[Senate Hearing 111-329]
[From the U.S. Government Publishing Office]






                                                        S. Hrg. 111-329

             FOREIGN POLICY AND THE GLOBAL ECONOMIC CRISIS

=======================================================================

                                HEARING

                               BEFORE THE



                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 25, 2009

                               __________

       Printed for the use of the Committee on Foreign Relations


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                               index.html






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                COMMITTEE ON FOREIGN RELATIONS         

             JOHN F. KERRY, Massachusetts, Chairman        
CHRISTOPHER J. DODD, Connecticut     RICHARD G. LUGAR, Indiana
RUSSELL D. FEINGOLD, Wisconsin       Republican Leader designee
BARBARA BOXER, California            BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey          JOHNNY ISAKSON, Georgia
BENJAMIN L. CARDIN, Maryland         JAMES E. RISCH, Idaho
ROBERT P. CASEY, Jr., Pennsylvania   JIM DeMINT, South Carolina
JIM WEBB, Virginia                   JOHN BARRASSO, Wyoming
JEANNE SHAHEEN, New Hampshire        ROGER F. WICKER, Mississippi
EDWARD E. KAUFMAN, Delaware
KIRSTEN E. GILLIBRAND, New York
                  David McKean, Staff Director        
        Kenneth A. Myers, Jr., Republican Staff Director        

                              (ii)        



                            C O N T E N T S

                              ----------                              
                                                                   Page

Kerry, Hon. John F., U.S. Senator from Massachusetts, opening 
  statement......................................................     1
Lindsey, Lawrence, former director of the National Economic 
  Council, Washington, DC........................................    13
    Prepared statement...........................................    15
Lugar, Hon. Richard G., U.S. Senator from Indiana, opening 
  statement......................................................     3
Soros, George, chairman, Soros Fund Management and Open Society, 
  New York, NY...................................................     9
    Prepared statement...........................................    11
Wolf, Martin, associate editor and chief economics commentator, 
  Financial Times, London, United Kingdom........................     5
    Prepared statement...........................................     7

                                 (iii)

  

 
             FOREIGN POLICY AND THE GLOBAL ECONOMIC CRISIS

                              ----------                              


                       WEDNESDAY, MARCH 25, 2009

                                       U.S. Senate,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:35 p.m., in 
room SD-419, Dirksen Senate Office Building, Hon. John F. Kerry 
(chairman of the committee) presiding.
    Present: Senators Kerry, Kaufman, Lugar, Corker, Risch, and 
Barrasso.

            OPENING STATEMENT OF HON. JOHN F. KERRY,
                U.S. SENATOR FROM MASSACHUSETTS

    The Chairman. The hearing will come to order. Thank you all 
for joining us this afternoon.
    Just when we think things may settle down for a moment, the 
markets have a way of deciding otherwise and sending a 
different message. I noticed today that the British bond sale 
failed, for the first time since 2002. And so, even today the 
implications of the current economic downturn are being felt 
globally, which is what we're here to talk about today.
    The United States is not alone in confronting an economic 
crisis at this time. And what started here has now gone global 
and continues to reverberate beyond our financial systems into 
the daily economic lives of people everywhere.
    The reality is, we don't quite know, yet, where the bottom 
is, or where the end is. And today's hearing grows out of a 
roundtable discussion which the committee held on this last 
month, where we began to scratch the surface of the global 
implications of the financial challenges that we face. And 
we're glad to do this before the full committee today.
    Dennis Blair, the Director of National Intelligence, 
recently told Congress, ``The primary near-term security 
concern of the United States is the global economic crisis and 
its geopolitical implications.'' That's an amazing statement, 
given the ongoing risks that we face from terrorism, two wars, 
rogue nuclear programs in Iran and elsewhere.
    Blair warned that, ``Time is probably our greatest threat. 
The longer it takes for the recovery to begin, the greater the 
likelihood of serious damage to U.S. strategic interests.''
    He also warned of regime-threatening instability. And 
today's economic crisis has already brought down governments in 
Iceland, in Latvia, and helped spark riots in Europe. Just this 
week, the Prime Minister of Hungary offered his resignation 
over the economic situation there. So, the crisis is likely to 
be a driving force, a geopolitical force, for some time to 
come, and the political ramifications could well become even 
more serious.
    If there is one lesson that we should take away from the 
experience of a number of these countries, it is to not 
underestimate the severity of these economic challenges, or the 
urgency of tackling them head on rather than deferring tough 
decisions.
    Last week, several of us had the opportunity to speak with 
Dominique Strauss-Khan, the managing director of the 
International Monetary Fund, and Bob Zoellick, president of the 
World Bank. We spoke about the snowballing financial crisis 
brewing in Central and Eastern Europe. They made it clear that 
if we don't act quickly, we risk replacing an era of promise 
and progress with one of soaring unemployment, instability, and 
a rollback of the influence and ideals that we have spent 
decades building. We also spoke about the need to strengthen 
our international financial defenses, particularly the IMF. And 
I'm pleased to join with Senator Lugar in supporting a dramatic 
increase in the IMF's capacity to respond to this crisis, just 
as Treasury Secretary Geithner has proposed.
    The IMF, along with the World Bank, is the best channel 
that we have to bolster emerging and developing markets as the 
economies and the banking systems and the political systems are 
all strained around them.
    The upcoming G-20 meeting in London is an important 
opportunity to enlist global support for decisive action on 
this issue. Strengthening the IMF, however, is only one 
component of a much larger challenge. We have to fix our 
banking systems, not just in America, but in every major 
financial center.
    To be sure, our economy and the global economy have reached 
this moment of crisis, but, as bad as the news has been, it is 
clear that, if we come up with the right solutions, if we move 
together, if we move with a certainty and confidence in the 
choices that we make, then there will be great opportunities, 
going forward.
    There's a great advantage to being the first to move in 
global finance. Washington has waited too long, already, while 
financial institutions remain frozen. Lending will not happen 
until banks have removed their toxic assets, and we hope that 
the Treasury plan, announced this week, will help us do just 
that.
    As we put our own banking system in order, there will also 
be new challenges waiting for us abroad. We're going to have to 
confront the potential for increased political instability, 
large-scale failures of other countries' financial systems, 
escalating financial protectionism, economic nationalism or 
trade wars that could help to deepen the crisis, increased 
poverty and hunger in the developing world, and competitors 
exploiting financial instability in ways that diminish our 
influence.
    And these problems are not confined to traditionally 
unstable corners of the globe. Europe is facing some deep 
financial challenges. Turkey, Indonesia, Pakistan, three of our 
most important partners in the Muslim world, all face acute 
balance-of-payments crises.
    We also need to confront the fact that there's a great deal 
of anger out there among people who blame the model that we 
exported. Even as we restore confidence in our markets, we need 
to find a strategy to project leadership, share burdens, and 
spread stability as the problems reverberate on a global basis. 
And as we balance the domestic and global demands of this 
crisis, we need to be warned that, in cutting corners for 
short-term savings, we risk creating far greater costs down the 
road.
    We're pleased with the panel that we have here today. The 
witnesses are a superb collection of innovative thinkers, all 
of whom think about, work in and around this sector on a daily 
and lifetime basis, and they will help us paint a fuller 
picture of the new foreign policy dynamics that these 
challenges create.
    Martin Wolf is the associate editor and chief economics 
commentator at Financial Times. George Soros is the chairman, 
Soros Fund Management and Open Society. And Lawrence Lindsey is 
president and CEO of Lindsey Group and former director of the 
National Economic Council.
    Senator Lugar.

          OPENING STATEMENT OF HON. RICHARD G. LUGAR,
                   U.S. SENATOR FROM INDIANA

    Senator Lugar. Well, thank you, Mr. Chairman. And I join 
you in welcoming a very distinguished panel, who will offer 
insights into the global financial crisis and recommendations 
for United States policy.
    As you pointed out, at this stage no one knows for certain 
how long or how deep this economic downturn will be. With the 
administration's announcement of a plan to manage the so-called 
``bad assets'' on the balance sheets of banks and corporations, 
we are at a critical moment in the resolution of our banking 
crisis. The fundamental strengthening of our banking system is 
a necessary precondition to the return to solid economic 
growth.
    I am hopeful that, as this plan is implemented, the U.S. 
Government will be judicious about sinking taxpayer money into 
banks and corporations that are insolvent. As many experts have 
suggested, we need a careful triage of financial entities to 
determine which ones can stand on their own, which could become 
healthy with a reasonable infusion of additional capital, and 
which are insolvent beyond repair. Banks that are insolvent 
should be either liquidated or, in some cases, merged with 
other banks. Depositors should be protected, but shareholders 
may have to take their losses. U.S. taxpayer funds should only 
be used for recapitalization of troubled banks in limited 
cases, and the terms for government assistance should be 
uniform and transparent. The goals must be to restore 
discipline to the banking sector, reestablish investor 
confidence in healthy banks, and ensure that banks have the 
capacity to contribute to economic growth. Actions to address 
our own economy are vital, but, given the linkages between our 
financial sector and that of other countries, we cannot achieve 
economic recovery in isolation from the rest of the world.
    The United States must provide leadership in restoring the 
health of the international financial system. In particular, 
the lending capacity of the IMF must be increased. The Obama 
administration has proposed increasing this capacity by $500 
billion, of which the United States commitment would be $100 
billion. I will be very interested to learn from the witnesses 
views of this proposal and whether they believe it's 
appropriately sized for the problem.
    As we work with other nations, our government must pay 
attention to how the global economy, and our role in it, can be 
rebalanced. Some level of deficit spending is appropriate at 
this stage of the crisis, but the United States budget deficits 
that are projected cannot be sustained without extreme risk to 
both Americans and the international community. We cannot 
depend indefinitely on China investing heavily in United States 
Government debt. Some thought must be given to how we work with 
China and other nations to establish more sensible global 
balance that depends less on demand by American consumers.
    We also must be cognizant of the incredible pressures this 
global financial crisis will place on stability and peace. We 
have to expect additional political, economic, or even national 
security shocks. We know, from history, that societies under 
severe economic stress often do not make good political 
choices. In the face of job losses, wealth evaporation, 
homelessness, hunger, and other outcomes, the fabric of many 
nations will be tested. The crisis is likely to stimulate 
nationalism that could lead to demagogic policies or 
governments. And under such conditions, some nations might 
experience a retreat from democracy. This, in turn, increases 
the possibility of violent conflict within and between nations. 
Consequently, maintaining international cooperation in 
addressing the economic crisis affects more than our own 
prosperity.
    The upcoming G-20 meeting must be a success, not just in 
the proposals that are adopted, but also in the tone that is 
established for subsequent cooperation. The meeting should 
offer a clear message that the major economies will cooperate 
on financial restructuring and resist protectionism.
    The United States must prepare itself for changes in its 
international role. We should ask ourselves, What will be the 
basis of United States national influence in the future? Why 
will nations continue to listen to us? What leverage over 
rivals can we preserve? And how can we ensure that we will 
still be able to rally friends behind vital United States 
objectives?
    The global crisis has increased the skepticism in emerging 
economies about American-style capitalism and is likely to 
reduce enthusiasm, within the United States and beyond, for 
liberalized trade measures that would greatly benefit our 
country.
    I do not believe that we are facing a precipitous collapse 
of United States influence, but we have to be far more 
deliberate in executing a rational plan that gets the most out 
of United States strengths and compensates for our new 
weaknesses.
    I thank the chairman for calling this hearing and very much 
look forward to the testimony of our witnesses.
    The Chairman. Thank you very much, Senator Lugar.
    Mr. Wolf, would you lead off? Mr. Soros, next, and then Mr. 
Lindsey. And we're glad you were able to arrange to be here, 
Mr. Wolf; I know it's not a normal role within your sphere, but 
we admire your voice and perceptions and, I must say, your home 
base is an important document for all of us to read, these 
days, and we appreciate its quality.

STATEMENT OF MARTIN WOLF, ASSOCIATE EDITOR AND CHIEF ECONOMICS 
      COMMENTATOR, FINANCIAL TIMES, LONDON, UNITED KINGDOM

    Mr. Wolf. Thank you, Mr. Chairman and members of the 
committee. I'm very, very honored to be here to discuss----
    The Chairman. Can you press your mike? The button, there?
    Mr. Wolf. I apologize.
    The Chairman. There you go.
    Mr. Wolf. Thank you, Mr. Chairman and members of the 
committee. It is my great honor to be here to discuss the 
current economic crisis and its impact on American foreign 
policy.
    May I add that, as a British citizen, and so, as a grateful 
foreigner, I am particularly honored and well aware of the 
extraordinary role of the United States in promoting freedom 
and democracy across the globe over the past seven decades.
    Yet, it is clear that we are experiencing the most 
dangerous financial and economic crisis since the 1930s. It is 
also a crisis for foreign policy, as you have noted. A deep 
recession--and that is sure--will shake political stability 
across the globe, and, as important, it threatens the very 
longstanding U.S. goal of sustaining and creating an open and 
dynamic global economy. And perhaps most important, the United 
States, rightly or wrongly, is currently seen as the source of 
the problem, more than of the solution, across the globe.
    The crisis is, therefore, a devastating blow to U.S. 
credibility and legitimacy as a world leader. If the U.S. 
cannot manage free-market capitalism, it is asked, who can? If 
free-market capitalism can bring such damage even here, why 
adopt it? If openness to the world economy brings such dangers, 
why risk it?
    As shock turns to anger, not just in the U.S., but across 
the world, these questions are unquestionably being asked. If 
the U.S. wishes to obtain the right answers, it must not only 
address the crisis at home, as is, of course, widely 
understood, but also do what it can to rescue innocent victims 
abroad. And this is not just a matter of charity, it is a 
matter of the highest enlightened self-interest, as American 
policymakers have understood for many decades.
    The decisions taken in the next year will, I believe, shape 
our world for decades. So, what has to be done? I'm going to 
make a few suggestions, in the limited time available to me, 
focusing, above all, on the G-20 and on the International 
Monetary Fund.
    First of all, we must realize that this is, indeed, a 
crisis of the global economy that the U.S. played a dominant 
role in creating. If that achievement, with all the promise it 
offers, is to survive, the crisis will also, by definition, 
have to be solved globally.
    Second, the meeting of the G-20 heads of government in 
London is a recognition of the global nature of this crisis. 
Management of the world economy can no longer be achieved by 
the leaders of advanced economies alone. While not all the 
countries there present are systematically important, all 
systemically important countries will be there. The world looks 
for achievement at this summit; it must not be disappointed.
    Third, the immediate priorities for this summit are to 
agree on how to sustain demand, fix the global financial 
system, and avoid a collapse into global protectionism. The 
longer term aim must be to reconsider the regulation and 
structure of the global financial system and reform the system 
of international economic and financial governance. Some 
progress has already been made on these fronts, but it is not 
nearly enough.
    Fourth, there is a very good chance that this crisis will 
lead to a much deeper decline in the world economy than is even 
now expected, and thereafter, a mere--no more than a slow and 
limping recovery. This risk of extreme outcomes has to be 
eliminated, if at all possible.
    Fifth, if emerging economies are to trust themselves or the 
world economy in the future, it is essential to offer generous 
assistance now. At the moment, as I have remarked, they blame 
the West for what has happened to them. It has been helpful 
that the Federal Reserve and other central banks have advanced 
loans to a few selected central banks, but much more than that 
is needed.
    But, sixth, the current lending capacity of the IMF is only 
about $250 billion, which, as I think everybody knows, is 
grossly inadequate. The U.S. administration has proposed that 
this be raised to $750 billion. And that is the very least that 
is now needed. It is important to remember that global foreign 
exchange reserves overwhelmingly held by emerging economies 
rose from about $1.5 trillion to $7 trillion between January 
1999--that is, shortly after the Asian financial crisis--and 
the peak they reached last year. And this is surely, at least 
in part, an indication of the extent of the demand for reserves 
around the world. It will be far more efficient if reserves 
were pooled than if every country tried to insure itself in 
this extremely expensive way. And that is what the IMF exists 
to do, and it should be used for this purpose.
    Seventh, in addition to increasing its resources, the 
government of the IMF must be changed. Asian countries, in 
particular, still remember with bitterness the humiliation they 
received a decade ago at the hands of the IMF and, in their 
view, the U.S. Treasury. They will want a bigger say in the 
running of the fund if they are to trust it. An important step 
is a huge reduction in Europe's voting weights, now about a 
third of the total, and also important is an end to the 
traditional practice of always having an American head of the 
World Bank and a European head of the IMF.
    Eighth, serious thought must be given to making an annual 
allocation of SDRs--that is specialty drawing rights--the IMF's 
own reserve asset. This could satisfy the world demands for 
reserves at no cost in resources, and I have noted the recent 
remarks by the governor of the People's Bank of China on 
exactly this point.
    Traditionally, the U.S. has regarded the SDR as a rival to 
the dollar as a reserve asset and treasured the ability to 
finance its external deficits through simple expansion of its 
own money supply. But, the economic developments of the past 
decade, and particularly the final consequences of the global 
imbalances, should have shaken this complacency. The ability to 
run very large current account deficits has turned out, in my 
view, to be a calamity, since it offers at least a part of the 
explanation for the current financial crisis in the United 
States and the world.
    Furthermore, the United States needs to be able to export 
its way out of its current recession--otherwise, it is likely 
to be stuck with these terrible fiscal deficits for the 
indefinite future--to offset the higher domestic private saving 
and structural current account deficit. Increasing the 
purchasing power of emerging countries through an allocation of 
even as much as a trillion SDRs, a little less than 2 percent 
of the world GDP, would go a long way toward solving this 
problem. I fear that if this does not happen, a return to 
generalized protection becomes likely as a way for deficit 
countries, even the United States, to strengthen demand for 
domestic output and employment.
    What I have outlined above is only a small part of the 
agenda, but it is a vital part. The more imaginative and 
energetic the U.S. now is, the better able it will be to 
restore its reputation and influence across the globe. This is 
unquestionably a time of decision. The United States has a 
choice of either doing everything in its power to restore and 
strengthen the global economic system it itself worked so hard 
to create or fails to do so. Choices must be made between 
outward-looking and inward-looking solutions. As we all know, 
we tried the former in the 1930s, and this time, as we know, we 
must try the latter.
    Thank you.
    [The prepared statement of Mr. Wolf follows:]

Prepared Statement of Martin Wolf, Associate Editor and Chief Economics 
          Commentator, Financial Times, London, United Kingdom

    We are experiencing the most dangerous financial and economic 
crisis since the 1930s. But it is also a crisis for foreign policy: A 
deep recession will shake political stability across the globe; and it 
threaten the longstanding U.S. goal of an open and dynamic global 
economy. Perhaps most important, the U.S. is currently seen as the 
source of the problem rather than of the solution.
    This crisis is, therefore, a devastating blow to U.S. credibility 
and legitimacy across the world. If the U.S. cannot manage free-market 
capitalism, who can? If free-market capitalism can bring such damage, 
why adopt it? If openness to the world economy brings such dangers, why 
risk it? As the shock turns to anger, not just in the U.S., but across 
the world, these questions are being asked. If the U.S. wishes to 
obtain the right answers, it must address the crisis at home, and do 
what it can to rescue innocent victims abroad. This is not a matter of 
charity. It is a matter of enlightened self-interest.
    The global economic crisis has become extremely severe: The 
financial system is on life support, with trillions of dollars of 
support by governments; three of the world's four most important 
central banks--the Federal Reserve, the Bank of Japan, and the Bank of 
England--have interest rates at close to zero, with the European 
Central Bank likely to follow; governments are also loosening fiscal 
policy aggressively, with the deficits of advanced countries that are 
members of the G-20 forecast at 6.7 percent of GDP this year and 7.6 
percent in 2010.
    This massive policy support comes in response to increasingly dire 
economic conditions: The International Monetary Fund forecasts that 
global output will shrink by between 0.5 percent and 1 percent this 
year, a downgrade of 1 to 1.5 percentage points in 2 months; it also 
forecasts that the economies of advanced countries will shrink by 
between 3 and 3.5 percent, the worst performance since the 1930s.
    None of this is surprising. Not only did the global financial 
system seize up at the end of last year, but the Asian Development Bank 
has reported that the total loss of worldwide market wealth is $50 
trillion, close to a year's world output. The loss of stock market 
wealth alone is $25 trillion. Demand for manufactures, world 
manufactured output and world trade in manufactures fell off a cliff at 
the end of last year: Germany's industrial output was down 19.2 percent 
year-on-year in January, South Korea's down 25.6 percent and Japan's 
down 30.8 percent.
    Inevitably, and tragically, the most adversely affected are 
countries that have opened themselves up to global capital flows, 
particularly emerging countries in central and eastern Europe. These 
were the only significant group of emerging economies to be net 
importers of capital in the 2000s, with results often seen before over 
the past three decades when capital takes fright. These countries face 
the risk of a meltdown, precisely because they trusted both Europe and 
the capital markets. The consensus of forecasts for growth of Eastern 
Europe this year has fallen from 6 percent to minus 0.5 percent since 
last June. It will surely fall further. But all emerging economies are 
adversely affected by the loss of external demand, the shrinkage in 
global capital flows and the associated jumps in the price of 
borrowing.
    In a recent article for the Financial Times, which launched our 
series on the ``Future of Capitalism,'' I argued that it is impossible 
to know where we are going. In the chaotic 1970s, few guessed that the 
next epoch would see the taming of inflation, the unleashing of 
capitalism and the death of communism. What will happen now depends on 
choices unmade and shocks unknown.
    Yet the combination of a financial collapse with a huge recession 
will surely change the world. The Great Depression transformed 
capitalism and the role of government for half a century. It led to the 
collapse of liberal trade, fortified the credibility of socialism and 
communism and shifted many policymakers toward import substitution as a 
development strategy. It led to xenophobia and authoritarianism. The 
search for security will strengthen political control over markets. A 
shift toward politics also entails a shift toward the national, away 
from the global. This is already evident in finance. But protectionist 
intervention is likely to extend well beyond the cases seen so far: 
these are still early days.
    In emerging countries, the number of people in extreme poverty will 
rise, the size of the new middle class will fall and governments of 
some countries will default. Confidence in local and global elites, in 
the market and even in the possibility of material progress will 
weaken, with potentially devastating social and political consequences.
    The ability of the West in general and the U.S. in particular to 
influence the course of events will also be damaged. The collapse of 
the Western financial system, while China's apparently flourishes, 
marks a humiliating end to the ``unipolar moment.'' As Western 
policymakers struggle, their credibility lies broken.
    These changes will endanger the ability of the world not just to 
manage the global economy but also to cope with strategic challenges: 
Fragile states, terrorism, climate change, and the rise of new great 
powers. At the extreme, the integration of the global economy on which 
almost everybody now depends might be reversed.
    The decisions taken in the next year will shape the world for 
decades. So what has to be done? I suggest the following, focusing on 
the role of the International Monetary Fund.
    First, we must realise that this is a crisis of the global economy 
that the U.S. played a dominant role in creating. If that achievement, 
with all the promise it offers, is to survive, the crisis must be 
solved globally.
    Second, the meeting of the G-20 heads of government in London is a 
recognition of this fact. Management of the world economy cannot be 
achieved by advanced economies alone. While not all the countries there 
present are systemically important, all systemically important 
countries will be there. The world looks for achievement at this 
summit. It must not be disappointed.
    Third, the immediate priorities are to sustain demand, fix the 
global financial system and avoid a collapse into global protection. 
The longer term aim must be to reconsider the regulation and structure 
of the financial system and reform the system of international economic 
and financial governance. Some progress has been made on these fronts. 
But it is not nearly enough.
    Fourth, there is a very good chance that this crisis will lead to a 
much deeper decline in the world economy than is now expected and a 
slow and limping recovery. This risk must be eliminated, if at all 
possible.
    Fifth, if the emerging economies are to trust themselves to the 
world economy, it is essential to offer generous help now. At the 
moment, they blame the west for what has happened. It has been helpful 
for the Fed and other central banks to advance loans to a few selected 
central banks. But much more is needed.
    Sixth, the current lending capacity of the IMF is about $250bn, 
which is grossly inadequate. The U.S. Treasury has proposed that this 
be raised to $750bn. That is the very least now needed. Remember that 
global foreign exchange reserves, predominantly held by emerging 
economies, rose from $1.5 trillion to $7 trillion between January 1999, 
after the Asian financial crisis, and their peak last year. This is an 
indication of the demand for reserves. It would be far more efficient, 
however, if reserves were pooled than if every country tried to insure 
itself, in this expensive way. That is what the IMF exists to do. It 
should be used for this purpose.
    Seventh, in addition to increasing its resources, the governance of 
the IMF must be changed. Asian countries, in particular, still remember 
the humiliation treatment they received a decade ago at the hands of 
the IMF and the U.S. Treasury. They will want a much bigger say in the 
running of the Fund. An important step is a huge reduction in Europe's 
voting weights, which are now about a third of the total. Also 
important is an end to the traditional practice of having an American 
head the World Bank and a European head the IMF.
    Eighth, serious thought must be given to making an annual 
allocation of SDRs (special drawing rights)--the IMF's own reserve 
asset. This would satisfy the world's demand for reserves at no cost in 
resources. Traditionally, the U.S. has regarded the SDR as a rival to 
the dollar as a reserve asset and treasured the ability to finance its 
external deficits through simple expansion of the supply of dollars. 
But the economic developments of the past decade should have shaken 
U.S. complacency. The ability to run very large current account 
deficits, has turned out to be a calamity, since, in my view, it offers 
a large part of the explanation for the current financial crisis in the 
U.S. and so the world. Furthermore, the U.S. needs to be able to export 
its way out of its current recession. Otherwise, it is likely to be 
stuck with a huge fiscal deficit for the indefinite future, to offset 
the higher domestic private saving and structural current account 
deficit. Increasing the purchasing power of emerging countries, through 
an annual allocation of about 1 trillion SDRs (a little less than 2 
percent of world GDP) would go a long way toward solving this problem. 
I fear that if this does not happen, a return to generalised protection 
would become likely, as a way for deficit countries, such as the U.S., 
to strengthen demand for domestic output and employment.
    What I have outlined above is only a small part of the agenda. But 
it is a vital part. The more imaginative and energetic the U.S. now is, 
the better able it will be to restore its reputation and influence 
across the globe. This is a time of decision. The U.S. can either do 
everything in its power to restore and strengthen the global economic 
system it worked so hard to create. Choices must be made between 
outward-looking and inward-looking solutions. We tried the former in 
the 1930s. This time we should try the latter.

    The Chairman. Very good. Thank you, sir. Very helpful, and 
we appreciate it.
    Mr. Soros, welcome. Glad to have you here. As a personal 
friend, it's good to see you. And also, we have enormous 
respect for your thinking on these areas, so have at it.

STATEMENT OF GEORGE SOROS, CHAIRMAN, SOROS FUND MANAGEMENT AND 
                   OPEN SOCIETY, NEW YORK, NY

    Mr. Soros. Thank you, Mr. Chairman.
    The Chairman. Can you push your mike? There's a button 
there. Thanks. Why don't you just leave them all on, and then 
you guys can intervene when you want.
    Mr. Soros. Thank you for the opportunity to testify today 
on the global financial crisis.
    I shall try to summarize briefly the main points of the 
argument I present at greater length in my written testimony. 
As you will see, my points are very similar to those of Martin 
Wolf.
    First, the current financial crisis is more severe and more 
widespread than any we've experienced since the 1930s. The 
international financial system has actually broken down and had 
to be put on artificial life support.
    Second, the countries on the periphery of the international 
financial system are even more severely affected than those at 
the center. The rich countries could effectively guarantee 
their financial institutions against default, but the less-
developed countries, ranging from Eastern Europe to Africa, 
could not extend similarly convincing guarantees. As a result, 
capital is fleeing the periphery and it is difficult to roll 
over maturing loans--$1.4 trillion of bank loans are coming due 
in 2009 alone.
    Third, to stop the capital flight, the international 
financial institutions, particularly the IMF, must be 
reinforced and reinvigorated. The primary responsibility lies 
with the United States, both as the originator of the crisis 
and as the dominant financial power. If we fail to live up to 
our responsibility, we shall cease to be the dominant financial 
power. If the multilateral system falls apart, every country 
will pursue its own interests unilaterally and China is liable 
to come out ahead. As things stand at present, China and the 
United States have a common interest in assisting the periphery 
countries. We must seize the opportunity, even as we address 
our own recession.
    Fourth, the upcoming G-20 meeting on April 2 is a make-or-
break event. Unless it comes up with practical measures to 
support the countries at the periphery, markets are going to 
suffer another sinking spell, just as they did on February 10, 
when the authorities failed to produce practical measures to 
recapitalize the U.S. banking system.
    In the preparations for the G-20 meeting, profound 
attitudinal differences have surfaced between the United States 
and Europe, particularly Germany. To put it in an 
oversimplified and exaggerated form, the United States wants to 
reinflate, Germany and Europe want to regulate. Actually, we 
need to do both, but the reinflation is urgent, and regulatory 
reforms will take time. Therefore, it should be possible to 
overcome the differences and find common ground in the need to 
protect the periphery countries from a calamity that is not of 
their own making.
    As things stand now, the G-20 meeting will, in fact, 
produce some concrete results. The resources of the IMF are 
likely to be doubled, mainly by using the mechanism of new 
arrangements to borrow, which will require congressional 
approval. The capital increase will be sufficient to enable the 
IMF to come to the aid of specific countries in difficulties, 
but it will not provide a systemic solution for the developing 
world.
    Fifth--and this is the most important point I want to 
make--a systemic solution is readily available in the form of 
special drawing rights, or SDRs. The mechanism exists and has 
already been used on a small scale. SDRs are highly complicated 
and difficult to understand, but they boil down to the 
international creation of money.
    The United States, Europe, and Japan are in a position to 
create their own money, and they are actively engaged in doing 
so in order to offset the collapse of credit. Less-developed 
countries can't create money that is internationally accepted. 
They are the ones who need the special drawing rights. Rich 
countries should, therefore, lend their allocations to the 
countries in need. They could do so without incurring any costs 
or deficits. The recipient countries would have to pay the IMF 
interest at a very low rate, the composite average Treasury 
bill rate of all convertible currencies. They would have free 
use of their own allocations, but the standing of the borrowed 
allocations would be appropriately supervised. This should 
ensure that the moneys are well spent. It's difficult to think 
of a scheme where the cost-benefit ratio is so favorable.
    Therefore, in addition to the one-time increase in the 
IMF's resources through the use of the new arrangements to 
borrow, there ought to be substantial annual SDR issues, in the 
range of $250 billion annually, as long as the global recession 
lasts. So make this scheme countercyclical, the SDR issues 
could be made callable when the global economy overheats.
    It's too late to agree on issuing SDRs at the G-20 meeting 
on April 2, but if it were raised by President Obama and 
endorsed by others, it would be sufficient to give heart to the 
markets and turn the meeting into a resounding success.
    I very much hope that you will embrace the idea and 
encourage President Obama to propose it. It would make a 
tremendous difference to the world, and it would help the 
United States to resume its leadership position in the world.
    While this is the main message I want to deliver, I also 
want to endorse President Obama's request for increased 
international assistance. The items included in the budget are 
well thought out. I would particularly comment, the increased 
support of the Global Fund to Fight AIDS, Tuberculosis, and 
Malaria, where our contribution mobilizes twice the amount from 
other donors, it would be a shame to cut it.
    And I'll be happy to answer your questions.
    [The prepared statement of Mr. Soros follows:]

Prepared Statement of George Soros, Chairman, Soros Fund Management and 
                       Open Society, New York, NY

    The current financial crisis is different from all the others we 
have experienced since the end of World War II. On previous occasions, 
whenever the financial system came to the brink of a breakdown, the 
authorities got their act together and prevented it from going over the 
brink. This time the system actually broke down when Lehman Brothers 
was allowed to fail on September 15, 2008. That event transformed what 
had been a mainly financial phenomenon into a calamity that affected 
the entire economy.
    Within days the financial system suffered what amounts to cardiac 
arrest and had to be put on artificial life support. That came as a 
shock to the business community and the general public. Everybody 
retrenched. International trade was particularly hard hit and is now 
down nearly $4 trillion from a year ago. The decline in employment has 
not yet hit the bottom, and the International Monetary Fund (IMF) 
estimates that globally more than 50 million people could loose their 
jobs by yearend.
    The countries on the periphery of the international financial 
system are even more severely affected than those at the center. The 
rich countries could effectively guarantee their financial institutions 
against default but the less developed countries, ranging from Eastern 
Europe to Africa, could not extend similarly convincing guarantees. As 
a result, capital is fleeing the periphery and it is difficult to roll 
over maturing loans. Exports suffer from the lack of trade finance. 
Deutsche Bank estimates that $1,440 billion of bank loans are coming 
due in 2009 alone.
    The capital flight is abetted by national regulators intent on 
protecting their own financial systems by tacitly encouraging banks to 
repatriate funds. When history is written, it will be recorded that--in 
contrast to the Great Depression--protectionism first manifested itself 
in finance rather than trade. To stem the tide, the International 
Financial Institutions (IFIs) must be reinforced and reinvigorated. 
Unless effective measures are taken to protect the periphery countries 
against a storm that originated at the center, the international 
financial and trade system is liable to fall apart.
    The primary responsibility lies with the United States, both 
because it is the originator of the crisis and because it enjoys veto 
rights in the IMF. It is not just a moral issue but a matter of self-
interest. We have derived great benefits from being at the center of 
the global financial system and we ought to do whatever we can to 
preserve that position. If the multilateral system falls apart, every 
country will pursue its interests unilaterally. Then China will be much 
better situated than we are. While we are, regrettably, still lagging 
behind the curve in dealing with the crisis, China is ahead of the 
curve. Its banking system is in relatively good shape and it can 
activate its large stimulus program faster than we can ours. The 
leadership realizes that it must ensure economic growth in order to 
avoid social unrest and it is both willing and able to apply additional 
stimulus if the current program is not sufficient. To support its 
export industries it will extend credit to periphery countries just as 
it did to the United States. As things stand at present, China and the 
United States have a common interest in protecting the periphery 
countries from a storm that originated at the center. We must seize 
this opportunity even as we address our own recession.
    While the primary responsibility is ours, we cannot act without the 
support of the European countries which carry a disproportionate weight 
on the governing board of the IMF. Unfortunately the IMF is ill-suited 
to the novel task with which it is now confronted. It is used to 
dealing with the failures of government policy, especially at the 
periphery; now it is confronted with the failure of the private sector 
at the center. To make matters worse, the IMF is deeply unpopular with 
public opinion both at the periphery and at the center--and that 
includes Congress. Moreover, there is a profound disagreement between 
the United States and Europe, particularly Germany, about the nature of 
the problem and the right remedies to apply.
    The United States has recognized that the collapse of credit in the 
private sector can be reversed only by using the credit of the State to 
the full. Germany, traumatized by the memory of hyperinflation in the 
1920s that led to the rise of Hitler in the 1930s, is reluctant to sow 
the seeds of future inflation by incurring too much debt. Both 
positions are firmly held and can be supported by valid arguments. In 
the case of Germany's opposition to the use of the German state's 
credit for the rest of Europe or the rest of the world, they are valid 
only from a narrow German point of view. Be that as it may, the 
controversy has dominated the preparations for the forthcoming G-20 
meetings on April 2.
    That meeting is a make or break event. Unless it comes up with 
practical measures to support the countries at the periphery of the 
global financial system, markets are going to suffer another sinking 
spell just as they did on February 10, 2009, when the authorities 
failed to produce practical measures to recapitalize the United States 
banking system. To put it in an oversimplified and exaggerated form, 
the United States wants to reinflate, Germany and Europe want to 
regulate. It should be possible, however, to find common ground in the 
need to protect the periphery countries from a calamity that is not of 
their own making. Actually, we need to both reinflate and regulate but 
reinflation is urgent and regulatory reforms will take time to 
implement. The urgent task has to be carried out mainly by the IMF, 
imperfect and beleaguered as it is, because it is the only institution 
available. The regulatory reforms will involve reforming the IMF and 
establishing other institutions.
    Periphery countries need to protect their financial systems 
including trade finance, and to enable them to engage in 
countercyclical fiscal policies. The former requires large contingency 
funds available at short notice for relatively short periods of time. 
The latter requires long-term financing.
    When the adverse side effects of the Lehman bankruptcy on the 
periphery countries became evident, the IMF introduced a new short-term 
liquidity (STL) facility that allows countries that are otherwise in 
sound financial condition to borrow five times their quota for 3 months 
without any conditionality. But the size of the STL is too small to be 
of much use, especially while a potential stigma associated with the 
use of IMF funds lingers. That is now being remedied, but even if it 
worked, any help for the top-tier countries would merely aggravate the 
situation of the lower-tier countries. International assistance to 
enable periphery countries to engage in countercyclical policies has 
not even been considered.
    The fact is that the IMF simply does not have enough money to offer 
meaningful relief. It has about $200 billion in uncommitted funds at 
its disposal, and the potential needs are much greater. As things stand 
now, the G-20 meeting can be expected to produce some concrete results: 
The resources of the IMF are likely to be effectively doubled, mainly 
by using the mechanism of the New Arrangements to Borrow (NAB) which 
can be activated without resolving the vexing question of 
reapportioning voting rights in the IFIs. NAB will require 
congressional approval.
    The capital increase will be sufficient to enable the IMF to come 
to the aid of specific countries in difficulties, but it will not 
provide a systemic solution for the developing world. Periphery 
countries are reluctant to apply to the IMF for support as seen from 
the fact that the recently introduced short-term liquidity facility 
that allows qualified countries to borrow without any conditionality 
has had no takers. A more radical solution is needed. Such a solution 
is readily available in the form of Special Drawings Rights (SDRs). The 
mechanism exists and has already been used on a small scale. There is a 
pending issue of SDR 21.4 billion ($32.2 billion), which only requires 
approval by the United States to become effective.
    SDRs are highly complicated and difficult to understand but they 
boil down to the international creation of money. Countries that are in 
a position to create their own money do not need them but the periphery 
countries do. The rich countries should therefore lend their 
allocations to the countries in need. This would not create a budget 
deficit for them. The recipient countries would have to pay the IMF 
interest at a very low rate: The composite average Treasury bill rate 
of all convertible currencies. They would have free use of their own 
allocations, but the IFIs would supervise how the borrowed allocations 
are used. (The World Bank, which has devoted a lot of resources to 
developing poverty alleviation programs, would be better suited for 
this task than the IMF.) This should ensure that the borrowed funds are 
well spent. It is difficult to think of a scheme where the cost/benefit 
ratio is so favorable.
    In addition to a one-time increase in the IMF's resources there 
ought to be substantial annual SDR issues, say $250 billion, as long as 
the global recession lasts. To make the scheme countercyclical, the SDR 
issues could be callable in tranches when the global economy overheats. 
It is too late to agree on issuing SDRs at the April 2 G-20 meeting, 
but if it were raised by President Obama and endorsed by others, it 
would be sufficient to give heart to the markets and turn the April 2 
meeting into a resounding success.
    The SDR proposal, arcane as it is, makes eminent sense. The United 
States and Europe are actively engaged in creating money to replace 
credit. SDRs would provide money to less-developed countries which 
cannot create their own--at no cost to those who make their allocations 
available.
    One of the obstacles standing in the way is the well-known negative 
attitude of Congress toward anything connected with the IMF. The SDR 
issue does not require legislation. Nevertheless, it would be very 
helpful if Congress expressed a willingness to authorize the NAB, which 
does require congressional approval and supported the SDR issue in 
principle.
    As we have seen, the IMF is far from perfect, but it is more needed 
than ever. It has a new mission in life: To assist the less-developed 
countries to protect their banking systems and enable them to engage in 
countercyclical fiscal policies. How well it fulfills that mission will 
have a major impact both on the survival of the international financial 
and trading system and on our leadership position within that system.
    While my testimony focuses mainly on the role of the IMF, we also 
need to dramatically expand foreign assistance. President Obama pledged 
to double United States foreign assistance and the proposed budget 
moves us toward that target, if not as quickly as I would like. I urge 
you to do no less than he requested and to look to supplemental 
appropriations to meet more ambitious goals. We need to help countries 
deal with the immediate impact of the financial crisis and help ensure 
that we continue to make progress on critical areas such as HIV/AIDS. 
Now is the time to do more, not less.
    One particularly innovative funding instrument is the Global Fund 
to Fight AIDS, Tuberculosis and Malaria. It has demonstrated remarkable 
results in the last 7 years, working to fill a gap not met by our 
bilateral programs. But for the first time, it faces a funding 
shortfall--there are more qualified proposals than there is financing 
available. Historically, the United States has provided one-third of 
the financial needs, and we should recommit to that goal. A particular 
benefit here is that the United States contribution mobilizes new money 
from other donors, increasing our impact.

    The Chairman. Thank you very much, Mr. Soros.
    Mr. Lindsey.

STATEMENT OF LAWRENCE LINDSEY, FORMER DIRECTOR OF THE NATIONAL 
                ECONOMIC COUNCIL, WASHINGTON, DC

    Mr. Lindsey. Thank you, Mr. Chairman, Senator Lugar, 
members of the committee. I am grateful for this opportunity to 
be here today.
    I associate myself with the perceptions that were stated in 
your opening statements. I also associate myself with the bulk 
of the comments of my colleagues on the table. My comments are 
mostly a difference of nuance.
    I think that America is a cause as well as a country and we 
represent the concept of economic and political freedom, and 
actually that our security as a nation is inextricably linked 
with the survival and success of liberty around the world. 
That's why I think policymakers must be particularly careful 
not to take actions that undermine those causes when they deal 
with current crisis.
    In my testimony, which I ask to be included in the record, 
I point out that there are a number of ways we can do a 
disservice to our cause, and thereby to our country. And, 
listening to my colleagues' comments, I would like to briefly 
comment on a third.
    First, although it is very common to think that this crisis 
was created by America, I think that the data do not actually 
support this conclusion. Obviously, we are the largest economy 
on the planet; we, therefore, have a disproportionate share of 
any financial crisis that may exist. On the other hand, I 
included in my testimony two charts, one on the global housing 
bubble, which shows that, in fact, the bubble in the rest of 
the world was actually greater than it was in the United 
States. And second, in the amount of leverage in the real 
estate market, which shows, essentially, that there is no 
difference around the world between the amount of leverage we 
extended and the amount of leverage everyone did.
    The causes of this crisis were global in nature, they were 
miscalculations by the global economics profession, 
miscalculation in the consensus view of global central bankers, 
and in the private sector. I don't think it was uniquely United 
States the cause of this crisis.
    Second, I think that there are many calls today to reverse 
some of the policies that create greater economic and political 
liberty around the world. And because it was the expansion of 
liberty that led both to an unprecedented advance in global 
prosperity and the improvement in security in America over the 
last 25 years, I think it would be foolish for us to reverse 
it.
    In fact, the biggest threat to our security today derives 
from that part of the world in which political and economic 
liberty have made the smallest advances in the last 25 years, 
particularly the Middle East. I think we, therefore, do 
ourselves a disservice, both economically and to our long-term 
security as a nation, when we undermine liberty, either by our 
own actions or by failing to set an example in these areas.
    The third point that I would like to make today, that is 
not in my written testimony but was raised by my colleagues, is 
the strain that the United States is placing on total global 
resources today by our large and historically unprecedented 
proposed budget deficit. We are proposing a budget deficit, a 
public-sector borrowing requirement, in the President's budget 
alone, of 16 percent of our GDP. On top of that, not in that 
budget were the borrowings that will be undertaken by various 
institutions, such as the TALF, the new PPIP, and the PPIF, 
which are off-budget borrowings.
    I am not a critic of budget deficits. I would even--I've 
been called Keynesian, and I probably am, but I'm a Keynesian 
who believes in using a sharp pencil. And when you start with 
18 percent of GDP, and you start thinking about how one would 
finance it, obviously you can only get there through placing 
enormous strains on global resources or directly resorting to 
the printing press. Last Wednesday, the Fed announced that it 
would--seeing the same problem, would actually start using the 
printing press.
    I think we need to take the budget deficit, therefore, that 
we are contemplating, particularly in the long term, into 
account in its effect on global economic recovery and our claim 
on global resources.
    These are the general principles I have in mind. I look 
forward to answering any specific questions the committee might 
have. And again, I thank you for the opportunity to be here 
today.
    [The prepared statement of Mr. Lindsey follows:]

   Prepared Statement of Lawrence B. Lindsey, Former Director of the 
               National Economic Council, Washington, DC

    Thank you, Mr. Chairman and members of the committee. It is my 
honor to be here to discuss the current economic crisis and its impact 
on American foreign policy.
    Let me begin by stating the basic principle that underlies my 
thinking. I believe that America is a Cause as well as a Country. From 
our inception as a new nation, we have been a champion of the cause of 
both economic and political liberty. Many generations of American 
patriots have given their lives to not only defend our own freedom, but 
to end tyranny abroad. They did so not only because they believed that 
it was the right thing to do, but also because our own freedom and our 
own security are inextricably linked to the success of liberty around 
the globe.
    I therefore believe that the biggest threat from the current crisis 
is the threat that it poses to liberty as governments react to events. 
Economic distress makes it easier for demagogues to come to power who 
are not friendly to either America the Country or to the Cause we 
represent. Even in the world's established liberal democracies there is 
a risk that elected leaders adopt narrow self-interested parties that 
might seem to be a short-term remedy to a domestic political problem, 
but actually exacerbate a global downward spiral.
    Therefore, if we truly want to bolster the cause of American 
security we must by our own actions work to continue the advance that 
liberty has made around the world over the past quarter century. There 
are a number of specific things that this Congress can do in this 
regard.
    First, we must stop thinking and speaking of the current global 
crisis as one that originated in America. We demean ourselves by doing 
so and only encourage those who wish us ill. America played its role 
and made its share of mistakes, and the fact that we are the largest 
economy on the planet means that our mistakes were quantitatively 
larger than that of any other country. But an examination of the facts 
suggest that we did so not because we are Americans, but because we are 
humans, and humans just about everywhere on the planet were doing the 
same thing.
    Consider the first two charts attached to this testimony. The first 
chart shows house price appreciation around the globe during the recent 
bubble from 1997 to 2008. We all know that one of the root causes of 
the current crisis was very rapid and unsustainable appreciation in 
real estate prices. But America does not stand out as at the top of 
this list; house price appreciation here was less than in most other 
places. The only two exceptions to rising house prices over this period 
were Japan, which was suffering from the ongoing collapse of its 
earlier bubble, and Hongkong, where it made a transition from 
governance as a British territory to its current status as a Special 
Administrative Region of China.
    The second chart shows that the excess leverage which contributed 
to our house price appreciation was also not an American phenomenon, 
but a human phenomenon. Our mortgage debt to GDP ratio was not 
exceptionally out of line with that of other countries.
    It is, and always has been, comforting for politicians in other 
countries to blame their own problems on America. There is nothing we 
can do about this since their only alternative is to blame themselves. 
But we shouldn't encourage it. This was not an American created 
crisis--it was a globally created crisis.
     Some of the blame lies with the economics profession which 
developed a wrong headed consensus view that inflation targeting was 
the right way to conduct monetary policy. Unfortunately, their 
definition of inflation was focused on goods and services prices and 
left no room for the incorporation of asset prices. The Federal Reserve 
was a part of this process and the bulk of the American economics 
profession also held to this view. But it was a global consensus within 
the economics profession, and not just the American economics 
profession.
    Not everyone shared this view. We debated this issue on the Federal 
Open Market Committee while I was a Governor, most notably at our 
meeting on September 24, 1996. In his famous Irrational Exuberance 
speech later that year Chairman Greenspan specifically warned of the 
risks inherent in not incorporating asset prices into our calculations, 
saying on December 5th: ``But how do we know when irrational exuberance 
has unduly escalated asset values which then become the subject of 
unexpected and prolonged contractions, as they have in Japan over the 
past decade? And how do we factor that assessment into monetary policy? 
We as central bankers need not be concerned if a collapsing financial 
asset bubble does not threaten to impair the real economy, its 
production, jobs, and price stability. Indeed, the sharp stock market 
break of 1987 had few negative consequences for the economy. But we 
should not underestimate or become complacent about the complexity of 
the interactions of asset markets and the economy.'' \1\
---------------------------------------------------------------------------
    \1\ The transcript of that meeting reports that I said, ``Everyone 
enjoys an economic party, but the long-term costs of a bubble to the 
economy and society are potentially great. As in the U.S. in the late 
1920s and Japan in the late 1980s, the case for a central bank to 
ultimately burst that bubble becomes overwhelming. I think that it is 
far better that we do so while the bubble still resembles surface 
froth, and before the bubble carries the economy to stratospheric 
heights. Whenever we do it, it is going to be painful, however.'' A 
very interesting analysis of the FOMC's approach to this issue is 
provided in ``Bubble Man'' by Peter Hartcher of the Sydney Morning 
Herald.
---------------------------------------------------------------------------
    But it was not just a consensus within the economics profession 
that was supportive of ``inflation targeting'' while simultaneously 
ignoring asset prices. Politicians around the world and of all 
political persuasions were also quite supportive of a monetary policy 
that let their constituents' assets rise in value in an unlimited way 
as long as goods and services inflation stayed under control.
    The political reaction to the Greenspan speech was extremely 
negative, coming from members of both political parties. As a guest 
interested in adhering to good manners, I will not quote any of the 
reactions of Members of the Congress to the Greenspan speech. Those 
interested in researching the issue can easily do a nexus search of the 
topic. And I would add that there were plenty of members from both 
parties in both the Congress and in the Clinton and Bush 
administrations that opposed any actions that might have interfered 
with the asset price advance of the past few years.
    So, it is not an issue of a mistaken view of the economics 
profession any more than it is a mistaken view of Americans that led to 
the current crisis. It is a human phenomenon: Everyone loves the kind 
of party that occurred. In fact, the response among European 
decisionmakers was even more supportive of this asset-price inflating 
doctrine than here in America. When then-Chancellor of the Exchequer 
Gordon Brown established the rules that gave the Bank of England 
independence from Her Majesty's Treasury, he explicitly made inflation 
targeting the sole objective of monetary policy. Moreover, he 
explicitly made the British Retail Price Index, similar to our Consumer 
Price Index, the measure of inflation that the Bank of England was to 
use. Like our CPI, the British RPI excludes asset price changes from 
its calculation.
    When the political leadership of Europe negotiated the treaty that 
established the European Central Bank they also created a single 
mandate of inflation targeting. Moreover, they chose an inflation index 
that also did not incorporate asset prices in the calculation. As a 
result, the European Central Bank has been far slower to react to the 
developing economic crisis than has the Federal Reserve. In addition, 
loans that supported asset prices that European banks made, 
particularly to Eastern Europe, were at least as egregious as those 
made in America.
    But a second set of policy mistakes that led to this current crisis 
were decidedly non-American in origin. During the 1990s, many of the 
world's newly developing countries, most notably China, managed their 
currencies in a way designed to increase exports and build foreign 
exchange reserves. We used to call such policies mercantilism, but 
diplomacy got in the way of the modern usage of that term. During the 
1990s China actually devalued its currency in the face of rising 
exports. America's efforts in the current decade to get China to adopt 
less Mercantilist policies were slow to bear fruit. The small 
improvements that occurred in 2007 and 2008 have begun to be reversed 
in recent months.
    The reason that this contributed to the Bubble and its Crash is 
that the result of a currency managed to maximize exports is a buildup 
of reserves which must find a place to be invested. China purchased 
hundreds of billions of dollars of U.S. Treasury and Agency securities, 
driving down our interest rates and facilitating the development of the 
housing bubble. The world saw the perverse economic result of Chinese 
workers and peasants being underpaid by their own government in order 
to finance the building of McMansions in America.
    But this result had its positive geopolitical side. After the fall 
of the Berlin Wall, a foreign policy consensus developed that the best 
way to incorporate China into a peaceful global community was to 
promote prosperity in that country. The argument was advanced that 
richer nations have more of a stake in both maintaining the peace and 
in preserving the existing world order. Chinese mercantilism, though 
economically inefficient, was a relatively painless and diplomatically 
acceptable way of advancing that cause because it led to rapid 
industrialization and capital formation.
    This observation about the relationship between the Bubble and 
Geopolitics leads to a very important second point we must bear in 
mind. As painful as the current crisis is, it follows at the end of a 
very long boom that brought tremendous gains to literally hundreds of 
millions of people on this planet. Perhaps half a billion people in 
Asia have joined the global middle class in Asia alone during the last 
10 years. The same is true for perhaps 200 million people in the former 
Soviet Empire and a similar number in Latin America. Hundreds of 
millions of children who would never have received anything more than 
the most rudimentary education now have acquired the skills to provide 
both for themselves and for future generations. Health care and life 
expectancy have increased tremendously. On a very real human level the 
past 25 years have meant improvements for the human condition on an 
unprecedented scale.
    Closer to home, real per capita disposable personal income in 
America grew 68 percent between 1980 when we began our experiment with 
open capital markets, free trade, and less regulation While America the 
Country has been partially responsible for this, the real credit goes 
to the Cause that America represents: Economic and political liberty 
for the individual. Our foreign policy must keep this in mind as a 
central abiding principle and we must continue to assert American 
leadership in these areas.
    A more prosperous world has helped make America a more secure 
place. Indeed, the greatest increased threat to our security comes from 
one of the few parts of the world in which real per capita incomes have 
not increased since 1980: The Middle East. (There are a few exceptions 
to this in some of the smaller countries of the Arabian peninsula.) Our 
long-term global interests require us to continue to advance the causes 
which have led to global prosperity. If I could sum them up briefly 
these are the free movement of goods, capital, and ideas.
    Today many of those causes are under assault. Some mistakenly 
interpret these objectives as the cause of our current crisis. Some 
merely oppose these ideas to advance their own power or their own 
special interests.
    Since the end of World War II America has led the movement toward 
freer movement of goods across borders. This accelerated rapidly with 
the Kennedy Round of Trade negotiations in the 1960s, with the adoption 
of NAFTA under the leadership of Presidents Bush and Clinton, and the 
extension of that principle to a host of new free trade agreements.
    Today free trade is under assault. Congress recently, and probably 
inadvertently, set off a trade war with our second biggest export 
market, Mexico with a provision in the just-passed stimulus bill 
regarding access to America by Mexican trucks. Europeans have objected 
strenuously to the Buy America provisions in the stimulus package. By 
themselves these are relatively small measures. The great worry is that 
they might become part of a trend toward protectionism. We learned the 
hard way during the 1930s when ill-advised legislation--the Smoot-
Hawley tariff--ignited a global trade war. We must not do it again. 
America should continue its historic leadership in promoting global 
free trade.
    There is also an attack on the free movement of capital and ideas. 
Our own Government has been guilty of this in both the case of the 
Dubai Ports case and in the matter of the purchase of Unocal by a 
Chinese oil company. Again, taken by themselves these are relatively 
minor matters. The risk is that they develop into a trend. But other 
countries are already beginning to do the same, placing limitations on 
foreign ownership of not only corporations, but also farm land. Isn't 
it simple common sense that two countries that invest in each other are 
much less likely to go to war with one another than two countries 
without such cross-border investment? Obviously domestic security 
issues and intellectual property protection are essential. But 
shouldn't those issues be addressed regardless who happens to own a 
particular company or sit on its board of directors?
    The free movement of capital and ideas is also under assault by 
some who are now proposing increased restrictions on a variety of 
global financial intermediaries including private equity firms and 
hedge funds. European politicians in particular argue that financial 
intermediaries such as hedge funds are to blame. But no hedge funds 
have been bailed out in this crisis. The bailouts have gone to 
regulated financial institutions such as banks and insurance companies.
    These regulated institutions often erred by taking risks that only 
hedge funds and private equity firms should take, but their mistakes 
led to bailouts because they lack the discipline that hedge funds have 
in having their limited partners, not depositors or contract holders, 
suffer whatever losses they might incur. Because they lacked that 
discipline, these regulated institutions actually took on greater 
leverage than the hedge funds and private equity firms they were trying 
to emulate. If we are going to have a prosperous global financial 
system going forward then we need to make sure that we regulate those 
firms, such as banks and insurance companies, who are betting the funds 
of innocent people like depositors and holders of insurance contracts.
    I believe that the most straightforward way of doing so is to 
reinstate minimum leverage ratios for these institutions that are in 
addition to the supposedly more sophisticated risk-based capital rules 
that are in place. Risk weightings and even supervisory judgments are 
inherently linked to the recent performance of the particular asset 
class in question. Recent experience has taught us that recent 
performance is not necessarily a fool proof guide to future results.
    But we must also make sure that we leave a lightly regulated sector 
that can actually take the risks inherent in any economy that are 
inappropriate for the more heavily regulated sector. The tradeoff for 
little or no regulation is that it is the investors in those funds, and 
not the general taxpayer, enjoy the benefits of success and bear the 
burden of losses. In various global forums, the United States should 
defend the rights of financial intermediaries to operate with 
relatively light regulation provided that they do not possess any claim 
on the taxpayer.
    Our security as a nation depends crucially on a resumption of the 
path we have been on for the last quarter century toward ever greater 
global prosperity. But that prosperity requires a continued effort by 
the American Government to promote the causes that have made America 
great: Economic and political freedom in particular. That may not be 
the politically popular thing to do in times of economic stress, but 
putting the long-term security and prosperity of America and the world 
ahead of short-term political popularity is what leadership is all 
about.



    Source: Economist, The Lindsey Group.

    
    

    Sources: National accounts; European Mortgage Federation, Hypostat 
Statistical; Federal Reserve; OECD Analytical Database; Statistics 
Canada; and IMF staff calculations.

    Senator Lugar [presiding]. Well, thank you very much, Mr. 
Lindsey.
    Let me, on behalf of the chairman, call for a short recess. 
We have a rollcall vote that is proceeding; that is why the 
chairman left, hoping that he would be back by the time your 
testimony was concluded, Mr. Lindsey. But, any event, I know 
that we all want to raise questions of the three of you. So, if 
you'll forgive us for a moment, I will call for a short recess 
and go vote. The chairman will arrive shortly and will proceed 
with the hearing. We thank you for your indulgence.
    [Recess.]
    The Chairman [presiding]. The hearing will come back to 
order. Thank you. I'm sorry, folks, about the vote, and I 
apologize, Mr. Lindsey, for having to run out on you, but I did 
read your prepared testimony, so I'm not wholly unprepared, 
here.
    Mr. Lindsey, you began your testimony by saying America is 
a cause as well as a country. And that is true. Is it important 
for us to make any acknowledgments here about how this began in 
order to have credibility in the fixing? And can we avoid some 
of the down sides that some people see if we don't do that? Do 
you want to, first, respond to that, Mr. Lindsey?
    Mr. Soros. Well, I think that it's recognized----
    The Chairman. Hit the mikes again.
    Mr. Soros. I think one needs to understand what has 
happened, that basically in the last 25 years or so, we--the 
global--the international financial system has been developed 
on false premises, and it has collapsed. And we do have a very 
serious----
    The Chairman. When you say ``on false premises,'' can you 
fill that out?
    Mr. Soros. Yes. Basically, the assumption was that markets 
are self-correcting and should be left to their own devices.
    The Chairman. Is it fair to say that Alan Greenspan 
acknowledged that in public testimony before the Congress?
    Mr. Soros. I'm sorry?
    The Chairman. Alan Greenspan came before the Congress, a 
month or so ago, and said, ``I didn't realize the degree to 
which the markets would not regulate themselves.''
    Mr. Soros. That's right.
    The Chairman. That was an open statement.
    Mr. Soros. Yes. Yes. And I respect the fact that he has 
acknowledged this. And now we have to--we actually have two 
problems. One is that the system has collapsed, and we have to 
rebuild it on sounder grounds. We must rebuild it. We do want 
an open trading system, we want global financial markets, but 
we have to put them on sounder grounds. But, more urgent is to 
arrest the collapse, which is having devastating human 
consequences. So, the first task is to stop the collapse, to 
reinflate, in fact, in order to keep the financial system 
afloat. And the second, then, is to reconstruct it.
    And as Mervyn King, the--of the Bank of England, has--who 
has also acknowledged the mistakes of the past--has very wisely 
stated, what we need to do in the short term actually is 
directly opposed to what we need to do in the long term. In 
other words, right now we have to compensate for the collapse 
of credit by increasing the money supply, which we are doing 
through expanding the balance sheet of the Federal Reserve. And 
in the longer term, of course, we must avoid doing what we did 
in the past, which was to build up a chronic current account 
deficit and spending up to 6\1/2\ percent more than we were 
producing. So, that's the longer term. So, we--but, we can't 
get back to a balanced position----
    The Chairman. What's the one-two-three of arresting the 
collapse?
    Mr. Soros. Well, basically we have to increase the money 
supply to compensate for the decline in credit, we have to 
recapitalize the banking system, and we have to deal with the 
crisis in the housing industry and prevent housing prices from 
overshooting on the down side the way they overshot on the up 
side. So, those are the three domestic. And then the fourth--
and we mustn't forget it--and that is, in fact, the subject of 
the hearing----
    The Chairman. The G-20 piece has to----
    Mr. Soros [continuing]. Today--is, we have to also look 
after and help those countries which are affected by the global 
economic recession and are not in a position, without 
international assistance, to do what we are doing, which is to 
reflate. We need to do that for--in our enlightened self-
interest, because reinflating the economy is a global task, and 
we need the less-developed world to stimulate domestic demand. 
And the issue of SDRs would help them to do that.
    The Chairman. What do you think of that, Mr. Lindsey?
    Mr. Soros. Pardon?
    The Chairman. I was wondering about Mr. Lindsey's response.
    Mr. Lindsey. I think that you will find very little 
disagreement on the overall strategy we should be following, on 
this panel. I've known both gentlemen for a long time. I do 
think there might be a small difference in the nuance with 
which we approach different tasks.
    The first challenge I think that we have to keep in mind 
here is the importance of fixing the banking system first. And 
that is going to require an enormous strain on capital--on 
global capital markets, to fill a hole. The hole is here, the 
hole is in Europe; it's even bigger in Europe. The hole is even 
bigger in Asia, as a share of their total banking capital.
    The Chairman. Effectively, you're talking about a lot of 
banks that are insolvent.
    Mr. Lindsey. Yes.
    The Chairman. That's the bottom line.
    Mr. Lindsey. Yes. We probably--I mean, there are a variety 
of estimates that are out there, and the answer is: No one 
knows for sure. But, in the United States the number is between 
$1 and $2 trillion, as the size the hole.
    The Chairman. Right.
    Mr. Lindsey. And I think it's important that we fill that 
hole as efficiently as possible, because when we do it in an 
inefficient way, we put, like, $2 of strain on the----
    The Chairman. What's the most----
    Mr. Lindsey [continuing]. Capital markets in order to fill 
$1 worth of hole. And I think that that's a mistake, because--
--
    The Chairman. Well, it's fair to say that TARP probably 
fell in the inefficient category.
    Mr. Lindsey. The TARP has fallen--the way it--yes, the TARP 
is in the inefficient category. I've felt that, a long time, 
yes.
    The Chairman. Now, I don't want to make this into the 
Banking Committee, but I do want to understand how we're 
proceeding forward here to restore confidence. The plan that's 
currently on the table offers a public-private partnership to 
buy a certain number of assets. It seems to me that is going to 
help with liquidity, but I'm not sure that it addresses 
insolvency.
    Mr. Lindsey. Yes, Senator. And I think that the Congress 
should take a closer look at the approach. I think the 
Secretary misspoke yesterday when he said that the public 
sector and the private sector share equally on the up side and 
down side. That is true for very small changes, but, in fact, 
on the down side, the public sector will carry about 92 percent 
of the losses, and the private sector, just 8 percent.
    The Chairman. Yes, I----
    Mr. Lindsey. Whereas, both share 50-50 on the up side. And 
I do think that, you know, before we proceed, discover that's 
the case, and then try and do a clawback, like happened with 
AIG, which would destroy what credibility we have left, that 
we, you know, take a sharp pencil to it now, know that's where 
it's headed, and realize that that may not be the most 
effective way, or efficient way, of injecting money into the 
banking system.
    The Chairman. I'm not going to go down that road right now, 
because I want to keep the hearing moving on the international 
piece, but there is a lot to talk about with respect to that. 
But my time is almost up--on the international piece, Mr. Wolf, 
going back to what Mr. Soros laid out as one through four, we 
have increased the money supply, we have done a significant 
chunk on the housing, we've put a very significant stimulus up, 
as has China, we have now put forward a mechanism for at least 
removing some of the toxic assets. Let's not worry about cost, 
for the moment; I'm worried about it, but, for the purpose of 
this discussion--the question now is on the recapitalization. 
Is that fair? Is that the big hanging-out-there issue? In terms 
of the global sense of confidence.
    Mr. Wolf. In terms of the confidence people have in the 
U.S., specifically, rather than the global solution, I would 
agree that the question of whether the U.S. has a credible 
policy overall to fix its banking system over the next 12 
months or so, ideally sooner, is certainly an extremely 
important one. I think that----
    The Chairman. And the key to fixing our banking system----
    Mr. Wolf [continuing]. In your--in the case of fixing your 
banking system. However, I would go along very much with what 
Mr.--Professor--Mr. Lindsey said. The--it is clear that, in all 
the respects that you listed, policy in other Western 
countries--and in this context, I am actually including Japan 
for this purpose--is behind on all those fronts. So, while I 
think, in every respect, the U.S. policy is far from having 
resolved the problems it faces, and is creating some new ones, 
as we discussed, in the fiscal and monetary areas, it is clear 
that the U.S. is ahead of most other places in addressing these 
problems. I think the reason for that is that the crisis became 
evident--we won't need to discuss its origins; we don't really 
have the time--in the U.S. before most other developed 
countries, and most other developed countries have, 
correspondingly, been relatively tardy in responding.
    The Chairman. Mr. Soros, you deal in the market in this 
way--is it your judgment that people are holding back with a 
kind of reserve wish that somehow, because of the things 
already done--the increase in the money supply, the 
reinflation, to some degree, through the stimulus and other 
things--that those assets that are currently toxic may somehow 
reappreciate and that they can avoid a crunch? Is there that 
calculated a sense of delay, or is it just that this is such a 
big chunk of money that people are having a hard time wrapping 
their hands around it? Certainly the response from Congress so 
far would indicate real reluctance up here for people to deal 
with reality.
    Mr. Soros. No, I'm afraid that this will not be sufficient 
to recapitalize the banks or remove enough toxic assets to 
enable them to resume lending.
    The Chairman. But, do you think that is the calculation?
    Mr. Soros. That is--it's not sufficient for that. It may 
turn out to be useful, in conjunction with the stress tests 
that are currently conducted, which may result in the need for 
the banks to accept lower valuations for the toxic assets, in 
which case the asked and the--the two prices, bid and ask, may 
actually come together. As it is, I think that will only happen 
in the very high-class assets, where actually providing 
liquidity to the buyer does improve their ability to bid. So, 
yes, I could see, on AAA assets, bid and ask coming together, 
and actually thereby providing some liquidity to the banks. 
But, it does not solve the problem where it comes to the toxic 
assets. So, I think there is more work to be done, and this is 
just a one step along the way.
    The Chairman. Well, let me say, in fairness, without 
letting the cat out of the bag on this, I actually asked the 
President this at the caucus luncheon that we had today, and he 
made it very clear that he understands there is more to be done 
and there are next steps. So, I think the stress test is a very 
important measuring point so that people can get a handle on 
exactly what the pricing might be and what the levels of 
toxicity are.
    Senator Lugar.
    Senator Lugar. Mr. Lindsey, you mentioned your opposition 
to the size of the President's budget request, and I, along 
with the chairman, do not want to get into a domestic quarrel 
today. Clearly one of the dilemmas that it presents, in 
whatever size, is--at least some of our staff have come up with 
the thought that $3.1 trillion, or 53 percent of United States 
debt, is now held by foreign investors and foreign governments. 
This is up from $1.5 trillion since the end of 2003, about 5 
years ago.
    Now, it's important to identify where we obtain the money 
to fund this budget formula. Presumably, much will be borrowed 
in the United States, but I think there's a presumption that 
much of it will be borrowed abroad.
    Now, what are the problems posed by that? Without getting 
into specific detail, the Chinese are often mentioned, because 
they have pointed out recently, themselves, that they would 
like for the dollar to be pretty solid and want to make certain 
we're doing the right things in our economy so that all their 
money that's in dollars would not be depreciated. Likewise, 
just 2 days ago, they mentioned a potential international fund 
or currency or financial equivalent other than the dollar, in 
which they and other people in international finance might use 
to diversify their portfolio. Now, always there were hints that 
there might be a worry, in due course, about the Chinese 
loaning us money, but the fact that this has come up a couple 
of times from the Chinese themselves presents another worry. 
Perhaps the best bet is for everybody still to go to the 
dollar, in terms of safety, for reserves and sovereign funds. 
What is your own judgment about the parameters of this problem? 
And should this influence our domestic debate, quite apart from 
our international debate?
    Mr. Lindsey. Senator Lugar, I think you've identified it 
correctly. Our budget is not just a domestic issue, it is very 
much a foreign issue. And simply because of the way the numbers 
are. If you go to the back of the President's budget, there's a 
page that's hard to fiddle with, and it has to do with the 
total expected borrowing requirement. And in the current year 
the number in the President's budget is $2.65 trillion.
    Senator Lugar. Borrowing.
    Mr. Lindsey. Of borrowing. That is--the CBO would estimate, 
is a little low, but why don't we work with it. And----
    Senator Lugar. We were at $5.9, according to my figures, at 
the end of 2008, so $2.75 on top of the $5.9.
    Mr. Lindsey. Yes. This is--now, we have 6 months left to 
the year, and we have borrowed about $700 of that $2,650, which 
leaves us with $1 trillion $950 billion more to borrow in the 
next 6 months, by the President's budget. On top of that, any 
borrowing you have for PPIP, PPIF, TALF, whatever it may be, 
would be on top of all that. But, let's just focus on that 
$1.95 trillion.
    Now, our personal savings rate's going up, and you said 
some of it will be financed domestically over that period. If 
we're lucky, I guess, U.S. household savings, including paying 
off those credits and everything else, all of it, would be 
about $300 billion.
    Senator Lugar. Right.
    Mr. Lindsey. OK? So, now we're down to $1 trillion $650 
billion to raise in the next 6 months. Well, there are exactly 
two--there's three sources left. One, you can crowd out 
domestic investment. And that's not good for the economy. Two, 
you can borrow it from abroad. And three, the Fed can print it.
    Last Wednesday, the Fed did the same math I just did and 
said, ``Oops, we're going to have to be printing some of it, 
because we're never going to get there.'' Fed said we're going 
to buy $300 billion. So, that takes the $1 trillion $950 down 
to $1 trillion $650 billion over the next 6 months.
    To put that into perspective, that is 100 percent of the 
GDP of China over the next 6 months. So, even if the Chinese 
didn't need anything, didn't buy a car, didn't build a 
building, threw everything into lending it to us, we would just 
cover our borrowing requirements.
    Senator Lugar. In the next 6 months.
    Mr. Lindsey. Over the next 6 months.
    So, it is very much a foreign policy issue. And the mention 
was, well, yes, these other countries need money. Right? 
Iceland's failing, and Hungary and the Czech Government fell, 
and what have you. Well, when we borrow from the rest of the 
world, we are crowding out those other countries.
    So, the only two answers are borrowing and global money 
creation. And I think we should just concede we're going to 
have money creation; and both of my colleagues have. But, 
believe me, this is very, very much a foreign policy issue, and 
the President's budget is, I believe, destabilizing to the 
global financial system. Not because I'm against budget 
deficits; I've got no problem with it. As I mentioned, I'm a 
Keynesian. But, I'm a Keynesian with a sharp pencil. And when 
you take the sharp pencil to it, it doesn't add up.
    Senator Lugar. What--explain to us what it means that the 
Treasury prints money or creates money. What's--how is this 
done, and what's the effect upon our economy of that kind of 
creation?
    Mr. Lindsey. The Treasury doesn't create money. My former 
colleagues at the Fed, that's their job. And what they do is, 
they--well, we used to say ``run the printing presses.'' It's 
now done with electrons instead of paper, most of it. But, they 
hit the button, and the electrons happen, and they generate 
$300 billion, and they buy $300 billion Treasury debt in the 
process. So--because, you know, I'm gray-haired, I think of it 
as ``printing the money,'' and--that's basically what happens. 
We expand our money supply in order to buy the Treasury debt.
    Senator Lugar. What are the implications, then, for us in 
doing that?
    Mr. Lindsey. Well, I have no problem with the $300; I'm 
worried about the other $1 trillion, 650 billion. And I think 
the amount of money creation that would be necessary to cover 
the budget demands would be very troubling for the price level 
in the United States.
    Senator Lugar. And that's just for the next 6 months.
    Mr. Lindsey. Yes.
    Senator Lugar. You're back in the same predicament, 
presumably, in the next year or the next two.
    Mr. Lindsey. We're back in the soup. It's a little bit--
under current numbers, it's not quite as bad, but it's still 
bad enough, that, yes, there's a problem.
    Senator Lugar. Thank you, sir.
    The Chairman. Just to expand the dialogue, do either you--
Mr. Soros or Mr. Wolf--want to respond to that?
    Mr. Wolf. Well, I would like to add something. The concern 
is a completely legitimate one, and we certainly cannot imagine 
that the world's markets have an infinite taste for either the 
U.S. dollar or U.S. Government debt. It is striking, however, 
and it is particularly striking to many of us--for instance, 
people living in Britain--that here we have a country that 
appears to be in the throes of a very severe financial crisis, 
and its currency is strengthened, and its government long-term 
interest rate has been more than satisfactory, by any 
standards. So, it appears, at least at the moment, maybe 
surprisingly so, that world markets--and we are talking about 
integrated world markets; we can't separate American for 
foreigners; they're all in the same market--are perhaps 
extraordinarily complacent about this situation and seem to be 
quite happy about accepting this amount of paper. And I 
wouldn't wish to conclude from that, that that will necessarily 
be true in the future, because, of course, as we have perceived 
very well in recent years, markets can change their minds. And 
when they change their minds, they can change their mind very 
brutally. But, it is important to remember that the U.S. dollar 
and the U.S. Government have a number of very substantial 
advantages, in terms of credibility, liquidity, long record, 
unquestioned survival, which other competing currencies or bond 
markets do not have. Other governments are going to have very 
large fiscal deficits. There is clearly very substantial money 
creation in other countries, because, indeed, they're affected 
by similar crises. The question of the survival of the euro is 
at least--I'm not saying it will disappear, but certainly it's 
a more natural question than the survival of the dollar.
    So, for all these reasons, I am actually somewhat more 
relaxed, in the short run, by which I mean the next 2 or 3 
years, about the ability of the United States to sell all this 
paper and to sell these dollars, and for the rest of the world 
to hold it. There is an extraordinary demand for safe assets 
out there in the world, and there will be, without question, an 
extraordinary increase in desired savings across the whole 
world, because that's what this sort of recession means.
    So, I'm not panic-stricken in the short run. The crucial 
thing, however, is that this doesn't go on for many years, 
because then the question of credibility will unquestionably 
come into play, and that is why having a global solution which 
allows the U.S. partly to export its way out of this, have a 
stronger world economy as part of the solution, and a credit 
fiscal package--profile or path out of this, does indeed become 
essential.
    The Chairman. With the indulgence of my colleagues, I just 
want to interject because I think this is an important point to 
be making here. There is an agreement and I think, Mr. Lindsey, 
you agree--there's been pretty near unanimity that we've got to 
spend some money to get out of this hole.
    Mr. Lindsey. Absolutely.
    The Chairman. We've got to spend some money to stem the 
housing issue. We've got to spend some money to put people back 
to work and turn the confidence around. We've got to spend some 
money to recapitalize the banks. We've got to spend some money 
to strengthen the IMF and keep some of these Eastern European 
and other countries afloat. There's almost unanimity on that. 
So, you've got to be a little careful about holding out this 
great big debt as something preventing action--we're forced 
into this situation. A lot of us are really unhappy about it, 
because, for the last few years, we've actually been fighting 
against some of the policies that have helped put us here. But, 
we're here. The President has made it clear, his budget in the 
out years is clearly focused on reducing the deficit. But, 
you've got to grow the revenues to be able to begin to get 
there.
    Go ahead, Mr. Lindsey.
    Mr. Lindsey. Senator Kerry, I agree. I have no problem 
spending money. I would simply point out that if you're in this 
bind, it is essential to spend money as efficiently as 
possible. And therefore, if you have a, why don't we call it, a 
$1\1/2\ trillion hole in the banking system to fill, it would 
be imprudent to borrow $3 trillion to have some jury-rigged 
system----
    The Chairman. Do it the right way.
    Mr. Lindsey [continuing]. To come up with filling up the 
1\1/2\.
    The Chairman. I agree with you. That's a good point.
    Mr. Lindsey. And that's where I would start, and that was 
my comment on the----
    The Chairman. Let me cut myself off, here, because I know 
some colleagues are time-sensitive.
    Senator Kaufman, do you mind if Senator Corker were to go 
and then we come back to you?
    Senator Corker. I really don't want to jump in front.
    The Chairman. OK, all right.
    Senator Kaufman.
    Senator Kaufman. Thank you.
    I'd like to talk about, kind of, some of the political 
implications of this economic crisis.
    Mr. Soros, I think it's fair to say that Russia and China 
have done everything they can to avoid an open society. And the 
general consensus is that that's OK, kind of, because the 
people of Russia and China thought they were doing better 
economically, they had hope, they had the idea they were going 
to do better, their children were going to do better. What do 
you think the implications are, in Russia and China, of this 
economic crisis, in terms of politically?
    Mr. Soros. Well, I think that China, of course, is also in 
a crisis. Exports have fallen very sharply. And China is not a 
democracy. And the rulers know that their hold on power depends 
on their ability to keep the economy growing. So, for them, the 
top priority is to assure--or to do everything possible to 
stimulate the economy and maintain the target 8-percent 
growth--well, it may be only 6 percent, but something of that 
nature. And they are in a position to accomplish this, and they 
did respond with a very large stimulus package. And they've 
made it clear that if that's not enough, they're going to do 
more. They also have large currency reserves, and they are 
liable to use those reserves also to finance their exports. 
Just as they did in the past lend us the money to buy their 
goods, they might do the same for others, as well.
    So, I think that they will, in fact, be able to recover 
faster than we will. And if they don't, you may have political 
and social unrest, and you could even have a breakdown, which 
would have a very negative effect for the rest of the world. 
So, it's not a desirable outcome in any way.
    Senator Kaufman. Right.
    Mr. Soros. So, that's as far as China is concerned. And 
it's very important, since we have common interests with them, 
that we should find the proper way to work together to restart 
the world economy. And that's why I think using the IMF is a 
very important foreign policy objective for us and why I think 
the SDR issue would be really a major accomplishment for the 
United States.
    Russia is a somewhat different situation, because there is 
a--the--there's tremendous resentment in Russia. Putin has been 
popular because he has actually, through the boom in oil and 
gas, been able to provide both security and stability and 
economic improvement. Now you have a very severe financial 
crisis, a collapse of the Russian stock market, and a debt 
crisis, and a severe economic decline. And he is no longer so 
popular, and there is a real danger that he will become 
increasingly repressive and perhaps also aggressive to divert 
attention from the troubles at home.
    So, I am afraid that, from a foreign policy perspective, 
Russia is a possible source of disturbance of peace. Tensions 
with Georgia, for instance, could easily escalate again to 
military action. Russia has used gas as a geopolitical power 
tool, may do that again. Russia is eager to reestablish control 
over Ukraine. Ukraine is in a very serious both financial and 
political crisis. So, I see that as a major trouble spot in the 
world.
    Senator Kaufman. And how--so, if that occurs, what are the 
implications for the United States, in terms of--both the 
Russian leaders and the Chinese leaders in the past have used 
us kind of as a villain, someone to turn to when things are 
bad, to explain why things are bad in their country. Do you 
think there's much chance of that happening? And how do you 
think it would impact on United States-Chinese and United 
States-Russian relations?
    Mr. Soros. Well, I think it's a very difficult task, 
because, on the one hand, Russia has become aggressive, and we 
must resist aggression, because otherwise we reinforce it. So, 
on the one hand, we have to support Georgia, Ukraine, et 
cetera; on the other hand, we do have common interests, many 
common interests, with Russia, so we must really have a two-
pronged approach. On the one hand, resist potential aggression, 
but, at the same time, try to develop the common interests and 
have a change of heart, perhaps, in the Russia leadership, 
which there is some possibility of achieving.
    Senator Kaufman. Thank you.
    Mr. Wolf.
    Mr. Wolf. I'd just like to add a couple of comments, 
because I think it's very important, and I think George brought 
this--Mr. Soros brought this out very clearly. These really--
there are obvious similarities. As you pointed out, these are 
not democracies. They are very different cases, and it's really 
important to understand this, particularly in relationship to 
this crisis.
    China has, in some very deep sense, invested its whole 
future, to a degree that most of us would have regarded as 
unbelievable 15 years ago, in opening up to the world economy. 
It is--astonishingly, this country--this giant country has the 
highest trade ratios of any big country in world history. 
They're three--ratios of trade to GDP in China are three times 
those of the United States. It's quite extraordinary how far 
they have bet themselves on the world economy. Of course, they 
don't have a completely liberalized capital market. We know 
this. But, they have accepted a vast amount of foreign direct 
investment and a large number of investors, though by no means 
all are very happy with their treatment here.
    China is riding the sort of tiger of development. They see 
the future as moving in their direction. They are largely 
stability-oriented, and I think they view this crisis, I 
suspect, not so much as an opportunity as something that they 
have to riding through.
    But, actually, let me be quite clear, China wants the 
United States to succeed. There's no doubt in my mind that 
China wants the United States to succeed and manage this, 
because the alternative for them is domestically very 
destabilizing. And I should stress, by the way, I am quite 
convinced that the choice for us is not between a democratic 
China or an authoritarian China, but an open authoritarian 
China and a closed and hostile one. So, that's a very different 
thing.
    Russia is genuinely revanchist. It has not truly integrated 
in the world economy, except in commodities. It is essentially 
a commodity exporter, as, of course, you know, and has suffered 
huge losses as a result. The Government is, in some ways, quite 
frightening and unstable in its--not unstable internally; 
that's a different matter--but unstable in its attitudes to us, 
and much more inclined to make difficulties on principle, 
because it seems to me the Russians still view their 
relationship with the West in general, and the United States in 
particular, as a zero-sum one; namely, if the United States is 
doing badly, they're doing well. I think that's how they see 
it; pretty primitive.
    I'm absolutely certain--and I've spent a lot of time in 
China, talking to Chinese leaders--that they do not view their 
relationships in the same way. Though, while I accept the 
similarity, it's a very important similarity, of course, I 
think we have to view our relations with these countries in 
very different ways, and also to recognize, of course, that, in 
the long run, China is going to be a great power with whom--
with which we will have to form reasonably productive 
relations, over centuries.
    Mr. Lindsey. I agree completely, although one caution I 
would add to this committee with regard to China. I think their 
perception--Martin used the word ``ride through,'' I think of 
it more as a ``building a bridge'' to the other side. And on 
the other side of the river, they expect to be able to continue 
or resume their large exports to us. And if that is not 
possible, then I think, you know, in 2011 or so, China will 
find that its bridge has not reached the other bank of the 
river, and then we're going to have the problems that Martin 
was talking about.
    Senator Kaufman. Thank you. I just want--the only thing 
that compare anything is, they're both nonopen societies which 
are going to go through an economic crisis, and that's the 
implication I want to make.
    Thank you, Mr. Chairman.
    The Chairman. Senator Corker.
    Senator Corker. Mr. Chairman, thank you. And I know you 
hesitate to turn this into a banking meeting, but I just want 
to say that I think this is a very, very important issue, and I 
hope we'll have more hearings on this topic. I don't know of 
anything more important, and I thank you for having this 
hearing, and certainly appreciate these three distinguished 
witnesses that certainly carry a great deal of clout and many 
people in the world listen to.
    I think, at the same time, it's actually important for us 
to be very honest about where we are financially, regardless of 
how we got here. And I hope that we'll focus on that in an 
important way.
    And with that, I've had a lot of time with Mr. Lindsey in 
the past, and certainly appreciate his contributions, so I'm 
going to focus on Mr. Soros and Mr. Wolf.
    We had a gentleman come into our office, Mr. Soros--and I 
know that you've had tremendous experience as a financier 
around the world--who made a presentation, from Hayman 
Advisors, a man named Mr. Bass--looking at where we were--where 
Europe is today. OK? And I know we've talked about the relative 
differences, as far as how we progressed on focusing on the 
financial institutions. But, he laid out some pretty alarming 
information--if it's true--would say that there's a calamity 
coming in Europe, regardless of what policies occur. And it's 
based on the fact that there's huge amounts of sovereign debt 
there already. The monetary financial institution assets, as it 
relates to the size of the GDP of the countries, is very large 
in some cases, similar to an Iceland-like situation before, in 
some cases. OK? There's huge structural deficits that are in 
place. And the interesting problem in those countries, as 
opposed to here, there are already high tax rates. So, in 
essence, while we don't want to use the ability we have here to 
tax higher, they are already at levels that are very difficult 
to go above, in some cases.
    You add to that the fact that, in some--their financial 
institutions in many are leveraged, as a group, at 37 to 1, 
assets to tangible common equity, which is a huge amount of 
leverage--meaning, when you have a down side, it's even more 
problematic. And then, many of their loans are to countries 
outside of their own; meaning, they have no control over the 
assets. And the picture that he would paint is that, in many of 
those countries, there is a calamity coming that cannot be 
averted. And I know that you invest in countries around the 
world, or in--I wondered if you had any response to that, or 
have looked at that in any way.
    Mr. Soros. No, I think, Senator, you are right in saying 
that Europe faces very serious problems. Some of those problems 
are, let's say, within the Euro group, tensions within the Euro 
group, and some of it are outside. And, of course, Eastern 
Europe, the new members--states--are in various--are at the 
focal point of the crisis, because they have--their banking 
systems, largely owned by the Western European banks, and the 
households have borrowed in foreign currency--strangely, more 
in Swiss francs, for instance, in Hungary, than in euros, but 
in other countries, euros. But, most of the household debt is 
in foreign currencies. And as they come under--as the banks 
withdraw and pull money out of Eastern Europe, currencies have 
come under pressure. They are not part of the euro. And the 
households find themselves in a much deeper indebtedness than 
they thought they were, because most of the loans went to 
finance real estate. So, there is a very serious problem there, 
and it's very important for them to hold together. They are, of 
course, guaranteeing their banking systems. But, since you've 
got national banking authorities, they tend to--there is this, 
what you might call, financial nationalism within Europe 
developing, which is a danger to the European Union.
    So, that is the situation. I think you assess it correctly. 
And I'm very hopeful that Europe will actually pull together 
and pull through. But, one should not--one should acknowledge 
the difficulties that they are facing.
    Senator Corker. And so far, that hasn't happened. I know--
Mr. Wolf, do you have any comments?
    Mr. Wolf. Yes, I--obviously, I didn't see this particular 
presentation, so I don't know precisely the numbers involved. 
Some of them that you've given me, I certainly recognize, 
particularly the leverage ratio in the banking system. In my 
view, that looks worse than it is, because you have to allow 
for the fact that there was an extremely large nonbank 
financial system in the United States which performed much of 
the function that was in the banking system in Europe, and that 
was more or less completely uncapitalized. So, I think if you 
look at the leverage and the total financial system, they're 
very similar, and I think the need for recapitalization, the 
numbers that Mr. Lindsey's given, will be very similar in 
Europe.
    Is Europe unable to meet these obligations? Actually, if 
you look at it--in fact, it's already implicit in what you 
said--it's quite clear that the biggest fiscal challenge--
again, one shared with the United States--is the long-term 
contingent liabilities associated with aging, very broadly 
defined. They're actually not dissimilar in scale. The big 
advantage the U.S. has, as you--one you mentioned--is, it 
starts with a lower tax level; though whether it'll be easier 
to raise taxes here will be interesting to see.
    Senator Corker. Hopefully, it'll be very difficult. 
[Laughter.]
    Mr. Wolf. And, of course, more important, the demography of 
the United States is more favorable, and that means underlying 
growth trends are more favorable. That should make it a bit 
easier to manage this.
    But, the point I would stress, which I think is more 
important for this purpose, is one implicit in one aspect of 
what you said, which is, this is a collection of countries, and 
their debt and deficit positions are very different.
    There are a few countries--by no means all and not the 
biggest, with the one exception, namely my own--which have 
extraordinarily large banking systems relative to their 
economies. The U.K. is the only big country to fall into that 
category. I am reliably informed by my friends in the U.K. 
Government that this is all under control. [Laughter.]
    It is a very interesting aspect of this crisis, and central 
to your considerations, because it's the border between 
financial and foreign policy that we have global financial 
institutions that are guaranteed by host countries which may be 
very reluctant or unable to meet all international obligations. 
I would like to point out the extreme difficulty created for 
the United States by the discovery that moneys going through 
AIG ended up in foreign banks. This is the problem for Britain 
multiplied almost by an order of magnitude. And it's a 
political problem as much as an economic problem, quite 
central.
    Apart from that, which is mainly the U.K., otherwise the 
other case is Switzerland, which is not, I think, a concern at 
this level--the really big problem is, there are a number of 
Member States in the euro zone, a number of Member States in 
the European Union that are not members of the euro zone, which 
are quite likely to get into sovereign debt problems simply 
because of this crisis. I don't believe that will include the 
biggest countries of the European Union, but there are some 
less-than-large ones, and even quite sizable ones, that could 
be seriously challenged. And ultimately, the question there is 
not whether the big countries are able to rescue them, because 
I believe they are--we could discuss that in greater detail if 
you wish to--but, whether they will be willing to. Ultimately, 
this is not a federal entity, it doesn't have a federal tax 
structure, there is no federal government, and so, ultimately, 
if there were to be a very serious difficulty in the debt 
markets for particular countries' debt, you might find that 
some member countries would be--big member countries, like 
Germany, for example, would be reluctant to rescue them. The 
rhetoric we have at the moment suggests they would help them. 
And, of course, George Soros has proposed the creation of a 
European bond market, partly to deal with these problems.
    But, we do have to recognize, in my view, the fundamental 
issue is not so much the scale of the problem, in aggregate, 
but its distribution across countries, and the less than 
perfect certainty, much less than perfect certainty, that 
strong countries would, in fact, rescue weak ones in a 
difficulty. We could well find a test of this within the next 
year or two.
    Senator Corker. May I ask one more question, based on what 
I'm hearing?
    I'd love to, by the way, give you this information. I 
didn't call out specific countries, because I don't have any 
way of validating this information, but I'd love to give this 
to you and see if you wouldn't--if you would consider 
responding to some of the factual information that's here. 
You'll do that?
    Mr. Soros, I met, yesterday, with the IMF and Mr. Lipsky. 
And I know there's--whenever--here in America, we talk about 
China and our debt and then people raising currency issues; 
that obviously gets everybody, rightfully so, up in great 
concerns. And I realize that that--right now, that's just talk, 
and we need to--what we really need to focus on is making sure 
we keep our house in order, short and long term. But, from your 
perspective, what is the reality of taking the SDR component, 
or some other component, but using that as a potential building 
block through the IMF for a reserve currency that is, in 
effect, the one that becomes our world currency, and not, in 
essence, using the U.S. dollar? What is the reality of that? Is 
that just talk, or is that something that might well become a 
reality in the future?
    Mr. Soros. I think it is much more than talk. It exists. In 
other words, SDRs actually exists. They are on the books of the 
IMF. It's not a new invention. It's very fortunate, because it 
would take quite a long time to put it in effect. It took a 
long time to devise it, and it was devised exactly for this 
contingency of a global shortage of liquidity; forgetting now 
about the solvency problem, as well, where it can be helpful 
also. So, this is the moment when using SDRs on a large scale 
could, in fact, make a major positive contribution in helping 
to resolve the problems of the world.
    You drew attention to the problems that confront Europe. 
You are fully aware, of course, of the problems that confront 
us. And also, the problems that are confronting Eastern Europe 
are even greater than those that confront Western Europe. And, 
of course, the developing world is the most vulnerable of all.
    And the SDR issue could help, particularly, the developing 
world, including, of course, Eastern Europe. And therefore, it 
would make a positive contribution, and I think it is an 
opportunity for the United States to exercise leadership by 
proposing it.
    Senator Corker. Of course, it will be very detrimental to 
the United States in proposing that, would it not?
    Mr. Soros. No, I don't think it would be detrimental, 
frankly. You could view it as an alternative to the dollar, but 
I can--I'm sure that the dollar will remain the world currency, 
even with the issue of the SDRs. The SDRs are a different 
kettle of fish. They are a reserve on the books of the IMF. 
They have to be converted into a currency to be used. So, they 
have to be converted into dollars or sterling or euros--or 
renminbi, for that matter--in order to be used for actual 
trading. So, I don't think they represent, in any way, a threat 
to the dominance of the dollar in the world.
    Senator Corker. I've got a colleague here, I know, that 
wants to ask questions. I want to thank you all, all three of 
you, for being here and for your input. I wish we had a longer 
time to be with you, and I hope there's a chance for you to 
come back, in the future.
    Thank you very much.
    Senator Risch. Well, thank you, Mr. Chairman.
    Actually, I just spent 3 days in Brussels, at the Brussels 
Forum, and sat through 3 days of economists debating these 
issues. I'm going to pass. Thank you very much.
    Senator Lugar [presiding]. Let me take advantage of that to 
raise one more question. You've all talked a little bit about 
the dangers of protectionism. Is it already the case that many 
countries, including our own, taking a look at their own 
problems, in terms of jobs, have become more protectionist? To 
the degree that that continues, this is not fatal to the 
scheme, but it certainly is a body blow. In terms of common 
sense, will countries come to some agreement? Domestic politics 
being what it is, Mexican trucks can hardly get across our 
border, we're still trying to keep sugar out of the South from 
Latin America, all the same old things, literally. And so, 
crisis or not, people are saying, ``First things first.'' These 
are things ingrained in our policies in the past, and they're 
not easily expunged by summits or by other things. Other 
countries have similar difficulties.
    Now, is there something about this crisis that is likely to 
change that ethos? And how might that come about?
    Mr. Wolf. This is a subject I've thought about for about 
three decades and am very interested in. I'm, as it were, 
pretty relaxed. I know free traders like me aren't supposed to 
say this, but I am pretty relaxed about the sort of protection 
we are seeing. We have experienced protectionism like this in 
every significant downturn in the last 50 years. It was very 
bad in the 1970s and early 1980s. And provided--we must--have 
to accept that politicians meeting together in international 
meetings say one thing and behave a little bit differently at 
home. This is just the reality of the world. And the system we 
have--the rules governing the system--does, in fact, allow 
measures to be taken to protect industries, in exceptional 
cases. And it will be very surprising if opportunities of that 
kind were not taken, in this case.
    So, I don't think that anything that has happened so far is 
devastating, as it were, to the survival of the world--of the 
world trading system, nor that anything that has happened 
should, in itself, be very surprising.
    So, could it be more dangerous than that? Yes, I think it 
could be more dangerous than that. And that's what I've been 
trying to stress in my recent writings. Protectionism has not 
been used as a macroeconomic policy tool--that is to say, as a 
tool for dealing with general unemployment--in any major 
country since the 1930s. It's always been used to deal with the 
specific problems of specific industries, sometimes important, 
as in the case, for instance, of automobile production, or, in 
this case, the financial sector, obviously, where it's most 
significant.
    There is, I think, a real danger that if this recession 
becomes very long and very deep, that the other methods we've 
talked about--fiscal, for example, or monetary--seem to be no 
longer effective or dangerous, that policymakers, in this 
situation, will turn to the idea of general protection as a way 
of achieving the Holy Grail, as it were, of ensuring demand 
remains at home.
    And it is, for this reason, so important that demand 
policies, expansionary policies, be agreed across the world, 
and, in my view, particularly so, a subject we haven't 
discussed here, in surplus countries, which have more room for 
expanding demand to increase their absorption of tradable goods 
and services, and thus, relieving, to some significant extent, 
the problems of deficit countries, like the United States, the 
United Kingdom, and others. So, my concern is that, in that 
context, of course, people would even be willing to throw aside 
the rules that were agreed in the GATT and in the WTO, and we 
would then move from a series of--as it were, from a snowfall 
to an avalanche.
    We're not there. There is no sign of it. But, if we don't 
fix this by orthodox macroeconomic policy means--and this is 
very much, I think, the thinking of somebody--of people in the 
1930s, that that will happen. And that seems to me the danger 
we really have to focus on. It's not happened, there's not much 
of it around, but I think it is where we could be, 3 or 4 years 
from now, if we haven't fixed this.
    Senator Lugar. Mr. Wolf, though you mentioned, earlier on, 
as we discussed China, the importance of China's willingness to 
open up, to have--not a grand bargain, but at least for us to 
understand that we need to accept exports from China, a 
significant part of the market is here in the United States. 
And, on the other side, not explicitly, but implicitly, the 
Chinese have been interested in buying our bonds, for safety 
reasons, but also because this is something that keeps the 
demand going.
    So, this is a very important flow. Counsel us a little bit 
about the China situation, since it's extremely important to us 
and to them. The fact, as you say, it's not a zero-sum game; 
there is a possibility, here, of seeing mutual advantage.
    Mr. Wolf. Well, I agree completely with your description of 
the current situation, the trade between pieces of paper and 
real goods and services. And it just seems, in many ways, 
rather favorable to the United States. But, in the longer run--
and by ``the longer run,'' I don't mean the next 10 years, I 
mean the next 3 or 4 or 5--I do think, particularly in the 
context of a general deficiency of demand of the kind we're now 
experiencing and the associated dangers, that we should be 
expecting--and I think that's the focus of the discussion, at 
least on macroeconomic policy--that the Chinese pursue policies 
which start reducing their current account surplus 
significantly. I think it is really hard to stabilize the world 
economy. It's a view I've expressed in a recent book. If a 
major emerging country like this is running a current account 
surplus of $400 billion a year or so, which might conceivably 
in the long run rise further, I think it is desirable that we 
discuss with them ways in which this can be reduced. This will, 
of course, reduce their capital outflow, but it will also 
increase export opportunities from the rest of the world. In 
other words, the rebalancing of global surpluses and deficits, 
in my view--I think it's a view that Keynes would have had in 
this context, in this sort of crisis--is a central part of the 
discussion we must be having with other countries around the 
world, and China is a particularly important one.
    Senator Lugar. Thank you.
    The Chairman [presiding]. Mr. Soros, fill out for us on the 
SDRs--a lot of people don't know what they are, these special 
drawing rights. They're part of the fourth amendment to the IMF 
articles, is that what you're limiting your comments to, or are 
you talking about the SDRs in the broader context that some 
people have talked about with respect to a full-blown currency 
concept under the IMF? Where are you on that? Just fourth 
amendment limited one-time draw, or are you taking broader?
    Mr. Soros. Oh, no, I'm suggesting an annual issue of SDRs 
while the recession--global recession is in place. Now, there 
is an existing pending issue--it's called the fourth amendment, 
and it's for $21.6 or $23 billion SDRs. And it is actually 
approved by a large majority of the country, and is only 
actually pending U.S. approval to----
    The Chairman. Right.
    Mr. Soros [continuing]. Be over the 85-percent approval 
that is needed. That could be used as a sort of a trial run of 
how this would work. So, it's a very practical proposition.
    There are some special difficulties or peculiarities with 
regard to that issue, because that was conceived 10 years ago 
to make up for the relative under-representation of Russia and 
Eastern Europe. And so, it has a more-than-proportional 
increase for those countries. So, I'm not actually necessarily 
advocating that we should use that right away. It could be 
used, but I think it could be perhaps only--or it should be 
used perhaps only after a better understanding has been reached 
with Russia.
    The Chairman. Fair enough.
    Mr. Wolf and Mr. Lindsey, I want to try to resolve, in my 
own mind--and perhaps it's good to have the public discussion--
about the degree to which the European experience right now is 
the result of mistakes that they made on their own or the 
result of their having bought into the so-called ``Washington 
consensus'' about reforms of the last 20 years, and practices. 
For instance, many of our folks urged them, in the privatizing 
of banking structures and so forth, to open it up and allow the 
purchase of banks. And indeed, Western European countries have 
bought a significant component of the Eastern European banks, 
to such a degree that some of those countries are now holding 
assets greater than their own GDP, but also leaving some of 
those countries almost without a banking system, so that if 
they withdraw to themselves now and take care of business at 
home, those Eastern European countries are in triple trouble. 
How do you assess--Mr. Wolf, maybe you go first--how they wound 
up where they are today? Was it the credit default swaps, the 
rapid purchasing, the entry into our housing bubble that 
created their bubble? As we work our way through the anger that 
exists--and you've acknowledged that anger in your own 
testimony, and I mentioned it in my opening--we've got to have 
some sense of how we got here.
    Mr. Wolf. Can I start----
    The Chairman. Go ahead, yes.
    Mr. Wolf. The story of Central and Eastern Europe, of 
course, is very complicated and--but, as countries concerned 
always remind us, they're all different. Nonetheless, there is 
a common element, which is obvious enough. And I think we have 
to start with--not so much with what they were told, but with 
what they themselves wanted. After the fall of the Soviet 
Union--a very important and blessed event--they were encouraged 
and, above all, themselves determined to join Europe and, in 
the same way, join the West. It's perfectly clear it was a 
common desire. George Soros, of course, knows much more about 
this than I did, and played a very large role in promoting 
this. This was both economic and political, and joining the 
European Union and the European structure was an important part 
of that.
    In the process, they committed themselves to opening and 
liberalizing their economies and trying to become as much like 
ours as they could, and did so to a very substantial degree. 
They integrated in trade to an incredibly high degree, foreign 
direct investment, open capital accounts and all the rest of 
it.
    And in general, looking back on this experience, if we 
leave aside where we are for now--and we can still get through 
this, I think; I have no doubt about it--it's been a big 
success. I think it's important that, you know, of all the 
things that has happened in the world, I think the opening to 
Europe and the integration of Europe is one of the great 
triumphs of Western policy, in the broadest sense, and of 
American policy.
    Now, there are, however, it's clear, a few vulnerabilities. 
First, this became the only region of the emerging world, and 
truly the emerging only region, because of their commitment to 
this and their will to this to become a very, very large net 
importer of capital. After the Asian financial crisis, no other 
region was. They--all the other regions accumulated reserves, 
and, to some extent, therefore, shielded themselves against 
this shock. These became very dependent on continuing inflows 
of borrowing capital. They run large current account deficits, 
not all enormous--Poland's is relatively small, but some are 
gigantic--so, if all the capital is cut off, by definition, 
they immediately go into a depression, because the capital that 
supported their activity--some cases, very small countries, had 
current account deficits of 20 percent of GDP. You can see what 
happens if that's cut off. So, they became vulnerable on that 
point. They became vulnerable, as you rightly pointed out, 
because their banking system in--because in order to introduce 
high-grade Western banks, as it was seen, banking, it became 
part--they became part of Western groups. And nobody thought 
this will be dangerous. I mean, truth. I don't remember anybody 
ever saying, ``We could get into a crisis in which the major 
banks in Italy, Austria, or Germany might start thinking we 
should actually have to serve our domestic interests rather 
than the interests in these countries.'' By the way, I don't 
think it's come to that yet, but that was something that we 
didn't think about. It is the most worrying aspect of this 
crisis, from the protectionist point of view, and that's 
something we didn't think about.
    The third thing they became vulnerable to, inevitably, was 
Western European demand. They export an enormous proportion of 
their output to Western Europe. And the Western Europeans have 
plunged into a very deep recession. These are the prices of 
openness.
    Now, for very small countries or countries in which with 
small economies--and Poland still has a very small economy--
this integration in the world is inescapable. There's no other 
way they could have become prosperous. But, it is clear now 
that there were risks associated with that which we didn't 
fully understand, and some which they took to willingly, like 
borrowing a large amount in foreign currency, and therefore, 
the risk of currency mismatches. So, they made mistakes and we 
made mistakes. There's no doubt--and by ``we,'' I mean, 
particularly, Western Europeans, in the advice that was given 
to them, but also, I think, others--the IMF, the Americans, and 
so forth. That's how we got here.
    But, I would stress that, despite these mistakes--and they 
were, they made the region more vulnerable than it needed to 
be--the process, by and large, has been very positive. That 
means that, if we can deal with the problems they now 
confront--and I believe they're all perfectly manageable--with 
suitable support, with insistence that the banks that went and 
bought their banks continue to operate effectively throughout 
the region, with assistance to make sure that currencies don't 
collapse too much, from the IMF, Western Europe, and so forth, 
by successful policies to relaunch demand in Western Europe, 
which is essential and for which Germany is crucial--I think we 
can get through this. Mistakes were made, but I would not--and 
they're clear that they were mistakes, and I've indicated some 
of them, but I don't think we should start saying, because of 
those mistakes, that something fundamentally was wrong with the 
effort. It has actually been, in many ways, one of the greatest 
successes, in both economics and foreign policy, of the West in 
the last 25 years.
    The Chairman. Thank you very much. Very good.
    Mr. Lindsey. Yes, if I could echo the point Martin made, 
and not just with respect to Eastern Europe, but the hundreds 
of millions of people around the globe who joined the global 
middle class, thanks to these policies, this is a step back, 
but it is a step back after two steps forward. It's not three 
steps back. We are still ahead of the game.
    Senator, I understood your question to be a little 
different, in that it was sort of a, do the Europeans have 
their own blame, or did they simply get it all from us? And 
there, I would--I really don't think that--I think we have an 
excess of self-flagellation of this side of the Atlantic. If 
one goes back to the 1990s and looks at the creation of the 
ECB, the American economics profession was virtually unanimous 
in recommending that this was a dysfunction setup. I testified 
before the British Parliament to that effect. They put 
themselves in a situation where they created an optimal 
currency zone--excuse me, they created a currency zone that was 
not an optimal currency zone. They have no fiscal authority, 
they have limited immigration, et cetera. And so, a lot of the 
problems and the dysfunctionality that's now in Europe was 
really a result of a political decision they made 15 years ago 
with which we not only had no involvement, but, as Americans, 
tended to recommend against.
    In addition, we Americans didn't tell the Irish to become a 
financial sector and follow the policies that they did. We 
didn't tell the Austrians and the Italians to do all the 
investing in Eastern Europe that they did. We didn't tell the 
Spanish to invest in Latin America to the extent they did. They 
did that without our help or participation.
    It's more that Europe and America made the same mistake 
than we exported our mistakes to Europe. The world financial 
system is global in its precepts. London is at least as 
creative a place as New York is. And the monetary policies on 
both sides of the Atlantic were very accommodative of a bubble, 
for reasons that, you know, have causes to defend.
    So, I really don't think that we should blame ourselves. We 
are part of the problem, but they're grownups and they made 
their own mistakes along with us.
    The Chairman. Well, thank you all very much.
    Mr. Soros, I want to ask you if you want to summarize and 
have the last word here, with respect to the foreign policy 
component of this and the challenge we face--if you just want 
to leave the committee with some last thoughts, pulling the 
afternoon together, that would be terrific.
    Mr. Soros. Well, all I'd like to say, what we have been, I 
think, saying all along, that the situation is very serious, 
that it is a genuine collapse of the financial system, the 
likes of which we have not seen since the 1930s. But, we have 
the experience of the 1930s to learn from, and we--I think we 
are trying not to make the same mistakes as we did then. So, 
the lessons of the 1930s were summed up in John Maynard Keynes' 
general theory which was published in 1936. We have the 
advantage that that book is now available, we can take it out 
of the drawer and dust it off and use it.
    The Chairman. There's another interesting book, 
incidentally, which I just reread the other day, which is John 
Kenneth Galbraith's ``The Crash of 1929''----
    Mr. Soros. Yes, very much so.
    The Chairman [continuing]. Which is well worth the wisdom 
in it, particularly with respect to some of the----
    Mr. Soros. And just--in summary, I just would like to, once 
again, emphasize how we do have this special drawing rights, 
which, again, is in existence, is real, and it can be used and 
could make a major contribution to alleviating the problem.
    The Chairman. Last question, Mr. Wolf. What's the most 
important thing that has to come out of the G-20?
    Mr. Wolf. I think the single most important thing, given 
where we are now, there has to be a really big demand 
commitment from the surplus countries; otherwise, the United 
States ends up with this nightmare fiscal position. They are 
the mirror image of each other. I think that's absolutely 
central, and there must be clear and credible ways forward for 
the fund--IMF system of which the SDRs are part. Those are the 
two absolutely central elements, in my view.
    The Chairman. And the ``demand piece'' means?
    Mr. Wolf. ``Demand piece'' means that--I think, that the 
Germans, Japanese, and Chinese have to have a target for 
domestic demand, which clearly means that they start 
reabsorbing their surpluses at home.
    The Chairman. Fair enough.
    This has been excellent. We really appreciate it. It 
scratches the surface of complicated issues, but it's a 
terrific outline, and we're very, very grateful to all three of 
you for being with us today. Thank you.
    We stand adjourned.
    [Whereupon, at 4:34 p.m., the hearing was adjourned.]

                                  
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