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Crisis of Global Capitalism: Open Society Endangered —A New Book by George Soros

Moderator: Leslie H. Gelb, president, Council on Foreign Relations
Speakers: Mort Halperin, director, Policy Planning, Department of State, John G. Heimann, First Chairman, Financial Stability Institute, Gerry Goodman, "Adam Smith"; founder, New York Magazine, and George Soros, Chairman, Soros Fund Management
December 10, 1998
Council on Foreign Relations


Dr. LESLIE H. GELB (President, Council on Foreign Relations): (Joined in progress) In all the years I’ve been here we have never had more brainpower assembled for one of our programs than this evening, your humble presider, to the contrary, notwithstanding. And with all that brainpower here, I hope we finally get an answer to the question that has bedeviled me for a long time, George, namely: If all the nations of the world are in debt, who has all the money?

“The Crisis in Global Capitalism: Open Society Endangered,” a new book by George Soros, takes us, I think, just in the direction we ought to be going in our thinking. One of the things that characterizes almost everything George Soros has done is that he has pushed the frontiers of our thinking and our actions, and I think he has done precisely that again. What he’s trying to get us to do is-I read your book, George. What he’s trying to get us to do is to think about not only those problems capitalism and free markets can help us solve but the dangers that it creates as well and to look at them just as hard as we look at the opportunities.

I don’t have to tell you George Soros’ background. I think he has done more to promote the fundamentals of democracies and open societies around the world than anyone in our generation. George is going to be talking for about 10 minutes, and then we will turn this into a conversation.

George’s book, I should tell you, is published by Public Affairs, and that’s a new publishing firm headed by one of our members, Peter Osnos. And Peter Osnos is, in my mind, the best finder and publisher of talent, writing in public policy, of anybody I know. And it’s not by accident that Peter and George hooked up for this book.

Our other conversationalists this evening are Mort Halperin, John Heimann, Gerry Goodman, or George W. Goodman, aka Gerry Goodman, aka Adam Smith.

Mort Halperin is now the director of Policy Planning in the State Department, a job once held by the likes of George Kennan and ably suited to Mort who, in addition to his many accomplishments in the past in government, was a Senior Fellow at the Council on Foreign Relations before he became director of Policy Planning. I don’t think my generation has produced a better foreign policy expert than Mort Halperin.

John Heimann is among the handful of people, I think we all know, most distinguished in the field of international finance. He’s been a leader with Merrill Lynch for many years, and he’s now taking on a new assignment as the First Chairman of the Financial Stability Institute, which—we agreed beforehand stability is like pornography: You know if when you see it

Gerry Goodman we know principally from his television programs, “Adam Smith,” which won every award in the business field for years and years, including, I believe, an Emmy for a program with George Soros. And you might not know that Gerry also is one of the founders of New York magazine and a Rhodes scholar.

Anyway, I promised you a lot of horsepower, and I’m sure my colleagues here will deliver. George.

Mr. GEORGE SOROS (Chairman, Soros Fund Management): Well, Les, I won’t stand up because I don’t have time for that. I think you’ve given me an impossible task, because if I could sort of sum up my book in 10 minutes, I wouldn’t have written it. It’s rather ambitious, and it covers a lot of territory.

I’d like to point out that I started writing this before the financial crisis, so then as the financial crisis developed, I incorporated it in the book. But the book itself and my critique of the global capitalist system predates the crisis.

I would say that there are three major themes in that book. One is that the system favors financial capitalists, but financial markets are inherently unstable, and international markets are even more so because we actually, through practical experience, have learned that markets are unstable and developed institutions to prevent them from breaking down. We’ve got central banks, regulatory agencies. But they are basically all lenders of last resort, but they’re all national in scope.

The financial markets have now become global, and we do have, also, international institutions—the Bretton Woods institutions—but they were designed for a different epoch, and they now, actually, have become a part of the problem, because when a country turns to the IMF, the IMF provides loans, imposes conditions on the countries, but has not so far permitted those countries to impose conditions on the lenders to those countries. And the conditions it imposes help to create a trade surplus, which then allows the country to meet its obligations. So in that, actually, this method has bailed out, let’s say, lenders, and this has given rise to what is called a moral hazard, where lenders have occasionally been rather sloppy.

Now I think that the moral hazard has actually been corrected, partly because lenders and investors have now suffered serious losses in countries like Russia and Indonesia, but even more because this moral hazard has now become politically unacceptable. And, for instance, the effort to stabilize the situation in Russia has failed exactly because there was so much political opposition to bailing out speculators or banks who have lent imprudently.

So now, I think, the problem will be how to maintain the flow of capital to the periphery. There are many other problems that need to be dealt with; I’m sure we will discuss them. So that’s the first major area.

Second is that market values have penetrated into areas of society where they don’t properly belong. Markets are basically amoral; you might—if you want to be more emotional about it, you can say inhuman, because they treat everything as a commodity. And yet, we need a moral judgment; we need distinction between right and wrong, which doesn’t actually come into the decisions of market participants. So the area for political and social judgments has been narrowed. Certain, for instance, intrinsic values are getting short shrift. This is a thing that I really don’t think I can sum up, this point, in a minute. And in the book, also, I’m rather tentative about it, but I think it’s a very important subject.

And the third point is that you really can’t have a global economy without a global society. And when I say “global society,” I don’t mean a global state. I have in mind what I call an open society. And you can’t actually define what an open society is because an open society is one that defines itself. But basically, certain shared values, a democratic government, a society that is not dominated by the state so, therefore, has an important civil society in addition to the state and, of course, a business sector which is independent of the state.

We now have this global economy, but we have sovereign nations, and certainly, there is no evidence that capitalism brings democracy. You do have democratic regimes at the center, but actually, many of the economic conditions that prevail at the periphery encourage nondemocratic forms of government. So I think that we really have to pay attention and create some kind of global political architecture. We talk about the financial architecture, but I think we must also talk about the political architecture. I mean, we had a stable international order. It was called the Cold War. That order has disappeared, and actually, we now have disorder. And you can see the world is now littered by trouble spots. And most of the trouble spots are actually internal troubles, and sometimes then they become internationalized, like, for instance, the situation in Rwanda, which was really totally neglected by the international community; now has resulted in what might be called almost a sort of a mini world war in Africa.

So I think we need some agreement on shared principles, and I have this somewhat Utopian notion that there could be a coalition of like-minded nations that would cooperate to influence the internal developments throughout the globe; not imposing uniform standards, because that is nonsense, but helping the move, allowing the people actually to determine their own destinies, so to establish, let’s say, internal conditions of an open society. And this would be done, I think, more by cooperation and could be done more by offering incentives rather than by imposing penalties. And I think if we did that, we would not have to have to impose that many penalties, as we are currently doing.

So as part of the financial architecture, I am proposing an international credit guaranty organization, which would be, let’s say, an additional window at the IMF which would be guaranteed by an issue of special drawing rights. I think this could help to even out the international flow of capital, because it would increase the flow when it gets arrested and then it could be withdrawn, giving a signal if things are getting too exuberant. So it would be a more balanced system than the asymmetric system we have now. And I think that it could also be a vehicle for improving the banking systems in the countries concerned because they would have to be properly supervised by the credit agency for it to get the credit, and I think it could actually be used perhaps in areas like Africa to get economic development going.

I think that covers the 10 minutes.

Dr. GELB: Yes, you did. Thank you, George.

There are lots of ends to begin tugging at here, and you can develop them in your conversation. But let me start you off with looking at the fundamental point, I think, in George’s book, pulling all three points together. Do you really need an open society for a global market, for a global economy? George’s argument that the best way to have a global economy without all these complications and problems and costs is by having a global society—haven’t we had one, in effect-a global economy—without open societies? Gerry, why don’t you...

Mr. GEORGE J.W. GOODMAN (Chairman, Adam Smith Global Television; Author, “Adam Smith’s Money World,” PBS-TV): I think, George, that sooner or later, you would have to have the open society, because otherwise, you wouldn’t have the rule of law and the transparency that you need and the level of trust to make the international economy work. But I wanted to ask you something, and that is, in your book, you deal a great deal with financial instability and you talk about the false example of equilibrium—how we’re all fixated on equilibrium but, in fact, financial markets overreach and exaggerate and so on. But you need the financial community to back you for your ideas, but the financial community has made an enormous amount of money out of instability, yourself included. So how are you going to enlist their aid when there’s been so much money made out of instability?

Mr. SOROS: I think it’s a very good question, and it’s a point that was, I think, very well made by Paul Volcker when he said everybody invades against volatility, but volatility has a strong constituency, because banks actually profit from it, coming and going, because volatility creates more active markets. So as market makers, they benefit, and then they also sell insurance against volatility, and that is another line of business. So actually, volatility has been rather profitable, and I think that...

Mr. GOODMAN: For you and for a lot of people.

Mr. SOROS: Pardon?

Mr. GOODMAN: For you and for a lot of people.

Mr. SOROS: Yeah, that’s right. And I think that that volatility has actually increased. It’s not something stable. As you know, I look at markets as a historical process; they evolve. And certainly, they have evolved in the direction of volatility, and we are now seeing the extremes of volatility which have resulted in the near-meltdown connected with the...

Mr. GOODMAN: So how do you get the financial community to come around to this point of view when it’s so profitable, they’d be, in essence, voting against their own interests?

Mr. SOROS: Well, I think that I will probably encounter quite a bit of resistance to it in the financial community. But surprisingly, in private conversations, I think that people are aware of these problems and they are actually quite troubled by it. But you can’t expect them, or, actually, me, to sort of cut our own throats. But I think that this is a political task.

Dr. GELB: John, this is going to be your new business. What do you think?

Mr. JOHN G. HEIMANN (Chairman, Global Financial Institutions, Merrill Lynch & Co.): I was thinking about pornography, because you mentioned it. Number one, the financial institutions, the financial system, has a vested interest in volatility; absolutely correct, as pointed out. Number two, volatility has increased dramatically because of technology, and the likelihood is that volatility will continue to increase as technology reaches further and further horizons over time. And those are the realities, and we have to remember that markets and financial institutions are made up of human beings. George said, and I think, that markets do not judge right or wrong. I think markets, at best, are a real-time referendum on reality. Markets do make judgments, and it is a real-time referendum on what they see and what does that mean to them from a financial or an economic point of view.

Mr. GOODMAN: I didn’t get that out of George. I got the opposite: markets are emotional and they are not a check on reality.

Mr. HEIMANN: I said they’re a real-time referendum on reality.

Mr. SOROS: And may I add one other—innovation is another element in volatility, because the derivatives, and particularly derivatives of derivatives, like no-count options, really pack a punch as far as instability is concerned.

Mr. HEIMANN: But I think we’re asking too much, and I don’t think we want financial institutions to decide what the world is going to look like. Financial institutions should be transmission mechanisms. They shouldn’t be making judgments that should be made in the political framework, and I think that was the point that George was making, so that the concept of markets making judgments in terms of what’s right and wrong, I think, is a trap, and it’s an illusion to think that that’s what we should have. And, you know, in final analysis, I agree with the increased volatility. I think it will increase further.

And I’ll say one more thing in that respect. George pointed out that the nuclear standoff in the post-World War II period had an effect, obviously, in stabilizing the world. There was a secondary effect much less noticed by all, and that was the financial institutions on a global basis investing more and more of their money outside of home country and having mutual interest in places like Brazil and others. In Brazil in 1982, a third of the money came from Japan, a third came from the United States and a third came from Europe. That has also had an effect on a one-worldishness, if you want to put it that way, and working together. So there is some good that comes out of the financial institutions’ expansion abroad.

Mr. SOROS: Yeah, but that actually also has been one of the transmission mechanisms of the contagion, because the Korean banks invested in Indonesia and they invested in Russia and Ukraine, and Brazilian banks or investment banks invested heavily in Russia. And the first, let’s say, time that Brazil was touched was because of the Korean crisis. So it’s actually a transmission mechanism of instability, also.

Dr. GELB: I don’t think...

Mr. HEIMANN: But let me just follow that for a second, then I’m going to—it’s your money. You will invest it. You will want the return. These institutions are presumably serving you, because you move from institution to institution based upon the return and their records. They’re doing what they think they’re being paid for by the people who give them money.

Mr. GOODMAN: But, John, we don’t know it for six months after they do it. We don’t know it until it turns up on the front page of The New York Times.

Mr. HEIMANN: Know what?

Mr. GOODMAN: That the Korean banks are heavily into Brazil and out of pocket, much less the Ukraine.

Mr. MORTON HALPERIN (Director, Policy Planning Staff, Department of State): But that’s the problem, though; we allow that to happen. I don’t believe the problem is that people who trade and make a lot of money on them will not want to reform the system. If we were sitting here before the period of antitrust, we would have said, you know, that Standard Oil is not going to break itself up. It’s making a lot of money. People invest in it. The problem there was ultimately corrected by the fact that we had a political system, and when the political system didn’t tolerate the gains that people were making because of the course, it was able to fix it.

George suggests in his book that he’s taking on a notion of capitalism which he thinks goes too far. In my view, that takes on an argument that’s unnecessary, because in the United States, we’ve had that fight and we have agreement. You don’t let people do whatever they want. You have a Securities and Exchange Commission process, which is extraordinarily intrusive into the free market. You have the Federal Reserve. You have the Congress. You have a whole set of institutions which interfere with the market. And while it is true if you went back, people would say, “This prevents us from making quite as much money as we used to or would like to,” they’re accepted.

But I think the problem is not that people want pure capitalism and want to do that. The problem is that we have no effective way to impose those set of rules, which I think are agreed rules, on the rest of the world because we do not have the equivalent of the Congress that says, “Enough. And we’re going to fix it.”

Mr. GOODMAN: Yeah, but we don’t even have the Congress that says that frequently.

Mr. HALPERIN: Well, but in the United States, we do. I mean, we don’t tolerate the kinds of lack of transparencies...

Mr. SOROS: Well, but actually, you know, the record of destruction that we have is basically left over from the 1930s, from the collapse of the banking system in 1993. And there’s been a constant erosion of that, and there’s a prevailing view today that those regulations are really not needed. And when you think of it, that you have to put out a 50 percent margin when you buy stocks, because there were stocks in the ‘30s, but you don’t have to put up any margin when you engage in a derivative transaction with a bank. There’s absolutely no margin requirement. So the need for margins today is not recognized.

Mr. HALPERIN: No, but what you’re saying is that we need to do some things domestically to get back to where we were domestically. But that, it seems to me, is not the major problem. The major problem...

Mr. SOROS: You are right about the other—there is the other problem, too.

Mr.-HALPERIN: ...which is a much—and the problem is, the only mechanism that could fix this now is the United States government, because it is, in fact, the equivalent of the Congress for domestic policy. And the American government has not taken the initiative here, I think, for two fundamental reasons. One is that any initiative has to put limits on the United States as well as everyone else. And if you look at the World Trade organization, we actually did a little of that in the world trade area, but we have this national security exception, and any time anybody says they want our rules to apply to the United States, we have this out. And even then, it was hard to get the Congress to do it. If you try to develop a set of new institutions, they would have to affect us, and the political view in the United States makes that very hard to do.

The second is that the U.S. government is simply not organized to do what needs to be done, which is not to come up with the kind of change that you recommend which, while I think interesting and obviously controversial, is much too modest. We need fundamental changes in the institutions to deal with the new realities of the global situation. And the first thing that has to happen is that we have to have those ideas. And I think they have not come either from the government or outside. And then we have to have the political will in the United States to present them to the rest of the world. I think if we got that far, the rest, while difficult, would fall into place.

Mr. SOROS: And I think the...

Mr. GOODMAN: I’d question whether there’s a consensus on what the ideas ought to be.

Mr. HALPERIN: Oh, right. Yeah. No, right. Yeah.

Mr. GOODMAN: George has really kicked off the discussion, but when Bretton Woods took place in 1944, it was in the middle of the war, and the United States held all the cards. By the time you got together, it took a long time to get that through. Now the only consensus is what George is talking about, the amoral consensus that markets are always right. So I don’t know how you get a consensus and a political theory that backs this kind of action.

Mr. HEIMANN: Well, I don’t think you can get a consensus, not for a long period of time. I mean, the IMF and World Bank have 180 member nations, if I remember correctly, and the United States does not have the power it once had, even though it’s the most powerful nation on Earth. It cannot command the world to do this. And we have to remember we’ve got 180 nations out there with sovereignty, and they guard that very jealously.

Mr. SOROS: I think, John, the IMF, distinct from the World Bank, is an institution very much under the control of the industrialized nations. They own 45 percent of the votes and very much, really, an instrument of the U.S. Treasury. However, the U.S. Treasury does not believe in regulation. I mean, you know, I have very high regard for the people who are currently running the Treasury, but I am convinced that if we had this conversation, they would be taking issue with the very idea that regulation is desirable.

Mr. HEIMANN: But I think we’re mixing up apples and oranges. And, first of all, the U.S. system is antiquated in this respect. There is no question about it. But that, to me, is not the basic problem this warrants. What you have to have is some kind of international system that sets standards. And, frankly, in the financial system, setting standards is not that difficult. That doesn’t mean they’re agreed upon. They are agreed upon by everyone. If you look at the G-22 statements, the G-7, the G-10, etc. and so forth, they all say there must be standards set in the international financial system.

Now that’s easier said than done, because you’ve got to get individual nations to agree to that. You can set the standards, but then everyone has to apply those standards. And in financial markets, there’s enormous mobility, again, as George points out. So if you don’t like the standards in Country A, you move your operations to Country B, where they have less-high standards. And you can do that.

Mr. GOODMAN: There’s always one more country, too.

Mr. HEIMANN: There’s always one more—right, there’s always one more country. So what’s needed here is—George, I think, is on the right path; I really do—and that is that we need to have some mechanism by which we can create standards that are accepted internationally and we can expect governments to do it. Let’s just take that as a given. Congresses, parliaments, are not going to accept those standards. We have to do it in a way that the financial system accept the standards. If financial intermediaries refuse to deal with banks or securities houses that don’t meet those standards, then you can get discipline in this system. But it’s going to have to come through the private sector because it’s going to be many, many years, barring an enormous catastrophe, for governments to accept any kind of standard basis.

Mr. HALPERIN: And the private sector’s going to have to lose a lot more money before it’s willing to go that route.

Mr. GOODMAN: Well, let me read you—


Mr. GOODMAN: —a sentence to that point, because here’s how to get the consensus that you’re talking about. All that has to happen is for the world to follow the script that George has outlined here. He says, “We’re in a bear market. Stock prices will eventually go much lower, but the bust may be much more protracted than the boom-bust model I’ve been working with would indicate. And the disintegration of the global capitalist system will prevent a recovery, turning the recession into a depression.” Now if you get that, you’ll have a consensus.

Mr. HEIMANN: That’s right, but...

Mr. SOROS: Could we have a consensus before that happens?

Mr. GOODMAN: That’s correct.

Mr. HEIMANN: Well, I think we could do it, but we’ve got to stop using phrases like “architecture.” I mean...

Mr. SOROS: Start or stop?

Mr. HEIMANN: Stop financial architecture.

Dr. GELB: I want to know what the odds are of this—(inaudible).

Mr. HEIMANN: We should be talking about plumbing. We should be talking about how the system works, not how we draw beautiful pictures and design the systems that take politicians to agree to it. It ain’t going to happen. Therefore, let’s concentrate on the plumbing and the electricity, and we’ll get a lot more done.

Mr. GOODMAN: George, do you agree with that?

Mr. SOROS: Well, the metaphor is fine. Well, the only sentence on which I disagree with John is when he says that these standards have to be accepted by the financial community and imposed by the financial community. Obviously, they have to be standards which the community accepts and can live with, but I don’t think it’s enough to expect voluntary compliance. There has to be some sanctions through the banking supervisors, who say, “If you do such and such, that requires such a haircut. And if you deal with counterparties that don’t comply, then you have, you know, some extra penalty or something.”

Mr. HEIMANN: Can I just pause? I mean, I agree with George; it needs to have some kind of sanction. But where’s it going to come from? Now if you’re in a developing nation, where the head of the largest bank’s wife is the sister of the prime minister, the poor supervisor doesn’t have much of a chance. And even if he wants to implement these standards, it’s very hard for him or her to do so. On the other hand, if the other banks around the world would say, “We will not deal with this bank unless it meets those standards”...

Mr. SOROS: But, John, just take it one step further because, basically, most of the transactions go through large banks, which are under the jurisdiction of the major regulatory authorities—U.S., U.K. --you can practically almost forget even the continent, because...

Mr. HEIMANN: No. No.

Mr. SOROS: Well, maybe not. But, OK, U.S., U.K., and Europe, so U.S. and Europe, there is practically—I mean, the volume of transactions that could be conducted outside channels that fall into those jurisdiction is actually very small. Now if you allow them, the banks will, you know, channel their transactions through Cayman Islands, but you can catch them because they can’t exist without having an...

Mr. HEIMANN: Yeah.

Mr. SOROS: in New York and London and so on. So, provided that there is a consensus and cooperation, I think the global markets can be regulated.

Mr. HEIMANN: We’re arguing on this. We agree. I mean, the key is to set the standards, have the U.S. supervisors, the U.K. or whatever, accept those standards and tell the banks they have to meet those standards. Then those banks will deal or not deal in the developing nations based upon acceptance of the standards or not, which will force the banks in the developing nations to get the standards accepted. Otherwise, they won’t get a flow of funds. That’s the way the system has to work.

Dr. GELB: I’d like to know, George, did you put the dire scenario in merely to provoke us into thinking about that, or does that represent your true view?

Mr. SOROS: Well, it represented my true thinking at the time when I wrote it.

Dr. GELB: That’s only two months ago.

Mr. SOROS: Only two months ago. And it may very well represent my thinking two months from now. Right now, you know, things look a lot better.

Dr. GELB: We should ask, where’s your money now?

Mr. SOROS: Well, the fact is that, you know, actually I’ve broken some of my own rules because I said never make a short-term prediction because you may be wrong. Then I made a short-term prediction. I said that markets won’t recover more than half of their losses. Some indexes, actually, made minor new highs. Now I happen to think that that’s, you know, just a little overshoot on the upside, but I’ve clearly been wrong. And since markets are reflexive, the fact that the authorities reacted so energetically—I mean, I must say that Greenspan, with his various charts of the relationship of various markets and how they were out of line with each other, turned on a dime and lowered interest rates.

The New York Fed, maybe with excessive zeal, put together a group to prevent the collapse of Long Term Capital Management. The Congress gave the IMF $18 billion. We put together a package for Brazil. The G-7 made some noises very much along the lines that I was advocating in the book. So all these things came together, and we have now a sigh of relief. Now I don’t think the problems have gone away, and I think it would be a great pity if, because of it, you know, we became complacent just because markets look better. Now the fact that markets look better is actually very important for the outcome, you see, because markets don’t just reflect; they actually create. And since the real danger for the world economy is if the U.S. consumer, which is the main engine of growth, were to get scared—and the U.S. consumer is overextended. It has a negative savings rate; it spends more than it earns because of the wealth effect. It has actually been reinforced it’s been right to buy the bottom again, so that helps to keep the engine...

Mr. HALPERIN: But even if the engine keeps going, I mean, one of the things your book talks about, which I think the new—and I still think it needs to be “architecture”—has to deal with is that, as you say in the book, because of the institutions that exist to react to these problems, in the developed countries, the solution to a concern about the economy is to do things that grow the economy out of the problem.

Mr. SOROS: Right.

Mr. HALPERIN: The solution we impose on the less-developed countries is to solve the problem by destroying the economy, putting everybody out of work, slowing the economies down. And that sort of helps the investors, but not the economies.

Mr. SOROS: Except the...

Mr. HALPERIN: And we cannot continue, I think, to go on indefinitely in a world in which we solve our problems by growing and insist that these other countries solve their problems by collapsing their economies. I mean, I think that that is going to produce an explosion of some kind, and I think it’s also not an acceptable form of policy.

Dr. GELB: Let me hold you there for a moment. And I hope the audience, our colleagues out here, will come back to the question of where you’re putting your money, George—standards, plumbing versus architecture—because I think we skipped over some interesting issues in the process.

And let me come back again to what I think is the core argument of your book, George; that is the intimacy between sustainable globalism and open societies, because that’s the heart of the matter. And it seems to me—I looked at the last 10 years—that we’ve had what we consider globalization, whatever that means, but certainly, expansion of the world economy without great expansion of the open societies, and that if we look at the emerging markets, the things we’ve talked about for the last several years, most of them were not very open societies. And if we want to worry about moral hazard, as we should, we can worry about the United States, because here, we’ve had the most open of societies and growing in equality and wealth.

So you have to explain to me somewhat more, George, exactly how you see the connections between the good, expanding, global economy and these open societies.

Mr. SOROS: Well, this...

Dr. GELB: It underpins our foreign policy, too, that same assumption. Is it valid?

Mr. SOROS: Well, this, of course, is my major concern, because what we have now is, the global economy imposes market discipline. But if the global markets are inherently unstable—and one of the causes of instability is actually institutional. I mean, this difference between raising interest rates or lowering interest rates, which is very understandable, but it has very different results.

So if you impose instability, how much instability can society take? So the real danger eventually is a political danger; that it becomes just too painful and destabilizing to be part of the system at the periphery. It’s great at the center but bad at the periphery.

Dr. GELB: But...

Mr. SOROS: Now we have democracies at the center, and democracies usually think of themselves. I mean, the voters vote their economic interests, generally. I mean, I’ve been warned when I was interviewed. They said, “Don’t talk about what happens, you know, in the periphery. Why does it matter to us?”

Dr. GELB: Right.

Mr. SOROS: So, of course, indirectly, economically, it matters. I mean, we are affected, etc. But there needs to be some leadership, some larger view where we are concerned with what happens in the rest of the world. We used to, actually. I mean, there is an American exceptionalism. We have always had this duality in our foreign policy. Unfortunately, the universal values usually lost out to geopolitical realism. And I think the present mood is very definitely geopolitical realism and not open-society thinking, and that is actually the main point that I’m trying to make: that you’ve got to change.

Mr. HALPERIN: Can I just...

Mr. SOROS: Sure.

Mr. HALPERIN: I think that the problem is that while you say that this notion is the basis of our foreign policy, it isn’t the basis of the foreign policy that the Treasury and the IMF impose, because when we go to these societies, on the one hand, we say—and they, I think, are beginning to—many people in these countries are beginning to understand that the problems of cronyism, the problems of secrecy, the problems of money disappearing from this society are the real problems and that there is beginning to be a political will in many of these countries to solve those problems.

The problem is that we arrive in the form of a society that claims to be preaching the need for an open society and demand a set of actions, which you can’t do if you open the society to greater democracy, because then you’re asking a more democratic society to vote for large unemployment, for a slowing down rather than the growing of the society. And I think that if we were honest and committed to our values, we would be willing to work with these societies and say, “The real problems are secrecy, lack of the kind of controls on investment that we have in our own country. And if you will make those kinds of reforms, we will supply you with the money that you need to make your economies grow and not grow.”

Rather than walking in and saying in effect, “We don’t care what else you do, shut your economies down for five years. And when you do that, we’ll come back and talk to you.” And that’s the incomparability.

Dr. GELB: Before I open it to our colleagues out here, let me just ask a very pointed question of you all that I think this is all leading to. What really was the cause of the financial crisis that we’ve gone through in the last year? Was it, as you argue, the lack of open societies? Mort is backing up that point. Is that the root of it, or is it something else?

Mr. SOROS: I think that there is an innate instability in financial markets, which is a rather abstract point that I’m trying to make, which is really built into the system. You know, there’s this idea that markets tend toward equilibrium. That is correct when markets deal with known quantities, but financial markets—not only do they deal with unknown quantities, but the quantities they deal with are unknowable because they are trying to discount the future, which depends on how the financial markets discount them at present. So it’s contingent. And so the idea of equilibrium does not apply to financial markets, and this is not sufficiently recognized in our—it’s inherent in the markets themselves, not just...

Mr. GOODMAN: But, you know, that...

Dr. GELB: John and Gerry, would you chime in?

Mr. GOODMAN: When we talk about the problems of these countries, and we talk about cronyism...

Mr. HEIMANN: ...happening now, and the same thing happened in the early 1980s. And where does it come from? The phrase we use is `leverage.’ There’s just too much money piled on to too narrow an equity base, and that’s in both corporate and a country sense. We have these cycles of capital flows, and George mentions them and I think he’s quite right in many of the things that he said. And that’s not going to change. If you’re going to have private markets, that will not change. Enthusiasm, opportunism, competition, and people go out and do some really stupid things, and they will continue to do that as long as the human being is what he is today. So that’s what it was, leverage; too much money.

Mr. SOROS: Let me just add one thing to this, and that is that actually, investors like authoritarian regimes. They like a strong government. You know, Indonesia, you know, is the —(inaudible)

Mr. HALPERIN: China.

Mr. SOROS: China. I mean, actually, the best example I think was Chile under Pinochet, because when Chile went broke and the private banks were indebted, the government, the state, stepped in and assumed the debt of the private banks because Pinochet needed the international credibility, the legitimacy, because he didn’t quite have it at home. You see, a democratic government would never have allowed the bailout of the private banks.

Mr. GOODMAN: Isn’t...

Dr. GELB: Thank you. Let me hold you there, Gerry.

As you know from the invitation, we’re going beyond our normal hour, and this will be an hour-and-a-half program. If any of you have to depart, please do it now rather than while the discussion goes on.

We’ll do the discussion the same way we always do. When you’re recognized, please stand, say your name and your affiliation. And please state your question or your point as crisply as possible. Floor’s open. Please. We have microphones here? All the way down in front. And would you wait for the microphones, please, before you begin to speak?

Mr. JOHN T. CONNOR (GAL-Russia): John Connor, Third Millennium Russia Fund. My question, Mr. Soros, is about decision-making in the Russian government. The first deputy prime minister was in town recently, and he said, `We got all this conflicting advice, and we took it all.’ And we had a panel the other day with the former prime minister, and afterwards, we had the professor from Princeton and the professor from Columbia. And it seems that it’s very difficult for these people to exercise critical thinking when they don’t have the experience base that the members of this panel have. And I would just like to have your thoughts on how it is a well-intentioned group of reformists, bureaucrats, can sort through this wonderful advice they get from academics and government officials and businessmen and make better decisions?

Mr. SOROS: Very good.

Dr. GELB: Good question, George.

Mr. SOROS: Very good. Please cut me off when I answer it, OK?

Dr. GELB: I will.

Mr. SOROS: Because I could go on talking about this for a long time. We have really fouled up in the way we approach the problem. One of the original mistakes was to give the job to the IMF, because the IMF is used to dealing with governments and they sign a document of conditionality. The governments don’t fulfill the conditions, they don’t get the money. But when you don’t have effective governments, this system doesn’t work. They can sign any piece of paper, but they can’t deliver, they can’t collect taxes. So you can have a plan, but you can—so we gave it to the IMF because we didn’t want to put up any money.

The IMF had money, so, you know, you get their money, not ours. So this was a very big mistake which, I think, actually, endangered the IMF as an institution. So what you needed at the time, because you had probably the most comprehensive social, economic and political ideological system in history disintegrated, OK? So you needed to create a new system. It was a tremendous task, and it would have required a much more intrusive method of approach. I believe that. I actually practiced this. So, I mean—I started out in ‘88 with a task force to create an open sector in the Russian economy, and at the time, I concluded it was too late because the system was already too rotten.

And then I argued that the money that the IMF gave should be earmarked and not distributed, except to pay the social safety net and unemployment. And if we had done that, it would have been the same money, $15 billion or whatever we gave, we would have today 20 million less people voting for the Communist Party. So we have really mishandled the whole thing because we didn’t understand what was going on and, unfortunately, we didn’t care enough.

Dr. GELB: John, do you want to come back on that or...

Mr. CONNOR: Well...

Dr. GELB: But I invite the others to join.

Mr. CONNOR: ...I would like to agree with him in the sense that the IMF approach is these macroeconomic indicators. And I think to those of us who’ve been in Russia for many, many years, the actual problem is that the enterprise level or the individuals running these enterprises cannot seem to narrow their focus to making a profit. And as a result, when you add up all of these little losses, you don’t get a growth economy; you get this social welfare orientation and a business unit that shouldn’t have to care about the medical clinic and the bus route and the kindergarten and all the subsidized housing and so forth.

And I think in the case of China—you know, I only know what I read. I’ve been there a few times, but—they seemed to have brought in all of these thousands of individuals who sat on the individual enterprises and showed them what to do, and the government didn’t seem so concerned about getting advice about these macroeconomic indicators. So I just wonder how we can get to the real problem in Russia, which is the virtual economy.

Dr. GELB: Thank you. Mort.

Mr. HALPERIN: The question, to me, sounded like one more plea for a one-armed economist, but I think sending the IMF to Russia was like sending the U.S. Army to Vietnam. That is, you knew there was a problem, you looked around for the institution that seemed closest to one that might be able to solve the problem and you sent it in even though it was created for a totally different purpose and had no idea how to deal with the real problem.

In my view, you get one chance to create the ethic and the function of an institution, and that’s when you create it. And if it’s created for one purpose, the notion that you can then change it to do something else sends you off into Vietnam and the IMF and Russia and so on. I think we have to create a new institution. We have a new problem of: How do we help these societies in a way that strengthens their commitment to an open society and deals with their problem by growing their societies rather than contracting them? And there isn’t any institution that has that mission or that capability, and I think we have to create it, as hard as that is.

Mr. HALPERIN: I agree...

Dr. GELB: Yes, John.

Mr. HALPERIN: I agree with Mort. I mean, why did we expect that the IMF had so much smarts, that they knew the answer to everything? I mean, it was really unrealistic. And it’s a very fine agency, a bunch of macroeconomics. They do a hell of a good job, but they’re not that much smarter than everybody else. And I agree with Mort, we have to do something about the World Bank and the IMF and to create something new out of that.

Dr. GELB: I hope some of you will come back to that. Please, down here.

Mr. JOEL E. COHEN (Rockefeller University): My name Joel Cohen. I’m at Rockefeller University, just down the street. Of our six billion people on the planet today, about two billion live on approximately $1 a day, and the average income for four-fifths of the planet is about $1,100 a year; that’s about $3 a day. At present growth rates, we are adding about 80 million people a year, growing at about 1.4 percent per year. If the percent were constant, we would have another six billion in 50 years. If the number is constant, we’ll have another four billion in 50 years. And 98 percent of that increase will not be in the rich one-quarter or one-fifth of the world but will be in the poorest countries.

That’s a rather long-term perspective, 50 years, from the point of view of the financial markets, but it’s a short-term perspective in terms of the children who are being born today. Do you think that these problems deserve more attention from the financial markets, and do you think there’s a potential destabilizing effect from the massive growth of a poor population surrounding the islands of wealth?

Dr. GELB: Thank you.

Mr. SOROS: I would say no, they don’t deserve any attention from the financial markets because these are not areas of any significance for the financial markets. They deserve political attention. They deserve the attention of our government and of society. And I just visited Haiti. I think the problem is almost entirely political in these countries. You know, I’ve been to Haiti; I have a foundation there. And I went to see what they’re doing. I mean, it really is a hopeless case, because 15 years ago, I would say, I thought this is the pits, you know, pretty well the worst. Go back 15 years later and it’s worse. I mean, the roads are worse. Everything is worse 15 years later, and it is due to the political situation, and it can only be changed through political change.

And, you know, I asked myself, `Why do I spend money here?’ Because actually my spending money there merely slows down the rate of decline. And actually, the only reason is because I’ve got a very good foundation there of people, Haitians, who have some idea, that they really believe that they can change the country. And they even have a strategy. So, you know, I don’t actually even believe in this fantasy, but I’m backing them because if they don’t do it, I don’t think we can do it for them.

Dr. GELB: Mort.

Mr. HALPERIN: Yeah. I mean, I think the connection between the two problems is this: We don’t solve the problems that George was talking about in his book. We’re not going to have either the wealth or the political will to solve the problem that you raised, but we can’t expect those institutions to solve that problem. It is a matter of political will. We can’t solve it here. We have, in this country, people who live in poverty amidst all of our wealth and all of our institutions. It’s a very hard and very serious problem, but to expect these markets to solve it, I think, is not where the solution is.

Mr. SOROS: But, however, I think the policies that we pursue can make a big difference by, let’s say, empowering...

Mr. HALPERIN: Right, these societies to deal with the problem, giving them the wealth to do so.

Mr. HEIMANN: Whenever we try to channel social programs through the financial intermediaries, not only in this country and other countries, we warp them, and they invariably come a cropper because of that and, therefore, it is a public policy issue. Do it through tax policy and a bunch of other things, but you don’t do it through the financial institutions. That’s a prescription for disaster.

Mr. GOODMAN: We’re so worried about unintended consequence because, I thought unintended consequences were a very interesting point of your book, where the cost of good intentions actually turns out to be the reverse. Talk about that a bit.

Mr. SOROS: Well, I mean, I talk about it throughout the book. I’ve, myself, encountered it.

Mr. HEIMANN: He believes in unintended consequences.

Mr. SOROS: No, absolutely. Absolutely. So...

Mr. HALPERIN: There’s a two-word example of that: development assistance.

Mr. SOROS: Development institute.

Mr. HALPERIN: Assistance.

Mr. SOROS: Right. Right.

Dr. GELB: Like your Haitian foundation.

Mr. HALPERIN: It’s the most persistent, clearest and yet ignored example of adverse, unintended consequences.

Mr. SOROS: Yes, but you actually can’t give up, you see? The fact that you have these unintended consequences would lead you to abandon all efforts and say, you know, “They have got to do it themselves.’ I don’t believe that. I think that you’ve got to recognize the unintended consequences and try to correct the errors that you make. Fortunately, I haven’t visited Bangladesh, so I can talk about it in an optimistic vein. I mean, I always considered that to be the other pits. With overpopulation, obviously these are areas—of course, Haiti has six—What do you call it?—births per—fertility rate of six, which now we have a program in a part of Haiti which has reduced it to 4.8, which is in that region.

But Bangladesh, with the Grameen Bank and its imitators, has actually really risen from the bottom. I mean, you know, the race to the bottom actually has done good to the bottom. They actually now have a big export trade in textiles and so on, so it’s not totally hopeless.

Dr. GELB: Question, please, over there.

Mr. PAUL JABBER: Paul Jabber, investment banker and former Senior Fellow here at the Council. Much of the discussion dealt really with issues of standards, transparency, the need for strengthening banking institutions in the emerging markets, regulatory issues of this nature, and I don’t think that there is much controversy about the need for enhancing these standards. But there are two more fundamental issues that were not really discussed very much and that were addressed by Mr. Soros in his book, having to do with the financial crisis, one being the question of uncontrolled, very large and very sudden movements of capital across borders, particularly in and out of emerging countries who are not able to handle it institutionally, and secondly, the moral hazard issue. Perhaps, you know, we should point out the technical definition of what moral hazard means, being basically the bailout of private investors with taxpayer money.

Now I’m a bit confused in terms of how these two stack up. If, indeed, we’re advocating a policy of introducing some regulation or controls over the unrestricted flow of capital in and out of emerging markets, at the same time we’re dealing with the moral hazard issue in the sense of removing it by making sure that, in fact, private investors are not bailed out with public money, it would seem to me that if you remove the moral hazard...

Dr. GELB: Jump to the question, please.

Mr. JABBER: ...concerns, then you’re increasing the risk to the private investor. The private investor will be leaving even faster and more quickly because they don’t have the umbrella or the hope or the safety net of being bailed out, in which case, in fact, wouldn’t the need for regulation of financial capital be even more intense? So can we have a removal of moral hazard without, in fact, dictating the need for some sort of control over the flow of capital?

Mr. SOROS: The answer is yes, actually/

Mr. HALPERIN: or no, depending on the form of the question.

Mr. SOROS: Exactly. Moral hazard, actually, is an asymmetry between the treatment of lenders and borrowers. And interestingly, in the international sphere, the asymmetry favors the lenders; domestically, the asymmetry favors the borrowers because there are very strong laws protecting the borrowers. So that’s the moral hazard, and so it’s an asymmetry.

Now I think that the moral hazard has actually been removed. There has been a penalty. And also, now the IMF will not, let’s say, bail out a country without some private participation. This was very interesting and amusing in the case of the Brazil bailout, or even before, actually. In the case of Ukraine, the IMF made its loan conditional on Ukraine getting a significant concession from the lenders, or the holders, of foreign debt. Eighty percent of the holders of the foreign debt had to accept a significant reduction before the IMF program kicked in. That was a first, you see, but very important change.

Mr. HEIMANN: There is a confusion, and this is a point of information. Moral hazard, as it’s been applied, has been directed toward the lenders, and George makes that point. But they’re not investors, they’re lenders. The investors in publicly held securities in any of these countries, whether it was the currency, the bonds or the shares, all took a shellacking. They weren’t covered by moral hazard. And just so when we have these discussions, we remember what we’re talking about, we’re talking about the lending function, not the investing function.

Mr. HALPERIN: Then George has got it backward because we want to encourage investment and not lending, and yet the way we’ve bailed them out has encouraged the opposite.

Mr. HEIMANN: Well, no. That’s the...

Mr. GOODMAN: We need the lending, too.

Mr. SOROS: Well, the bond holders, actually, were bailed out in Mexico.

Mr. HEIMANN: In Mexico they were, yeah.

Mr. SOROS: The big...

Mr. HALPERIN: They were testabonos.

Mr. SOROS: You know, that was actually where, let’s say, a mistake was made by making the bond holders hold, and that really kind of, I think, played a role in encouraging people to invest in Russian bonds.

Dr. GELB: John.

Mr. SOROS: But coming back to your question, just to venture, yes, the moral hazard been cured. The question now is: Will there be sufficient flow of capital to the periphery countries? And that is the consideration that has led me to this proposal of the ...(unintelligible) insurance scheme.

Dr. GELB: I’m losing kind of the drift of some of the arguments here because if you all think—I’m not sure you do—that the bailout in Mexico was wrong, and you have serious questions about the performance of the IMF, and yet you seem to think that we’ve kind of survived the economic crisis of the last year, at least so far as the eye can see at the moment.

Mr. SOROS: So far this year.

Dr. GELB: So far this year, but wasn’t the renewed stability causedby the very actions that you’re criticizing?

Mr. SOROS: Yes, but look at the cost of it. You can see now interest rates, for instance, in Korea are now down to 8 percent, but that’s after the economy has declined by, I don’t know—industrial production fell probably by 25 percent or something.

Mr. HEIMANN: Twenty-three.

Mr. SOROS: So the cost is that one-third of the globe is now in conditions that qualify as depression. So is that the appropriate price to pay? And you then have political consequences. You have Indonesia and you have Russia. Now you have, actually, positive political outcomes in Thailand, and you have Malaysia also as a voluntary opt out to preserve the regime, isolate itself. You have Thailand and Korea, where you had, really, a transition to a much more democratic and transparent regime. So it is the political consequences that you have to consider.

Dr. GELB: Thank you.

Mr. HEIMANN: I would just like to add we’re groping our way forward. What’s gone on since the 1980s, with the crisis in Latin America, all of these systems—the IMF, the World Bank—everyone’s been trying to learn. What George is doing, and I think it’s so valuable, is trying to take the next step. What have we learned? And we’re going to continue to make mistakes, and we have to learn. And that’s the process we’re going through.

Mr. HALPERIN: Les, can I respond to him? We’re always fearful that a country’s about to collapse. Countries don’t seem to be able to collapse, so the system goes on. But we have to ask about the consequences for our desire to promote open societies and our concern about economic growth and economic equality in all these countries.

Dr. GELB: Question here. Let me move on please. Question here.

QUESTIONER: I’d like to ask you a question. If you don’t agree with the IMF’s way of lending money, how would you put money into these countries—I ask Mr. Halperin and Mr. Heimann—in such a way that doesn’t get just taken out of the country, as it would be in Russia, or just dissipated by more bad loans on top of bad equity bases and bad overleveraged businesses? How do you put the money in, in a way that would keep those economies going rather than putting them into recession?

Mr. HEIMANN: I’ll take a crack at it. Very simply, we have to promote what is known as foreign direct investment. What is the most important form of money going into a country is the building of productive capacity, and that is when Company A, whether it’s an American company or German, builds a plant somewhere, hires people and produces product. I mean, the problem in Asia was not of foreign direct investment. That is the best form of quality of capital that can go into a country. The next step is equity, but I’ll stay with foreign direct investment now.

Mr. HALPERIN: We want to...

Mr. HARPEL: But that’s not going to solve any problem today. That’s too much foreign direct investment.

Mr. HEIMANN: No. No.

Mr. HARPEL: It’s just—that’s not it.

Mr. HEIMANN: Well, it’s plant, equipment, services. There are a variety of things that can go into a country. And, obviously, when you go through a crisis, as we have today, it’s got to sort itself out. There’s going to be time for healing and time for some revitalization in these economies. I thought you asked the question: What is the best form? And the best form is foreign direct investment.

Mr. HARPEL: We should be putting some money in today. Instead of the IMF going to a country and shutting it down, the question is that that’s the wrong way to do it. We should be putting money in the...

Mr. HALPERIN: No. I don’t think we should be—my view is putting money in can’t solve the problem. You’ve got to permit and encourage the countries to have economic policies which don’t deprive their own citizens of income so that they can’t buy products, so the factories can’t produce anything. We’ve got to permit them to have economic policies which encourage direct investment and grow the economies rather than don’t grow them. We could start by reading (inaudible). I mean, I would say that’s our first step.

Mr. HARPEL: What about those people, in the case of an Indonesia, a totally corrupt system...

Mr. HALPERIN: It’s to get rid...

Mr. HARPEL: ...all the leverage from these with bad debts. How would you do that?

Mr. HALPERIN: Bankruptcy. I believe in bankruptcy. I mean, we started all this when we bailed out Chrysler. I think that was the beginning of all the trouble. You have bankruptcies. You have people go broke. You encourage economic policies of openness and accountability and regulation, which encourages direct investment and which enables people to have money to spend, and you grow the economy.

Dr. GELB: John Heimann likes that plumbing. Next question.

Mr. HEIMANN: That’s right. I agree with that wholeheartedly, by the way.

Dr. GELB: Go ahead.

Mr. SOROS: Let me suggest—you can ask him, you can direct at me, but I’d like you ...(unintelligible) because I think it’s actually quite clear. In the case of, let’s say, Asia, you had an external problem and an internal crisis. And we dealt with the external crisis. We should have encouraged or insisted that the countries deal with their internal crisis. If you take, let’s say, Korea, where you had companies where the debt-equity ratio was average of 395 percent, that is nearly four times as much debt as equity, and the companies were not particularly profitable. So the coverage for the debt was only 1.3 times, all right?

So you had to have a debt-equity conversion scheme, which would have relieved the external pressure also, because you wouldn’t have had to pay the interest. Banks would have been given shares, which they could, you know, do whatever they like with them. They wouldn’t have to repay them. So interest rates could have come down, and the recession would have been much, much shallower than it was.

Dr. GELB: Thank you. Question, please.

QUESTIONER: I’m also with an investment bank, Dresdner Kleinwort Benson. I’d like to come to the question about the morality of the market system, a point you made very early. It seemed like it was one of the essential themes in your book, that markets being amoral—not only are they amoral, they’re encroaching on more and more aspects of human endeavor and perhaps that’s wrong. And I’d like you to address that question because I’d like to put forward a different opinion on that; that perhaps markets are, in a sense, inherently moral.

But I think the basis of our free and open society and democratic system, is based on a market system that is very moral in its essence. By that, I mean it’s based on private property, the rule of law, the freedom to choose—and, you know, freedom is a famous phrase—not simply to go to the market and choose apples or oranges, but to choose how to use one’s talents, how to organize an enterprise, how to create the greatest good for the greatest number. That is the basis of, I think, the system in this country, a very, very moral system. And so I’m a bit surprised that you characterize the market system as being amoral and perhaps somewhat dangerous. There’s a tone there that suggests that there’s an inherent flaw.

Dr. GELB: Thank you.

Mr. SOROS: Well, you see, what our market values, what one individual participant is willing to pay another in a f