McKinsey Executive Roundtable Series in International Economics: Reforming the IMF: Is Bigger Better, and Who Should Get More Say?

ROGER KUBARYCH: This is called a BlackBerry. I think you all have one. It now gets turned off. And the reason -- I asked, what was the reason, the first time I heard this announcement, which I hear every time. And it interferes with the sound system.

And you don't want to do that, because we have a wonderful panel with Allan Meltzer and Anne Krueger, both of whom prove that you can be a renowned academic economist and still matter a lot, for practical decisions of real institutions. I would say that they have written widely on the IMF.

Anne has been the number-two at the IMF early in this decade and served with great distinction at a very difficult time. And now we're in another difficult time. And Allan Meltzer has had his paws over the IMF and World Bank as the Roger Ebert of the international financial institutions. (Laughter.)

Roger Ebert is and has been a great critic, my favorite movie critic, for a long time. But he did try his hand at making one movie himself. It was a slash-and-burn sort of B-level -- what do they call it -- well, trash movie, to tell you the truth, which he admits. And he said basically he's better as a critic than as a moviemaker.

But both Allan and Anne have raised important issues and have contributed widely both to the literature and to real decision-making. We're glad to have you here, now that all of the BlackBerrys are off.

The formal biographies are in the package. I won't repeat them. But I want to start by asking a couple of questions and then turn to all of you. I'm glad you came on the first day of the long weekend.

The IMF is considered widely to be a big winner from the G-20 summit in London. It's going to have its kitty expanded considerably. Or at least people are making pledges.

I'm on the vestry of our church. And the pledges last year were wonderful. But the actual receivables, receipts, were 25 percent lower, showing that even the Episcopal Church has been affected by the recession.

But in the case of the IMF, I am sure that all of these bigger tabs will be -- pledges will be honored. We hope so.

Is a bigger IMF needed, and will it make a serious difference to this global financial crisis? Allan.

ALLAN H. MELTZER: Well, I think the IMF is needed, but it needs to be in a much smaller role than it's now moving into again. The reason we see the expanded IMF is because the U.S. government did not have the courage or the intelligence to say "No." The European Central Bank wanted the IMF expanded because the European Central Bank did not want to be responsible for lending the money to countries in Eastern Europe that were heavily in debt to the Western European banks, especially to the banks in Germany and Austria, but others as well. And so, since the European Central Bank didn't want to make those loans -- at least, well, it didn't want to make them by themselves -- they got the president and the secretary of the Treasury to agree that we would increase the money for the IMF.

The idea that the United States is going to increase its debt yet again in order to prevent other people from borrowing seems to me to be a foolish idea. This is an administration which seems to have no limit on the amount of debt that they're willing to issue, or no limit on the amount -- on the number of ideas that they want to finance by issuing debt. And that's going to be something that we pay for. So it's a bad idea to expand it the way we're doing, because it's going to be costly to us, along with all the other debts that we incur.

The expansion of the SDRs, you haven't asked about, but maybe you will.

KUBARYCH: Yeah, we'll wait on that.

Anne, do you think that bigger is better?

ANNE O. KRUEGER: Well, two parts to that. One part is, how many resources do they need right now. And given where things are at, I think some increase in their lending capacity was almost essential, in that what was already sort of in the pipeline was going to absorb most of what was there.

And much of it may never be used -- which would be wonderful. But on the other hand, not having it there in case it's needed I think would have been a bad idea. So I guess I'm a little less negative on that.

The other part is the IMF and its role. I agree with Allan, there are some things it does that would best be left to the World Bank, and I have in mind in particular work in low-income countries. On the other hand, the IMF is, I think, if anything, too lean and too small a staff. It's got 186 countries. It's supposed to do good surveillance on all of them. This takes both functional people in fiscal affairs, monetary affairs and so on, and country people. And it's so lean that in many African divisions there will be three countries per person, and you just cannot do the job that way. It is that thin.

So the big part is both function, where I think there is a case for getting the IMF out -- but the Europeans will never have that -- and the amount of capacity they have in reserve for lending, and there I think there was a case for an increase.

How much, you could argue about.

KUBARYCH: Now, a word from our sponsor. This is the -- the McKinsey Executive Roundtable Series in International Economics, for which we're grateful. It's very important for us to have this corporate support and member support for ongoing series like this. And my colleague Benn Steil has been instrumental in really being the spearhead of making sure that we have timely, really well thought-out issues for discussion, and the right people to discuss it. So we're very happy with the McKinsey support, and with people like Ben that make it -- actually implement it.

Secondly, every meeting seems to have a different rule. You almost have to bring your lawyer to know if this is on the record, or off the record, or partly on the record? (Laughter.) We're partly on the -- (laughs) -- we're partly on the record.

Well, no, we're all on the record. (Laughter.) That means all of the things about -- you can use the information, or maybe you can use it -- in fact, you can not only use it, you can cite it. Penny Sender (sp) is here, from one of these newspapers that I read. And she will definitely use it, because everybody else in her paper has taken the weekend off. (Laughter.) You know, sometimes she has three bylines on their front page, all on the same day. And there are some other journalists, as well.

So that's -- and you've turned off the Blackberries. That's all the advertisements and public service announcements for the day.

Let's turn to the SDR and the whole nature, basically, of IMF surveillance and why they're connected.

I gave a seminar here yesterday for students and faculty of the Central Committee Party Graduate School. And Allan assured me that that was definitely worth doing. I can tell you, the questions were very tough, and half of them were about the dollar, its outlook and, basically, how can we spend our money and how can we diversify? And we went on in a different room, and it was very interesting. So -- and does the IMF have a role in helping China, which has amassed these vast reserves -- $2 trillion, roughly -- to diversify them off market, without an exchange-rate risk, through the SDR?

KRUEGER: No, it doesn't have any such obligation -- the way you phrase that.

I mean, there are different parts to that question.

KUBARYCH: Take it apart.

KRUEGER: Okay. Well, a first question is Chinese economic policy --

KUBARYCH: Right.

KRUEGER: And you already mentioned surveillance.

KUBARYCH: Right.

KRUEGER: And there the IMF does have a role. In my view, while the exchange-rate changes matter somewhat, the more important part actually is the balance of the macroeconomic policy with the exchange-rate policy and savings rate and so on. And at the moment, incentives in China seem to be highly skewed towards saving, and there probably is not enough investment that's healthy, which is why they ran the large current-account surpluses.

Now, granting that, I think the IMF has a definite role in surveillance, a definite role in consulting with Chinese officials -- as they do with officials in other countries -- and pointing out that this is not a sustainable policy, et cetera, et cetera. You can move on the exchange rate, but as long as that saving-investment balance is where it is, you're not going to get terribly far. It helps at the margins somewhat, but not that much. So in that part, yes.

Does the IMF have a role, or should the IMF somehow provide the Chinese with a non-dollar risk-free reserve asset? No, except insofar as China's a member and you have something like an SDR allocation that is allocated according to formula, when the SDR allocation itself is done for global reasons, not for Chinese reasons.

KUBARYCH: So when our Chinese visitors yesterday resurrected Fred Bergsten's original idea of a substitution account, you think that maybe that should stay basically in the archives.

KRUEGER: I'm certainly not attracted to it. I am not attracted to it.

KUBARYCH: Allan, what do you think about how the IMF should be dealing with China?

MELTZER: Oh, dealing with China? I think that the U.S. government -- I'll start there -- has exactly the wrong policy. It's building consumption. This is an opportunity to make the adjustment that we have to make to lower imports and more exports. So what we should be doing is boosting investment so that we become a big exporter.

The future for the U.S. consumer is going to be different than the past, because the growth of consumer spending is going to be lower. And whether the Chinese want to adjust to -- by themselves or whether they want to adjust to when we adjust, they're going to adjust. I mean -- so we don't have to lean on them or try to talk them into doing their exchange rate, because none of that is going to matter. At least -- the Chinese are going to do what the Chinese think they ought to do, just as we do what we think we ought to do, whether it's right or wrong.

But when we stop spending for consumption at the extraordinary rate that we have been spending, the Chinese and the rest of southeast Asia are going to have to adjust to that. And that's going to be the difference that the world is going to have to face as we go ahead. We would be much better off if our policy were directed to building investment and exports, and -- rather than building consumption and imports.

KUBARYCH: Do you think the IMF has been successful in making that kind of argument to the United States government?

KRUEGER: No. I don't think anybody has been successful in making the argument. (Laughs/laughter.) To the American Congress, I think, more is where the opinions are.

I would add to what Allan is saying that once again you're hearing these noises, at least, in Congress talking about we'll put a tariff on Chinese imports if they don't do something on the exchange rate, which strikes me as, again, a negative in the sense that it's making the Chinese less willing to take other kinds of actions because of the sense it's conceding that there was something to the American argument.

I agree with everything Allan says, except in addition I would add that all the talk about the exchange rates has, in my judgment, held up the degree to which the Chinese have been wiling to consider the issue.

MELTZER: Right. Bilateral exchange rates are really not very important for most things, period.

KUBARYCH: But I thought that's what the IMF was, with the -- the various discussions really focuses on. Well, both exchange rates and budget policies.

KRUEGER: Well, but remember that what you have is macroeconomic policy, monetary policy, exchange rate policy.

KUBARYCH: Right.

KRUEGER: And with open capital accounts. You've got choices that you can make as to whether you want to have a fixed exchange rate (and make your ?) monetary policy go, and your monetary policy -- (inaudible) -- let the exchange rate float, et cetera, et cetera. So the IMF really has to look over the constellation of policies and not one in isolation. The IMF has never said to Hong Kong, "You can't run your currency board," because they can and do. They run other policies consistent with it.

The problem comes when policies are inconsistent over the longer run, and that's where surveillance comes in.

KUBARYCH: Now, one of the other outcomes of the G-20 summit which I liked, but hasn't gotten an awful lot of attention, is the -- sort of the promotion of the Financial Stability Forum, which is at the bank for International Settlements and has done some really kind of impressive work in terms of making suggestions for reforming regulatory -- financial regulatory systems. Basically, it got elevated to be now the Financial Stability Board. I don't know the difference, but --

KRUEGER: It means it has a staff. Until now, when the Financial Stability Forum has wanted to, quote, "do anything" between meetings, it's use the IMF staff. It had almost no -- they had two or three people only of their own. And this will make them another international organization, is what it will do.

KUBARYCH: And working closely with the IMF.

KRUEGER: Well, working closely with everybody, I presume.

KUBARYCH: Yeah.

MELTZER: I think the Financial Stability Board is a good thing, as far as those things go, but I believe that what we have done and what we're doing with the plan in the United States is we're talking about a super-regulator. Those are non-starters. I mean, there just isn't any example in Federal Reserve history or SEC history -- this is the age of Madoff, after all -- where they were able to get on top of a crisis before the crisis began, as far as I know. I mean, their record on regulation of that kind is just not very good.

In fact, it's abysmal.

What we need to do, if we want to eliminate the -- to reduce the risk in the banking system, the financial system, is shift the other way. We need to go to more responsibility for the bankers and the financial community, and that means "too big to fail" -- we have to get rid of "too big to fail." And that is not the only problem that brought this crisis, but it is one of the major problems.

If you tell banks that they don't -- that they -- "too big to fail," some of them are going to increase their leverage, and many of them -- some of them did. And that's a big part of the problem. Prudent bankers didn't quite do that. But there are a lot of imprudent bankers, as we've now learned.

And "too big to fail" -- how do you get rid of "too big to fail"? I don't think that's a problem. You know, the reason "too big to fail" has to go is because it's too big, too big because there's no stretch of the imagination under which the economies of scale and scope are going to compensate for the losses that get pushed on to the public.

So, one, we can't have a system for very long. Some politician will wake up to the fact that we now have a system with "too big to fail," in which the bankers make the profits and the public takes the losses. That's not a viable system. It's --

KUBARYCH: But we've had a bipartisan effort by two governments to go in exactly the opposite direction --

MELTZER: Yes.

KUBARYCH: -- Paulson with the TARP and Geithner with the TARP II???.

MELTZER: Right. Hasn't happened yet, but it's bound to happen --

KUBARYCH: Bound to happen.

MELTZER: -- bound to happen that some politician will recognize that "too big to fail" -- that the system in which the public takes the losses and the banks make the profits is not a system that's in the interest of the public.

And so that is going to happen. When it's going to happen, I don't have the slightest idea. But it has to happen.

KUBARYCH: Do you think the IMF has views on whether the -- whether banks should be owned by government, controlled by government?

KRUEGER: Well, I think the experience worldwide with public ownership of banks is not good, to say the very least. I hope that --

KUBARYCH: Right. They're learning that in Germany with the Landesbank.

KRUEGER: Well, when they've got the three sets of banks, they've got the state banks and everything, so it's an even worse problem, that.

KUBARYCH: Yeah.

KRUEGER: But the experience with publicly owned banks is that the politicians get in there; effectively what seems to happen very quickly is credit rationing. Credit rationing goes to those who are politically favored and not those otherwise. So I think that's a very bad idea.

But if I could come back to Allan for a minute, I agree it's going to be difficult to get international regulation, but a number of issues have come up, especially in Europe, that make me think that people may be more inclined than they were. First off, we're going to have international banking. And I think anything that makes them too small so they can't be international is a problem.

But secondly, we've had, for example, the Belgians and the Dutch, and what do you do when it's a jointly owned cross-border bank? And that's an international issue, which in that case is within ECB, but not all of them will be.

You then have issues such as the Irish putting on deposit guarantees when others didn't, and what that did to the banking systems elsewhere. And maybe you can do it through something like a -- in a Basel-type accord. I don't mean a Basel agreement on what you -- risk allocation is but in terms of what can be done. But I think there is going to have to be more of an understanding than there was on how you handle some of the issues.

MELTZER: I think it's fine that regulators get together and talk about their common problems and how they think they can be handled.

I see no reason to object to that. I think those are useful things in a world that we live in these days. All I want to do, to get rid of "too big to fail," is to say, the larger you are, proportionally more reserves you have to hold.

MR. : Proportionally more.

MELTZER: Proportionally more.

You have to insure us against you.

MR. : And you know, how big could those reserves be, 15 percent?

MELTZER: Big enough to stop them from getting too big, however they judge too big. I don't want the government to decided, because we don't know what the optimum size is. I'll leave that to the bankers. But I'll just say, you need to compensate for the risks that you're taking, that you're pushing off onto the public.

Bank regulation, in my opinion, having just completed my history of the Fed, bank regulation almost always works to protect the banks, not to protect the public. That's not a very good idea.

KRUEGER: But that is true of almost all industry regulation, simply because it's only people in the industry who understand the industry well enough to do the regulation. And it seems to me that when we talk about regulation, we need to recognize that particular aspect of things, that there's only so far you can go.

And then the question is, what universe do you regulate, anybody who does anything financial? Well, that would include you and me. The minute you cut the definition down, there are going to be at the margin people who move outside the regulatory framework.

MELTZER: Right.

That brings me to the first law of regulation which is, bureaucrats and lawyers make regulations; markets learn to circumvent them. The Basel Accord is a wonderful recent example where they said, hold more reserves, and therefore secure us against the risk that you take. So they took them off the balance sheet. Didn't work, they later found out. But it didn't produce a disaster.

MR. : The curious thing to me is that since we do know this principle, since you've been teaching it to us for a long time, why we shareholders -- whether we're directly a shareholder in a bank or whether we own some mutual fund, just an index fund -- we still have 15 percent of our money roughly -- it used to be 15 percent of an index fund would be financial stocks; now it's maybe half that.

But it's striking to me how passive and, I would say, complacent investors have been, shareholders have been, assuming that this regulatory system works to their interest, when you have been teaching us correctly that it doesn't.

MELTZER: Well, I can't answer that. I wish I could.

MR. : It's more of a rhetorical question.

MELTZER: Yeah. I wish I could but I can't.

MR. : Now, I want to turn to all of you right away. They told me that we should continue this dialogue a lot longer. I don't think that's a great idea. I think we can go to your questions and comments too.

But I do have one last question for Anne before we do that, and that is -- you've had this really historic financial meltdown with -- and it was -- I can't -- I do not believe it was unpredicted. I believe that there were certain people who saw it coming explicitly, basically got it right, and were ignored. And how -- when the report card of the sky is written, how does the IMF come out as seeing the early warning signals of this really historic screwup?

KRUEGER: Well, I think it's going to come out pretty well. The IMF was screaming about global imbalances for a long time.

KUBARYCH: Yeah.

KRUEGER: I still see low real interest rates for so long as having been a major, if not the major, factor leading -- underlying many of the things that you said of the housing bubble -- the search for yield, et cetera, et cetera, therefore, taking more risks, because the risk premium (fell ?), et cetera, et cetera.

The IMF was certainly onto the housing thing.

KUBARYCH: Yeah.

KRUEGER: And it certainly had a special issue of the World Economic Report on that. It certainly got the search for yield down and the worry about the lowest -- (inaudible). Raghuram Rajan gave -- who was the chief economist of the Fund at the time -- gave a talk at Jackson Hole in 2005, where he spelled out pretty clearly what was going to happen and how, and oh, boy, did we get feedback -- I mean, pushback.

KUBARYCH: Really?

KRUEGER: Oh, yeah. I mean, that was not something the IMF was supposed to be coming out and being that pessimistic about, et cetera, et cetera. But I think the IMF is on record, and while I don't think the Fund could go public and say, look we're going to have a crash in six months, I mean, I think that the pieces were there.

I think Rodrigo de Rato's effort to get multilateral consultations between the major surplus and deficit countries was another recognition, and everybody there agreed. They came in -- the Chinese agreed their surpluses should fall; the Americans agreed their deficits should fall, et cetera, et cetera. Everybody agreed that all -- all of the oil exporters agreed to their part and so on. And everybody went home and did nothing.

The problem, I think, was not with the IMF. I think the problem was with the, what shall I say, the failure of the -- or the unwillingness -- whichever you like -- of the major participants to recognize anything multilateral and to act upon it. Now, in the case of the U.S., I think it was the administration's feeling they couldn't do anything -- (inaudible).

MELTZER: In the epilogue to my book about the Fed, I have a section -- I was asked by the editor to write a section on the causes of the current crisis. The IMF doesn't appear there.

KRUEGER: (Laughs.)

MELTZER: I have seven causes. I won't go through all of them, but I do want to talk about three, because I think that some of them are relevant. The first is Fannie Mae and Freddie Mac. If there was anything that was warned about, it was the dangers that were in Fannie Mae and Freddie Mac.

KUBARYCH: Fair enough.

MELTZER: You know, Fannie Mae and Freddie Mac are a way of subsidizing mortgages. You know, should be on the budget. We should close down Fannie Mae and Freddie Mac and put it on the budget. The subsidy should be on the budget. That's what decent governments do. They put their expenditures on the budget. They don't hide them in --

KUBARYCH: By the way, that's what S&P and Moody's will eventually want us to do.

MELTZER: Good.

KRUEGER: (Laughs.)

MELTZER: The second one is "too big to fail," and I've talked about that.

KUBARYCH: Right.

MELTZER: And the third, which is quite relevant for this audience, is that neither the Federal Reserve nor the regulators nor the people in the market have risk models which allow for fat tails.

KRUEGER: Yeah.

MELTZER: They don't allow for permanent changes in environment, like the Russian default, the long-term capital management, the decline in housing prices. So they underestimate the risk of large changes, and that's a mistake. And they need to improve. If we're going to have better risk management, we have to improve the models and think something -- some more deeply about how we deal with large-scale, sudden, permanent changes. And nobody does that. The Fed doesn't do it; the market people don't do it.

KUBARYCH: You don't think --

KRUEGER: And if I could add --

KUBARYCH: Yeah, go for it, please.

KRUEGER: Not only that. Most of the stress tests take one variable at a time, and don't recognize how correlated they are. So you ask first, what would happen if the housing price went down? Then you put the housing price back up, and ask about the next thing. Well, what happens -- never ask what happens when all of these things happen together.

MELTZER: Right.

KUBARYCH: Yeah, I was quoted as saying we had an unstressful stress test.

KRUEGER: (Laughs.)

KUBARYCH: But if you were in that job, you would do it the same way, because you couldn't possibly run a stress test where you didn't know the result already, and say, "Oh, gee, I didn't realize that." (Laughter.)

By the way, the stress test that was done used to be done routinely by bank examiners for generations, until it was -- they were put in handcuffs in 2000.

Now, to your questions. The rule is, state your name, affiliation. But if you want to make a comment rather than a question, I always think that sometimes the questions are comments and you have to sort of raise your voice at the end. (Laughter.) But I don't mind comments.

Arturo has been eager, David's next, and over here, and then Mickey.

QUESTIONER: Good morning. I'm Arturo Porzecanski, with American University. And thank you for your initial comments.

I want to go back on -- really focus on the IMF. I mean, the IMF is part of the international regulatory superstructure that failed. All those financial sector stability reports -- good for nothing. All those country reports on the life of Iceland and you can -- I'm not saying that they should have, you know, solved the U.S.'s problems, but there were a lot of countries with currency mismatches, with maturity mismatches, with the kinds of things that the IMF should have insisted on -- get fixed in case there was a major financial earthquake. This is sounding more like a comment than a question.

But my question is, really, one more crisis -- haven't we learned? The IMF cannot exercise, you know, the kind of useful surveillance role that we all had wished that they would exercise. It's basically a fire department. When the Treasury calls and says to them, you know, "You've got to lend to Ukraine, because we like that government," or, "You've got to lend to Pakistan because we've got to support that --" they do. And when they say, you know, "You've got to give some no-strings-attached money to Mexico," they do, and things like that.

But let's -- let's abandon the illusion that they can really -- as you said, really spell things out clearly and serve a useful preventive function; and think of them as a much more streamlined fire department that comes in, you know, once the fire is raging.

KUBARYCH: Okay. (Laughs.) Arturo doesn't mince words.

KRUEGER: Well, I mean, I would say that there have been instances -- some of them were not made public -- where, indeed, there have been things -- the train has been coming right at them, and Fund surveillance has made a difference. I don't think there's any question about that. Financial-sector stability reports are -- have been given credit by Bank of England, Reserve Bank of Australia and others as having pointed out, we --this is in the framework, that were corrected, and they've been given a fair amount of credit. And I think most central banks have regarded that as one of the functions that have played out well.

Now, that doesn't mean you catch everything. In fact, when I was at the Fund, I went through the roof one day because a country that had recently had an FSAP -- financial-sector stability report -- then had gone immediately into a banking crisis. But what turned out had happened -- financial-sector stability report, basically assessment, basically goes and what it does is look at the regulations and so on and assumes that they are indeed implemented. It doesn't go into whether, indeed, people have actually been actively stealing, et cetera. And what had happened in that country is the bank owner had been siphoning off the equity and getting it out of the country and, of course, had been in banking difficulty. But it was not something it could pick up.

So there are some of these things, I agree with you, the IMF should have been more on top of, but I disagree with you that the whole exercise has been un-useful. I would also point out that the Report on Standards and Codes has improved their reporting to member governments a great deal, and has, I think, improved their ability to assess things as well.

So I'm less negative than you are. And a lot of people, even in the private banking sector, say that the Article IV reports, and the staff reports behind them, are as useful as they can find on the country. So I'm not quite as sure that all of that is as negative as you think it is.

As to just being a fire department, the trouble is, first off, that you want the people in the Fund who are technocrats to have contacts in the country, to be familiar with the officials, so -- if for no other reason than, when there's a fire, they know who to talk to and they're on top of the situation. So in a sense they have to be there anyway.

But in addition to that, I think the surveillance is a valuable function.

MELTZER: In a world which is going to depend mainly, and has depended mainly, on private capital movements, you want somebody to provide information. The IMF is very well positioned to do that. And, you know, the next step is to get the countries to do what you want them to do, you know. Anne's description of China and the United States talking about their balance of payments, everybody recognizes that that was a problem. But getting the political will within the country to do it, that's a very different story. I mean, there's not much political will, even now, to do what needs to be done, which is to reduce imports and grow exports.

KUBARYCH: David, Stephanie has a mike for you.

QUESTIONER: David Heleniak, Morgan Stanley. Before asking a question, I have to make a defense of my former profession and correct Professor Meltzer, who's otherwise brilliant.

But lawyers not only lead technocrats in building the regulations, they lead the market in circumventing them, too. (Laughter.) I think they balance it.

MELTZER: Okay, I'll take that.

KUBARYCH: This is the proverbial honest man. David is here for the -- playing this role.

QUESTIONER: The -- but my question -- and I can't articulate it well enough, because I didn't read it carefully enough -- but I think an extremely important event happened in the last week, when President Lula visited China, and a statement was made about reserve currencies. And I wonder if you could say something both about what was said but, more importantly, what the significance of it is.

KUBARYCH: Very good question.

KRUEGER: Yeah. Well, the statement that they made was that they didn't want the dollar as a reserve currency, so they would each accept the other's currency in payment. The Chinese have already done that -- my recall is, to the tune of about $87 billion before this one -- and I don't know any magnitude on this one -- where they've had such agreements with Argentina and other countries.

Now, it's all fine and good -- I mean, if the Chinese want to hold Brazilian reals, they're going to be welcome to do so. But I find it hard to believe that they're going to be willing to stack up Brazilian reals as a store of value and think that that's a risk-free currency. The track record doesn't say that.

And I think there's a little there -- now the renminbi is not -- or the yuan, whichever you want to say -- is, at the moment, not a convertible currency. So how that would then work I have no idea. I mean, I think that whatever the Brazilians hold would, indeed, be payable only to China or some other country that wanted to buy from China. So it looks to me like a bilateral arrangement. And I haven't talked to anybody at the Fund, but I'm not even certain if it's bilateral, and, if it's not convertible, how the articles of agreement would pertain to it. But I've had questions.

MELTZER: Yeah. As far as the Chinese, the Chinese have certainly sent us plenty of messages which we don't want to receive that says they worry about what we're doing.

A week ago the State Department had me talking to Chinese journalists in Beijing, Shanghai, Guangzhou. One of the questions that most concerned them was, what about TIPS? They're -- they obviously are concerned about the inflation, which they believe is going to come here -- at least think there's a very good chance, as I do.

As far as their proposal about the SDRs, which is the other thing beside -- there's nothing to prevent them from creating SDRs. That is, they can hold a basket of currency that looks like the SDRs, and they can pay them out to anybody who's willing to accept that mix instead of accepting dollars.

So it's easy to see that the dollar is likely to be a depreciating currency. It's much harder to see what's going to replace it. And that's been true for a long time.

KUBARYCH: Peter Garber.

QUESTIONER: Peter Garber, Deutsche Bank. I'll -- I actually liked that question, so I'll just follow up on it --

KUBARYCH: Okay.

QUESTIONER: -- expressing a little bit of fear that we have. Obviously the real leg didn't matter, because the Chinese could always take real. But now -- but the Brazilians couldn't take renminbi, and now they -- now they're inside that fence. And one fear that has kindled among us is, is this going to be a way to lead in to bilateral clearing mechanisms, regardless of what the Fund says, and start to balkanize the world in that way?

I kind of thought of it as a camel's nose under the tent. It's small but may be the first move in that direction. In order -- the reason that you would go for that is again for the Chinese to preserve their trade surpluses, in a way that would compete, by multiple pricing of their currency effectively.

KRUEGER: Well, my first comment would be, if they do that, they're going to find themselves tripping over themselves economically very quickly. I mean, you know as well as I do, that's an incredibly difficult thing to arrange and manage, in any form, and once started very quickly proliferates in regulations, what have you. And I think they'd trip over it, before they got very far at all, would be my first thought.

My comment about the inconsistency with the articles was precisely the same comment as you're making. Namely there is a danger of bilateral clearing. But bilateral clearing, for countries that have tried it, has in the past been disastrous. And I see no reason to expect it to be different, if they try it again.

MELTZER: The only think I would add to that is, why the Brazilians want to take an inconvertible currency and hold it is a mystery.

KUBARYCH: It's not a mystery. The Brazilians are trying to position themselves as being a friend of China, a pal, a growing trade partner and business partner. You invest here; here's a few firms we'd like to sell you.

No. There is a lot of that going on. The Europeans are doing the same thing, part of it, not with the currency. But the Chinese are everywhere, doing deals everywhere.

KRUEGER: Sure. But that's not the same as running a bilateral clearing arrangement, which is --

KUBARYCH: Correct.

MELTZER: With a fixed exchange rate, an inconvertible currency and a rotten banking system. (Laughter.)

KUBARYCH: The world is full of dilemmas.

We've got to go in the order that I promised.

Mickie.

QUESTIONER: Muriel Siebert, Muriel Siebert & Company, former superintendent of banks.

Do you think that the damage to the global financial system has been severe enough so the countries would take international banking regulation? I don't think we can have all these derivatives sloshing around, no transparency. We don't know who owns what.

And in the past, because I've talked to people, they say, oh, no, we don't want our country to have the same regulations as you do. I received that answer from the head of Deutsche Bank at a meeting in this room.

KRUEGER: Well, I mean, the United States is first among those who say they will not accept international regulation. On the other hand, the U.S. has been a participant in the Basel Accords, admittedly not the most useful of it. But I mean, they've been willing to agree to that sort of thing.

So I'm not sure where we come down. If in fact there are no more agreements this time, I would guess that after the next crisis, we'll finally get around to it. I mean, it seems to me, there has to be some kind of agreement. It doesn't have to be international regulation so much as it has to be international agreement on some sorts of things.

Some of the things you're talking about could be handled simply by bringing them into markets, rather than having them traded as they now are, individually. And there are other things that can be handled that way.

So I don't think that everything has to go international. And certainly -- (inaudible) -- should hold as much as it can. But on the other hand, I do think that we will see some of these things come more to light internationally and somehow or other be handled.

MELTZER: If we keep in mind what happened, what the Europeans did to Intel, earlier Microsoft, we'll go slow toward international regulation.

KUBARYCH: Very interesting.

Now, again, a new crowd here. One, two -- who -- I saw a third one over here. Maybe not. Henny's next.

QUESTIONER: Just to add to Peter's comment --

KUBARYCH: Wait for the mike. Tell them all who you are.

QUESTIONER: Sorry. I'm Henny Sender, with the Financial Times. I think that this is one of many steps. I think it's also very interesting that when Iran and China agree on energy and China buys oil from Iran, it's also not priced in dollars.

But my question is for Anne, and I want to pick up on the Jackson Hole comment. I was at the BIS -- and I think it was '03, '04 -- and I was meeting with Bill White, who was then head of research. And he was describing the incredible pressure that was brought to bear on the BIS when they were doing one of their research reports, and they wanted to highlight the danger of the monoline insurers in the credit default swap market. And to use your word, they had huge pushback. And they totally diluted that section which was incredibly prescient in my view. I wonder if you could talk in -- generally about the extent to which political pushback is a problem?

KRUEGER: Well, I think I'm glad you asked, because I should have answered more on the other earlier -- Arturo's question on that subject.

In my judgment, first off, a lot of countries hurt themselves by doing as much as they do it; but the U.S. foremost among them, simply because the U.S. is the most powerful. I think the U.S. would get more value out of the international organizations if it used its power with less of a club, and a little bit more with persuasion. It has on occasion done that.

And you can understand why. I mean, the U.S. sort of started out -- the U.S. and the U.K. held more than 50 percent of the shares in the Fund and the Bank when they originally started. And of course, those shares have gone down, but the U.S. is still the only one, you know, with 17 -- 16 point-something -- 85 -- point-85 percent -- and does have a large role.

But as some comments here even have indicated, that's been a problem for the Fund and for other international organizations because they've seen this as a U.S.-dominated institution, which I think reduces its effectiveness. If the world recognizes, yes, there are some things that are better done internationally, technocratically, and leave it to that, I think we'd be much better off, in terms of having usable -- useful international organizations.

Now, that's perhaps idealistic, perhaps -- and certainly, you can never keep politics out of things completely. But many countries have come to the fore -- Allan mentioned that the Europeans have been adamant that they didn't want to do the financing of Eastern Europe. And they pushed really hard on at least one of the loans, which I won't mention, where everybody's waiting for something to go wrong, because it just isn't right. And there are others where they've pushed hard because they thought that should be the Fund business. Well, they should have then left the Fund to make the conditions of the loan, instead of insisting that, no, this shouldn't and that shouldn't happen and so on.

So, yes, there are individual countries, and it's not just the U.S., although the U.S. certainly stands out because of its importance. And they do on issues of concern to them get in there in ways that make it look, even when it's not true, that the U.S. is dominating things.

MELTZER: I'd just add to that a brief thing, which is to say, when I went around to talk to various governments after the commission had completed its report, the one question which the Asians were interested in was representation. That's a question which the IMF has not been able to solve, probably because the Europeans are unwilling to reduce their -- but for whatever reason.

So although Larry Summers, in his earlier incarnation, prevented them from forming their own West Asian monetary fund, or whatever, they've certainly moved strongly in that direction, most recently by increasing the funds through (Chiang Mai ?) Association. So I read that as saying that they've sort of at least given -- possibly given up the idea that they're going to be able to dominate the Fund.

After the 1990s, they saw the Fund just the way Anne described it: as the United States, one step removed. And they didn't want that, so they're going their own way and establishing their own internal -- external mechanisms. And I believe the only way that you can get them back into the Fund is to give up the U.S. veto power, get the Europeans -- you know, things which are non-starters. I can't see the Congress giving up the U.S. veto power.

KRUEGER: But in fact, the big imbalance -- I mean, I do buy that you want representation in the international organizations, to some extent, to reflect reality.

You know, "one nation or one person, one vote" doesn't make much sense in an international organization, and "one government, one vote" doesn't either. And in some sense you want it to reflect -- well, the final formula has always had in it, quote, "basic votes," which are so much per country. And that's kind of the -- even the littlest country (gets bit ?). But then on top of that has been mostly percent of share in trade and percent of share in GDP.

If you take that formula and apply it almost any way you care to, you would find the U.S is slightly under-represented now, which is a different issue than veto. You would find the Europeans are grossly over-represented, and you would find that Africa's slightly overrepresented and Asia's grossly underrepresented.

The big battle ought to be between Asia and Europe. The United States really is not at the forefront in that one, and in fact gave up share that on formula it wouldn't have needed to this last round, even to get that little bit done. So, much as I can be critical of the U.S. on some things, that is not one of them.

Now, the problem is that the Europeans not only think that they don't want to give up share, but they think those poor African countries deserve more. Now, in some sense, 44 countries do deserve more, but I do not know how to make 100 percent into 150 percent. I mean, that's where the problem lies. And getting that resolved will be of some importance, and there's certainly strong feeling about it.

On the other hand, how much difference it actually makes to the way discussions go at the board and so on, in the Fund, I really have serious questions. It's an interesting contrast, because I recognize it has to be done because of the importance attached to it.

MELTZER: Most votes are unanimous.

KRUEGER: Hmm?

MELTZER: Almost all the votes are unanimous.

KRUEGER: Almost all votes are -- well, yes, but some things don't come because it's understood that and so on and so forth. And sometimes by the time it gets there, it's been pushed one way or another.

But I mean the strongest feeling, I think, is far disproportionate to the true value of more votes even if you adjusted completely. So --

KUBARYCH: But what exactly are the -- sort of the hot-button issues in which the corporate governance, the legalisms of the corporate governance really matter? Are we talking about individual votes on deals, to support Ukraine or Turkey or whatever? Are we talking about whether certain Article IV things have to be --

KRUEGER: No.

KUBARYCH: How does this -- where does this show as an important practical issue?

KRUEGER: I think in the five years I was at the Fund, three things came to a vote in the board. And I chaired more breakfast meetings than I care to count to get some other issues sorted out to unanimity. I mean, it was not true that everything came automatically.

KUBARYCH: I'm glad you're early to bed, early to rise.

KRUEGER: (Laughs.) But in any event, the issue -- and I don't think I can recall one of them, though -- and this will give you an idea -- is that the major industrial countries wanted all Article IV reports published within a certain period of time. And there was a lot of pushback. I think it was Article IVs. It was some publication -- policy where the industrial countries wanted it immediately, the developing countries wanted not. That was one where it finally did actually come to a vote. We could not reconcile it completely. There was even there a compromise, which was that we would not implement the policy for a year. So it was not as if it wasn't there. There were a couple of others where votes came up, but they were the same kind of issue.

Let me give you another one which was more substantively important and where I think some of this comes from. There was a decision last year or the year before -- I'm not sure which, last year, I think -- a new surveillance exchange rate decision, having to do with exchange rate. This is a policy paper saying what the Fund would do and so on.

The Chinese felt -- which I don't think was really true, but they felt -- that this was aimed at them. They felt that this new paper where the Fund was going to pronounce (something ?) on an exchange rate, and the realism in each country -- which it should have been doing anyway, and was, at least when I was there -- was now going to be enshrined in policy, and they thought that was aimed at them.

And that did go through on a vote, and they felt that this was sort of, you know, discriminatory towards them. And I think that's one of the reasons they feel so strongly about representation. I don't know this, you know, in the sense that nobody from China told me, but I just could infer.

KUBARYCH: I appreciate that answer.

MELTZER: We now see that the Chinese, the Brazilians and others are not willing to contribute funds directly to the IMF on the latest currency regime or willing to lend them money. That's, I think, a sign of the disaffection that they have.

The other thing which I wanted to comment on is a very simple thing. The quickest way, I think, to destroy an international organization that's involved in lending is to put the -- put greater control in the hands of the debtors.

KRUEGER: (Chuckles.) If I could add one more thing, though -- and this is interesting -- about the Brazilians in particular, not the Chinese -- in 2002, you may recall, there was -- yeah, summer of -- no, it's -- that must be summer 2002 -- there was an election coming up in Brazil. Brazilian economic history was not exactly stable in the past (and that could weaken others ?) coming into elections. Nobody trusted Lula. And the Fund went in, talked with the three presidential candidates -- then there were three -- and basically got a commitment from each of them ahead of time as to what would be the macroeconomic policies afterward, backed that up with a major loan.

The crisis never culminated or whatever the right word is for crisis finally taking hold. And of all the people who should be appreciative of the Fund, I could regard President Lula as one of the major ones, sort of his -- the degree to which the Brazilian economy sorted out after that was beyond expectations even of those of us who were moderately optimistic.

So why he was to say -- that has to be truly political and he has to know that that was not the way things were and that the Fund actually did Brazil a big favor, and not because of the voting shares. It was simply because that's what needed doing in the work.

KUBARYCH: Well, that's one of the great trades of all time, to buy Lula at 4 --

KRUEGER: (Laughs.)

KUBARYCH: -- then sell it last year at 1.55 -- (laughter) --

KRUEGER: (Laughs.)

KUBARYCH: -- for those of you who are conversant with the Brazilian currency rates.

Dick Huber.

QUESTIONER: Dick Huber, Antarctic Shipping, amongst others. (Laughter.)

I think that those of us who have been around the block a few times do remember in the late '80s when the Japanese were going to be -- first of all, inherit the earth, and secondly, they were going to buy up all of America, because they had accumulated large reserves, and they wisely said, you know, this is an incredibly vanishing currency; let's convert these pieces of paper into hard assets.

We haven't seen it really take off yet. But I can't -- I just can't imagine that we're not going to see a wave of direct investment in American hard assets that's going to eclipse anything we've seen before.

If you halfway agree with that, what do you think will be the political backlash? Remember the backlash of the Japanese buying Rockefeller Center, the -- Dubai buying all the ports? I think that's going to be very entertaining to see.

MELTZER: Unpleasant, I would describe it as -- (laughter) -- yeah, I think you answered your own question, Dick. The backlash will be enormous.

KRUEGER: Well, but --

MELTZER: And you already saw it, for example, with Union Oil and --

KRUEGER: Yeah.

KUBARYCH: Yeah.

MELTZER: -- to add to the list that you have there. And so you know that the Congress will want to declare almost anything as a strategic asset.

KRUEGER: Yeah. But -- remember, the Chinese are buying up lots of things. They're just not in the U.S. They're much more -- they seem to be, if you'll observe by their behavior, much more concerned with what they would regard as having ownership that then gives them entitlement to raw materials, so that so far, their efforts have been directed elsewhere. And I would guess that the Chinese leadership is sufficiently astute, so if they would worry about the backlash, that that would hold them back somewhat, in a way the current account deficit didn't.

The other question from the 1980s that I also recall the episode, as I'm sure Allan does too -- is a question as to whether it -- was the backlash against the direct foreign investment or was the backlash against the import of Japanese goods. And my read is, it was as much on the goods side, if not more, than it was on the foreign direct investment. Could be wrong.

MELTZER: Both.

KRUEGER: (Chuckles.)

KUBARYCH: Yeah. I'm sorry. I skipped --

QUESTIONER: That's quite all right.

KUBARYCH: Yeah. Fritz.

QUESTIONER: I'm Fritz Link from Davis Polk & Wardwell, and I'm puzzled by something that goes to this voting question. The voting and the delegates that are sent to the IMF are usually from the treasury, but the IMF always deals with the central banks. And in dealings that I have had in the past during restructurings and things, it's always been the central bank and usually somebody from the fiscal authority, the treasury or the Ministry of Finance.

And the central banks are traditionally -- and I think this is constitutionally -- extremely independent. They are not alter egos of the government.

And that -- I'm wondering, first of all, do you feel that's changing in the United States, where we have two bank regulators who are very sympathetic to the banks' plight, who are in the position both of Treasury secretary and head of the Fed, and where fiscal policy seems to be dominating over the ideas that are normally independent central bank ideas, which are price levels, including interest price levels, and monetary aggregates and so forth?

KRUEGER: Well, the legality is that each country appoints its governor of the IMF, and they can appoint whomever they want. They do the same for the World Bank. In both cases, it's the (place ?) of the country, what they do.

At the World Bank, actually, many of the governors are aid ministers. They're not even central bank or treasury. The country can also appoint a fiscal agent.

In terms of the financial dealings that you're talking about, the Fund deals with whomever is appointed the fiscal agent, just as a matter of law. And the fiscal agent is the one that then keeps the accounts and, if there's a loan, sets where it go, et cetera, et cetera. Sometimes it's in the treasury. Sometimes it's in the central bank.

When there are meetings of the board of governors, usually, in many more cases than not, it's the secretary or the secretary of treasury/finance minister who is the -- sort of is the governor, and usually the central bank governor is deputy governor for the country at the IMF. So usually the Finance Ministry is on top. Certainly Secretary Geithner will be and is the governor for the United States. When he was the chancellor of the Exchequer, it was Gordon Brown from Britain and so on.

I think all G-7 do have finance ministers as their governors in the IMF, and most but not all other countries.

MELTZER: I'll take up the independence issue. You know, (didn't ?) -- Arthur Burns? Not very independent. Paul Volcker? Very independent, (though ?). Alan Greenspan? Rather independent. The current Fed? They've become the operating arm of the Treasury.

I mean, you know, when the secretary of Treasury gets up and announces that the Fed is going to buy a trillion dollars' worth of securities, that's hardly an independent central bank. And that's not the only mistake they've made -- bailing out, buying the $29 billion, doing all sorts of fiscal operations which, historically, no Fed ever did.

I mean, you know, the reason we have the federal land banks is because when Congress leaned on the Fed in the 1920 deflation -- and it was a really serious deflation -- the Fed said, "It's not our business. We don't do that." So we've got the land banks. Same thing is the reason we've got the federal home loan banks, because they lean on the Fed to help housing. The Fed said, "We don't do that. "

KUBARYCH: Right.

MELTZER: This Fed doesn't say that.

Now, they think, they tell me, they're going to be able to take that back. I'll make the bet that it won't be easy. It won't be easy.

And they've taught the Congress something which they should have never have taught the Congress. That is, that they can do credit allocation. You know, can you see Barney Frank wanting to give up credit allocation? I mean, he sees the banking system as Fannie Mae and Freddie Mac expanded. You know, take that away from him? That won't be easy.

Congress has the power to change the rules.

That's different from the ECB. The ECB is the only real independent central bank, because it doesn't have a government. And so -- and it has -- the -- it has the ECB law, which says -- it can't be changed -- their mandate is to control inflation. The Germans got that into the law. That's their only obligation, and they point that out all the time.

And it can't be changed, because it has to be changed by unanimous consent. And only -- that means the Germans have to agree to it. That's not going to happen, at least not in modern-day Germany. So that's an independent central bank.

We no longer have even the vestige of an independent central bank.

KUBARYCH: Well, I'd like to end on time. I know why we should end on time. Almost all of us are overscheduled. I'd like to go over and over and over the time limit, because it's truly always a personal pleasure to be with Allan and Anne. We've crossed paths.

And the council always says the role of the council is to tell truth to power; you have a couple of people who have really done it. And so we're proud to be here with you today. We've learned even more than we learned from reading some of your stuff. (Chuckles.) I'm glad that you weren't too shy.

Thanks for all of you, your questions, and thanks to Anne and Allan. (Applause.)

MELTZER: Thank you, Anne. Thank you.

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