum, no central bank should be viewed as countenancing these inflationary pressures, or accommodating them. I think that would lead to an erosion of faith in a faith-based currency. So, at a minimum you don't want to be viewed as encouraging in any way, shape or form. I do think that the realities of the positioning of these economies are going to create new inflationary forces at this point in the cycle. Let me give you a simple example. And forgive me for drawing on personal history.

In the late 1970s, Bob Hormats and I were the two kids that were sent out by Cy Vance and Michael Blumenthal to go visit the Saudis and others, the Al-Sabahs in Kuwait and the Emirati. And basically, I'm central bank so I have to be careful, I won't use the word beg, but talk about oil. And we had this U.S.-Saudi oil commission. Well, think about what it was like if you were the Emirati or the Al-Sabahs or you were the family in Saudi Arabia. You only had three markets in 1978. What we know as the 10 nations, then called Western Europe, Japan and the United States. Oil was at $100 a barrel in today's dollars. Now look at who they have to sell to. Small wonder that oil is above $100 a barrel; not a surprise to me, shouldn't be a surprise to anybody. Yes, there is speculative activity at the margin.

If you sit down and talk to Rex Tillerson at Exxon, or an independent like Ray Hunt in Dallas who runs a big independent, they have no idea how much is speculation and how much is real demand. But the majority is a demand-supply function. So we know the world has changed. That's easy. How it works its way into the gearing of the U.S. economy, we still don't have a clear picture because we don't have the data because all of this is so new. We haven't been able to model it. Our judgment tells us that it is creating inflationary pressure. Then how do we adapt and how do we conduct monetary policy? If we conduct monetary policy in a way that looks like we're accommodating those inflationary pressures, what happens? Consumers begin to expect us to do more. Women and men that run businesses expect us to tolerate it and it changes their behavior. And the worst conceivable thing that can happen is for inflationary expectations to take grip and that's what we worry about the most.

And I've said it a million times and I say it every time I speak, and I'll say it again. The most pernicious threat to capitalism is inflation. It distorts all decision-making. It hurts the poor and those that live on fixed incomes. And you can see it today. The poor are suffering the most from inflationary forces. We cannot allow it to take grip. We cannot accommodate it. And in the meantime, we have to figure out a way to understand it better and how we might coordinate our activities with other central bank in the world or conduct ourselves, if we have to, unilaterally, to offset it. I don't have the answer there but I wanted to put it in context.

QUESTIONER: Good morning. I'm Whit Bower with 3I Group. Questions related to the second half of your equation of sustainable non-inflationary growth coming out of the anemic growth period that you see over the coming period. What do you think will fuel a resurgence in growth? Will it be many of the same factors we've seen over the past decade or so or will some of that actually have been spent, lower labor costs, information and capital flows which we've have tremendous growth from over the past couple of decades. What do you see driving us out of the anemic growth period?

FISHER: Well, not that I see anything specific but I do see the ability to adapt which we are the masters of. We are the masters of creative destruction. That's what American capitalism's all about. And I think it'll be intelligence and information driven. Will all due respect to Al Gore, he did not invent the Internet but American's perfected it. And if you look at what -- that's why I refer to the two Steves -- Jobs and Wozniak. And if you look for example at what's happening, and I'll use my state and my district as an example, oil does not drive Texas, medicine drives Texas. It employs 10 times the number of people employed in the oil industry. And it contributes a great more to our state GDP equivalent. Medical science, biotechnology, the frontiers of the higher value additive services. And we better do that well because the Chinese are moving up that ladder very quickly, which gets to one of my hobby horses.

Forgive me, long-term the only way we'll compete and succeed and continue to be the driving force in a global economy is by mobilizing the most powerful engine of the knowledge age, which is this right here. And that means higher education. Ron Daniels, sitting behind you, if my alma mater, Harvard, and these great institutions don't stay ahead of the game, then we'll start to lose. And I think that's really the higher value added -- what Churchill called the super fine processes. The higher value added levels of the service chain are what are going to propel the U.S. economy and put us ahead. And people will use them if we provide them. That's a general statement, but I see that's where our future lies. And that of course requires an enormous amount of expenditure of resources.

I like to remind people when they look at my skyline or you look at this skyline, you don't see one smokestack. You see glass and steel boxes that house human brains. What are they doing? Writing software, designing buildings, all the things that brains do. That's what'll propel us out of this. And we need to regroup. We need to find the means to underwrite it which is what Mr. Robinson was referring to earlier, and I believe that'll happen. I don't believe the downside is as severe. It is potentially severe as a tail risk but I think the most likely prognosis is it's not as severe as people feared, but I think it takes a while to regroup, go through the destructive side of creative destruction, construct again and come back out. By the way, my favorite economist is Schumpeter. His first lecture at Harvard, he stood in front of the classroom and said, "I had a dream of three great things that I would become; the world's greatest economist, the word's greatest horseman and the world's greatest lover." And he said, "I haven't done well with the horses." (Laughter.)

QUESTIONER: Thank you very much for this fascinating presentation.

You've mentioned the European Central Bank. You've mentioned the U.S. monetary policy. Would you care to make a few comments about the implications for Japan and the world of Japanese monetary policy?

FISHER: You know, we don't pay enough attention to the Japanese. It is still the second most powerful economy in the world. And I lived there and ran my fund out of Japan in 1990. I still don't understand Japan. And I think we ignore them at our own peril for many, many reasons -- some which have nothing to do with monetary policy.

But in a way -- and I want to be careful here -- as important and powerful they are in terms of economics and their increasing influence and interaction with China in particular and in that part of the world, we -- other than at the Federal Reserve and in our trading activity -- we don't seem to pay enough attention publicly to their prominence, particularly from an economic standpoint and therefore, from a monetary policy standpoint.

There is a great lesson to be learned from Japan, which is how to respond to deflationary forces or a slowdown in the economy. But I think you can draw the wrong lessons from Japan. The Japan that I knew and lived in was extremely rigid. And when it went into the tank starting in 1990 and began this period of a long period of no economic growth -- that's an interesting cell phone call.

I apologize for the musical interruption.

There was a temptation among some economists to say we're falling to the Japanese disease. I think that's a horrific miscalculation, because the Japan that went into that period was rigid, largely state directed, was successful as an exporting economy, enormously inefficient domestically.

We had this joint exercise between Hashimoto and Clinton -- the Commission on Deregulation and Competition. I co-chaired that and Larry Summers did an enormous amount of work on that on trying to restructure the Japanese economy. And a substantial portion of that has been done -- not so much because of that commission, but because Japan needed to do it.

We're enormously more flexible here in the United States and I don't think it's an apt analogy. So if that was the hint that you were providing in your question -- or I'm just reading it into it -- to say that we were falling to the Japanese disease I think is an artificial conceit.

QUESTIONER: But the point I wanted to make was that when you have low interest rates in a big country, those interest rates then are available to people all over the world. And when we have ultra low interest rates here, it affects interest rates globally. And when the Japanese have very low interest rates, it also affects the capability -- (off mike).

FISHER: Yeah. It's a good point.

QUESTIONER: And I'm just saying we don't seem to have any global way of addressing those inherent problems.

FISHER: No. Let me just add one thing: If you have low interest rates that are below the rate of perceived inflation, you're going to distract capital, not attract capital.

That's a good point, by the way. Thank you.

QUESTIONER: Thank you, Karen.

A quick question. I sounds like -- you spoke about the toolkit earlier that the Fed is evolving. It seems that part of that toolkit is discussing more openly views on the dollar by the Fed.

Obviously, we have kind of an intercontinental battle going on between Trichet and Bernanke at the point, but could you comment on how the thought process is evolving on the dollar and how the Fed discusses it more openly?

FISHER: Well, going back to Karen's comments, I may be colorful, but I'm not given to hyperbole and battle is a hyperbolic word. So I would not agree with your statement.

Let's go back to Trichet. What do you do with -- remember, it's a 10-year-old currency. Having raised kids -- it's not even a tween yet, okay? And you want to teach the right lessons. And the most valuable lessons a central banker can teach -- our mantra as central bankers, whether we have dual mandates or single mandates is price stability. And particularly if you're trying to corral a broad range of countries from what traders call the pigs -- Portugal, Italy, Greece and Spain all the way up to the Nordics, or at least to the Germans --

and he has a tough task.

So I do believe, if you want to establish yourself in a globalized world as a key currency -- not only as a unit of account, but a medium of exchange -- you'd do exactly what Trichet is doing. And you would do what we were doing as having the senior currency and the senior (age ?) in the world. I don't view this as competition. I view it as getting it right.

Now, actions speak louder than words. And those that evaluate the euro and those that evaluate the dollar -- and their relative value will be driven not by what we say, but by what we do. We are expressing, all of us, basically a sense of what I call -- and if you look at the minutes of the last meeting that were released there was reference to it -- a negative feedback loop that we're aware of of a different kind, which is that a weaker dollar can lead to further inflationary pressures, which in turn leads to a weaker dollar, et cetera -- and to dampen economic activity.

If your costs are going up as an operating company because of inflationary forces, and you have done what we've done to achieve incredible productivity in this country, which is you learn to run a very tight ship and your cost-to-goods sold is increasing, what is your reaction? If you can't -- you try to move as much through pricing as you can. If you have limited pricing power what you do is you cut back on other things -- headcount, cap ex, et cetera. So you can see how this negative feedback loop could work.

We're aware of that negative feedback loop. We did have a crisis we needed to stem. I speak for myself always when I speak, but I think I can safely speak for my colleagues here: None of us are willing to countenance inflation. And what we're worried about, always, is expectations. The survey data has not been positive recently. There are other measurements that have been positive. We have a trim mean that we pay attention to in Dallas. We don't -- in Dallas we don't pay attention to the core. We believe that people have to eat and air conditioned and drive their cars.

The core's a nice measurement if it can sort out signal from noise, but in this transmogrified economy, this globalized economy, I don't think sorting our energy -- since we've had these tectonic changes I talked about earlier -- makes a lot of sense. So we use a trim mean measurement.

We've had some moderation over the last 12 months. It's still running a little bit too high at about 2.3, but the anecdotal evidence, the headlines, what we're reading in the newspapers, et cetera and what we're seeing in the survey data is not encouraging. And we want to make sure the message is clear -- I certainly do and I believe my colleagues do as well -- that we will not countenance building inflationary expectations.

By the way, two of my favorite headlines -- I'll even name the newspaper -- in The Wall Street Journal -- they ought to get the prize. One was taking off on food prices in China, the greatest parody of Tammy Wynette's song, which is "Stand by Your Ham". I thought that was a good one. And the other was "Trouble at the Pump: Women's Shoes" and the pricing of women's shoes.

So you're beginning to see through the reportage -- if you really want to see, by the way, an expression of inflation, read a real newspaper like USA Today. And I'm serious. You will see constant reporting every day of some price pressure somewhere. That worries me a great deal. It's beginning to work its way into expectations. And when you begin to work your way into expectations, business and consumers behave accordingly and then we have a problem. So we want to make sure that that is not encouraged and we'll do the level best we can to do so.

This lady here.

QUESTIONER: Have you given -- Muriel Siebert, Muriel Siebert and Company.

FISHER: Yes, ma'am.

QUESTIONER: Have you given any thought to how our regulation should be recast, because we've seen now that the banks and the security firms both got into trouble on the same things, and yet they have totally different regulators. That'd be number one.

Number two: Have you thought about global margin requirements? Could we lead the way on that, because it isn't right when somebody can go abroad and borrow six, eight, 10 times on their capital and play around in the markets the way they've been doing.

FISHER: Well, Muriel --

QUESTIONER: Is that too tough?

FISHER: No, ma'am.

Answering you is like addressing Athena. This is a tough thing to do, given your role in the securities industry.

And I think Tim addressed that fairly comprehensively yesterday. Here's the point -- certainly what I feel -- is that if we're going to lend money to somebody, we're going to have our nose under that tent. There is a basic old-fashioned rule which people forgot in the lending business: Know your customer. That should be inscribed -- it should be tattooed on every banker on their forehead. We forgot that basic rule.

We're going to know our customer. In my book, if we're going to lend money to somebody, we will know everything about them. To me that's required. Now, that's my personal view. I think you've heard an expression of a different form more eloquently from Tim yesterday.

As to the second question: That's to be determined. And I hinted my own personal preference, given that we live in a globalized world, we have to figure out something. That's -- I'm not specifically addressing margin requirements, but the general idea of having perhaps a little better coordination, if not more uniformity on a globalized basis, because that's the world that we live in. Without surrendering our sovereign interest -- without threatening those that define our sovereign interests -- which are the people that we elect to office.

FELD: I think we have time for one more question.

QUESTIONER: Hi. Larry Kantor, Barclay's Capital.

I think you've made it clear to everyone, not just this morning but in prior speeches, your commitment to price stability.

My question has to do with how confident you are that the rest of the FOMC not only shares that commitment, but will be willing and able to act on it.

So let me put this question into context. You mentioned that one of the reasons why the Fed cut rates to 2 percent was this tail risk. Suppose the -- and it seems that Chairman Bernanke yesterday believes that that tail risk is considerably smaller. Let's say the economy, with all the stimulus that's been applied -- not just monetary, but fiscal -- and the currency and so forth starts growing at say a trend rate of 2 to 2.5 percent, I think you'd agree that not a lot of slack has been built up in the economy.

It looks as if, just from a casual observation, that the bar to lowering rates is a lot lower than the bar to raising rates. In other words, the Fed's independent, but it operates in a political environment. And we really haven't seen anybody since Paul Volker willing to raise rates sharply in a weaker economic environment. In other words, suppose you're right that 3.5 is really the rate -- that's 150 basis points from where we are now.

How confident are you that with an economy growing at say 2 percent or 2.25 and inflation pressures still where they are or rising, that you're going to be able to do this? You know, it's sort of a question about the character of the Fed here and the ability to do this in the political environment. You know, why should the market be confident?

You know, maybe if you were chairman, given what you would say, how -- why should the market be confident in this commitment?

FISHER: Well, this is one of those questions -- statements disguised as a question. (Laughter.)

Let me give you a one word -- how confident am I in my colleagues and their abilities? Very.

Thank you.

FELD: Thank you very much. (Applause.)









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