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THURSDAY, MAY 20, 1999
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to call, at 10:00 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach; Representatives McCollum, Roukema, Bereuter, Bachus, Royce, Kelly, Paul, Cook, Manzullo, Ryan, Ose, Biggert, Toomey, Green, LaFalce, Vento, Frank, Kanjorski, C. Maloney of New York, Bentsen, J. Maloney of Connecticut, Weygand, Sherman, Meeks, Lee, Goode, Mascara, Inslee, Schakowsky, Moore, Gonzalez, Jones, and Sanders.

    Chairman LEACH. The hearing will come to order.

    On behalf of the committee, I would like to extend a warm welcome to Secretary Rubin and Chairman Greenspan, as well as our second panel of witnesses. As Members know, this may well be the last of Secretary Rubin's appearances, at least as a formal officeholder. In my judgment, the Secretary has been one of the most effective Secretaries of the Treasury in American history, both internationally and domestically.

    The close cooperation the Secretary has developed with this committee, particularly on the international side, is a model of executive legislative relations. We will miss your contributions, Bob, and we wish you well in your return to private life.
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    Mr. RUBIN. Thank you.

    Chairman LEACH. The committee also extends a warm welcome to Chairman Greenspan. And your wise counsel, sir, is always appreciated.

    This is the first in a series of hearings on key issues in global finance. The format and witness list has been developed in close cooperation with the Chairman of the Subcommittee on Monetary Policy, Mr. Bachus, as well as our distinguished Ranking Member, Mr. LaFalce.

    Consistent with past committee practice, when the Treasury Secretary and Fed Chairman are testifying, it is the intention of the Chairman to restrict opening statements to the Chairmen and Ranking Members of the Full Committee and subcommittee of jurisdiction and to limit questions of both panelists today to the global financal subjects on which they have been asked to testify.

    Today we are examining proposals to reform the institutions, structures, and policies of the international financial system in order to reduce the likelihood of crises arising, and to manage more effectively those crises which do occur.

    Tomorrow we will address in detail an important theme in the policy discussion on the new financial architecture; namely, which exchange rate systems best promote global economic growth and stability. Next month, the committee will examine Administration policy toward economic stability in Russia, as well as the issue of how best to provide debt relief for the world's poorest countries. Additional hearings on related themes are planned for later in the year.
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    From a congressional perspective, it would appear that the global financial crisis which began in Thailand in July of 1997 has at last bottomed out. Crisis-hit Asia is showing nascent signs of recovery, while Brazilian markets have stabilized far more rapidly than most would have dared to hope a few weeks ago. Nonetheless, the recovery is fragile and vulnerabilities remain: Japan's murky economic growth prospects; Brazil's political will to sustain reforms; China's difficult transition to a market economy and the impact of a growing U.S. trade deficit on our economy and protectionist sentiment around the world, including Capitol Hill. The question of how best to improve today's international monetary and financial arrangements is extraordinarily complex.

    I personally identify with the gradualist approach of Secretary Rubin and Chairman Greenspan, in part because it rests on commonsense assumptions: that appropriately liberalized financial markets offer compelling benefits to the world economy; that globalization and capital mobility are here to stay; that domestic and international financial issues are increasingly intertwined; and that in a global economy, occasionally characterized by financial crises, the International Monetary Fund and its sister institutions can play a constructive role in helping sustain and contain systemic risks and attendant economic hardships.

    In this context, there are a number of themes that we will want to discuss this morning. I would like to ask unanimous consent to put the remainder of my statement in the record and ask unanimous consent for any other Members to put statements in the record.

    Chairman LEACH. And at this point, let me turn to Mr. LaFalce.

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    Mr. LAFALCE. Thank you very much, Mr. Chairman. And first I would like to thank and commend you for holding this hearing. It is the first in a series of very important hearings on international economic, financial, and banking issues. I also want to publicly thank you for the full and complete cooperation of your staff with my staff. It has been excellent.

    Last year brought severe economic and financial problems in many parts of the world and the real prospect of global economic recession. Happily we got past that situation with relative success. But it is important to examine the causes of these crises and the adequacy of multilateral efforts to deal with both the crises themselves and to help the affected countries get on the road to recovery.

    This morning it is a particular pleasure to have Secretary Rubin and Chairman Greenspan here to discuss the issue. Both gentlemen have done a magnificent job and must be complimented for charting a safe course through the international economic difficulties of last year. It is now incumbent on us to draw the appropriate lessons from that experience and make necessary changes. And I very much look forward to hearing their proposals, suggestions, and thoughts for reforming the international financial architecture.

    I would also like to take this opportunity to especially commend Secretary Robert Rubin for the great job he has done as Secretary of the Treasury. This may or may not be his last appearance before our House Banking Committee. Mr. Secretary, you have been an outstanding public servant. I mean, the big debate is: Are you the best Secretary the Treasury ever had, or are you second only to Alexander Hamilton? Let us flip a coin on that.

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    I daresay, though, that never in the history of our country have we had such a tremendous combination of Secretary of the Treasury and Chairman of the Fed at the same time. And so that is meant as a great compliment to you, too, Chairman Greenspan. You have worked together magnificently. It is so ironic. You hear one one-thousandth of the issues that we might differ and people will tend to focus on that, overlooking the unbelievable convergence of opinion that you two have had on the much more important issues of the day.

    Let me just also comment on something else with respect to Secretary Rubin. In addition to his expertise as Secretary of the Treasury, he has brought something else to the job that I, we, everyone, attempt to emulate, and that is a very, very warm, human approach. He has never taken himself too seriously. He has always been self-effacing.

    He has testified before us and responded to questions in a way that enables us to literally see his mind at work, which is refreshing, because you can appreciate the intellectual honesty that he brings to the formulation of his responses. He has also had another very, very important attribute, and, that is, he realizes that the spirit of liberty is that spirit which is not too sure that it is right. In other words, there is always the possibility we could be wrong. And it is necessary to have that attitude, I think, as we proceed on a day-to-day basis.

    Back to the issues before us. When our committee considered the IMF funding and reform legislation last Congress, there was a strong sense within the committee, the Administration, and the international economic and financial community more generally, that the basic architecture of our international economics system did need to be reexamined, and our legislation specifically addressed that issue. Appropriate refinement of the international financial architecture seems necessary or desirable to help us anticipate and perhaps avoid sporadic economic crises abroad.
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    Absent such change, periodic crises of a similar nature could continue to take enormous economic and human toll on the affected countries and potentially jeopardize U.S. and world economic performance. This hearing can provide an important opportunity to see how that effort is progressing.

    We can easily take credit for where we are, but analysis is needed to see what policies worked, what didn't work, what could have been done better. Moreover, we should also be somewhat skeptical of representations that the global financial crisis is absolutely over, and there are still a lot of pitfalls out there.

    Economic conditions may well be better in some countries. One result of the crisis is that some other countries weakened or the vulnerabilities of still others became more apparent. Japan still has not shown real signs of improving its economy or fixing its financial system. It is possible that stock market investors may be premature in their optimism over Brazilian recovery, although we certainly hope they are correct. And Russia presents so many economic financial and political concerns that our committee will appropriately devote a full hearing to discuss its problems. And other countries still pose potential risks, such as Argentina, which may be vulnerable to Brazilian problems if they materialize; China, which some many analysts predict will devalue its currency sometime this year; or Germany, the keystone of the European Monetary Union, which recently suffered a slight recession and whose banks now are collectively the largest bank creditors to non-industrialized and emerging countries.

    Unfortunately the subject of international financial architecture mystifies many, because of its apparent complexities. This can be dangerous, especially if that complexity provides a cloak behind which financial speculators attempt to profit at the expense of whole societies. The proposals for reforming the architecture are as complex as the system itself. Secretary Rubin's reform suggestions, though modest in comparison with many that have been suggested, are nonetheless complicated and articulated in seventeen categories.
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    Though highly complicated, we must resist the temptation to ignore these important issues and leave their resolution to others. In carrying out Congress' oversight role, we need to be clear on what perceived reforms are intended to address; the nature of the reforms; how these reforms will be implemented; and how we can be satisfied that these reforms significantly and substantially reduce the incidence and magnitude of future financial crises.

    I want to mention finally one issue that is very important to me and a number of Members. Some tend to forget it. There is a tendency in hearings on international economic and financial issues to forget the human elements. The financial crises in East Asia led to considerable civil unrest in Indonesia, harsh economic restructuring in Thailand, and massive labor market problems in Korea, painful adjustment in Brazil.

    And though economic and financial conditions need to be adopted by these countries that the multilateral banks are assisting, we should also be very concerned about social and humanitarian conditions, and that they are as equally important requirements for assistance. I also think that if we are truly coming out of the global financial crisis, then now, more than ever, might be the appropriate time for the United States to take the lead on international debt relief efforts to the world's poorest countries.

    A number of us have co-sponsored, along with Chairman Leach, H.R. 1095, an order which provides one vehicle to do that. We look forward to working with the Administration and others to pursue that this year. I thank the Chair very much.

    Chairman LEACH. Well, thank you very much, Mr. LaFalce.
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    Mr. Bachus.

    Mr. BACHUS. Thank you, Mr. Chairman.

    Secretary Rubin, you had a real good run, and you are going out a winner. And I have to tell you that it couldn't happen to a nicer guy. You and I have had, I think, a very good relationship. I found you to be trustworthy, honest, all those things a good Scout would be, but that we don't often find—or we sometimes don't find in Washington.

    I think we find more often than people think, there are a lot of honest, good people in Washington. But a lot of people leave Washington, people come and go, and they aren't missed. And I will tell you that you will be missed. You have made a difference. And last week I noticed that the stock market responded for about an hour to your announcement. And I thought they had underestimated the loss to our country and to our financial intellect here in Washington.

    And then when I saw that the CPI numbers and the Fed tightening had about the same effect, I realized that the stock market evidently doesn't respond to anything today. So I want to tell you I join with others and tell you that you will be missed.

    And I also want to say that with you leaving, Chairman Greenspan, I feel like we ought to put you under protective custody to make sure nothing happens to you. So I hope you are well guarded and have good doctors advising you.

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    Let me say this, I am going to mention two concerns today in my questions. We have had a host of economic crises hit countries all the way from Thailand to Russia, to Brazil, and we have just had waves of distress sweep over governments and their people. And we have had whole economies that have been financially devastated.

    And now when these countries fall off the cliff economically, we have asked our banks to postpone loan repayments. We have asked the creditor governments to go in and participate financially in the rescues. We have asked almost everybody to pick up part of the burden, even the citizens of those countries. We have asked them to tighten their belts, we have encouraged them to raise taxes. We have used American taxpayers dollars. We have made payments to the IMF. In fact, we have used hundreds of billions of dollars, and that is ''b,'' billions, spent on these organized bailouts.

    But the one group that has gotten what I will say is a free ride is the private bondholders. To me that shouts inequity. In fairness, can we continue to allow these bondholders to sit back as we say in Alabama, ''fat, dumb and happy''—and they are certainly not dumb—while millions are thrown into poverty and not ask them to participate in the burden?

    Now, I know several reforms have been suggested to address this problem. And when you and others have suggested that the bondholders ought to participate in not only ending the risk, in response they have threatened to either raise their rates or to pull out of the markets altogether. That seems to be their defense. But in reality, there are huge profits to be made in these bond markets. There is a competitive bond market out there, and I don't see them leaving.
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    I do see them maybe raising their rates. But why shouldn't rates reflect the risk? What is so bad about that? Isn't that something that we ought to embrace to let the rate reflect the market reality? And I would like to hear your comments on that, because I think that is the one group that has been treated with kid gloves; and in fact the IMF has moved to protect them when they have moved to protect no one else.

    The second problem: the crippling effect of currency devaluations on the emerging nations and on their economies and on their people and on their trading partners. Devaluation is one of the worst forms of price instability, one which throws a wild card into financial dealings and often leads to recession, poverty, a loss of jobs, and so forth. Now in these currency devaluations, we have speculators, we have what I will call currency raters, who have basically taken advantage of the misery of these people. Part of that is just the market.

    But we have had banks and currency speculators that have reaped huge profits at the expense of these developing nations which have been forced to devalue. Now, Brazil is an excellent example: speculators anticipating the fall and the price of the real purchased dollars and futures. And when Brazil was forced to devalue, banks such as Chase Manhattan, Citibank, J.P. Morgan, all reaped hundreds of millions of dollars worth of profits.

    And my question is: Is there any way to insulate these economies against these currency raters—against these speculators? And the second question as a part of that is: A lot of these economies are moving the dollarization; is that going to aggravate the problem? What effect is that going to have?

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    Let me end by saying that these new international financial problems affect us. In the new global economy, when Russia or Brazil experiences a crisis, the shock creates ripples and affects not only the New York banking industry, but also every community in this Nation. When these crises do occur, and they will, we in Washington need to make sure that those who take advantage of the crises do not unduly profit and that the burden of losses is shared fairly and by all involved.

    Thank you.

    Chairman LEACH. Thank you, Mr. Bachus.

    Minority is entitled to one more speaker. Normally it would be Ms. Waters. But, Mr. LaFalce, would you like to designate someone else?

    Mr. LAFALCE. We have approximately five minutes. Mr. Sanders has made a request to speak. Is there anybody else who wishes to speak? I would divide the time, if that is the case. I have only two requests then.

    Mr. Sanders, I will yield you four minutes and, Mr. Sherman, one minute.

    Mr. SANDERS. Thank you very much, Mr. LaFalce.

    And also let me say nice things about Mr. Rubin. I do not agree with a lot of the policies that he has advocated, but his sincerity and his intelligence, his willingness to work for the public, deserves the respect of all of us. And I thank you and wish you the best in your future endeavors.
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    Mr. Chairman, I thank you for holding this important hearing on globalization. There is a whole lot of debate. I am not as optimistic about the future in terms of the global economy as some of my colleagues. I would quote an article that appeared some months ago in the New York Times. It said, and I quote: ''For much of the world, the magic of the marketplace extolled by the West in the afterglow of victory in the Cold War has been supplanted by the cruelty of market wariness toward capitalization and new dangers of instability.''

    A couple of months ago, BusinessWeek editorialized: ''Austerity policies forced upon countries by the IMF in return for loans transformed bad debt problems into economic debacles. The austerity policies of the IMF and U.S. Treasury aren't part of the solution, they are part of the problem.'' If you look at what is happening in the world today, we should pay attention to what the World Bank is telling us. For example, the World Bank says that people living on less than $1 a day, the number of people living on less than $1, has risen from a billion a few years ago to about 1.3 billion today, and would probably reach 1.5 billion by the year 2000.

    So we are seeing a significant increase among some of the very poorest people in the world. In Eastern Europe, in the former Soviet Union, the World Bank calculated that the number of people who were living under the poverty line of $4 a day has grown from 14 million in 1989 to 147 million today. That is not good news.

    What some of us have done, and I, my own office, has been working with economists, NGOs, people in the trade union movement, and we have developed an alternative approach to the world architecture. And let me talk a little bit about some of the aspects that will be part of legislation that I will soon be introducing.
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    Our concern for the global economy that we want in the future is based on labor and human rights, protection of the environment and new initiatives to encourage socially and environmentally sound national and local development. In other words, our goal is to protect the poorest people, the working people, the environment, and not just necessarily the large banks and financial institutions that have been making huge sums of money in recent years and in the process causing massive harm all over the world.

    What we are proposing, following the leads of finance ministers in Germany and Japan, we are calling for tighter controls on currency movements and international cooperation to manage exchange rates. We are following the initiative of the labor and human rights movements worldwide. We are calling for enforceable human rights, including labor, social and economic rights, as fundamental principles embodied in trade agreements.

    Following the call of religious groups around the world, we are calling for the canceling of the debt of the world's poorest countries. Following the proposals of the environmental movement worldwide, we are calling for an end to the funding of environmentally destructive projects by the World Bank and IMF, and China's global investment funds into sustainable development that strengthens the economies of local communities. Following the works of groups concerned with poverty in the Third World, we are calling for the termination of the IMF mission creep and limiting the IMF to its original mandate of contributing to the promotion and maintenance of high levels of employment, and so forth, and so forth, and so forth.

    In other words, I think the time has come to raise some fundamental questions about the nature of the global architecture that this country has helped develop, and has caused massive economic problems for the poorest people and for the environment, and I am very concerned about the kinds of volatility that we are seeing. And if people think that what happened in Asia, what happened in Mexico, what has happened in Russia is just going to pass by when you have all of this flow of capital up and down, I think we are making a very sorry mistake, and I think we really do need to thoroughly reexamine what we are doing.
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    Thank you very much, Mr. Chairman.

    Chairman LEACH. Thank you.

    Mr. Sherman.

    Mr. SHERMAN. Mr. Chairman, I look forward to the more serious part of the discussion after the testimony, but I just want to take this minute to join with those that have nominated Secretary Rubin for sainthood. And I know that he plans to escape to the private sector where huge riches may await him, or perhaps something even more valuable: sufficient sleep. But, Mr. Secretary, it may take a year, it may take two years, but we will pull you back into Government service, I am confident. This country very much appreciates your service. I am just seconding what I think we all believe here. Thank you.

    Chairman LEACH. Thank you, Mr. Chairman.

    Before proceeding, Mrs. Roukema has a statement.

    Mrs. ROUKEMA. Mr. Chairman, thank you very much. I really do appreciate it. I am very anxious to hear from our witnesses today, but I cannot let this time pass without seconding the motions of Mr. Bachus in terms of his acknowledgment of Mr. Rubin's intelligence, acumen, leadership and vast experience. So I second that motion. But I also second the motion that we put Mr. Greenspan in protective custody.

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    Thank you, Mr. Chairman. I am most anxious to hear from these two leaders.

    Chairman LEACH. Well, with the call for the wardens, Mr. Rubin may begin.


    Mr. RUBIN. Thank you, Mr. Chairman. Let me start by saying that I enormously appreciate the comments that all of you made. Let me just say that it has been a remarkable 6 1/2 years for me, and many of you have been in the public sector for a long time. For me, it was new, and it really has been an extraordinary opportunity to try to contribute, at least, and to be part of a lot of very important issues. And I greatly appreciate the comments of all of you.

    I would also say, Mr. Chairman, Mr. LaFalce, that we at Treasury in the time that I have been there had a very good working relationship with this committee on some very, very difficult issues, beginning—the first issue I faced when I became Secretary—with the Mexican support package, and going on to a whole host of issues since then. And I greatly appreciate that relationship. And I know people at Treasury are totally committed to having an equally good relationship going forward under a truly outstanding leader, subject to the will of the Senate, Larry Summers.

    With that let me say, Mr. Chairman, Ranking Member LaFalce, Members of the committee, that I am very appreciative of the opportunity to present the Administration's approach with respect to reforming the global financial architecture. It is, as many of you indicated, a very complex subject, and also one of enormous importance to the people of the globe and to the people of our country. And as I believe Mr. LaFalce said, just as the origins of the crisis itself were complex, so too are the challenges that we all face in reforming the architecture of the global financial markets.
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    Overall, our objective is to build a system that best promotes global growth, that most effectively shares the benefits of global growth, that reduces vulnerability and susceptibility to crisis, and that best deals with crises should they occur. I think a good deal of progress has been made so far, very much with the leadership of the United States.

    There is now a broad-based consensus in the international arena on the framework for reform, although certainly there are many issues which are still unresolved within that framework. We do not believe that there is some simple or single dramatic answer to these issues. As the Chairman said, we believe that there are many actions that would have to take place over time, but I do believe in totality it is a powerful program and should have a powerful effect.

    Today I would like to focus on some of the most important issues in six broad categories: involvement of the private sector in crisis response; reforming the international financial institutions; improving transparency and disclosure; macro-economic and financial policies in emerging markets; strengthening financial regulation in industrial countries; and policies to reduce the effect of financial crises on the most vulnerable in society.

    I think it would be fair to say that the role of the private sector is one of the most complex issues we face today, involving powerful competing considerations. It is our view that, at least, we must not undermine the obligation of countries to pay their debts in full and on time. It is that credit culture that enables capital markets to work. At the same time, as Mr. Bachus said, market discipline only works if creditors or investors bear the consequences of the risks that they take. And the key is to strike the right balance between these considerations and, at least in our view, to do that on a practical case-by-case basis.
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    When a government's capacity to pay its debts in full and on time may depend on the provision of official resources, we believe that the international community always must consider what the role of the private sector ought to be in burden-sharing, if any. In addition, we encourage the broader use of provisions in bond contracts that can facilitate creditor coordination and steps to strengthen national bankruptcy regimes, since that can prevent individual bankruptcies, insolvencies or debt problems from escalating into sovereign crises.

    Second, international financial institution reform. The international financial institutions, especially the IMF, will in our judgment continue to play a central role with respect to preserving financial stability. But at the same time, we are deeply committed to continuing the process of reform that has begun and with which we have been deeply involved with this committee.

    The IMF has established a contingent credit line that is designed to help prevent crises. The IMF has also implemented important new reforms to improve the openness and transparency of its own policies, including a formal presumption that Letters of Intent with respect to programs by borrowing countries will be released to the public, and a pilot program for the release of Article IV reports; that is to say, surveillance reports on the member countries of the IMF.

    IMF programs also increasingly reflect reform efforts, led by the United States, to address a broad spectrum of policy concerns, many of which were raised by this committee. For example, substantial interest rate premiums have been a feature of all recent major IMF lending programs. And program content has increasingly reflected our concerns with respect to trade liberalization, the elimination of subsidies and directed lending, reduction in military and other unproductive spending, the promotion of core labor standards and protection of the environment.
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    Third, important steps have been taken to increase transparency and disclosure with respect to all countries, developing and industrial, with respect to both performance and conditions. For example, the IMF has enhanced its Special Data Dissemination Standard, and that is going to be made available through the Internet. In addition, the international community is working to create, and in some cases has already created, standards and best practices that can help guide countries' policies, and is working to create a system for evaluating adherence to these standards and for disclosing that evaluation.

    Fourth, macro-economic and financial policies. One of the problems that became evident during the financial crisis was reaching for short-term capital, which clearly can increase systemic risk. We support international guidelines for sound debt management by borrowing countries that particularly focuses on limiting, in appropriate cases, borrowing on a short-term basis in currencies other than the country's own.

    Similarly, the short-term foreign currency exposure of the banking system can create instability, and in appropriate cases there should be limits, in our judgment at least, on such exposures. The choice of a country's exchange rate regime is also central with respect to financial stability, although it is worth remembering that in every case, the ultimate key to stability is sound policy.

    We believe the international community should not provide exceptional, large-scale official finance to countries intervening heavily to defend an exchange rate peg, except when that peg is judged to be sustainable, and there are certain exceptional circumstances, for example, the potential for systemic risk.
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    Fifth, strengthening financial regulation in industrial countries. One important step is to make the Basle Capital Accord more sensitive to the risks of short-term lending and lending to emerging markets. In addition, we believe that supervisory focus on risk management, particularly credit risk management with respect to emerging markets and to highly leveraged institutions, should be substantially improved.

    And the point here with respect to emerging markets is that in the recent crisis, one of the principal factors that caused this crisis were excesses in credit extension from industrial countries due to an underweighting of the risks during good times.

    Improvement of disclosure and of management practices with respect to highly leveraged institutions could also help reduce systemic risk.

    Finally, protecting the most vulnerable. With our strong support and encouragement, the World Bank is identifying best practices and policies to protect the most vulnerable in society and substantially increasing its activity in the social sector. In addition, the IMF in designing its programs also should take, and, in fact, is taking more action to minimize the budgetary impact of its programs on the most vulnerable.

    Mr. Chairman, we believe that our approach to reform with respect to global financial architecture is based on the fundamental belief that market-based systems create the best prospects for job creation, economic growth and rising standards of living in the United States and around the world. We believe that the result of the approach that I just outlined will be a more robust global economy, one that is less susceptible to crisis, and one that will deal more effectively with crisis should it occur.
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    We are now working to resolve the issues that are unresolved in the international arena and build consensus for an implementation of this approach.

    Thank you very much, Mr. Chairman, Mr. LaFalce. After Chairman Greenspan's testimony, I would be delighted to respond to questions.

    Chairman LEACH. Thank you, Mr. Rubin.
    Chairman Greenspan.


    Mr. GREENSPAN. I would like to also say that we at the Fed are going to miss Bob Rubin and jointly we wish you good fishing.

    Mr. RUBIN. Thank you.

    Mr. GREENSPAN. Mr. Chairman, Mr. LaFalce and Members of the committee, we at the Federal Reserve are in broad agreement with the approach outlined by Secretary Rubin, and expect to continue to work closely with the Treasury in this area.

    As I have indicated previously before this committee, dramatic advances in computer and telecommunications technologies in recent years have enabled a broad unbundling of risks through innovative financial engineering. The new international financial system that has evolved has been, despite recent setbacks, a major factor in the marked increase in living standards for those economies that have chosen to participate in it.
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    It has taken the longstanding participants in the international financial community many decades to build sophisticated financial and legal infrastructures that buffer shocks. Those infrastructures discourage speculative attacks against a well-entrenched currency, because financial systems are robust and are able to withstand the consequences of vigorous policy responses to such attacks. For the newer participants in global finance, their institutions, until recently, had not been tested against the rigors of ''major league pitching,'' to use a baseball analogy.

    The heightened sensitivity of exchange rates of emerging economies under stress would be of less concern if banks and other financial institutions in those economies were strong and well capitalized. The failure of some banks is highly contagious to other banks and businesses that deal with them, as the Asian crisis has so effectively demonstrated.

    Exposure of an economy to short-term capital inflows, before its financial system is sufficiently sturdy to handle a large unanticipated withdrawal, is a highly risky venture.

    It thus seems clear that some set of suggested standards that countries should strive to meet would help the new highly sensitive international financial system function effectively. There are many ways to promote such standards without developing an inappropriately exclusive and restrictive club of participants.

    For example, in any set of standards, there should surely be an enhanced level of transparency in the way domestic finance operates and is supervised, as Secretary Rubin mentioned. This is essential if investors are to make more knowledgeable commitments and supervisors are to judge the soundness of such commitments by their financial institutions. Some of the ill-advised investing of recent years can be avoided in the future if investors, their supervisors, and counterparties are more appropriately forewarned.
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    Broader dissemination of detailed disclosures by governments, financial institutions, and firms is required if the greater risks inherent in our vastly expanded global financial structure are to be contained. A market system can approach an appropriate equilibrium only if the signals to which individual market participants respond are accurate and adequate to the needs of the adjustment process.

    As a consequence, the G–10 central banks and the IMF initiated an effort to establish standards for disclosure of on- and off-balance sheet foreign currency activities of the public sector by countries that participate, or aspire to participate, in international capital markets. The focus of this work was the authority's foreign currency liquidity position, which consists of foreign exchange resources that can be easily mobilized, adjusted for potential drains on those resources.

    Such transparency suggests a second standard worth considering. Countries that lack the seasoning of a long history of dealing in international finance should manage their external assets and liabilities in such a way that they are always able to live without new foreign borrowing for up to, for example, one year. That is, usable foreign exchange reserves should exceed scheduled amortizations of foreign currency debts, (assuming no rollovers), during the following year. This rule could be readily augmented to meet the additional test that the average majority of a country's external liabilities should exceed a certain threshold, such as three years. The constraint on the average maturity ensures a degree of private sector ''burden-sharing'' in times of crisis, since in the event of a crisis, the market value of longer maturities would doubtless fall sharply. Clearly few, if any, locked-in holders of long-term investments could escape without significant loss. Short-term foreign creditors, on the other hand, are able to exit without significant loss as their instruments mature. If the preponderance of a country's liabilities are short term, the entire burden of a crisis would fall on the emerging market economy in the form of a run on reserves.
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    Some emerging market countries may argue that they have difficulty selling long-term maturities. If that is indeed the case, their economies are being exposed to too high a risk, generally. For too long, too many emerging market economies have managed their external liabilities so as to minimize their current borrowing cost. This short-sighted approach ignores the insurance imbedded in long-term debt, insurance that is almost always well worth the price.

    Adherence to such a rule is no guarantee that all financial crises can be avoided. If the confidence of domestic residents is undermined, they can generate demands for foreign exchange that would not be captured in this analysis. But controlling the structure of external assets and liabilities nonetheless could make a significant contribution to stability.

    A third standard could be a legal infrastructure that enables the inevitable bankruptcies that will occur in today's complex world to be adjudicated in the manner that minimizes the disruption and contagion that can surface if ready resolutions to default are not available.

    A fourth standard is the obvious necessity of sound monetary and fiscal policies whose absence was so often the cause of earlier international financial crises. With increased emphasis on private international capital flows, especially interbank flows, private misjudgments within flawed economic structures have been the major contributors to recent problems. But, inappropriate macro-policies also have been a factor for some emerging market economies in the current crisis.

    There are, of course, numerous other elements of sound international finance that are worthy of detailed consideration, but the aforementioned would constitute a good start. Even so, improvements in transparency of commercial and legal structures, as well as supervision, cannot be implemented quickly. Such improvements and the transition to a more effective and stable international financial system will take time. The current crisis, accordingly, has had to be addressed with ad hoc remedies. It is essential, however, that those remedies not conflict with a broader vision of how our new international financial system will function as we enter the next century.
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    Thank you, Mr. Chairman, I would appreciate the full text of my remarks be included for the record.

    Chairman LEACH. Without objection. Any addendums to either statement will be placed in the record.

    Let me just begin by noting that in the wake of the Mexican financial crisis, there was a flurry of effort in reform, and there is some IMF reform that followed, but then there seemed to be a kind of a doldrums periods. And one of the questions becomes, ''Are we, in a progress kind of way, really seriously putting new reforms on the table?'' Second, what is the role of the international financial institutions? I mean, are they expected to be financial policeman, firemen, maybe just hospice, like nurses for failing economies?

    And thirdly, one of the lessons that appears to be the case in the Asian economy, although it is unclear whether it is the dominant lesson, is that corruption does play a role in all of this, and how can the international financial community influence corruption in a positive way in the nation-states that have not well dealt with that issue?

    Let me begin with Secretary Rubin.

    Mr. RUBIN. Thank you, Mr. Chairman. Let me try to very briefly respond to all three, and then accede to the Chairman.

    I think that you are correct in your observation. After Mexico, there was some focus on reform. It started, I guess, in Naples and then with the Halifax G–7 meeting. And I think it is fair to say some things came out of that, particularly in trends toward disclosure and in the Basle Bank Standards, the core standards for banks in the developing countries, that were quite useful. But I think it then lost some of its energy.
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    I think just the opposite has happened now. Now I think what has come out of the Asian crisis, in my view at least, what has come out of the Asian crisis is an enormous global focus on architecture, a lot of debate, a lot of different views. I think it is actually very healthy. I think that the key here, particularly with the United States having pretty much developed its proposals, is to bring all of that energy together around a set of proposals that are going to be implemented; and to some extent that has happened, but a lot of it lies ahead. I would have a fairly high degree of confidence this energy will not flag.

    On the second question of the IFIs' role, I think it is hard to characterize it very briefly, other than to say it seems to me that their fundamental function in this whole process is to promote reform; that is to say, to deal with the problems through reform conditionality, to be apprised of potential crises in individual countries they are dealing with, and then to support that reform with finance.

    And one of the key questions obviously is: How much of a role does their finance play and how much of a role should private sector burden-sharing play?

    On your third question about corruption, I think having now lived with these issues for pretty much the whole time that I have been in this Administration, or particularly since the beginning of the Mexican crisis, I think corruption is a major economic issue, a major impediment to economic reform, and in some countries may even be the threshold issue.

    I think on the one hand it is a devilishly difficult problem for all kinds of obvious reasons. And on the other hand, I think it is somewhat encouraging that at least it is now being discussed very openly in the international arena and the World Bank and the IMF are very focused on it. The World Bank, for example, now has developed an approach, if you will, a set of programs to deal with it, and a number of countries have signed up with some of these specific programs.
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    This is not going to be easy. I think there are going to be a lot of disappointments, but at least there is a lot of focus and there are real, concrete, practical proposals that exist for trying to help deal with this.

    Mr. Chairman.

    Mr. GREENSPAN. I agree with what the Secretary said. Let me add just a few additional observations.

    One of the reasons why the international reform impetus slowed after Mexico is we had at that time only one observation of how a crisis would emerge and what was then a very clearly new type of international financial system, which for the first time had huge amounts of funds freely flowing back and forth between various different sorts of countries.

    It is very difficult to generalize from one observation on what is the appropriate restructuring nature of the reform that is applicable under such conditions. The reason why I think Secretary Rubin is correct in saying that we are in a different environment now, and that the flagging is very likely to be much less, is that we have now a significant number of additional observations, which has very considerably enhanced our sense of the way the world financial system functions, where it can go wrong, and therefore what types of structures are appropriately applicable to the particular system.

    So in that sense, I think he is correct in his views that there is a momentum here, and the momentum is largely the result of the fact that we now have far more information, far more understanding and the capability of confronting these things, which I don't believe we had immediately after the Mexican crisis.
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    The issue of corruption is a very serious problem. You have to be very careful, because a corrupt economic system is structured as a means of distributing goods and services. You just cannot readily strip it out and say that if you strip out all of the corruption, that the thing will, therefore, function effectively as all fundamentally non-corrupt economies function. The absence of corruption is not the existence of a viable market system under the rule of law.

    You have to look at both the negative, getting rid of the corruption, but making certain that institutions are in place of a positive nature, which enhance the rule of law, and remove the myriad types of avenues of corruption, which are caused because there is no rule of law. It is important to look at this as a total issue. And I suspect that as we look at it, the size of the problem and the difficulty of coming to grips with it has made us very much aware of how difficult this problem is, but, more importantly, how critical it is for the international financial system to remove these huge pockets of corruption which are doing so much harm, especially to emerging countries, but also very considerable harm to the whole international financial structure itself.

    Chairman LEACH. Thank you very much.

    Mr. LaFalce.

    Mr. LAFALCE. Mr. Chairman, I believe we only have about seven minutes or so. If I take my five minutes, I won't be able to make the vote.

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    Chairman LEACH. Why don't we do this, John? We will recess pending the vote on the floor. The hearing is in recess.


    Chairman LEACH. The hearing will reconvene. And the Chair is forced to observe that it is not often that our witnesses are asked to sign autographs, but I guess when you have the ''Babe Ruth and Ty Cobb of finance,'' it is not inappropriate.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman.

    I will make a few observations and ask for your comments on them. First of all, I remember our dinner meeting that I was having, I think it was at the end of the 1980's, with Paul Volker and Bill Miller, and both of them made the observation that perhaps the most important thing we could do is stop corruption, if there was some way to do that. And that is the trick. How do you do that? But it would be very difficult to achieve any good economic reform without dealing with the corruption, wherever the corruption is, whether it is in Russia, Mexico, the United States.

    I also make this observation, too. I think we lost a golden opportunity at the demise of communism when we were to witness a tremendous amount of privatization within the formerly Communist countries, and elsewhere in the world, when the phenomenon of privatization was taking place to do more to help bring about equity, equitable participation amongst the masses in the wealth of society, rather than see it transferred into the hands of, in the nomenclature, the patrons, and so forth.
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    We can't put the genie back in the bottle, but there is still a tremendous amount of privatization yet to take place. And in my judgment, we in the United States, the accounting firms, the international financial institutions, have focused too much on the efficiencies of privatization, rather than the equities and the prevention of corruption within the process. That is one observation.

    Second, I am just wondering how the President of the United States—and I have a Secretary of the Treasury who is going to be in office in another month-and-a-half, and if I were to call him in and say, ''Mr. Secretary, pick one of the seventeen priorities, or one of the six priorities, and work on that full-time for the next six months,'' what would you work on?

    And then third, with respect to all of these important priorities, I am very concerned, not just about articulating them, but a formalization of the process, the mechanisms that we will use, the process we will use, the transparency and accountability of that process.

    And I do not think that I have an adequate enough vision of that process with the means, therefore, to hold accountable according to successes, timelines, and so forth. It is just a little too ephemeral for me in any event. I ask either of you, or both of you, to comment on any of the remarks I made.

    Mr. GREENSPAN. I will respond to the corruption issue by expanding on my remarks earlier, because I do think it is a terribly important issue. Let us remember that the basis of corruption is the interposition of people where usually law would determine what happens in the contract; in other words, the sort of very simple-type of corruption that occurs, say, at the border with customs agents who try to get additional cash or something of that nature. What that is is a mechanism to facilitate the movement of goods.
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    And you get a corrupt official in a government, who, if you didn't pay him, would not move a piece of paper which legally is supposed to be moved; but if you pay him, it does. Then clearly what is happening is that the mechanism of corruption somehow is trying to get the system to work. The trouble with that obviously is it is an extremely inefficient, inequitable and really immoral system of determining the distribution of goods and services. If you have a rule of law which basically stipulates that, for example, the customs official cannot take anything in payment for signing off on a particular inflow of goods, and that is adhered to, then you have effectively created a system in which market forces will determine what is happening and you get an equitable distribution in that context.

    The point that I was making before is that the reason this is such an insidious problem is that a number of people think that if you just merely take the ability of the customs official to take any money away from them, that that will increase the movement of goods; the answer is no. The alternative is, he will sit down and do nothing, and the goods won't move.

    And as a consequence of that, there is more to corruption than just eliminating it. It is the positive issue of creating a rule of law which is so fundamental to the prosperous societies of this world. Indeed, I know of no prosperous society economy which does not fundamentally function on the rule of law.

    And I think the Russian experience is a crucial one. They don't have a capitalist system. I don't know what you want to call it. They have a system where there is no rule that is functioning the way it functions in the United States. They are trying very hard to put a legal structure in place and there are large numbers of people in the Russian government who see this problem very clearly and are trying to address it. And I think they understand that it is not an issue of eliminating corruption, it is an issue of putting in place the rule of law.
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    Mr. RUBIN. And the only thing I could add to that, Mr. LaFalce, is that the Carter Center had a three-day colloquium or series of seminars on corruption. Recently I was down there as a keynote speaker. And it would be worth getting hold of the program and taking a look at it. They had a lot of very interesting practical ideas, including—particularly, I think, focused on deregulation—because every time you take away some government act in a society, you take away opportunity for bribery.

    In terms of priorities for the next six months, it is hard to judge. But I guess mine would be continued fiscal responsibility and that is obviously an issue that is going to have a lot of aspects to it in the debate in Congress. This architecture issue that you are having your hearing on has enormous impact on our economic well-being for years and decades to come, and on continuing to promote growth in developing and industrial countries around the world, since in today's global economy ours is the only major economic area that has robust domestic demand-led growth.

    And the question of transparency. It is a complicated issue, Mr. LaFalce. It essentially has many dimensions. I think a great deal has been accomplished to increase the ability to see what is going on at the international financial institutions and in developing countries, and for that matter in industrial countries, which should enable the markets to work with greater discipline.

    Chairman LEACH. Are your full questions answered Mr. LaFalce?

    Mr. LAFALCE. My time is expired. I would really like to explore all of those at greater length. Other Members have other questions too.
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    Chairman LEACH. Without objection, I would like to ask unanimous consent that Secretary Rubin's speech at the Carter Center be placed in the record, if the Treasury can please produce it at some point.

    Mr. RUBIN. We would be delighted, thank you, Mr. Chairman.

    Chairman LEACH. Thank you.

    Mrs. Roukema.

    Mrs. ROUKEMA. Thank you, Mr. Chairman. I hope I am able to get through two questions here.

    The first really follows on what Mr. LaFalce was asking about, because I too, am having a great problem with the issue of transparency seeming to be the answer to everything. I am not quite sure I am comfortable with that.

    But let me put it in a specific way. Let us recognize the limitations on transparency and not having accountability, in my understanding, anyway. I want to put into the question, money laundering and hedge funds and, particularly, with the G–7 nations.

    Now, I know that the Administration is clearly intent on working with the G–7 nations. If you will excuse me, however, please tell me how you are going to take leadership here on these issues. It seems to be we need leadership here, and if we can't get the G–7 to move fast enough, then maybe we should be doing something on our own with respect to the money laundering and the proposals by the advisory committee regarding both money laundering and, more importantly for this discussion, the hedge funds question. I want to go on to a related question.
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    Mr. RUBIN. Congresswoman, I think with respect to the hedge funds issue you have raised, we have just submitted our report on highly-leveraged institutions, which I think has some very constructive, in fact, I think really quite constructive proposals in it. What we are now doing is discussing this with the other G–7 nations. Our view is to proceed ahead in the United States, but at the same time on a sort of dual track, proceed to implement the proposals in the study—or the report, rather—and at the same time, try to get consensus elsewhere and deal with the other problem, which I think you implicitly raised, which is this question of offshore centers.

    Mrs. ROUKEMA. But that working group report is precisely what I was referencing. It seems to me that we have got to take a little more leadership, if you will, maybe initiative based on that report to get the G–7 to move. Am I wrong on that?

    Mr. RUBIN. No. Well, let me say we are very energetically involved with the G–7. The international process is not always as rapid as one might—even congressional processes occasionally aren't as rapid as one might wish—and the international process can even get more complicated, because it very often has to funnel back into parliaments. So I think your point is well taken.

    But on the other hand, we are really applying a lot of energy to try to get movement forward on our views, at least as to what are to be done with these high-leveraged institution proposals.

    Mrs. ROUKEMA. All right. Mr. Greenspan, do you want to add anything or should I go on to the next question?
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    Mr. GREENSPAN. Why don't you go ahead?

    Mrs. ROUKEMA. Maybe you will come back to that, because they are related. The working group report also makes some recommendations regarding the hedge funds, and here I am going to the hedge funds again. I hear what you have said, and I know what the report talks about, transparency. Although you have made reference to systemic risk, I am not sure. I am not comfortable with whether or not this is adequate, particularly in terms of what we have learned from the LTCM rescue, which was definitely a wakeup call. One of the words, a sentence rather, the words that haven't been used yet today, at least I didn't hear it, that is in the headline of the Wall Street Journal article today, ''derivatives,'' and the Martin Mayer article in today's Wall Street Journal, ''The Dangers of Derivatives.''

    I think there is another way of talking about what I am saying is this is a wakeup call. I am not sure we are taking enough action based on what we learned with LTCM. It raises important questions.

    For example, let me just read one thing. It is a lengthy article, but just one thing: ''Unfortunately, these over-the-counter derivatives created, sold, and serviced behind closed doors by consenting adults who don't tell anybody what they are doing, are also a major source of the almost unlimited leverage that brought the world financial system to the brink of disaster last fall.'' And it goes on. How do you address that component of the problem?

    Mr. GREENSPAN. Let me say that I read the question, and Martin Mayer is a very thoughtful analyst, and much of what he says I find myself in agreement with. The issue of derivatives is a very tricky question, and it really gets to the question of hedge funds, leverage and the like. We—and I say we, the working group—are clearly concerned about the degree of leverage in the international financial system, largely because history tells us that leverage carried to extremes when confronted with a major decline in the value of assets is the powder for a real potential explosion.
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    It is very difficult to argue that if derivatives were eliminated from the scene that the degree of leverage we currently see in the system would change. What would happen, if history is any guide, is that the degree of leverage that people seek—and it is a conscious act on the part of investors—would be achieved in a different manner. In other words, what would happen is that derivatives would decline, but debt would rise, because, in a sense, what derivatives do is enable you to take a position without taking three or four different types of instruments.

    But leaving aside that, the issue of the cost of derivatives is a lot less in terms of transaction costs and processing costs than putting on debt and the like. There is very little reason to believe that if we were to severely restrict derivatives that that would in a substantial way lower the degree of leverage in the system. I think what we have to do is approach the issue of leverage generally as an overall portfolio question, and in so doing, we can come to grips with the issue of where we see the particular problems.

    And one of the reasons that we like to use the term ''highly leveraged institutions'' instead of ''hedge funds'' is hedge funds are not highly leveraged institutions, they generally are largely equity based, with very little debt. LTCM is a rare case. It was a highly leveraged institution. Like other highly leveraged institutions, it is that not hedge funds per se, which I believe is the really crucial question.

    And I grant you that transparency per se helps, but it obviously is not a cure. It makes the system more efficient, but it cannot in and of itself solve all of the problems, and I don't think that any of us hold that view.
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    Mrs. ROUKEMA. Well, I think we have a large agenda out there for us to work together with the best minds in the country on it, not only in this country, through the G–7 as well we need to address this, because I am very uncomfortable about sitting here and waiting for the next LTCM-like failure, and the systemic risks that there will be. I am really concerned about that. I am not smart enough or experienced enough to know the answer to this important issue, but I hope we can all work together.

    Thank you.

    Chairman LEACH. Mr. Frank.

    Mr. FRANK. Thank you, Mr. Chairman. I appreciate being here at the abdication of Saint Rubin. I don't know whether it will be—I am trying to decide whether it would be more appropriate to have him included in Chanukah or Purim for worship purposes. But what I have is kind of mixed praise for both men.

    In the major areas that are of concern in the globalization in the economy, you have obviously both made significant improvements. Mr. Greenspan, your insistence that we not go by old benchmarks and automatically raise interest rates when things went well, is obviously an achievement you are not too eager to talk about, lest you get in trouble with some of the constituencies.

    But while you remain poker-faced, I will tell you how much I appreciate your having done that. I understand that there was a major effort to raise interest rates that would have had disastrous social effects, and further undermined your ability to get the kind of support you wanted for international economics. And your recognition that there are some new things going on in the economy, that we are clearly in a situation where we can sustain lower unemployment without inflation is an enormous accomplishment, and I am very grateful for it.
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    Mr. Secretary, you also have changed the rhetoric, and rhetoric is very important in public policy. When you took office, the whole notion of international economic development was still ''trickle-down.'' We were told that all we had to do was to facilitate the movement of capital, and as capital moved to find its best place of return, everyone would be better off, and it is a substantial improvement.

    And I would say, Mr. Greenspan, I appreciate your contribution to that. Your speech in Texas, where you acknowledged that the process of internationalization in the economy hurts some people in the domestic economy, I think is important. And I must tell you, if someone were to go back and do content analysis when we were first debating NAFTA, that wasn't part of the rhetoric, and I think it is very important that we have recognized this.

    But we haven't yet taken the second step. And I don't think that either of you, or the people in the financial community or the general financial establishment who you work with, understand how fundamentally things have shifted. We had from World War II until a few years ago, a national consensus in America that supported an international economic approach which is focused substantially on freeing restraints on capital and getting capital where it needed to go.

    Two things have changed. First of all, that movement used to have much less impact on American workers than it now does. In 1950 and 1960, international trade and international economic movements were much less significant in cumulative impacts on the American economy. Globalization, the kind of technological and other changes Mr. Greenspan has talked about, has changed that. American workers are now much more affected in fact by the global economy.
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    And while the country as a whole benefits from the kinds of efficiency-inducing effects Mr. Greenspan has talked about, there have been some inequitable effects: the fact that we have had a period—recently changing—but, a period when the wealth of the country went up while income distribution either stagnated or got worse. For those of us who think that is a problem, that has caused you some problems.

    Second, the consensus in favor of international free flow of capital suffered a grievous loss with the death of communism. I think we only now understand how significant anti-communism was as a force in generating political support, for foreign economic assistance, for free trade, for the IMF, for the World Bank. Look at the difference in the way this country approaches crises in Indonesia, in the 1960's under Sukarno, and recently under Suharto. There was much more—I believe it is so much easier to rally support when there was a fear that Indonesia would go Communist. That has changed substantially.

    What that means is you have lost support for this international consensus on the right, because the demise of communism has allowed some natural isolationist forces and the conservative movement in this country to get stronger; and on the left, because while 30 years ago workers and the political representatives of workers would shrug off international economics, because it was too marginal, now has a very significant effect.

    I think the consensus that you had, which was a center-right consensus in terms of American politics, in favor of the free flow of capital, is irreparably damaged. I hope it is, I should tell you, because I think it adds a real problem. We now have in the movement of capital, something which has two effects; one, it increases wealth worldwide in particular nations, I agree with that; and it enhances efficiencies, as Mr. Greenspan talked about when he talked about the balances of the effect of trade.
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    But it undermines equity. It undermines environmental rules. It undermines workers' rights when capital is the mobile element and nothing else is. When everyone wants capital and wants to keep our workers, obviously the terms of the bargain internally are changed. And while the rhetoric of this Government now recognizes that, to Mr. Rubin's credit, and we have begun to move some in that direction, not nearly enough has been done.

    And I have to tell you, until and unless you can persuade working people, lower- and moderate-income people, some middle-income people who see the negative equity effects of this more than they see the broader effects—I would appreciate one more minute, if I could, Mr. Chairman.

    Mr. Greenspan, you said in your speech on trade that people will be losing their jobs, because they were the victims of the Schumpeterian creative destruction. And as you understand, from the political standpoint, people don't much care if the destruction of their livelihood was creative or malicious; destroyed is destroyed. And until we put something in its place for them, they will be resisters.

    So you have begun the job, but it must get more work. And I just—we were about to vote, I am told, that the World Bank, that the IDA, where China shouldn't be in the first place, I guess they are going to go out to finance the Chinese project that is going to move ethnic Chinese into Tibet. That would be a terrible error.

    Second, we have in NAFTA—and I will close in 30 seconds, Mr. Chairman—blatant violations by the Mexicans of what NAFTA says is the rights of people to bargain collectively, inform unions. The United States officially has found Mexico to be in serious violation. I don't believe we have voted against Mexico anywhere.
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    I appreciate the rhetoric. I appreciate the recognition that we are able to do a better job of allowing employment to flourish, but we have not yet finished it. And I must tell you that I think in the current situation, the old consensus has been destroyed and the new consensus has not yet been rebuilt, and it will have negative consequences for the kinds of things you believe are important.

    Thank you for your indulgence, Mr. Chairman.

    Chairman LEACH. Thank you. I am not sure that requires a response or not.

    Mr. RUBIN. Can I say one sentence, if I could?

    Chairman LEACH. Mr. Rubin, yes.

    Mr. RUBIN. My view, whatever it is worth, Mr. Frank, is that I think you raised a profoundly important question. I agree with most of what you said. I think the consensus for the national economic policy has broken down, and you can see what has happened over the last couple of years in measures before Congress. And I think a new consensus does need to be created. And I think a lot of what you said about the impacts of those on trade and capital is true. The greatest good for the greatest number also carries with it harm to some. And I think that is a very serious problem that nobody has yet figured out quite how to relate to or deal with that, either substantively or politically.

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    And I think it is sort of two-dimensional. I think both dimensions are there. We don't have the time now to try to carry forward that discussion, but I think you have framed an extraordinarily important question. I think it is particularly important, because I at least think that the international economic policy that we tried to pursue is enormously in the economic best interests of this country; and yet, you are correct that the political difficulties in doing it will become greater unless we can somehow forge a new consensus, and I think the forging of that consensus is going to involve facing the problems that you raised.

    On this Tibetan issue, let me say we are enormously concerned about it. We are inclined to oppose it. We have not made that decision. You have identified and we have also identified, I might add, a very serious problem.

    Mr. FRANK. Thank you.

    Chairman LEACH. Thank you.

    Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman.

    Gentlemen, thank you very much for your testimony. And, Secretary Rubin, I want to join in commending you as one citizen for the extraordinary public service that you have delivered to the country. On a different note, I thought Mr. Frank's comments—broadly sweeping comments—deserved an answer. I understand they can't be discussed here, but I think it is important to look at the transcripts and have some attention focused on the questions brought up by Mr. Frank.
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    I am going to go, I am afraid, to the mundane mechanics.

    Mr. Chairman, you talked about as a third standard some kind of adjudication or legal structure for adjudication of bankruptcies. I would like to know how this standard would operate? What kind of institutional setting are we talking about, an international organization or agreement? I would also like to try to pose a series of questions to Secretary Rubin, and continue with staff from the Treasury, if time allows.

    They all relate to the contingent credit lines, or CCLs, that the IMF is beginning to use with, I think, strong support and encouragement from the United States Government. What are the criteria for precertification under CCLs and how do they differ from Article IV consultation process? If a country decides to activate the line of credit under the CCL, is disbursement automatic or are decisions from your staff and board still required? If it is not automatic, how would the facility differ from the traditional or precautionary IMF financial arrangements? What is the criteria and the process for allowing a country CCL precertification? Is that going to be open enough? Are the reasons available to the public on IMF's decertification to prevent a crisis and to avoid a panic?

    These issues relate back to the CCLs which are now in use. And if I could come back to you, Mr. Chairman, and see if you would answer the first question related to adjudication.

    Mr. GREENSPAN. Mr. Bereuter, we have known for quite a long time that the issue of resolution of defaults is very crucial for a domestic market system, but also clearly in the international arena as well. For a number of years, there has been an endeavor on the part of a number of international institutions, basically the Bank of International Settlements and others, to try to find a vehicle by which a general standard of bankruptcy could be applied on international transactions.
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    It floundered, and it floundered largely because it turns out that the bankruptcy question is not strictly a legal issue, it is a cultural issue. Some countries subsidize bankrupts, others put them in jail. There is no general view of what is the appropriate approach between creditor and debtor, and very specifically what penalties should be imposed on debtors.

    Nonetheless, you don't need a universal bankruptcy code. What you do need, however, is individual codes within nations which are clear, unambiguous, and essentially adjudicated in a fair and impartial manner, so that investors know in the event of default in that country what they are confronted with and therefore how to price the particular instruments they are using to lend money to that particular country.

    The issue that I think we need to focus on is that too many emerging countries don't have formal types of bankruptcy statutes that we in the United States are so accustomed to and indeed most of the industrial world is accustomed to.

    It is that which I was addressing and that which I think is a really important issue in making certain that the international financial system functions, because if you cannot properly adjudicate the faults of cross-border lending, the system cannot function efficiently.

    Mr. BEREUTER. Chairman Leach, I assume my time is about to expire. If you prefer the Secretary to respond in writing to my questions about the CCLs, I would appreciate that.
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    Chairman LEACH. We have been generous with time, I think the Secretary can respond directly.

    Mr. RUBIN. Let me try to respond very briefly, Mr. Bereuter, and then we can do much more in writing. I think the primary point about the CCL is that no disbursement will be made until it comes back to the executive board. So what will happen is a country will come, ask for a CCL, and there will be a set of criteria, which are not yet fully developed. The IMF then will make some kind of judgment as to whether a critical mass of these criteria has been satisfied; if it has been satisfied, then there will be given this contingent line.

    But the key is—and hopefully this will create, ex ante, an incentive before crisis develops for countries to improve their policies so they can get the CCL—when the country wants money, it then has to request a disbursement, and that will come back to the executive board, and the executive board will take a look at what criteria have not been fully satisfied or what more the country needs to do. And, in effect, there will be conditionality of—but it will be a looser—I shouldn't say looser, but it will be conditionality. Presumably there will be a lot less conditionality than an ordinary program. Instead of having regular tranching, it will be a line they can draw down pretty much on the basis of some sort of flexible agreement they have worked out with the IMF.

    And in terms of decertification, we talked about that; that really is not a fully resolved issue yet, but since they can't get money without coming to the executive board, it isn't—it probably is not as central as—in fact, it surely is not as central as it would otherwise be. This is because if they get a CCL and then they start to fail in their policy adherence when they come to the board for the money, they simply wouldn't get the money unless they satisfied the conditions that reestablish their policy regime.
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    Mr. BEREUTER. Will the rationale be made public so there is not a panic and the uncertainty of why it is not proceeding with a tranche?

    Mr. RUBIN. Oh, I assume the answer to that is yes, just as there would be in any letter of agreement with the country, because what would happen is they would come and they would seek the money, the disbursement. The IMF, I presume, would then have a letter of intent of some sort with a whole set of conditions, and presumably that would be a public document. As you know, they are not necessarily public now, but we try to create a presumption in favor of them becoming public documents. So presumably they would.

    Mr. BEREUTER. Thank you.

    Chairman LEACH. Mr. Sanders.

    Mr. SANDERS. Thank you, Mr. Chairman.

    Let me focus on an issue that has concerned me for a little while. I think that there is widespread agreement among economists that globalization has contributed to an enormous increase in the concentration of wealth in the world, and, in fact, the impovertization of the poorest people in the world. As I understand it, the wealthiest 447 individuals on this planet now own more wealth than the bottom half of the world's population, some 2.5 billion people; 447 folks over here, 2.5 billion people over there, and that situation is becoming worse.

    Of course, in our own country, one person now owns more wealth than the bottom 40 percent of the Nation. The gap between the rich and the poor in the United States is now wider than in any other industrialized country on Earth. As I understand it, the total wealth of the world's three richest individuals is greater than the combined gross domestic product of the 48 poorest countries, one quarter of the world's population, and that situation is becoming worse.
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    So I have a couple of questions, but I would hope that in a moment that Mr. Rubin and Mr. Greenspan could deal with that very important issue of the growing gap between the rich and the poor in the world, and the impovertization of the poorest people.

    The second question, picking up on Mr. Frank's remarks: Will you both encourage the IMF and other international financial institutions to follow the initiatives of the labor movement and the human rights movements worldwide, and establish enforceable human rights, including labor, social and economic rights as fundamental principles? In other words, do we continue to encourage investment and protection through the IMF at other institutions in horrible dictatorships?

    We propped up the Suharto regime for many, many years. Right now in China, I don't have to go through a long story, there is no disagreement, people can't speak out on their rights. There are no dissidents; people are paid 20 cents an hour. And there is no problem with American companies investing huge sums of money in that country while they are laying off American workers.

    So my question is, will you encourage our representatives to the IMF to fight for labor and human rights as part of our contribution to the international financial institutions?

    And my third question is that while the poorest people in this world become poorer, I would point out that Mr. Wolfensohn of the World Bank recently stated that the number of people living on less than $1 a day has risen from a billion a few years ago to 1.3 billion today, and would probably reach 1.5 billion in 2000.
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    Would you encourage the call of religious groups around the world and move toward a canceling of the existing debts of the world's poorest countries? So those are some of my questions.

    Mr. GREENSPAN. Congressman, I doubt very much if globalization is the big issue here with respect to the statistics which you referred to. The very substantial part of the increase in wealth of the individuals to whom you refer is largely a consequence of a very substantial rise in equity values throughout the world. It is not clear how much globalization is crucial to that. Clearly, it is not an issue that directly relates to the flow of capital.

    It relates to the valuation of existing assets within countries. I don't deny that globalization does enhance the capability of individual companies to sell abroad and around the world and probably enhance the value of the organization itself. There is no doubt that globalization has probably been a factor in the lower inflation in a number of the countries around the world, which has lowered interest rates, which has effectively significantly raised the market value of assets.

    Mr. SANDERS. Mr. Greenspan, I don't mean to interrupt, but do you have a problem that fewer than 500 of the wealthiest people in this world own more wealth than 2.5 billion of the poorest people?

    Mr. GREENSPAN. Let me put it this way. My concern would be on the absolute level of what the remainder of the people had. In other words, I don't begrudge individuals on getting wealthy. If they are taking it away from somebody else, that is a different question. But that is not what this issue is, because as far as I understand the data, what we are observing is a very dramatic increase in a relatively small number of people getting substantial increases in their wealth; but it is not, as best as I can judge, at the expense of anyone else, largely because the aggregate amount of market valued wealth in the world is up very substantially.
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    Mr. SANDERS. Do you disagree with Mr. Wolfensohn, who indicates that the poorest people in the world are becoming poorer and we are seeing more——

    Mr. GREENSPAN. No, I think that is not globalization.

    Mr. SANDERS. Some would argue that it may be that we are destroying local sustainable economies, and capital is flowing in and out. And in Russia, for example, there is no question that globalization has had a very deleterious impact.

    Mr. GREENSPAN. I would disagree with that. I would say that the problem Russia has had is the aftermath of a highly centralized Soviet system which was falling apart in the latter part of the Soviet regime, and what we are seeing to a large extent is a consequence of that. I would scarcely argue that globalization is a major contributor to that problem.

    Mr. SANDERS. You really don't think that all the capital flowing in and flowing out has had an impact on lowering the standard of living of so many people in Russia?

    Mr. GREENSPAN. I think that a lot of things have had problems. I wouldn't deny that the crisis that occurred in Russia last year has had a very major negative effect on the standard of living of very many Russians. But I would not attribute that to globalization. I would attribute that to the aftermath and the heritage of an economic system which was corrupt and in default.
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    Mr. SANDERS. What about debt relief for the poorest countries?

    Mr. GREENSPAN. I would leave that to the Secretary, because that is his area.

    Mr. RUBIN. Thank you, Mr. Chairman.

    Mr. Sanders, let me respond to two parts, three parts of the questions you raised, though there are a lot of questions embedded in them.

    On the question of poverty and Jim Wolfensohn's statistics, without disagreeing with his data, and clearly the recent crisis has had adverse impacts on a lot of the most vulnerable people in the world, I think that is one reason why the whole architecture issue is so important.

    I think it is also true if you go back over twenty years and take a look at a very large number of countries in the developing world, there are people, not just the most wealthy, but there are people who are substantially better off today than they were twenty years ago. And I think that is a result of some fair measure of global investment, and what you would, I guess, refer to as global integration.

    Mr. SANDERS. I am not sure. In Mexico, for example, that is not the case. People in Mexico today are worse off than they were a number of years ago.

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    Mr. RUBIN. You said a number of years ago. They had a crisis in 1995 and the real incomes were very substantially affected by that, and they are now starting—in my recollection, I have seen numbers recently—they are starting to recover somewhat. But if you take a look across Latin America, Argentina, Brazil, inequities are enormous and I think very troubling. I agree with you.

    But I also think what the Chairman said is right in terms of absolutes. A lot of these people are better off than they were twenty years ago. That does not in any way deny your observation about the inequities being far greater than would be optimal.

    On the question of debt relief, I think it is a very complicated question. The President made a proposal with respect to debt relief in which there was provision for very substantial, but not total, debt relief. At least in my judgment, there is the correct balance between maintaining a credit culture so that capital in the private sector will flow to these countries, which capital, at least in our judgment, is essential for long-term growth, and at the same time relief, so unsustainable burdens of debt can be reduced to sustainable burden.

    Chairman LEACH. The time of the gentleman has expired.

    Mr. Bachus.

    Mr. BACHUS. Thank you.

    Mr. Rubin, first of all, Mr. Sanders mentioned the debt relief issue. It is my understanding that that is going to be one of the two agenda items at the G–7 meeting in Cologne on June the first through the nineteenth.
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    Mr. RUBIN. Correct.

    Mr. BACHUS. At that meeting, I would think the United States is going to ask the other members to participate in debt relief and try to get some understanding at that meeting; isn't that correct?

    Mr. RUBIN. We will be advancing the proposal that the President made some time ago with respect to debt relief; that is correct.

    Mr. BACHUS. I would say to you that sometime after that meeting, the Congress I think is going to want to discuss this issue of debt relief, since we do have legislation moving. And I think, as you and I have discussed, it is important that we come back from those meetings prepared to move some legislation. OK?

    Mr. RUBIN. Well, we in our appropriations request this year requested funding for the existing HIPC and other debt relief programs, Paris Club and bilateral, but surely there will be additional work with Congress on the additional aspects of the President's proposal.

    Mr. BACHUS. All right. I mentioned bondholders sharing the risk in my opening statement, and let me address this question to both of you. Now, I am very aware that it is—bond sales are now the leading source of capital for emerging countries. As I understand it, that is how they raised—I think it is something like 34 percent of their capital is raised through bond sales. So at least let us say it is an important source of capital for emerging countries.
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    I am also aware of issues of contract obligations. We never can get in a situation where we encourage people to break their contractual obligations and you never want to encourage people not to repay debt. Those are obviously things we don't want to do in our policy, I would think. But in asking bondholders to—first of all, I might ask you, do you agree that bondholders should share in the burden when these emerging countries get into financial difficulties?

    Mr. GREENSPAN. I think that there is no question that all creditors who make bad investments should get the appropriate remedy, which is loss. And I think the issue is how one does that in a manner which does not shut down the flow of capital to a developed nation. You can basically stipulate that a government can just default unilaterally and that will solve the problem, but it will also prevent capital from flowing in; and to the extent that foreign capital has been of assistance in raising standards of living, there is a tradeoff here.

    One of the reasons I raised the issue of bankruptcy with Mr. Bereuter is that one of the purposes of the bankruptcy statute is you can handle both banks and bonds in an appropriate manner. One of the reasons that we have had so much difficulty of late is that while you can handle banks without a bankruptcy statute, it is very difficult to handle bondholders without one. And the degree, or the lack of firm, appropriately legally-structured bankruptcy procedures in a number of these countries has created a very difficult problem with respect to bondholders.

    And I would say the first thing we want to do with respect to bondholders, aside from a number of issues which the Secretary raised, is to get a firm rule of law with a bankruptcy code which people understand and can deal with; and I suspect that will solve a very substantial part of this inequity, which unquestionably exists.
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    Mr. BACHUS. Let me ask you this, Mr. Chairman and Mr. Secretary: How about changes in the bond contracts themselves? Is that a part of the solution?

    Mr. RUBIN. I think, Mr. Bachus, that, over time, having clauses in bond contracts that provide for some mechanism whereby borrowers and creditors could resolve in an orderly fashion the issues that arise when there is an inability to pay, would be very constructive. The question is how to get the international community to incorporate those kinds of clauses in bond contracts.

    My own view—for whatever it is worth—is, over time, creditors and debtors both will see it is to their advantage to have it happen, but it is something we are very strongly advocating.

    Mr. BACHUS. All right, thank you very much.

    Chairman LEACH. Thank you.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    First of all, let me associate myself with the remarks of others commending Secretary Rubin on his career as a very successful Treasury Secretary, and particularly what Mr. LaFalce said. He said he thought you were the most successful Secretary since Alexander Hamilton. I have somebody else in mind, but that is just a personal bias on my part; but nonetheless, a very successful Secretary.
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    Mr. RUBIN. I would agree with you, Mr. Bentsen.

    Mr. BENTSEN. Let me ask a little bit of follow-up questions. First, let me ask one question of both of you. There has been a lot of criticism since the Asian currency crisis with the IMF prescription and the IMF/G–7 prescription of the tight monetary policy to restore confidence and thus rebuild confidence in the currency. And while I appreciate and agree with the idea of fair labor rights and human rights, at the end of the day, do either of you believe there is any other prescription which can be followed?

    And the same should be said with respect to Mexico. At some point when you have a faulting currency, do you have any choice but to put on the brakes and drive up interest rates to restore confidence in the currency? And there is a lot of pain that is felt by that, but is there another way that could be better?

    The other question and as a follow-up on Mr. Bachus—and both of you talked about this in your testimony—Mr. Rubin, you talk about the need to limit short-term debt. Mr. Greenspan also talks about in his statement creating a new standard by extending the average maturity of external debt, and having effectively a reserve, I guess, or being able to live for a year without relying on external debt. I think those are very prudent suggestions.

    I guess my question is, how do you make that happen?

    Mr. GREENSPAN. The first thing that it is important to do is to identify those types of activities that might be pursued by those who do not have and have not had many decades of association and interaction with the international financial system. Once those are identified—and I think we are beginning to understand such things as the role of interbank credit, very specifically interbank credit in a foreign currency which is unhedged, and the role of banking generally in a developing nation without the type of infrastructure that we, for example, in the United States have with respect to regulatory issues, and the whole counterparty interface of organizations within our country and indeed with industrial countries as well—once you identify what is missing, then the question is: How do you implement it? First, I think you are going to find that a number of countries will do so immediately and voluntarily. Indeed some of them are already beginning to think in those terms. The question is, how do you create incentives to get that to happen? I do not believe that what we need is some international coercive organization which somehow induces some regulatory strictures on sovereign nations to induce them to do what we perceive to be the right thing.
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    I don't think it would be effective; I don't think it would work. And, indeed, I think at the end of the day, the endeavor to meet the letter of an agreement or some form of set of standards would very rapidly dissipate, because you could get around these things if you were really interested in doing so. So I think it is a question of peer pressure and moral assuagement. I am somewhat optimistic that that is more likely to succeed than not, whereas ten years ago I would have said ''no way.''

    Mr. RUBIN. I think the only addition—I agree with everything that the Chairman said. I think the only addition I would make, Congressman Bentsen, is that—and I totally agree that some sort of international coercive mechanism would be non-constructive. I think if we can develop standards, if you then have an evaluation—I am talking about debt management now—and you then have disclosure, then that provides at least the potential for market discipline to be effective. And I think that there is a lot of promise in that, over time.

    Mr. BENTSEN. With respect to the IMF austerity proposals, is there any alternative?

    Mr. RUBIN. I will give you my view, I think that what the IMF faced in these situations was sudden crisis, and the first key had to be to reestablish the beginnings of stability, and it was not the programs of the IMF that were the cause of the enormous hardship, it was the crisis and the things that gave rise to the crisis. And I think there were two paths that these countries faced. Neither one was attractive.

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    One was to not try to reestablish stability, in which case I at least think you would have had instability and crisis of far longer duration and far greater depth, or put in place the kinds of measures that would reestablish stability. That in itself is a difficult path to go, but it was a path that then created the possibility and potential for recovery as we have seen in Korea and Thailand and hopefully are in the process of seeing in Brazil. All three of these countries have a lot of difficulty ahead of them.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Bentsen.

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman.

    Secretary Rubin, I want to echo the plaudits of my colleagues on the committee. I also want to remind you that there are good, many fine trout streams in the 19th Congressional District of New York, and you are welcome there. I know you know where we are, so you are welcome to bring your rods and reels and so forth and come on up.

    I just have two questions for you. One is a question of Argentinean dollarization: good?, bad? I am aware of the fact that there has been testimony about this. I am aware that Panama and Liberia already operate under the dollar. I envision that we could risk the anger of these countries since we would not be expected to alter our monetary policy procedures to take into account their needs. And I am wondering if we should be helpful in their efforts to dollarize if they choose.
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    Secretary Rubin, do you want to answer that or——

    Mr. RUBIN. I will give you a response, but I think the Chairman should respond as well. I think that these are a complex set of questions, and I think there are clearly advantages to another country—advantages to them dollarizing. And there may be some advantages to us if, in fact, it enables them to be more stable. But it also means that they are giving up sovereignty with respect to monetary policy and exchange rate policy. And that is a very, very substantial and consequential decision to make.

    And I think it should be absolutely clear, as the Chairman has said on many occasions, this will not give them access to our window or affect our monetary policy. I guess my own view, for whatever it is worth, is to be agnostic as to whether it is good or bad on balance for them or for us. And one thing I do feel very strongly is if a country is going to do this—and they can do it unilaterally, of course—if they are going to do that, they should come and consult with us first.

    Mrs. KELLY. Thank you.

    Mr. RUBIN. Mr. Chairman.

    Mrs. KELLY. Mr. Chairman.

    Mr. GREENSPAN. I can't add materially to that. Just let us be careful to remember that if you are endeavoring to dollarize as a substitute for fundamental policy issues, it will fail. And there is a very significant argument here where there is undoubtedly the question of a number of countries who, if they would have the appropriate monetary and fiscal and general structural supervisory and regulatory policies, they wouldn't gain any benefit from dollarization, in the sense they have a solid currency themselves. They would have seigniorage, and dollarization wouldn't make any sense.
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    It is possible that there is a small group of countries which even though they are engaged in sound fundamental policies, nonetheless get caught in a downdraft, in a volatile international financial system, and conceivably they could benefit from dollarization or euroization or a tie to a major currency. I am not sure that list is very long.

    So it is by no means clear to me that we know for sure that dollarization per se is a viable means of developing a solid international financial system, I do think we ought to examine it case by case, because it clearly depends on individual countries. As I said, I have no doubt that there are some countries who will engage in sound and fundamental policies and could still be helped by dollarization.

    But I don't think you can make that judgment without looking at the individual country in very considerable detail. And, as the Secretary says, we are certainly, as we have in the past, willing to discuss what our views are with respect to how one can achieve appropriate balances of policies in this regard.

    Mrs. KELLY. Thank you. I would like to give you a written follow-up on that if you don't mind. Is that OK, Mr. Chairman?

    Chairman LEACH. Yes, absolutely. And I am sure that our witnesses would be delighted to answer the questions in writing.

    Mrs. KELLY. Thank you.

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    I have one more question that I would like to ask, if that is OK. This morning, the U.S. Commerce Department announced that the U.S. trade deficit has widened to a very large record, $19.7 billion in March. I have a question about that. Do you think that this new record is a danger to our economy?

    Mr. GREENSPAN. I addressed that issue in a speech in the last couple of weeks. And I raised the question of can we sustain an ever-larger trade deficit and an ever-larger current account deficit definitely into the future without creating a significant rise in debt or claims against us by foreigners which could essentially destabilize our system. So far, what we are observing is a very substantial inflow of imports, largely because our economy is moving far more rapidly than others.

    We have seen no evidence of any unwillingness on the part of foreign investors of taking up the necessary claims, which is the accounting identity which is required, and then we perceive that in fact that the value of the dollar has been reasonably stable. So that there is no evidence that there is any immediate problem coming, because of the fact that we are, as an economy, growing far faster than the rest of the world.

    But it is an issue that has disturbed me, has disturbed me for years, because I know eventually, what economists call the elasticity of demand for imports relative to income in the United States being higher than in the rest of the world, we have a higher propensity to import than foreigners. The long-term equilibrium is working against us, but so far it appears, long term, there is very little if any evidence that there is anything immediate to create a problem for us.

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    Mrs. KELLY. Thank you.

    Chairman LEACH. Thank you, Sue Kelly.

    Mr. Sherman.

    Mr. SHERMAN. Thank you, Mr. Chairman. I would like to join with Mr. Frank in praising the Chairman for the decision of the Fed not to raise interest rates. Not only is that good monetary policy, but I think it will have a positive impact on human needs and a positive impact on the international situation as well.

    I would like to pick up on the comments of the gentlelady from New York. In defense of those who might choose to dollarize, they may not have a choice between outstanding domestically-tuned monetary policy and an outstanding monetary policy of the United States, though one selected to meet our domestic needs and not theirs, many citizens in various parts of the world, or many investors may conclude that they are unlikely to get well-thought-out and disciplined monetary policy in the absence of dollarization.

    I would also like to pick up on Congresswoman Kelly's comments about the trade deficit. I would point out that this is not, as you very well know, a new thing. But we are always blaming something about America for the trade deficit. When Japan does well, we are told we can't do anything about it, because we are dependent upon them. When Japan does poorly, we are told that we have to be nice to our friends.

    When our national debt is high, we are told that the trade deficit is our fault. When the national deficit is low, we are told that we can endure a trade deficit. What we are faced with year after year in every kind of international and domestic fiscal, monetary, and economic situation is a continuing trade deficit, year after year.
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    Trade barriers are an issue, but I guess in terms of economic theory, eventually in the long term, exchange rates are exposed to compensate for this. And I won't pause for a question now, but at the conclusion of my remarks, if you could please address the issue of what we can do to make the exchange rate more favorable to U.S. exports and why we tolerate it when Japan and others lower their currency in relation to ours at a time when they are running a trade surplus with the United States?

    The second issue I would like to bring up is the fact that U.S. financial institutions seem to prefer often to make large loans to foreign governments, even corrupt foreign governments, and not to extend credit on the same basis to small businesses run by hardworking, honest people and, more importantly, small businesses in my district.

    I can understand that huge financial institutions prefer to make multibillion dollar loans than to go to the work of making loans of a million dollars or less to smaller business, but I think this is exacerbated by U.S. Government policy. Just here at today's hearing, we talk about the term ''burden-sharing'' to mean that when banks make bad international loans, they should suffer some of the loss.

    Well, when you make a small business loan in my district, there is no issue of burden-sharing; the financial institution bears all of the loss. And in exploring possible solutions to this, there is a tendency that these countries are ''too-big-to-fail,'' that the institutions involved are ''too-big-to-fail.'' When someone engages in a risky policy that will require or just politically necessitate a bailout should things go wrong, we often force them to buy insurance. For example, we force concerned landowners to buy flood insurance.
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    Should we increase the costs of foreign lending by forcing American, at least insured American financial institutions, to contribute to some sort of national insurance fund, knowing that there will be pressure to bail them out should the situation fail?

    Second, in terms of bank regulation, should we do more to force higher reserves on foreign loans or should we do more to acknowledge the creditworthiness and require less reserves on loans to small business in my district? I will address that to both panelists.

    Mr. RUBIN. Let me just pick up one question and then defer to the Chairman on all of the others.

    Mr. GREENSPAN. Thank you.

    Mr. RUBIN. It looks like a reasonable apportionment—that is, burden-sharing. I do think, Mr. Sherman, on the question of the exchange rate that we should not use—we said this consistently—we should not use our exchange rate as an instrument of policy with respect to trade. I think the key with respect to the trade deficit, and I agree with the Chairman, it seems to be sustainable right now. It is probably in some measure the effect of the confidence that the rest of the world has in the United States.

    But I think that is why it is imperative that we continue to focus on trying to promote growth abroad both in developing and the industrial countries. It would also help if our savings rate was higher, and so it is very important that we focus on trying to increase the savings in this country. I do not think that we should use our exchange rate, however, as an instrument of policy with respect to trade. And as our exchange rate is basically our terms of trade with the rest of the world, the stronger our currency is, the more confidence there will be in this country, and the less expensive to us will be imports; and the lower rate of inflation, lower interest rates, market interest rates—I am not talking about the Fed—and the better economic conditions.
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    Mr. Chairman, on the rest of it.

    Mr. GREENSPAN. Let me just quickly comment on the issue of capital and the nature of bank regulation with regard to small business versus large institutional—large bank purchases of foreign debt. It is certainly the case that we have regulatory differential rates in the Basle Accord with respect to borrowing. Where small business in the United States requires, so called, full capital weight, some sovereign borrowers abroad will have less in certain degrees.

    The truth of the matter is that most banks nowadays, specifically as a consequence of very complex financial types of instruments and assets, hold far more than the regulatory capital, and in that sense, the regulatory capital requirements have become largely moot. And, indeed, one of the reasons why we are involved in endeavoring to get a new Basle Capital Accord is precisely that the existing capital accord on which a number of these regulatory requirements is predicated, is significantly obsolescent, verging on the obsolete.

    A banking organization, when it sees a profitable opportunity, I hope, will largely take it. While it is certainly the case that large banks in the United States do lend to small business, that smaller banks are by far the larger lenders, because they have the capability of being more interrelated with the companies, and they have greater knowledge than some of the larger institutions.

    We have not found in the studies that we have, a significant deficiency of lending. I think there are elements of discrimination, which I am aware of and that do concern me, but when you take a look at the National Federation of Independent Business, which surveys its members every month, the availability of credit in recent years has been more than adequate, at least according to the reports of their membership.
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    Nonetheless, we are aware of where deficiencies are. We are working very strenuously to try to open up credit for small business. We have innumerable conferences. We meet with numerous individuals who can be of assistance to us in that regard. But the difference between lending to foreign sovereign governments and small business in the United States, I should say, those are really basically two different markets. And I am not certain that if you somehow alter the pattern of how we supervise lending to foreign governments, that that will in any way open up additional credit for small business.

    Mr. SHERMAN. Mr. Chairman, if I can just make one comment. At least in Los Angeles, 95 percent of the bank deposits are in banks that are not headquartered in Southern California, and most of them are huge financial institutions. So your comments may relate to different parts of the country.

    Chairman LEACH. Thank you, Mr. Sherman.

    Mr. McCollum.

    Mr. MCCOLLUM. Thank you very much.

    Secretary Rubin, I certainly want to join and take this opportunity in telling you, while we have differed a few times over a few things, I have enormous respect for you, and you are going to be missed as the Secretary of the Treasury. And I wish you well in what you do afterwards, because you have served our Nation well.

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    Mr. RUBIN. Thank you.

    Mr. MCCOLLUM. I want to raise an issue that I don't believe—I couldn't be here for all of the questioning—has been raised, and that is what each of you think with regard to the use or absence of use of currency boards. I know that has been a subject of considerable discussion. I think, Mr. Rubin, you should not be allowed to walk out of the Secretary of the Treasury job without having one more opportunity to address it.

    I know Hong Kong has them. I know there has been a lot of discussion about whether they should be used, and there has been a lot of discussion reported in the press, particularly, as to your views on the subject having perhaps changed over time.

    Would you care to tell us what you think after the Asian experience your thoughts are now on currency boards as to their viability? Should they be used? Are there times where they can substitute for the absence of a strong independent central bank?

    Mr. RUBIN. Let me respond, if I may, Mr. McCollum.

    Mr. MCCOLLUM. I would like the Chairman to. I was picking on you only because your name associated with them has been more prominent in recent days.

    Mr. RUBIN. My view has basically probably been about the same throughout this whole experience that they got a lot of prominence, as you recollect. I think we have even discussed this, as a matter of fact, I think, at the time in the context of Indonesia, and because they have been used successfully in Argentina, some people said should they be used in Indonesia at the time there was great financial instability in Indonesia.
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    My basic view is as follows. The currency board is really just an institutionalization, it seems to me at least, of an aggregation of political commitments to sound macro-economic policy, fiscal and monetary, particularly monetary. And it seems to me that they probably are useful and can work in a very limited number of circumstances where there is the real political will. But there is no substitute for the political will. Ultimately they will work or not work, depending on whether they were adhered to, and therefore it is going to come back to whether there is the political will to adhere to sound macro-economic policy, particularly monetary policy.

    It does have the advantage, I suppose—it does have the advantage of institutionalizing the commitment through legislation, but almost inevitably these currency boards get tested from time to time, and when they get tested, you are going to come back to whether there is the political will to adhere to them. So I don't think that they are a substitute for a strong central bank.

    I think, in fact, they require a strong central bank if they are going to be successful. And our view is that in most countries, it probably will not work; in some countries, it may well work. But they are not a substitute for sound policy. They are an institutionalization of a political commitment to sound policy, and they will be tested, and therefore they will only continue to work if the political commitment is real.

    Mr. MCCOLLUM. Chairman Greenspan, do you want to comment on currency boards?

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    Mr. GREENSPAN. I think the last couple of sentences that the Secretary used captures very much what the nature of the problem is. A currency board is one step back from dollarization but many of the problems that exist for dollarization exist for a currency board—namely, the endeavor to substitute some mechanism for the hard political choices that are involved in an economic policy is doomed to fail, and such endeavors are doomed to fail in a currency board as well as under dollarization.

    So currency boards can be quite valuable, as has been demonstrated in certain instances, but they will be only if they are a mechanism to implement sound economic policy.

    Mr. MCCOLLUM. It strikes me that the heart of the question does rest back where you are saying in basic reforms—I think to Mr. Bereuter's question—judicial reform is structurally not there in most of these countries. And I have been struck by the fact that our system of justice just doesn't exist elsewhere, in many places—in most of the world.

    And absent that confidence, the banking community and the financial community and the business community have a tremendously big problem in the investments that we make there. So I would hope that the conditionality with which our international organizations proceed always puts that first. It strikes me that that is paramount even to some of the tax-and-spend issues that are out there, that at the moment may not be the hot burning item on the table. We have got a budget problem, we have got a crisis and whatever, but that is the type of structural reform, the banking reforms themselves, and the judicial reforms ought to be paramount.

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    And you are shaking your head in concurrence, Mr. Secretary?

    Mr. RUBIN. I am shaking in concurrence, because I think there is a broad-based recognition developed over the last few years, particularly on the issue of corruption, if that is what you are referring to, Mr. McCollum, in many cases is central and in some cases even the threshold issue with respect to——

    Mr. MCCOLLUM. Corruption would never be in Russia. It would never be in Indonesia or anywhere else if they had a strong judicial system.

    Thank you very much, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. McCollum.

    Mr. Meeks.

    Mr. MEEKS. Thank you very much.

    I have two questions. Earlier, Representative LaFalce referred to H.R. 1095, which is intended to provide debt relief to some of the world's poorest countries. As we discussed new financial architecture and possible IMF reforms, can either of you discuss the current and future methodology of evaluating a country's ability to service debt by our international financial institutions?

    Additionally, how do we balance the Nation's debt serviceability against the basic need for funds to provide for their people? That is my first question.
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    And the second question, Chairman Greenspan had talked about how a lot of the wealth was accumulated recently by equity. But a nation like Morocco, which pays its IMF obligations regularly and must allocate a fairly significant portion of its annual revenue toward debt service, has indicated that it would like to have a greater percentage of its debt converted to equity.

    In the new financial architecture, do you see a place where the multilateral financial institutions would have a greater role in providing nations with equity capital, which would lesson the burden of debt in exchange for some managerial oversight in targeted projects?

    Mr. GREENSPAN. Let me just address the first part of your question, which really distinguishes between grants and loans. I think that when you talk about the issue of needs, I think we should talk about grants—because those are typically from bilateral or multilateral organizations. Grants flow where needs are seen, and we see a good deal of that. When you are dealing with debt, you have to be careful not to mix the issue of needs with the issue of debt service.

    Debt service is a standard accounting basic type of analysis which everyone has to go through, and I think it is important for the integrity of the country involved to not look at debt funds as something which do not have to be paid back. Because if you do that, I think you undermine the capacity of the country to have an adequate flow of foreign capital to enhance living standards.

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    So I would say that clear distinctions have got to be made between various different types of grants or even debt subsidies whose basic purpose are a grant and a standard loan. The integrity of our international financial institutions require that those distinctions be made but, more importantly, the distinction is very crucially important to the debtor nations as well.

    Mr. RUBIN. The only thing I would add, Mr. Meeks, agreeing with what the Chairman said, is that in terms of methodologies, the HIPC program and a lot of these debt relief programs are designed around the question of what is the ratio of the debt to exports, and is it sustainable or not sustainable. There are also other ways of looking at sustainability since—what I said is correct, but I think we can respond in writing and give you a better response.

    Mr. MEEKS. I appreciate that.

    Mr. RUBIN. On the question of debt equity on Morocco, I don't know anything about Morocco as such, or at least I know very little about it. But a debt equity swap arrangement of some sort might be feasible in a private sector debt context, but I don't think in a public sector debt there is a way, none that I know of, to swap or convert debt into equity.

    Mr. MEEKS. All right.

    Chairman LEACH. Thank you, Mr. Meeks.

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    Dr. Paul.

    Dr. PAUL. Thank you, Mr. Chairman. I have a couple of questions I will address to Mr. Greenspan about real money, not the kind that central bankers can create out of thin air. The subject of the trade deficit came up, and we certainly are running a huge current account deficit. Mr. Greenspan, you have expressed concern about this.

    And you have also acknowledged in the past and in your writings that under an international gold standard, we of course don't get these disequilibriums. They are self-adjusting, and that was one of the trademarks of the gold standard. I do think, though, that we cannot carelessly dismiss, even though we expressed mild concern about these huge deficits, by saying so far so good, because inevitably in monetary history, we do know that a country that runs huge deficits eventually they have to pay, they pay by that currency going down in value, interest rates raising, and price inflation hitting the domestic economy.

    And I think if we don't admit up to the fact that that is a strong possibility, I think we are putting our head in the sand.

    But let me address my questions on the gold, to what the central bankers are doing with gold, as well as the IMF. The IMF is planning to sell gold, and they have announced that, and they seem to do this in a way that it does affect the market. The gold prices usually go down.

    Now the purpose of the IMF selling gold is, so called, to help the Third World nations' debt problems. Yet at the same time, the money that they are getting from these sales of gold really isn't directly helping them, but it is going to be put into account in the interest, which I would think would be very small an amount, would be used to help them. So it seems like the announcement might have been the most important thing.
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    Central bankers around the world systematically have either announced loans or sales by six years, and if they sell the gold, they make the announcement, and then usually several months later, they sell the gold for a lot less than the market was when they decided to do it. We saw the best example of this just recently with the British making an announcement—yes, indeed, they will sell 400 tons of gold—and the gold price promptly dropped.

    This is in contrast to individuals considered to be rather astute in the marketplace, like Warren Buffet. He buys a large amount of silver at $4 an ounce, rather quietly; the market discovers it during his next report, the silver price shoots up, and he quietly sells his silver again. So I see central bankers who are usually considered pretty smart people doing exactly opposite what the marketplace does, and you just wonder why this happens.

    I have a couple of specific questions. One is: Why will central bankers loan gold at 1 percent? That seems like a pretty good deal, whoever is receiving this. And the other is, once the sales are announced and then they sell this gold after it falls, you just wonder why would they do it that way? And there may be some beneficiaries to this, because those individuals who have been borrowing gold from central bankers to a large degree over the past six years would be in big trouble if the price of gold goes in the other direction. They will be hit with a short squeeze, and there will be major trouble.

    So could there be a relationship to these announcements that sometimes pan out, and the driving down the price system to those who benefit, who would be really in deep trouble once the price of gold turns around?
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    Mr. GREENSPAN. Congressman, it is fairly evident that central banks are acutely aware of the fact that if they announce they are going to sell gold, the price will go down, and then if they sell it, they will be getting the lower price. And it is true no self-respecting private trader would ever think of doing such a thing.

    The reason they do it is they believe it is appropriate that they not take advantage of the market, in the sense that to the extent that they are a public institution, it is my suspicion—although I have never discussed it with them directly—that it would be inappropriate for a public institution to take advantage of private market participants and effectively sell them to the market, and the private people who are buying at those prices would be the loser.

    I can assure you it is not because they are dumb. They know fully well what they are doing.

    On the issue of trying to react to some of the holdings of gold on loan, I know of no instance of which I am aware in which the motive of selling or not selling gold in any way was related to that phenomenon.

    Dr. PAUL. One quick follow-up. Gold essentially has been demonetized and it is proceeding and even the Swiss now are talking about selling half of their gold. And if this is the case, would you advise that we should seriously think now about getting rid of our gold, for the IMF to get rid of it, out of our Treasury? Why hold it if we demonetized it? And Milton Friedman would agree with this, and he is pretty good at monetary policy.
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    Mr. GREENSPAN. I agree with virtually everything that Milton Friedman usually says. This is one of the few times I don't.

    Dr. PAUL. Why do we need it?

    Mr. GREENSPAN. This is a very interesting issue. This issue was debated, incidentally, in the United States in 1976, and the conclusion was that we should hold our gold, and the reason is that gold still represents the ultimate form of payment in the world. It is interesting that Germany in 1944 could buy materials during the war only with gold, not with fiat, money paper. And gold is always accepted and is the ultimate means of payment and is perceived to be an element of stability in the currency and in the ultimate value of the currency and that historically has always been the reason why governments hold gold.

    But although I can wax eloquently on this issue, it is the Secretary of the Treasury and the Treasury which owns it. So I am just really a side commentator. He has the real answers.

    Mr. RUBIN. It is always good to hear from a citizen, though. I don't think, Dr. Paul—I do think it is correct, I do think the IMF selling of gold is sound and sensible for their purposes. I do not think the United States should sell their gold, for a whole host of reasons. It is a complicated subject. But I agree with the conclusion of the Chairman.

    Dr. PAUL. A pretty good statement for the gold standard.
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    Mr. RUBIN. That would not be one of my reasons.

    Dr. PAUL. I am sure.

    Mr. RUBIN. That would actually not be one of my reasons.

    Chairman LEACH. Thank you, Dr. Paul.

    Mrs. Jones.

    Mrs. JONES. Mr. Chairman, I would like to thank my colleague, Mr. Inslee, for letting me step up in his place.

    First of all, thank you, Mr. Chairman.

    Mr. Greenspan, I want to go right back to the issue that you raised with regard to legal and cultural differences with regard to countries and for purposes of resolving possible conflicts. If we keep in mind that there are legal——

    Mr. GREENSPAN. I raise it with respect to bankruptcy, actually.

    Mrs. JONES. I understand that. But bankruptcy in the discussion of how do we resolve conflicts, wherein you have a crisis in countries, right? OK. So my question is, keeping in mind the fact that there are legal and cultural differences in various countries, how would you suggest in the course of us putting together a global financial system we factor in legal and cultural differences in various countries?
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    Mr. GREENSPAN. Well, I think we automatically do that in the form of the negotiations which we engage in, because, as the Secretary knows, and all those of us who have been involved in these international negotiations know, each country brings to the table its own cultural background and its view of what the appropriate relationships are amongst citizens within their country and between countries, and so that is actually either implicitly and on certain occasions explicitly put upon the table during the negotiations.

    Mrs. JONES. So is it fair to say that that is used as a signal to the investor that this is what you are facing, or is it used as a discriminatory factor in some way with some countries? Help me through that.

    Mr. GREENSPAN. Well, it can vary in a number of different ways. I can't get into the detail, but we are in a negotiation on certain issues at this particular stage in which cultural, historic differences are crucial issues, and precedent and various other things of individual countries are major problems that have to be worked out. And what we try to find out is a common ground where everyone can agree, even if you only go 80 percent of the way and solve 80 percent of the problem.

    In many respects, I think you are pointing to one of the issues which is at the root of why it takes so long to implement a number of these international agreements in the financial area. Everyone thinks they are finance and legal; they are not. The big differences are implicitly, rarely explicitly, cultural.

    Mrs. JONES. Thank you.
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    Mr. Rubin, I join with my colleagues in congratulating you and thanking you for your service. I want to know, is there room on the boat for us who haven't been here long enough to get to know you, so we can get some financial advice as we work our way through Congress? I am a great cook. No.

    My question to you, Secretary Rubin, is to what extent and to what degree do we, the United States, have a contingency plan for unforeseen financial crises which potentially affect the entire U.S. financial system and the world financial system?

    Mr. RUBIN. I don't think that we have, or should have for that matter, a contingency plan per se. I think the best protection for the United States with respect to the unforeseen, and the unforeseen does happen, is to continue its sound policy and sound—I won't comment on the Fed, but whatever the Fed does—sound fiscal policy, sound exchange rate policies, sound banking policies, sound policies, sound trade policies, sound international economic policies, sound policies in all of the areas in which we are involved. And I think that is our best protection against the unforeseen.

    Mrs. JONES. I probably have more questions. I have one other. This is in your written statement, Secretary Rubin, at the back. You included a good social policy, and they include the importance of—I want to go to number three, which says, ''strengthening anticorruption measures, especially through fiscal transparency and accountability.''

    With regard to that, I am not going to think of a particular country. Say I represent a particular country and we are talking about how do I deal with the issue of corruption measures in my country? Do you factor into dealing with that recovery of dollars that have been lost from my country as a result of corruption or allow my country to get a plus or a credit for attempting to recover dollars from corruption?
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    Mr. RUBIN. I don't think the issue quite comes up in that context. The World Bank and IMF are very focused on this issue of corruption, and they have conditionality in the case of the IMF, and programs in the case of the World Bank try to deal with these issues. So it has become now—is part of a Country Program, if you will.

    In terms of recovering funds, that I think does not tend to arise; although if a country sought the assistance of the United States with respect to what it asserted were illegally obtained funds internally, that is an issue that we would have to deal with as it arose.

    Mrs. JONES. Just a quick follow-up, Mr. Chairman. Would that be a logical way of assisting some of the countries, that our country, or internationally, we would assist them in recovering funds that were taken as a result of corruption? Because my guess is there are a significant number of countries who would not be underdeveloped if, in fact, corruption was dealt with by us internationally on their behalf. Or, I could be wrong.

    Mr. RUBIN. This actually has come up in particular specific cases. And the Chairman will respond, but it has to be—if a country believes that there has been a corrupt misappropriation of funds, then it has to resort to legal process within its own country or within this country, so it has to go through established legal processes.

    Mrs. JONES. I am going to let you go with that answer, Mr. Rubin, only because it is probably the last time I will get a chance to examine you. If you were in a courtroom, I would probably go a little bit further, but I thank you very much for this opportunity. Thanks, Mr. Chairman.
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    Chairman LEACH. Thank you, Judge.

    Mr. Ryan.

    Mr. RYAN. I want to thank you gentlemen for joining us today. Mr. Rubin, I come from Wisconsin. We have great walleye fishing there, great muskie fishing. I know you are fly-fisherman, but I would invite you to try Northern Wisconsin fishing for pike. Have you ever tried it?

    Mr. RUBIN. I have not, but it is a nice idea.

    Mr. RYAN. Muskie hunting is a great sport.

    I have a quick question I would like to ask Chairman Greenspan. I would like to ask the two of you a question. I was intrigued with the dialogue that you had with Mrs. Roukema about derivatives, and Martin Mayer in his column today says the derivative industry is now a $70 trillion industry.

    To what extent do you think that the derivatives market is attributed to the floating exchange rate system and unstable exchange rates?

    Mr. GREENSPAN. Certainly in part, derivatives are fundamentally instruments to redistribute risk in one form or another. Clearly, if all financial markets were flat, no changes in price, there would be no risk and therefore no need to distribute risk. So clearly, floating exchange rates—floating anything—is an element which would increase the demand to have derivatives.
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    And indeed I am sure if we had adequate statistical techniques, we could probably differentiate where all of the volume is coming from. But I am not sure we need to go through that exercise. It is pretty obvious that volatility breeds volume in the derivatives market and creates demand.

    Mr. RYAN. Thank you. I notice that in each of your statements, the last points you mention are the need for sound money or stable monetary policy. And while I appreciate that mentioning, I am concerned that we are missing the crucial point here. For myself, I come from a fifth-generation family of earthmovers from Southern Wisconsin.

    And we find, and I have learned from this business, that if you are going to build a house or a shopping mall on a faulty foundation, on a sandy foundation, that infrastructure, that architecture, that home, or that shopping mall will indeed crumble, and the homeowner, the business owner, will lose their asset.

    What we find is we haul in clay and put it as a pad underneath these infrastructures, a good sound foundation from on top of which the architect and the builder can then come and build a solid structure that will be permanent and lasting.

    The reason I digress on this point is because I think it is a fitting example of where we are right now. This hearing is about proposals for a new international financial architecture. I believe we are missing the point, because we are—what about the foundation? Before you come forward with a plan for a new international financial architecture, shouldn't we be concerned primarily with the foundation on which that architecture is rested upon?
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    And looking at some of the comments you mentioned, you did in each of your statements suggest we need some monetary policy, I would like to submit to you that I think the best service you could possibly provide this country and this hearing room right now is for the two of you to say that your primary objective is to focus primarily on stable money, on stabilizing exchange rates, and that you will work with other countries to pursue that type of agenda.

    I would like to ask you, each of you, if you think that pursuing a solid monetary foundation, the pursuit of stable money, sound money, as a primary foundation preceding a new architecture plan is in your best interests, in our best interests. And if we were to pursue a sound monetary foundation, would that not alleviate some of the concerns and the problems we are trying to solve with talk of a new financial infrastructure or architecture?

    It is my concern that this talk of a new architecture is essentially—agencies, international financing organizations in search of a mission, when the real heart of the matter is the foundation we are attempting to build this architecture on top of.

    Mr. GREENSPAN. I don't think there is a contradiction, Mr. Ryan. We, central bankers around the world, are increasingly becoming aware that stable prices or price stability is the point at which risk is least; that is, as inflation picks up, the volatility of prices and our measure of risks rises. And we presume that whatever evidence we have, falling prices do precisely the same thing, with price stability being the point of lowest overall risk; and that if you have a system around the world in which everyone is practicing price stability, the types of international financial accidents that are likely to occur are limited.
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    And what the Secretary, I, and our colleagues are doing with respect to this issue of architecture is to take as a given what we know about how economies work and ask ourselves, with the new type of financial instruments, with the tremendously changed structure of international finance, what type of supervisory elements are needed to supplement the crucial supervisory structure, which is essentially private counterparty surveillance. That is not inconsistent with an endeavor to focus on the foundation and build from there.

    Mr. RYAN. Is it as high a priority as the architecture concerns?

    Mr. GREENSPAN. I would say it is part of the overall discussion. We discuss that all the time as part of the structure.

    Mr. RUBIN. Yes. I would simply make one comment, Mr. Ryan. If what you are saying, I might be misunderstanding what you are saying, but if what you are saying is that there should be some sort of, in some fashion, mandated or directed price stability and then everything else builds on top of that, I think it is sort of backward. I think myself that it is sound policy that leads to stability.

    And the whole focus of this architectural—the whole focus of this architectural effort has been both to identify what constitutes good policy or sound policy, if you will, in both developing and industrial countries, and then to develop inducements to sound policy. The end results of sound policy should be greater stability. But you don't start with stability, you start with sound policy.
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    Mr. RYAN. Do you not believe that sound policy comes from sound money, that if we have reliable——

    Mr. RUBIN. I think sound money comes from sound policy.

    Mr. RYAN. OK. I see that my time is up. I would like to ask one more question, if I may, which would require a brief answer.

    Chairman LEACH. Please, Mr. Ryan. You have been here all morning and you deserve the right.

    Mr. RYAN. Thank you, Mr. Chairman.

    What are your thoughts on late ideas about sharing seignorage with dollarizing countries? We make money on seignorage, and do you think that it is a wise policy for those countries that unilaterally dollarize, that we share those proceeds with those countries? What are your thoughts on that proposal?

    Mr. GREENSPAN. I usually ask the Secretary of the Treasury that question. Let me just raise one issue before he gives you the definitive answer. Once you raise the question of sharing seignorage for new issuances of currency, you immediately run into the problem, what do you do about the outstanding issues? But, more importantly, it is not sort of a fixed stock, it is continuously turning and turning, and it is moving. As you know, more than half of our currency is held abroad, but it is not held in fixed places. It keeps moving around.
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    And the question is, how do you address that particular issue and the equity of the question of seignorage sharing with one country and not others, and you get into some very interesting technical problems of defining how to handle the mechanics of the seignorage itself. But at root is really a question of sharing revenues. And this is a budgetary problem, which the Congress clearly must be involved in.

    Mr. RYAN. CBO seems to be a little at a loss at how to score this.

    Mr. GREENSPAN. I can understand why. It is a very tricky issue.

    Mr. RYAN. Yes.

    Mr. Rubin.

    Mr. RUBIN. I guess the best answer I can give you, Mr. Ryan, we haven't had to face that issue yet, as you know. We are agnostic with respect to the dollarization. And I guess with respect to sharing seigniorage, it is not an issue we have had to face. And I think that one would have to make a very strong case as to why we should want to do that.

    Mr. RYAN. All right. Thank you. Thank you, Mr. Chairman.

    Chairman LEACH. Thank you.
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    Mr. Inslee.

    Mr. INSLEE. Thank you. Mr. Secretary, I want to thank you for your leadership on privacy issues. You were recently at the White House announcing the President's new privacy initiative and a lot of us appreciate your efforts and leadership in that regard.

    I want to ask about how you view our ability to protect privacy during the increasing globalization, really, of the financial industry. And, you know, we have issues; for instance, the European Union had requirements on privacy. They are asking us to accommodate those needs before we have a shutdown on the Internet industry essentially, and I know that the Administration is working on that issue right now.

    I would appreciate your comments and advice what direction we ought to take in this regard.

    Mr. RUBIN. Let me limit my response only to the sense, Mr. Inslee, as you correctly say, there are discussions going on with the Europeans particularly on this issue. And I think it is probably better for me to limit my comments simply to the notion that I think this whole set of privacy issues, both domestically and internationally, is a very complex set of issues.

    On the one hand we need to be very mindful of the needs of privacy. On the other hand, there are conflicting needs. We have to find some sort of a sense of balance.

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    That is what we have been trying to do. I think, for example, the Bank Secrecy Act, with respect to some of its requirements, is absolutely critical if we are going to deal with money laundering, for example; and dealing with money laundering is in some ways, if not most, our most effective, at least a very effective way of getting organized crime and narcotics. So we have to very careful in this area to make sure that we strike sensible balances.

    Mr. INSLEE. I appreciate that. If you haven't already, we are pursuing a bill that would incorporate the idea of the ability of consumers to opt-out of information-sharing with their banking industry. And when you are in your other life, maybe we will come looking to you for help in that regard.

    Mr. RUBIN. OK.

    Mr. INSLEE. Mr. Chairman, may I ask you a question, and this may be a difficult one. I was trying to understand your testimony, the best I could understand it on this issue of short-term versus long-term capital for some of the nations that have found themselves in difficulty.

    As I understand what you were saying is that having too high of a ratio, if you will, of short-term capital versus long-term capital makes them fragile and subject to overdue risk. I am not sure I heard your solution to that though, however, we here can affect that situation or if we should try to, and I appreciate your thoughts on that.

    Mr. GREENSPAN. Well, it is not so much that we in the United States can affect that, except indirectly through our supervision of lenders to emerging nations or developing nations which have not yet created a financial infrastructure which is world class.
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    The issue that I am raising is that usually long-term debt has a higher interest rate than short-term debt, and that too many emerging nations have endeavored to borrow short-term, because the immediate costs were less, whereas what they were doing effectively is failing to take out insurance premiums which would insulate them against the types of major capital flows which has major problems.

    It is the same issue as somebody deciding not to take out fire insurance. The chances are your house will not burn down. And, indeed, it is cheaper not to have fire insurance, but it is unwise. And the fundamental point that I was making is merely an issue which I was directing more at borrowers than lenders in the sense it is to your interest to borrow longer, to have longer maturities and, indeed, to pay somewhat higher interest rates as a consequence, because it very significantly insulates you from the potentials of international financial crises.

    Mr. INSLEE. Do you think in retrospect—or prospectively, we ought to be more attentive in our supervision of lenders in that regard? Then, should this be something that is our policy?

    Mr. GREENSPAN. I think that the process of maturities moving out is already in place as a consequence of the Asian crisis we have just been through; that is, lenders are becoming more wary of the issue. And so, both borrowers and creditors, I think, are beginning to see that the insurance premium itself may appear expensive in the short run, but it is a very good investment.

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    Mr. INSLEE. Thank you.

    Chairman LEACH. Well, thank you, Mr. Inslee.

    We've been discussing abstract economic issues with concrete implications.

    Earlier, a column in today's Wall Street Journal by Martin Mayer was referenced. Mayer's column concludes with an observation of ecomonist Frank Knight, who suggested that economists err when they don't emphasis the ''approximate character of their conclusions.''

    Implicit in Knight's view is that ecomomics is not a precise science and in fundamental senses may be more like politics than physics.

    Of course, from time to time, there are cross lessons for each discipline. A physicist might note, for instance, that because of gravity, what goes up tends to come down. Likewise, there is a gravity to politics, with the only question being related to timing.

    Indeed, arguably, politics has contributed this past year to the development of a Fourth Newtonian Law of Physics, that being that ''reaction is greater than action.''

    Anyway, there is an interplay of nature and human nature best understood by this century's smartest soul, Albert Einstein. Forty years ago, Abba Eban, Israel's Ambassador to the United States, journeyed to 17 Mercer Street in Princeton, New Jersey and, on instructions from his government, offered Einstein the Presidency of Israel. Without hesitation, Einstein declined, noting that he ''understood a little of nature, and nothing of human nature.''
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    I raise this perspective as relevant to today's discussion for three reasons: One: Certitude is seldom possible, and even if it were, not always helpful in the field of political economics; Two: Advising other nation-states is a frail art and is sometimes counterproductive; Three: Nationalism, as we are finding out again in the Balkans, appears to be a habitually underestimated force that can be expected to continue to dismay Western rationalism.

    There is no approach that will perfectly end risk in the international financial system, but some things may be done to diminish that risk, if there is good leadership and goodwill.

    Here, I would like to conclude by stressing again the consensus of this committee that Secretary Rubin has served his country with distinction. Treasury-Fed leadership has been impressive. I strongly endorse the President's nomination of Mr. Summers as the new Secretary, but it is difficult not to note how well the combination of an individual with such extensive investment banking experience has fit with an individual backgrounded in macro-economic analysis. In a world crying out for a one-armed economist, we are going to four-handed United States financial stewardship. Hopefully, the innate inability of economists to agree with each other can be avoided to the maximum extent possible in future Treasury-Fed relations.

    In any regard, we are entering an era in which United States political goodwill in may parts of the world has been radically eroded due to events in the Balkans. Hopefully, people and leaders throughout the world will be able to distinguish between political and economic policies, and integrate the two only to the extent common interests can be advanced.

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    Did anyone else—Mr. Bachus, Mrs. Roukema?

    Thank you very much. We appreciate your testimony.

    Mr. RUBIN. Thank you very much, Mr. Chairman, and thank you for your very kind words. Thank you.

    Chairman LEACH. Thank you. Thank you.

    I would like to announce that we will have a hearing again tomorrow at 10 o'clock. But our second panel will now be asked to join us. If I could have your attention, please. They have just placed a vote on the House floor. And I think rather than beginning, we will recess pending the vote.

    And based upon the bells that are currently ringing, it implies that it is a vote to be followed by a vote, and so that probably means about 25 minutes. The hearing is in recess pending the votes on the floor.


    Chairman LEACH. The hearing will reconvene. Our panel consists of five very distinguished practitioners of economics.

    Mr. Steven S. Roach is a Managing Director of Morgan Stanley Dean Witter & Company. He is the Chief Economist and Director of Global Economic Analyses. He is widely quoted in the financial press and his work has appeared in numerous academic journals. He is currently a member of the Commission on the Future International Architecture, set up under the auspices of the Council on Foreign Relations.
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    Mr. David Folkerts-Landau is Managing Director and Head of Emerging Markets Research for Deutsche Bank, London. From 1992 to 1997, he was Head of International Capital Markets Surveillance and Emerging Markets research for the International Monetary Fund. Mr. Folkerts-Landau has written several publications and articles. He holds a Ph.D. in economics from Princeton and a BA from Harvard.

    David Malpass is Bear Stearn's Director for International Economics. He joined the firm in 1993 and is a Senior Managing Director. His group reports have covered Latin America, emerging Asia, Japan, the euro, Turkey, Russia and Washington policy issues. Mr. Malpass writes frequently for publication, including articles in the Wall Street Journal. In May he testified in the U.S. Senate Budget Committee on Japan's economic decline.

    Anne Krueger is Herald L. And Carolyn L. Rich Professor of Humanities and Sciences and Director of the Center for Research on Economic Development and Policy Reform at Stanford University. She is also a Senior Fellow with the Hoover Institution; also at Stanford. Ms. Krueger has written numerous books and monographs on international economic development and policy themes.

    Our final witness is Karen Shaw Petrou, who is President of ISD/Shaw, Inc., a Washington-based financial services consulting company. Ms. Shaw Petrou is a widely respected analyst whose comments appear regularly. And prior to founding ISD/Shaw Financial Services practice in 1985, Ms. Shaw Petrou served as Vice President for the Bank of America. She holds a Master's degree from Berkley and a BA from Wellesley.

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    Chairman LEACH. We will begin in the order of introductions, and we will begin with you, Mr. Roach.


    Mr. ROACH. Thank you very much, Mr. Chairman, in my——

    Chairman LEACH. Excuse me. If I can ask you if you could bring the mike closer, then you could lower it slightly and bring it and then—perfect. A little closer yet. I think you will find even speaking lowly, the mike will pick up.

    Mr. ROACH. I am afraid I might swallow it. It doesn't appear to be working.

    Dr. KRUEGER. I don't think it is on.

    Chairman LEACH. If I can ask staff to look into that microphone issue. If you will just withhold for a moment.

    Please proceed.

    Mr. ROACH. I will steal David's. How is this? OK?

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    Chairman LEACH. Works fine.

    Mr. ROACH. Great. Thank you very much, Mr. Chairman. In my prepared testimony, which I have submitted for the record, I made three basic points which I will identify and then briefly summarize to you.

    Number one, in my view, the global economy and world financial markets are now beginning to heal. This comes after a deep and very severe financial crisis. But my message is, ''Watch out. Healing could well be a recipe for complacency.''

    Second, this crisis, while extraordinary and unprecedented in many respects, is not an aberration. There may well be systemic tendencies of an increasingly integrated global economy and world financial markets that make these crises the rule and not the exception.

    And my third point is that this is the time to begin worrying about the next crisis and not frame policies solely on the basis of the last crisis. In that light, while I think many architectural reform measures, which I will talk about briefly as well, are appropriate, they should not be viewed as a panacea for all that ails the global economy. And it is my deeply held conclusion that there are more significant problems that could well trigger the next crisis, rather than those simply pertaining to the architecture. I will conclude with some thoughts on what worries me the most in that regard.

    First of all, global healing. The world is getting better. In the past eight weeks, the global economics team that I head up at Morgan Stanley Dean Witter has raised growth estimates in eight countries around the world: the United States, the United Kingdom, Canada, Mexico, Korea, Malaysia, India, and we have made three revisions in Brazil.
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    Over that eight-week period, our estimate of global GDP growth for 1999 has gone from a near recession-like outcome of 2 percent, to an increase currently expected to be 2.6 percent. That still is below trend, but nevertheless comes as welcome relief after the recession-like outcome in 1998.

    I would say quite candidly that we are not done yet in making upward revisions. There is probably more to come in our current forecast for non-Japan Asia and Latin America. Significantly, we believe that global economic growth will improve further over the course of this year, and we fully expect that momentum to set the world up for an estimated 3.2 percent increase in the year 2000.

    Our optimism on the global economy, and we are more optimistic than most, is predicated on our belief that the world has been given the functional equivalent of a large tax cut. This global tax cut has three components; interest rate cuts in the G–7, or the industrial world; lower inflation, which has boosted the purchasing power of the private sector; and the IMF-led bailouts in the five countries—Thailand, Indonesia, Korea, Russia and Brazil—collectively totaling $181 billion or half a percent of world GDP.

    As the lagged effects of this global tax cut now come into play, the global economy will continue, in our view, to awaken from its slumber. This is the essence, but by no means the entirety, of global healing. The patient, in our view, has been given some strong medicine and the medicine is now beginning to work.

    That brings me to my second point. Unfortunately, in the modern-day era, especially the last two decades, financial crises have become the rule and not the exception. According to research conducted by the International Monetary Fund, since 1975 alone, there have been 158 exchange rate crises and 54 banking crises. These crises are impossible to predict and yet there are those who believe that we can develop a new system of early warning indicators that would allow policymakers to nip the next crisis in the bud.
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    I have been a forecaster for 27 years and like you, Mr. Chairman, when you alluded to the wisdom of Frank Knight, I do not share the confidence in either the art or the science of economists in being able to forecast with great prescience. I have, instead, come to the conclusion that there may well be some characteristics of the existing global architecture, as well as in the inherent imbalances in currency and capital flows between developing and developed countries, that may well result in a systemic tendency toward all-too-frequent financial crises.

    This suggests two lines of attack. One, the architecture issue, which is the subject of these hearings. And I have no brilliant insights to offer in that regard, other than to endorse what I believe are five lines of improvement that are now making their way up through official and private circles, many of which were alluded to earlier today by Chairman Greenspan and Secretary Rubin.

    Number one, I would certainly be in support of improved standards in transparency for borrowers and lenders alike.

    Number two, I would be in favor of constraining the excesses of capital inflows into the developing world, especially short-term capital.

    Number three, I am in favor of a new liquidity backstop; although I do have some reservations about the contingency credit line having been proposed by the IMF.

    Number four, I am agreeable, in principle, to proposals that would ''bail-in'' private investors.
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    And, number five, I agree with the general drift of sentiment in favor of abandoning fixed exchange rates, or pegged rates, for developing countries.

    But at the same time, I would warn that while these proposals are important, and in many respects long overdue, they will not be sufficient to prevent the next crisis. And I think that the time to begin thinking about the next crisis is now.

    Which brings me to my third and final point. The architectural flaws and financial asset volatility in the world today are very serious issues that need to be addressed in forums just like this. You are to be commended for doing just that. But they are not the problems that in my view challenge the essence of globalization. And I think it is appropriate to bore deeper into this dilemma that we all face, which underscores the reason why you called this hearing. I stated earlier that predicting the next crisis is impossible, but I think it is possible to take a reasoned stab as to what might take us there.

    At the top of my worry list is the fear of increased trade frictions and a growing protection of sentiment throughout the world. Risks in this direction could well take us to the brink of, if not into, the next crisis.

    There are four reasons that I would cite in this regard.

    Number one, and I heard this repeatedly in the discussions this morning, there is growing concern here in the Congress and around Washington about America's growing trade deficit. The record $19.7 billion gap reported for March this morning underscores those concerns. There is a piece in today's Financial Times, authored by former Secretary of Labor Robert Reich, claiming that Americans are turning against free trade.
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    Second, there is the coming globalization of restructuring, not just in the United States, but increasingly in Europe, non-Japan Asia, Latin America and, believe it or not, even Japan. The globalization of restructuring, in my view, will intensify the battle for market share in an increasingly competitive global economy and heighten the risk of protectionism.

    Third, there is a risk of inward-looking tendencies in the developing world. That raises the risk, in my view, of anti-IMF, anti-American political and social backlash around the world. Malaysia's experience with capital controls may well turn out to be tempting and alluring for other hard-pressed developing countries.

    And, fourthly, I worry about what I would call a new statism of government intervention. In particular, I would be critical of proposals to establish or endorse currency target-zone procedures. I question the ability of regulators to determine the appropriate equilibrium value, not of currencies in small countries—not just for the dollar, but also the yen and the euro. And I suspect you will hear some proposals in that regard at tomorrow's hearing.

    I would also warn in the same vein against the increased proclivity of the International Monetary Fund toward what Martin Feldstein has referred to as ''structural intervention.'' That is the example of a macro-regulator taking explicit actions in the micro-arena. This new statism, in my view, also challenges the market-driven forces of free trade and I worry a lot about that.

    In conclusion, my advice is to study these architecture issues very, very carefully. And yet I agree with Congressman Ryan who is not here, but who stated eloquently that any architecture must be built on a solid foundation. That describes the underpinnings of a market-driven global economy. Some forms of the architectural reform are long overdue and entirely appropriate. I ticked off five that I think are worth consideration.
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    But do not be lulled into believing that there is a quick fix—that you can just do a few tweaks with the architecture and the days of crisis are behind us. In this brave new world, I don't think it really pays to think linearly. Do not extrapolate from the past to try to predict the future, but think laterally and try to look out to what it is that might cause that next crisis. We must do better on that score. We must not be reactive, we must be proactive if we are to be better able to learn and to live with globalization.

    Thank you very much.

    Chairman LEACH. Well, thank you, Mr. Roach.

    Dr. Folkerts-Landau.


    Dr. FOLKERTS-LANDAU. Thank you, Mr. Chairman. To keep matters brief, let me give up front the key conclusion. It is my view that, despite what we heard this morning, the ongoing efforts at designing and implementing a new international architecture are misguided.

    Chairman LEACH. Excuse me, Doctor, if you could lower the microphone just a little bit, I think it would be better. Fine.
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    Dr. FOLKERTS-LANDAU. They are misguided, ineffectual, and ultimately will produce little of relevance to the functioning of the global financial system in broad terms. At best, these efforts will leave things much the way they are, because they will be circumvented. At worst, they may actually prove disruptive to emerging market finance.

    During the last eighteen months or so, we have been hit with a global financial crisis centered on the emerging markets, as they were, that we have not seen since the late 1920's and early 1930's, and events in the U.S. dollar credit markets last fall suggested that it could have been a lot worse had it not been for the type of intervention from the Federal Reserve.

    Three related explanations bearing validity have been put forward for this volatility in global finance. First, international markets are variously thought to be irrational, driven by hurried behavior, panics, manias, and given to extreme overlending and mispricing of credit and market risk. This is the explanation that has been favored by economic critics and by the IFIs.

    Second, it is apparent that emerging countries mismanage their macro-economics and structural policies.

    And, third, the international finance institutions, particularly the IMF, did not live up to their mandate to identify the conditions that could lead to financial problems in member countries, and, more importantly, did not act decisively to prevent such crises through forcing countries to undertake remedial actions.
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    Now, when designing the architecture of the global financial system, it is important to understand which of these three sources of instability we are trying to correct. I believe that an objective look at the evidence suggests that the largest part of the blame falls on the emerging market countries themselves for trying to basically have it both ways: reaping the benefits of integration into the global financial system and thereby gaining significant access to large inflows of capital, without accepting or wanting to accept the necessary policy discipline and without making the necessary improvements in their financial structure. Thailand, Korea, Indonesia, Brazil and Russia are all extremely persuasive examples. Perhaps Argentina, perhaps less so.

    Next, it is equally obvious that the International Monetary Fund, the key player in the international financial system, has by and large failed to live up to the surveillance mandate given to it with the second amendment of the Articles of Agreement in 1978. Growing financial problems and policy inconsistencies in emerging market countries went largely undiagnosed and, more importantly, when they were recognized, then the Fund was not able to bring to bear sufficient pressure on governments of these countries to force remedial changes in policy.

    Finally, international lenders, particularly the international bank lenders, did what they always do in crisis situations when information is hard to come by. They run and contribute to the massive liquidity problem that we have seen, and the Asian crisis was no exception to this rule. In addition, leveraged market participants, the so-called ''hedge funds,'' exploited the policy inconsistencies in these countries and they attacked overvalued exchange rates in the knowledge that central banks could not potentially defend such regimes in the face of overwhelming weakness in the local banking system.
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    But these were not the root causes of the recent financial instability. The market arrangements and leveraged participants tend to make crisis more pronounced and more difficult to manage, but they are not the root cause of the crisis. Instead, the root cause of financial instability, particularly in emerging market finance, is that the existing international financial arrangements, the international financial system, has failed fundamentally in the key area, in that the existing structure cannot police itself and it cannot force countries that are participating in global markets to behave responsibly.

    The problem with the current efforts then to reform the architecture of the international financial system is that it has focused on what I regard as the least important source of instability; namely, the intrinsic behavior of international financial markets, rather than on the policy failures of emerging market countries themselves or on improving the effectiveness of the IMF in detecting such problems and in giving the Fund the ability to get countries to change destabilizing policies. And this is why I believe that the efforts currently underway in the discussions will in the end not be effective.

    As you know, there are three key types of reform proposals. The first type suggests rewriting international bond and loan covenants to achieve the bailing in of creditors when countries experience financial difficulties. But would a country really wish to tell lenders in advance they will be forced to roll over exposures when this border is in trouble? I think not.

    In any event, this approach would result in a significant increase in borrowing costs at a time when trillions of dollars will be needed for infrastructure finance in these countries. Besides, if this is such a good idea, I would suggest that perhaps the G–7 should introduce these covenants on their own public debt.
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    The second type of proposed reforms focuses on the so-called private sector burden-sharing, including private external bond obligations in the restructuring of official credits through the so-called Paris Clubs. Clearly, eurobonds will have to be restructured at some point. If you are asking eurobond holders to restructure their obligations, assuming that the legal quagmire can be avoided, then one would have hoped that the IFIs would no longer be able to maintain their preferred creditor status. In the case of countries like Russia, this is a very significant step.

    The third idea of reform seeks greater disclosure from leveraged institutions, hedge funds, propriety trading desks of banks, and so forth, and further improvements in the potential supervision of lenders—not of borrowers, I might add—as well as the imposition of capital requirements on lending to certain emerging markets. These are all what I would call ''motherhood'' issues. Most of them will be very difficult to implement, and those that are would be fairly easy to circumvent through the current status of financial engineering.

    I am afraid the horse has left the barn. It would be difficult to get it back in. What reforms have a chance of providing greater global stability? Well, after the end of Bretton Wood's system of fixed exchange rates, the Fund's Articles of Agreement were amended to give it surveillance responsibility over its members' policies in order to ensure stability in exchange markets and to avoid international contagion.

    Even to a long-time admirer of the Fund like myself, this mandate has not been entirely successfully implemented and the Fund's ability to prevent global crisis remains rather limited. It did not anticipate in 1982 the Latin American debt crisis, nor the 1992 ERM crisis, nor the ongoing Japanese crisis.
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    Likewise, the 1994/95 Mexican Tequila crisis came as a surprise, as did the bulk of the 1997 Asian crisis; but more importantly, in those cases where the Fund did anticipate a crisis—for instance, in Thailand, Korea, and in Russia—they were not able to induce the country to implement remedial policy measures. The mandate simply does not go far enough to achieve that.

    This is the key feeling as far as I am concerned. The growth of the international financial system will need to be corrected. The growth of the global system demands an institution that provides liquidity in times of crisis as the Fund does, much like national central banks, but this institution needs to have the ability to supervise its members, to detect problems, and to force remedial policy actions. This is the key missing piece in the current financial architecture. The Fund, its management and style, is an extremely capable and invaluable institution. I am, of course, a biased observer, but it is my view that with relatively minor internal reforms, the Fund could easily build the capability to do effective financial surveillance of its member countries.

    However, the hard part is to empower the Fund to force countries to change destabilizing policies. To achieve this change in the architecture is inherently harder than the proposals that are currently on the table. It will require much more painful political commitments than, for instance, forming BIS committees to talk behind closed doors about changing bond requirements, burden-sharing, or information disclosure, but ultimately it is the only effective way to avoid crisis. And I very much agree with my colleague to my right that crisis will recur in the absence of such fundamental reforms.

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    More concretely, after improving its surveillance capability, the Fund will need to go public with its findings and let markets do the rest. It will need to pressure countries publicly for policy changes, including international sanctions, aid curtailment, the imposition of additional cap requirements on bank lending to countries identified as following destabilizing policies. For instance, following Chairman Greenspan's observations this morning, countries that do not follow the proposed rules of debt management that were put forth this morning should be publicly identified and ultimately declared countries ineligible for access to the Fund lending facilities.

    In some sense, when you think back over the events of the last fifteen years, it is astonishing that we have never given this kind of mandate to an institution that is supposed to safeguard us from global crisis. But such an approach requires significant agreement within the G–7 and resolve among the Fund's other major shareholders if it is to be successful. But without such reform, crises will recur with the regularity that they have over the past fifteen years.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much.

    Mr. Malpass.


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    Mr. MALPASS. Mr. Leach, Mr. LaFalce, Members of the committee, thank you very much for the invitation.

    I don't think the world really needs a new financial architecture. What it needs is a new foundation for growth. In my view, this should be based on a clear and more operational U.S. commitment to a stable value for the dollar for a long time going forward. The new foundation should drastically scale down the role of the IMF. The IMF should focus almost all of its efforts in its country programs on creating sound money, a stable liquid store of value, so that people can save, invest, and innovate.

    As countries move their exchange rates, it deeply cuts into their ability to grow, and yet that is the system that right now we are operating in. The IMF, in a string of its failures including Yugoslavia—which, remember, was the biggest borrower from the Fund during the late 1980's, just before its breakup—Russia and Indonesia failed to do the simple step of allowing the people of the country to have a store of value. That needs to be addressed and should be the focus of the inquiry.

    I am saddened by the poor economic progress in many developing countries. People can talk about the rebound, but the fact is, developing countries are doing poorly on average. For example, in Southeast Asia and South Korea, per capita incomes in the year 2000 will be well below their 1995 levels, a huge setback for this region of the world, especially at a time when the U.S. is growing so rapidly.

    We see in the Wall Street Journal today an article about Asia's wealthy ended up 10 percent in 1998, at a time when most of the people in their region were taking a huge step backward. That would show up in falling median income numbers if those were available.
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    I think U.S. economic policy bears substantial blame for the poor economic performance of many developing countries, and particularly for the plight of poor people in those countries. Their growth is not our responsibility. But, it is our responsibility to provide a stable value for the U.S. dollar which has now become the global standard of value. And it is also our responsibility to, as the most influential member of the IMF, to have it do no harm. In this regard, the U.S. is not providing economic leadership to the world and in many cases is actually blocking growth.

    As the U.S. becomes more isolated in its full employment and wealth, poor economic conditions abroad raise major issues for our national security, immigration policy and future economic growth, not to mention raising moral issues for us.

    The U.S. needs, I think, a wholly new international economic policy and exchange rate system, not just a facelift named ''financial architecture.'' In my view, the Administration's effort on financial architecture would not help economic development abroad. A proper policy should be built on our country's economic beliefs: sound money, limited government, free trade, and a belief that people at the bottom of the economic ladder should be able to move up.

    This isn't what we do in our international economic policy. We don't promote U.S. values abroad. We should have a strong focus in both our domestic and international economic policies to put an immense emphasis on money as a store of value and an enabler of economic and political development.

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    This clearly did not happen in 1997 when the dollar gained substantial value against gold, almost all commodities, and almost all world currencies. Either you can argue that all of those currencies and commodities lost value or you can argue that the dollar gained value. It seems to me more logical to believe that the dollar gained value.

    Mr. Greenspan this morning offered to wax eloquent on gold as a standard of value. The committee didn't take him up on that, but he was prepared to do it. The sudden change in the value of the dollar put immense pressure on dollar debtors and commodity producers around the world. We're still feeling the results of that change in the value of the dollar. Farmers in the United States are feeling it in low commodity prices. In the paper yesterday, there was Canada's largest copper mine closing its doors because copper prices fell.

    The value of the dollar went up in 1997. We should as a country state clearly and repeatedly that our own economic policy depends on achieving a stable value for the dollar over long periods of time. We should debate and implement mechanisms to accomplish this. It is absurd, in my view, that the U.S. builds its own policy around a strong dollar and then backs policies and economic concepts guaranteed to force poor people abroad to use bad money. That is what we are doing.

    You heard this morning Secretary Rubin say that he expected the strong dollar to continue, and he said that the dollar is not an instrument of trade policy. In my view the best way to address our trade deficit is to have growth abroad. Rubin was right in saying that we shouldn't go changing the value of the dollar because of our trade policy. And yet through all its efforts, power, and institutions, the U.S. is doing just that abroad. We try to get countries to float their exchange rates and change the value of money for trade purposes.
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    So we are trying to have it two ways. For the United States we want a strong dollar and we won't change it for trade reasons. For foreign countries, we want their currencies to be weak and to change for trade policies. That doesn't make sense, and yet it is the U.S. policy.

    Chairman of the Federal Reserve Greenspan this morning said that types of accidents are eliminated if there is less uncertainty within the system. That should lead the committee to think about the problems caused by uncertain exchange rates around the world.

    We have a host of problems that are all trying to be addressed by tinkering with the architecture. These problems are really coming from the fundamental instability of currencies in the world. For example, when you talk about corruption in foreign countries, a huge slug of it is related to the exchange rate issues in those countries.

    If we look at derivatives, a huge chunk of derivatives are related to volatile exchange rates, and also interest rates, which are interrelated. If an exchange rate moves, often the interest rate moves. You need derivatives to ensure against that movement. And so if we are worried about the derivatives market, let's talk about the exchange rate policies underlying that.

    Maldistribution of income is related to exchange rate volatility. Remember what happens in countries when their currencies move. The wealthy are able to protect themselves, as we see from the Wall Street Journal article this morning: Asia's wealthy were up 10 percent in 1998. Asian poor down 50 percent in 1998 by the count. And so the maldistribution of income is directly related to exchange rate policies. There were several committee Members this morning wanting to address that. Please look at exchange rates as an issue.
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    If we are worried about why governments in foreign countries have so much regulatory power and so much intervention power in their economies, remember that the most important thing that governments do is provide a store of value, a stable exchange rate. To the extent that we are prescribing and encouraging countries to have unstable exchange rates, we are inviting their governments to take control of their economies. We are also inviting the IMF to have immense power in those countries, because exchange rates are at the core of how their economies are going to develop.

    This gets to a key point that Secretary Rubin raised this morning. He said that countries must reform in order to have sound money. That is a critical comment. That is saying that poor people in countries in Asia need to have their governments put in good policies in order for those people to merit sound money. That doesn't make sense. That is not the way countries actually develop as we look at the world's economic development. Countries first put in sound money, a stable store of value, and then they are able to achieve economic and political changes within their system.

    How can the president of a country having a weak exchange rate and where its people are being actively impoverished go about reforming the country? You don't have the political stability, the popularity to actually make changes. The Secretary is arguing that countries have to have good monetary and fiscal policies in order to have stable money. I think it is very hard to have good monetary and fiscal policies unless you have stable money. You start with stable money as the starting point for economic development and then you have a chance to get economic reforms, proper banking regulation, proper political structure. If you look at the history of developing countries, that is the clear story. Very few developing countries have developed well politically without a stable currency to start with.
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    Secretary Rubin also this morning talked about no support for pegged currencies. That is a very complicated issue. The financial architects, the people promoting architectural changes, seem to want to force countries into either fixed or floating exchange rates. This is the wrong issue to tackle. All of our efforts should be directed at encouraging stable values for money regardless of the system used. The Asian miracle after all, which lasted for nearly fifteen years, was built on pegged currencies. Are we saying that was wrong for all of those people who were in poverty to pull themselves out?

    We have the recent example of Brazil which pegged its currency from 1994 up through 1998. It had a huge development in its political and economic circumstances that never would have happened without the peg. Are we now saying that the people in Brazil didn't deserve to have that economic and political advance?

    In conclusion, we don't need a new financial architecture. What we need is a more stable foundation for growth, including a clear U.S. commitment to a stable dollar and a scaled-down mandate for the IMF, putting currency stability at the core of each of its economic programs. Thank you.

    Chairman LEACH. Thank you very much, Mr. Malpass.

    Dr. Krueger.

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    Dr. KRUEGER. Thank you, Mr. Chairman.

    I would like to take on three issues that it seems to me are important if we are going to talk about new financial architecture. First, I think it is necessary to address the causes of the crisis and see what it is we are trying to fix. I want to talk a little bit about the structural reform programs that were put in place at the time of the crisis, because I think some of the discussion of architecture comes out of that. And then, of course, I will conclude by talking a bit about the functioning of the system and how it might be improved.

    Turning first to the causes of the crisis, I share the views of those who say that they were predominantly internal and consisted of policies in the countries themselves. I think in the cases of Mexico in 1994, Thailand, Malaysia, Indonesia and South Korea in 1997, you can identify some very common characteristics that they all shared. One was the maintenance of exchange rate policy which was determined by central bank policies and intervention, rather than the market, and those policies were not consistent with the macro-economic policies they were following, so that there was a consequent tendency for real exchange rate overevaluation.

    Secondly and related to the first, there was a rapid expansion, you could almost say explosion, of domestic credit during the mid-1990's, which basically meant the banks were increasing the contingent liabilities of the governments at the fixed exchange rates they chose to maintain.

    Third, there were current account deficits resulting from the first two of very sizable proportions: 8 percent in the case of Thailand in 1997 and in Mexico in 1994, and Malaysia in 1996.
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    Fourthly, there was a relatively open capital account, so that expansion of domestic credit fed directly into the capital flows, as I mentioned, and of course there were diminishing reserves, which were a necessary trigger for the crisis.

    While the combinations of events differed among countries a little bit, all of them had these same features in common and the magnitudes of the crises to a large degree were determined by the extent of the resulting macro-economic policies, inconsistencies, and misalignment. It is argued that if adjustments had been made earlier, the extent of the needed adjustment might have been smaller. But there is little doubt the fact that the one country had a crisis led market participants to scrutinize their portfolios carefully and, as a consequence, timing for the other countries may have been affected by the first.

    In discussing the crises, it should be remembered that not all countries experienced crises. There were many that didn't and many that were vulnerable. Chili maintained her policy stance intact, even though the price of copper has been depressed and there has been a recession in some of her Latin America trading partners. Thailand grew at 5 percent. Argentina has severe pressures coming out of the Brazilian crisis but weathered other things very well. And, of course, Australia, which had the first hit from the Asian crisis in terms of what happened to its commodity prices and its exports, had the highest growth of the OECD last year. So contagion isn't everything.

    Let me turn then to the structural adjustment programs that were adopted. First off, I think it is important to remember that there has been very little time to act. If you contrast it with the crisis of the 1980's, Mexico announced its inability voluntarily to service its debt in August 1982. And a Fund program was finally put in place in December. By contrast, in Korea, the Fund had three days.
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    Second and importantly, the crises were not ''caused'' by capital flows, although the timing may have been affected, but by the underlying unsustainable policy stances.

    Third, once capital accounts are opened and domestic credit is expanding, it is not possible to ''fix'' the problems resulting in crisis without addressing the banking situation. You simply have to do so.

    You probably could not have had the rate of credit expansion you had in the ''crisis'' countries without banking problems. You just can't expand credit that quickly and be prudential. There were a lot of non-performing loans in the banking system before the crisis in most of those countries. Once there is bad paper there and once you have had borrowing denominated in foreign exchange, the necessity to devalue does increase the non-performing loans of the banking system. And so as a part of crisis resolution, two things must be done: First, the bad paper has to be removed to the bank's portfolios; and second, and equally important, means must be found to prevent a repetition of unwarranted lending. That you have to do something about it, I think, is amply demonstrated by Japan, where their failure to act has kept them in recession more severely than certainly would otherwise have been the case for a very long time.

    But you also, as I said, have to restructure the financial system and that does bring new challenges for international financial architecture. Anyway, there are two essential tasks necessary for managing these crisis, as I have already said, and these are tasks for which the IFIs were not well prepared at the time of this particular last crisis and something on which we can work. Basically then, insofar as the structural adjustment programs focused on issues previously regarded as domestic in the financial sector, it is my judgment that measures relating to the restructuring of the banks were essential and I don't think it was recognized ahead of time.
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    I don't think we know how to do it yet and research analyzing alternative means of achieving financial restructuring and prudential supervision is going to be highly productive over the next several years and I am sure we can do better. That said, I think the overall judgment has to be that the international financial institutions and especially the IMF did very well in working out the programs as well as they did, given time constraints and given what was known. They imposed some conditions on domestic policy performance that were not related to the crisis and in that sense they can be second-guessed, although I think that one can be argued either way. But overall, the situation would have been much worse without them and especially without the IMF. The recoveries that have already been alluded to in other testimony that are underway, I think, attest to the soundness of the policies that were involved.

    So let me now turn to the third question: How do we improve the architecture based on that kind of an analysis of what happened? The first lesson, it seems to me, is the evidence strongly supports the view that exchange rate policy must be one of either a fairly clean float or, in a few instances if there is enough political will, a currency board.

    A fairly clean float prevents the build-up of pressures that has happened under the more fixed exchange rate regimes that the crisis countries had, while a currency board guarantees—or can be made to guarantee—that the exchange rate will remain unchanged and thus prevent speculative attacks. A currency board, however, is very difficult. Policies in the middle, such as the pegs that the countries in Southeast Asia had, I think, are very likely to run into trouble, and if they are tempted again will run into trouble sooner.

    Second, we have to get improvements in financial supervision and strengthen domestic banking systems and that has to result in greater transparency, without doubt.
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    Third, many developing countries will probably find it desirable to hold higher levels of reserves than they have been doing, although if the underlying policy stance is inconsistent, high reserves can simply hold and often attack for a while, making it more severe when it finally comes.

    Fourth and most important, however, attainment of consistent macro-economic policies, including measures that prevent overly rapid expansion of domestic credit, will do much, but not everything, to prevent crisis.

    I think it is the first point, financial supervision, and the fourth, domestic credit, that provide the most basis for optimism. Policymakers around the world have been witnessing the appalling costs of financial and exchange rate crisis. The lesson that fixed nominal exchange rates are crisis-prone seems to have been learned. If, in addition, policymakers address their underlying macro-economic policy stance, the changes in the future crisis will be greatly reduced.

    There has, as an alternative, been proposed that there should be stronger controls on capital flows and especially short-term capital flows than there were in the crisis countries, based on the reasoning that capital controls would have prevented capital inflows that reversed during the crisis.

    In my judgment, this argument is flawed on several grounds, although I would agree that countries with relatively closed capital accounts should open them up as they achieve other conditions for macro-economic stability and growth.
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    If there had been controls on capital flows, it is most likely they would have been ineffective. If not, they could at best have resulted in a delay, but not an avoidance of crisis. As long as nominal exchange rates were more or less fixed, there were above average rates of return to be achieved by inward flows of capital and there were equally strong temptations for domestic residents to find ways of getting funding from abroad. These decisions were profitable until the crisis struck and, in my judgment, proposals for capital controls seek to avoid the necessity for consistency in macro-policies, which is the only way in the longer run that crisis can hopefully be avoided.

    What do we do about the architecture? I concur that it is a number of minor changes and not a major overhaul. We need to do more on prudential supervision, but I don't think we exactly know what, so my prescription would be to let there be a little competition between the IMF and the World Bank and the BIS and whomever else for the time being, as different things are tried and we can learn from experience.

    Meanwhile, of course, there are other things that can be done. One thing is to get a market-based proposal centering on the idea that borrowers might seek or require or be required to have clauses in loan contracts which would permit them to unilaterally suspend debt service for specified periods of time, possibly at penalty rates to be accrued during the suspension period possibly at the instigation of the IMF.

    There are a number of other proposals on the table, but at this time I think that is the one that looks most likely to redress the imbalance of penalties between various classes of those extending capital to developing countries. The history of the developed countries is full of financial crises in the past. As developing countries achieve growth, they too have to strengthen their financial systems.
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    Improving the international financial architecture in the small ways that I have outlined will improve growth prospects for those countries, and hence for the world as a whole. Thank you.

    Chairman LEACH. Thank you very much for that very thoughtful testimony. It is good to have a West Coast perspective.

    Now for an inner Beltway one, Ms. Shaw Petrou.


    Ms. SHAW PETROU. Thank you, I think, Mr. Chairman. Thank you very much, Mr. Chairman. Batting cleanup as I am, I would——

    Chairman LEACH. I apologize. I didn't mean to have the two women at the end. For the questions we are going to reverse the order. Please go ahead.

    Ms. SHAW PETROU. Thank you. I would like to summarize my statement and ask that it be submitted for the record.

    Chairman LEACH. Without objection. All of your statements, if they are fuller, will be submitted and if you want to add reasonable amounts of extra material, we will accept those too.
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    Please, go ahead.

    Ms. SHAW PETROU. Thank you. I would like to focus my remarks on the issues that everyone else has touched on, the financial industry structure and particularly the prudential regulatory issues that I think are so critical to a sound global financial architecture. And I would like to focus on three relatively technical areas: financial institutions supervision, bank regulation, and financial industry structure. These are often arcane, particularly bank regulation, but I do think they are critical.

    The failure to get bank regulation right, if not the driving force in the global financial crisis of the last few years, is certainly a predicate factor and it is critical to get banking systems right.

    I would also like to focus on these issues this afternoon, because several things I would like to suggest do fall within the jurisdiction of the committee and may be easier to get one's arms around than the more macro questions of international exchange rates and global capital flows.

    First, on financial supervision, I would like to suggest that we do more in the United States to use our massive financial market and our excellent structure of financial industries supervision, not only to set a good example but to make that example enforceable by building on some provisions the committee enacted in 1991 to make entry into the United States banking industry, and I would go farther and say financial services industry, conditional on a commitment by a bank at the parent company country level to what we would deem best practices. I don't believe that that is extraterritorial, as I would like to explain briefly in a moment.
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    Second, bank capital structures are badly broken. Chairman Greenspan today said that they are obsolescent. I think he said obsolescent, if not obsolete. I think they are badly flawed and create some of the perverse incentives that both Chairman Greenspan and Secretary Rubin were discussing this morning.

    Ms. Roukema asked about derivatives and why they are becoming such an important and gigantic part of the financial markets, and one reason is the risk-based capital rules. If you keep an asset on your books, you pay, as a bank, a high capital cost for doing that. If you break the risk into its derivative components, those derivatives are subjected to a very different capital regime; and even though the risks may be the same, if not greater, a bank is rewarded for taking a derivative structure onto its books in contrast to a traditional loan. That may be engineering, but I am not sure it is a better engineered product.

    And finally I would like to touch briefly on financial institution, financial industry structure. I know this committee under both Mr. Leach's and Mr. LaFalce's leadership, has spent a great deal of time on trying to get the structure of the American financial industry straight by acting this year early on H.R. 10, an issue that should come soon to the House floor. I hope this year will finally do the trick and the committee will see its financial modernization legislation enacted into law.

    It is important to get the structure of our industry straight. Again, we can't provide the capital for the rest of the world or be competitive in it with an obsolete financial industry structure, but we also need, once that modernization legislation is in place, to turn to the structure of those conglomerates that have been created and how best to regulate them.
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    To go back for a second to my first point, financial institution supervision. In 1991, in FDICIA, Congress required that any bank doing business in the United States be comprehensively regulated on a consolidated worldwide basis. That standard was put into law in response principally to the BCCI scandal in which one of the rationales for how that bank was allowed to expand here and acquire control of a major institution in this city was that the bank regulators lack the authority to deny entry based on a reading of the prudential standards.

    I think that legislation was a significant achievement. It has been used since by the bank regulators to slow the pace of entry by foreign banks, particularly foreign branches and agencies where the capital of the enterprise in the United States is more remote from U.S. supervision. But that slowdown has created a great deal of uncertainty, particularly in foreign banks, of when they will be allowed entry into the United States and on what terms. We have seen considerable slowdown, in part the result of the global economic crisis, but also the result, particularly before 1997, of ambiguous U.S. policy.

    I think American regulators, particularly in their own experience and from their work at the BIS, have a solid understanding of what types of capital and prudential standards it takes to run a sound bank. This understanding is analogous to the Supreme Court's long-recognized definition of pornography: They know it when they see it.

    It is much more difficult, of course, to define. As the Basle committee, the G–7, the G–22, the G-whiz wrestle with all of these complex accords on transparency and on international accounting standards, I think it is important for the U.S. regulators to stand firm for their principles that have stood this banking system well and conditioned entry into it on a commitment at the parent bank level to comply with prudent capital, prudent supervisory and sufficient recording standards so that it is possible for U.S. counterparties of these institutions to assess their safety and soundness and protect our system from global contagion.
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    To the Basle Accord, again, in 1991, this committee and the Congress took a look at the Basle risk-based capital systems and instituted them into law. In essence, you hard-wired them for U.S. banks. You put into FDICIA prompt corrective action provisions which are sometimes, and I think rightly, proposed for adoption worldwide.

    America is unusual. We have two capital standards. One is the Basle risk-based accord, a complex mostly credit risk-based approach to capital adequacy which varies the amount of capital banks must hold for on- and off-balance sheet assets according to the risk of those assets.

    We also have a leverage rule which simply says regardless of how a financial institution has jiggered its balance sheet, a certain amount of hard dollars must be put up front against that risk.

    That leverage standard has long been viewed as primitive, simple-minded, and unduly onerous and in many respects, the level that the leverage requirement is now set too high. But I would suggest that as it becomes increasingly obvious that tinkering with the Basle standards only creates more unintended consequences and a much more complicated system that is less and less transparent, even to highly sophisticated practitioners, it may be worthwhile to evaluate a more simple capital standard that better approximates for banks the capital rules imposed on securities firms and insurance companies. The committee might wish perhaps to ask the bank regulators to study this approach and report back on alternatives to the Basle standard, even as efforts, I hope, are accelerated to improve it.

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    Finally, as I said, the committee has worked very hard on a significant financial modernization bill. That legislation eliminates decades-old barriers between the banking, securities, and insurance industries. I think everyone here on this committee voted overwhelmingly to support it, so its benefits are not elusive. I hope, though, after it is enacted, the one issue that I think the bill does not address comprehensively is looked at, and that is ''too-big-to-fail.''

    You will be creating, and the country needs, diversified financial companies engaged in numerous lines of business, but I think the capital requirements that are imposed on those enterprises, the ability of one affiliate to transmit risk to others and, most importantly, the fact that some of these companies may be deemed ''too-big-to-fail'' requires urgent attention.

    Long-Term Capital Management would never have been deemed to be a company worthy of ''too-big-to-fail'' protection, and even under H.R. 10 it still would not be so, because it does not control an insured depository. But we have learned that risk travels very fast and in unanticipated ways, and I think global financial architecture requires an understanding of who will be rescued, when, and under what circumstances.

    Thank you very much.

    Chairman LEACH. Thank you very much, Ms. Shaw Petrou.

    Let me begin with one question and I will ask it in reverse order here.

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    It is impossible to develop good policies to meet problems unless you understand the causes of the problems. And for example, there is still discord in what is at the root of the Asian crisis. Some have suggested macro-economic access. Some have suggested overextension of credit. Some have suggested corruption. Some have suggested interplay between domestic financial weakness and global capital flows, and George Soros has even suggested it simply has something to do with the structure of global capitalism as it is now developed.

    How do you see the principal causes and how would you rank them?; and given those causes, then, what public policy structure would you apply, Ms. Shaw Petrou?

    Ms. SHAW PETROU. I think the principal cause if you looked at the 1980's financial crisis, particularly in this country and then the repeated ones in the 1990's worldwide, is fear; fear by regulators in the United States to call what they see what it is in the markets and in public, and a reluctance sometimes to take hard steps early-on. This was painfully obvious in our own thrift crisis, from 1979 and into the 1980's, that as the U.S. thrift industry started to go belly-up, we needed higher capital and much more stringent prudent regulatory standards for that industry, but it took another nine years to achieve them.

    I think this occurred after 1994 in Mexico when the combination of economic factors, corruption, a fatally flawed financial system, were widely recognized, but the international financial institutions function of coming in, focusing on macro-economic fixes and not often on the structural issues permitted the regulatory system to move forward and not address these very fundamental and, I think, ultimately more fixable aspects of the global financial architecture.

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    Chairman LEACH. Dr. Krueger.

    Dr. KRUEGER. There is that old story about the man that goes out on the leaky boat. I am sure you have heard it, no question. The storms come up, and various things happen, and he can't swim, so he drowns. And the question: What was the cause? Was it the leaky boat? The fact he couldn't swim? The storm? And, of course, they are all there.

    I think the same is very much true on what happened in Asia and Mexico and elsewhere in the effort to say what is one thing and if we could just fix that. It doesn't work. One of the fundamental precepts of macro-economics is that you cannot over the longer run maintain inconsistency between your interest rate, your monetary policy, your fiscal policy and your exchange rate policy. If you have got expansionary fiscal and monetary policy, that is going to feed over into price level increases and so on, you can try and hold that down by sitting on the exchange rate for a while, but eventually it will blow.

    Now, in East Asia, I see the combination, East and Southeast Asia, in the case of Thailand and Malaysia for a long time had an almost constant nominal exchange rate to the dollar while their domestic price level was rising at an average annual rate of 8 to 10 percent and we had fairly caused—much lower rate of inflation during that time. At some point that system simply had to go.

    Now, in the process, of course, they increased domestic credit, which is why they had the inflation. But that domestic credit was virtually guaranteed by the government as long as they maintained the nominal exchange rate. So they had themselves in this inconsistent macro-stance and, of course, there was the opening of the capital account. There is no doubt that played in. But without the opening of the capital account they couldn't have participated in global markets as much as they did.
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    You cannot really restrict the capital account and have open trade. So I would read it in the combination of trying to sort of sit on the exchange rate, letting domestic credit expand very rapidly, and in that sense having inconsistent policies.

    Chairman LEACH. Thank you.

    Mr. Malpass.

    Mr. MALPASS. Asia's devaluation crisis is obviously a complicated question. I will give you my list, and I agree the problems are interrelated. First, the IMF actively undermined currency pegs in countries which had used them for fifteen years. By 1996 and 1997, the IMF was telling them to stop pegging. That was done in secret meetings, as we have now read about in the magazines. That makes it very hard for a country to decide what to do. They live and die by their peg, and yet the IMF thinks that they shouldn't have a peg. So one cause of Asia's crisis was simply an ambivalence or an active undermining of currencies by the IMF without having some other idea in place. The IMF severly underestimated the impact of its actions, leading directly to Thailand's devaluation, Indonesia's collapse, and so on.

    Second, imperfect pegs. The countries had their currencies pegged, yet didn't have clear rules on what they were going to do if there was a capital outflow. A currency board gives clear rules. When people want dollars back, the central bank gives dollars and takes local currency out of circulation. If the pegs had been operated like a currency board, they would have been more resilient.

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    Third, the U.S. dollar changed value drastically early in 1997. United States' real interest rates went through the roof. We raised nominal interest rates at a time when inflation was falling. The debt that had been accumulated in Asia in 1996 became unsustainably high.

    Fourth, the local banking regulators were not doing their job. In Thailand they allowed people to take out a 100 percent leverage. The IMF, rather than targeting bank regulation, targeted the currency peg. Why didn't they spend the equivalent amount of time arguing both privately and publicly for the countries to change their bank regulation? That would have helped the situation rather than harming.

    Fifth, Japan has been in a ten-year recession because of bad policy choices. Its economy was in a bad state during Asia's devaluation crisis.

    Chairman LEACH. Thank you. That is a fine list.

    Mr. Folkerts-Landau.

    Mr. FOLKERTS-LANDAU. Thank you, Mr. Chairman. I would say there are two principal causes. I would identify a weak domestic financial system as perhaps being the single cause that should be most of the blame for the problems.

    We entered a period of very high rapid international capital flows into emerging market countries. Yield-seeking domestic portfolio market participants invested in these countries and essentially the domestic financial systems, banking systems, were not capable of intermediating these flows. There was not enough bank supervisory expertise. There was simply not enough expertise in allocating the capital and pricing the risk. And in some countries there was a very significant level of corruption in the use of these—use of these funds.
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    So the inability to intermediate the capital, the global capital inflows into these countries, and to mediate those properly into the domestic corporate system, industrial system, is very much at the heart of it, because once that is the case, then the ability of these countries to defend an exchange rate, even if the macro-policies overall are consistent, it is just not there anymore.

    You cannot raise local interest rates if your exchange rate is under attack, if you have a weak domestic financial system. It just doesn't work. We saw this in the 1992 year-end crisis and we saw it in Thailand, Korea, and all of these places. Most of us on this table knew that that condition pre-existed, so the moment there was a problem in Thailand, pressure on the exchange rate, several of us on this table here went out to advise international investors to get out, simply because we knew they wouldn't be able to hold it because they couldn't raise domestic interest rates. It was a very simple conclusion that all of us grew from what we knew about these countries.

    The second is, and here I very much would echo—I won't repeat what Dr. Krueger said—that inconsistent domestic macro-policies, you can't have a fixed exchange rate and run a discretionary monetary policy. It just doesn't work.

    But the larger sort of background that one has to understand before one points fingers and starts blaming countries too much is we did enter a new global era, one of capital account liberalization, one of massive global flows in the 1990's, starting in 1991. I don't think certainly in my contacts with officials of Southeast Asia and Latin America, there just wasn't a level of awareness as to what these flows could do if they were reversed; if they were reversed, how quickly they could reverse; because if they had been, there would have been more stringent policy put in place. The world changed and there was a growing awareness that came with it, but it didn't grow fast enough. By the time the crisis happened, there was just not enough preparedness to deal with it.
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    Finally, I think it is very important to understand that there is a basic policy problem that we need to deal with and that is, there always will be flows from the G–10 countries, from the mature capital markets into emerging market countries, because there are always portfolio holders that will seek high levels of return, because they have to have guaranteed nominal returns on their own policyholders—insurance companies, for instance—so they will go after higher yield around the world and these markets are sufficiently small. The countries are small. It doesn't take very much money to cause a disturbance.

    So if you are a small country, take Poland, for instance, which is having a situation like that right now, you experience a capital inflow because your domestic policy measures are in order, you do a good job, you have a tough central bank president and good consistent policies, capital flows in, you get a domestic overheating, what do you do? You raise short-term local rates to slow down the economy. The problem is that just attracts a lot more short-term capital into the banking system. And so this is what you do.

    Well, you can't intervene and sterilize, because that has a domestic monetary impact. So basically it is that reason that has pointed increasingly to the use of capital controls and inflows and I would say that is a very sensible conclusion, because there is that basic problem of a small country dealing with massive international capital inflows.

    Thank you.

    Chairman LEACH. Thank you.
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    Mr. Roach.

    Mr. ROACH. Thank you, Mr. Chairman. You have heard the answer. It is just a question of which one of the four preceding speakers said it. I am not certain myself, but I think somewhere in those responses was the answer.

    Let me try a slightly different tack, and that is that while I agree with what many of my distinguished panelists have just said, I think that as we put ourselves back into time in the 1990's, especially the early part of the decade, the East Asian growth miracle was the miracle that we all wanted to believe in. This was the acid test that the brave new paradigm of globalization was working. What better example could there be to have these Asian Tigers, with their entrepreneurial skills, their endowment of technology, their work ethic, join the family of newly industrialized nations and to do it with virtually a seamless transition?

    In retrospect, we asked them to run before they could walk. Courtesy of capital account liberalization, one of the basic precepts of the IMF, and courtesy of massive liquidity flows, courtesy of our own spectacular liquidity cycle in the developed world. Capital was there for the offering and it seemed free and easy. The whole Asian miracle seemed to work.

    I agree with David Folkerts-Landau in his comment that what was lacking were the financial institutions that had the integrity in the developing world to receive that capital and to intermediate it effectively into productive uses.

    There was corruption. There were certainly inappropriate foreign exchange and fiscal policies that were begging for correction. But again, the miracle itself was so easy that we all wanted to believe in it and make it work. So we let our guard down. And in this liquidity-driven world, with yield-hungry investors awash with inflows, diversifying from large developed markets and to tiny emerging markets, the tendency and proclivity for asset bubbles to come and go becomes almost systemic. But we got away with it, and then one day we didn't. We all ran for the exit doors at the same time.
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    The rest is history. But I think the lesson here is that economic development is a long and arduous process. There are no shortcuts. The East Asian miracle in retrospect was a classic example of trying to take a shortcut. Thank you.

    Chairman LEACH. Thank you.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman.

    Mr. Roach, when you speak somewhat of the folly of those, speaking of the Asian miracle, I am thinking of a representative from your firm. I think it was Barton Biggs returning saying, ''maximum possible bullish''; and ''Oh, well, it may have turned out in retrospect to have been a little bit too enthusiastic.''

    Mr. Malpass, I am just trying to refresh my recollection. I remember working with you when you were in the Treasury. I think it was the Reagan rather than the Bush Administration. What years were you there?

    Mr. MALPASS. I was at Treasury from 1986 through 1989 and then at State after. We probably worked together on the debt facility and the transition from the Baker plan to the Brady plan.

    Mr. LAFALCE. I remember it very, very well, the 1986 bill where the President vetoed the omnibus trade bill for four reasons. Three of them were my provisions, one dealing with the international monetary facility that I argued should, in a sense, act as a referee in bankruptcy; the other dealing with the creation of a Council on Economic Competitiveness, something similar to what the President created when Bob Rubin came in, International Economic Council; and the third, where I had some differences with David Mulford. I thought we had an overvalued dollar, most of which had been taken care of by that time. We certainly did circa 1985 when we had about 260 yen to the dollar and we wanted some currency stability. We were able to iron it out by 1988 and include provisions which ultimately were modified, but it did become law. But I remember working with you during the Mexican difficulties that we had at that time.
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    And Karen Shaw Petrou, it is so good to be with you again. I remember going back decades, but I was scratching my memory. I can't recall if you have ever testified before the committee before. Maybe you have many times, but I just can't recall. Have you?

    Ms. SHAW PETROU. I have a few times, particularly during FDICIA, but not in recent years.

    Mr. LAFALCE. OK. Let me commend you. You just spontaneously, extemporaneously did a magnificent job. Congratulations. A number of you earlier this morning, a number of others, have pinpointed many potential causes. It is complex in nature and it is multiple in nature and the approaches we need to take, there are probably elements of truth in everything that every witness has said.

    The question is, was there more truth and what priorities should you pursue? It would be difficult to argue that we do need a sound financial foundation and economic foundation. We certainly need currency stability, and you could—once you get beyond that, you are going to have difficulties. And certainly we need best possible capital standards, clearly what they should be, and we have had problems with excessive capital flows and how do we best deal with that without being counterproductive.

    Bankruptcy has been an enormous problem. It is difficult for me to say which one is the most important problem. I am going to ask you that, but right up there must be the fact that if you don't have some adequate bankruptcy laws and you are a creditor, there is a problem. Your first initial tendency is to just pull out everything as quickly as you possibly can.
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    Underlining all of this, too, is the corruption that exists in a good many countries which makes it almost impossible to deal with the country; corruption in its broadest sense, not just financial, but going to the very construct of law itself.

    If you were able to whisper into the ears of the President of the United States and the new Secretary of the Treasury, and you were able to direct the actions of this Congress too, where would you have us put our priorities?

    And, number two, what mechanisms would you establish, either within the United States or internationally, that could produce some clear vision of where we should be going, what changes we should be working on with enough transparency? I am talking about transparency of process and goals right now so that we can have accountability.

    I think that is important. And I might be the only one that thinks that is important, but otherwise I think all of this talk is going to get lost. You don't really know what the G–7 is doing, or the G–10 is doing, or the IMF is doing, it is just a great big muddle.

    So I seek your assistance and comments on the questions and points that I have raised. And we will start with anyone who wants to start. Anybody?

    Mr. Roach.

    Mr. ROACH. We will go reverse. Reverse.
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    Mr. LAFALCE. OK.

    Mr. ROACH. In terms of taking from the laundry list.

    Mr. LAFALCE. You are a member of the Commission on the Future International Financial Architecture under the setup of the auspices of the Council on Foreign Relations. Maybe you have been grappling with some of the questions I just posed.

    Mr. ROACH. I would hope so; and we are. And we will be putting out a report shortly that identifies what a large collection of us feel is appropriate from the standpoint of architectural reform. Of the laundry list that all of us have tossed out here, if I had to pick just one thing in response to your question for prioritization, it would be the seemingly boring and mundane topic of standards and transparency. I think it is the opaque nature by which financial——

    Mr. LAFALCE. Standards for what and transparency?

    Mr. ROACH. Standards for borrowers and lenders to negotiate the exchange of financial capital for some stipulated short-term or long-term financial arrangement. These transactions, as they have taken place in the 1990's, have been opaque. They have been in many cases based on hope, promise, return, and confidence in a miracle that in retrospect was not as miraculous as we thought.

    The lack of transparency seems OK as long as the returns were attractive and awarded you as a lender a premium relative to less risky alternatives. In retrospect, that was terribly wrong. And so my sense is that we need to establish a level playing field in understanding most importantly, and in a very clear fashion, what the financial condition is of a borrower, of a country, its reserve position, and its exposure to international debt.
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    We need to know a lot more about macro-risk in the country that we were committing capital to. In terms of the mechanism that would take us there, I am increasingly of the view that we need to take this out of the realm of bilateral or official organizations, such as the IMF, the World Bank.

    It may well be appropriate to create a new round of multilateral negotiations, akin to a round of trade negotiations, where we put these issues on the table to be negotiated in a global market, once and for all, to set the rules and parameters for globalization in the 21st Century. These are not matters that can be managed through our traditional and existing organizations, and if we face up to the imperative globalization, why not sit down through a long and arduous process and try to pound out some rules that we can all understand and be governed by?

    Mr. LAFALCE. Thank you.

    Mr. FOLKERT-LANDAU. Thank you, Mr. LaFalce.

    The one item that I think is in a class by itself of all of the various reform proposals and efforts underway is the reform of the International Monetary Fund. You have entrusted it with a significant increase in its quotas, and it is now capable or very capable of supplying liquidity to countries that are in temporary need, because of the liquidity crisis.

    The next step has to be to get the institution to strengthen its surveillance over member countries to be able to identify, and it can do that, to identify problems, inconsistent policies that might lead to international spillovers and to contagions and to other kinds of crises.
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    This technically can easily be done, but it is not very difficult. You will not identify each and every crisis, but you certainly can identify policy strains, policy inconsistencies and fragilities in the system. And the Fund indeed has been able to do some of them. I identified a number of countries earlier where we were able to do that. That is the first step.

    The second step is once that is done, by itself it doesn't help you very much. You then need to give the institution the tools to be able to induce countries to implement remedial policies. Without that, the first step doesn't help you very much. To identify a problem but not be able to do anything about it doesn't help you very much.

    You can compare this to if you had a central bank that could identify a bad bank, they wouldn't be able to close it or wouldn't be able to issue a cease-and-desist ruling or anything like that. It would just end up spending its own money. That is sort of the position the IMF is in now.

    It has got the money, it is close to be being able to identifying problems, but it can't do much about this. It cannot go sufficiently public with the information that it has, it cannot impose sanctions, such as withholding aid; and in the extreme, such as excluding countries from the ability to borrow from the Fund, it simply has no measures to enforce. And during my years as head of capital market surveillances it was very, very clear.

    I remember being in Korea in May 1997 and sitting across from a set of Deputy Assistant Secretaries and telling them that what they thought was wrong with the financial system—at the end of a two-hour fairly heated session, it was a very respective thing: ''Thank you very much for your views, and now let us go and have a drink.'' That was the end of it. There was nothing else. I could not go and hold a press conference and make public our findings. And as a result, they were largely wasted.
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    So that is the second step that needs to be gone done. And here again, it is not a major change in the international financial system, because I believe it is the basic system, the basic feature, the basic characters of this house works reasonably well, it just needs to be strengthened here and there.

    And the two elements that I indicated I think would be ones that would go a long way. Those are the ones I think are just head and shoulders above everything else. Anything else to do with changing of eurobonds, there are various bailing in procedures; well, if you can get them, fine; I doubt you can. I believe that every single one of those, there are plenty of people around who are just dying to get around these—through financial engineering—and they will. So I don't think that is going to go very far. But anyway, that is my answer.

    Mr. MALPASS. Mr. LaFalce, thank you for your recollection of the 1980's. I want to commend you for the goodwill and interest you showed throughout for people both in the U.S. and abroad.

    There is one thing that I think Congress has to do, and that is enter into this exchange rate dialogue. The world left the gold standard in 1971. We are now on an experiment, that is all it is. We have been at it for 25 years. It might work, it might not. Economists argue drastically over whether it is working. I think it is not working.

    I have documented for you that the developing countries with floating rates are getting poorer and poorer. The system can't work. When a corporate treasurer is presented a project by his managers that want to make an investment in another country, the first question is: ''What is going to happen to the exchange rate?'' And if the answer is, ''Well, it floats, we don't know. It might go up, it might go down.'' Then the project doesn't get done. If it does, it has to have a much higher hurdle rate in order to go forward.
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    The level of capital investment going on in poor countries is simply not high enough to get the growth rates up. The system is accepting slow growth rates. We are seeing 3 percent growth from poor people and saying ''That is good enough, that is all we expect of you, that is a rebound.'' The people at the bottom should be catching up. There is no reason in a globalized economy why we have the differences that we do, except we have relegated a whole group of people to having bad money.

    They try to make a living, they try to save some money. Yet they are always running with this huge handicap of having to do it with money that doesn't work. You asked for priorities. To me, the priority is for everybody to have an opinion on this. Does it make sense that money should change value? A lot of people say it does, that it should change value for trade purposes. My own view is that it is simply a store of value that people can use, so it shouldn't change value.

    What could be done? Try sound money in some countries. Every time a country puts in a currency board, its per capita income shoots through the roof. Who has the highest per capita in Latin America? Argentina. When did that happen? Immediately in the years following their installation of a currency board. They went from one of the lowest income per capita, to one of the highest of the major countries in Latin America.

    In Southeast Asia, which country or which entity was least affected by the devaluations? Hong Kong, which had a currency board. And so their per capita incomes remain very high, while Indonesia's are now down at $300 to $400 per capita.

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    We have ample evidence on the record that techniques for stabilizing currencies raise people's living standards. Let a few countries try it. Get Treasury to have a pilot program of countries that would try stable money and see how fast their living standards can rise and compare it to the test group.

    Chairman LEACH. If you would withhold, Mr. Malpass.

    Mr. MALPASS. I am done.

    Chairman LEACH. We have a vote on the floor.

    I want to ask Mr. LaFalce if he wants to continue.

    Mr. LAFALCE. I am going to have to go and not return. I wonder if I could hear maybe a one-minute response from Dr. Krueger and Ms. Shaw Petrou.

    Chairman LEACH. Let us try to make it less than one minute.

    Mr. BACHUS. Mr. Chairman, we will have additional questioning when we get back?

    Chairman LEACH. Yes. We will continue after these questions, but why don't you go ahead, Mr. Bachus, and we definitely will not adjourn.

    Dr. KRUEGER. I will try and very brief. From the viewpoint of the developing countries and from the world economy, the most important thing over any period of time, short-term, long-term, is obviously healthy growth of our own economy and of the international economy. And what that means more than anything else, believe it or not, and this is not a long way out, is keeping free trade going and all of that.
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    Now, the longer term, nothing we can do quickly, but something we can work on, as I tried to stress, is I think we can work on getting a better understanding of how to strengthen the banking structures in the middle-income countries. And I think that is something that is going to take five years or so.

    I don't think there is any consensus. And, obviously, it is an intensely domestic political issue. It is not something that could be imposed from outside, so it will be a process of discussion. So I think funds in the bank will be critical in that.

    Chairman LEACH. Thank you.

    Ms. Shaw Petrou.

    Ms. SHAW PETROU. Risk, I think, is essential. I would like to build on the comments of everyone here to improve the transparency of the market, because the markets will get this right if they have the information to get it right, and they pay the price if they get it wrong; that is my capital concern as a bank supervisory issue. And I think it also gets to the question of the bondholders and their stake in the international credit flows.

    But if the markets work better, market participants would make better decisions and that would go a very long way toward stabilizing the situation.

    Chairman LEACH. Well, thank you very much. The hearing will be in recess pending the vote.
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    Chairman LEACH. The hearing will resume. And, Mr. Bachus, would you take the chair briefly?

    Mr. BACHUS [Presiding.] I appreciate your indulgence and, Mr. Roach and Mr. Malpass—am I pronouncing that right? One question I have, Mr. Malpass, you mentioned that in many of the emerging countries that per capita income is actually going down, and Mr. Roach mentioned that one of the things that concerns him about the global economy is that countries are looking inward, and protectionism and things of that nature, you know, and their trade policies.

    I have a concern that I think both of those items touch on the same thing; and that is our multinational corporations, American corporations that are doing business in many of these emerging countries. And I would ask you, what do you see with the increase in poverty in some of these countries with, as you are saying, the inward focus of some countries, trade protectionism, a lot of sentiment for protectionism? Do you see any anti-Americanism or anti-American sentiment? Do you see this as a threat to these corporations? Is it real or is it imagined?

    You know, I recently was at the Chinese embassy—we heard reports of some of the Chinese students talking about boycotting American products, but just express your feelings on that.

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    Mr. ROACH. I will, just be brief. I don't have any hard empirical evidence other than the impressions of someone who travels the world a lot. And I have been to Asia five different times in the last fourteen months, most recently four weeks ago. And I am not saying I pick up a representative sampling of opinion, but I certainly hear and feel an undercurrent of anti-American, anti-IMF, anti-G–7 backlash.

    Quite frankly, I was very surprised as someone who has been very optimistic about the resilience of the Chinese economy in the depths of this crisis, to see the intensity of the emotions spill over in China. Clearly some very difficult tensions surfaced last week.

    The case for multinational corporations, be they U.S., European or the like, providing employment opportunities and the opportunity to raise the standard of living in these Asian and Latin American countries is a good one. It is a solid one. But there clearly is resentment that transcends that benefit, largely brought about through the Depression-style output contractions that recently have been evident in the crisis economies of East Asia. Correctly or not, those output contributions are perceived out there as largely being the instruments of U.S., IMF-sponsored policies, and they don't like it.

    So I think you are onto a very important issue. It is a public relations issue. I am not saying that there is substance to those beliefs, but I think you are accurately picking up a worrisome shift in sentiment.

    Mr. BACHUS. All right.

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    Mr. Malpass, and I will ask that to all panel members, if you have some words.

    Mr. MALPASS. I agree. The perception abroad is that we control the IMF, and IMF destroys countries. There is a strong sense that what is happening is turning people's lives upside down. In many developing countries, people who were going to go to high school aren't going to go; people who were going to be able to, in their lifetime, afford a used car so they didn't have to walk, have no shot at affording a used car.

    In Russia, we have a country that was freed from communism which now is anticapitalist. The good feelings we have for our Nation and for our goodwill, doesn't project or get transferred. If you are living in a developing country and the IMF comes in and proposes a stiff value-added tax, a tax on consumption, when you can barely survive, the system doesn't make any sense to you.

    Mr. BACHUS. All right.

    Dr. Krueger.

    Dr. KRUEGER. Thank you. It is a good question. I think the China situation is a little different from the others. I think the Chinese bargained very hard on WTO and gave much more than most of the well-informed China watchers that I know expected them to. And, in fact, they look and say they can't believe that the Chinese actually gave that. There was already reaction from that.

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    China has some very significant internal economic problems. And then when the bombing in Yugoslavia came up, that triggered things for a whole variety of things. And I would put that one separate from the other, the rest of your question, which I think is an excellent question.

    I would distinguish the short run and the long run in terms of answering it. There is no doubt those countries and the countries in East and Southeast Asia have had major difficulties, there is no doubt many people have been hurt, and there is no doubt that there has to be some change. And in the short run, of course, that is blamed on everything, and whenever something goes wrong, it is easier to blame people outside. There were some policies that had to be changed in that sense.

    And in the longer run, I think I would have a slightly different emphasis than my colleague to my right, in that living standards have risen dramatically. Korea is a different country now than it was 30 or 35 years ago. The longer term trend has been toward more open markets and more integration with the national economy. This is certainly a relatively nasty accident along the way, but I don't think anybody that I know, at least among the Korean policymakers and economists and people and students that I talk to at universities, challenge the underlying progress that has been made.

    Of course, everybody would like to have life smoother, and it would have been nice if it could have been smoothed out. No doubt about it. But I don't sense that that is the fundamental problem. Now everywhere in Korea a year ago, you saw signs where the only words you could read were IMF, and everything else was in Korean.

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    And then one that you asked, that is an IMF sale, and prices were coming down on economy. And so the short term, yes. And the longer term, at least there, I think don't so. And I think Indonesia has more political problems. That is the one where these people are really being pushed back from the middle class down into subsistence level very badly.

    And I think there, the political outcome and what they then do will be important in determining the longer outcome. I think as of now in the middle-income countries which are successful, even though living standards have clearly fallen in the past two or three years, they are clearly 3, 4 and 5 times what they were 30 years ago. People know that. Nobody wants to go back there. And they know that the old state-controlled system didn't work, and they are opening up.

    Mr. BACHUS. All right.

    Ms. Shaw Petrou.

    Ms. SHAW PETROU. I think I tend to agree with Mr. Malpass and Mr. Roach. I think it is an interesting irony, as last year, that when Congress is asked to approve funds for the IMF there are a variety of things that Members all over the Hill want to do and the Congress is told, ''No, no, no, you can't do that.'' They are multilateral agencies, but, of course, all around the world everybody thinks they are wholly-owned subsidiaries.

    We as a country will get most of the blame for policies well or badly misunderstood. We are seen to direct them and I think that is having an impact on the view of U.S. economic policy and the role U.S. institutions, private and public, play all around the world.
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    Mr. BACHUS. All right. And I would ask you this. Have any of you traveled overseas since the Balkan war and has that aggravated sentiments? I mean, it has in China. But other than in China?

    Mr. ROACH. I was in Asia four weeks ago, but before the infortunate bombing of the Chinese Embassy. And in my conversations with Asian officials, including high-level Chinese officials before the bombing, which I think is a cleaner read, there clearly was an undercurrent of concern as to the political willingness of Asia to stay a course that was perceived to be directed from institutions such as this or elsewhere in this part of the world. Again, I am not saying that perception is correct, but that is a perception that I have picked up.

    Mr. BACHUS. All right. I would say and, Mr. Malpass, let me direct this question to you, tomorrow we are going to have hearings, the subcommittee, on exchange rates and the effect of those rates and of different systems on sound monetary policy. What recommendations do you have for exchange rates, policies for emerging countries?

    And you did mention the peg. And you spoke—you somewhat admired the peg, and I know in Hong Kong that was one example where currency traders were not able to drive the currency down and really add to the misery, because they defended the peg.

    Mr. MALPASS. The issue is whether you can grow if your currency changes value. My view is that you can't. The recommendation is that people have a view on currency stability. You just heard Secretary Rubin and Mr. Greenspan defending the idea of the exchange rate keeping its value, in their own words. Yet as we project abroad, we don't do that.
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    At the front of every IMF program should be the idea that the IMF has goodwill toward the people in the country, wants to see their living standard go up, and thinks that a starting point is that the country's money is real money, is meaningful money, and will have a long-term value.

    You will hear tomorrow a divergence of views from people, as exists on this panel. You have to really get at the issue of whether a country can grow if you don't know what its money is going to be worth. And once you allow its money to move around, what anchor does the government of that country have to control itself?

    We have over and over again the theory of a floating exchange rate that will stay stable. But invariably the country finds a reason that it needs to print a lot of money for an election or for whatever. Once you have gone down the route of thinking that it is OK to vary the value of money, you really don't have any anchor on the rest of the government's policies. It makes sense both for the poor people in the country and for their relationship with the government, to start from the goal of stable money.

    Mr. BACHUS. Thank you. Anyone else wish to comment on that?

    Dr. KRUEGER. I certainly concur that price stability is desirable. And certainly the poor people lose when there is not price stability. I think the really important question is how do you achieve the monetary and fiscal policies that will—or one important question is, how do you achieve the monetary and fiscal policies that will enable the country to have price stability;, because we all know that you cannot go increasing the money supply for very long without having some kind of a domestic inflation, even if you have got an open trade account and the rest of the world isn't willing to finance your deficit forever if all you are doing is building fancy monuments and things.
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    So that part I think is clear. I think the evidence, interestingly enough, it is coming out statistically now that we have the fifteen years. There are a couple of preliminary papers, I don't think anybody would claim they are conclusive, but the preliminary evidence across the developing countries is that those unflexible rates were slightly more responsible in their monetary and fiscal policy, meaning closer to consistent and maintaining constant price level, in countries under fixed rates.

    And the argument seems to be, and the reason seems to be, because in those countries, the people who are making the decisions know that if they increase the money supply, for example, before an inflation, the exchange rate will move right away, and so it will be obvious to everyone. Whereas with a fixed exchange rate, you can postpone the catch-up rate for a year or two, so in the short run, you can be more irresponsible. So there is a lot of argument about this.

    Mr. BACHUS. All right.

    Mr. ROACH. I would just add one thing, Congressman, and, that is, I know based on the witness list that I have seen for tomorrow, you will hear one very strong advocate for currency target zones within the G–3: The view there is that currency volatility, especially the yen versus the dollar, has been the root cause of a lot of the instability that has wreaked havoc on Asia. I think the jury is out on whether or not that is correct.

    But I would just weigh in strongly against currency and target zones as an unnecessary and dangerous regulatory intrusion. I do not think that any policymakers really, with all due respect, have the wisdom to determine what is an appropriate target that should be aimed for. And as Secretary Rubin has said repeatedly on public occasions, this is a recipe for procyclical monetary adjustment policy that could force a central bank to raise interest rates to defend a currency when an economy is in a recession.
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    Yet there are very strong advocates of this. And I would just weigh in on the other side of that, because I know you will hear that tomorrow.

    Mr. BACHUS. OK.

    Mr. Malpass.

    Mr. MALPASS. On that same topic, I agree with Mr. Roach. We probably have disagreements on other things. I am in favor of stable exchange rates, but not having three governments deciding together that they are going to have stable exchange rates and what those rates are going to be. It seems to be that it would be useful for the Europeans, the U.S., and the Japanese all to say, ''We want our money to hold its value over a long period of time.'' Then see what happens; let the markets operate, but have each of the players unilaterally make a decision of where they want to go.

    Mr. BACHUS. All right. You may have heard Chairman Greenspan. He had this standard. He said he would like to see these emerging countries, or countries which qualified for IMF funding, to have sufficient foreign exchange reserves to make their payments for one year. How many of these emerging countries can meet those standards?

    Dr. KRUEGER. As of right now?

    Mr. BACHUS. Right.

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    Dr. KRUEGER. Right now?

    Mr. BACHUS. Yes.

    Dr. KRUEGER. Right now, China probably could. Taiwan probably could. Hong Kong. Argentina, if you count their contingent reserves. Those would probably be close. Those are all I know of that are anywhere near. One year is a lot.

    Mr. MALPASS. It could be the U.S. would have trouble meeting the standard.

    Mr. BACHUS. I see. I am not sure how you would implement that as a policy.

    Dr. KRUEGER. Oh well, we, the United States, could not implement it as a policy, but the International Monetary Fund could, for example—I am not sure this is desirable, but the International Monetary Fund could say, for example, in the event a country goes into crisis, we will not do anything. If countries, before they went into it, did not have a year of reserves, you could also have commercial banks put in clauses in their lending contracts requiring, just as banks do, monitoring various conditions of companies.

    There are ways to do that. I am not sure that makes it desirable. I do think that the experience does suggest that some mechanism for holding larger buffers of reserves—or larger buffers of resources that are liquid is desirable.

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    Mr. BACHUS. I see. You know, presently, basically none of them would qualify, but that might—it certainly would cut down on our involvement in some of these bailouts.

    Dr. KRUEGER. They might also hold higher reserves were they to discover their incentives were changed.

    Mr. BACHUS. That would be a positive step. Finally, I will ask this question in conclusion. Our trade figures were out this morning, the record-high trade deficit. I guess it is a record.

    Mr. MALPASS. In nominal terms.

    Mr. BACHUS. What?

    Dr. KRUEGER. In nominal terms.

    Mr. BACHUS. Yes. We have got an ever-larger capital account deficit, and I think it was described this morning as an ever-larger trade deficit. What implications does that have for us?

    Mr. MALPASS. We have a capital account surplus, in that the capital comes in to fund the trade deficit. Secretary Rubin gave a very good answer. He said it is not an exchange rate issue. Maybe Mr. Greenspan gave the other answer, that our economy is growing faster than those outside the U.S. That creates a trade deficit, meaning we are importing more than we are able to export, because we are growing faster.
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    Also, our investment climate is more attractive than that of other countries. For one, we have good money, and so people want to build factories here because they know they will be able to get their money out. Many foreign countries don't have that, so you don't want to invest there. The best thing that could be done for the trade deficit is get some growth abroad and investment climates improved abroad. Let foreign countries earn enough money so that they can buy things from us.

    They just don't have enough money to buy the things that we produce. That goes back to the exchange rate issue. As far as the trade deficit itself and its U.S. aspect, I think it is a natural part of our economy, given the state of growth here and the high quality investment climate.

    Mr. BACHUS. All right.

    Dr. KRUEGER. The only thing I would add to that, I agree with most of it, the only thing I would add, of course, is that we have a very low savings rate. And I think that is a cause for some concern and especially over the longer run; and the assets, or the capital that we are importing from abroad, one form or another, is the counterpart or the investment here that we are not financing with our own savings. And in some sense, it is our own macro-economic balance that is doing it.

    The worry behind that is American consumers may be spending out of what they think is going to go on forever in the stock market and so forth; therein lies some source of fragility. So there may be some concern there, but I think as a macro-economic concern and not a trade policy concern. And saying it the other way around: If we didn't have that inflow of capital, we couldn't finance as much investment and we wouldn't have the very healthy growth that we are having.
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    Mr. BACHUS. One thing in connection with this, and I have sort of a reason to lead into this, but the fact that the trade deficit is a function of the rest of the world not economically making the progress that we are making, and that that is a long-term concern and also a concern for us, is we do trade with them? And also from a humanitarian standpoint, that there are many countries that are going in the opposite direction; their per capita income and their standard of living is going down as opposed to up.

    With this in mind, I and several other Members of Congress, are sponsoring a debt relief bill for our poorest countries. To qualify, they have to be among the poorest of the poor. Most of those countries are in Africa, although there are a few in Latin America and South America.

    Do you think that this is an appropriate step for the United States to take? And we are involved with our allies in this. Do you have any comment on that? Now that money, as opposed to being forgiven, it is not a blanket forgiveness, that money must be redirected by those governments into educational or medical or humanitarian services for the people.

    Mr. MALPASS. I think it is an appropriate effort. I was involved in some debt relief for the poorest countries in the 1980's in the Reagan and Bush Administrations, and I think those efforts have been gradually expanding. It is an appropriate role for Congress to tradeoff the costs and the benefits. It may be a better form of foreign aid to do debt relief than to do something else. It may be more practical legislatively, and so I think it makes sense.
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    Mr. BACHUS. Thank you.

    Dr. KRUEGER. I am very sympathetic with what you said here. I happen to think it is very good foreign policy. I think we get into big troubles, because we are blamed for things going on. And on the other hand, those very poor countries are poor, in part, because their own economic policies have been so inappropriate. And if I have put on my pure economist hat, I say why forgive the debt when we know that debt is built up because they have been importing Mercedeses or whatever? Why not, instead, finance the bridges or the agricultural extension that will bring income streams to poor people?

    The trouble with that is that gets us so involved in internal policy, it might not be worth it. But I do think that one may ask, why not have a bigger program where we make sure that—I think something you said, in the bill you are going to ensure that how much does that get us involved in looking at the budgets of other countries, and where does that leave us in terms of the internal political stuff? So I think it is a very difficult issue.

    I commend you for wanting to help. I think this is certainly an approach that has a lot of cleanness to it, which is why I like it. I wish we could do more for the very poor countries.

    Mr. BACHUS. Many of those countries are unable to pay back anyway in that way, if we can get them to redirect some of those funds. Second, it constitutes a great percentage of their gross national product, just servicing that debt, which is the hardship that is going to be hard for them to recover from. So we do feel that it will not only raise the standard of living, but that, in turn, will allow us, through our corporations, to export to them and even help American taxpayers here.
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    I have no further questions. With that, we want to thank you for your presence at the hearing, and at this time, the Banking Committee of the U.S. Congress standards in recess. Thank you.

    [Whereupon, at 4:26 p.m., the hearing was adjourned.]