tv Today in Washington CSPAN October 26, 2011 2:00am-6:00am EDT
as members of this committee have noted, the united states has deep trade investment and financial links with europe and stability in europe is crucial for our exports and for american jobs. it's clear that the europeans have resources and capacity to deal with challenges they face. european leaders made progress over the weekend toward designing comprehensive frame work for tackling this crisis and leaders will meet tomorrow. this agreement will need to be implemented quickly and firmly. stepping back for a moment, the macro economic and financial challenges faced by several european countries since the 2008 financial crisis have exposed serious crisis within
the union. recent experiences reveal the need for stronger mechanisms for fiscal discipline and more markets that allow countries to achieve growth potential and for adequate crisis response tool kit to respond to economic and financial stress. in response to these challenges, europe has taken wide ranging action both to strengthen national policies and to reinforce the overall frame work for the euro area. at the country level over the last 18 months, much of the region has embarked on accelerated fiscal consolidation, growth orientated structural reform and banking sector repair. this is an extremely challenging agenda and completion will require efforts over sustained period of time. in parallel, european leaders have pledged to do whatever it takes to ensure the future of the euro.
they have provided financing together with the imf to greece, ireland and portugal as these countries undertake very difficult reforms. moreover, leaders have expanded financial capacity of the main european financial crisis and the financial stability network and broadened the ways in which these resources can be deployed. meanwhile, the european central bank has played a crucial role providing liquidity to banks and buying sovereign bonds in the secondary market and to prevent future crisis, the europeans have agreed to governance reforms that include a broader array of surveillance tools and enforcement devices to improve fiscal discipline and they also agreed on a permanent crisis resolution mechanism. europeans have been working hard to design credible and effective approaches to mobilize the
increased resources and greater flexibility of the efsf with the aim of reaching agreement at the leader summit tomorrow and delivering a comprehensive plan to address their crisis by the summit in early november. this plan will need to have four parts. first, europe needs a powerful firewall to guard against contagion concerns to ensure that governments outside of the periphery can borrow at sustainable interest rates while they bring down debt and strengthen growth. second, european authorities will need to ensure that their banks have sufficient liquidity and stronger capital to maintain the full confidence of depositors and creditors and if needed, access to a capital backstop. third, europe will need to craft a sustainable path forward in greece as it implements its difficult fiscal and structural
reforms. finally, european leaders must tackle the difficult governments challenges to address the root causes of the crisis and ensure that every member state pursues economic and financial policies that support growth. let me emphasize that the successful resolution of the current european crisis matters deeply to us here in the united states because our country has no bigger more important economic relationship than we have with europe. while the direct exposure of the u.s. financial system to the most vulnerable countries in europe is limited, we have substantial trade and investment tries with europe and european stability matters greatly for american exporters and for american jobs. already the crisis has slowed growth significantly in europe and around the world as increased uncertainty and red e reduced risk appetite, undermine
business and consumer confidence and reduced household wealth. there are downside risk to the outlook for the u.s. economy and job creation. it is vitally important to the united states that europe is able to address its issues effectively and in a timely fashion. for this reason the administration has closely engaged with european leaders to encourage them to move forward in an effective way. at the same time, our supervisors have for some time been working closely with the u.s. financial institutions to identify risks and to improve their ability to withstand a variety of contagion events emanating from europe. in managing global risks, one key challenge is to ensure sufficient financing in crisis situations. the european countries themselves are appropriately contributing the bulk of financing to countries in the
euro zone periphery. in addition, the imf is an important role of financing and expertise in the effort to contain the crisis with long experience and independent judgment they set strong economic conditions for loans which return countries sustainability by promoting greater stability and safeguarding against deterioration of economic conditions, the imf supports the global economy and with that u.s. growth, jobs and exports. in addition to involvement in europe, the imf continued to offer financial support more broadly to countries around the world at a range of income levels. in closing, we appreciate the leadership and support of this committee on the key challenges and we look forward to working with congress as we engage with our international partners. thank you. >> dealing with greece specifically right now is a very small percentage of the eu which
everybody recognizes and it sounds apparent that some form of a write-off will take place in terms of the debt that they currently owe which has to take place resolution of that before you can move onto italy and spain and you stated in your testimony you believe the eu leaders are finally ready to come to an agreement but what if that doesn't occur in the next few days? what downside is there to that not taking place? >> there's clearly deep commitment with european leaders to reaching a strong agreement over the next few days. there is a deep understanding that failure could have very damaging consequences within the euro area although greece itself is relatively small share of the
european economy. there's already been a considerable contagion affecting other countries in the euro area for events and greece and european leaders have realized the serious dangers if they do not act sufficiently quickly. the longer action is delayed, the more the dangers increase. that is why we do think that they are going to take actions in a comprehensive way over the next few days to put in place frame work for protecting the rest of the euro area from potential contagion from events in greece strengthening the capacity of euro zone sovereign to continue to access markets at reasonable rates and making sure the european banking system is
adequately capitalized and adequately funded while at the same time -- >> on that capitalization the concern is that our downturn and banks held real estate. their's held sovereign debt. the ones who invested in greece know they will take some form of a loss. are they moving rapidly to make sure there's adequate capitalization for their banks so they don't pull their head in like a turtle and say we won't get further involved based on current debt we hold. >> european banks have taken significant action to strengthen their balance sheets both writing down the value of greek debt and also raising additional capital earlier this year despite this we do think they need to take substantial additional action to strengthen their balance sheets and in particular to further boost their capital.
the concern that markets have is now not just with exposure to greece but also exposure to other sovereigns that are under pressure and for this reason, we understand that agreement is likely as part of this comprehensive package on an approach to ensure adequate bank capitalization and to provide a path to raise european bank capital to at least 9% capital relative to risk weighted assets which is a strong capital base. >> what role has administration played in negotiations so far and what, if any, commitments have they made on the part of the american taxpayers to this issue. >> the administration is closely engaged with europeans at all levels. >> can i ask the witness move the microphone closer to your
mouth. i'm having a hard time hearing you. be proud of who you are and belt it out. >> the administration has been closely engaged with european officials at all levels. the president himself has regular contacts with his counterparts in europe to raise the deep concerns that we have in the united states. in the treasury we have continuing conversations. secretary geithner has visited europe many times in international meetings like the recent g-20 meeting. the situation in europe dominates the conversation. under the secretary, i myself and our whole european team is in constant conversation by phone and visiting europe. we feel that we can play a constructive role by sharing our
own experience in the united states that we gained in dealing with our own financial crisis. there are lessons that europeans can learn. i think europeans themselves are interested in perspectives and our views and they welcome our close participation. participation does not involve any commitments of u.s. taxpayer money. i believe the imf can play a very important role in supplementing european financial resources and through the imf, the united states can be very supportive. the united states has a substantial financial commitment to the imf but involvement in
imf does not put a material risk on u.s. taxpayers. u.s. taxpayers never loss any money from its financial commitments to the imf. the imf has preferred creditor status which means the imf is always paid first before any creditor and imf is a strong track record of being repaid by countries that do run into continuing difficulties. we also believe that strong commitment of the european leaders and strong commitment to european finances demonstrates the very strong likelihood that europeans will achieve success and that is ultimately countries in europe will meet their financial commitments so we're not concerned about exposure of
u.s. taxpayers. >> they are moving at a cautious pace which i understand. i hope the pace picks up rapidly. ranking members recognized for five minutes. >> thank you. thank you for your testimony. i want to go into two questions. the european financial stability fund, that's going to be replaced in the year 2013 by a permanent lending facility, european stability mechanism. do you anticipate frame work will complement dodd/frank reforms that we have here and going back to issues that you talked about with imf, if imf creates additional crisis assistance mechanisms how would that impact lending capeabilities for the future? >> the esm will basically be a
device for providing financing solve rinse that run into difficulties. it will have a different structure from current esf but will have same activities that esf does. it's not directly related to the implementation of the financial regulatory reforms in europe similar to the dodd/frank reforms in the united states. nevertheless, europeans are taking actions to implement regulatory reforms that largely parallel the reforms that we are implementing in the united states and we in u.s. treasury are closely engaged with european counterparts to make sure that as we move ahead in
financial regulatory area that we are maintaining a level playing field and ensuring that we are achieving high standard regulatory regimes in europe and the united states. in terms of imf resources, the imf has committed substantial resources to the euro zone periphery countries to greece, ireland and portugal. nevertheless, those commitments are still relatively small share of the imf's total available financial resources. they remain a very substantial arsenal of financial resources to the imf, which it could use if needed to extend financing to european countries or countries around the world.
we think imf does play a constructive role in europe but it equally important that that role continue to be in the context of a strong and comprehensive commitment by the europeans to dealing with the problems. europeans themselves have the financial resources to deal with this crisis. the imf plays a supplementary role and can substitute for european financial resources. >> following up on that, when the emerging markets are able to adequately fill potential gaps, the emerging markets, will they be able to support just say if the eu is having a tough time? can they fill that spot? >> certainly the emerging markets are playing an
increasingly important role in generating moment yum for the global economy, i think around 80% of global growth over the last year or so has been in fact contributed from emerging market economies like china, israel and brazil opposed to advance economies like u.s., europe and japan. we think the emerging markets could play a stronger role going ahead by shifting the balance of their economies relying less on exports to other countries and boosting the strength of domestic demand in their own economies and we same time as we've been working with europeans to resolve the european crisis we've also been working hard at the g-20 to
encourage the emerging economies to take steps to ensure that their own growth momentum is sustained by boosting their own domestic momentum and by adopting exchange regimes which are consistent and i would encourage the shift in the pattern of global demand growth. >> thank you. my time is expired. >> vice chairman, recognized for five minutes. >> secretary collins thank you for being here. i would like to discuss if i could just your thoughts on international monetary funds role in resolving the european crisis and could you tell me and tell us the panel how the imf is assisting european countries and how imf's participation benefits the united states and if you could the degree with which the imf participation exposes the american taxpayers to potential losses? >> the imf is playing a crucial
role in europe through a variety of channels. the most obvious one is the financial channel. the imf contributed around a third of the financial resources that have been provided. >> can you give me a rough estimate of what a third is? >> a third is around maybe $150 billion. around a third of the total commitments by the european economies. the imf is playing a crucial role in the design of the adjustment programs and play as crucial role as an independent partner with european countries to make sure that the adjustment programs are strong and well designed and able to address the fundamental issues so we are in
the treasury strong proponents of imf playing this role. as i mentioned before, the imf can play and has played a critical part in sustaining global financial stability through this crisis management role without exposing u.s. taxpayers to risk of material losses. they have a strong record of getting repaired by countries given the preferred creditor status. we believe that imf can continue to play this strong role but as i said it needs to be in con junction with the european commitment to right policies and european commitment of adequate financing. >> secretary collins, from the u.s. economic perspective, what do you think are the most sensitive issues in resolving the euro zone's economic problems from our perspective? >> from our perspective, the key
issue is really containing the contagion effects as investors are concerned about possible implications of what's happening in relatively small countries in the periphery, what are larger risks for countries in europe with slow rates of growth and relatively high rates of public debt. these are countries that are much more significant in terms of their trading relations and financial relations with the united states. if there were to be further deteriorati deterioration that would be a dangerous impact on u.s. financial markets and global financial markets. the key instrument that is
needed is to create imposing firewalls that break the connection between difficult situations like greece with the stronger countries that are closer to the euro zone core. we know europeans are working hard. we've heard about various devices that they are looking for to leverage the resources that they have set aside to build this firewall so that's a very important task in the days ahead to provide a mechanism that will work effectively that will be a america nichl that markets can work to continue to provide adequate fiscal resources that will be adequate financing to meet fiscal needs. >> there are those that believe the reason why focus is not on the united states is because of the problems in europe right now and that we're going to be next. do you believe that the united
states has a similar spending problem as europe does and how would you compare europe's problems to our problems? what are similarities and what are main differences? >> the united states clearly has a serious fiscal issue over the medium term. >> medium term being defined as what? >> the administration has committed to a very substantial reduction in the fiscal deficit over the next few years under the president's plan. fiscal deficit will be reduced over the next three years and it will be put on a path that will lower public debt to gdp ratio consistent with our commitments to the g-20 at the toronto
summit. at the same time, however, the united states does not face the short-term fiscal pressures that are faced by some countries in europe. we believe there's an important role for providing additional fiscal support to the u.s. economy over the next year or so to maintain momentum of the present recovery that is not as strong as we would like. the progress on raising employment and reducing unemployment rate has not been as strong as we would like and we think it would make sense to provide some additional fiscal support to slow the pace of fiscal consolidation. in europe there are other countries outside of the
periphery that also have maintained the confidence of markets and where the imperative fiscal consolidation is not as urgent. no country like germany for example the debt to gdp ratio is high and it does have room within constraints of its own debt break, it has room to stabilize work to support the german economy to play an important part in sustaining momentum of growth in europe. fiscal issues are certainly important in the u.s. in medium term but if we are able to put in place a convincing and credible approach to dealing with these issues, that would also provide us with room to
taking steps to support our economy in the short-term and supporting american jobs. >> thank you, mr. chairman. my time is expired. >> thank you, mr. chairman. mr. collins, in the wake of the 2009 financial crisis, the u.s. passed comprehensive financial regulatory reform designed to promote transparency, monitor systemic risk in the financial system and ensure that financial institutions can withstand shocks to the system. how have these reforms improved the ability of u.s. regulatory authorities and financial institutions to mitigate the impact on the u.s. financial market of economic turmoil in europe. >> i think the financial reforms have played an important part in strengthening the resilience of the u.s. financial system and helping to contain potential
risk coming from europe in a number of different ways. one is that the united states banks are much more strongly capitalized today than they were before the 2008 financial crisis. >> you need to move the microphone closer. we're having trouble hearing you here. >> the largest u.s. banks now have average tier 1 core capital ratio of over 10% substantially higher than it was back in 2008. there has also been a major reduction in reliance on market funding on wholesale funding to fund u.s. bank lending and substantial improvement in liquidity situation of american banks.
all of this is consistent with the stronger capital liquidity and funding requirements put in place by dodd/frank. in addition to this, dodd/frank has put in place important mechanisms to make sure that u.s. regulators work closely with u.s. banks to anticipate potential risk events in particularly the financial stability oversight committee has met frequently to assess potential risks and supervisors have benefited from the insight of this work to work closely with financial institutions within the united states to strengthen financial institutions capacity to deal with potential risk events coming out of europe. >> what is the role for the g-20
in coordinating policy responses? >> the g-20 has played an important part and continues to play an important part and one area where its role is crucial is in the financial regulatory area. the dodd/frank legislation has put in place a very strong and very high standard set of regulatory requirements in the united states but it's important that leading financial centers around the world also adopt high standard regulatory frame work consistent with what we are doing in the u.s. and the g-20 has played an important part in making sure that this is achieved. the g-20 has also provided a forum in which challenges to global stability such as those coming out of europe are
discussed, and where key countries, emerging market countries, can also express their concerns. so for example, in g-20 meetings, the situation in europe is discussed extensively and the concerns that are expressed, it's not just the united states that is expressing concerns, but also the large emerging market countries are also expressing their deep concerns and i think helping the europeans understand the critical importance of addressing their issues in a fundamental and decisive way. >> thank you. thank you, mr. chairman. i yield back. >> mr. mcconnell, you're recognized for five minutes. >> thank you very much. just a quick question. how is what is happening in the eurozone and the policy prescriptions that are being put forward differ from what the united states did during the t.a.r.p. situation back in 2008?
>> in some respects there are similarities but there are also important institutional differences, of course, between the u.s. and europe. important similarities is that this is a crisis of confidence and a crisis that has led to huge increase in uncertainty with potentially very negative impact, if not contained. both here in the u.s. and in europe, what is needed, therefore, is an overwhelming, powerful response to reduce concerns, to reduce the uncertainty, to reassure investors that the situation is
being contained. in europe, it's been more difficult to put this decisive response in place, because of institutional constraints. there are 17 members of the eurozone and they all need to reach agreement on steps to establish and develop these crisis resolution mechanisms. that has taken time. politics is always complicated but we're talking about the politics in a multiplicity of countries. there's also a difference in the role of the european central bank, the ecb, from the role of the fed. during the arc financial crisis, the u.s. treasury and fed were able to work together closely and very quickly to develop effective tools to reassure markets that funding would continue to be available.
the ecb's legal constraints have meant that there could not be such close relationship between the ecb and european treasuries and for this reason, the mechanisms that are being created now to reassure markets that funding will be available need to be more complicated and have taken more time to design. >> in discussing those differences, one of the reasons that europe seems to be having difficulty with this is because unlike the united states, where we have a union of 50 sovereign states governed by a federal government, the individual nations of the eu seem to be having trouble, i think very understandably so, with the concept of their taxpayers bailing out the investors for problems that were caused by other nation' fiscal -- lack of
fiscal discipline. in the united states that was clearly a much lower hurdle to get over for the federal government to do, rather than trying to corral 50 different state legislatures to agree to do that. but doesn't the central principle of what they're trying to do in the eu equate with what was done in the t.a.r.p., in short, whether it is by individual nations of the eu or done in the united states by the federal government, the way they're trying to solve this crisis of confidence is to essentially tell investors to the greatest of their ability that you will not lose money under any circumstance, and that the taxpayers will cover it if you run into this. is that not the case? >> that is certainly the case, and that's particularly relevant for the creation of this firewall that we have discussed, but i think the problems in europe go well beyond the construction of the firewall.
there also needs to be a fundamental economic reform in a number of countries in europe, greece being the most prominent examp example. a commitment to massive fiscal consolidation, and to deep-rooted reforms that restore dynamism to the greek economy. ultimately, the european crisis cannot be resolved until countries around europe are able to convince markets they are going to be able to achieve the fiscal adjustments and the economic reforms that restore sustainability. >> just if i may, mr. chairman, just a quick point. one of the problems that greece experienced, much like it once did during the time of the athenean city state, was when people realized they could avail themselves of the public treasury for their own benefit,
and the absence of fiscal discipline that you see out of a country like greece, where they have an exploding public sector and an anemic private sector are not necessarily constrained to europe. thank you. >> i like starting with athenian democracy, working through roman republic. great way to start this. i like that. mr. lynch, you're recognized for five minutes. >> thank you, mr. chairman and the ranking member. again, this is a very important hearing. mr. secretary, one of the next panel witnesses, desmond lockman from the american enterprise institute has raised some interesting questions and he points out that now the imf is acknowledging that greece's economic and budget performance has been very much worse than originally anticipated. he points out that there's been a 12% contraction in greece's
real gdp over the last 24 months, their unemployment has increased to over 15%, and that the situation there makes it a substantial write-down of greek sovereign debt in the amount of about $500 billion highly probable within the next few months. so in many analysts' minds, it's not a question of whether greece will default, but when. that would be the largest such default in history. the imf is proposing european banks accept a 50 to 60 cents on the dollar write-down on their greek sovereign debt holdings and that would have a material impact on european banks' capital reserve positions. so what i am worried about is whether these european banks --
have these european banks or will these european banks be required to mark to market their greek debt before the recapitalization plan goes forward? because that obviously represents a delta or a difference between what they're saying their capitalization will be versus what we determine it to be after stress tests and after properly marking down this greek debt, and do we have any sense of the real strength, the real health of these european banks? >> european banks have already been significantly marking down -- >> the imf now is saying, given today's situation, they're looking for a 50 to 60 cents on the dollar write-down of greek debt. >> markets have already been
pricing in a very substantial discount on -- >> but the banks aren't marking the market. they're assets. that's the problem. the markets are discounting them but the banks, the banks are not showing that markdown on their balance sheets. so if you are going to stuff those banks full of money to save them, there would be a lot more money involved than what the banks are saying. that's the problem i have. >> right. banks have, in fact, been making progress in marking down their exposure to greece on their balance sheets. they -- >> not nearly, though. 15%, not 50%. >> over time, they are moving in the recapitalization effort exercise that is now under way, this exercise will take into account sovereign risk in assessing banks' need for capital. and that assessment of sovereign risk will be based on market valuations rather than book
value valuations of bank capital. so this exercise should be much more effective in boosting bank capital than previous exercises that the europeans have undertaken over the past -- >> don't you think your analysis is unrealistically rosy? from what we're seeing? i mean, just look at the data. look at what's happening. look at the contraction in the economies. look at the slowdown even in some of the core countries like germany and france. i'm not -- i'm not -- look, i'm not trying to take you to task for anything. i think you're doing a great job. i just think that we're not being realistic with what's coming down the road, and that is inhibiting our ability to prepare for that. that's all i'm saying. i'm not trying to be the bearer of bad news. i just know what the numbers tell me. and you try to prepare for that instead of constructing this,
you know, from what we've seen so far and the response from the european union and god bless them, you know, it's difficult because they are not unitary, like we are. they don't have a single fed and a single treasury totally committed to one program. it's been rather fragmented. but all i'm saying is that we can't build our expectations or our course of action based on very rosy scenarios that you're playing out here, you know. someone's got to sound the alarm and i think your folks at treasury are probably the people to do that. and if you don't, then you're letting us walk this, you know, we're walking right into this and we're not taking, i think, reasonable precautions under the circumstances. >> we are certainly expressing our grave concerns based on our
perceptions of the downside risks. we don't just look at baseline scenarios that may be optimistic but rather, we try to think what could go wrong and how do we take steps to make sure that the downside risks are not realized. both by encouraging the europeans to take more forceful action to deal with their problems, and by making sure that we have adequate defenses here in the u.s. and in particular, the u.s. financial system is adequately protected from potential risk events. that's the crucial part of what the fsoc has been doing. >> have we done an assessment on what our exposure is? >> i'm sorry. >> thank you for your tolerance. >> you and i have the same concern. i wish germany would use more of a panzer approach to getting this done but they are very cautious on that kind of concept. their moving rapidly wouldn't hurt the mark. mr. huizenga? >> thank you, mr. chairman.
i appreciate the opportunity to come. apologies, i had a bill up in front of the -- another committee and had to testify on that, so i'm trying to catch up based on some notes and some things that were handed to me. i just thought if you could address a little bit about u.s. exposure, whether there's direct exposure or exposure through other organizations that were involved in imf, for example, and what that may mean to the taxpayer. >> right. u.s. direct exposure to the weakest countries in the periphery to greece, portugal and ireland, is really quite minimal. financial institutions have been aware of the risk and have been lowering their exposure and the residual risk is very small. the concern is that there is deep interconnectedness more broadly between the american financial system and the
european financial system. the exposure to financial institutions in the european core are very large indeed. and these are institutions that themselves are exposed to risk in the european periphery. so any increase in volatility and market uncertainty about the financial institutions in the european core very quickly translate into increased uncertainty in u.s. financial markets. we have seen that playing out over the past couple of months. and this is an area where u.s. financial supervisors have been working very closely together with u.s. financial institutions to try to identify these risks and contain the risks. an important topic for -- important focus for the fsoc as they consider -- >> it seems to me that exposure
and risk might be two different things. i understand the mitigation of the risk, but do we have exposure and through the imf or through some other organizations, if and when, because i think i agree with my colleagues here as well, i'm very concerned about what may be happening and how does that translate, and then, you know, adding into that some of the requirements that may be coming under basel 3 and those types of things. how does that play into their ability to recover? >> the u.s. government has minimal direct exposure. we do not lend significant sums to countries like greece. we are supportive of the imf playing a significant role in helping europe to deal with this crisis. the imf has provided about a third of the financing for countries like greece, ireland and portugal, and the united states makes a financial contribution to the imf.
however, this financial contribution does not put the u.s. taxpayer at material risk. the imf has preferred creditor status which means it gets repaid first. in the past, the record of repayment to the imf has been excellent. the u.s. taxpayer has never lost a cent through its exposure to the imf. so the imf really plays an ideal vehicle for us to make sure that the european programs are well designed based on the imf's role, drawing on its long experience and expertise in dealing with financial crises. while at the same time providing a certain amount of financing. >> we've got just over a minute and i'm wondering if you could touch on basel and what that may mean as they're trying to recover. >> basel 3 is very important to
improve the capital adequacy standards in banks in u.s. and in europe, in reducing reliance on -- excessive reliance on market funding and improving liquidity. as banks have moved towards strengthening their positions in these respects, their exposure to potential risk is correspondingly reduced. so we think that basel 3 is already playing an important factor. the rules themselves do not yet come fully into effect, but financial institutions are anticipating in advance the requirements that they will face. >> in my closing seconds here, you just used a phrase excessive reliance on market funding. so you are expecting that there needs to be government funding as opposed to the market? >> no. by market funding i mean wholesale funding rather than
deposit funding. banks need to have stable funding base, based on consumer deposits, retail deposits and other resources that can be relied upon to be stable, rather than using wholesale funding from the market to an excessive degree that could expose a bank to risk in a volatile financial environment. i'm certainly not talking about official funding for banks, either united states or in europe. >> i thank you. my time has expired. thank you, mr. chairman. >> the chair notes that some members may have additional questions for the witness, which they may wish to submit in writing. without objection, the hearing record will remain open for 30 days for members to submit the written questions and for responses to the record. we have many more questions, i know you have a lot of answers. we just don't have the time.
>> i would like to welcome our witnesses. mr. peter rashish is vice president for europe and eurasia/u.s. chamber of commerce. mr. rashish leads a team focused on advancing the broad and deep economic and commercial relationships that exist between the united states and the european union and developing new opportunities in the continents' emerging markets. dr. desmond lockman is a resident fellow at the american enterprise institute focusing on the global macro economy, global currency issues and a multi lateral development -- multi lateral lending agencies. previously he served as deputy director to the imf policy development and review department. in this role he was active in staff formulation of the imf policies. he has written extensively on the global economic crisis, the u.s. dollar and the strains in the european area. mr. douglas elliott is a fellow at the brookings institute and focuses on issues surrounding public policy and financial institutions. he was an investment banker for
two decades, principally with jpmorgan and was president and principal researcher for the center on federal financial institutions. i would like to welcome you all today. mr. rashish, you are recognized for five minutes. >> thank you, chairman miller, ranking mcmccarthy. >> you might want to move that microphone close to you so we can actually hear this panel. is it on? >> how's that? >> really good. we're on our way. >> thank you, chairman miller, ranking member mccarthy and distinguished members of the subcommittee on international monetary policy and trade. my name is peter rashish. i am vice president for europe and eurasia at the u.s. chamber of commerce. the trans-atlantic commercial relationship is by far the largest in the world. with the united states and the european union surpassing $4.3 trillion in trade, investment and sales by foreign affiliates of companies in one of those markets. u.s. companies have over $1 trillion invested in the eu. in ireland alone the stock of
usfdi totaled $165 billion at the end of 2009, which is more than the u.s. has invested in china, india, russia and brazil combined. eu investment in the u.s. is accords 3.6 million jobs in 2008. its investment in california alone supported 287,000 jobs while its investment in new york supported 255,000 jobs. these figures make it plain that the fate of the u.s. economy is intimately entwined with the fate of the european union and the eurozone. because of the deep level of integration between our two economies, we will sink or swim together. the collapse of the eurozone would not only mean the end of the common currency and the he finishesly it brought to the european economy but also likely lead to the disintegration of a crowning achievement, the single market enacted in 1992. while the single market and its freedoms of movement of people, goods, services and capital, not only would europe's economy suffer, but u.s. companies would no longer be able to benefit from operating across a barrier
free internal eu market just as european firms do. while europe's political commitment to finding a solution to the crisis is strong, it is struggling to identify the right policy tools to contain financial con taj on, shore up the banking system and rein in fiscal deficits while boosting economic growth. no budgetary austerity or financial rescue programs will provide a long-term solution to europe's economic woes. where can europe find the economic growth it needs which would ensure that u.s. companies continue to reap the enormous commercial benefit from its trade and investment with european union. one avenue is for the eu and its member states to pursue structural reforms of their economies that would liberate growth. another path is for europe to invigorate its push to complete its internal market. while most barriers to trade across the eu have fallen, an important number remain, particularly in the services sector. the creation of the single market has led to a surge in inter-eu investment and this has been a key source of the eu's economic growth.
the elimination of the remaining barriers in a single market would have major benefits for its economy but also for ours. there is however one area that until now, has been neglected as a source of increased economic growth in the eu and for that matter, in the u.s., and that is the trade relationship between these two commercial partners. if the two trans-atlantic economic powers want to inject more dynamism to their economies, there is one quick step they could consider. eliminate all tariffs in trans-atlantic trade. while the tariffs are low between the u.s. and eu, because of the enormous size of the economic relationship, even small steps can yield very large gains in prosperity. according to a report by a brus sells-based think tank, such a trans-atlantic zero tariff initiative would increase combined u.s. eu gdp by $180 billion over five years. that's more added growth and we would receive from the completion of the dohar round of
multilateral trade talks. while the round is facing serious obstacles to its completion, a trans-atlantic zero deal could be agreed quickly as the kinds of issues that have in the past held up bilateral trade pacts shouldn't be a factor between the u.s. and eu. the u.s. and eu should be ambitious and not stop at eliminating tariffs. they should aim to open up services markets to each other, create a single investment area and pursue compatible regulatory regimes. such an initiative does not have to be a traditional free trade agreement based on what is called a single undertaking which could take years to complete if progress in one area is dependent on how far negotiators have gotten in another area. to avoid the declarations that characterized the relationship in the past, the two sides should commit themselves in a legally binding way to the achievement of a barrier free trans-atlantic market. on november 28th, the united states and european union will hold a summit meeting in washington in which president obama will welcome eu council president and european economic president. an announcement at the summit of
a bold trans-atlantic initiative for jobs and growth including the elimination of tariffs on trade would inject a sorely needed sense of confidence into the u.s. and eu economies and would produce significant gains to both sides. such an agreement would not free the eu and eurozone of finding lasting solutions but would create prospects of growth without without the crisis would likely endure. we look forward to working with members of the subcommittee to reach full benefits. thank you very much. >> your written statements will be made part of the record. i should have announced that beforehand but i didn't. dr. lockman, you are recognized for five minutes. >> thank you very much, mr. chairman, for inviting me and thank you, mr. mccarthy. what i propose to do is divide my remarks into four groupings. the first i want to talk about the intensification of the crisis in europe. the second i want to touch on the implications for the united
states. third, i want to discuss what the europeans are doing to address this crisis and why i think the efforts might fall short, and the last i just want to touch on the united states' role, what the appropriate role for the united states is in this crisis. turning first to the intensification of the crisis, there is little doubt in my mind that we have seen substantial and very disturbing intensification of this crisis that is likely to create real problems for the united states economy in 2012. among the indications of an intensification of the crisis are first, that greece looks like it's on the cusp of defaulting. this would be the largest default, sovereign default, in history. it would involve something like $450 billion.
i think that one really has to dismiss the notion that greece is a small economy. the fact that it's a small economy doesn't mean that it's highly indebted. a lot of that debt is sitting on the banks of the core countries in europe which could really have serious concerns. we have already seen contagion to portugal and ireland. if we include portugal, ireland and greece, we are talking about $1 trillion of debt, a lot of that with the banks. what is of real concern in terms of the intensification is that this crisis has now spread to italy and spain. the europeans are trying to create the narrative that italy and spain are innocent bystanders of the crisis, where in fact, they've got deep problems. italy, you can look at, it's got serious budget problems. spain is very exposed externally. we are seeing strains in the
european banking system that are of concern. if they get a big hit now, this is really going to cause a real credit crunch and the imf is estimating that the shortage of capital of the european banks is about 200 billion euros whereas market estimates are about 300 billion euros. finally, in terms of intensification, what we are seeing is france and germany moving into a downturn. if we get intensification of the crisis, that is going to cause germany and france to move into meaningful recession, which will really complicate the issues for the eurozone. being brief on the implications for the united states, my two fellow panelists have touched well on the trade channels and the investment channels. i would emphasize the exposure that we've got to the banking side, through our banks. while the administration is indicating that we don't have too much in the way of direct exposure to the periphery, the
exposure of our financial system to the european banking system which does have enormous exposure to the periphery is huge, and therefore, i would say that our financial system has got very big exposure. what i'm referring to is our money market funds have got something like $1 trillion lent to the european banks. the u.s. banks have got about $1 trillion of exposure to germany and france. and we've written -- our banks have written a lot of cds and other derivative products which really expose us enormously if things go wrong. in terms of what is to be done, the agenda in europe is to try to deal with the greek situation in a definitive way, to try to ensure that banks are properly capitalized and to erect a firewall around italy and spain. i have my doubts as to how effective they are going to be this time around. the whole of this crisis has been characterized by too
little, too late response and i think that this is going to be another indication of that. there are indications that the banks are resisting the 50 to 60 cent write-down that the europeans are proposing on them. it's not clear whether the europeans are going to come up with $2 trillion that awould erect a firewall around italy and spain and money is not going to be nonconditional money that will give them a big bazooka and i have misgivings about the way in which the bank restructuring is being done in france and germany and the core countries in the sense that this is all too likely to provoke a credit crunch as banks are given time to raise capital on their own, what they're going to do is opt for deleveraging rather than raising the capital that will dilute their share holdings. finally, in terms of the u.s.
role, the u.s. has been providing support both through the federal reserve as well as through the imf. it's not clear to me that the united states should be doing a whole lot more. the problems in europe are ones of solvency rather than liquidity. throwing more money at this, i'm not sure that that provides a solution. we would certainly be putting taxpayers' money at risk which i'm not sure that that is a good idea. the europeans did not help us in bailing out our banks in 2008-2009. i'm not sure that i understand the logic why the united states should now help them. finally, i would say that relying on the imf is not the most indicated course. they haven't covered themselves with glory in the way in which they've dealt with this crisis, and i take issue with the fact that using the imf to lend more
to these countries doesn't expose the u.s. taxpayer to risk. i would just note that in these countries, the imf has never lent as much money to a country as greece. the lend to portugal and ireland has been huge to date. i wouldn't take much comfort in the track record that in the past, the imf has always been repaid. when you've got exposure of this size, you really are taking risks with u.s. taxpayers' money. thank you. >> thank you. mr. elliott, five minutes. >> thank you, chairman miller, ranking member mccarthy, members of the subcommittee. the euro crisis is deeply concerning, in part because the path that follows is likely to be the main determinant of whether we go back into recession. if europe were to be shaken by a series of nations defaulting on their government debt, i am convinced that the continent would plunge into a severe recession. their recession would trigger
recession here because of a number of links across the atlantic. i think everyone before me has done a great job of talking about those links, so i'm going to just touch them very briefly, then move on to other parts of this. trade. we export about $400 billion to europe. we have about $1 trillion of direct investment of things we own in europe. the financial flows, we have about $5 trillion of lending and other commitments to europe as a whole. a good chunk of that's the uk. but the uk is also very closely tied to the eurozone. then as we talked about, there's the effects on business and consumer confidence, partly that come through the financial markets. we saw in august how badly we could be hit once people get scared about europe. let me be clear. i believe europe will probably muddle through, ugly as the process has been and will
continue to be, and frightening as it's been. however, the problem is there's perhaps a one in four chance that something really bad will happen. that would lead to a series of national defaults that run from greece, portugal, ireland, spain and take italy as well. there's also a small chance of an even worse outcome in which one or more countries leave the euro. my one in four probability estimate is very rough. there are many different ways that things could go wrong because we have 17 different countries, each with their own political, social and economic systems. so there are a lot of ways things could go wrong. each of them has a low probability but there are just so many of them that they add up to give me certainly very serious concern. now, i think the actions that are going to be announced this week in europe are generally positive.
but i agree with desmond that it's once more a case of saying they're going to do a lot more than they actually are. i have serious concerns about what's been proposed so far. the three steps they're taking are interlinked and because they have political constraints that are really very binding, they're not doing enough on any of them. for instance, they're going to try to lever up the efsf so they have something closer to $1 trillion or $2 trillion -- of euros to deal with the potential problems. however, because they're not willing to commit the base amount of money that they put in, they're not willing to increase that, it makes it hard for them to do anything terribly effective with the efsf. they're talking about providing insurance so that if you own say a new italian bond, you know at least 20% of it will be paid.
given that greece is about to have a 50% hit, that's not going to bring substantial new investors in. i think it's an ineffective way of doing it that's being forced by not being willing to increase the 440 billion euros of base commitment, of real money. this also means they don't have a lot to do for the banks. so they're trying to shoot for about 100 billion euro recapitalization. the imf thinks the losses on the sovereigns on market terms is 200 or 300 billion euros. there's $1 trillion of capital already there so 100 billion is only a 10% increase, and there's a staggering $27 trillion of assets in the european banking system. so you're talking about the 100 billion euros as less than half a percent of the total amount of assets. the assets are generally pretty safe, but there's just a lot of them, if they go wrong.
so all these things tie together and they're not i think going to be doing enough to deal with them. so whatever happens this week, i think we need to be prepared in case the crisis worsens. we should continue to encourage the europeans to do what they need to do and i think they need to do a lot more. we should continue to provide the u.s. dollar swaps through the european central bank that will allow them to provide banks with dollar funding. and our regulatory agencies should continue to monitor very closely our financial exposures, but not do it in a way that causes a panic reaction that makes europe's situation worse. and i do think that we ought to be prepared if needed to have the imf provide substantial further assistance. the eurozone has the joint resources to do what they need to do but it's very helpful to have the imf. it shows the markets there's
more funding available. it brings the ability to place conditions which as a third part of the imf can more easily do and the technical aid they can provide, which is substantial, gets listened to much more readily if they have provided money as part of it. so this is a european problem. they need to provide the backbone of the solutions. but it is strongly in our interest to help in any reasonable way that we can. thank you. i look forward to your questions. >> thank you. in my previous statement, i wasn't trying to underestimate the impact of greece. my comment was associated with the fact that there are approximately maybe 2% of the eu, yet if it's not handled properly, it can be a significant impact, and that the eu has to somehow move rapidly to capitalize, whether joint financing, resources, however they do it, to make sure there's liquidity in the banks, so the
banks, if that's not done beforehand, and they take the hit on greece, they might be very reluctant based on their own interests to not get further involved, especially in light of the situation that might occur with italy and spain. that is my concern. if they do not move rapidly and greece hits first, there might not be motivation on the part of the banks to move rapidly to help others, if they know they're going to take a further hit on that. i guess my question would be to all of you, what would happen to the u.s. recovery if european countries simultaneously implement austerity programs and what can we do to protect the u.s. economy and u.s. exports if that occurs? we'll start from mr. rashish and work right across. >> thank you, mr. chairman. i think that one thing we can make sure to do is keep our markets open to trade and investment. its saernl not the time, if there ever is a time, to close them while our major trading
partner is going through the challenges we see right now. we want to encourage companies from europe and around the world to invest in the united states. we want to pursue export-oriented policy of our own, but i think what's attractive about trade policy in this context is it's something that we can do together, in fact, we need to do together with the european union, the european commission negotiates trade policy for all the 27 member states, including all the 17 eurozone member states, and if you look at our trade policy agenda, i think that we've now -- the good news, we've passed free trade agreements, we have the trans-pacific partnership which is still on the table, but i think that there should be some room for us to think about some additional trade policy initiatives and i
think that one the european union recommends it. i would say why not look at the policy tools we have at our immediate disposal which don't have any implication for the taxpayer, don't have any implication for budgets, but which instead would liberate growth in the united states and europe. that's why we put forward this idea of a zero tariffs initiative. thank you. >> i think your question really goes to the heart of the problem in europe and that is that the imf is imposing massive amount of austerity on countries in a fixed exchange rate system. when you do that amount of austerity and i'm thinking about countries like greece, portugal, ireland, spain, what you have to expect is you've got to expect deep recessions in those countries. we have seen that already in greece. we've seen it in ireland. we are going to see it in portugal and we will see it in spain.
that has a material impact on both those countries' growth prospects but it also has a material impact on the european banking system and through that, we get recessions in france and germany. i think the implications for the united states should be that there's a sense of realism in making our policy decisions, that we shouldn't be making our policy decisions on the basis of rosy global scenario that is going to help the united states get out of its difficulties. i think that rather, in my mind, this would have bearings on how quickly one does the withdrawal of stimulus from the united states economy, that would be one aspect that one would have to look at, but the other aspect is when one does one's budget projections, one should be basing this not on the rosy scenarios that the cbo is doing, but rather, on what is likely to happen in terms of growth over
the next year or two, because of the european crisis. what that would argue for is very much more serious effort at medium term budget consolidation, because what this is going to do is it's going to cause our budget ready to blow out. >> what my concern is, it hasn't been talked about much, is we looked at what happened to u.s. banks in 2008, when they lost trust, they lost faith, they quit lending to each other. similar situation could occur in the eu, if greece takes a huge hit first before they capitalize them properly. i guess i will let you try to respond, mr. elliott. you're the one that's left and i'm out of time. >> actually, it works out because i'm principally and financial sector expert so you have asked me something that i do focus a lot on. first of all, i would echo something desmond said. i'm quite worried that the banks may be pushed to restore their capital ratios by shrinking. >> yes.
>> at a time when we don't want them to be shrinking. so your concern about austerity measures and private sector initiatives that all move in the same direction of slowing the economy down is a very valid one. >> they're not moving rapidly to solve the problem. that's my concern. >> no. they really are not. i would like to see a significantly larger fund available to infuse capital because this would give them an incentive to keep doing the business. and the ability to do it. in terms of the u.s., it's difficult to be 100% sure, but i do think our financial system is a lot stronger than it was a couple years ago. i do think we're much better prepared to handle the shocks that will come out of this but certainly, we ought to do everything we can to keep ourselves with a stable financial system. >> thank you very much. ranking member is recognized for five minutes. >> thank you. mr. elliott, just going back on
something that you had said a little bit earlier. with the factors that are going on with the eurozone agreement, that measures a country's credit -- what it's worth. if not, should there be something in place so that the 17 countries that are coming together, so that everybody actually knows, like we have the federal system. some people disagree with that, but when you're trying to deal with 17 countries and the solvency of those individual countries, how can they all come together when you basically only have one or two countries that possibly might be able to help them out? >> look, that's a really central question. my belief is that because the governments have not moved fast enough to show the markets that they'll take this seriously, they have blown several chances
now by doing the minimum to get past the immediate crisis. that the market is going to force a great deal of fiscal integration, where they act more like one country. there are multiple ways that could be done. there is so-called euro bonds that would be backed by joint and several guarantee of all the countries. the central bank could simply step up very considerably its purchases of government bonds in the secondary market. you would come to the same effect. or you could make the stabilization fund a lot bigger so that it could provide that. so there are various mechanisms. what i believe will have to happen is that the european leaders will have to come to the edge of the abyss. things will have to get considerably worse than they are now so that they see that they can either lose the next election by doing something their public is reluctant to do, or they can lose the next election by letting europe fall apart. so they might as well at least do the right thing.
>> but when you talk about that, and i'm sure there are many members here in congress who are saying the same thing, but our country also, in my opinion, is in trouble, and yet we don't seem to be really doing a lot. to me i thought when you came to congress, you made the tough votes to do what's best for the country. if that means losing elections, so be it. >> i think the good and the bad thing is i think the u.s. situation has a longer fuse. i think the european fuse is very short right now. >> mr. rashish, with the significant saddling of the euro zone countries and the need to recapitalize the european banking system, how do you think this will impact the u.s. trade relationship with europe in the near future? just one other thing. i asked this question before. do you lts salso see the underdeveloped countries filling
that gap at that particular time? >> thank you, ranking member mccarthy. let me, if i might just quickly, add something to what mr. elliott said. i think one distinction between the united states and the european union is that we are institutionally mature whereas the european union is still building its institutions. it started out with the steel community in the early '50s, the common market, they moved to the single market, then passed the euro. i think one of the distinguishing features is that in europe, you still have a large number of people both on the level of the public and the level of the leadership who are very strongly committed to creating a stronger european cooperation for the good of all. i think that motivates a lot of the decisions that are being made and motivates a number of the leaders, motivates the public, and i think that impetus to create more cooperation at the european level for the good of all is something that shouldn't be underestimated as a driving force, and so i think that if things go well, i think historians may look back at this time as one of those sort of
crucibles where the european union found it had the strength it needed to move to the next level of european cooperation. let me say i think that is one thing that distinguishes the united states from the european union. my colleagues have spoken eloquently about the nature of the banking and financial interrelationships. clearly, if you're going to increase trade, you're going to have to make sure the financial sector is enabling and there is going to be liquidity for our companies to take advantage of that. but i think that we need to be able to do more than one thing at a time. i think that the europeans need to find the solutions to the problems that are outlined here today and at the same time, i think that in terms of what the u.s. can coribute, i th certainly, i'm not sure contribute is the word but in terms of a u.s. role, ihink at at the same time, as the euroans are doing things on thugtrade. financialeulipeans >> anybody else? is. >> yeah. if i may.
and i'm a financial sector expert, more than an economist. so let me just say, dr. lockman is in a minority among the economists i have spoken with, as i think he would admit. that doesn't mean he's wrong. >> he seems like a nice guy. >> no, he is. and a tremendously smart guy. i just wanted to try to provide a little balance in the sense that most economists that i speak with and read think that the transitional costs would be really awful. because there are so many things you have to get exactly right in making that change. it's extremely unlikely to work out quite that way. you also have political constraints. the damage of them coming out of the euro to the rest of the eurozone is quite considerable, partly because of contagion issues. the people then have to start worrying in portugal, et cetera, as to whether they'll find
themselves with scudos again instead of euros, and that can create a lot of flight. in addition to the direct effect of that, it has a political issue, which is right now something like 4% of greece's gdp comes from regional aid from the rest of the eu. if the rest of the eu is really annoyed with greece, because they've just broken out of the euro and caused all these other problems, that regional aid may or may not continue. there's a whole series of reasons to be concerned about the change, in addition to the potential benefits that dr. lockman has mentioned. >> i would also add that it is key, whether it's greece alone. because if it does lead to several countries leaving the euro zone, then what you're going to have is a kind of very hard -- currency area, in fact. dominated by germany and the netherlands and austria and finland who have very strong economies. and the lower exchange rates and interest rates, let alone the
purchasing power that you had in the south of europe, because they had the euro is going to go away. and so the ability of the country like germany to be the expert super power that -- which has really been the main fuel for its growth, is unlikely to continue. and i think that would have very serious impact on the performance of the european economy as a whole. so i think we need to think, you know, about how it would impact all of the different members of the eurozone and what it could do to the competitiveness of the main drivers of growth right now. >> dr. lockman? >> if i may say, i heard these arguments in december 2000, just before argentina broke from the convertibility plan. i heard similar arguments right around about the time of erm in 1992, when that broke up. i wasn't around during the gold standard, but those were the kind of arguments that ran around before countries left gold in the 1930s. so i think that there are political dynamics.
it's not necessarily going to be the most rational choice for the country, but when countries are in as dire straits as greece does when its politics get polarized. when you see the kind of street action that you have in greece, you've got to expect politicians to be suggesting alternatives to the kind of approach that is being offered to them by the imf and eu. we've just seen two years -- gdp has literally imploded, offering that -- you know, if that is the future that you're offering, people are going to want to take chances with different kind of policies. and i think that that's the reason why i see them both defaulting and in time leaving the euro. >> thank you. that was an interesting question, wasn't it? >> very good. i want to thank our witnesses. you've all been very excited about answering the questions, which is very rewarding, from our perspective.
and you're a wealth of knowledge, and i appreciate your talent, your time that you have given us today and the chair notes that some members may have additional questions for this panel, which it may wish to submit in writing. without objection, the hearing record will remain open for 30 days for members to submit questions to these witnesses and to have their responses placed in the record. this hearing is adjourned. thank you. welcome hank paulson
back to the podium. our speaker brings back fond memories of his time as distinguished visiting scholar and fellow of the bernard schwartz forum on constructive capitalism. from january 2009 to june 2010, he was here, and indeed i remember attending a class on china's financial system, and professor butler had the pressure of introducing the famous secretary paulson to his class months after he departied
government. hank paulson is steadfast in business, fill philanthrope by. and family, and it's a pleasure to introduce a banker who believed in the mission of capital markets, to finance the great american market-based economy, and led his firm as president and then ceo of goldman sachs for 12 years in a time when it was held in great esteem around the world. coming out of chicago to new york city, hank paulson was then welcomed to washington, where he was sworn in to the office of secretary of the treasury by president george w. bush in 2006. he stayed for the harrowing challenges of the financial crisis during the months of
peril from stearns, the aim to the government the day after the inauguration of president obama. he turn the treasury over to his comrade in arms, tim geithner, and the grad who worked with him from the new york fed. hank settled into a year of major efforts as he set this. the therapeutic task of writing the first draft of history, the book about the global financial cries called "on the brink." i read the book cover-to-cover in record time. it's a gripping tale, marinate first person, when the government depended on his steadiness and expertise and openness to risk-taking and innovation. it's a hair-raising story, instructive for our students on so many levels. hank has had two major cultural -- two major
intellectual, cultural and emotion interests. they are china, where he is well-known and held in high esteem, and conservation. a lifestyle passion that he shares with his wife, wendy. indeed, those two seas of china and conservation, are linked because hank and wendy's commitment and curiosity for the natural world led them to explore china that most business persons or tourist never seen. hank worked with china's leaders and helped establish china's national parks. today, our guest will concentrate on china in the global economy. he used his knowledge of china to establish a die -- dialogue between the countries countriesd an essential roll on the frame
work on the environment. he is chairman of the paulson institute which he founded earlier this year as an independent business center located at the university of chicago. professing his long and deep commitment, the institution's initial focus is on the united states and china. very much like hank him, it's a place focused on action, new do tanks than think tank. the institute aims to help businesses, governments, and ng os get tangible things down, increase cost investments, which will lead to the creation of jobs. support energy efficiency, develop and deploy the clean energy for sustainable going to, and promote those better environmental processes and, third, promote best business practices on issues of international concern. and as i close i would be remeese with our current
students if i did not note that mr. paulson is well-educated and acquired, like so many of you, taste of public service early in his career. he is a graduate of dartmouth college and earned his mba in harvard. then he came to washington, where he worked first in the pentagon and then in the white house on the domestic council under president richard nixon. i'm sure he did not imagine return as the key member of the cabinet some 35 years later. from washington he win back to chicago, joined goldman sachs, and the rest is history. hank paulson, welcome back. [applause] >> jessica, thanks so mach for this introduction. it's great to be back here. so terrific to be here.
i'm sure you have all noticed that the world economy continues to face some tough challenges. in the united states, banks and capital marks are more stable and better capitalized than they were in 2008. and government regulators have important new authorities that they lacked just three years ago. but we need to restore economic growth and that challenge is made more difficult because of our government has an unsustainable fiscal deficit. what's more, american families have too much debt, and they will be working to reduce that debt for some time. in europe, leaders are wrestling with a difficult fiscal condition of several eu members and complex challenges around the structure of the european union. and they're working to stabilize their banks. there aren't any easy answers here, and the outcome in europe will effect us all.
but this much is clear. three leading economies, not just two, now confront growing vulnerabilities and thus have special responsibilities. china has cemented its place with the united states and europe as one of three principal engines of the global economy. that means that the world increasingly looks to china as well, to help power global growth to reinvigorate global demand to rebalance its own economy, and in doing so, help rebalance global investment flows and ultimately help speed up the global recovery. don't get me wrong. the united states is still the largest and richest economy, with a nominal gdp more than twice the size of china's.
with the most important source of trade and investment, and america is a leading innovator, a builder. we have a particular responsibility, working closely with europe among others, to find a pathway to recovery from the current crisis. but i'll be blunt. we also need china to get ahead of its growing economic challenges, which now threaten to interrupt its truly remarkable record of economic success in recent decades. china's success at sustaining growth, fighting inflation, transitioning from an economic model too dependent on exports and fixed asset investment, is closely connected to our own success. nor can we afford to have all three of the world's principal growth engines facing a crisis simultaneously. problems in any one of these three economies will make it that much harder for the other two.
at every one of today's principal economic challenges can be addressed more effectively if we work with china in complimentary ways. we don't always need to work jointly, but we do need to take steps most individually, sometimes together, that will have the mutually beneficial effect of supporting and sustaining economic growth. so. let me ask this deceptively simple question. can the united states and china address today's dynamic and considerable economic challenges with a policies we have currently? the answer, i believe, is no. so, today i'm going to speak about how to put the american and chinese economies, and by extension the global economy, on a more sustainable footing. the bottom line is this. we're missing opportunities to benefit from one another's
strengths. for our part, we need a level playing field in china for u.s. firms. but we also need more investment from china, which is, after all, sitting on over $3 trillion in foreign exchange reserves, much of it in u.s. dollars, with billions more in the hands of corporations eager to invest here and become global companies. and why wouldn't we want those dollars back? to be invested in productive ways to create american jobs, and boost the american economy. that's why we should be more open to chinese investment. but it's also why chinese investments would be on a sounder footing here if they helped to establish good jobs for american workers. for its part, china wants a fair shot at u.s. markets, too. the chinese want policy change that will allow better access to technology, for one, and for another, a clear, more
predictable process for investing in the united states. both nations can help themselves and each other to succeed for mutual benefit, but to do this i believe we need overhaul the trimwork that guides our economic relations. how? i've worked with chinese leaders for nearly two decade, as a banker, as treasury secretary and conservationist, and reflecting on those experiences, i disstilled them into five essential principles, and by the way, these five principles won't just help put our economies on a sounder footing. they can help assure a more complementary footing as well. principle number one. unlock the promise of capital cost investment. for the united states this means assuring greater openings to chinese investment, lead the creation of american jobs. for china it means undertaking
financial reforms now that beijing might prefer to kick down the road. principle number two. assure financial markets that are transparent and have strong oversight. for the united states, this means clarifying new regulations and implementing sensible regulatory practices, and also means correcting flawed policies that led to massive consumer debt, a housing bubble, and unsustainable household leverage ratios. for china, it means speeding up financial reforms and strengthening oversight and transparency of nonbank lending, and also means correcting flawed practices that led to massive producer debt and the misallocation of capital. principle three. work to strengthen market confidence in our economies. for the united states, this
means overcoming the market's lack of confidence in our government's able to take the necessary steps to protect our economy and keep it competitive. for china, it means overcoming a lack of transparency, not least, a death of trust in government data and questions about corporate can'ting and disclosure. principle four. free up bilateral trade. for the united states, this argues for moving toward bilateral trade negotiations with china. the global trade round is going nowhere fast and also means granting china market economy status on a sect you're-by-sector basis. for china, this means getting more serious about three things. first, boosting domestic consumption. so that its market becomes a much bigger export destination for u.s. products. second, expanding market access, including completing residual
wto commitments, and, third, ending an array of discriminatory and anticompetitive practices. principle five. help technology flow more efficiently and promote innovation. for the united states, this means reforming our outdated export control system while assuring national security. too often we restrict trade that would create u.s. jobs and is in our national interest. separately, the clean energy policy challenge is now so great that we should have a u.s.-china pilot project, relying on scientific input and evidence to make it easier for the world's two largest economies, energy consumers and carbon emitters, to use the best technologies. for china, it means respecting and enforcing intellectual property commitments. ultimately it means making the shift from a consumer a producer
of intellectual property by legitimate means, not using its access to its market as a backdoor to obtain intellectual property developed by others. only when china innovates, not assimilates technology, will that happen during incentives to protect it. now, why do i believe these five principles are so important? and how do we fulfill them? let's start with the first principle. unlocking the promise of capital and costs of investment. as jessica said, i've devoted my career the principle that world class capital markets are essential to economic success. capital marks fund entrepreneurs and businesses of every size and scope. and strong capital markets make average families richer by generating returns on savings. so, with china already bumping
up against the limits of its existing growth model, financial sector development is essential if the leaders are to realize the goals at the heart of their blueprint for the future, the five-year plan. that plan aims to ease china's transition to an economy less reliant on investment and exports. so, in theory, china should shift from one mod toll another. today, china lends money to cheaply to state-owned businesses, sometimes with little prospect of remain. instead, china should ensure that domestic savers, who are often families, get a fairer return. the lack of good investment options for ordinary chinese, coupled with inflation and low interest rates on deposit accounts, means the return on their savings is probably negative, but chinese companies, especially state-owned
enterprises supported by the government, can access cash at rates that are cheaper than what the market should support. this isn't good for the long-term competitiveness of the companies nor is it good for the efficiency of the chinese economy. in fact recent economic events and current global challenge demonstrat the need for even bolder financial reforms as well, like liberalize the capital account, enshoing and showing greater flexibility in the exchange rate. i've worked with the chinese leaders for more than two decades, and they do understand the need for well-developed capital markets. they also made significant progress in some areas. from restructuring banks to developing domestic and equity markets, asset managers, and a regulatory system. in chinese leaders are committed to currency reform because they recognize that capital markets
won't function efficiently otherwise. bit while the commitments are there, a global economy appears to have eliminated in the sense of urgency for such reforms. friends in beijing tell me china has reform fatigue, that china has accomplished so much that the moment behind reform is fading fast. in my view, china needs to fight through that skepticism. i agree with those in china who argue, in the speeding up of reforms will give them a valuable tool to fight inflation and meet other macthrow economic challenges. here's something else to feel better. what is happening in europe is china's second warning bill in as many years. china is just too big an economy, and still too dependent on exports, to ignore what is happening in their own markets whose demand pass powered champions growth for so long,
and frankly, the present crisis should make financial reforms more, not less urgent for china. china has been able to wall off its financial system in the past. during the asian financial crisis, for example, and again more recently. but can a $6 trillion chinese economy deeply integrated into the global system, remain forever immune to what is happening in the $30 trillion economies of europe and the united states? it cannot. so, by putting the right financial tools in place today, china will be better positioned to responsible to the current crisis while preventing china's own crisis down the road. china has a choice. it can maintain its intervention in the currency markets or speed up a reform toward a market currency. if it does the first, china will continue to accumulate foreign
exchange reserves, buying more treasuries and bonds, but in doing so, it will become an even bigger funder of the structural deficits in the europe and the united states. so, instead it should pursue a market determined remedy and an accelerated timetable for capital didn't liberalization and that would give beijing the economic tools it needs in a large and increasingly complex economy. i know convertibility and capital account reforms and an open -- and a more open financial system aren't popular in china. many in beijing believe these reforms will make china more, not less vulnerable to future crisis, but china can play defense or it can play offense, or if you prefer, china can continue its single-mined focus
on it five year plan, slowly unrolling reforms, when it needs reforms today that into give beijing the tools to effectively respond to future crisis. in the fall of 2008, chain had just one tool to deal with a crisis. massive spending to support growth. and while, yes, that helped cushion the impact of the slower expects as global trade shrank, china's response would be years if it hat the full suite of financial poll skis that ultimately requires convertible currency. i realize currency value is a political issue in both countries and it's an important trade issue, too but i have always believed that all to turnery value is a contributor to trade def circuit it's just one.
we have a trade deficit with the world. it's a necessary part of reducing the economic distortions that can create credit risks, bubbles, and domestic imbalances that threaten stability in china. so, that's another reason to accelerate evidents to diversify and modernize china's financial system. open and efficient capital markets go hand in hand with a market-determineed currency, and other reforms would be useful as well. eliminating remaining geographic descriptions -- restrictions on financial service firms. and allowing financial service firms to operate in china as they do in other leading financial service centers subject to domestic regulation. but modernizing china's system isn't the end of the story. to unlock the promise of
capital, americans also need to think hard about our own openness to investment, and including investment from a china that is sitting on huge pools of prospective capital. but it's largely one way, from the united states to champion u.s. government statistics show in 2010. chinese fdi stock in the u.s. was $5.9 million, just about one-tenth of the 50 billion of u.s. stock in china. that grows moe more and faster chinese capital to sustain jobs. many americans reaction negatively to chinese investment, and for that matter, any foreign investment, even though foreign direct investment is, in my judgment, the up mat vote of confidence in our
system. fdi creates good jobs in the united states. 5.6 million, including over 2 million in manufacturing, and the average salary of these jobs is 33% higher than the national average. but the u.s. government estimates affiliates of chinese firms in the u.s. implied little more than 4,000 americans in 2009. so, there's plenty of room to grow, not least because chinese companies have been reluctant to invest, judging they won't be welcomed here, because they don't understand the investment process. there's a lesson here. chinese leads the world in foreign holdings of u.s. treasury securities with $1.14 trillion. but it would strengthen our economic relation if china put more of those dollars to work in higher return investments that
create jobs in the united states. of course, we'll need to maintain an environment open to investment from all countries. we need to make sure that the process for investing here is clear, open, and fair. when i was treasury secretary, we streamlined the process to ensure that the rules for investing here would be as clear and fair as possible. but five years have passed. so the administration should update its examples and guidelines for successful review, drawing on experience from the first few years of the new law. we should publish more and clearer illustrative examples of investments that passed or failed the new review process, hoping to demystify the process and further clarify how it works. and since china's state-owned enterprises want to invest here, weed in a process to divide
principles. like the santiago principles. discussion of such principles is underway right now in two forms. oecd and the transpacific partnership. but china isn't a principle in either group, so i encourage our governments to seek ad hoc mechanisms to involve beijing in the discussions. and finally, we need to finalize the bilateral investment treaty. how can we have a -- not have a treaty in place to protect u.s. investments in china. china signed 120 investment treaties, including with our closest economic partners, japan, germany and britain, and some of those give foreign investors strong protections, including the absence of binding international arbitration for investment disputes. shouldn't we want that for our
companies? now consider the second principle. we need efficient and transparent markets with strong oversight. well-functioning markets get money where it's needed but they also prevent financial systems from creating hidden accesses or bubbles which are counterproductive and can be destabilizing. so, this principle requires first that we change incentives that have led to bad behaviors. in the united states, government policies helped to fuel the credit housing bubble and unsustainable household leverage ratios. indeed in the runup the crisis, household debt as a percentage of an american family's disposable income more than doubled from historic levels and households still have a long way to go to pay down their debt, reach a sustainable level, and start spending again to support growth.
oversight of china's knorr midranking lynndie is going to be a challenge, and the aftermath of beijing's mammoth 2009 the lending stimulus the country is is an understandable and difficult side-effects not least of which inflation. in these challenges are hard to deal with for two reasons. first, with official intervention leading to an artificially weak currency, the central bank has been denied useful monitoring tool to fight inflation. second, without sufficient oversight of non-bank lending it is more difficult for chinese policy makers to effectively joined liquidity. so the so-called shuttle landing is also problematic because it is on transport and it creates risks and potentially bubbles. raising this i don't want to minimize the progress china has made. it's remarkable, for example,
china's banks which were fought ten years ago have come so far they can serve as a vehicle through which beijing injected stimulus lending into the economy in 2009. that was a critical step for sustaining growth in china and became an growth in the entire world. for china as all state owned enterprises, the next step -- the next challenge is to run them as commercial enterprises. for the financial system more broadly, assuring that transparency and oversight will mean dealing with among other things problems of unapproved one bank lending. such lending poses an important risk to the chinese economy, because it has the same macroeconomic landing as chinese big banks but without the same level of transparency and
oversight. china is a wash in unregulated capital. everyone is lending. not just banks but asset management companies, local government investment vehicles and even state owned enterprises some economists argue formal lending was responsible for as much as 40% of new credit creation in 2010 and the first half of 2011. and much of that appears to be company to company lending. at least one estimate i seen puts this intracompany loans at 4 trillion outstanding at the end of 2010. that's more than $600 billion. nearly doubling from the end of 2008. these loans are esoteric like the securities and help create credit risk in the united states and they are filling an important gap by cutting the capitol into the hands of those such as private firms that cannot easily get it from the
chinese big state banks which lend disproportionately to the state-owned enterprises. recent reports of the faults demonstrate the risk at year end and the sum authorized loans. beyond the questions of oversight, the chinese investors also need a variety of well regulated products to invest so china and the financial innovation and liberalization, but it needs strong financial oversight and more transparency, too. the third principle, working complementary ways to strengthen the market confidence. by that i mean bolstering trust respective economic choices. i've talked a lot about transparency today because it is the lifeblood of confidence and good markets. markets are built on trust.
transparency foster's it. a lack of transparency and erodes it. look at the u.s. experience. in the crisis of 2007, 2008, the market's lost confidence in the mortgage securitizations and perhaps all securitizations because they were so complex. credit ratings lost their meaning to the credit rating agencies lost their credibility particularly with regard to the securitized products. and one institution after the matter said they were healthy right up until the warrant and the field. in the u.s. we are still working hard to restore that trust. but assuring trust is the challenge for china, too. here's an example. recently outright fraud in a number of chinese companies that were that were listed in the united states has morphed into concerns about the transparency of chinese banks. meanwhile, everyone knows the
chinese economy is growing rapidly. but there is less confidence in the chinese economic data. so to restore trust, beijing needs to rectify problems with government and the corporate accounting and disclosure. then there's the second reading of bolstering market confidence. we need a stronger government commitment to addressing our respective economic challenges. for china it means deepening its commitment not just of growth but also to rebalancing and thus to sustainable growth. we've difficult decisions to make, too. we must forge a political consensus to haskell our fiscal deficit, and we need fundamental reform to restore our competitiveness including but not limited to entitlements, taxes, immigration, housing, education and training, education and the tort system. taking action requires
bipartisan cooperation and compromise. we are a rich country coming and if we act soon we can deal with our fiscal deficit and other economic challenges with shared sacrifice, but without any segment of our society having to sacrifice too much. the longer we wait, the more painful the medicine will be, and if we wait too long, the market will force it upon us. we need to free up and rebalanced street. that's the fourth principle. trade has benefited and continues to benefit both the united states and china. at this moment of the greatest economic challenge, we need more, not less than we need fewer barriers, not more hurdles. this year marks the tenth anniversary of the chinese succession to the wto. much has been achieved but frankly, trade with china should
be more important source of economic growth in the united states. the scope and scale of our bilateral trade falls below the potential. our first challenge is to rebalance our economics and thus our trade flow, it isn't rebalanced our economy and thus our trade flow. china saves too much, produces too much, cells too much to us and others and consumes too little on its own. the u.s. saves too little, consumes too much and would like to produce more and to sell more of what we produce to china. so why are we falling short? well, we need to understand first that there is good news about trade. u.s. exports to china have nearly quintupled since china entered the wto ten years ago to almost 100 billion in 2010. our exports have grown more quickly than our imports from china, and china is our fastest
growing export market. consider this, when u.s. exports as a whole dropped by almost 18% in 2009 during the financial crisis, our exports to china jumped by less than 1%. it's a demonstration of china's's potential to become a two-man driver for u.s. products over the long haul. yet our trade deficit for china has widened over the past ten years. so, we must press harder for market access for american goods and services. and in doing so, even as we applaud chinese remarkable growth, which is lifting millions of poverty and it is worth asking our chinese friends what they think chinese growth trajectory would have been at its major trading partners employed the same practices china does. we need to press hard for changes to the chinese regulatory framework and we must
aggressively enforce our existing trade agreements with china. american companies can't for example be expected to trade to transfer proprietary technologies when china assets on ferre domestic content rules. no one has worked harder than i to open chinese markets and fight for a level playing field for u.s. firms. but i am also a free trader. ultimately, i believe what we need is an affirmative agenda to enlarge the entire pie. so with the doha around going nowhere, it means beginning bilateral negotiations with china and the most important sectors including clean energy technology and seeking to include china with a broader group of like-minded countries as well we should work within the wto from work. but much as we did with japan in the 1990's we should also aim to identify and resolve structural
impediments to enter trade and contribute to the bilateral global top balances. another useful step would be to begin immediately granting china market economy status on a sector by sector basis. this would allow china to recognize the economy the past ten years, but it will also force china to discover requirements and opening its markets. china is still not a market economy in some ways. it retains legacies of central planning, industrial policy and state control. but there are parts of the chinese economy that function according to the market economy rules. china's chief of small and medium-sized enterprises for the simple including many exporters are largely excluded from the realm of the state loans and in put subsidies. so to encourage china to move in the right direction, we should
recognize progress with an expectation that all players and sector's current market economies that this act on commercial principles. here is the fifth and final principle. but all want technology in more areas of mutual benefit, and ultimately we want both sides to promote innovation so that china moves beyond assimilating technology developed by others and u.s. intellectual property is respected and protected. americans want to do this but in a way that protect the national security and intellectual property rights and assures our competitiveness and leads to more jobs and exports. there is currently an effort underway in the u.s. government to reform and streamline a cumbersome export control bureaucracy. i applaud this initiative. but it seems to have lost steam.
it should be completed as soon as possible. it is also good reason to experiment in areas that are decidedly in our national interest. like helping china meet certain environmental goals. why? well, china has an economy - energy intensity but low in energy efficiency. china's leaders have committed in the plan to change during the efficiency diversifying resources and reducing carbon intensity. if china doesn't meet these goals, in whole world including the united states will pay the price. so we should be willing to export innovative technology that can help china reed is its energy consumption and grow into the future. but we can't do that meaningfully if china fails to respect and enforce intellectual property rights. beijing needs to meet its commitment in this area real and
needs to change the system that is often looked the other way or complice it in intellectual property theft. we also need enhanced end user programs with china to ensure that our technology exports are being used as intended and not in ways that threaten our national security. and separately we need to listen to the best scientific of fice available as we seek to overcome pressing environmental challenges. so, i propose a pilot project with china which would convene a team of technical experts of both countries to focus on existing and emerging clean energy technologies. there are expert input can guide officials in both countries but will also be useful as a u.s. to expedite the licensing process. over the long term we want china to become more of a technology innovator not just because it could lead to breakthroughs that won't be a public benefit, but also because it will change the
incentives in china to protect the fruits of its labor. china that consumes rather than produce is intellectual property will never sure the underlying approach to the intellectual property protection that has developed in the end of enervate economy -- innovative economy. we are approaching a election while china faces its own succession and the growth are the number one issue in both countries. these five principles of the recommendations associated with them or intended to help our economy is sure growth and expand opportunity. they will require china to reform, perhaps at a faster pace than the leaders are comfortable with, but and i believe reforming poses a greater risk to china's economic stability that many in china believed to be for our part, they require
the restoration of our own economy and addressing our fiscal deficit and growth outlook and that can only be achieved in the fundamental reform based on a bipartisan cooperation. the era of the over conception of the united states is gone forever and with hindsight, we can see that like all, it wasn't sustainable. as american families' repair their balance sheets, consumer spending won't need growth as it has in the past. but i have an abiding faith in the resilience of the u.s. economy we have by far the world's richest and largest economies, and although we face significant problems, the challenges we face start with those confronting china and virtually every other nation. and our problems are of our own making. our continued leadership will be a function of our ability to make required policy adjustments it is our choices that matter most as we seek to remain globally competitive andç z(j(@