THE FINANCIAL CRISIS, THE US ECONOMY, AND
INTERNATIONAL SECURITY IN THE NEW ADMINISTRATION

New School University
New York City
November 14, 2008

 4:30 – 6:00  Session IV: A New International Financial Architecture

Jamie Galbraith:
            In my comments this morning I focused deliberately on the domestic issues. But, they formed only part of the agenda of the discussions of the Paris meetings which gave rise to the idea of this conference. We had, in fact, there an exceptionally talented, diverse, and experienced group of specialists on the international monetary system, and we were conscious of the implications of a financial crisis arising in the reserve country, in the United States, on the future of partner countries around the world and of the international monetary system itself. We have here this afternoon for our final session a panel, four of whose participants were at the Paris meetings, and who represent, I think, an exceptionally high order of global professional knowledge in this field.   I’ll introduce them very briefly:
            Paul Davidson, now a senior scholar at The New School and the editor of The Journal of Post-Keynesian Economics;Ping Chen, a colleague of mine at the University of Texas at Austin for many years and a fellow of the [?] Center, a physicist by training, closely associated now with the Center for New Political Economy at Fudan University in Shanghai and the China Center for Economic Research at Peking University in Beijing; Luiz Carlos Bresser Pereira, former finance minister of Brazil and a senior fellow, scholar, at the Fundacion de Julio Vargas in Sao Paolo, and a friend and colleague going back to the days of the debt crisis in the 1980s—and I should say also, Luis Carlos, that he is one of the world’s great specialists on the control of inflation, both from a practical and a theoretical point of view; John Eatwell, president of Queens College at Cambridge University, a figure I have known since my youth in the early days of the Robinson-Eatwell textbook, and a senior advisor particularly on financial matters to the Labor Party, member of the House of Lords. We are especially privileged, in addition, to be joined this afternoon by George Papandreou, former foreign minister of Greece, and president of the Socialist International.   I should say, George, in addition to his present leadership positions, in helping the socialist and social democratic community of Europe—and of the world—form a response to the present crisis, I’m particularly delighted to have you here because of the bond between our families, between my father and his father, Andreas Papandreou, that goes back practically to the dawn of time, but to the early professorship and graduate studentship of my father and Andreas respectively at Harvard in the 1950s, and an association that carried through for the rest of their lives.
            Let me say, then, that it’s with great pleasure and delight that I welcome the panel, and I would ask John Eatwell, if you would, to lead off.

John Eatwell:
            All right, so we’re talking about the international financial architecture, and the response might be to current events. My talk is going to start with two themes, two really rather separate themes, which I then hope to bring together to confront international problems.
            The first theme derives from the nature of financial regulation itself, and the way that the regulators, or regulatory theory, if you like, and practice, have developed over the past 10, 20 years. This was very well summed up in Alan Greenspan’s confession before—or was it the Senate? Was it in committee, what was it, a month or so ago, where he had one particular phrase. He said he had thought that firms would manage their financial risks themselves.
            That’s revealing in two ways: First of all, it reveals that, like most of the regulatory community, he had bought the argument that modern risk management technologies based on the developments in statistical financial theory and in data processing, had created technologies, risk-management techniques, for firms that, if applied, if best practice was applied, then this would reduce risk for the system as a whole. He had bought that argument.
            Because what I think he should have said was not that, I thought firms would manage; but I thought could manage. Because one of the themes, one of my two themes is that risk management by firms themselves, however best practiced, and however sophisticated, does not actually reduce systemic risk for the system as a whole. There are risks which the firm itself cannot measure. The jargon is the risk is mispriced. The standard bit of economics which lies behind this is the simple economics of externalities which we learned in Economics 101, the effect of the factory owner who produces dirty smoke; he or she takes into account the cost of materials and the returns that they get from selling the products of the factory, but not the cost of the smoke in terms of its impact on the health, on the cleanliness of the local region, and general pollution.
            That same idea carries over into finance, in the sense that the risks that an individual firm takes may be measured in terms of its own risk exposure; but it doesn’t take into account the consequences of its risk exposure for the system as a whole. The easy example one gets is the idea of a bank run. Bank A fails because it’s made inappropriate loans, or been imprudent. Bank B down the road is perfectly prudent, and solvent, and careful. Because Bank A has failed, everybody thinks, oh my god, perhaps the banking system is not as safe as we thought. They rush down to take all their money out of Bank B, and Bank B fails because it can’t produce the cash fast enough, even though it’s perfectly solvent, perfectly prudent, and perfectly well-run. The risks that were created by Bank A included risks to Bank B, which of course it didn’t take into account. It didn’t price.  This is what is really meant by systemic risk. It’s the risk which is the characteristic of the system as a whole which the individual firms, however expert they might be in managing their risks, cannot actually evaluate. It’s not their fault. They can’t do it. It’s an externality. It has to be measured and managed by those who manage the market as a whole, in this case, the financial regulators. That’s one particular theme. As I say, the regulators bought into the argument that new risk management techniques were sufficient; and they were not.
            The other theme that I want to talk about, and then I’ll want to join these up at the end, is the way in which institutions, international regulatory institutions, have developed since international financial markets began the long road to liberalization in the early 1970s. It was actually after the turmoil at the end of the fixed exchange rate system of Bretton Woods. It was actually in January 1974 that financial markets were effectively liberalized internationally in the United States, in Germany, in Switzerland, and so on; and then most other G7 OECD countries followed on in the next three or four years.
            It was in the summer of 1974 that there occurred the first international financial crisis. This was the so-called Hershtadt Crisis. For those of you who don’t know the story, it’s an informative story. What happened was there was a bank called the Hershtadt Bank which was trading in futures on the New York money markets. The Hershtadt Bank failed. It got things wrong. It went along to its regulator in Germany, and the regulator said, Okay, at 4:00 on Friday afternoon when the exchanges are closed, you will fail, and we will close you down, and then we’ll come in and clean up the operation, not taking into account that at 4:00 on Friday afternoon in Frankfurt, it’s only 10:00 a.m. in New York, and the markets are still open. You may think this is funny today, but people were sitting in just national jurisdictions.
            What happened was there was consequent chaos on the New York money markets, and settlement procedures froze. It’s often the back office, which is really the basis of financial crisis, its settlements, which causes all the problems. The settlement structures of the entire US banking system were threatened by this. The Federal Reserve came along and said to the Bundesbank, “What are you going to do about this?” And the Bundesbank said, “Nothing. It’s in New York. It’s your problem. What are you going to do about it?” The Federal Reserve said, “Nothing. It’s a German bank. It’s your problem.” This was the first time that there was this recognition that we needed some form of international procedure for managing the risks in the new internationally liberalized system.
            There developed as a result of that the Basel Committee on Banking Supervision, set up by an outfit called the G10. G10 is an interesting organization. There are lots of G’s around. The G10 has always had 12 members, which has always puzzled me somewhat. It’s the main European countries plus Canada and the US and Japan, and so on.  They set up an organization called the Basel Committee on Banking Supervision, and there were two other committees, one to do with settlements and one to do with structures of international markets. They were set up as an informal system. It was, if you like, committees of consenting adults. What they did was they developed rules. In this case, how to solve the problem in the Hershtadt risk was who was going to be responsible. Which regulator would be responsible, the home regulator, or the host regulator? They developed rules for how this would be done.
            Over the next 30 years, steadily these committees have developed more and more rules. They are actually the people who are behind the definition, for example, of the amount of capital the banks must hold, first in the Basel I agreement of 1988, and then the Basel II agreement, which has just come into force, and a whole series of others, principles and codes which define how banking is supposed to work.
            The interesting thing is that this is a consensual organization. It is what the lawyers call soft law; that is, that they develop rules which then have to be incorporated by national jurisdictions into their law. They have no powers as such, but there they are. They’re there, and they’re the main international rule-making organization.
            At the time of the Mexican […?] Crisis, in December 1994, the G7 was meeting, and started to get very nervous about this. The G7 countries themselves started to worry about international financial regulation. They hadn’t really been involved as an organization before.  Then, following ’97-’98 Russian and Asian crises, the G7 set up the Financial Stability Forum as their, if you like, intellectual or financial think tank. Today it is the Financial Stability Forum, which is a committee which consists of, for the G7, their central bankers, their regulators, and their treasury departments, plus some other organizations, the IMF, the World Bank, and the Bank for International Settlements. This organization is really [making the running?] now on what is to be done with respect to financial regulation. It was making the running before the current crisis, and they’re making the running now. Because this was the organization which published recommendations as to what to do in April last year, and their recommendations were endorsed by the G7 finance ministers; and in just this October, they published a follow-up which is actually setting the framework for the meeting in Washington today, today and tomorrow.
            They are the intellectual force. They have three basic themes in their argument. The first is transparency, the second is disclosure--the difference between transparency and disclosure is transparency is the instruments you should be able to understand, and disclosure is that you reveal the procedures of the firm--and more effective risk-management by firms. In other words, they are still accepting the argument that more effective risk management by firms plus market sensitivity and more information will be enough. They are ignoring externalities. They are still ignoring systemic risk.
            Just the other organization that started to get in on the game is the IMF. The IMF started reinventing itself round about ’98, ’99 as a financial regulatory organization. It took the intellectual lead from the Basel committees and from the Financial Stability Forum, but used the powers, its treaty powers, to actually start doing inspections of countries’ financial systems, the so-called Financial Sector Appraisal Program. They have now actually inspected financial regulatory systems around the world and produced a whole number of reports. They haven’t done anything, but they have collected a lot of data, actually some rather useful data.
            There we are. We have actually some structured institutions, and we have a particular theory. The theory is very useful, because suppose that you had an international regulatory organization which actually was going to manage systemic risk, was going to operate at the level of the system as a whole. Let’s take a policy proposal which deals with systemic risk, which is so called pro-cyclical provisioning, which is that you require banks to put aside more capital in the time of a boon, and they’re allowed to run some of it down in the time of a slump.  It’s a provisioning structure for a rainy day.
            Suppose you try to implement that internationally. It’s easy to do at the national level perhaps—well, maybe it’s not so easy, but you can understand how you can do it legally—but how would you do it at an international level? Suppose, for example, people’s cycles are not all at the same time, so one area of the world is in a boom when the other area of the world is in a slump. That means the capital requirements will be different in one part of the world than they would in another. And lo and behold, banking operations would move very rapidly into the part of the world which had the lower capital requirements. Once you start saying, “How do we actually have systemic regulation, which is what we need on an international level,” then you run into some very significant difficulties, analytical difficulties. International regulation has developed a framework, a quite successful framework up until now, because it hasn’t faced up to the problem, which is the real problem.  It has actually left the control of risk essentially to the firms. All it’s done is develop better rules for firms and so on, rather than addressing this bigger problem.
            It is a major issue, this big problem, because if you have liberalized financial markets which need regulation to manage systemic risk, the regulators are trapped in irrelevant national boundaries, national juridical boundaries. They don’t have international regulatory powers. Therefore, you have ineffectual international regulation; you have the ability of financial institutions to practice regulatory arbitrage and to move to those areas where regulation is more slack; and even though there is a clear global connection, especially these days, in financial markets, it is not matched on the regulatory scale.
            I said just now that the Financial Stability Forum had come up with a framework which essentially was the same as before, that is, the same as the intellectual framework which has dominated the development of regulation for the last 20 years—transparency, disclosure, risk management by firms—no attention to systemic risk. That’s not entirely fair, because they did have one very good proposal which they’ve actually taken over from some European Union ideas, which is that there should be colleges of supervisors responsible for large international firms. What that means is that the regulators for a major international firm—let’s take HSBC, the biggest bank in the world, stretches all over, from Asia into the Americas. Its regulator would be a collectivity of the regulators from its major jurisdictions. You would have this college, this group, which was especially put together from Singapore, from Hong Kong, from London, from New York, and so on and so forth, to regulate that institution. This is an attempt to develop a framework which actually would deal with global institutions.
            We do have a problem. There is a lot of institutional development actually, a lot of institutions out there; but they don’t have a framework, apart from this one good idea, within which to operate. The British government’s main line, if you like, going into the negotiations today and tomorrow is that the Financial Stability Forum has the ideas and no power, and the IMF has power and no ideas. Therefore the two should be put together, because the IMF is a treaty organization with legal rights and responsibilities defined by the Articles of Association, and also it overcomes some of the democratic deficit in the G7 organization. The IMF may have an imperfect governance structure, but at least everybody’s involved; it’s not just the G7 telling the world what to do.
            What we’re going to see, I think, over the next few years, is a great concentration of reinventing the IMF, reinventing it as a financial regulator. That’s what I expect to happen. Therefore, if we want to influence this debate and develop a structure that actually confronts the problem of systemic risk that, I think, is where our interests should be targeted.

Paul Davidson:
            The last two lines of a book I wrote which was published last year titled John Maynard Keynes. It was written in July 2006, the whole manuscript. Let me quote the last two lines: “When, not if, the next Great Depression hits the global economy, then perhaps economists will rediscover Keynes’s analytical system that contributed the golden age of the post-World War II. For Keynes, however, it will be Pyrrhic victory. I didn’t think the time would come that quickly. If I had time, I’d say, “Well, what do you think?” This book, by the way, has nothing to do with biography. The question is, “Do you have to have a theory in order to know what you’re going to do in policy? What do you think Keynes’s theory is about?” People say, “Oh, sticky wages.” Keynes said, no, it was not sticky wages. “Oh, it’s liquidity trap.” Keynes says in the general theory there is no such thing as a liquidity trap. Then they say, “But Keynes didn’t say anything about international things in the general theory.” There are actually 15 passages in the general theory which mention how the general theory will be modified if it’s an open economy, as well as all his work on Bretton Woods.  I will recall you one more thing: He wrote an essay called “Self-sufficiency,” in which he said the law of comparative advantage is really irrelevant in trade patterns today. The only time comparative advantage works is if you have natural resources, or something that is climate. Obviously you don’t want to go to Iceland to do sunbathing if you’re a tourist. He says for all the other things, as long as capital is mobile across national borders, it’s absolute advantage, not comparative advantage that turns trade patterns.
            Let me just give you the example that I used: Suppose China built a factory in California that hired child labor, had no occupational safety regulations, polluted the atmosphere, and made people work 45 to 60 hours a week at a very low wage. The United States laws would say you are not allowed to trade with that factor. Why is it, if they put the factory in China, we allow the anybody in residence in the United States, to buy it?
            One of the things we see Obama said, we have to change the free trade agreements, and so on. Why did we pass child labor laws? Because we believed it’s uncivilized to let children under 14 work—not because they didn’t want to work, or their parents didn’t want them to work. We have some things that we limit people’s ability for self-regulation.
            Second thing is, Keynes; what was his revolution? It had to do with taxonomy. I mentioned this earlier today. Keynes spent 10 years trying to figure out what was wrong with the classical theory. He knew by the Treaty of Versailles there was something wrong, but he didn’t know what it was. What he did in essence was change the definition of words that we use in economics. Remember, savings was time preference in the classical theory. It just meant you bought something later rather than later, and the manufacturer knew, because markets know when you’re going to buy these things, so built more capital equipment to apply for this extra demand later. He said no, it’s the propensity to consume, and what you save you have as liquidity preference; that is, you want to put your savings in liquid assets.
            He has a whole chapter called “Essential Properties of Interest and Money,” in which he says every liquid asset has two essential properties: a) Anything that’s liquid cannot be produced in the private sector by the use of labor; and b) The law of substitution, it will not be substituted. If the price of liquid assets goes up, you will not substitute products of industry. What did that mean? It meant if you save, you bought things that couldn’t be produced in the private sector; and no matter how the price ran up you would never substitute producible goods for it. That’s what caused unemployment.
            The same thing is true in his talking about the financial markets in the international sphere. Instead of efficient markets, he said that markets were liquidity preference markets. They were not efficient. That’s why he talked about animal spirits driving it, and not some idea of what makes an efficient market. You know the future. At least you know it with statistical reliability. I hate when people keep saying risk management, because there is no such thing as risk management in these things, since you can’t predict the future. Keynes continually said that and, as I’ve argued several times, Keynes says it about Mr.—. He didn’t know the word ergodic, because ergodic theory was still in Russia under the Moscow theory of probability. Although Keynes knew a little Russian, he didn’t know about that. However, he said about Mr. Tinbergen’s method that the economic data are not homogeneous over time, and not homogeneous is a sufficient condition for non-ergodic systems. You can’t predict the future, and that’s why liquidity is important. Arrow [and Harnes?] says when a serious monetary theory is to be written, the fact that contracts are made in the form of money will be the essential part of it.
            Think about contracts in a global economy, where you have people in two different countries entering into a contract. What currency do you use? Very often you use a third currency, usually the dollar, particularly if it’s a commodity. If it’s a manufactured good, you usually use the currency of the producer. This creates all sorts of problems for the system.   Keynes was very clear about that, and he suggested a plan at Bretton Woods to solve this problem. The plan has to have certain characteristics.
            I feel like a broken clock. A broken clock tells the correct time twice a day every day. Since 1983, I’ve been saying the international system is terrible, international payments. We have to change it more towards the Keynes plan. Every once in a while I’m right−with the Mexican problem, with the ’98-’99 default problem, now, the Paris meetings in the ’80s. At least four or five times during the day I’ve been right. It’s a long day, but it’s not the long run.
            What did Keynes want to have in this Bretton Woods system? He said there are certain things that have to be: First you want a global monetary regime that operates without currency hegemony. He didn’t want the dollar, the system. He conceived of some supernational central bank with an international currency for banks, which only central banks could deal with; the public would never deal with it.  I’ve been arguing that you don’t need a central bank; what you need is a clearing union. Again, the international money is something that the public cannot speculate on, because speculation is a really difficult problem.
            Secondly, you want global trade relationships that support rather than retard domestic development. As soon as a country starts to develop, if it gets out of step with its trading partners, it starts running balance-of-payment problems, and therefore must tighten its belt trying to succeed by controlling the currency, and therefore never having to worry about balance of payments problems–so far anyhow.
            Third, Keynes’ familiar capital flow constraints - which is again, part of China’s strategy, and it seems to work.
            Fourth—and here’s a very important one: If there is a balance of payments problem, you want an international currency that puts the major onus on the creditor nation to solve the problem, not on the debtor nation. What is true under the current system says the problem with all convertible currency, whether they be fixed exchange or variable exchange doesn’t make any difference, is that the situation is that the debtor nation is the one that’s required to tighten its belt; whereas the wherewithal for solving the problem is with the creditor nation. They have the money to solve it. He suggested certain things that had to be done: a) You either have to somehow force the creditor nation to spend, when it runs up excess reserves, it could spend it on buying products from other people.  It could make foreign direct investment, but it has to get rid of those extra credits. If it doesn’t want to buy the products, for instance, if China doesn’t want to buy cantaloupes, which will at least create jobs for illegal Mexicans in California, if nothing else, it can—Ping suggested in Paris that maybe one of the things they ought to do- is invest in light rail industries in the United States, now that we have to solve our transportation problem. We could see municipal bonds to China to produce light rail, solving two problems at once and getting rid of their excess dollar reserves. Or c) if they won’t do either of those two, Keynes said there would be a 100 percent tax to take away these extra reserves. Instead of that, we would have something which we’d call the Marshall Plan.
            Let me just remind you of what the Marshall Plan was about. At Bretton Woods, Keynes said that the European nations would need approximately $10 billion to rebuild. Harry Dexter White said, “Never.” Congress would never give more than $3 billion. The Keynes plan was dead. IMF and the World Bank were supposed to somehow recycle private funds over the $3 billion that the Congress might allow. In 1947, there was bad agriculture. Western Europe looked like it was failing, that they might even go to Communist; so people convinced General Marshall to give the Marshall Plan. In four years we gave $15 billion—not 10—to the Europeans. It was good for them, and it was good for the United States.
            Why was it good for the United States? It was the first period after a major war where we didn’t have major unemployment. Just think: 9 million men and women come out of the army into the labor force. Some of them were absorbed into colleges under the education [plan]—but there were still a lot more. Government spending went down by about 45 percent. Where did we hire? There was some pent-up demand in government bonds, people had consumer spending, but export industries grew dramatically because of the Marshall Plan, and that created jobs. Therefore, we gained, and they gained. That was Keynes’s argument. The surplus country should have the situation as well.
            In the essence of the Keynesian system, it is that it is liquidity and financial markets that make a monetary entrepreneurial economy run; and it’s a double-edged sword. On one edge, if it’s run right, you can have economic growth at a rate that you can’t have in a barter economy. If it’s run wrong, you have what we have now, a depressed economy. Keynes once said that if you take an economy where the real wealth is constant, and people are handing around pieces of paper to each other, and each day the price of the paper goes up, everybody feels better off. If each day the price of the paper goes down, suddenly they feel worse off. The real economy hasn’t changed at all, but it will change if they feel worse off.
            These are the characteristics of what we need in an international monetary system. We have to recognize a) that we cannot leave it to the market to solve these problems; the capital markets are not efficient; b) that liquidity is the essence of the problem, and we have to encourage people to spend. What always amazes me now is everybody now picks on the poor American consumer because they spent more than they earned, and equity, and so on; but we forget, since 1992 the global economy has been driven by US consumers spending like crazy. Allen Sinai pointed out it went up from 67 percent to 71 percent of GNP in the United States, and of course this created not only the engine of growth for the United States, creating profit opportunities for our people, but also for the rest of the world. China’s growth is in large part America’s ability to buy Chinese goods.
            Let me say this: What we need is an international system based on these principles that I’ve indicated, an international global system. The hard problem is how to get from here to there. It’s clear that that’s what we need, but – a recent email asked: How is your system going to solve the Icelandic bankruptcy problem? The answer to this, if somebody is in bankruptcy, it’s too late to solve it. That’s why we have bankruptcy laws. They get them out of it with the least penalty to them and to the lenders.
I can’t solve the Icelandic problem, but I can tell you that if we do change the system, we will have a system that encourages every country to pursue full employment.
            Why capital controls? Just think if we had these capital controls, could we have passed off all of this toxic acid, so to speak, to Iceland, Germany, Northern Rock, what have you. All of these things could have been prevented.
            Would they have been? This again requires regulation and some intelligence, and a meritocracy. One thing Keynes always believed in is that our regulators, our civil servants, would be a meritocracy. If they’re not a meritocracy, no policy will work. All I can say is let’s have a meritocracy, and let’s understand the theory and the principles of what we need.
            John’s saying, let’s reform the IMF – I think that may do it; but I would doubt it very much. We need a new institution. Somebody earlier said – was it Bill? I forget who, I guess Barclay – we could use the old institutions to do new things. I don’t care whether you call it an IMF or not; I call it an international clearing union. Let me just be clear: The international clearing union clears between central banks. The public never gets hold of the accounting – and hopefully central banks don’t do accounting fraud, Bill – and then each country is permitted to set its exchange rate for one-way convertibility between the clearing union unit of account and its current account. It can permit two, but it need not. All it has to do is say, “All right, if you have one IMCU, it’s worth so many dollars.” The advantage of that is every central bank will be willing to hold IMCU’s because they know they can always products at a fixed exchange rate.
            Finally, does the exchange rate ever change? Yes. The exchange rate changes. I won’t go into this, but just throw out the idea: if the efficiency wage, that is, productivity less money wage, improves, then there’s an advantage in changing the exchange rate. What I’m arguing is that you have relative real efficiency wages between countries that shares productivity growth among every nation of the world. We also have this onus on those countries that run up too big a balance in the clearing unit. They must get rid of their balance by buying something from others, which allows the debtor nation to work their way out of debt. That’s what we want people to do, work their way out of debt, not bail them out of debt. Thank you.

Ping Chen:
            I was trained as a physicist in China, Austin, Texas, and Brussels, Belgium; so I have a lot to observe different ways that address similar problems. I agree most of the speakers talk about today. I only address some issues maybe less frequently mentioned.
            I raise several issues seems missing from many discussions today. How do you deal with American economy? Do you treat American economy as a closed system, or open system? People used to think only small countries need consider that, but not the United States.
            Secondly, I will ask a question: Why do financial investors, like Goldman Sachs, behave much better in China than in the United States? The question is asked about the issue whether you have a micro-foundation or macro-foundation for firms’ behavior. Specifically here I will talk about financial firms’ behavior. They make decisions not in a vacuum. They [need that?] macro-environment. A lot of people may blame our financial firms; they have good reason.  But also I think they have to ask a more fundamental question: Why American financial firms doing a much better job in China than in the United States?
            The third thing I will ask is to question economic theory. What’s the driving force of growth? It’s consumption, or new technology and new industry. Many times, we hear the voice we have to encourage consumption, especially to buy new house, new cars to prop up the economy. I was very puzzled. If you recommend the same measures to developing countries, let’s say, you spend more money, you can drive up the economy; how can you afford that?
            The fourth question I will ask: When we discuss what shall we do in United States, have we ever considered what’s the condition for effective macro-policies that should depend on domestic politics alone, or also you need consider international competition?  Say there are two countries, one country spend most of money in propping up consumption; another country spend more money to encourage innovation. You think which country will win? That’s a very simple question, right? No matter what the natural resources, no matter what kind of property rights they have.
            Also I should say for last 28 years I stay in United States. I learn a great deal from Americans, from my colleagues. This is a time: Can you think you can learn something from others? Like European Union, or Japan, or China, or Brazil? Certainly I cannot speak for other countries. I would address issue from China’s lessons, whether it’s relevant to American economy today.
            Final question I would ask: We discuss a lot about new thinking in policies. Why shouldn’t we think new thinking economics itself? If we have a bad theory, then it would be very hard to imagine you will produce good policies.
            I will single out four misleading economic theories and dangerous policy implications: Number one, many people really point out: the noise-driven cycle model of [Frisch?] is behind mainstream economics. They believe market economy itself is fundamentally sound. Any trouble is caused by external shock. Now people realize it’s inside system itself.  We know this since 1996, because after we discover why the evidence of [color?] chaos […?] biological clock in a macro-economy and financial markets. The external driving force theory is completely irrelevant.
            Second thing I will emphasize: Right now people believe in Friedman theory of monetary movements. It’s wrong, because Friedman assumes monetary movement is exogenous. So central bank can do whatever they do. This is also the implicit assumption behind his theory of Great Depression. I think it’s very dangerous right now for Paulsen and Bernanke and all, a lot of central bankers follow Friedman as theory to dealing with the current financial crisis. I would think that’s very dangerous, because we know in 1988 we find the first evidence of monetary chaos, which supports the Austrian theory of endogenous money, but rejects freedom as theory of exogenous money. I will discuss this maybe later.
            Third thing, I would think most dangerous theory was Robert Lucas’ theory of micro-foundation and rational expectation. Because if you know the principle of large numbers, you will find out the driving force of business cycles is not from household. We have a huge number of households, and not from firms, but right from financial intermediates. Why is that I will show later, but I will mention fourth one first.
            So far nobody speculates. The collapse of the derivative markets are not just driven by greed, but also caused by bad models, [Blackshaw’s?] model, which is explosive in nature. When you don’t know how to evaluate the price of derivatives, you count on the so-called rocket science model. But it was the wrong model. It collapsed.
            For these four theories we have analytical solutions [and theoretical theses?], not just philosophical arguments.   I would specifically mention one simple mathematics, which was used by Schrodinger, the founder of quantum mechanics, but ignored by economists because there’s a conflicting relation between micro-efficiency and macro-stability.
            Let’s say we have 1,000 banks. You merge them in 10 banks. You think bigger is more efficient? More stable? Wrong. Its aggregate fluctuation will amplify by 10 times. That’s what’s going on in United States. [shows formula on slide]
            I should remind you Peter [Taming?] at MIT completely [discredited?] Friedman’s theory about Great Depression. I would recommend Kindleberg’s theory about Great Depression is more relevant to current situation. It’s not accidentally by monetary authority to trigger the Great Depression. It was a collapse of Britain-led globalization without any new system supporting. The three big Allies after World War I – that’s United Kingdom, United States, and France – kicking a ball among them, have a collapse of the whole global [?] system.  This lesson discussed by Kindleberg is much more relevant to the current financial crisis than the story by Friedman.
            This is a picture we will discuss, the driving force of economic growth and our understanding of Shumpeter’s creative destruction.
            Let’s go to final one. This slide shows an explosive [Blackshaw?] market. I would say the problem of imbalance in international affairs was caused by American policy creates a new type of international division labor. How is this the case? I think Reagan revolution: on one side you have a military expansion; the other side you have deregulation. You force industry sourcing out first to Japan and Asia. Then you push Japan yen to appreciate. Then you force the industries sourcing out from Japan, Asian Tigers to mainland China. Then Americans doing the same thing try to push China to raise the currency, to appreciate currency. Then you have another round of sourcing out.
            However, no matter how exchange rate fluctuates, America has a persistent trade deficit. But Germany and Japan have persistent trade surplus. It’s nothing to do with exchange rate, only to do with American security policy. That’s […?].
            Secondly, China benefits the most from American-led globalization in what sense? Accidentally, during Asian financial crisis, China did not devalue the currency under American recommendation. I know very well from Martin Feldstein, a longtime friend, and all the mainstream American economy before and during Asia financial crisis, their recommendation to Latin America, to Hong Kong, to China is dollarization, dollarization, and dollarization. That’s why the Chinese prime minister believes that buying American Treasury bills is the best way to preserve the value, rather than invest in China’s state-owned enterprises. However, once China did that, it became a trap. They find out you accumulate a huge number of Treasury bills, it’s just paper. For Japanese and European, if your currency goes up, you can buy American assets, buy American technology; but not for Chinese, because we have security barriers.  It’s an unequal trade and an asymmetrical opening. Chinese government ends up in the trap. You can only collect the paper bill without any choices.
            However, you find unintended consequences, because if the United States allow ssymmetric trade, China will buy two things: rice and corn - agricultural products. On the other end, they would buy lots of hi-tech technology. However, United States will not allow sales to China, but they can sell to Japan, and East Asia countries, Malaysia.  China got second-hand technology from these countries.
            Then you find out for last 10 years China had persistent trade deficit with Japan, Korea, Taiwan, South Asian countries, and Singapore. […?] almost seem like a persistent trade surplus with the United States. Actually America has given away a huge benefit to China’s neighboring countries. What are the consequences? In 10 years, these formerly China’s enemy countries have become China’s best friends. They join great China economy which is a de facto dollar zone, which helps to stabilize American dollar. So you should think about that.
            American can still maintain financial power with increasing deficits simply because China targets the dollar as [?]. So China happy, and America happy. However, China did not get any credit. They only get China bashing.
            Let’s say, what are the choices? I have some choices for you:
            One secret is that why China’s saving rate is so high for a poor country that end up we have to subsidize America for excess consumption. I tell you the story very simple. Because the foreign trade was mainly conducted not by Chinese firms, but by multinational firms like Wal-Mart.   Chinese company have no pricing power. For any product to sell in the United States, Chinese company only gets 2 to 5 percent of the price.   China’s market right now is more competitive than the United States, or Japan, or any other country. The profit margin for the firm is very thin. To survive, they have to upgrade their technology by self-financing.
            You can see here: This is the data from [?] at Stanford University. The main saving is not household saving. The saving is mainly for firm saving for survival. Then you can see the monopoly power of the United States end up as excess consumption, but the fierce competition in China results in high saving by firms and the rapid advance technology.   I would say if you want to change this pattern, you have [to want?] more balanced trade. You only know one thing: international anti-trust law applied to both multinational companies and […?]. Then we can have better financial order.
            Let’s have several suggestions from my American friends. I consider myself as half-American because I stay in Texas for 28 years. I also consider I was a citizen of European civilization. There’s no incentive for Chinese people to want to replace America or Europe as world leader. That’s impossible.
            What’s the lesson we learn from China economy? I would suggest first: Growth first. Then reform and redistribution second. If you have a shrinking pie, you have no way to reform. A lot of people discuss we have to increase pension fund, save this, save that. Where’s the money come from? You have to come from growth first.
            Secondly, for United States you have to change your consumption-driven gross to export-led gross. What you can export? Exporting T-bills is a very bad strategy. Okay? You can export, let’s say—General Motors, they invent it: all-electrical car. They cannot sell in United States, but I say you can sell to China because we have a large-scale economy. Also America’s most competitive industry is universities. Every Chinese family, including poor farmers, if they have savings, they want to send their children to United States to learn. Why can’t we switch? Right? You accept more Chinese students, and you form a system partners with Chinese province or cities. They invest in American education system or invest in municipal bonds to develop infrastructure, and you help China develop better education. Why can’t we do that?
            Certainly, I can say this morning you have a genius proposal. You can ask a government as insurance, but I’m afraid American government right now is so poor, they cannot insure for credit. However, if United States and China and Europe can reach the mutual trust for long-term, not just as a self-appointed world police, self-appointed judge to manipulate China’s affair, this could be done.
            How can we do that? I would say China government can act as insurance for China private investors to invest in American cities and universities. If American government can provide matching funds, that’s even better.
            Cross-investments will encourage trust around the world.  The people may think that I’m crazy, wondering why we need Chinese investment. I tell you, China doesn’t need American money. China attracts large amount of foreign investment mainly because if this investment bring new technology, new manufacturing, you are welcome.   China’s open door policy is selectively open—not open to speculators. I think America can do similar thing.
            Another thing I would suggest: The Paulsen recipe for calamitous financial trouble is recipe for great trouble. You should be breaking monopoly firms first into competing groups, rather than to let them merge, you become more trouble. If you let Citibank take over Merrill Lynch, next trouble will be Citibank. I think this is a very simple lesson for Russia. They privatize the monopoly company without breaking them out; but China is breaking […?] companies without privatizing them.
            Finally, I would say flexible exchange rate is a disaster, and fixed exchange rate is much better for effective fiscal policy. The future financial international order should be: you should create a basket of major currencies with relative exchange rate. Then we can have effective fiscal policies.
            I think my time is up, and thank you for your patience.

Luiz Carlos Bresser Pereira:
            Thank you for the invitation. I think that in this crisis, or after this financial crisis, we learn several things.  I think this group here discuss this whole day the things that you learned. We learned that financial systems need regulation. We learned that regulation cannot be only national; it has to be international. We learned that initial crisis evolved into real economic crisis. Fourth, we learned that only to solve the financial crisis will not solve the economic crisis that was its consequence. You have to take measures to sustain effective demand in this moment.
            I think that you are consensual about this, but I think that you forgot the major problem. I think that you are addressing this financial crisis as if financial crisis were only of one type, the type that we are facing today, that is, banking crisis. For a great country like United States, the other type of crisis probably will not happen.  For rich countries normally the other type of crises do not happen—although England was in the early ’80s victim of it.
What is the other type of crisis?  The other type of financial crisis is a balance of payments crisis - the crisis to which developing and middle income countries are subject strongly.
Crises are very relevant, not only relevant for the developing countries, but given the increasing role and weight that these countries have in the world, these crises have systemic consequences, as [John Eatwell?] spoke so well.   We didn’t address this type of crisis, and also we didn’t address which kind of measure should we take to prevent this. Because I think that this has been in some ways very poorly done - the matter of IMF. This was the Bretton Woods concern sixty years ago. I am in favor of international currency, but I don’t believe that it will solve the problem. I am in favor of increasing the role of developing countries in the new financial architecture that will evolve from this crisis. My country is strongly proposing that the G20 has more power.  I think that’s okay, but I don’t believe, again, that this will solve the problem. You really address the question – which question – of how we prevent balance of payment crisis.
            What will resolve the problem is the decision of countries, and the surveillance of the financial system as a whole of the global governance: is to limit current account deficits;  to limit foreign countries’ indebtedness; is to remember that growth is supposed to be done through domestic savings, not foreign savings; that foreign savings that is current account deficit – foreign savings is current account deficit; it’s synonymous. Not borrowing or direct investment are ways of financing the deficit, but not necessarily the [?].
            The solution, in my view, is to limit indebtedness. Because how happens the current balance of payment crisis? Very simple. The country becomes indebted. Or even before getting indebted, if it begins to have a very large current account deficits, in one situation or the other, creditors at a certain moment lose confidence and stop renewing the debt. Suspension of the rollover of debt causes the crisis. Then the IMF and the United States come to solve the problem, but the crisis is already [dead?]. A normal devaluation of the currency is the response.
            What’s interesting about this question is that neoclassical economists, they are very much against budget deficits, but they have no critique at all—on the contrary, they’re adamantly in favor - of current account deficits because this [grows foreign?] savings. This is a wonderful thing, rich countries tell developing countries. This mistake, I believe, is not a mistake that is limited to neoclassical economists. I believe that most economists, conventional economists in general, believe this one phrase: that capital-rich countries are supposed to transfer their capitals to capital-poor countries. This seems very obvious, very clear. It’s a footnote, for instance, of a paper by [Eischrich?], this phrase; but a footnote is easy not to remember.  To me it’s the same thing when you say that you are supposed to go with foreign savings, with current account deficits, you are being as true as you are when you say that the earth is flat. I developed a full argument about this in papers that it’s not the moment here [to recite], to discuss why these current account deficits are negative; but you can think the problem in three stages:
            The last stage is the budget payment crisis. The previous stage before this is the financial fragility, and so the enormous dependence of the country on the creditors and on IMF, and what goes to the confidence-building attitude—do everything that the creditors want me to do. But before these two things that are obviously disasters for the countries, what we have – and this is the model that I developed – is a high rate of substitution of foreign for domestic savings. Why? Because when you have a current account debt, the exchange rate appreciates, wages go up, etc. I’m not going to present you with the full model here. The Journal of Post-Keynesian Economics published my paper about this.
            What we should discuss here, in this subject, and take seriously, is a recommendation. We should do what the Europeans did about the budget deficit. The European Union established by convention among them that 3 percent was the maximum. Sometimes you can go out; but in general 3 percent was maximum. I think that would be a good idea. This is a good idea. We can discuss sometimes this is too much, if we have to go up; but in general I think that the limit is reasonable to my view.
            I think same thing should be done in terms of current account deficits, and that should be really seriously discussed; then if we arrive 3 percent or 2 percent, I prefer, limit, then let’s do it. The IMF, for instance, is supposed to hold the head banner, when things happen, when the problem is happening, the country’s going out of this. I am very much aware that I am saying something that is very new, and same time is very old. Very old is about 10 years old. Ten years old sometimes is very old. Why is 10 years old? Because I began to develop these ideas is 1991, let’s say. It was a little before that, after 1997 [sic], that developing countries very strongly began to make current account surpluses.
            My friend Jamie had an explanation for this, and I think that’s a good explanation, why United States has a current account deficit and how this is functional for these developing countries that want reserves […?]. I agree with this. However, I don’t think that this is the main point, the mean reason. I think it is one reason, but I think the main reason is that developing countries learned that current account deficit is disastrous. Who really learned were the Asian countries, the four Asian countries that ran into a major financial crisis in 1997 because they were running high current account deficits. They were not running budget deficits, but they were running high current account deficits.
            There’s another explanation besides this, and this for the fact that not only United States, but also Europe and Japan, will have in the future some current account deficits that will have to be negotiated—not developing countries. This is related to the Dutch Disease but again I cannot present here.
            What I am suggesting is that the idea that the market is able to control, is able to adjust global financial indebtedness is absurd. This should be put on the agenda, and you should have a very strong recommendation to put limits on current account deficits. Thank you.

George Papandreou:
            Jamie Galbraith didn’t mention that my father owed his life to Kenneth Galbraith. He was arrested many years ago in Greece during the junta. I was then just a young teenager, and my father faced possible execution. Then Kenneth Galbraith called President Johnson, who answered with a number of superlatives [expletives?], but was convinced to actually pressure the junta not to harm or execute my father. So it is a great honor and a pleasure to be with you tonight.
            I’m here in New York at this meeting because I share with you a profound concern about the financial crisis, which of course began here in New York and then spread throughout the world. I am the president of the Socialists International, and am on my way to our meeting in Mexico on Sunday. I usually had great difficulty mentioning my title in the United States without provoking shock and awe. That changed slightly when I was last here. That was the day that Wall Street crashed. I repeated my title, President of the Socialists International, at a charity function, and a lady said, “We sure need more of your guys here in the United States.” I later felt that I was in much better company when now president-elect Obama was accused of being a socialist.
            In all honestly, I’m very proud to be heading this movement, which has had active leaders in the past, such as Willy Brandt, Bruno Kreisky, Francois Mitterand. Our movement now does represent more than 160 parties around the world, from Latin America to Asia. A month from today, Nelson Mandela’s African National Congress, Michelle Bachelet’s party in Chile, both the labor party of Israel and the Fatah movement of the Palestinians, President Zardari’s Pakistan People’s Party, all European social and labor parties, from Gordon Brown in the UK to President Tadic of Serbia, and many more. Our movement has been around, yet the world order has been dominated neo-liberal and neo-conservative rhetoric over the past years, one which loathes any words of social justice, empowerment of our citizens, equity, democratic accountability and oversight, transparency, solidarity, stimulus packages, regulation of markets, unemployment benefits, fair distribution of wealth for green development. We’re pleasantly surprised that these words, these concepts, are again a la mode.
            I am foremost here to tell you that throughout the world and certainly our movement welcomes the arrival of a new American president, a new administration, and with it a new opportunity. The drama around the success of an African-American in defeating a dominant conservative party has created great expectations, a new promise. This promise translates, of course, into a new challenge, and we progressives around the world are both ready and willing and hoping for a new partnership with your new president, with the new government of the United States for change on our planet.
            Solving this financial crisis certainly is not a technical matter, even though it is very important that we look at the technical aspects. It is fundamentally, I believe, a political matter. It concerns the most fundamental global values and choices that we in the 21st century face. We need to solve today’s crisis in a way that empowers our citizens, peoples, societies, and with them, empowers our global, political, and financial institutions so that we can deal effectively, equitably, sustainably with the daunting planetary challenges.
            International institutions, as Professor Eatwell said earlier, regulators trapped into the national, as he said, irrational boundaries, whether it’s a WFO, or a super-bank, or global currency, or [a killing unit?], as Professor Paul Davidson mentioned, these institutions are important, are necessary in one way or another; but they also need to have the legitimacy, I would say the necessary powers. We then come to the question of who will decide on this global governance.
            This is a fundamental question for a new geopolitical balance. Underlying this question is: what do you mean by a democratic governance, or democracy at a global scale? Unless we believe in an enlightened global aristocracy that will govern the world, the challenge is basic. It is a democracy, which is why I think we also need to convey, and I’m doing so on behalf of the Social International message to those who are meeting tomorrow at the G20 in Washington DC. It is a clear message that globalization must be for the people and by the people. We need democratic change for democratic global governance, one that ensures the participation of the disempowered, the poor, the middle class, the small and medium-sized enterprises, the productive forces of the world; one that democratically sets new priorities at a global scale and new global institutions; and uses our time and wealth and resources in a sustainable way.
            New rules must emerge from a new understanding of democracy as both a global condition and a philosophy that includes economic institutions, not just political institutions. This is the challenge, but this has also been the problem: How do our nation-states, our democratic institutions, cope with globalization?
            Think about it: a real paradox. Humanity today has amazing capacities – technological prowess, wealth, innovation, knowledge, and creativity – unheard-of power to influence our lives for the better. Our citizens see power, yet we very often feel very disempowered. Not only that: our generation and certainly our next generation are facing the most difficult and complex issues humanity has ever faced. Climate change on a vast scale linked to carbon-based energy consumption, new and old pandemics, poverty, the bottom billion, arms, drugs, and human trafficking bringing in profits that overshadow the GDP of many countries in the world—issues that theoretically we can deal with if we had concerted, coordinated, global efforts.
            What do we see? Instead of global solutions, our problems are compounded by the financial crisis, one which has revealed, has uncovered major flaws: the amazing concentration of money by the few, and which of course is only paralleled by the concentration of media power, which in turn has led to the concentration of political power, at the same time the corruption of our democratic institutions – the uncontrolled, if you like, power.
            This is a problem around the world. This is a democratic challenge. Our institutions, our political institutions, our democratic institutions, the rule of law have either been captured or circumscribed, as Paul Davidson said concerning labor relations and labor laws, by big interests. The state, the markets, politics have been captured. So we could say that today we have, in a sense, a state welfare system for the rich and the powerful, a [clientalistic?] capitalism.
            It’s in this spirit that I asked Joe Stiglitz to chair a commission we set up for a global social democratic response to our financial crisis. We’ve come up with an interim report, and you can get it on the Web. We mention that we need immediately to cooperate to soften the consequences of this dramatic failure of unregulated markets, not just in the US, but globally. As markets freeze, as recession begins, our duty is to think not only of Wall Street, but also of the billions of men and women and children around the planet. If we are to save banks, we first should do so in a way to save the right to employment, pensions, accessibility to food, education, health services, strengthening the real economy. Regulation of global financial markets must be thorough-going, must reestablish public control of the private markets, and must be prepared at every turn to combat the excesses of speculation and greed that have brought us to this point.
            Secondly, we need to put a floor under the slide into recession, maintaining and enhancing social protection systems, supporting working men and women, insuring productive enterprises, avoiding layoffs, limiting damage to our productive capacity and the social fabric of our world. We certainly need to continue development assistance to the less developed countries, protect the most vulnerable, and show solidarity beyond borders.
            Thirdly, we need to invest—and certainly public investment—to stimulate our economies, but in particular, to create a new engine of growth around the concept of green development. Mobilizing resources in a time of crisis has been done at times through wars; so our challenge is to show that we can do this through peaceful means, and do so in creating a new sustainable future for our planet. I would go so far as to say that either we move towards green development, or we will be moving towards conflict and war. Either we move towards democratic empowerment, social justice and solidarity, green development; or we move towards barbarism on our planet.
            No one can do this alone—not the US, not China, not the European Union, not others – but the US will have to play a leading role. Three reasons: First, it has its huge responsibility in creating, if not fully creating itself, but very much responsible for a large part of the mess, the crisis we’re now seeing. Secondly, not even the US can escape interdependency. Thirdly, there is a new administration that will command great respect, and therefore legitimacy, around the world.
            However, it cannot lead by force, it cannot lead by dictate, as Professor Ping Chen mentioned concerning China and other countries. It can lead by example. Preventive diplomacy rather than preventive wars, globalization for the people and by the people, markets that serve people and are profit only, taking the lead in renewable energy, leading on the issue of nuclear disarmament. The challenge of global governance is immense. If we fail to move towards democratic global governance, our peoples will be prey to all forms of extremisms, absolutisms, fundamentalisms, and populisms. They will retreat either into passivity, or into violence.
            This means that I see Obama’s victory in many ways as a revolt against the demise of our democracy, as a hope for a re-empowerment of our citizens and society, certainly in the United States, but I think that’s seen as the same sign and symbolism throughout the world. It is a daunting challenge, a huge responsibility, and also a huge opportunity. A new page to be written, but it must not be written in haste, but at the same time we must not allow the blanks on the page to be filled in by fate or happenstance. Your role as economists, as progressive economists, is and will be crucial in writing these new pages of our global, political, and economic history. Thank you very much.

JG:
            We can take a few minutes for questions and comments from the floor.

Barkley Rosser:
            I have a question that mixes theory with policy. It came up in several of the talks that were given. I’m sorry John Eatwell is not here. He sort of started it with this idea of what was good for individual firms in their risk management creates these externalities for the system. Ping Chen talked about the problems of micro-firms forming larger units that then create larger macro-fluctuations. Luis Carlos was talking about separating these two different crises; but in fact we’ve seen recently that when there are crises, they can combine. The countries that are in trouble now, like Iceland, and Hungary, and Pakistan are having both banking crises and now their currencies are crashing; so these things come together.
            What I want to pose is that whether we go with Paul Davidson’s new ICU, or with Eatwell upgrading the IMF, or we end up with some kind of solution that’s sort of a semi-coordinated bunch of nations doing things within themselves, we really do face a tradeoff, and we need to be very clear about it. There’s a deep idea in ecology between resilience and stability in a system. Translating this into economics, we can think of stability as being a combination of efficiency, or low variance, especially for individual units. Resilience is that old Minsky concept of financial fragility. We’ve had this conflict between things that make things more efficient apparently, and maybe even more stable in the short run; but they’ve undermined the resilience of the entire system. What we have to do is we have to somehow get mechanisms that are probably going to do this through increased regulation. We’re going to forbid certain kinds of financial transactions, for example, and certain other things will happen. Those may reduce certain kinds of short-run efficiencies; but those may be necessary to get us global resilience of our entire system. Any comments on that?

Paul Davidson:
            The United States has 12 central banks. This one is issued from the Central Bank of Richmond; this one is issued from the Central Bank of Philadelphia. There are current account imbalances between them. We don’t change the exchange rate between these dollars. How do we solve the problem? Where Roosevelt solved the problem very easily by a progressive income tax where the surplus countries [sic], because they’re growing income more rapidly, paid more taxes, and then they were spent in places like where I used to teach, in Tennessee Valley, and so on, creating jobs over there.
            Since Reagan came in, we solved the problem by Rust Belt versus Sun Belt. When the balance of payments gets bad, the banks run out of reserves, and the Federal Government doesn’t recycle this money into the situation where it should be.
            The other point I want to make is, remember the old S&L’s. In the old days, before regulation, the S&L’s and most commercial banks could only service their local area, which they understood. They knew who were the good loans and who weren’t good loans, and they had to worry about that. Once we suddenly said, No, you could service anything. An S&L in Princeton, New Jersey, would finance a golf course in Tucson, Arizona, knowing nothing about any of this; and this leads to bad banking.
            The financial system that I’m suggesting here, which is the equivalent to the international system, says that we stop at national borders, and we create a system where each nation has the incentive and the responsibility to create full employment and rising wages for its workers, and can do it without worrying about balance of payments problems, and without worrying about getting stuck with somebody else’s toxic assets. There’s no other way of solving those kinds of problems. I don’t know what institutions you want to do—

JG:
            I perceive a certain complementarity between the issues that you’re addressing and this geographic scale we’re discussing; and the issues Luis Carlos was addressing and international geographic scale that he was speaking to. Want to take a word?

Luis Carlos Bresser Pereira:
            I want to respond more specifically to your question, Barclay. The problem is IMF. Because the international finance, you need to remember who has the power—some power at least—is the IMF. The fact is that I, myself, specifically I, I don’t have trust in IMF. I don’t belief that IMF is there to really regulate and put order in international finance in the interest of everybody. Since IMF is controlled by rich countries, controlled very clearly in terms of stocks, this means [it] responds to the interests of these countries. Given the fact that I think cooperation among countries is essential, and an organization or institution like IMF is necessarily the outcome of cooperation among countries, I believe also that competition among countries is very strong. In this process I think that we will have to solve the problem of legitimacy of IMF, if IMF is supposed to continue. I would prefer another institution—not IMF.

JG:
            We’re going to take two more questions, we’ll take them together, and then I’ll let Professor Nell ask the last one.

Q:
            I want to thank you all for your presentations, very informative, and for mentioning also the importance I think you were talking about – I work on these issues also at the UN – of unity and a new spirit.  You brought up the harsh competition between nations and corporations, etc., which have gotten us into this mess, as well as the religions, I might add, and the need for reconciliation and the meaning of words. I’m supposed to go to a function later tonight or tomorrow on mental health education awareness on general semantics and the meanings of words. When you said socialist from this country’s perspective tends to have a negative meaning; but on the other hand, if you take social justice, I think most people will be. Same thing with liberal, if it’s liberal open-minded thinking, or it’s traditional American values. The meaning of words, and also the reconciliation factor, and also the causes which caused the conflicts of different mindsets or world views. Also that the UN, the kings of Spain, as well as Saudi Arabia, have actually proposed a large interfaith Madrid gathering, interfaith council, which isn’t being acted upon, as usual, because I guess the US wants to not talk about these things. What can we do to develop a capacity for greater reconciliation and compatibility for more ethical and humanist culture, which actually many religions, (which I was talking of to Mrs. Davidson about Rabbi Davidson, many of the liberal clergy who don’t have a problem with human rights, or universal human rights) demonstrate the need for greater consistency and compatibility, even with some of the more conservative orientations that we are warring with, from various perspectives, violently or nonviolently?

Lucy Webster:
            I wanted to ask Mr. Papandreou something about the potential for the Socialist International providing some sort of leadership in the direction of IMF or reform of the international financial system and generally addressing some of the international issues where I think there’s a lot of consensus which has just been referred to in various circles that we move in; but there’s a lack of initiative, a lack of precise programs.

JG:
            I’d summarize that by saying one of the most dangerous things about the movement you represent is always saying things that the rest of us also agree with.

George Papandreou:
            I think we are facing in many ways when we talk about global institutions, whether it’s the IMF or it’s a new institution, the need to create first of all a sense of rules, common rules, we can all live by; a sense of a rule of law, if you like, on our planet. That inherently means that there are some basic values which we share, I think, in all these movements—and I’ve been involved quite a bit also in these dialogue of cultures, and dialogue of religions. Coming from Greece, as foreign minister, I worked quite a lot with Turkey, and we are in an area where there are orthodox Catholics, Jews, Muslims—quite a mishmash, for many centuries—and I think what we need is to be able to, on the one hand, create a set of principles and rules, which may seem technical, but behind them there are really values, political principles, which will allow, however, for a wide diversity and resilience, whether it’s political, cultural, or economic. That balance is going to be very important. In a sense, you will need some central control and consensus; but at the same time, decentralizing power, innovation, a dynamic in our societies, and see how our nations will fit into this new architecture. That’s going to be very difficult and daunting.
            I think the European experience is an important experience because what we have been able to do is quite different cultures and from different political backgrounds work together in a globalizing world as nation-states in a system which is quite coordinated. As a Socialist International, we, I think, first of all were not very much on the radar, particularly by international media, for a number of reasons; but I think more and more, as we are representing a large number of parties from around the world, and we do hope to link up more with Brazil, Lula’s party, I’m working with Sonia Gandhi also in India, Third Congress Party. The Chinese Communist Party is an observer. I think it’s quite interesting, because I think it’s not a party and could not become a member for a number of reasons, but particularly because it lacks the democratic institutions; but I think it’s an observer because it’s actually looking to see how it may develop into a democratic party using the example of Socialist International. Of course we are seeing how we will work with the Democratic Party in the United States. We are working with the Democratic Party in the United States; but of course socialism is a taboo word, so we need to see how we can. Once we can create this somewhat more progressive alliance around the world, we’ll have much greater clout.

JG:
            Let me give the final question to Professor Ed Nell, a distinguished member of the faculty of The New School, so a very appropriate person to end the day.

Ed Nell:
            Thank you very much. In the past few financial crises, there have been some successful resolutions; but they haven’t involved much in the way of institutional innovation on a large scale. This contrasts with the 1930s, in which, in the United States, the Roosevelt administration really did make some very large changes in the way in which institutions worked.
            It seems to me that the crash that we are experiencing now poses a very interesting question. We are about to suffer, and we have indeed seen, the wiping out of literally trillions of dollars of wealth, and we are now seeing a collapse of incomes. This is an enormous impact on the real economy and on people. Why did we permit the development of a financial sector that grew from, in the 1960s, somewhere around 10 percent of GDP, to somewhere around 20 percent, and absorbed a great deal of extremely high-powered intellectual human capital? What did it give us that made it worthwhile from the position of the society as a whole to take the risk of this kind of crash? It seems to me that this is a plausible question. What does the financial sector do for us?
            There are some obvious answers: It provides the currency. That is the payment system, and the payment system isn’t necessarily connected to capital markets or the financial sector more generally. Indeed, it is the process of securitization that has connected it, and it is that which makes the present situation so dangerous, particularly with some $62 or $64 trillion of derivatives, of which some significant percentage are expected to go bad. That’s going to be a very big loss, and it’s very hard to find those. So why did we—we can ask this question, and I think as intellectuals we ought to be—Economists for Peace and Security—asking what are the services which the financial sector delivers? Could they be circumscribed in a way so that they are much safer? And should, in fact, the size of this sector be itself reduced?

JG:
            When you say, “Why did we allow… how did we allow this to happen?”

EN:
            That’s a manner of speaking.

JG:
            I’m tempted to respond with the most famous words that Tonto probably never did say to the Lone Ranger: “What do you mean, we?”  I’ll leave the response to members of the panel.

Luis Carlos Bresser Pereira:
            I respond also to this question, but I want first to respond to the question that was made in relation to Papandreou’s wonderful presentation. Because, look—and James made a joke, saying how this problem of your saying everything that you agree. You agree, but you don’t do. That’s the question. Because your speech is a wonderful speech, and a speech on values. The speech that you are used to make, the speech that you make is the speech of science and of politics. It’s finally the speech of power. We are discussing here the international financial system, the national financial system, we are seeing that some forms of power failed and are waiting to be replaced by others; and we are assessing which are our possibilities of doing that, and trying to be realistic.
            And then comes Papandreou and makes a fully different speech. I think that this speech is also very important, because it’s impossible to make the [gain/game?] if you don’t have the values, and to have this dialectic between the values and the power, lets say. We are [not specialists in power?]—but you are a politician, you know very well also the other side.   I just want to make this comment.
            In relation to the question of what do financial markets do for us – I think that our president Lula, in one of his speeches – a very intelligent man, a very smart man – he was responding to this question. He was saying, more or less indignant, that finances make to finance production, to finance economic activities, and not to speculate, not to build wealth over wealth over wealth. That’s fictitious wealth finally. I think that this is the problem.
            I saw two numbers. I saw one newspaper in Brazil that the percentage of the profits of a business enterprise went from 5 to 25 percent of total. Now [the second figure was?] 15 to 30. The figures are different but the logic is the same. It was an enormous capture by predation, by the financial system, of the wealth of society. Part of this was created, because we can measure the wealth, the bonds and stocks of a country, and there are measures like this. Another thing, the number of transactions that make one over the other. What you see is that in the last years, last 20 years, there was enormous increase in this wealth. That has nothing to do with production. GDP was having one behavior much more normal. This makes a lot of sense because the capitalists were became richer because their assets; but who are making became much, much richer? The technocrats, the MBA golden boys that direct the banks, that receive their commissions, their bonus, and they receive always a commission over the operations, and a performance fee.  The money that they put in their pockets was really real money.  I think when you discuss regulation, I think you should discuss regulation in terms of preventing, with an objective of preventing new financial crisis; but another, with making it less socially acceptable, and not permitting the capture of the resources of society.

Paul Davidson:
            I wrote a paper for the Schwartz Center last January on housing. If you leave it to the housing market to adjust to what Krugman calls normal ration of income to housing prices, the estimate is that American homeowners, even if you don’t have a mortgage, will lose between $6 and $12 trillion in wealth. Just think of how that’s going to hit Cindy McCain. It’s not going to stop her. There was an article in Fortune, I think, that Warren Buffett just lost $9 billion in the last quarter. The number doesn’t particularly matter; it’s how much of the wealth is leveraged, and how much of it do you have to use to live on. John McCain and Cindy McCain are going to live a very pleasant life even if it goes down 50 percent.   I should say the same thing. My wife owns all our real estate, and she’s so wealthy, it doesn’t matter.

Ping Chen:
            I would say three points:
            First, in English words, crisis is a bad thing, but in Chinese words it means danger plus opportunity. From my observation, financial crisis is not bad. I have experienced two crises: one recent crisis was the Hong Kong real estate crisis. The housing price dropped one-third to two-thirds. What’s happened? The economy revitalized again because they have everything else. Only labor costing too high cannot compete with the Shanghai needs. If their labor cost 10 times them. You cannot save something unsustainable.
            Another crisis was our experience in Austin, Texas. In late 1980s, you have savings and loan crisis. The homeowners being foreclosured and banks closed. I bought the house at the time with half the price, and I was very happy. What’s happiness in Austin: the poor African-Americans, they finally got the house for one dollar. They’ve solved the inner-city problem permanently. It’s not a bad thing for a burst of the housing bubble; but if you want to sustain that, you have big trouble. That’s one story.
            Second story that’s a real story. When China decides whether they want to join WTO, at that time most of China’s economists predict there would be disaster for Chinese economy. Agricultural sector will be gone, automotive will be gone, finance sector will be gone. However, the two leaders of the Chinese Communist Party decide to go ahead. For what purpose? Because they find for them very difficult to push the reform agenda because of a strong domestic […?]. They think to introduce outside pressure is the only way to push the reform agenda. What’s happened? After China joined WTO, miracle happens. The Chinese agricultural sector competes; Chinese automotive companies can compete; Chinese finance companies can compete. Listen, many people predicted China state-owned bank will end in bankruptcy; now their market value is bigger than Citibank.  What happened?
            Third thing, I will raise the question and not answer it.  Many people believe American democracy ends up with financial power only to serve the minority, not majority of people. The Chinese political system ended up with an elite group serving the majority people, lifting the majority of families from poverty. Don’t you think there’s another way of democracy, or do you think there’s only one type of democracy? You have to think about it. Thank you.

George Papandreou:
            Just trying to answer Luis Carlos also, what you said about power. Our tradition, of course, is linking both democratic institutions with social cohesion, and social cohesion not as an impediment, but as part of a necessary element for competitive economies; and I think this is something which has been born out by many theoreticians, like Amartya Sen and others.
            I think the two issues that have made us less effective in the last years: First, it is the end-of-history theory after the fall of the Soviet Union, which we had nothing to do with as social democrats; but that only the markets were the solution. Even Fukuyama now is revising his theories. That was hegemonic. That was very difficult to hear anything else, and that was up to just before the crash here and Wall Street.
            The second is that with the growth of these pockets of wealth, you had not democracy, but the capture of democracy. What I see as a politician—and this is the question of power, it really is a question of power—who are the actors? We politicians, you think, have power. The real power lies somewhere else. When we have to run for getting money for media, when media is controlled by basically the corporations – and that’s why the Internet was so important in this campaign –  when laws are passed or not passed because the lawmakers can be captured in one way or another through lobbyists, or through donations, or whatever else—this is not only an American phenomenon; this is a worldwide phenomenon. Just think of a country like Greece, or a larger country. We are so small, so small, as far as power is concerned when confronting huge, huge enterprises that have more money than our GDP. How will democratic institutions cope with this kind of power? How will we be able to really represent our people, express our people, when the powers are much much stronger than our institutions? There is a deep question of democracy. What you said is, who makes these decisions? Who are the we? It’s not necessarily the politicians.
            In fact, we need to liberate politics from this and reinvent democracy, and I think this is how I would say dealing with the crisis. A crisis is an opportunity as long as  – I would agree –as long as you understand, what some of the basic elements of the crisis [are]. Again, it’s not simply technical. It’s partly technical, but it’s deeply political; and I think this is what we need to change in our world. Thank you.

JG:
            Let me just say a final world. This has been a mesmerizing day, and as the master of ceremonies I’m reluctant to bring it to an end. However, we do have (and I think our conversation today has underlined for us that we are at) the beginning, at this moment, of a most important process.  I think the note on which we end it is appropriate, because it is a process of action.  The results will be tested in the very near future by the capacity of our country in particular, as well as that of our partners and friends in the world, to reform, restructure, rebuild, re-energize the economic process, and to do so in a way which is more sustainable and more just than the economic life-process through which we’ve been passing for the last few decades. That past is going to be upon us, it’s going to be imposed upon us; and for all of us here it’s incumbent, I think, to continue the discussion that we began today to make clear, clarify ideas, and to place before the centers of policy action sensible, practical, and effective means to pursue those objectives.
            I want to say once again – I said this at the beginning; I think it’s worth saying again – an exceptionally warm word of thanks to the many people who made this conference possible; to, first of all Pierre Calame and Aurore LaLuc of the Charles Leopold Meier Foundation and Initiative for Rethinking the Economy; to Dimitri Papadimitriou of the Levy Economics Institute; to Teresa Ghilarducci and all of our friends at the Schwartz Center and at The New School; and to, especially, to my friends and colleagues in the leadership of Economists for Peace and Security. There are a number of them here: Jeff Madrick, who’s a member of our board; Lucy Webster, who’s a member of our board and was a director of the organization; our founding director, Alice Slater, was here, I don’t know if she’s here now; Alan Harper, our treasurer, was here—this is a remarkable group of people and part of a larger network, a national and global network of professional economists who have acted to bring considerations of economic policy and action into contact with the larger questions of global security—physical security, national security, and economic security. The work of this organization is, I think, of continuing importance.
            On a more direct and concluding note, there are some people here without whom this event would certainly not have been possible, and I’d like to acknowledge them: Patty Curry; Elizabeth Dunn of the Levy Institute; Nancy Barthelemy of CEPA; and of course, first, last, and always, the person who really did the legwork and put all of this together from start to finish in every possible way, director of Economists for Peace and Security, Thea Harvey. Thea, would you stand up.
            With that, I want to thank you all. The success of this conference is in part measured by the fact that it is 6:15 and the hall is full. That’s just remarkable. I thank you for coming. I really appreciate everything you’ve done to make this conversation a success.