[Senate Hearing 112-350]
[From the U.S. Government Publishing Office]
S. Hrg. 112-350
THE G-20 AND GLOBAL ECONOMIC AND FINANCIAL RISKS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
SECURITY AND INTERNATIONAL TRADE AND FINANCE
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING THE DIMENSIONS OF THE EUROPEAN ECONOMIC CRISIS INCLUDING
OPTIONS FOR RESOLVING IT AND IMPLICATIONS FOR THE U.S. AND GLOBAL
ECONOMY
__________
OCTOBER 20, 2011
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Security and International Trade and Finance
MARK R. WARNER, Virginia, Chairman
MIKE JOHANNS, Nebraska, Ranking Republican Member
SHERROD BROWN, Ohio MARK KIRK, Illinois
MICHAEL F. BENNET, Colorado
TIM JOHNSON, South Dakota
Nathan C. Steinwald, Subcommittee Staff Director
Sarah Novascone, Republican Subcommittee Staff Director
(ii)
?
C O N T E N T S
----------
THURSDAY, OCTOBER 20, 2011
Page
Opening statement of Chairman Warner............................. 1
Opening statements, comments, or prepared statements of:
Senator Johanns.............................................. 2
WITNESSES
Lael Brainard, Under Secretary for International Affairs,
Department of the Treasury..................................... 3
Prepared statement........................................... 28
Uri Dadush, Ph.D., Director, International Economics Program,
Carnegie Endowment for International Peace..................... 13
Prepared statement........................................... 30
John Makin, Ph.D., Resident Scholar, American Enterprise
Institute...................................................... 14
Prepared statement........................................... 36
C. Fred Bergsten, Ph.D., Director, Peterson Institute for
International Economics........................................ 16
Prepared statement........................................... 40
(iii)
THE G-20 AND GLOBAL ECONOMIC AND FINANCIAL RISKS
----------
THURSDAY, OCTOBER 20, 2011
U.S. Senate,
Subcommittee on Security and
International Trade and Finance,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 3:04 p.m. in room SD-538, Dirksen
Senate Office Building, Hon. Mark Warner, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN MARK R. WARNER
Senator Warner. I would like to call to order this hearing
of the Banking Subcommittee on Security and International Trade
and Finance. This hearing's subject, which is more timely than
I think when we initially planned it, is the G-20 and global
economic and financial risks.
We are fortunate to have on our first panel the Honorable
Lael Brainard, Under Secretary for International Affairs at
Treasury, with us today, and since we moved this hearing back
from 2 o'clock to 3 o'clock because we had votes, I will be
very brief in my opening comments and try to make sure we take
advantage of the witnesses' time for questions.
Obviously, the timing of today I think is particularly
important in the fact that the G-20 Finance Ministers just met
this past weekend where they issued a new communique, and we
have got the European Union summit this weekend, which all the
eyes of the world will be on. Following these two summits, the
G-20 will hold a full summit in Cannes, France, November 3rd
and 4th.
The single most obvious challenge facing the G-20, at least
at this moment, is the European Union economic and financial
crisis. It is not the sole responsibility of the G-20 to fix
Europe's problems, and obviously this is not the only item on
the G-20 agenda in early November. But if the G-20 is to prove
itself useful--useful in the long run--and demonstrate its
ability to react and at times get in front of the next economic
or financial crisis, then these next few weeks are going to be
extraordinarily important.
The world economy now faces a variety of crises. We still
have in America an economy that, while technically in recovery,
a huge number of Americans have not felt that yet. A further
shock to the system coming about from a non-structured default
by Greece or any other country or even contagion spreading
across Europe that could freeze financial markets will have a
dramatic effect on our economy and an effect that, if not
appropriately monitored and dealt with, could even rival the
challenges of 2008. And the challenge right now is we do not
have all of the same tools available to us that we had in 2008,
both in terms of monetary policy and fiscal stimulus, as well
as a growing concern and some level of skepticism amongst the
American public that some of the actions in 2008
disproportionately helped financial institutions over many of
our fellow citizens.
So we are very, very pleased to have Under Secretary Lael
Brainard here, somebody whom I have had the opportunity to know
and work with over the years. She has got an enormous
challenge, and obviously I will submit my full statement for
the record.
Senator Warner. I would like to now turn it over to my good
friend and colleague, the Ranking Member, Senator Johanns.
STATEMENT OF SENATOR MIKE JOHANNS
Senator Johanns. Let me just start out and say to my
colleague, Senator Warner, thanks for your willingness to do
this. This could not be more timely and could not be more
important.
Secretary Brainard, I think you said it well and very
directly. I was reading through your testimony, and right here
you say, ``Europe's financial crisis poses the most serious
risk today to the global recovery.'' And that is what this
hearing is about. We want to hear about that and what you see
on the horizon.
If I might just offer a couple of thoughts about what I
would see because I would like your reaction to that at some
point. You know, on the one hand, I think there is consensus
about the need for action, obviously. You have countries like
Greece and Portugal that are really struggling and trying to
figure out how they better position themselves.
On the other hand, you have political realities, too. How
far can other leaders move to deal with the crisis that they
are facing? And every day is a day of concern. Every week is a
week of concern. And as we continue to move down this pathway,
if there is not some hint of resolution or some pathway, then
it appears to me that whatever sense of security the financial
markets have in the potential for resolution, the underpinning
for that really gets hit, and they begin to be more and more
concerned, and it gets tougher and tougher to fashion the
solution.
So, again, today this could not be more timely. We
apologize for putting everybody off, but that is the way of the
Senate. My life is more dictated today by what Mitch McConnell
and Harry Reid are doing than what my wife is doing, and that
is a terrible thing to admit in an open hearing, but it is
true. Some of this is just unavoidable, so we appreciate your
patience.
With that, I am very anxious to hear from you, Secretary,
your thoughts on this, and this is informal enough where I
think we can actually engage in a dialogue about what we see
and what we need to thinking about in the weeks and months
ahead. Thank you.
Senator Warner. Thank you, Senator Johanns. And both of us
being relatively new here, it is particularly painful for us as
former Governors when we used to make the agenda to have these
kind of constraints.
[Laughter.]
Senator Warner. Again, with no further ado, Secretary
Brainard.
STATEMENT OF LAEL BRAINARD, UNDER SECRETARY FOR INTERNATIONAL
AFFAIRS, DEPARTMENT OF THE TREASURY
Ms. Brainard. Well, thank you, Chairman Warner and Ranking
Member Johanns. As you said, this hearing is very timely.
Today Americans are focused on securing good jobs,
providing for their families, building opportunities for their
children. That is why it is so important for us to strengthen
America's recovery, which still remains too vulnerable to
disruption beyond our shores.
Europe's financial crisis poses the most serious risk today
to the global recovery. While the direct exposure of our
financial system to the most vulnerable countries in Europe is
moderate, we have very substantial trade and investment ties
with Europe, and European stability matters greatly for
consumer and investor confidence.
Last week at the G-20 meetings in Paris, and on an ongoing
basis, the Europeans are discussing their efforts to deliver a
comprehensive plan to address their crisis by the Cannes Summit
in early November. This plan must have four parts.
First, Europe needs a powerful firewall to ensure that
governments can borrow at sustainable interest rates while they
bring debts and strengthen growth.
Second, European authorities are taking steps to ensure
their banks have sufficient liquidity and stronger capital to
maintain the full confidence of depositors and creditors, and,
if needed, access to a capital backstop.
Third, Europe is working to craft a sustainable path
forward for in Greece as it implements very tough fiscal and
structural reforms.
And, finally, European leaders need to tackle the
governance challenge to get at the root causes of the crisis
and ensure that every member state is pursuing economic and
financial policies that support growth and stability.
For our part here in the United States, pro-growth policies
in the near term and meaningful deficit reduction in the medium
term provide the best insurance policy to protect the U.S.
recovery from further risks from beyond our shores.
To promote near-term growth and job creation, the President
has put forward a series of proposals that would put veterans,
teachers, and construction workers back on the job and put more
money in the pockets of every American worker.
President Obama has also proposed importantly a framework
to put our medium-term public finances on a stronger and more
sustainable footing, placing the Nation's debt-to-GDP ratio on
a declining path by the middle of the decade.
With overall demand in the advanced economies likely to
remain weak, it is essential for emerging economic powers in
the G-20, such as China, to move more rapidly to a pro-growth
strategy that is led by their domestic consumption by allowing
their exchange rates to adjust. At the G-20 meeting the surplus
emerging market economies, including China, committed to do
just that--accelerate the rebalancing of demand toward more
domestic consumption and to move toward more market-determined
exchange rates.
We have made this our top priority with China, and we have
seen progress with appreciation of over 10 percent real terms
bilaterally since June 2010 and with exports to China growing
twice as fast as to other markets. But the exchange rate
remains substantially undervalued, and we need to see it
appreciate faster.
There are two other priorities that I will just touch on
briefly in the G-20 and in the Financial Stability Board.
First, we have been working very hard to level up the
playing field across major and emerging financial centers. In
the wake of the most globally synchronized financial crisis the
world has seen, we are working to implementation the most
globally convergent financial protections the world has
attempted. And we are trying to do so in lockstep as we
implement the reforms here under Dodd-Frank.
The G-20 endorsed new global capital standards in November
of 2010. It will endorse a new international standard for
resolution regimes at this summit so that large cross-border
firms can be resolved without the risk of severe disruption or
taxpayer exposure to losses. And it is very important that we
move forward in sync with our G-20 partners on the reforms to
derivatives markets that were enacted under the Dodd-Frank Act
and that are extremely important for ensuring that there is
much greater transparency about where the risks in the system
lie and efforts to mitigate them.
Finally, sustained and strong American leadership through
the international financial institutions is vital to achieving
our goals in the G-20 and at home. We were instrumental in 2009
in strengthening the IMF, which helped to strengthen the global
economy, and our continued leadership is vital in the IMF to
provide us with outsized influence as the IMF responds to
challenges, such as the European crisis, which matter greatly
to American jobs and growth.
We look forward to continuing to working closely with you
on these important challenges, and with that let me conclude.
Senator Warner. Thank you, Secretary Brainard.
Senator Johanns and I work very well together, and since it
is just the two of us, rather than putting time on the board, I
have got a couple questions, and if you want to break in at any
point, we will go back and forth in a more informal fashion.
The first question is--and here we are a year-plus after
Dodd-Frank, 3 years after the 2008 crisis. One of the things we
saw in 2008--I am not sure we would have predicted that not
only Lehman but then potentially the counterparty exposure with
AIG, because we did not have accurate real-time ability to
figure out counterparty exposure and overall exposure. This is
not directly your area, but with the FSOC in place at this
point--the Financial Stability Oversight Council--we have seen
a lot of published reports about U.S. bank exposure to Greece.
What level of confidence do you have, at the regulator level,
at the FSOC level, that we have enough knowledge to know not
only depository exposure but we have talked a little briefly
about money market exposure, counterparty exposure? Obviously
direct and indirect exposure is only one thing. If we have a
freezing of the credit markets, the percentage of our financial
exposure to Europe or to Greece in particular all goes out the
window. But do we have enough current real-time knowledge in
terms of our financial institutions' exposure both to Greece
and some of the other countries that are at least talked about
being in the path of contagion?
Ms. Brainard. Well, I think as you indicated, some of the
reforms under Dodd-Frank and some of the confirming reforms in
the international system under the FSB will help over time,
although these are in the process of being implemented as we
speak. The FSOC has spent time on the risks from Europe, and it
does provide a forum, as was intended, for sharing of
information among the supervisors and the regulators so that
they have common assessments of risk.
As you said, the direct exposures particularly to the most
vulnerable periphery countries are relatively modest at this
juncture. There is also----
Senator Warner. Direct exposures, not just depository
institutions but----
Ms. Brainard. Direct exposure from depository institutions
to----
Senator Warner. Insurance companies, money market. We do
not have as much knowledge of hedge funds. What about these
other----
Ms. Brainard. So in terms of the information we have on
some of the other entities in the system, there is much greater
information, much more detailed information available now on
money market funds, and that information is publicly available,
and that was a critical development from the crisis. Insurance
is still a work in progress, but I think we are going to see
that moving along at a rapid pace as well. And, of course, the
reforms that are just in the early stages on derivatives will
provide extremely important transparency into what was
previously a very opaque set of markets between central
clearing, between the information being reported on a real-time
basis to trade, depositories, those reforms as they move
forward will make a material difference in terms of our
regulators' and supervisors' visibility into the system.
Senator Warner. Well, again, I just hope we recognize that
we are doing as much as possible we can at this moment in time
in terms of the counterparty exposure of some of our
institutions.
Let me ask one other question, and, Senator Johanns, please
jump in.
We had Chairman Bernanke in around lunch to do a small
briefing around some of these issues as well. One of the things
that I think obviously Europe is wrestling with, we have
focused on Greece, and we are looking at what the Europeans
directly have done in terms of the European Stabilization Fund
and potential ways to lever that up. But my understanding--and
Chairman Bernanke made the point that in the next--if we were
to see contagion while Greece--a central default on a run on
Greece would be challenging, if this were to spread to Italy,
which has got to roll over a trillion euros in debt over the
next year, and Spain, 500 billion euros in debt over the next
year to roll over, when you look at the size of the European
Stabilization Fund, you know, even if you then layer on top of
that the IMF dollars, our reserves, those reserves are not
enough to take on the kind of challenges and the firewall you
mentioned in point number one, the Europeans need to do in
terms of this firewall, but do they have enough capital at this
point under the current framework to provide that firewall?
Ms. Brainard. Well, I think it is very important, as you
say, to emphasize that in order for Europe's financial
stability to return, what they categorically need to do is take
the risk of cascading defaults and bank runs off the table. And
in order to do that, they need a firewall of sufficient force
and size to overwhelm the markets. I think that is something
that we saw in our own financial crisis was critically
important in helping to restore orderly functioning to our
financial markets, and it is something that European leaders
are talking about as they are moving forward on this
comprehensive plan.
They have quite substantial resources in the European
Financial Stability Fund, but they will need to----
Senator Warner. They have about 440 euros?
Ms. Brainard. They have 440 billion euros under the
structure that was just approved by the national parliaments in
the euro area. And that funding is going to be critically
important for doing those things that we talked about earlier,
which is to ensure that large sovereigns with sound policies
such as Spain and Italy can fund at affordable rates so that
they can implement those critical reforms that will allow them
to grow and to bring their debt down. They also need to have
adequate bank capital backstops so as they move forward with
their plans to set strong capital buffers in the banking
system, that where needed they have public capital backstops.
In order to do that, the EFSF will need to be leveraged up.
There are a variety ways of doing that. It is achievable. These
goals are achievable with the capital that they have, but that,
of course, is one of the key issues that will be part of their
comprehensive plan.
Senator Warner. Again, I want to turn to Senator Johanns,
but you did say you think within that European Stabilization
Fund it is adequate when we are looking at a trillion dollar
rollover in Italy and a half trillion dollar rollover just in
Spain alone, not counting some of the other nations?
Ms. Brainard. The funding that is available in the European
Financial Stability Fund can be leveraged up to adequately
address the needs that we were talking about to ensure that
Italy and Spain and other large performing sovereigns have
adequate funding to backstop the banking system and, of course,
to continue to fund the program countries as they perform. But,
again, it is vitally important that they leverage up the EFSF.
Senator Warner. They have not decided how to leverage it up
yet.
Ms. Brainard. And what is on the table right now is
precisely what is the form of that leverage. And that leverage
needs to be credible in the markets, and it needs to give them
that overwhelming force that takes the threat of defaults and
bank runs off the table.
Senator Johanns. There is so much to talk about and ask
about, but let me, if I might, start with some of the thoughts
expressed on Dodd-Frank and I think the dilemma that we are
heading toward. We have put in place with Dodd-Frank an
enormously complex piece of legislation. I did not support it.
Now the rules are coming out, and it is just a massive amount
of injection of new systems, new rules, new requirements for
the financial system.
At a Banking hearing some months ago, a concern was
expressed actually by Senator Johnson, and others actually, and
the whole issue was how is this going to be harmonized
internationally. And Deputy Secretary Wolin said, and I am
quoting, ``We are working closely with our G-20 partners to
make sure that we get a regime that works worldwide so we do
not have new opportunities for arbitrage.'' I think,
translated, what we are all concerned about is you end up with
this U.S. system and then our capital flees because why deal
with this if you can find less resistance in Singapore or a G-
20 country?
Soon after that, I am reading an article, and I probably
will butcher his last name, and Michel Barnier of the European
Union said this: ``We don't support the same approach.'' He
said, ``That is not what we are going to do,'' and really kind
of put down what we had done in the United States.
So what assurance can you give me that the G-20 with all of
these other problems that they have--and they are economy-
threatening problems for that part of the world--that in the
midst of that they are sitting there trying to figure out how
to put the Volcker Rule in place and how to put this rule in
place, et cetera, and following the leadership of the United
States?
Ms. Brainard. Well, Senator, let me just say, first of all,
I could not share more fully your concern and your
determination to make sure that as we move to put in place new
mechanisms to ensure the vibrancy and the resilience of our
system, that we move in lockstep to ensure that other financial
centers around the world, both established financial centers
and those that are coming online, move in sync with us so that
we do not inadvertently undermine the safety and soundness of
our system by providing regulatory arbitrage opportunities or,
equally importantly, create a competitive disadvantage for our
financial institutions.
I believe we have done more on that than has ever been true
in the past, and we are having quite a lot of forward momentum
among the other members of the Financial Stability Board and in
the G-20.
Michel Barnier, the Commissioner who has responsibility for
these issues in the Commission, meets very regularly with
Secretary Geithner, and they both have repeatedly stated their
commitment to ensure that as we move to put in place new
capital liquidity leverage standards, the Europeans do the
same; that as we move to put in place requirements for
standardization and central clearing, trade repositories on
derivatives, they move to do the same.
I think we have had successes in terms of getting general
adoption of the principles across all the G-20 and FSB
membership. I work very hard with my counterparts to make sure
that not only are they adopting these principles but they are
implementing them, and our staffs sit with the staffs of
international financial authorities and go through in fairly
great detail, as do the staffs of the SEC and the CFTC, and we
are trying to be as granular as we possibly can to make sure
that as our implementation proceeds, theirs does as well.
Obviously, we each have different national legal regulatory
environments, and so there are going to necessarily be moments
where, for instance, on Dodd-Frank we move forward with our
legal framework more quickly than the Europeans did, but we
have similar implementation deadlines, and we are all working
extremely hard because they are--similarly, they are as
committed as we are, and I think they see the same risks to
their system, which are more evident today perhaps than ever
before of not moving forward on those key requisites for a
sound financial system.
Senator Johanns. Like I said, we could spent hours on this,
debating this, but here is my impression. My impression in
having worked with the European Union for many, many years,
part as Governor, more intensely as Secretary of Agriculture,
is that this is a very unusual governance system, something we
are not used to. You have got this umbrella organization out
there, and it is not really a central government, but it kind
of tries to act like a central government. You have got all of
these other countries that are member countries of the European
Union. They are forever proclaiming their sovereignty because
it is important that they proclaim their sovereignty to their
citizens in their country. And, you know, when you talk about
principles being adopted, it is not very reassuring to me, to
be honest with you. All that tells me is that we are having a
lot of meetings. I think you are working hard. But I will bet
when we look back 12 months from now and 24 months from now and
36 months from now, we are going to see little activity by the
member countries to embrace anything near what we did with
Dodd-Frank, putting our financial structure at a serious
disadvantage.
Now, I hope you can call me in 12 months and 24 and 36
months and say, ``Boy, Mike, you were really wrong about that,
and I am here to call you and tell you you are.'' But I do not
think I will be wrong about it, unfortunately.
But if I might move on to, I think, what probably is
occupying our attention right now, and that is the financial
crisis that we are all worried about. Here is another
impression, and I would like your reaction to this. We have a
handful of countries that really are struggling. Greece would
lead that. You could probably talk about Portugal, Ireland. I
hope their Ambassadors do not call me and yell at me, but I
think, quite honestly, they are really trying to figure out how
to deal with what is a crisis. There were huge protests in
Greece yesterday, for example. They are really resisting the
efforts.
You have got a second group of countries--Spain, Italy--
that somebody said to me, and it probably describes it well,
too big to fail, too big to bail out, large economies. If
somehow the problems with the other countries cannot be walled
off, they kind of get tangled up in it, and their cost of
borrowing goes up, et cetera.
You have got serious undercapitalization of the banks. You
have got stress tests that nobody has regarded very seriously.
I think they made an attempt, but, quite honestly, our
financial community is not relying on their stress tests. And
then in the midst of all of this, you have got a European
system, and you have got people, citizens like mine--it would
be like--you know, for Germany to embrace the idea of bailing
out Greece, it would be like Nebraska with a balanced budget
amendment and an obligation that we cannot borrow any more than
$100,000 so we have no debt bailing out another State that
spent wildly and borrowed money. Well, you can only come to
understand how the Germans are looking at this and going, ``Are
you kidding me?''
And then you begin to realize how do you move those
dynamics with this system to the kind of resolution that is
necessary, because we are not talking about a few dollars. And
if the market does not have confidence that this is a big
enough firewall--and I think guaranteeing 10 or 20 or 30
percent of the debt is not going to be sufficient--and you
cannot calm the markets down, then I think this thing really
has some serious, serious potential.
Now, boy, I have put a lot out there, but I would love to
have your reaction. Where am I wrong in this? What have I
misread about this?
Ms. Brainard. Well, I think the risks that you point to are
real. I would say, though, on the other side that Europe has
the resources, it has the capacity, and we have heard from
European leaders that they have the will. The things that need
to be put in place I think are fairly clear, and, of course, as
you said, I think there is mixed public support. But if you
look at the vote, for instance, in Germany of the EFSF,
overwhelming majority in favor of supporting the July 21st
reforms, which expanded the EFSF and enabled it to do the
critically important functions of providing precautionary
financing and backstopping the banks.
So you are exactly right that Europe will need to muster
the political will, but everything we have heard is that
European leaders are determined to do so. And they have the
capacity, they have the ability to leverage up the EFSF to a
magnitude that really is commensurate with the size of the
challenges. They have the ability to take the risk of contagion
to Italy and Spain off the table entirely, and we will see over
the next days and weeks how they are going to confront those
challenges.
As you indicate, though, over a slightly longer period of
time--and they are talking very clearly about this--they will
need to move forward on putting in place mechanisms that give
them the fiscal capacity that really matches their monetary
union, and that is the piece that will take a little longer.
But they are going to need to have much more fiscal unity and
much more centralized fiscal governance over time. And I think
that is something that member states are clear-eyed about in
the face of this crisis.
Senator Johanns. If I might, just one more. Does that
require a treaty change, the last step that you have just
described? It does, does it not?
Ms. Brainard. It depends very much, Senator, on how they
decide to move forward on creating a more unified fiscal
structure. Some of the ideas that are being discussed would
require treaty changes. Others might not. They have already put
forward some very important governance reforms in terms of
surveillance and penalties for not meeting fiscal targets, for
instance. So some of these issues have already--we have already
got a sense of where they are moving. On the broader sense of
where their fiscal governance is likely to be in several years'
time, I think they are still working on that, but they are
committed to it from everything we hear.
Senator Johanns. I only raise that because changing their
treaty is akin to amending our Constitution. I mean, this is no
easy task. A complicated problem, I guess, is what this all
comes down to, a very complicated problem.
Senator Warner. I would, first of all, agree with Senator
Johanns about the complexity of this. I would think, though--I
think what we have got a little bit, to carry on your analogy,
is a balanced budget state, as well, with a AAA bond rating----
Senator Johanns. Yes.
Senator Warner. I get what you are saying, but it is kind
of like----
Senator Johanns. Good governance----
Senator Warner.----de facto that if the Nebraskan
government was well run but Nebraskan banks completely financed
California's budget, you have got a little bit of that problem
that I think we are looking at in Germany in that, one way or
the other, Germans are going to have some level of
responsibility, whether directly through their people or
indirectly through their banks' exposure.
I think one of the things--we had a spirited debate about
Dodd-Frank. I think it is imperfect, but the reaction I heard
more from our European colleagues was, thank goodness that at
least America went first, and again, echoing what Senator
Johanns said, because we have advanced capital standards, move
further, and we have had more transparent stress tests, for
example. And the fact that we are intertwined, whether we like
it or not, if we did not try to have these coordinated
standards, slipping to lowest common denominator is not going
to help anyone.
I believe that, and I share Senator Johanns's concern about
how we do this in an organized basis. I want to go off subject
a little bit. I actually think you may see, as we have seen in
the United Kingdom, they may even be taking an even more
structured approach than what we took. And when you hear some
of the leaders in France and Germany in terms of transaction
tax or other things that would go way beyond even Dodd-Frank in
terms of financial constraints, and while we may disagree about
merits or lack of merits around Dodd-Frank, I think we would
both agree that we need to have not this arbitrage and
consistently moving forward.
At the end of the day, I think we and the EU will mesh,
probably the Japanese and others. But as we get to this G-20
framework, how do we make sure that, even if all the West moves
forward in a coordinated fashion, that there is not that kind
of outlier in this enormously interconnected system that does,
in effect, become the equivalent of a tax haven but with a low
standard financial center that does not agree to these
international standards? What are we doing to grapple with
that?
Ms. Brainard. Well, Senator Warner, as you said, I think we
derived tremendous advantage from moving first and pulling the
world to our high standards. And what we have seen in the G-20
and the FSB is that we have succeeded in having all the members
of the G-20 and the FSB sign up for tougher standards on
capital liquidity and leverage at banks, sign up for
resolution, higher prudential standards, greater intensities of
supervision around systemically important financial
institutions, and sign up for a host of very profound changes
that will make our derivatives markets less opaque, more
transparent, less risky.
In terms of getting emerging financial centers to come on
board, that is why we thought it was so important to be working
through the Financial Stability Board and the G-20 where the
major financial centers and the emerging financial centers sit
together, and so we have a variety of standard setting bodies
now, the Basel Committee, the FSB, where we have emerging
markets, emerging financial centers represented and taking on
the same obligations, the same principles, the same
commitments, the same Basel III standard uniform across all
members of the FSB. We are intensely engaged with Singapore on
our derivatives reforms and we have received repeated
assurances from the Singapore monetary authorities and
financial supervisory authorities that they will move in
lockstep as Europe and the United States come together on their
derivatives regimes.
So I think that the concerns that you raise are very real.
We are working very hard on them. We have to stay extremely
engaged at a level of detail on implementation, which we will
continue to do. But I think we have a real chance of having a
system that has far fewer major areas that present regulatory
arbitrage risks and disadvantage our financial institutions.
Senator Warner. We will obviously want to monitor that, and
we need to have--we need to establish what those metrics ought
to be. I know you have got to leave in a couple minutes. I want
to ask one more question and make sure my colleague gets
another crack at you.
I think we just saw today--you may not have even seen the
news--that while there was some anticipation that the EU might
resolve some of these issues this weekend, they are already
talking about now a second summit, meaning they may not get
there. A lot of pressure on the meeting in Cannes. How do we
make sure that this crisis does not just--or what--is there
anything we can do other than continue to urge you to move
forward and the Administration and others to move forward to
make sure this does not just drag itself out? At some point, we
in this country, right or wrong, stanched some of that with
dramatic actions in late 2008.
What is your--I recognize you do not want to make news on
this, but what is your best guesstimate that we will see
definitive action within this next 30-day period with this
summit, Cannes coming, and probably a second summit within the
next 30 days, or is this going to be an overhang that is going
to take months and months to work through?
Ms. Brainard. Let me just say that the European leaders, I
think, are very intensively engaged on this. I think it is a
good sign that they are meeting intensively on this. President
Obama has been on the phone with European leaders and has spent
a lot of time asking them about the comprehensive plan as they
are developing it. He is very, very committed to ensuring that
the U.S. economic recovery is as robust as it can be and as
insulated as it can be from shocks emanating from abroad,
recognizing that Europe has--headwinds from Europe have slowed
our recovery somewhat.
I think that the set of issues on the table are the right
set of issues. European leaders are focused on the firewall,
the bank recapitalization plan, ensuring Greece is sustainable,
and then that longer-term set of governance reforms. And again,
I think that they have that capacity. They have stated
repeatedly that they have the will, they have the resources,
and I think they know from discussions that we have had among
finance ministers and central bank Governors at the G-20 last
weekend that this is an issue that the world cares a great deal
about, that the emerging markets that are part of the G-20 also
see European financial stability as central to their own
economic growth, that this is the most important priority for
the G-20 meeting, and we see every indication that the
Europeans are working very hard to come with their plan and to
have a plan that succeeds on the four dimensions that they are
talking about.
Senator Warner. Well, I understand your answer and I
appreciate your comments and I appreciate your appearing before
me. I hope, recognizing that we are inexorably tied, that there
will not be continuing ratcheting back of expectations, which
seems to be the news of today if the European Union has already
decided a second summit and is opposed to putting out those at
least first two steps of the plan in terms of the firewall and
the bank capitalization in a definitive way this week. We do
hope that the G-20 will continue to show that these kind of
large international organizations can be successful, but
dragging this out is not clearly in Europe's interest nor
clearly in the United States' interest.
Senator Johanns did not have any other questions. Again, we
appreciate your time, Secretary Brainard, and now we will move
on to the second panel.
Ms. Brainard. I appreciate the opportunity.
Senator Warner. Thank you.
If we could go ahead and move to the second panel, and as
they get settled, I may go ahead and start to make some
introductions, recognizing that we will probably have another
round of votes at some point.
Senator Johanns. Yes.
Senator Warner. In our second panel, we are going to
continue this question of G-20, the European crisis, and
currency issues, in terms of making the point that all our
economies are enormously intertwined. So we have three very,
very distinguished panelists.
Dr. Uri Dadush serves as the Senior Associate and Director
for the International Economics Program at the Carnegie
Endowment for International Peace. His work focuses on trends
in the global economy and the implications of the increased
weight of developing countries for the pattern of financial
flows, trade, and migration, and associated economic policy and
governance questions. A French citizen, Dr. Dadush has
previously served as the World Bank's Director of International
Trade and before that as Director of Economic Policy. He
directed the Bank's World Economy Group, leading the
preparation of the Bank's reports on the international economy
over 11 years. Before that, he was President and CEO of the
Economic Group's Economist Intelligence Unit and Business
International. Thank you, sir, for joining us.
Dr. John Makin is a Resident Scholar at the American
Enterprise Institute. Dr. Makin is a former consultant to the
U.S. Treasury Department, the Congressional Budget Office, and
the IMF. He specializes in international finance and financial
markets, including stocks, bonds, and currencies. Dr. Makin
also researches the U.S. economy, including monetary policy and
tax and budget issues, as well as the Japanese economy and the
European economy, so we will be anxious to hear your comments
on some of the EU actions. He is a principal at Caxton
Associates and is the author of numerous books and articles on
the financial, monetary, and fiscal policy. Dr. Makin writes
AEI's Monthly Economic Outlook.
And, our good friend, Dr. Fred Bergsten, has been Director
and a widely quoted think-tank economist at the Peterson
Institute for International Economics since 1981. He has been
ranked as somebody who can move the markets by Fidelity
Investment's Worth. Dr. Bergsten was the Assistant Secretary
for International Affairs at the U.S. Treasury under the Carter
administration. He also functioned as Under Secretary for
Monetary Affairs, representing the United States on the G5
Deputies and in preparing a G7 summit string in 1980 to 1981.
During 1969 to 1971, Dr. Bergsten coordinated U.S. foreign
economic policy in the White House as an Assistant for
International Economic Affairs to Dr. Kissinger at the National
Security Council. Dr. Bergsten is also a well-published scholar
and has served in several distinguished institutions on foreign
policy, economics, and competitiveness matters throughout his
career.
I want to thank all of you for being here today. Again, the
timeliness of this hearing could not be more important. And
with that, we will get to Dr. Dadush and we will start with
your testimony. Thank you.
STATEMENT OF URI DADUSH, Ph.D., DIRECTOR, INTERNATIONAL
ECONOMICS PROGRAM, CARNEGIE ENDOWMENT FOR INTERNATIONAL PEACE
Mr. Dadush. Thank you very much, Mr. Chairman, Mr. Ranking
Member, for inviting me here today.
On the Euro crisis, I think it is apparent from the
discussion that just preceded that everyone understands that
sets of sovereign defaults in Europe, possibly leading to a
collapse of the Eurozone, would have major repercussions in the
United States and could lead to a Lehman-like event, but in my
view, one of longer duration.
What I think, however, is not sufficiently understood is
that the Eurozone may not be able to handle this crisis on its
own, and this is because of two dimensions. One is the politics
and the other is, even more importantly, the economics.
The politics because Europe remains a half-built structure.
The Commission is not the Federal Government and the European
Central Bank is not the Federal Reserve Bank. So, therefore,
the example of Nebraska bailing out another State, I think, is
extremely appropriate in terms of understanding the dynamics of
the current situation, but I would take it one step further,
which is I do not think there is any question about Nebraska
and other States considering themselves part of one country,
America. We are far from that situation in Europe.
The second aspect is the economics. Whereas the Eurozone,
as distinct from the European Union, is quite a bit smaller
economy than the United States, the subprime crisis was between
one and one-and-a-half trillion dollars, depending what you
define as subprime. But the sovereign debt of the periphery
countries is $4.5 trillion. Furthermore, banks are much more
important in the European Union economies or the Eurozone
economies than in the United States. They are just a much
bigger part of the financing. And as you have already
recognized, policy is largely out of bullets.
It is also important to realize that the European Financial
Stability Fund is--there is an element of smoke and mirrors in
it, because the guarantees come in part from countries that are
themselves in trouble, and even the countries that were thought
not to be in trouble, like France, now are confronting a
billowing cost which has doubled the spread of France vis-a-vis
Germany in the course of the last several months. It is in
excess of 100 basis points. That is an indication that the
market is now calling into question the capacity. And actually,
referring to the guarantees themselves in the most recent
Moody's decision to put France on credit watch, referring to
the guarantees at the current levels, not at the levels that
are contemplated for the next stage, as being one of the
reasons that they are considering the downgrade of France.
So that is why in my written testimony I have proposed that
there is an emergency, and as a precautionary measure, the
IMF's resources should be expanded by a trillion dollars. I am
audacious enough to say, with the United States making a
contribution to that expense, audacious because I know that the
previous expansion has not yet been agreed, but, you know, this
is the situation that I see. I see it as an insurance against a
very bad event. And I do not think--while I think the emerging
markets want to contribute, I do not think the emerging markets
will put all of that amount by themselves, and even if they
wanted to, the United States would not necessarily want to see
its interest diluted in the IMF to that extent.
Thank you.
Senator Warner. Just one point. The current IMF balance
sheet is about $300 billion, is it not?
Mr. Dadush. I think the available forward capacity of the
IMF, new commitments, according to Managing Director Lagarde,
is $400 billion. I think the total balance sheet is somewhere
in the region of $850 billion. So $400 billion is the forward
capacity.
Senator Warner. Thank you, sir.
Dr. Makin.
STATEMENT OF JOHN MAKIN, Ph.D., RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE
Mr. Makin. Thank you, Chairman Warner and Ranking Member
Johanns, for the opportunity to testify. I am going to focus my
comments, as well, on the European situation. It is, I think,
appropriate to remember that the G-20 was first established in
1999 after the Asian debt crisis, which was tied to excessive
rigidity of exchange rates in the region and attempts to avoid
those adjustments. My contention today is that the European
crisis will not be contained until some of the problems that
are inherent in an unstable and nonviable currency regime are
addressed.
And I think if I go a little bit in detail as to how we got
here, how did we get to a situation where last April we were
all thinking we were out of the woods, people were starting to
invest again, the U.S. economy was looking good, to a situation
where we are looking at a weekend where, once again, Europe is
delaying needed adjustments, with good reason, because they
face some very formidable problems.
Europe's current problems, I would term internal systemic
driven. That is, they have a flawed currency system. How did
they get here? When the European monetary system was set up,
the assertion was made that you became a member, Greek debt was
the same as German debt. So if you were a bank and German debt
was commanding an interest rate of 20 or 30 basis points
above--Greek debt was above German debt, you lent to the Greek
Government. You then could use that claim on the Greek
Government to borrow from the European Central Bank and the
process began. In effect, the European monetary system
initiated a massive increase in the credit ratings of the
weaker Southern European economies whose unit labor costs
suggest that they were in no position to continue to compete
with Germany.
And so, over time, the European debt crisis was built on a
premise, that is, that sovereign governments do not default.
The U.S. debt crisis, or the systemic financial crisis, was
built on the premise, the fallacious premise, that house prices
never go down. Those problems come back to haunt you.
Why is it so difficult to address this crisis? First of
all, there are really four ways to address it. One, the one
that is being contemplated now, is to engineer massive
transfers from Northern Europe to Southern Europe, and as
others who have testified have suggested, really, we are down
to Germany, because even the French have their problems. The
EFSF with its 440 billion euros is a bit of smoke and mirrors,
as Uri has suggested. Just the journal today, I think when we
were discussing that earlier, when you take away the funds that
are already committed, you are down to 275 billion. And then
when you look at the commitments from Italy and Spain, which
are prospectively going to be recipients, you really do not
have any fund. So the idea that you can leverage that up by
saying that you will somehow guarantee the first 10 or 20
percent of the liabilities of the countries involved, I think,
is perhaps wishful thinking.
The second way to deal with the problem, aside from massive
transfers--the resources are not there to make the massive
transfers, so what else could you do? Well, last year, the idea
was to say to the Greeks, we will give you money if you will
blow your brains out, that is, if you will make massive cuts in
spending, massive increases in taxes, and render the economy or
push the economy into a tailspin. That means that the debt-to-
GDP ratio will be higher this year than it was last year. That
is where we are with Greece. That is conceivably where we could
be headed with some of the other countries.
A third alternative which, again, is being rejected, is to
force wages and prices in the Southern European countries to go
down so rapidly that they are able to compete with Germany.
That is not going to happen. Greece, Italy, Spain are not going
to turn into Germany, and so that is just not a realistic
alternative.
The fourth alternative is to allow currency adjustments
within the Currency Union that would address some of the
stresses that are there. I think that is probably where we are
going to end up, although we are certainly going to exhaust a
lot of pain and suffering before we get there. I do not see a
way to make Greece a viable member of the European Currency
Union. Neither do its citizens. The parallels with the
Argentine debt crisis are there. You go through a long period
of promise we will do this, we will do that. You have internal
strife, and the government is left in a very difficult position
where they are really not prepared to undertake the adjustments
that are required of them.
So I think it is probably not wise--I would respectfully
disagree with my fellow panelist--to put more resources into
shoring up what probably is not a viable system, and why would
it be a viable system? To say--to impose a single central bank
on an area as diverse as Europe, which has 17 treasuries--the
Nebraska allegory breaks down--is just not a workable system,
and the sooner we recognize that, the better.
Thank you.
Senator Warner. Well, two out of three. So far, this panel
is not going to lack for some questions.
Dr. Bergsten.
STATEMENT OF C. FRED BERGSTEN, Ph.D., DIRECTOR, PETERSON
INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Bergsten. Mr. Chairman, Secretary Johanns, I will make
a few points that will complement what the earlier panel and my
colleagues here discussed.
The most important role for the G-20 summit in Cannes is to
inject renewed impetus for world economic growth. We are not
going to solve the European crisis, whatever financial
engineering is done, unless the Europeans can get more growth
going. Yet the strong countries in Europe, led by Germany, but
also Holland, Austria, and the Scandinavians, are
consolidating. They are tightening budgets, under no pressure
from the bond market vigilantes. They should stop their
tightening of policy and instead start expanding.
Moreover, the European Central Bank should cut interest
rates substantially. It is the only major central bank that is
considerably away from the ``zero bound.'' Unless Europe gets
growth, none of the financing is going to work. Unless the
United States--the Congress and the Administration--can get
together and provide some new stimulus to the U.S. economy, the
world will continue to wallow, as well.
The good news is that half the world economy is still
booming. The emerging-market economies, which now make up half
the world economy, are expanding by an average of more than 6
percent. Moreover, they have policy space to do even better.
They have low budget deficits and debt ratios. They still have
fairly high interest rates. We should now ask the emerging
markets, which are the leaders of global growth, to do more.
They can certainly expand further. They have been worried about
inflation, but now with the rich countries slowing down and
commodity prices having leveled off, that is no longer of deep
concern. They have been the beneficiaries of global growth
strategies led by us and Europe for 30, 40 years. It is time
for them now to take the lead that their economic capacity and
achievements permit.
So this Cannes summit needs to replicate, at least to a
degree, what the London G-20 summit did in April 2009, namely
take parallel and to some extent coordinated actions, to get
the world out of the last economic crisis. We have to do it
again. Only this time, the effort should be led by the emerging
markets but with Europe and the United States chiming in as
well.
It is critical how that emerging-market growth impetus
takes place. It has to be done by expanding domestic demand,
letting their big trade surpluses decline to impart growth to
the world, not take it away from the rest of the world, which
higher trade surpluses would do, and that means letting their
currencies go up much more and much more rapidly.
On the European crisis, I will make four quick points in
addition to faster growth. They need to leverage the European
Financial Stability Facility to create a total resume of two
trillion to four trillion euros. I disagree with John Makin. I
do not think the eurozone is a failed experiment. It is a
halfway house and the other half, the fiscal union, has to be
completed. The way to do it is to complete the fiscal union,
not to abolish the monetary union.
With great respect, I am going to disagree with an
analytical point made by Secretary Johanns. Nebraska and other
surplus U.S. States do, to a degree, bail out deficit U.S.
States, not by direct loans, but through the Federal budget,
because when they transfer their surpluses to Washington and it
transfers that to deficit Mississippi, there is some degree of
bailout. Likewise, when States import citizens from those that
have had high and rising unemployment, the importing States
help bail out those losing States. The Europeans do not have
these two types of mobility. That is why they need fiscal union
to complement their monetary union.
I agree with a key point Uri Dadush made, particularly if
the Europeans do not get their act together quickly, Plan B
would have to center on the International Monetary Fund,
because if the Europeans cannot put together an adequate safety
net, only the IMF can provide it. His trillion dollars may
actually need to be a little bigger. That money would have to
be borrowed from the big surplus emerging markets--China,
Korea, Brazil, India, and others including the oil exporters.
They should provide the money. They need to pay back.
Finally, what should the United States contribute to all
this? I have suggested our Government needs to get its act
together to get growth on track. We obviously need to move to
tangible, credible means of bringing our budget deficit down
over time without interrupting growth in the short run. And I
think we ought to take on a new commitment to eliminate our
trade deficit, because that is a way to create three to four
million U.S. jobs over a 5-year period or so. We have been
running huge trade deficits for 30 years and facilitating the
export-led growth of these emerging markets. They have piled up
huge reserves as a result, partly by manipulating their
exchange rates. I think we are perfectly justified, and it is
not protectionist or beggar-thy-neighbor to eliminate our big
external deficit. We are the world's largest debtor country.
They all tell us not to keep building it up. The G-20 has
agreed at every summit on rebalancing of the world economy.
That means eliminating the U.S. trade deficit, which would
create three to four million U.S. jobs. If we are serious about
getting back to full employment, we have to add that. I would
throw that into the hopper at Cannes as a U.S. commitment to
implement agreed G-20 strategy, but then we have to do
something serious about it like reining in the budget deficit
and getting growth going through domestic demand here.
Senator Warner. You did not disappoint.
Let us--there are so many different places to go with this.
I would like to ask Dr. Makin and Dr. Dadush to respond to at
least one part of the provocative part that Dr. Bergsten just
said, was what do you think--is there any realistic chance that
through the G-20 mechanism we could really see a challenge or a
coordinated action where the emerging nations would take on
these kind of growth policies, since it seems to me that there
has been a, for the most part, an enormous lack of coordination
amongst the more industrialized nations on issues like
currency, and then when we try to perhaps ham-handedly deal
with China on a one-off, always maybe not the most effective
tool, I will grant, but let us just start with Dr. Bergsten's
first prescription. What do you think any chance of that could
happen, either one of you?
Mr. Makin. Let me just take a--I will just focus on Europe.
If I am China or India, why would I want to finance this
European experiment that has been struggling since 2009? Why
would I want to invest in a system that is just not going to
work?
Fred says let us have fiscal union. We are not going to get
fiscal union in Europe, and we have a monetary union that is
not viable. Are the Chinese going to invest 500 billion euros
in trying to turn Greece into Germany? It is just not going to
happen.
So while the Chinese certainly, in view of their aggressive
geopolitical ambitions, will want to appear to be stepping in
here where the United States is unable to do so, I would be
surprised if they were willing to commit many resources.
If you look, first of all----
Senator Warner. Could I just ask one thing here?
Mr. Makin. Yes.
Senator Warner. I can----
Mr. Makin. I mean, it would be nice, but----
Senator Warner. I understand the point that they are--the
direct assistance--and I want to come back to your questions
about Europe. But the kind of more macro agreement that there
could be coordinated growth policies across emerging nations
letting their currencies appreciate, I mean, is that even
realistic? I guess it could happen, but is it really----
Mr. Makin. Well, what have we been doing since 2008?
Senator Warner. No, but from the emerging--obviously----
Mr. Makin. But, remember, in 2008, after the Lehman crisis
when the Fed cut rates aggressively and we engineered a large
fiscal stimulus in the United States, China engineered the
largest stimulus in the world. They engineered a stimulus that
was worth 15 percent of GDP over 2 years. They got their
economy going. They have, of course, the fortunate situation
that they have lots of resources and lots of things that need
building. So they made a huge contribution to global growth in
2009 and 2010, although it had its downside in the sense that
they were--you know, China is such a new force, their
contribution was so great that they were pushing up commodity
prices and energy prices and so on.
I am not quite as sanguine as Fred is about where China is
headed now, but I think that if I were the Chinese I would say,
look, we did a lot. We did a lot, it was in our own interest,
we wanted to stimulate our economy, and the spillover effect
was very positive.
So I would think what is realistic now at Cannes, or
elsewhere, is to see if the Chinese are prepared to back off a
little bit on tamping down the growth rate because they are
seeing higher domestic inflation, which some estimates are put
as high as 10 percent.
So they are involved in a kind of conflict situation. This
is a very tough situation. So I would not, let me put it this
way----
Senator Warner. Is your prescription in terms of China or
your expectation in terms of China for other emerging nations
as well? You know, whether you take India or whether you take
South Korea----
Mr. Makin. I think China is so big, the South Koreans are
certainly--you know, they are in very good fiscal shape. They
are not in a position to do what the Chinese could do. My
bottom line is this: I would not bet on a lot of help--if I
were a realist, I would not bet on a lot of help from emerging
markets for the European experiment nor for the American
conundrum as well.
Senator Warner. Dr. Dadush?
Mr. Dadush. Yes. First of all, I agree with John Makin that
the emerging markets played an absolutely instrumental role in
2009 in particular in supporting global economic activity at a
very difficult moment, and with China playing a
disproportionate role. But I think we need to recognize that
that was a very particular situation, and as the emerging
markets kind of accelerated extremely rapidly beginning in the
second and third quarter of 2009, they within about a year, a
year and a half, were running into what is called a ``supply
constraint.'' Basically inflation was building up. There is
also a real concern in asset price bubbles--there was--in a
number of them. So they were reaching their natural limit.
Now, again, Fred Bergsten makes a good point. In a scenario
where global economic activity deteriorates in a rather
significant way, I think emerging markets can provide a
cushion, if you see what I mean, because they do have room and
it will take a while. It is not evident right now, but it might
take 6 months, 9 months for the inflationary pressures that
have built up over the last couple of years to abate in the
emerging markets, and then they can accelerate their growth
again because they have that capacity.
But I think it is safe to say that their contribution in
this kind of scenario will be relatively modest. And as I put
in my written testimony, I think we should always remember that
American GDP is, to take one example--I could take other
examples from advanced countries--is composed of domestic
demand and net exports. The problem is domestic demand is about
34 times bigger than net exports. So, you know, even in the
best of circumstances, just simple arithmetic tells you that
the real key to American growth--particularly American growth
because it is a large relatively closed economy. The key to
American growth is the internal dynamics in the United States,
and the trade balance will help a little bit at the margin.
And, by the way, I also would stress the fact that there is
virtually no conceivable increase in demand from China that
would have a significant impact on American economic activity,
very simply just as a result of the fact that China is one-
third the size of the United States and the United States is a
relatively closed economy. So it is about domestic activity,
and it is about domestic reforms. It is about domestic
structural reforms. It is about domestic fiscal reforms. That
is the essence of what will drive American growth in the long
term.
Finally, if I may, I also want to disagree with John Makin
about not helping Europe, and not because I am a French
citizen, but because should Europe not be able to get its act
together--and I fear that it might not, or it could not to a
sufficient degree--and that led to a collapse of the eurozone
of this ``half-built failed experiment,'' as John would
describe it, if that were to lead to a collapse of the
eurozone, then I assure you we would have a crisis of
absolutely global proportions that, again, as I said at the
very beginning, would be of much longer duration than the
Lehman episode.
Senator Warner. Senator Johanns.
Mr. Bergsten. Could I go back on that at some point?
Senator Johanns. No, go ahead.
Mr. Bergsten. On this argument about fiscal union in
Europe, the Europeans are not going to give up. They are not
going to let the euro collapse. That has been their fundamental
goal for over 50 years. The history of European integration is
that when they face crises--and they have faced many before--
out of that and all the uncertainty and the cacophony of the
different voices comes progress toward greater union. We better
understand that and support their move toward fiscal union
because that is the positive outcome for us as well as them
over time.
On the debate about emerging-market growth, I absolutely
agree with my colleagues. China played a decisive role in the
world recovery from the big crisis in 2008-09. I said that in
my testimony. I applaud what they did. I draw the opposite
inference. They did it last time; they can do it again this
time. And the supply side constraints that John talked about
have declined sharply as world growth prospects have declined
and as commodity prices have leveled off. They have huge
further infrastructure needs and demands. They have those
programs out there and have plenty of financing for them. The
issue is when. From their standpoint, as well as the world's
standpoint, now is the time to do it.
Some of the other emerging markets have already reversed
policy. Indonesia just last week--or earlier this week--began
to cut interest rates. Brazil has begun to cut interest rates.
Other emerging markets are also already moving in the direction
I suggest, and I believe China, which is by far the biggest but
others as well, can do it. I think the G-20 can push that
process.
I will reiterate what I said at the outset. These emerging
markets taken together are half the world economy. They are
growing 3 times as fast as the rich countries, which means
their share is rising a couple of percentage points every year.
A decade from now, they will be two-thirds of the world
economy. They can be drivers if we can get them to do even a
fraction of what China did last time around.
Finally, I want to take up Uri's point that the external
side is not very important for the United States because we are
a closed economy. Well, we are looking at 2 percent growth,
maybe. It is perfectly feasible for us to strengthen our
external position by one-half to 1 percentage point of GDP per
year for the next 4 or 5 years. That would take our growth up
significantly and create a big number of jobs.
We are a relatively closed economy in the sense that Uri
mentioned, but at the margin our economy can greatly benefit
from growth in our external sector. It is absolutely right that
exports to China alone are not going to do that. But if we can
get the kind of pickup in world growth that I talked about at
the outset, with all the emerging markets plus at least a
little more in Europe, there is no reason why we cannot expand
our international contribution to GDP growth in a major way. We
are missing a major bet in not emphasizing that as part of our
current job strategy.
Senator Johanns. As I look at these issues, the debt of the
European Union, its countries, and the United States and slow
economic growth, just a whole host of things going on, I wonder
what the potential is that inflation kind of rears its head
again. How does that fit into the equation here, or does it
fit? And maybe that is not a question when actually we probably
worried more about deflation in the last few years. We have
historically low interest rates, et cetera, et cetera. But it
just occurs to me that the pressures out there are enormous to
roll over debt. You have got a situation where countries will
be struggling to finance that debt. What is the potential that
inflation becomes a more serious problem as we look 2 years and
5 years down the road? And I would like everybody's thought on
that. I am going to work my way across the panel, so everybody
is going to get a shot at that.
Mr. Dadush. Well, right now inflationary pressures are
quite muted. You are seeing some pickup in headline inflation
in Europe, for example, but a lot of that is a reflection of
some--you know, the delayed reflection of commodity prices to a
large degree.
There is so much unused capacity and so much risk
aversion--in other words, tendency by people to mask cash and
banks to mask cash if they possibly can--that even with the
expansion of the central bank's balance sheets that we have
seen, the actual expansion of credit remains relatively
constrained. And that is a general phenomenon in the advanced
countries. It is rather different in the developing countries.
In the developing countries, you are seeing, have seen a very
significant acceleration of inflation.
I think if you look some years forward, a lot depends on
what you assume is the capacity of central banks as the economy
recovers to withdraw the massive amount of liquidity that they
have injected into the system over the last few years. And
central bankers will tell you, ``We know how to do that.'' The
problem I have and the risk that I see is I know they know how
to do that, that they have the instruments to withdraw the
liquidity with selling bonds and changing reserve requirements,
et cetera, et cetera. But the big question is: Will they be
able to do it elegantly? Will they be able to do it in a way
that you avoid a very rapid rise in interest rates, as has
happened many times in the past, against a background of a lot
of overextended investment and lending that is maybe triggered
over a period of years by the abundance of liquidity?
Senator Johanns. Dr. Makin?
Mr. Makin. I am not concerned about inflation right at this
point. I would add, however, that if a trillion, 2 trillion
dollars of additional resources were made available to try to
shore up a fixed exchange rate regime in Europe, the
possibility of inflationary risks would rise.
In the Great Depression in the United States, and usually
after financial crises, there is a greater risk of deflation
than inflation. And, second, as we learned in the Great
Depression, the requisite way out initiated in 1933 by the U.S.
devaluation of the dollar versus gold, which implied a
devaluation of the dollar, a sharp exchange rate adjustment, is
exchange rate adjustment. And our friends in Europe would like
to maintain a single currency. I understand that. And I
understand the firmness of their commitment to that. But I
think the risks of following that path do include some
inflationary potential.
Senator Johanns. Dr. Bergsten?
Mr. Bergsten. I agree with my colleagues, but, again, you
have to make two key distinctions. You made one, which is
timing. Over a 2-year horizon, I certainly would not worry
about inflation. Over a 5-year horizon, I would on the grounds
John just mentioned, and particularly if we do not get our act
together here in terms of fiscal policy in a credible way.
The other distinction is, of course, between groups of
countries that Uri made. I do not see any inflation risk
certainly over the near term in the United States or Europe or
Japan, given slow growth and high unused capacity levels. The
developing countries and emerging markets have had that risk.
They are now recognizing the need to pivot their own policies--
I mentioned Brazil and Indonesia already--because of the
slowdown in world growth. Nevertheless, they are closer to
capacity margins. Supply constraints there are potentially
greater, so I would not expect them to do nearly as much as
China did in 2008-09, but I still think they can change the
sign of their policy from contraction to expansion. And if they
do it and the Germans do it and we do it, that could have a
huge effect on resolving all the problems we are talking about.
Senator Johanns. I would just ask one more question, and it
is maybe one of the most complicated things to try to figure
out. But it is no secret, if you look at the published polling
numbers in Germany and France, leadership there is really
struggling. People are looking at what is being asked and
required and kind of recoiling. And yet----
Senator Warner. Is it lower than the United States
Congress?
Senator Johanns. Well, I am not sure I can add any thoughts
on that, but it is a difficult situation, and the political
issues here are significant.
What happens if you get a year and a half out there and all
of a sudden in response to actions that have been taken you
have governmental change, campaigns that have been run on an
anti-this or anti-that approach, and all of a sudden you have
got a whole different set of circumstances from a leadership
situation? Try to factor that in for me and give your best
thoughts on that.
Mr. Bergsten. Certainly, that is a theoretical risk, and I
have worried for a long time about populist politics in Europe
that would go in that direction. But I must say there is
virtually no evidence to support it. The Germans bitch and
moan--pardon my German--but they vote strongly on every
occasion in favor of the pro-European policies, the pro-
European parties, including those that have mounted the
bailouts. The fundamental fact is Germany is a huge beneficiary
from the euro and the European Union. We know the underlying
politics going back to the wars and the millennium of
conflagration in Europe, and the Germans do not forget that.
But in pure economic terms, for the reasons Makin described,
the euro is nirvana for the Germans. They are the world's
largest surplus country, but their currency stays weak. That is
the dream of Helmut Schmidt and the other German leaders I used
to work with when I was in government. Every time they would
run a big surplus, their currency would go up. They would
complain about the weak dollar, but they were complaining about
the strong Deutsche Mark. Now they have overcome that.
Germany is such a massive beneficiary from the economics of
the eurozone that the business community knows it, the labor
unions know it. The one party that has opposed the European
bailouts, the Free Democrats, got thrown out of the government
in the last election in Berlin. Parties that are in favor of
continuing the policy are getting 80, 90 percent of the popular
votes in the Bundestag. The opposition in Germany is even more
strongly in favor of it than Chancellor Merkel's party.
So it is a risk that we need to keep our eyes on. It could
happen. But I would say watch what the Germans do, not what
they say.
Senator Johanns. Dr. Makin.
Mr. Makin. I always know when I am getting to Fred, I am
demoted from ``Dr. Makin'' to ``John Makin'' or ``Makin.''
Mr. Bergsten. Just showing you what good friends we are.
[Laughter.]
Mr. Makin. You know, I think that, again, looking at
Germany, Germany has been a great beneficiary of the monetary
union. But now that the financial complications of the currency
area have begun to jeopardize the stability of the financial
system and you have a failure of a major financial institution
2 weeks ago in Belgium, German economic activity is slowing
rapidly, partly, I would argue, because things are slowing in
China, but also partly because European citizens pick up the
paper every day, and they look at the headlines in Greece, and
they look at what is going on, and they know that something is
not working.
So I understand--and I think if we listen to German
leadership carefully over the past several weeks, I am sure
that they are contemplating their options. A German Finance
Minister said a Greek default may be necessary. That is
tantamount to suggesting that Greece leave the currency union.
The German public was never asked--it was never permitted
to vote on Germany joining the currency union. The German
elites are powerful, and they manage the system very well--up
to a point. And I think we may be approaching that point. We
may see some of the pressure, some of the political pressure,
which is obviously in Greece which is on the receiving end of
the adjustment. But the political pressure is rising in Germany
and could continue to rise. And since they are being asked to
pay the bills, that would be a destabilizing factor that could
be preempted, again, by being more realistic about what is a
viable currency regime for Europe.
Mr. Dadush. Yes, I tend to agree with Fred that the
European project goes very deep in Germany, very, very deep,
and that of all the parties, the least likely to desert the
euro is Germany, not just because they are the beneficiaries,
and right now, I mean, I could make a very Machiavellian
argument that Germany is actually benefiting in some way from
the crisis because of its low interest rates and because of the
low euro. But more fundamentally, if Germany, which is actually
benefiting and not under direct pressure at the moment, were
itself to say, ``No, I am fed up, I am leaving,'' that really
would be the end of the European project. That would be--OK. It
is very different if Greece says, ``I cannot take the pain
anymore.''
And, finally, I do not want to--I am not ready to predict
how things will develop in the European periphery. Let me just
point to the fact that domestic demand, consumption plus
investment plus government spending, in Ireland is down 20
percent compared to 2007. I mean, the magnitude of that number
should strike one. All right? An indication if Greece were
already down about 15 percent on 2007.
What we are witnessing in the periphery countries is the
equivalent of a Great Depression. It is just not called a
``Great Depression'' because it happens to occur in some small
countries that are sort of a little bit outside the news. But
for all intents and purposes, it is a Great Depression. And in
Spain, unemployment is now up at 24 or 25 percent.
So I think it is remarkable, the degree to which this
structure has held together under enormous economic pressures.
But if we go--if as I believe, because I believe it is a
structural crisis more than a fiscal crisis, it is a
competitiveness crisis, it is a growth crisis that is affecting
the European periphery, if we are now talking another 5 years
of adjustment, it is very difficult to say whether the polity
can actually stay together in these countries. And that is one
of the arguments why the combination of the commitment to the
European project and the incredible stress under which the
system is being put is one of the arguments, I think, to say
that Europe should be helped in a situation like that.
Mr. Bergsten. Just if I may, two quick sentences back to
Dr. Makin. He says the Germans pay the bills. Right, but that
is a gross payment. Net they are still huge winners from the
eurozone, and you could view those payments as kind of an
insurance premium to keep their very big winnings rolling at
the tables.
He also suggested that Greek default would equate to exit
from the euro, and I disagree. Greece may default. They have to
default. It certainly will have to restructure substantially
its external debt. But I think both the economics and the
politics suggest they will do it inside the euro not outside,
and they will come out better for doing it that way.
Senator Warner. I have got one last question, but do you
want to--because I just----
Mr. Makin. Yes.
Senator Warner. Could you respond to that? Because one of
the things in your initial points, you paint, I think, an
appropriate challenge. And I clearly think the idea of a
currency union without fiscal union has presented a half-built
house. I 100 percent agree with you. But I think the
implications of yours is that if you are going to break up the
currency union, you are going to have some really short-term
huge disruption, right?
Mr. Makin. Yes, so are we going to have----
Senator Warner. If you could just give a quick response to
that last question.
Mr. Makin. Look, we are not in a good situation here,
right? And so getting out of it is going to be difficult. It
just seems to me that addressing a reality, which is that
Greece cannot co-exist in a currency union with Germany without
massive transfers in their direction and without infecting the
rest of the system, is probably going to be a positive thing. I
do not see how it is worse than going from weekend to weekend
where we keep saying, oh, well, you know, we were going to
settle it this weekend, but we are going to do it next weekend.
Remember, the 440 billion euros was agreed to in July and
was finally largely agreed to over the past several weeks, and
it is not enough. So how much is enough?
Again, getting a resolution to this problem containing the
fallout, it is not going to shock many people in the financial
markets if Greece either defaults or leaves the union.
Senator Warner. Well, listen, I know everybody has been
very generous with their time, and I just want to say I
really--this has been a fascinating panel, and provocative. I
hear at least one major consensus point, that whether this
leads to currency breakup or continuing the European alignment,
the current resources available to ring-fence or stanch, I
think everybody--I am hearing everybody would at least concur
on that. There may be different paths. But----
Mr. Makin. Well, if we are going to insist on shoring up
the currency system.
Senator Warner. Right, agreed. Agreed. Agreed.
If we each could, please, no more than two or three
sentences, if possible, but give me your best projection in
terms of what, if anything, will happen out of the EU
activities this coming weekend and what should we realistically
expect coming out of Cannes in a few weeks, either way, any way
you all want to do it.
Mr. Bergsten. I will just venture to say what comes out of
the EU this weekend is further steps toward the ultimate
objectives that we are all talking about here. They cannot do
it all in one leap. There are too many players, and too many
different actors. But they will take some steps forward on a
path that will eventually lead to the outcomes that I was
talking about, namely, a highly leveraged EFSF that will
provide a ring fence around even Spain and Italy and further
institutional reforms that eventually will lead to fiscal
union.
But in the meanwhile, there will be so much cacophony and
so much uncertainty generated by market pressures that the
crisis atmosphere will continue. But I think they will move
forward.
At the G-20 there will be more pressure on the Europeans to
complete that progress. They may take some steps along the
growth path, probably not as much as I would like to see, but I
think there may be some steps. The Finance Ministers last
weekend actually did reach a fair degree of consensus on the
direction that is needed, including a stronger Europe,
certainly in the United States, and encouraging the emerging
markets.
The IMF portion I think is not as clear, and that will
depend a lot on how much uncertainty the Europeans leave. If
they leave a lot, I would not be surprised to see some movement
toward what I call Plan B and at least putting in train an IMF
resource expansion effort that would enable it to plug the
gaps--which, incidentally, I think ought to be pursued anyway
because in the uncertain world we are facing for several years,
who knows when and where the IMF will be needed. And I would
shore it up, in any event, though a European act on its own
would clearly galvanize that.
Mr. Makin. This weekend I think we have already heard what
we will hear, we are going to have another meeting next weekend
or in the middle of next week, because, again, the problem--the
alternatives are so unattractive, it is very difficult to step
up to the plate. What the French will do is put out a number
that is over $1 trillion that somehow is going to be a shock-
and-awe number, but really nothing much will get done. If
eventually they do come up with more money and they try to
shore up the system, 6 months from now we will be back with
more problems and looking for more resources. That is why I
think it is a bad idea to go down this road.
Senator Warner. G-20?
Mr. Makin. G-20? Well, I was going to say you could just
read the last G-20 statement that came out in April, but at
that time they said the global recovery was broadening, so they
will have to say the global recovery is narrowing and we have
got problems and we hope everybody gets everything straightened
out. What else can they do?
Mr. Dadush. Yes, my projection is, first of all, that the
crisis will continue to fester for at least another year or
two.
The second is with regard to the next 2 months over to the
G-20, I think you will see a bank recapitalization decision
in--a significant bank recapitalization decision. You will see
a structure for the forgiveness of Greek debts that will be
fleshed out.
I think you will see a larger and better articulated EFSF,
and I believe that with all that you will also see some
significantly greater engagement on the part of the
International Monetary Fund. I believe you will see that. I do
not know where exactly how that money will be found or how much
it will involve the United States. But I believe that that is
going to be part of the game going forward.
With all that, the crisis will continue to occasionally
rear its ugly head over the course of the next several years
because, again, as I said at the beginning, this is a crisis of
economic structure, a crisis of competitiveness, a crisis of
growth. It is not just a fiscal crisis.
Senator Johanns. Thank you very much.
Senator Warner. Thank you all. The hearing is adjourned.
[Whereupon, at 4:43 p.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF LAEL BRAINARD
Under Secretary for International Affairs
Department of the Treasury
October 20, 2011
Chairman Warner, Ranking Member Johanns, and distinguished Members
of the Committee, thank you for the opportunity to discuss how we are
working with our G-20 partners to advance America's economic interests.
There is no stronger economic imperative today than to strengthen
our economic recovery, create jobs, fuel growth, and build a stronger
fiscal and economic foundation for our children and grandchildren. That
is the prism that shapes our engagement in the Group of 20 (G-20) and
with our international partners more broadly.
Safeguarding and Strengthening the Recovery
At the Pittsburgh Summit in 2009, the G-20 adopted as its core
mandate achieving strong, sustainable, and balanced global growth. In
the G-20 and in our bilateral engagements, we press vigorously for
substantive economic, financial, and exchange rate reforms that will
help achieve stronger and more balanced global growth in order to
strengthen economic opportunities and growth for American families and
workers. Our recovery in the United States remains fragile and all too
vulnerable to disruption beyond our shores. Earlier this year, high oil
prices and the tragic earthquake and tsunami in Japan led to a sharp
economic slowdown. Consumer and business confidence was shaken in the
summer in part because of the debt limit debate in the United States
but increasingly because of the intensification of the European crisis.
Europe's financial crisis poses the most serious risk today to the
global recovery. While the direct exposure of the United States'
financial system to the most vulnerable countries in Europe is
moderate, we have substantial trade and investment ties to Europe, and
European financial stability matters greatly for consumer and investor
confidence. That is why we have been working closely with our partners
to support their efforts to resolve the crisis swiftly and resolutely.
Last week at the G-20 meetings in Paris, the Europeans committed to
delivering a comprehensive plan to address their crisis by the Cannes
Summit in early November. There are four key elements. First, Europe
needs a more substantial financial firewall to ensure that governments
can borrow at sustainable interest rates while they implement policies
to bring down their debts and strengthen the foundations for growth.
Second, European authorities are taking steps to ensure that their
banks have sufficient liquidity and build capital cushions to maintain
the full confidence of depositors and creditors, and to ensure that
banks have access to a capital backstop where needed. Third, Europe is
working to craft a sustainable program in Greece as it implements its
fiscal and structural reforms. Finally, European leaders must tackle
governance changes to address the root causes of the crisis, and ensure
that every member state pursues sound economic and financial policies.
The United States must also do our part, and as the world's largest
and most vibrant economy, we recognize that we have a global leadership
role to play in strengthening the recovery. To promote near-term growth
and job creation, the Obama administration has put forward a series of
proposals in the American Jobs Act that would put veterans, teachers,
and construction workers back on the job while rebuilding and
modernizing America's schools and neighborhoods, and put more money in
the pockets of every American worker by cutting their payroll taxes in
half.
President Obama has also proposed a framework to put our medium-
term public finances on a stronger and more sustainable footing. The
President's proposal to the Fiscal Commission would place the Nation's
debt-to-GDP ratio on a declining path no later than the middle of the
decade through a balanced plan to reduce deficits by $4 trillion over
10 years when combined with the $1 trillion in savings enacted in the
Budget Control Act of 2011.
Together, pro-growth policies in the near term and meaningful
deficit-reduction in the medium term represent our best insurance
policy to protect the U.S. economy from further risks from global
markets. We must work together to safeguard America's economic
resilience and strength from further stress.
Emerging markets must also do their part to strengthen global
growth through rebalancing. With demand in the advanced economies
likely to remain weak, it is essential for emerging economic powers,
such as China, to play a bigger role in bolstering and sustaining
global growth. These emerging markets with large current account
surpluses have substantial capacity to pivot more rapidly to a pro-
growth strategy led by domestic consumption.
At last week's G-20 meeting, the surplus emerging market countries
such as China committed to accelerate the rebalancing of demand toward
more domestic consumption and to move toward more market-determined
exchange rates and achieve greater exchange rate flexibility to reflect
economic fundamentals. By allowing its exchange rate to appreciate more
rapidly in line with market forces, China could boost consumption,
strengthen domestic demand, and help curb inflationary pressures. We
have worked aggressively to pressure China in particular to move much
faster in allowing the value of its currency to appreciate. We have
seen some progress on this front, with appreciation of over 10 percent
in real terms bilaterally since June 2010 and 38 percent since 2005,
but more is needed.
We will continue to urge the IMF to use the considerable scope it
already has to identify risks to the international monetary system--
particularly external ones such as exchange rates--and ensure that IMF
members are meeting their international obligations.
Strengthening the Global Financial Sector
The second focus of our work in the G-20 and the Financial
Stability Board (FSB) has been leading a ``race to the top,'' leveling
up the playing field across major and emerging financial centers. In
the wake of the financial crisis, and with the leadership of this
Committee, the United States moved quickly with the passage of the
Dodd-Frank Act to undertake financial reform. We have moved in lockstep
on our international financial reform agenda, securing adoption of key
conforming reform commitments in the FSB and G-20.
With financial markets that are globally integrated, we need
financial reforms that are globally convergent. This is particularly
important in areas with the greatest potential for small discrepancies
in national regulations to create disproportionate dislocations in
global markets that could negatively impact our economy and our firms.
Accordingly, we have focused on three key areas: stronger global
standards for bank capital and liquidity; heightened prudential
standards and orderly resolution processes for large, complex financial
institutions; and aligning global derivatives markets.
First, following international negotiations that were concluded in
record time, G-20 Leaders endorsed new global capital standards in
November 2010. These standards will raise the quality and quantity of
capital so that banks can withstand losses of the magnitude seen in the
crisis, strengthen liquidity standards, and limit leverage.
Implementation of these reforms will proceed at a pace that reduces
risks to the economic recovery and ensures a level playing field around
the world.
Furthermore, we have successfully called on the Basel Committee to
ensure that risk-weighted assets are measured similarly across the
world. This is essential to maintain a level playing field and to
ensure consistency across borders.
Second, for the largest, most complex firms, whose failure could
cause the greatest damage to the economy, we are establishing a new
international standard for resolution regimes, so that large cross-
border firms can be resolved without the risk of severe disruption or
taxpayer exposure to loss; more intensive and effective supervisory
regimes; and a capital surcharge. The G-20 Leaders in Cannes will
endorse this set of reforms for these global systemic financial
institutions (G-SIFIs).
Third, G-20 Leaders adopted new principles for the first time to
promote international convergence across derivatives markets, which are
fully aligned with the Dodd-Frank Act. In the run-up to the financial
crisis, few understood the magnitude of aggregate derivatives exposures
in the system and the risks embedded in these exposures as derivatives,
such as credit default swaps (CDS), were traded over the counter on a
bilateral basis and without transparency. Moving derivatives trading
onto exchanges and requiring trades to be centrally cleared increases
transparency and reduces systemic risk. Central clearing will greatly
reduce risk by requiring a central clearinghouse to guarantee the
transaction and help market participants better monitor their risk.
Mandatory trading on exchanges or trading platforms will improve price
discovery and greatly enhance transparency, and reporting to trade
repositories will shed light on what was once an opaque market. New
work is beginning on our call to establish global standards for margins
on un-cleared derivatives trades that will incentivize central
clearing.
We are working with our G-20 counterparts to synchronize the
implementation of these derivatives principles, and the United States
is providing leadership by meeting the end-2012 deadline for
implementing new rules consistent with these commitments. When taken
together, these reforms will provide policymakers and investors a
clearer picture of the true exposures and interconnectedness among and
across financial institutions.
The examples above highlight areas where international convergence
is imperative to preserve global financial stability. In other areas,
the international regulatory system has long recognized differences in
the institutional structure of national financial systems, reflecting
different laws and histories. For example, the Volcker Rule in the
United States and the Independent Banking Commission recommendations in
the UK, though taking different approaches, are taking more restrictive
positions on the permitted activities of banks than are some other
countries which still use the universal banking model.
Retaining U.S. Leadership in the International Financial Institutions
Across all of these economic priorities, sustained and strong
American leadership through the international financial institutions
helps to facilitate solutions, advance growth, and build a better
future.
In 2009, the United States was instrumental in supporting an
expansion in the emergency financing of the International Monetary
Fund. Rapid Congressional passage of legislation enabling U.S.
participation helped stabilize financial markets at home and around the
world during the peak of the crisis, paving a pathway for renewed
global confidence and growth. Our continued leadership role at the Fund
provides us with outsized influence to shape the IMF's responses to
economic challenges, such as the European crisis, which matter to
American jobs and growth.
Our leadership at the multilateral development banks (MDBs) has
likewise offered us immense leverage and influence to shape development
around the world, and thereby strengthen our own security and economic
growth, while advancing American principles and ideals.
Yet today our leadership at the international financial
institutions could be at risk if Congress does not act to support our
commitments to these institutions. For example, at the World Bank, we
currently have a veto over changes to the Articles of Agreement, which
govern Bank membership and leadership, among other issues. At the
African Development Bank, we have our own board seat, and can influence
regional development to ensure that there are strict environmental and
procurement standards. Other nations, particularly China, are eager to
take up our shares in these institutions if we do not meet our
commitments.
We must continue to work together in a bipartisan manner to renew
U.S. leadership at these institutions, just as at the end of the cold
war, when President Reagan advocated for the last general capital
increase for the World Bank and a Democratic Congress approved it.
These institutions provide immense leverage of our scarce resources,
with every dollar the United States contributes to the MDBs generating
$25 of investments.
It was through the power of our ideas and our values that we became
leaders. With the emergence of new powers and new challenges, we will
remain leaders by expressing that same commitment and vision through
our evolving global partnerships in the 21st century. Our leadership in
the international financial institutions, the G-20, and the FSB will be
essential to securing the future we want for our children and for their
children.
Our leadership in the G-20 helped to avert a much deeper recession
after the crisis and to forge a common effort to strengthen the
recovery and the financial system. The U.S. will continue to emphasize
the critical role of the G-20 in developing a strong, collective
response to overcome near-term vulnerabilities, and put in place the
building blocks for more balanced and durable growth going forward.
We appreciate the leadership and support of this Committee on these
key challenges, and we look forward to working with Congress as we
engage with our international partners, and encourage robust policy
responses to today's global challenges.
______
PREPARED STATEMENT OF URI DADUSH, Ph.D.
Director, International Economics Program
Carnegie Endowment for International Peace
October 20, 2011
Mr. Chairman, Mr. Ranking Member, distinguished Members of the
Subcommittee, thank you for inviting me here today. In my testimony, I
will address three issues: the G20's role in the Euro crisis, its role
in restarting sustainable economic growth, and the G20's own
functioning.
Can the G20 help coordinate a response to the Euro crisis, and what
should that look like?
As it did last weekend, the G20 can exercise moral suasion on the
eurozone countries to act more forcefully. More important, in the event
that Spain and Italy are unable to raise money at reasonable interest
rates--as happened to Greece, Ireland and Portugal--the fallout on the
global and European economy would be so severe that it is doubtful in
my view that the Europeans could handle the crisis on their own. In
this case, the G20 would then have to coordinate a response.
Bailing out Spain and Italy would entail, as in the case of the
other peripheral countries, covering their public financing
requirements for 3 years. The associated loans would amount to about
$2.1 trillion. This large sum poses two separate problems. First, if
the IMF were to fund one-third of the total, as it did in the case of
the other countries, its share would amount to about $700 billion,
exceeding its current $400 billion new lending capacity--recently
indicated by Managing Director Christine Lagarde. The eurozone
countries, for their part, would have to find $1.4 trillion, which
exceeds the available capacity of the rescue fund, the European
Financial Stability Facility (EFSF), by over $1 trillion, not counting
any draw on the fund that may be needed to recapitalize European banks.
Though the eurozone economy is large enough to theoretically cover
such an outlay, in practice it remains a half-built economic and
political union and each individual member would be hard-pressed.
Eurozone member nations manage their own fiscal and financial
operations as do U.S. states, but there is no Federal Government of
anywhere near corresponding size or clout that can spend--and just as
importantly, borrow--like the U.S. Government can. Moreover, the
European Central Bank (ECB) lacks the Fed's political legitimacy to
intervene in support of member nations, and is, in fact, explicitly
forbidden by treaty from doing so. The resignation of two German ECB
board members over its emergency purchases of the periphery's
government bonds is a clear signal of the profound opposition to such a
course.
The institutional deficit of the European monetary union explains
why marshaling an appropriate and timely response to the Greek crisis,
whose debt is less than 15 percent of that of Spain and Italy combined,
has been so extraordinarily difficult. But the political dimension is
only one aspect of the problem should the crisis spread to the larger
countries. Markets are very well aware that a bailout of Italy and
Spain may fail, as it has in the case of Greece, and that the ability
of the European core countries to cover these losses is limited. The
spread on France's Government bonds relative to Germany's has doubled
in recent weeks and is now well in excess of 100 basis points. In
motivating its recent decision to place France's AAA credit rating on
downgrade watch, Moody's pointed to France's share of the EFSF
guarantees, which already amounts to 8 percent of its GDP, not counting
new commitments to recapitalize its banks. According to the IMF,
Germany's debt-to-GDP level is projected at 77 percent and France's at
90 percent by 2015, and it is clear that other large expansions of the
EFSF would place France, and perhaps Germany in dangerous territory.
But these calculations greatly understate the problem. Even with a
bailout, a sudden halt of financing to Spain and Italy would be
accompanied by a severe recession in those countries which would have a
major spillover on the rest of Europe. (Real domestic demand in Ireland
and Greece, for example, is down 20 percent and 15 percent,
respectively, compared to 2007, and is expected to continue to fall in
Greece.)
Were, on the other hand, Italy and Spain forced to fend for
themselves, in the event of a sudden stop in financing, an extremely
dangerous European and global banking and economic crisis comparable in
size and virulence to the Lehman episode, further undermining the
public finances of all European countries, could erupt. Bearing in mind
the disproportionate role that banks play in the European economy,
Europe's political divisions, and the European governments' limited
ability to respond now compared to 2008, it is easy to envision a
scenario in which the acute phase of such a Lehman repeat would last
not 6 months, but many years. Some may think that this scenario is
alarmist, but I think it is important to bear in mind that, whereas the
U.S. subprime mortgage market totaled between $1 and $1.5 trillion at
its peak (depending on how subprime is defined), the outstanding debt
of the European periphery now totals $4.6 trillion.
The global implications of such a scenario are dire. The United
States would be affected, through trade and foreign investment (profits
from its international companies and returns on the equity and bond
portfolios of U.S. residents), but most importantly through the banking
system. U.S. banks have $850 billion in direct exposure to the
eurozone, including nearly $400 billion in exposure to eurozone banks.
Moreover, they have an additional $1.8 trillion in indirect exposure,
through instruments such as derivative contracts and guarantees. These
numbers do not include U.S. exposures to banks in the UK and other
European countries outside the Euro zone which are themselves exposed.
The emerging markets of the G20 would also be affected through the
trade and banking channels as well as through ownership of European
government bonds. But they are more exposed to a European crisis than
the United States in two main ways: Europe attracts exports equivalent
to 5.4 percent of its GDP (compared to 1.7 percent of GDP for the
United States) and they are more likely to suffer a contagious
withdrawal of external financing, as is already happening, while the
United States is protected by its safe haven status.
Were this risk to materialize, it would be entirely appropriate for
the G20, operating through the IMF, to seek to support the European
adjustment. In order to cover, say, half of the cost of the bailout of
Spain and Italy and retain the firepower to deal with the fallout on
other countries, the IMF's resources would have to be expanded by about
$1 trillion, of which the U.S. share would be $177 billion. It is
important to bear in mind that IMF resources represent contingencies,
not actual outlays, part of a ``bazooka''--to use former Treasury
Secretary Paulson's term--that may not need to be used. Such IMF loans
have historically been paid back.
In the event of an expanded eurozone commitment, the G20 should
insist that the IMF impose demanding conditions not only on the
recipient countries, as it does at present, but also on Germany and the
other core countries, as well as on the ECB. These conditions would be
designed to ensure both that the program is well funded and designed,
but also to promote the establishment of the institutional framework
needed for the currency union to be sustained in the very long run.
Such steps would include new fiscal and monetary arrangements capable
of dealing with the diversity of European situations, a powerful
European Banking Authority, mechanisms for managing default and exit
from the eurozone, as well as structural reforms that increase the
flexibility of the markets for goods and services inside the union.
The suggestion that the United States may need to provide
additional IMF resources while it has not yet ratified the previously
agreed-on expansion will appear audacious to some. But this is, in my
view, the situation we may soon have to confront. Against the risk of a
eurozone collapse, the G20, including the United States, should see
expansion of IMF resources as a relatively cheap form of insurance.
Even if it remains unused by the eurozone this time around, it may well
come in handy in the not too distant future as the fallout from the
financial crisis and the Euro zone crisis continues to reverberate.
Can the G20 help restart sustainable economic growth?
Yes, by appropriately mandating the main specialized economic
agencies--the IMF, OECD, World Bank, and WTO--and by monitoring their
work. This is already happening to a degree, but here, I would like to
highlight two areas where a shift of focus is warranted and where
leadership from the United States is badly needed. The first relates to
the appropriate focus of global growth policies, while the second
relates to restarting the world trade system as a driver of reforms.
Global Growth Policy
Policies for restarting sustainable economic growth as managed, for
example, through the Mutual Assessment Process of the G20/IMF, suffer
from two deficiencies in my view. First, they do not place sufficient
emphasis on domestic policies and instead overstate the importance of
global rebalancing. Second, domestic policies are not paying sufficient
attention to structural reforms as distinct from macroeconomic
management.
It should be obvious that domestic policies, and not those of other
countries as reflected in trade balances, are the overwhelmingly
important drivers of economic growth. After all, in the United States,
for example, domestic demand is 34 times larger in absolute terms than
(negative) net exports. And any single trading partner has only a very
limited impact on the United States' GDP through net exports. For
example, I have made the following calculation.
Assume that, in response to U.S. pressure, Chinese leaders could
dictate that their country's savings be reduced immediately by 10
percent of GDP--approximately $500 billion. Even more implausibly,
assume further that none of this additional spending could go toward
domestic products, and that all of it instead went to imports,
immediately making China a larger external deficit nation proportional
to its GDP than the United States. If the increase were allocated
geographically in proportion to China's recent import spending, the
direct effect on U.S. exports and demand would be only $40 billion--or
0.3 percent of U.S. GDP--equivalent to about one-ninth of U.S. Fiscal
stimulus measures in 2010.
This type of calculation actually overstates the importance of
policy changes in other countries on the United States, since imported
components and raw materials account for a significant part of the
total value of U.S. exports. So the demand impulse from exports is less
than it appears. On the other hand, the importance of imports in
assuring the efficiency of U.S. producers and exporters, not to mention
living standards, tends to be overlooked.
More generally, while demand stimulus is sometimes needed in
emergencies, its importance--whether it occurs through fiscal and
monetary policy in the United States or in its trading partners--in
assuring sustainable long-term growth is almost insignificant.
Structural reforms, such as privatization and liberalization of product
and factor markets and encouragement of research and development, are a
much more important driver of long-term growth. Under a broad
definition of structural reforms, I would also include tax and
expenditure reforms that modify incentives, reduce waste, and assure
that a nation's fiscal situation remains on a sustainable path.
A good example of inadequate attention to structural reforms comes
from Japan, which has been mired in slow growth and deflation for close
to two decades. Japan has tried every trick in the macroeconomic policy
book--repeated fiscal stimulus, zero interest rates, and quantitative
easing--without any notable success in breaking out of its rut, and its
public debt has exploded. The fact that it has systematically run a
current account surplus has not helped. But observers of the Japanese
economy long ago identified a number of structural weaknesses on which
little or no action has been taken--for example, the nation's
demographic decline combined with extremely restrictive immigration
policies; an inefficient, overregulated, and protected service sector;
super-protected agriculture; overbuilt and corrupt infrastructure
sectors; and a state-owned post office and savings bank that
artificially channels a huge part of the nation's savings to the
purchase of government bonds instead of to more productive activities.
Similar structural weaknesses help explain the dire growth and
competitiveness problems in countries such as Greece, Italy and Spain,
which in addition suffer from extremely inflexible labor markets, where
``insiders'' enjoy job security and extensive benefits while an army of
outsiders remain in precarious occupations or are unemployed.
Instead of insisting that the G20 pay so much attention to trade
imbalances, which are a minor part of the problem and largely reflect a
needed adjustment to domestic imbalances, the United States would be
well served to place a greater focus on the latter, and especially on
how structural distortions, including misguided tax and expenditure
policies are hobbling the G20 economies. The OECD and World Bank are
especially well-placed to support this work.
There is also a very rich reform agenda here on which the United
States and China, the two largest economies, could lead the G20 by
example. Detailing the needed structural reforms in the United States
and China would take us beyond the current topic, but one structural
reform area of great importance--in which the United States has just
taken a notable step forward through ratification of agreements with
Korea, Colombia, and Panama--is trade.
Trade Policy
WTO disciplines, reinforced by the G20's standstill agreement on
new trade restrictions in November 2008, helped contain protectionism
during the height of the crisis and avoid a repeat of the disastrous
experience of the 1930s. That is the good news.
The bad news is that the failure to conclude the Doha Round of
multilateral trade negotiations 10 years after they began shows that
the WTO is broken as a liberalizing force. This means that huge parts
of global economic activity, including large segments of services,
foreign investment, manufactures imports in developing countries, and
agriculture--all areas of vital interest to the United States--may
remain essentially exempt from effective WTO disciplines. The world
economy is still being propelled by the great opening up that occurred
in the 1980s and 1990s as country after country embraced more market-
friendly policies, but the inability to move forward on deeper global
trade reforms will, in my view, increasingly constrain sustainable
growth in years to come.
Just as it has done with the IMF and the World Bank, the G20 should
now focus its attention on how the WTO can be reformed. How can the WTO
regain the effectiveness of its predecessor, the GATT system?
Drawing on work carried out by the trade council of the World
Economic Forum, of which I am a member, I would recommend that
agreement to the current Doha draft be linked with establishment of a
forward agenda of ``plurilateral'' negotiations. Plurilateral
negotiations are negotiations among a critical mass of countries on a
specific issue, such as trade in environmental goods, for example.
Unlike multilateral rounds, they do not require that all members agree
on every single agenda item before a deal can be struck. Examples of
successful prior plurilateral negotiations include the Government
Procurement Agreement and the Information Technology Agreement.
Examples of plurilateral agreements that could be of great interest to
the United States and to many other countries would include many areas
in services and trade in high-technology products.
By supporting such a course, the United States would accept an
admittedly low-ambition Doha deal, but, in the process, capitalize on a
few aspects of the Doha draft that are of interest (such as trade
facilitation), break the impasse in the WTO, and establish a new, much
more flexible negotiating framework capable of yielding gains in a wide
range of sectors in the decades to come. Though I believe there is
interest in adopting a plurilateral approach to negotiations among the
WTO membership, progress is only possible if the United States actively
supports it and works through the G20 to promote it. As the next step,
the G20 meeting should mandate trade ministers to meet to: a) link a
Doha conclusion to plurilaterals, b) reach agreement on such a deal,
and c) establish an agenda for reforming the WTO. The G20 trade
ministers would then promote this approach among the entire WTO
membership.
What should the G20's role be in the long run, and what would make it
more or less likely to succeed?
The G20 heads of state summit was born of the financial crisis, was
sponsored by the United States for its first meeting in Washington in
November 2008, and was charged to be the preeminent forum for global
economic policymaking at the Pittsburgh summit in September 2009.
Comprising 10 emerging markets, 9 advanced economies, and the EU, the
G20 has the potential to fill a large gap in global economic governance
that its predecessors, such as the G7 and G8, were not able to bridge.
It reflects the reality of a global economy where emerging countries
are headed toward representing well over half of global GDP and trade.
In a forthcoming paper co-authored with Kati Suominen of the German
Marshall Fund, I argue that, to succeed in global economic governance
as well as crisis-fighting, the G20 needs to confront four major
challenges: sticking to its comparative advantage, being realistic in
what it can achieve, effectively integrating emerging economies in
decisionmaking, and clarifying its own structure and composition. It
will also need leadership from its largest members, beginning with the
United States but supported by China.
Comparative Advantage
The G20 is not designed to be a decisionmaking body: it is not
universally representative and its deliberations are not ratified by
parliaments. It is also not well-suited to engaging at the granular
level, which would risk encroaching on the territory of established
multilateral institutions, such as the IMF, World Bank, or WTO, whose
technical competence is far greater.
The G20 is very well-positioned, however, to function like a
steering committee. It is flexible enough to react quickly to events
and, therefore, manage crises, but also to provide general guidance for
how the international institutional architecture should evolve.
The G20 countries, which together account for the vast majority of
the ownership and voting power in the major global institutions, should
focus on the big picture and look to these institutions to translate
the G20-designed strategy into explicit decisions.
Realism
The G20 has unique strengths as a coordinating forum, but it also
has limitations that should inform its agenda. Expectations of what it
can accomplish must be tempered.
While the G20 economies were able to deliver on most of the
commitments they made during the peak of the crisis, including fiscal
stimulus, they have had much less success in dealing with longer-term
issues, for example, restarting the trade agenda.
For one, the G20 and its watchers need to differentiate between the
issues that multilateral institutions can genuinely make progress on
and those--for example, taming global imbalances--that depend instead
on domestic political processes in the largest economies and their
willingness to engage.
One has to distinguish, in other words, between the need to improve
the rules of the game and the need for key players to raise their game.
Lacking enforcement tools, the G20 cannot induce action. But, over
time, it can aim to develop broad consensus on the approach to take on
global issues, nudge the executives in member states in new directions,
and provide political cover for policy change at home. Such an approach
is not always given to dramatic successes or flashy announcements.
Include the Emerging Economies
The G20 has created the possibility of shifting coalitions that cut
across developing and advanced country lines. But including emerging
countries as full participants could also limit the G20's
effectiveness. The argument is often made that even as the emerging
powers demand a larger voice in international organizations, they
resist taking on the associated responsibilities and are reluctant to
yield sovereignty, even at the cost of torpedoing international
consensus. There is some truth to this argument and, in my view,
examples of it can be found in the Doha trade negotiations and in aid
policy. But equally clearly, developing countries are not the only ones
that have failed to live up to their international responsibilities, in
areas ranging from agricultural trade policies to control of carbon
emissions, not to mention taking adequate precautions to avoid
financial booms and busts.
So while both the emerging and advanced economies need to learn
from their mistakes, emerging economies need to be given time to get
the hang of international negotiations, to articulate a clear vision of
the specific policies they want to drive on the global stage, and to
establish a clearer ordering of their various preferences and
interests.
Structure
To play a strategic role in global economic policy, the G20 must
strike a balance between bringing too many countries and institutions
around the table and being too small to be representative. Thoughtful
leaders in such nonmember nations as Denmark or Chile have questioned
the legitimacy of the self-appointed G20, even though its members
account for some 80 percent of world GDP.
But catering to these concerns would only lead to ineffectiveness.
The G20 already borders on being too unwieldy and is also taking on too
many issues at once, which risks diluting its focus. At the same time,
power on the international stage, rather than numbers, ultimately
determines who will call the shots. In the final analysis, the five or
six largest G20 members are in charge and including another economy the
size of Argentina will not change that fact.
To improve continuity and build institutional memory and capacity,
proposals have also been aired to establish a G20 permanent secretariat
and a more durable presidency. The current set-up is not ideal, but it
is not clear that any alternative, such as the IMF model of national
groupings headed by rotating chairs, would be preferable. A longer
Presidential term would also give one nation too much weight, as the 19
others would have to wait for their turn for years. And while a
permanent secretariat would lead to more continuity, it would also,
once established, increase the risks of bureaucratization, mission
creep, and competition with other institutions.
The U.S. Role
As the crisis began spreading across the globe in 2008, the G20,
led by the United States, which was at the epicenter of the crisis,
helped avoid descent into a second Great Depression. Since then, it has
also shown glimpses of its longer-term potential--beginning the hard
work of revising the roles and structures of major institutions and
setting the long-term global economic agenda.
Above all, the G20 needs to avoid the temptation to be all things
to all nations and instead keep its eye on the ball--the systemic
short- and long-term global policy issues that affect all nations and
require major coordinated reforms. It also needs to know how to pick
its fights and focus on those issues where there is a genuine emerging
consensus about what to do.
The key factor between success and failure will be leadership. As
in the past, there are only a handful of members that can swing the big
decisions. Of these, the United States is still by far the most
important and the only plausible leader--and will, in my view, remain
so in coming decades. No relationship is more crucial for the United
States in leading the G20 than that with China, a developing economy
that is also the world's second-largest and fastest-growing economy. As
in the past, the United States will lead best by example.
______
PREPARED STATEMENT OF JOHN MAKIN, Ph.D. *
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* The views expressed in this testimony are those of the author
alone and do not necessarily represent those of the American Enterprise
Institute.
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Resident Scholar, American Enterprise Institute
October 20, 2011
Thank you, Chairman Warner, Ranking Member Johanns, and Members of
the Committee for the opportunity to testify.
The first paragraph of an article on how to save the euro in a
recent issue of the Economist captures a significant part of what has
gone wrong with the European economy.
So grave, so menacing, so unstoppable has the euro crisis become
that even rescue talk only fuels ever-rising panic. Investors have
sniffed out that Europe's leaders seem unwilling ever to do enough. Yet
unless politicians act fast to persuade the world that their desire to
preserve the euro is greater than the markets' ability to bet against
it, the single currency faces ruin. As credit lines gum up and
outsiders plead for action, it is not just the euro that is at risk,
but the future of the European Union and the health of the world
economy.\1\
---------------------------------------------------------------------------
\1\ ``How to Save the Euro,'' The Economist, September 17, 2011,
www.economist.com/node/21529049 (accessed September 20, 2011).
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As we enter the fall of 2011 , 3 years after the Lehman Brothers
crisis, Europe and the United States are teetering on the brink of
another, potentially more serious, systemic crisis. It is surely fair
to ask how we got to this point just a few months after the U.S.
recovery had been declared well-established and European leaders had
created a fund with resources that were supposed to be sufficient to
ensure that Greece, the fulcrum of Europe's debt crisis, would not
default on its debt. Figure 1 shows the sharp rise in interest rates on
some European governments' debt--especially Greece, Ireland, and
Portugal--and a recent jump in Spanish and Italian yields that is
emblematic of Europe's intensifying debt crisis.
The crisis in Europe is somewhat mirrored and amplified by a
parallel sharp growth slowdown in the United States. After last year's
second round of quantitative easing (QE2) and extra fiscal stimulus
spawned expectations of 3.5 percent growth, actual U.S. first-half
growth of only 0.7 percent has changed everything. During the spring,
the Federal Reserve began talking about detailed strategy for exiting
high levels of monetary accommodation, while during July's debt ceiling
fiasco, U.S. policymakers wrestled with the need to reduce deficits and
debt accumulation. In the end, they left the heavy lifting to a
congressional ``super committee'' that is to report back to President
Obama by Thanksgiving. But before the super committee could even meet,
the President reversed course in the face of the threat of a double-dip
recession and proposed nearly a half trillion dollars in additional
fiscal stimulus for 2012 that repeated and expanded measures the last
Congress passed in December 2010.
Americans who follow deliberations in Washington, especially about
taxes and Government spending, can be forgiven some confusion. During
much of the second quarter in the lead-up to the July debt-ceiling
debate, which was punctuated by threats of America's default on its
debt, politicians loudly touted the benefits of living within our
means, which meant cutting the deficit, which in turn meant cutting
Government spending, raising taxes, or both. As Congress returned from
vacation, the President offered up a jobs program costing nearly half a
trillion dollars that involves cutting taxes and increasing Government
spending.
Of course, the President followed up his jobs plan with proposals
for future tax increases and spending cuts he claimed would provide
more than $4 trillion in deficit reduction over the 10 years after 2013
``as the economy grows stronger.''\2\ It seems unlikely, though, that
the tax cuts and higher spending that are supposed to make the economy
stronger in 2012 will, when reversed in 2013, somehow not cause it to
grow weaker.
---------------------------------------------------------------------------
\2\ White House Office of the Press Secretary, ``Fact Sheet: Living
Within Our Means and Investing in the Future: The President's Plan for
Economic Growth and Deficit Reduction,'' September 19, 2011,
www.whitehouse.gov/the-press-office/2011/09/19/fact-sheet-living-
within-our-means-and-investing-future-president-s-plan (accessed
September 22, 2011).
---------------------------------------------------------------------------
We, and many in Europe, are left to wonder whether it is deficit
reduction that is good for the economy or euphemistically named things
like ``jobs programs'' that increase the deficit. It is important to
ask how, at the time of this writing in September 2011, Europe has
reached an acute sovereign-debt crisis while the U.S. economy
simultaneously threatens to contract, exacerbating both its own
budgetary problems and Europe's sovereign-debt crisis.
What Happened in Europe?
Europe's problems, which are probably more acute than America's,
spring from a simple cause: an attempt to forge and maintain an
impossible currency union. The European Monetary Union, which includes
such disparate economies as Germany on the strong side and Greece,
Ireland, Portugal, Spain, and Italy on the weak side, requires the
assumption that monetary policy that is appropriate for Germany is also
appropriate for Greece. Europe's adoption of monetary union enabled
less credit-worthy countries such as Greece to borrow on virtually the
same terms as Germany because both were issuing debt denominated in
euros and the European Central Bank (ECB) was treating those debts as
being of identical quality.
The European Monetary Union was, at first, attractive for all of
its members, including Germany. European banks were happy to make euro-
denominated loans to government and private borrowers in southern
Europe who could suddenly borrow for less, given that the loans were
denominated in euros. If a bank lent money to, for example, the Greek
Government, it acquired a claim on Greece that it could take to the ECB
and use as collateral for further borrowing. The terms for that
transaction were virtually identical to the terms available if claims
on the German Government were used as collateral. Easy credit
accelerated European growth, not to mention German exports. As
inflation and growth surged in southern Europe, so too did borrowing in
those countries.
Adoption of the euro by countries like Greece and Spain meant that
they got a German credit rating that enabled them to purchase more
Mercedes--on credit. At first, German exporters were pleased. But now,
Germans are being asked to help borrowers in these southern European
countries repay these loans.
By 2009, some lenders began to notice that Greek budget deficits
and government debt were rising rapidly. When Greece revealed late in
2009 that its deficits and debt were substantially larger than
previously reported, the first phase of the European debt crisis began.
However, the ECB continued to allow banks to use Greek, Italian,
Spanish, and any other sovereign debt from the European Monetary Union
as collateral for loans. Banks were also not required to hold reserves
against their sovereign-debt loans because it was effectively assumed
that sovereigns do not default.
The solution to the Greek crisis that emerged in the spring of 2010
was essentially perverse. In exchange for additional loans so that
Greece could roll over its debts and pay its debt service, the
International Monetary Fund (IMF) and the European Union imposed strict
conditions on Greece in the form of higher taxes and sharply
contractionary cuts in government spending that caused the economy to
slow further, undercutting its ability to service outstanding debt and
additional debt.
By the second quarter of 2011, it was clear that Greece would
require additional funding to meet its debt service obligations, while
similar problems arose for Portugal, Spain, and Italy. Ten years of
pretending that loans to southern European governments carried as
little risk as loans to the German Government left Europe's banks with
nearly $2 trillion worth of claims on those riskier borrowers. For the
purpose of ``stress tests,'' it was assumed that these claims were
worth 100 cents on the dollar when the marketplace implies
substantially lower values. The large sovereign-debt holdings by
European banks pose a threat to the solvency of many of those banks
that rises in proportion to doubts about governments' ability to
service those loans. Given these conditions, if Greece, for example,
defaults on its debts, the possibility of defaults by other sovereign
governments in Europe may rise, triggering solvency problems for most
of Europe's private banks.
Many hope to preempt this disaster scenario by recommending
aggressive steps to prevent a Greek default. The problem is that
Germany, the country that would have to foot most of the bill, is
insisting that Greece adopt additional austerity conditions in exchange
for the loan. The austerity conditions, in turn, imply that Greece will
be less able to service its debts a year from now, given that the
economy is expected to contract at a 5 percent rate if these austerity
conditions are imposed.
Impact of Europe's Debt Crisis on the United States
Americans are exposed to the European debt crisis through money
market funds, among other channels. The rapid slowdown of U.S. economic
growth, along with the elevated uncertainty tied to July's debt-ceiling
fiasco, caused many households to sell stocks during August. Typically,
investors move such funds into ``cash equivalents'' or money market
funds, which pay virtually no interest but are meant to be highly
liquid should households need to reinvest the funds or to purchase
goods and services. As Europe's debt crisis intensified during the
summer, U.S. money market funds were, in effect, lending heavily to
European banks that in turn were significantly exposed to shaky
sovereign-debt issuers like Greece, Portugal, Spain, and Italy. The
result was that Americans who wanted to avoid more risk by exiting
stocks and entering money market funds were effectively lending to
Greece and Portugal. This discovery led money market funds to sharply
reduce their exposure to European sovereign debt as depositors began to
exit for fear that the funds would be vulnerable to a Greek default and
other European sovereign-debt problems.
The search for safety outside money market funds drove risk-averse
American investors into U.S. Treasury bills, bonds, and notes. As a
result, the yield on 4-week and 3-month Treasury bills was driven to
zero or below by late August, while the yield on 1-year Treasury bills
was driven to an incredibly low six basis points. So desperate were
American households, and undoubtedly some firms, for a risk-free cash
repository that in some cases they were willing to pay the U.S.
Government one or two basis points for the privilege of lending to the
Government for a short period. Those who wanted more yield bought 10-
year notes and 30-year bonds, pushing yields on 10-year notes below 2
percent, even lower than they had been after the Lehman crisis, and
yields on 30-year bonds down to 3.25 percent or below. Other investors
seeking safety and expecting higher inflation bought gold, pushing its
price over $1,900 per ounce at some points.
It is worth commenting on the simultaneous increase in the price of
gold and the drop in interest rates on 30-year bonds. Because gold pays
no return, buyers are essentially betting on an increasing price of
gold to reward them. If inflation continues to rise, as gold buyers
expect, purchasers of 30-year bonds will be at risk since they will be
paid back in dollars with less purchasing power. As a result, the most
popular fixed-income instrument, whose returns rival that of gold
during 2011, have been U.S. Treasury inflation-protected securities
(TIPS). So eager are investors for a safe haven that the real yield on
TIPS has been driven well below -1 percent. That means buyers of TIPS
are willing to pay the U.S. Government more than a percentage point for
the privilege of owning a long-term, inflation-protected asset.
But why are some investors betting on inflation by purchasing gold
while others are willing to bid up prices on long-term Treasuries that
would be harmed by higher inflation? The answer may be that the
extremely high level of uncertainty in financial markets implies a wide
range of possible outcomes, including both higher inflation and
deflation. Gold is a somewhat illiquid way to play the inflation
scenario, while longer-term Treasuries are a bet on the deflation
outcome. Investors who remember Japan's deflationary experience after
1998 and the resulting drop in long-term interest rates to below 1
percent may buy Treasury bonds, while those who fear debasement of
paper money may buy gold. Gold buyers are also concentrated in
countries like China and India where local-currency, long-term
government securities are not available and gold is the preferred safe-
haven asset.
No Place to Hide
The systemic mess the United States and Europe--and eventually, the
rest of the world--are facing in the fall of 2011 is greater than the
sum of its parts. The U.S. economy slowed down even after substantial
monetary and fiscal stimulus had been applied. The slowdown was
surprising and also disconcerting to policymakers who had to entertain
the notion that the policy levers they were pulling were no longer
effective. Just as these disquieting realizations were arising in the
United States, the European debt crisis reintensified as Greece
teetered on the edge of default and the crisis environment spread to
the rest of southern Europe. These conditions raise some serious
questions.
Why Isn't the United States Stimulus Working?
The short answer is this: monetary policy is not stimulating the
economy because the United States is in a liquidity trap. At first, the
Fed's QE2 was followed by higher interest rates as markets expected
further growth. But as growth failed to materialize, interest rates
came back down, stock markets weakened, and funds went back into cash.
Viewed another way, the Fed's QE2 initially induced investors to put
more money into riskier assets like stocks, but when growth failed to
materialize, the funds left those riskier assets for cash. It was
additionally disconcerting that one of the first cash destinations,
money market funds turned out to be essentially lending to European
borrowers who were even riskier than U.S. borrowers. As a result, funds
flowed into the Treasury markets, pushing short-term Treasury yields to
zero or below. Those fearing eventual currency debasement and inflation
bought gold.
The Fed's latest attempt to offer additional stimulus is somewhat
bizarre. After its August meeting, the Fed indicated strongly that it
would hold short-term interest rates at zero for another 2 years. That
amounts to promising that the economy will not recover for 2 years
because if it did, short-term interest rates would rise as cash
balances sought higher returns on investments in the equity markets,
which would improve as the economy improves. Those seeking a positive
return on investments must bet either on higher inflation and buy gold
or on higher growth and buy stocks.
The Fed has sought to push down immediate and longer-term interest
rates with Operation Twist, whereby it is concentrating its purchases
in the Treasury market on 10-year notes and 30-year bonds at the
expense of shorter-term bills and notes for which interest rates are
already virtually zero. Lower interest rates--even lower longer-term
ones--are not likely to produce much growth in an economy with
virtually no demand for credit from qualified borrowers.
Fiscal stimulus is not working because the constraints of rising
deficits and resulting debt mean that it is by definition temporary and
must be reversed after implementation. Last December, the Obama
administration announced temporary tax cuts. Enactment boosted incomes,
but termination a year later will slow their growth. Obama's early
September 2011 proposal for a $450 billion stimulus package for 2012
was followed in mid-September by another package proposal that promised
more than $4 trillion in deficit reduction--nearly 10 times the
stimulus proposal--over the next decade. The impetus for Obama's 2012
stimulus was the end of the 2011 stimulus, which not only did not work
to boost the economy but also will cause a slower economy once it ends.
In other words, because the 2011 stimulus did not work, the President
is claiming that we need another one in 2012 that will be reversed in
2013.
Why Doesn't Europe Either Let Greece Default or Bail It Out?
The question of Greek debt has to be addressed very soon. If Greece
unilaterally defaults, fears of defaults elsewhere in southern Europe
may produce a run on European banks that hold claims on those
countries, leading to a full-blown financial crisis in Europe. It
probably would be better for the ECB--or the ECB, European Union, and
IMF, collectively--to offer unconditional guarantees on sovereign
European debt. This would mean the euro would likely end up as a
relatively soft currency, so the German Government, which would have to
fund much of the sovereign-debt bailout, has so far refused to agree to
this plan. Given the cumbersome nature of the European Monetary Union
and its institutions, it appears likely that an agreement will not be
reached and that some kind of Greek default, probably preceded by
capital controls, will occur before the end of this year. The fallout,
sharply lower European growth and sharply elevated financial turmoil,
will be negative for the United States and the rest of the world.
What Should the United States Do?
This fall, while Europe is awaiting Greece's impending default, it
appears that American policymakers will repeat July's debt-ceiling
fiasco: ambivalence about whether tighter or easier fiscal policy is
better for the United States (that is, are we supposed to raise
deficits or reduce them?) will be rendered moot by the super
committee's likely inability to find an additional $1.5 trillion (or
more, if any stimulus measures are enacted) in deficit cuts over the
next 10 years. If that is the case and U.S. fiscal policy essentially
continues on its current path through the end of the year, while Europe
is in a default mess the United States will be experiencing fiscal drag
equal to about 2 percentage points of gross domestic product,
exacerbating any global slowdown caused by a failure to resolve
Europe's debt mess.
No easy or obvious ways exist to bypass this bad outlook that has
grown out of the inability of European and U.S. economic policymakers
to make hard decisions over the last several years. The signs that such
an outcome is becoming more likely include a slowdown in inflation and
a threat of deflation as more households and businesses seek the
relative safety of cash equivalents like Treasury bills and rein in
their spending in anticipation of substantial financial turbulence and
slower growth. That development, coupled with the surge in demand for
liquid assets that usually accompanies an acute financial crisis, will
require central banks to print a lot more money to avoid a self-
reinforcing deflationary disaster that raises the real debt burden at
the root of the problem faced by banks and governments in Europe and
banks and households in the United States.
One encouraging sign is that we may already have seen an initial
step toward preempting deflation. On September 15, the Fed, in
conjunction with the central banks of Europe, Great Britain,
Switzerland, and Japan, arranged to supply dollars to Europe's banking
system. The flow of dollars to Europe's banks has dried up as other
banks and U.S. money market funds feared their exposure to large
quantities of sovereign debt issued by southern European countries. The
swap lines, as they are called, will be available to help with year-end
funding needs by supplying the dollars European banks need to finance
their dollar loans and other dollar liabilities. At the least, this
step represents a solid move toward financial coordination among
central banks that may help ease what appears to be an upcoming global
financial mess.
______
PREPARED STATEMENT OF C. FRED BERGSTEN, Ph.D.
Director, Peterson Institute for International Economics \1\
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\1\ And formerly Assistant Secretary of the Treasury for
International Affairs and Assistant for International Economic Affairs
to the National Security Council. His 40 books on global economic
issues include Global Economic Leadership and the Group of Seven in
1996 and he chaired a ``shadow G7'' during 2000-2005.
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October 20, 2011
The world economy obviously faces major risks. There are three
separate though related problems: the possibility of renewed recession
in the three large high-income areas (United States, Europe Union,
Japan), the continued fragility of the global financial system and most
immediately the threat of renewed crisis in Europe.
At the same time, the global economy does exhibit several
significant strengths. The emerging markets and developing countries,
which now account for half of all global output, continue to grow
rapidly. Many of the design shortcomings and implementation failures of
the previous financial regulatory regime have been reduced by the Basel
III agreement and by regulatory reform at the national level, including
importantly the Dodd-Frank law in the United States. World trade has
continued to expand and the feared outbreak of protectionism has failed
to materialize.
In this mixed setting, what should the G-20 do at its upcoming
summit in Cannes on November 4-5? I recommend a three-part initiative.
Promoting Global Growth
The most critical task is restoring economic growth throughout the
world and the G-20 should act to do so at Cannes as it did at London in
April 2009. The group should postpone its 2010 pledge ``to cut budget
deficits in half by 2013.'' There is no problem in the emerging
markets: they continue to expand at an average rate of 6 percent and
some, including China and India, are doing much better. Such growth is
pervasive across all groups of these countries, including Latin America
and sub-Saharan Africa as well as East Asia.
All three of the traditional global economic leaders, however, are
struggling to reach even 2 percent growth. All are experiencing high
and persistent unemployment. Compounding their policy problems, all
simultaneously face large budget deficits and rapidly growing debt
burdens that require fiscal corrections rather than the expansions that
would normally be adopted in such circumstances.\2\ Nor can monetary
policy do very much since all three central banks are at or not far
from the ``zero bound'' of interest rates.
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\2\ See Joseph Gagnon, The Global Outlook for Government Debt over
the Next 25 Years: Implications for the Economy and Public Policy,
Policy Analyses in International Economics 94, Peterson Institute for
International Economics, Washington, June 2011.
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The world will thus have to continue to rely--increasingly so--on
the emerging and developing economies led by China, which alone
accounts for one quarter of all global growth.\3\ These countries
should adopt new stimulus programs to strengthen the global prospect.
Some, notably Brazil and Indonesia, have already begun to do so.
Fortunately, almost all of them have fiscal and/or monetary policy
space to deploy expansionary policies. Moreover, they are already
planning to spend trillions of dollars on new infrastructure projects
over the coming decade and acceleration of these efforts should be
feasible as well as desirable. Their recent concerns over inflation,
which justifiably have deterred some of them from shifting their policy
gears heretofore, should be mitigated by the weakened prospects in the
high-income countries and the leveling off of most commodity process.
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\3\ China accounts for about 10 percent of global output (at
purchasing power parity exchange rates) and has been growing at about
10 percent per year for over three decades. Hence it contributes 1
percent to global growth, about 25 percent of the current total and 20
percent even in the boom years of 2003-07.
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In short, it is time for the emerging economies to assert the
leadership of the global economic system for which their dramatic
progress of the last decade or so has prepared them. China already did
so to an important extent in 2008 when it acted most quickly and most
decisively of any major economy to promote recovery from the Great
Recession. This time the emerging markets as a group need to move with
equal vigor to prevent another Great Recession.
It is also essential that the emerging markets promote global
growth through the shape of their expansion strategies. China and the
other countries with large reserves must provide stimulus through
domestic demand and reductions, rather than renewed increases as
forecast by the International Monetary Fund, in their external
surpluses. This is the only way they can help the world as a whole,
including a number of poorer countries as well as the high-income trio,
attain renewed growth--which is of course critical to them as well.
China continues to buy $1-2 billion every day to keep the exchange
rate of its renminbi 20-30 percent below equilibrium levels. It and
other emerging and developing countries spent $1.5 trillion in 2011
alone to hold their currencies down, substantially increasing the trade
and current account deficits of the United States (and Europe and a few
others). These countries achieved much of their rapid development by
exploiting demand in the rich countries and it is time for them to
promote domestic consumption and social infrastructure spending and to
let their exchange rates appreciate much more rapidly (which will also
help counter any inflationary pressures from their new stimulus
initiatives).
The European Crisis
The most immediate problem is of course the European crisis, and
the G-20 should be in a position by Cannes to endorse a comprehensive
action plan.
Here too, however, renewed growth is essential. Austerity alone
cannot restore economic viability in Greece, Italy or the eurozone as a
whole. Two steps are required on this aspect of the European problem:
Germany, the Netherlands and the other strong countries of
the European ``core'' should, at a minimum, postpone the
further tightening of their fiscal policies that is now planned
and let their automatic stabilizers play through, and
preferably adopt temporary stimulus measures for the next
couple of years;
The European Central Bank, which alone in the high-income
world has tightened monetary policy this year and is some
distance from the ``zero bound,'' should reduce its interest
rates by at least 100 basis points.
In addition, the eurozone must deal decisively with its financial
perils. The only way to do so is by leveraging the European Financial
Stability Facility (EFSF), through the European Central Bank (which
will remain the ultimate source of eurozone bailouts) or whatever
techniques prove to be most feasible politically, to create a total
reserve of 2-4 trillion euros. Such a war chest would assure markets
that the zone itself could handle any conceivable contingencies,
including defaults by Italy and Spain, as well as provide the financing
necessary to provide the essential recapitalization of European banks
and enable Greece to buy back large portions of its existing debt and
thus restore national solvency.
For the longer run, the Europeans must continue with the steps
toward completing their Economic and Monetary Union that have already
been galvanized by the crisis. These will include a fiscal union, a
European Monetary Fund to systematize their rescue capabilities (and
the accompanying conditionalities) and a comprehensive mechanism for
regional economic governance. Such evolution will almost certainly
require changes in the EU treaty and national constitutions. It will
obviously take time, perhaps 5-10 years, but is an essential complement
to the current crisis management to prevent replication of the present
difficulties and restore assured stability to the European Union as the
single largest component of the global economy.
If the Europeans fail to get their act together sufficiently to
deal with their crisis themselves, which we should know by Cannes, it
will be necessary to move to Plan B: mobilization of global resources
to do so through the International Monetary Fund. The Fund is the only
alternative through which such financing, along with the requisite
adjustment programs, could be obtained.
The G-20 would have to play a crucial role in any such process, as
it did in raising $750 billion for the Fund in 2009, because the IMF
would have to raise several trillion dollars to enable it to deal
effectively with the European difficulties. Such funds could only be
borrowed from the emerging market economies that have built huge
reserves of foreign exchange: China, Russia, Brazil, Korea, India,
Mexico, Singapore, Hong Kong and several others including a number of
large oil exporters.
Such investments would be attractive for these countries because
almost all of them would like to diversify their reserves out of
dollars. A claim on the IMF would provide them with an asset that was
both diversified in terms of currency risk and paid a higher interest
rate. They might also, quite legitimately, link their provision of such
funds to the IMF to further substantial increases in their quotas, and
thus voting rights, at that institution.
I believe that the IMF should seek to avail itself of such
additional resources, with or without an immediate need in Europe, due
to the ongoing fragility of the global economy and its uncertain
prospects for at least the next several years. But Europe's
requirements could provide a compelling case for urgent action and this
issue could in fact leap to the top of the G-20 agenda in Cannes.
Global Financial Regulation
It would clearly be desirable to implement a common financial
regulatory regime that encompassed all major parts of the world and all
classes of financial institutions. We are still far from being able to
achieve such a regime, however, as indicated by the fierce battles over
key components such as capital requirements and resolution mechanisms.
The G-20 should thus agree to implement on schedule--and sooner
where feasible--the minimum bank capital and liquidity requirements
under Basel III including the capital surcharge for global systemically
important banks. In view of the market funding strains and contagion
risks facing banking systems in some important economies, this is
decidedly not the time to be heeding pleas to weaken and/or postpone
these key reforms. This is of course especially the case in the Euro
area, where large holdings of beleaguered sovereign bonds by banks and
credibility problems with previous bank ``stress'' tests have increased
the risk of significant spillovers from the smaller periphery countries
to larger ones at the center (particularly Spain and Italy).
In this connection, it is instructive to note that, in the latest
(September 2011) IMF Global Financial Stability Report, bank leverage
(defined as the ratio of tangible assets to tangible common equity) in
the Euro area is over twice as high as in the United States (26 versus
12) with particularly high leverage for German, Belgian, and French
banks (32, 30, and 26, respectively). Concerns that efforts to increase
bank capital ratios will result in a fire sale of bank assets (by
lowering the denominator of the bank capital ratio) can be countered
either by requiring banks to meet the higher capital requirements in
absolute terms (that is, by raising a specific amount of capital
without regard to risk-weighted assets) or by picking a benchmark for
the capital ratio that uses a level of (risk-weighted) bank assets
prior to the required increase.
The G-20 should also redouble its efforts in two other reform
areas. First, it should underline further the importance of the FSB and
national authorities monitoring carefully the buildup of risks in the
``shadow banking system'' so that tougher capital and liquidity
standards in the banking system do not merely result in a shifting of
risk to less regulated but increasingly systemically important nonbank
entities. Second, it should press the FSB to make further and faster
progress in securing G-20-wide agreement on a cross-border resolution
regime--especially for the 28 globally active banks that have been
identified as global systemically important institutions. This should
be a priority since such global institutions typically have hundreds or
even thousands of majority-owned subsidiaries in other countries and
resolution cannot take place effectively without such a cross-border
agreement.
What Role for the United States?
The United States must obviously play a central role in galvanizing
such a G-20 program at Cannes if it is to eventuate. It can make five
major contributions:
agreement between the President and Congress to adopt a new
stimulus program to enhance U.S. economic growth for 2012; we
can hardly expect China and Germany to take responsibility for
maintaining global expansion if we continue to be paralyzed in
moving similarly;
tangible progress toward credibly reining in the U.S.
budget deficit over the remainder of this decade, going far
beyond the procedural legislation passed on August 2, to
stabilize our debt buildup and thus restore global confidence
in our economy and the dollar;
a commitment to eliminate our current account deficit,
which would create 3-4 million new U.S. jobs and carry out
previous G-20 pledges to correct the large global imbalances in
order to achieve sustainable world growth;\4\
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\4\ C. Fred Bergsten, ``An Overlooked Way to Create Jobs,'' The New
York Times, September 29, 2011. Copy attached.
House passage and Presidential signature of the China
currency bill recently passed by the Senate, to emphasize our
seriousness concerning the rebalancing issue and thus increase
the incentives for China to both stimulate world growth via
domestic demand and let its exchange rate strengthen more
rapidly; alternatively, or in addition, the numerous G-20
countries concerned by China's currency manipulation could file
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a joint case against it in the World Trade Organization; and
support for augmenting the reserves of the IMF as suggested
above, including a commitment by the Senate and House
leadership to enact the pending IMF reform legislation once it
is sent to the Congress by the Administration and an expression
of U.S. willingness to increase the weight of the emerging
markets at the Fund (primarily at the expense of the Europeans,
who would be gaining directly--indeed rescued--from the new
funds provided by those countries).
The United States has a massive national interest in successful
revival of the world economy, especially as a large part of our own
recovery will depend on our success in expanding sales to external
markets. We must exercise a new style of leadership to catalyze action
by the still-new, and diverse, G-20 but a good start has been made over
the past 3 years and the stakes are so high that we must place the
highest priority on utilizing the institution effectively over the
coming months and years.