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The Levin Institute

Transcript: “Fixing Global Finance” with Martin Wolf

Event:  “Fixing Global Finance” with Martin Wolf (Co-hosted with Bard Globalization and International Affairs Program)

Moderator:  Garrick Utley - President, The Levin Institute

Introduction:  Carter Page


Martin Wolf - Associate Editor and Chief Economics Commentator of the Financial Times

Garrick Utley

Good evening, ladies and gentlemen, if we can get going right now.  Good evening, I’d like to welcome you here to the Levin Institute.  I’m Garrick Utley, the President of Levin Institute which is part of the State University of New York, SUNY, and this is a special occasion tonight.  First of all, to be with so many students from Bard, part of the Bard program, and Carter Bales who is going to speak in just a moment to welcome you too and introduce our distinguished speaker, Martin Wolf, tonight.  I will not say anything more.  I think most of you know about the Levin Institute.  We deal with key aspects of globalization and never were the times of more dramatic than they are right now and of course the financial issues right at the heart of this. 

Also, we think we have location, location, location being the heart of Manhattan.  From time to time we look out the back door because our back door in 54th Street goes into the headquarters of CitiGroup, and so we have somebody on permanent watch to tell us when the Feds drive up and take over.  We are not sure whether that’s going to happen; maybe Martin has a comment on that.  Also I was talking to some colleagues of mine who I was listening in a conference call on an investment committee for a nonprofit organization today; and they were talking to the investment advisers, and saying, :Well, what do you think about the markets?”  And he said, “Personally, I have a very strong opinion!”  And was then silent, and he says, “A strong opinion that it’s going to go up or it’s going to go down further?”  He said, “I have a very strong opinion that I don’t know.”   So that may be where we all are today.

Anyway this a special occasion and what we’ll do we’ll hear from Martin this evening talk about his book and the subject of fixing the whole financial problem, and I think many of you have read that as part of your assignment, and then we’ll get into a town hall discussion as to where we are and where we are going.  But right now we turn over to Carter who has really been instrumental in putting this together.

Carter Page

Thank so much Garrick.  As Garrick mentioned, we’re privileged to have Martin Wolf as our guest speaker this evening at the James Chace lecture series.

Martin is the Associate Editor and Chief Economics Commentator of the Financial Times.  He is also a professor of Economics at the University of Nottingham in the UK.  Martin is currently spending a few months in New York, working out of the FTs office here as well as spending some time at the Council on Foreign Relations where he is the Distinguished Visiting Fellow in International Economics.  His most recent book, “Fixing Global Finance” was published in September of last year and will provide the foundation for his comments this evening.  In our final presentation of last year, Robert Samuelson of Newsweek discussed some of the economic aspects of globalization focusing on the great inflation era a few decades ago.  There is actually an in-depth article in the latest edition of Newsweek adjacent to Robert’s article where there is a profile of the new head of the White House National Economic Council entitled “The Re-Education of Larry Summers”.  And that the article discusses how the changing economic conditions require a new approach and some creative thinking.  While the article critics his personal style and his personal elements to it, it also refers to him as “Perhaps the brainiest of the best and brightest assembled by Obama.”  Prior to his nomination by President Obama, Dr. Summers actually had the following comments about fixing global finance, “Martin Wolf is the world’s preeminent financial journalist.  This book should be read by anyone who cares about the future of the international system, which given recent events, is anyone who cares about the global economy or their economic future.”

In light of the trends of the past several months, the list of current challenges, which Dr Summers salutes to and the issues that he and each of us now face have, of course, grown far more extensive.  And these factors make tonight’s lecture especially timely.  The students in Bard Globalization International Affairs Program who are here tonight have heeded Larry Summers’ recommendation and have read this important document as Garrick mentioned earlier.

We are also joined by many in the audience who studied these issues in Bard Colleges Main Campus as part of the Levin Institute based in Annandale-on-Hudson and several of them are here in person as well as others that are joining us via video link tonight.  We are also joined by many others from our community who have worked in the global markets.  So I am certain we’ll have a very informed and engaging discussion after Martin’s comments.

The Chace lecture is also co-sponsored by Foreign Affairs Magazine of which its namesake James Chase was a former managing editor.  And following Martin’s presentation, we are fortunate to have the President of Levin Institute, Garrick Utley, as the moderator of the Q&A session of tonight’s event.  From his career as a leading television journalist, Garrick has extensive experience in his capacity including three years as moderator of NBC’s Meet the Press.

So we are very thankful to the Levin Institute for joining us as a co-sponsor of this evening’s event.  With that, I will turn it over to Martin.


Martin Wolf

Thank you very much.  It’s a great privilege and pleasure to be here not least because I’m giving quite a number of lectures, some connected with the book and some not.  In the United States during the three months I am living here with my wife and this is the only one that requires a 10-minute work from my office.  So I am really very grateful to you as Garrick said, “Location, location, location.”  This location is perfect so if I come and do this again in New York and I planned to, I think we’ve decided to make this a regular annual event.  In fact, we are thinking that the price is moving so attractively here maybe we can buy a small condominium.  [Laughter]  But not unfortunately in pounds, that’s another issue.  I’d be happy to come back.

Just to remind to tell those who haven’t been in the program and therefore not being forced to read my book, that it originated out of lectures that I gave at the School of Advanced International Studies in John Hopkins University in Washington two years ago, actually now it’s three years ago, I have to say.  At that time, I was invited by Frank Fukuyama to speak in a lecture series which was actually three successive lectures of an hour and a half each which is not my normal sort of stint.  So I said what I’d like to talk about what’s going on, in my view, with the global financial system and so I did, and those lectures then were the basis of this book.

What I was concerned with was global macroeconomics, the way the global financial system would work and how that, in my view, was related to the so called “imbalances” which have become a big topic among international macroeconomists in the early part of this decade.  And the concern I had that the trends we were watching in these flows above all those associated stocks, liabilities and assets were unsustainable and dangerous – that was the theme of the book.  I have to admit that what had since happened has vastly exceeded my most pessimistic expectations because though I, some of what has happened particularly the effect on consumers’ housing, things like this, were I think reasonably clear to me the complete implosion of the American and world financial system was not and it turns out that I was too wildly too optimistic. 

So I like to say when I talked about this, and I was within reason to be in good company many of you may not realize that even my friend, Nouriel Roubini who is fiat and notorious of course for the accuracy of his predictions.  And if you look back on what he predicted what happened a year ago, he was far too optimistic.  We have widely exceeded the most pessimistic expectations of any competent professional observer including myself.  I’m not saying that I’m a competent professional observer.

The only other point I would make about this book and the theme, is why did I get interested in this.  I had previously completed a book in 2003 which was published in 2004 with a rather bold title “Why Globalization Works”.  When I finished that book, it became obvious to me that there were two big issues whose implications I haven’t fully explored and which I planned to explore. 

One was the global financial system and its repeated failures.  I already discussed that in this book but I haven’t been able to elaborate further.  And the second is environmental questions in which I clearly wrote far too little but there was a limit.  The book was already 50% longer than my publishers wanted so that was that.  And they were very kind to publish it anyway.

So there is still in my mind the plans to write a much bigger book on global environmental constraints and was Malthus right, and that may come in 2012 given my normal pace of writing particularly since I intend to do for fairly obvious reasons a second edition of this book.

Okay, let’s start this subject.  I thought this is a nice drawing, just to get you in the right mood for this subject.  I found this on the Internet as one does these days.  It is of course for everyone here will immediately recognize the painting from which this was drawn.  Edvard Munch’s famous picture, The Scream, which I’ve been privileged to see in the original twice; it’s a very great picture and I think it captures pretty well the existential situation of human beings.  Anyway, late 19th century picture and, of course, it is The Scream on Wall Street.  I don’t think I’ll need to elaborate on that.

The second think I’d like to say which is very relevant to our theme it’s about the emergence of Asia as the central surplus region of the world, the capital surplus region of the world.  I don’t need to read this text I think you can all see it.  Joe Stiglitz of course is based in New York and so it’s really very, very strange that so much of Asia-- so visible of Asia saved so much.  Their savings rate, I’ll come to that later, are quite extraordinary.  And second that they don’t have functioning financial markets in Asia and instead they’re sending the capital to the US, in particular, to a lesser degree, the U.K. and some places; where if you worked through the flow of funds, and I’ll come to this in the moment, a large part of it seems to have gone, well all of it has gone into consumption, there is no doubt.  All of it is going into consumption and about half of that was public consumption and about of it was household consumption.  And at the end of this tremendous flow of capital into the Western world, in particular into the US, there is essentially nothing to show for it except for a lot of empty houses.  This is a fairly tragic and grim story seems to be in terms of the misallocation of global resources.

And finally I will, my final quote which, of course, I have in the book, economist note called this Stein’s Law.  Herbert Stein, I think died in the later part of the 1980s – somebody can correct me or maybe it was in the 1990s, was it 1990s?  Yes, 1990s.  He was Chairman of the Council of Economic Advisers under Richard Nixon.  And despite that he was an astonishingly witty, amusing and delightful man.  I’ve always found this very fascinating.  And he wasn’t an economist who published a lot that influenced people but he was a very influential man.  Many nice good people I know worked with him. And, anyway; he made the famous proposition which I think is a good thing to remember when we think about what happens in the world, “Things that cannot go on forever, don’t.”  And I’m go talk about two things that did go on forever and then stopped.  And we now live in the era when those two things which I think are very closely related had stopped.  And the interesting question, more than interesting of most profound significance is what comes after because we are in the transition phase.

Then what I’m going to talk to you in the start about how we got to this disastrous situation that is written in the book; for those who read the book you’d be happy to know that most of these analyses go beyond it.  I’m not going to repeat what I said in the book because, of course, as you all know, the book analysis essentially completed a year and a half ago that being the problem with academic publishers so I’m going to bring it up today.  Then I’m going to talk about the crisis, the response.  I’m going to talk a bit about scenarios for the future.  And then I’m going to try and focus if I get through quickly enough on the reform questions which are central part of the book because I am arguing one element in getting out of this mess.  And I don’t wish to stress that it’s more than just one element but I can’t talk about everything.  Is the so called rebalancing the world economy.  I don’t think it is possible to imagine that we’re going to get back to sustainable growth in the world economy in which as we experienced in the earlier part of this decade, in the US, in the UK, in Spain, in Australia, domestic demand, predominantly consuming demand, grew faster than disposable income year after year after year; therefore by essentially creating the excess demand which absorb the excess supply or excess savings as it was growing in the rest of the world.  That’s not a balanced growth--growth level is not sustainable until we got to think about something else, and then I’m going to have a brief assessment.

Now, I’m going to talk about destination is disaster and let me stress, I’m not talking about the details of the financial sector about derivatives and all the rest of it not because I haven’t thought a lot about these things recently but because I just don’t have the time to explore those dimensions of the catastrophe, and probably don’t have much to add to what people already know.

The first thing is the imbalanced history.  In the 2000s, this decade “extraordinary”, I’m not going to put quotes around imbalances in which economists like to put quotes around imbalances because they are not really imbalances, but I’m just going to say we had an extraordinary pattern of current account surpluses and deficits emerging in the world completely unprecedented in scale or at least since the 19th century, the late 19th century.  And I don’t have the time to talk about the between similarities and differences with the late 19th century.  And this emerged out to the Asian financial crisis and got more significant in this decade.  And again, I’m not going to focus on the other developed countries that became large-scale borrowers or recipients of net capital flows.  I’m going to focus on the US again because I don’t have the time to look at the others though.  Some of them are very interesting, I think the UK and Spain in particular very interesting but they are less important of course because of the size of the US economy.  And this is really the important point when the US emerged as borrower of last resort within the US.  By definition if a country, its people, its residents are spending more than their income, there must be people or entities within that country that is spending more than their income, and it turns out that the most important such group in the US case were households, the same is true with the UK, and also the government, we’ll come to that in a moment.  And this process is essentially now, it’s in the end, this consumption and residential investment which are the two components of that excess spending by households are slashed then I’ve got a chart which goes up to the third quarter which shows that.

Now, why did this happen?  Why did we have this phenomenon which is I think really quite extraordinary and it’s what got me into being interested in this topic.  That we had a large number of predominantly poor countries, they’re not exclusively, and China is the most important example; exporting vast savings to rich countries.  And when we--30 years ago, I was working at the World Bank and we thought about what would happen if we open up the world’s capital markets.  We liberalized in the way we have.  The normal assumption is we would get a sort of world we had in the late 19th or early 20th century when money flowed from the then most advanced country in the UK to the then emerging countries of which of course the US was a technically important example, Argentina, Australia, Canada, and so forth.  And this is not what has happened this time.  This time, after a series of big crisis, all of them associated with previous capital inflows into these countries, all of which lead to massive financial crisis documented in my book.  These countries stopped the importing capital and started exporting it.  The sums involved were very, very large way in excess from developing countries alone of a trillion dollars a year.  China, itself, far and away the world’s largest capital exporter, now roughly as big as Germany and Japan puts together the second and third countries.  And China’s current account surplus has been well over 10% of GDP for the last three years.  So we are--that’s really not what we would expect to see.  It’s a very extraordinary phenomenon.

Now, I argued in the book that a part of what lead to this and there’s more to it is the major financial crisis of the late 1990s which convinced many governments including the Chinese, in my view, that it was incredibly important to run policies that avoided the slightest risk of running a large or an appreciable current account deficit and ending up as you always did with large current account deficits or nearly always with large short-term foreign currency borrowing and associated currency mismatches in your financial system.  One of the features if you start becoming a large-scale borrower you almost automatically ended up with large-scale foreign currency debt in your financial system and predominantly of course dollar-debt.  Now, when you got a period very much like today, you can see this in emerging economies now when what a very good and important Latin American economist, Guillermo Calvo at Maryland calls a “sudden stop” happens.  You get a sudden cessation in capital inflow because there’s a shock to the system and confidence is gone, really what happened to the world after Lehman.  Then currencies collapse because there is no more foreign currency inflow.  And because the currency collapses and because there is so much foreign currency borrowing in the system, you get a tidal wave of bankruptcy in the financial system and in a non-financial corporate sector usually as well.  And those crises created huge collapses and this is just a story of what happened to Indonesia, Korea, Malaysia, there is South Korea, of course, and Thailand.  When the collapse occurred that is from the book and you can see that in Indonesia case in particular, the crisis was incredibly severe and took an immensely long time.  Indeed you could say that in all those cases, with the possible exception of Korea, none of them fully recovered from the impact of this crisis.

In addition associated with the foreign currency loss, Turkey had a very similar experience in the early part of this decade after 2001 because of this massive currency mismatches.  Because people have borrowed dollars and had domestic currency assets, when the currency collapse the banks was so comprehensively wiped out that the bail-out cost turned out to be absolutely staggering.  And in a number of cases, I’ve listed some of the bigger cases, we are talking about bail-out cost of 20 to 50, 60% of GDP.  So to put the number, in American terms, 60 % of GDP, I supposed, is about $8 trillion, $8-1/2 trillion just to bail out the insolvent financial system.  So these were tremendous shocks.  And a consequence of this, in my view, is an essentially pretty well every region of the emerging world with the exception of Central and Eastern Europe – and Central and Eastern Europe was excepted because they really believed how foolish they were as we can now see that capital inflows would be safe in their case because it was part of a leader to integration in Europe.  So they did go on with the sort of policies emerging countries had done at in the 80s and 90s, what nobody else did.  Essentially, they were no more significant net borrowers in the emerging world.  That was the first thing and that was quite general, quite general.  And in addition, there were a number of emerging countries as I’ve mentioned particularly in Asia that became very, very large capital exporters.  This graph shows at a very crude level the global balance of payments in this decade and you can see that it was Japan as a consistent exporter, that’s the yellow one; this just shows of all GDP--the Europeans were roughly imbalanced, at least the Euros almost roughly imbalanced, neither absorbing nor exporting capital.  And then there were two massive surplus regions.  The Asians predominantly China but not only China, the countries hit by the crisis and the oil exporters, of course, is a temporary boost in the more recent years.

And until the housing bubble burst and that was a decisive turning point for the US and for the world economy, the US was overwhelming the most important importer of this capital.  In fact, if you look at it regionally, so you treat Europe as one entity, it looks rather different if we treat European countries as separate country.  If we treat Europe as one entity, the United States imported 70 percent of the surplus capital, the surplus savings of the entire world.  As I’ve said before nobody really imagined when we were liberalizing global capital flows that the net effect 25 years later was that the world’s biggest and richest economy would become overwhelmingly the largest capital importer in the country.

And another theme of my book is all these didn’t happened just by accident, it wasn’t the result of pure market decision formed from it, it was a result of conscious policies of government to keep their exchange rates down, to accumulate foreign exchange in official reserves, to sterilize these inflows, I won’t go into all the monetary policy problems this creates, and to take the current accounts surpluses they would then earning, and the very substantial capital inflows which most are private capital inflows which I don’t have time to show the data of.  Take the whole lot and recycle them as official foreign currency reserves.  The rise of the official foreign currency reserves in emerging countries in this decade has been a truly staggering phenomenon. 

Over decade as this chart shows essentially between 1999 and early 2000 and the peak, the increase in the world’s official foreign currency reserves predominantly, though not entirely, US official liabilities.  The GSCs, Fannie Mae and Freddie Mac and such institutions; the increase was $5.5 trillion, incomparably the largest official accumulation of capital, the largest capital outflow by governments.  I refer to this when I joked about it as incomparably the largest official aid program in world history from developing countries overwhelmingly to the United States, and that as I said it was five and a half trillion.  Of that five and a half trillion roughly two close to two is China alone; but the remaining three and a half, that is about half of trillion of Japan and the other three is other developing countries.  So this really was officially organized flows to accumulate foreign currency reserves, restrict, limit the risks of currency appreciation, support export growth and accumulate the reserves as insurance.  My own view in terms of the motivation of these policies was a mixture which varied among countries between the desire to pursue export-oriented policy to support the export sector, very important I think in China, partly to preserve monetary stability by keeping the exchange rate fix but at a low level which they could sustain, so there was no risk of it being forced down as it happened when they were capital importers and finally to accumulate reserves as a form of insurance.

And if you talk to emerging market economist today about their experience in the last crisis, all those that have accumulated these massive reserves are very grateful; they think it was a very good idea.  So, one way of thinking about this, this has been a pretty good treat for the US.  It has essentially printed money, the world has purchased it and it has raised the standard of living.  However, it has been not without problems in the United States.  If we start looking at where these money all went?  Where, in terms of national income, the flows all ended up?  Very similar pictures emerged for U.K. and Spain and a lot of details I can’t go into, but this chart really shows the core of the story for the US private sector.  This shows the so called financial balances which are simply income and expenditure of different sectors of the economy.  If we added up all the sectors of the economy – the government, the non-financial corporate sector, the corporate sector, the household sector, and the foreign sector – it must add up to zero.  By definition, good savings and investments must be equal at that level.  But the really striking feature, I’m just going to focus on the last decade, you can see this rather clearly, is that the US household sector went up to the middle of this decade ever more increasingly into deficit.  The point which of course the Levin Institute papers co-authored by you and others have made very often, when Godley among them, the US household sector went ever more deeply into financial deficits.  I spent even more relative to income, peaking in the early middle of this decade on these accounts which are the national income and product accounts.

That tendency which is same thing as saying that spending grew faster than income for the household sector was go back to the beginning of the 1990s, a very long term process.  The business sector on the other hand is a very different story.  As you can see, it also moved into deficit in the late 1990s, at a time the stock market bubble back then burst.  This led to a massive adjustment essentially in investment which never recovered.  And the business sector has been running a financial surplus of this decade essentially continually.  After the housing bubble burst in the United States you will see that there was massive and swift swing back into balance.  This goes up to the third quarter, by the way the data I don’t have for--I haven’t done the fourth quarter of last year for this data I don’t think it’s--it’s actually the fourth quarter. Is it available?  I don’t know but I haven’t look.

But the basic point is all that red line going back is essentially the household sector spending growing more slowly than its income, it is extracting demand from the economy.  And it is, in my view, the principal reason why the US was first in the growth recession.  Growth was slower than potential since 2006 and is now with the present shocks actually in recession.  So the US household sector was the great borrower.  If we aggregate it all and have the private sector which is the household and business together, the government and the foreign sector which is, of course, providing capital, and I’m doing it such that they add up to zero, so it’s a foreign capital inflow.  You can see that in the peak, it was the government and the private sector were roughly absorbing this capital equally.  And now that the private sector is going back to balance since that the foreigners is still lending money very freely to the United States it’s contracted a bit, the government deficit is exploding, and that is in my view.  I’ve accepted this analogy, the principal reason why the fiscal deficit this year is now expected to be in the federal government sector 12% of GDP.  It’s because of the combination of the massive cutbacks in the private sector with the continuing inflow of capital from abroad.

Now the second aspect of this story, which I think it relates to this, it’s pretty easy to see how it relates to the story but it has a central element in which is autonomous and goes back 30 years, is the huge increase in credit debt in the US and global economies over the past decades and particularly in the household and financial sectors, the intermediation sectors.  And these developments accelerated in my view because of the financial imbalances. I’ve talked about the global imbalances remarkably.  This was an area, you will remember, of low nominal and real interests rates and housing bubbles.  The low nominal interest and real interest rates, in my view, are very powerfully related to this saving surplus condition which I’ve shown you for much of the rest of the world.  This is I think a truly remarkable chart which shows the total stock of US public and private debt as a ratio to GDP since 1870.  And you will see that there were two peaks in this, the first was, of course, 1929 which led to two decades of debt destruction and mass bankruptcy, and the second peak much bigger than the first also driven by the private sector not as everybody focused upon it, the public sector is the one who’s then, in my view, we’ve just seen the great bubble in credit, the great expansion credit.  And you will see just in the last 10 years or so the ratio of debt to GDP has gone from a less than 250% of GDP to 350% of GDP, all of it in the private sector, a massive explosion in credit in the United States.  And this of course is being associated with a massive borrowing boom.  This showed the rates of growth of credit in the United States by sector since 1975 and you will see, just to look at the last period, a staggering expansion in credit year by year between 2001 and 2007 running up to rates of 20 to 30% a years’ growth in credit.  And if you look at the details, you will see, it’s all essentially until 2007 in the household and the financial sector itself; a massive great growth enlargement of the balance sheets of the financial sector and enlargements of the debt of the household sector.

The last column which is the third quarter of last year--it would be fascinating to see the fourth quarter, is I think quite as fascinating.  Because for the first time in this series, household borrowing was negative, household stopped borrowing and actually started to repay.  I expect that to continue for a long time.  And if you will see the financial sector continue to expand its balance sheet probably because of the trust lending but what really is interesting thing is of course that government has taken its place.  And you can see consistent in my chart that government borrowing is now sustaining the entire borrowing system in the United States.  This shows the stocks of that to GDP over this period and I just focus on two elements of it which are I think intimately related to the crisis the acceleration is obvious, the simply staggering growth in the debt which is also the assets and liabilities of the financial sector which have risen from about 20%of GDP to about 120% of GDP on the last three decades and have moved from 60 to 120% in the just the last decade or so.  I mean the financial sector basically went mad.  And a similar data are clear for the U.K. and worse.  There are other countries that have had the same phenomenon.  And the second is of course the household sector.  And again you might note that in the last quarter, of course you are beginning to see a downturn in the household sector.  It’s just consistent with what I just showed the household sector is at last truly retrenching and that’s consistent with what I also showed for the financial balance sheet.

So, in my view, these were the background conditions for the great financial euphoria in the mid-2000s.  And what happened as we’ve seen in 2008 is partly the result of a panic as people realized how much bad debt and how much badly re-structured debt into their system.  But in my view that panic is rooted in the twin realities of this mountain of bad debt plus a reversal in the previous excesses of consumer spending in the US and elsewhere; which were essentially the balancing wheel in the entire global macroeconomic system and unsustainable system which is the theme of my book.  So where I put it which is very high and immensely success spread excess and excess spread collapse and that’s where we are.

The crisis which we are now living through, which is of course a monster, has had essentially three stages and incipient crisis from the time when the housing bubbles started to burst in August 2007 when people began to realize just how widely spread toxic assets were chronic from August 9th, 2007 to September 15th, 2008 when it was clear that there was a very serious liquidity disruption in the financial system.  And its succession of panics here and elsewhere but no real crisis and then it went critical of the September 15th, 2008 when Lehman was about to fail.  And that of course in my view added elements to the initial adjustment processes which we expected, the risk adjustments and all the rest of it, the macroeconomic adjustments.  It destroyed trust and under-minded the functioning of the financial system.

 I don’t have time to discuss what happened after Lehman, but some of it is truly astonishing.  And as it was, I can see entirely without precedent in world history.  There was a period in late September and early October when basically all the major banks which relied on wholesale markets to fund themselves to any significant degree.  That is any investment bank and any commercial bank with large investment bank operations relative to its assets essentially was financing the entire balance sheet overnight, if I could get for that long, and which with the hourly.  I talked to some very senior, you probably know this but I talked to some people who run very, very large institutions which were basically spending the whole day just financing the balance sheet.  This is ceased to be a functioning financial system.  And that of course lead to the re-capitalization advocates and the extension of government guarantees gigantic expansions in Central Bank liquidity operations.

This is a beautiful charting from the fund which simply showed how once the panic hit, it then moved.  And I want to trace it up from sub-prime residential mortgage securities to essentially every significant financial market; were contagioned in the last ones to be hit and very significant at the moment, I don’t have time to talk about that is the emerging markets.  Now actions of G7 governments have saved core banking institutions and there is lots of measures in terms of risk spreads, I don’t have time to go through, showing that confidence is slowly returning.  But in my view we are still talking about massive underlying recession re-forces.  First, massive losses in mark-to-market losses, which again a run-through the banking books, the loan books of many institutions; that’s why the market cap is now so different from what the book value says about the value of financial institutions, like CitiBank since you’ve mentioned it.  Credit markets remained somewhat dysfunctional and the old shadow banking system, the off-balance sheet banking system is essentially imploded, what the commercial paper market relates to money market and so forth.  As the price collapses in housing and equities are ongoing across the globe, I don’t have the chart here, but from the peak a little over a year ago, the loss of market value in the world’s equity market is close to $40 trillion.  And I’m not even mentioning the losses in the housing markets.  So there has been a massive loss of paper wealth.  It’s about 50% of world GDP, a bit more than 50% of world GDP.  Asset price collapses in housing and equities are ongoing across the globe and of course consumers are cutting back spending dramatically and this is now across the world.

This is what happened to industrial production and merchandise exports right and left scale up to the beginning of--this January data, I presented some more data in my charts this week.  They are all absolutely scary.  Japan’s manufacturing output today is back to where it was in 1987.  And I can tell you that those of us who wrote about Japan in 1987, and these were the glory years could never have imagine that 22 years later they would be reducing the same amount of manufacturing, because Japan is, of course, so export dependent.  Globally of course the idea of decupling is now dead as emerging economies are incredibly hit hard by the loss of external demand from countries like the U.S., U.K., the other big importers and indirectly by the loss of external financing; and that particularly both the Central and Eastern Europe.  Deep recession are certain in the US and Europe.  No significant spending offsets can conceivably occur in the rest of the world.

And that’s why I believe there’s going to be a very prolong slowdown.  I find it very difficult to believe in the optimistic forecast for growth.  This by the way and no forecast is worth anything, this is what happened to the forecast, the consensus of forecast for the output for the developed world in 2009 since the first set of forecast probably put together in January 2008.  Just to give you some idea how wrong they were.  We take the Japanese case, in January 2008, they expect that the Japanese economy to grow by 2%, they now expected to shrink by 4%.  The other developed countries are all expected to shrink about 2 to 2 ½%.  The world, as a whole, is now forecast to shrink for the first time since the 1930s.  So this is a pretty significant event.  This is what the picture for developing countries looks like and you’ll be interested to know that China and India look much more robust than the Asia-Pacific region, Eastern Europe or Latin America; all of which have collapsed.  This is really is a synchronized global recession as the corrective forces worked through with incredible violence and speed.  This is the IMF’s growth forecast for next year.  They, of course, put in a wonderfully vigorous recovery in 2010; there isn’t a slightest reason to believe that.  But the IMF would not be allowed to print anything else.  I mean that quite literally, they could not get away with printing anything else.  So just focus on what they are showing for 2009.

So what is going to happen next?  And what are their formed implications?  I’ve gone over a little time so I’m going to cut it down to five minutes.  We started a few minutes late so I’m within my time, I think.

First of all, there is story you can tell, I just want to stress that there is a story of really quite swift recovery.  There are some good things that are happening.  We have much lower oil prices, there is a shift of income to consumers, we have much lower interest rates, extremely aggressive monetary policy.  We have some massive fiscal boost, mostly in the US and China, not really elsewhere and I tend to think that’s too small.  We have a significant reduction in risk spreads in markets across the globe and, therefore, some people would say demand in the deficit countries would be soon restored and that would generate business as usual.  The problem I have with that is, essentially, we have a massive debt overhang in the private sector and in the household sector, and the core of the, the drive of the demand was consumption.  And I don’t see how you get a real consumer boom out in the Western world again when house prices are collapsing, asset values are collapsing incredibly implausible.  It’s much more likely that there has been a structure rise in savings and that’s being shown in the very, very weak demand.  So I regard this as it’s not impossible but it’s a very low probability event, it’s a low probability event.

Another event which I think is also about equally likely is that we are actually in a breakdown period.  That this is, we discussed this, an epochal event and the integrated global system is in the process of disintegration.  And I’ll just going to list some of the factors that might deliver that continued rapid rise in desired savings in effect to fiscal stimulus, mass bankruptcy and soaring unemployment.  We see all these things happening, friction between deficit and surplus countries with the deficit countries telling the surplus countries they are not expanding demand enough.  Major currency crisis are possible, these are forecasts and then protectionism put an end to the open world economy.

Now I tend to think that this is also a low probability outcome, but that probably because we probably already realized I’m a great optimist!  So I think the most likely is something like this muddling through lower oil prices, monitoring fiscal easing, restore degree of confidence as fiscal stimulus in surplus countries as well as pick up in private spending in some deficit countries.  And this gives you a slow recovery.  This is the sort of, I do regard this is a very long and shallow ‘U” in the debate economists have already something that looks quite “L-ish” down like this and up like this, and that seems to be the most likely outcome.

Now, let me just conclude with what I think this might lead in for the reform agenda if we get to it.  So assuming we get through this and we have to think about the world is going to work macroeconomically thereafter.  I think there is a big U.S. adjustment ahead, also U.K. and other developed countries, and this is only possible with global growth since I think the net exports have to improved considerably they can’t rely on the success spending domestically.  Other countries need to have smaller surpluses or bigger deficits.  Now all exporters, I think, will be back and right now all exports surpluses are shrinking massively because prices are collapsing.  Once the world economy recovers which is what I’m thinking about.  Oil prices will rise.  We will be concern again about their savings and I think their structure because all exporters have good reason to turn their assets into wealth.  So part of the adjustment is that non-oil exporters reduce current account surpluses or increased deficits and this means they must spend more relative to income and China is the most important case.

So how are emerging countries to run current account deficit safely which is the theme of my book?  And the answer is external finance must at least be relatively stable.  And there I think three elements in a solution.  I would shift my emphasis now somewhat from the book.  The first is equity investment–that is well known, there isn’t something more to say.  The second is almost complete reliance on local currency finance and the development of local currency bond markets–which is what Joe was talking about.  And the third element is a big increase in collective insurance.  And I have reason to be arguing that the IMF currently about $250 billion needs to be at least an order of magnitude bigger to give countries the insurance they need and the assurance they need that they can get through crisis.  Of course, the development of local currency events also depends on the sustainable fiscal position as sound currencies are well-regulated financial system and openness to foreign investors.  And without those qualities local currency will fail for both domestic residents and foreigners. 

But there wasn’t, before these crises, encouraging signs and it has added a real element of robustness to emerging economies in this crisis that emerging markets local currency bonds which are what shown here which I’ve taken from my book a massively increased in scale at least up to the middle years of this decade.  And I think it’s very important.  But still more important is a much bigger global insurance system.  The IMF’s lending capacity as I said is about 250 billion.  It needs to be an order of magnitude bigger and that means a big reengineering of voting weights.  Today, believe it or not, Europe still has a third of the votes in the IMF, America is about another 18% and that cannot last.

So let me just, the conclusion of my argument for today is we have, I think, reached a real turning point.  The end of the U.S. and U.K., Spain, a few other countries as borrowers and spenders of a last resort in entire global system; the natural limit of the Asian export lead the Cantonese model of growth the way I put this is China cannot be South Korea.  It’s just too big that puts you that line of development.  It has to a more balanced growth model without this massive surplus savings.  The reduction in internal imbalances in the U.S. and other countries like this, the increased savings, the reduction in spending depends on reducing external imbalances at the same time while maintaining global economic growth, and so achieving this depends on big changes in the rest of the world and the massive reforms in the global financial system I’ve outlined.

The big point I would make in the conclusion, we got into this mess over a long time.  We worked very hard to create it.  It’s going to take our lot of effort to go out, get out of it and unfortunately it’s not going to be easy.  And the other thing I would stress because it’s not part of the American debate as I read the American debate, this is the product of the global system.  The US is embedded in the global system and it cannot be durably resolved without changes in the global system.  Thank you!

Garrick Utley

Thank you, Martin, very much.  [Audience applause]

As you take your breath, thank you for a very thorough and detailed and an insightful description of how we got where we are and where we are.  And I think many of us are not in the financial business and the fact that you went into this detail is really, I think, is commendable.  And we want to follow up now with a Q&A period of the discussion for about another half an hour.  And let me if you got in your questions ready.  And, please, I know some of you have read Martin’s book and you may have some particular aspects you want to reference in your questions.  Others are from the financial communities so no holds barred here.

But let me just start off with your column yesterday.  You talked about leadership, about the role of United States.  And your column was entitled, “What President Obama Should Tell the Leaders of the Group of 20?” who are meeting in London on April 2nd, which is shaping enough to be a very important meeting indeed.  And let me read you the second or quote your second paragraph and I love your phraseology.  You don’t give the person credit, but your words are “The world now needs change it can believe in.  [Laughter]  Only Barack Obama, the US President can provide the desired leadership.  He is untainted, popular and the leader of the country that for good and ill remains central.”  We are all in this as everybody says that Barack Obama has now walked into it.  He’s addressed the nation, today the budget is out.  Do you see signs of leadership coming from his administration?

Martin Wolf

Well let me think because this is such a huge question.  Let me just make three comments.

First, I think the issues that the administration has addressed in the first–is it now five weeks, something like that, have been the right issues.  The domestic issues they have addressed have been the right issues–the stimulus, the bank reform and the home-housing issue.  I would say that, in all three cases, the measures were, in my view, and I have expressed these again I will not get into details.

As my second point, disappointingly modest in scale and ambition given the scale of what I see is the crisis.  I think people haven’t yet, I don’t have any idea of how this is going on because though I know some of the policy-makers very well–they aren’t speaking to me anymore so or I don’t know.  I haven’t spoken to them since they got into office–so I don’t know why, but I think there isn’t yet a full measure in the policies I have seen of gross being the scale of the crisis.  In a way that reflects the fact that this President came into office too early in the crisis; it’s almost as if FDR got elected in 1930 or 1931.  It needs to be really bad before people will accept the scale of the action that I think is required.  That is the second point.

The third point I’d make is that, as everybody knows in terms of manpower, people power, whatever; this administration is not yet stopped.  So the Treasury Department today apart from the permanence of the services consists of one person.  And one person cannot run the Treasury Department.  Is it pretty obvious the White House has a few more people but and by own be, he is obviously stronger which is why they can produce a pretty decent budget document even though it’s forecast are of course a fantasy.  I won’t discuss that.  But there is no machinery.  They have focused on domestic issues for very good reason but therefore they have not to my knowledge even begun to grapple with the global issues.

I do know however that, since you have mentioned him, Larry Summers, would fully agree with the analysis I presented both in terms of the micro- and the macroeconomics, and would have ambitioned of moving the world in this direction.  Whether he can persuade the President that this is a high priory or the highest priority that the resolution of the global problems is actually an essential part of the resolution, the domestic issues, I don’t know.  We haven’t seen much sign of this, there’s no great admissions.  Up to now, most of the running and this has been made by the Europeans in general and the British in particular, and they’ve been doing a pretty mediocre job.

So at the moment I am very, very worried about this London Summit which is a good potential for being, a very good potential break for being a completely damned squib.  I could make one final comment here, you probably all know that this summit particularly for a 22-country summit like this, plus the World Bank and IMF; that everything that is decided is decided by the so-called sherpas–the sherpas are, of course, the people who helped them up to the summit, you understand the metaphor I’m sure or maybe it’s more familiar in France or Britain, I don’t know. 

But anyway, the sherpas helped them up.  The text will all be finish in the next couple of weeks.  So the real decisions that will relate to this summit will be made in the next couple of weeks, not by the leaders there.  And it’s the focus on the meeting that leads to the decisions.  From what I am hearing so far, and I’ve talked to quite a few very senior people engaged in this, the signs are rather disappointing.

Garrick Utley

Question time.  Start right here, please identify yourself.  Then ask your first and we’ll go back and forth.

Audience 1

I have MBA students at Pace University and one of the issues that concern my students is the future of global governance.  Will the leadership of the world rise to the occasion or will they be submerge by domestic politics?  And I ask this in the context of the G20 because this is a world leaders’ level.  This is only the second meeting.  So how is global governance in your view going to take place over the next five to ten years so that my anxious students in their 20s and 30s can have some confidence that the older generation will serve them well for the future?

Garrick Utley

Not to mention the students in this room?

Martin Wolf

Yes.  I think people, I don’t know how old your students would be, let us supposed they are under 30, will they be under 30?

Audience 1

Twenty’s and 30s.

Martin Wolf

Okay.  Well, they have fairly good reasons to think that our generation has made a pretty fair mess of it.  And unfortunately, we inherited a better world than we will bequeath which I think is pretty scandalous in many respects.  I would say that I’ve done my best but perhaps not enough or intelligently but I think in general, we have done a pretty bad job.  I find it very difficult to give them comforting news.  In a sense giving good news, okay... 

The global governments can be think/thought of in two different ways:  As a way of informal coordination issues among--informal coordination machinery among states and the formal institutional structure.  Both of which are very important. 

But just start with the former, the informal coordination machinery, power still rest with states.  Ultimately power rest with states and effective governments does therefore among other things require effective and workable coordination among relevant states.  Now the move to the G20 shows from the G7 and clearly it’s G8, it’s clearly a real shift, is a recognition that emerging economies are now a central players in the global power structure.  My own view and I’m not going to do the invidious thing of listing the members of the G20 and telling you the countries I don’t think should be there.  There are probably more countries in there than we need in the sense that there are quite a few systemically not very significant countries.  But it is clear that all the systemically significant countries in the world, all those countries that have a real impact on the world are members of the G20.  So they’re all there, that very, very important particularly and above all, China’s there and China’s there with other developing countries.  So it doesn’t feel as if it would feel if it were just a member of G8 or G9, that it’s being picked upon which is I think what they felt.  So, that’s very good a genuine improvement.

However, this is a large body of very different states where they don’t share as much as the old Western states did.  They are not naturally inclined to follow the US leaders the Europeans have been.  So it’s going to be much more difficult.  A much more effort is going to need to be made to make this sort of world system work.  A world system in which China and India are great powers is going to be very different from the world system the West has happily run for the last half century.  And I don’t think the West has begun to understand what that means; and that particularly true interestingly of the Europeans even more than the Americans. 

The other side of it which I’ve just said is the formal institutions. I talked about the fund, I could talk about all of them, I’ve worked in the bank and that we need massive restructuring of the fund.  It needs to be much bigger and completely restructured in terms of governance in the fund.  The European have a third of the votes they’ve always have the Managing Director and the Europeans go vote for the fund.  Which is ridiculous, the Western Europeans are dominating.  Will they accept that, one of my favorite statistics the quarter for Belgium and the quarter for India are the same.  Let’s think about it.  Now will that change?  Over their dead bodies.

The US will accept.  US voting weight is probably about right.  It’s actually roughly in line with the size of the economy which is at least the measure.  The China is far too small, India is far too small, and what happens needs to happen is the European weight has the half, essentially it has the half.  And then it’s clear that the Europeans are fighting to their last tooth and the difficulty therefore is I think we might get the reforms, make the G20 work, make the IMF work, it will take five to ten years and we don’t have five to ten years.  It’s the time horizon, that is the problem.  The crisis is now, it has to be dealt with now, and the institution reforms that I’ve talked about are just going to be too slow.  And that’s why I come back to what I said.  The only country that can make a difference here is the US.  And the US has to decide, this is what they really wants to do.  And it has been pretty clear to me that this is not what the US has decided.

Garrick Utley

Question over the back.  Let’s start right down in here.  Please identify yourself and turn on your microphone right there.

Audience 2

My name is Raffy O’Rose.  I’m from Hampton College.  I wanted to ask you if you think there is any danger of Germany getting out of EU or EU breakup if the crises continue going the way it is or did you see any danger?

Martin Wolf

You asked the really interesting questions.  Okay.  You are asking real end-of-the-world questions here?  [Audience laughter]  And maybe you don’t realize that these are the end-of-the-world questions, but these are end-of-the-world questions.

The structure of the European–let me ask the big question in this small--one smaller question, or so many questions that I’ve been discussing these with people here.  The normal answer takes half an hour.  So I’ll cut them at half an hour.

The construction of the European Union was an existential project designed to solve the history problems of interstate relations in Europe–I think you all know about that–which culminated in two sizeable wars.  The last of which in the last of which, 55 million people died and most Europeans, the sensible Europeans decided this was not an experience to be repeated soon.  They’ve done it twice in 30 years that was enough.  So the European Union is not some small economic project.  It’s an existential project.  And above is an existential project for Germany.  In two respects, it solves the problem of Germany in Europe.  Germany has many problems because of its location, importance, significance and weight in Europe and the most obvious is it has nothing but neighbors.  It has nothing but neighbors.  But it doesn’t have these problems.  That’s why we don’t much, right.  For Germany, the whole reason to have the EU is it solves the neighbor problem.  Because they are all one family, there’s an institutional structure for dealing with every problems.  Everybody knows how it work from day to day, predictable, manageable and it doesn’t get anywhere near politics.  That’s the deal, right?  And for Germany, this has worked pretty well for 60 years.  It’s a prosperous, peaceful nation surrounded by neighbors resumed relations in the past have now always been an ideal, okay, to put it gently.  Therefore, what you are envisaging, Germany leaving the European Union is as I said the end of the world.  We are then in a world so inconceivably frightening, that they would only do that if they felt the whole systems smashed to pieces.  Nothing like that has happened.  I don’t think that’s incredibly likely though I would never put things past politicians when they really go on.  However, there are immense stresses in the system now because the Germans have not performed their proper function in my view as a central country in the system.  They’re sucking demand out of the system instead of adding to it, they are putting massive deflationionary pressure on all their neighbors.  That is the real problem in this union.  There is a very real risk if this crisis continues of fiscal crisis within the Euro zone and with all their neighbors to the East.  We have very important Germany they are all neighboring countries and if Germany doesn’t do anything, it could become a not advanced and other big countries, it could be an incredible mess.  The Germans have now committed themselves to bailing out Greece and other such countries if they get into great difficulty but they have to do that.  Greece is likely what they make, what did US do when Mexico goes trouble in 1994.  They rescued it.  They have to.  In the same way Germany has to rescue its neighbors.  They find it difficult to accept this they’re got to do it.  Will they rescue their neighbors to the East?  Yes, in the end, they will.  Unfortunately, they will be drag kicking and screaming to do this, but they will because the alternatives are and they’ll come back to it, the end of the world.

Garrick Utley

Just a follow up quickly on the final point, I think, the sense of your questions.  What about EU nation leaving the Europe?

Martin Wolf

I think the only nation that could credibly leave the Euro is Germany.  The problem that failed the others of leaving the Euro is – well, the problem is a technical problem, very difficult to dispose of quickly.  If you leave the Euro either you re-denominate all your national debt in the domestic currency or you don’t.  If you re-denominate all your debt in the domestic currency that you are now creating, this is a comprehensive, complete international default.  An act of war, essentially, you’re basically robbing all the savings in the world of the value they thought in its currency.  It is doing what Argentina did and this within the Euro zone will be really unfriendly.  If however they didn’t re-denominate, they would then immediately have to default on everyday.  And private and public, they would all be bankrupt.  So for a country with a weak currency situation to leave the Euro zone is Armageddon.  The Germany can from an economic point of view leave the Euro quite easily.  It would have a problem because of the currency with so on, its exporters would be incredible troubles so it would be very unpopular but they could do it, unfortunately, comes back to the end of the world.  So my view is the Euro zone, they’re stuck.  This is marriage from which there is no divorce.

Garrick Utley

Let’s move away from the end of the world.  And get a couple of question.  Manuel–

Manuel Escudero

Manuel Escudero, Senior Fellow of the Levin Institute, two very brief questions.  The first one is that we also have realized with the crisis that we live in a multipolar world.  A multipolar world without multilateralism could mean in the next 20 years fragmented alliances are not very unclear leadership.  Do you think that this is an important factor also for the recovery?  And the second one would be, is the greening of the economy a part of the recovery or is an obstacle?  Can they be reconciled?  Can they go together?

Martin Wolf

Okay, very quickly if I can.  The world is clearly more multipolar than it was 10 years ago.  But it was never even close to be that as unipolarist as some Americans thought.  So I don’t you should exaggerate the change.  I mean if you compare it with 20 years ago or 25 years ago, the Soviet Union is gone, that’s quite helpful.  And most of the states that are left all wanted, the important states, want to play in the same game.  That’s quite important.  They’re all trying to play the same game more or less in the world economy, making the market economy work.  In other words, there are quite powerful shared interests here.  That’s very, very important.

The second point is I would make is though the U.S. is nothing like as unipolar as it thought it was.  The world is nothing like as unipolar as it thought it was.  There is still, the U.S. is still today despite what everybody says, the most powerful single player by a long way though clearly diminished from where it was some years ago.  And I do believe that the rest of the world is looking to the US to provide leadership because there isn’t another leader, there just isn’t.  And we’ll coalesce around it if it’s reasonably sensible in what it proposes and pushes it reasonably hard.  So I think there is some possibility of running this world now effectively.  Ten years from now if everything proceeds as we now expect, 15 years from now it will stop looking very bipolar.  God, it’s going to be very, very big.  And how that will start again, as when it gets bigger it will start looking tripolar.  But how that will look, I don’t know.  I have thought a lot about this, the relations between China and the U.S. in the long run, and I have no real sense of how that will play out because they are two very different civilizations obviously.  I tend to the view I used to tend to the view.  Unless they are so sure of that they had both of these countries have one thing in common.  Basically important they were quite pragmatic.  You know, basically they were on massive ideological crusades to transform the world.  I’m not so sure about this anymore for the US so we’ll have to see.  But I’m not completely I don’t think it’s impossible to imagine you could make this a reasonably stable bipolar world.  But we’ll see.  At the moment however, it isn’t really bipolar.  We’re trying as much we can with the United States, a much more vulnerable and they know it.  They really do know it.  Otherwise, why the hell would they bought $2 trillion of U.S. dollar liabilities.  This isn’t the source of strength; it’s a source of weakness.  The U.S., as I’ve pointed out of my book, could sequester the whole lot and default on it overnight in a conflict situation, very unattractive.

On the greening of America, the greening of the world, I tend to think it’s a help.  I don’t see why it shouldn’t be if you pursue one of the encouraging things in the budget is there is the announcement essentially that the US is going to a cap-and-trade system.  We’ll have to see whether that works when it happens.  I think it’s going to be part of the solutions to revenue problems.  You know the U.S. can tax gasoline, well, it can tax carbon it’s just as good.  And the U.S. is certainly going to need revenue.  The budget statistics are quite something in the long run.  And I think that we need a large world investment program of some kind to absorb all these excess savings instead of putting them into houses nobody needs.  We could actually build useful infrastructure and as part of it, it would be new power grids and power structures.  So I actually don’t see why it shouldn’t be a useful part of the medium to long run recovery from this mess.  People want to save more than they can use at home, at least put it into investment, don’t consume it.

Martin Wolf

Questions here.  Any among the, any students?  Thank you.  We want to come back to you because you’ll be called on.  Jack.  Just identify yourself.

Jack Callaman

My name is Jack Callaman and I’m a stock broker.  Ever since Obama has been elected, the “N” word has been haunting him.  How would you counsel him to deal with the nationalization question?

Martin Wolf

Yes.  I’ve been thinking of writing a column about this for next Wednesday because I think it’s a complete--the way it’s presented is complete non-issue.  I just don’t understand what this is all about.  Let me put it in two ways:

First one is the real question.  The real question is who bears the losses?  It’s quite simple.  In my view, there are very large losses which have reduced almost certainly but we don’t know.  I will see about the famous stress testing.  The value of a number of major financial institutions have assets below their liabilities.  So they are massively capital short, right?  And that would be true even if they were roughly–So we are going to get additional capital into these institutions.  And the question which has very uncertain balance sheets on the asset side.  The question is how do you that?  In essence, in the present circumstances because of the uncertain, I can’t get more--choose any true sources of this capital.  One is the public sector – so we invest a large amount and in the process electively becomes the majority owner which is where it’s going.  And the second possibility which is the standard route is bankruptcy.  What most people talked about when they talked about nationalization, I think they actually mean bankruptcy.  They mean what they have FDIC would normally do.  You take an institution, you write down the value of the assumed debt, they preferred, they subordinate it, they loss a hell of a lot of money, they are then the owners of the institution; you got your capital.  End of story.  The real issue here is that they don’t want to do that.  Because the people who own this stock really don’t want to be liquidated.  Well, that’s quite understandable but it’s bankruptcy.  And the funny thing is that’s what most people mean by “nationalization”.  You take over the institution, restructure of the asset, and so forth.  But in the end, the question is where the capital come from?

Now, am I tend to be very sympathetic to the latter solution, the bankruptcy restructuring solution.  If the government doesn’t go that route and decides essentially to do what it’s now doing, putting more and more capital into these institutions, it is the predominant supply of risk capital to the institutions which they are now.  I don’t care what you call it, it’s nationalize.  If you are running CitiBank today, who is your most important shield?  The government.  Who else you care about?  Then I need people to supply capital to you so of course you have to pay attention to what the government thinks and the idea that in this situation, the government can say, “Well, we are the dominant investor.” You go and run the institution any way you please.  It’s absurd.  You can’t possibly do it.  So instead of just doing it out right, making the decision, we are playing games and pretending that what is in fact the nationalization process isn’t one.  As combination which you got the private decision making in the institution and the government is bearing all the risk, is not tenable.  So they have to decide in the end what the solution.  And my solution is, in my view, is you restructure this.  They have to restucture the institution for a bankruptcy process as I’ve described.

Finally, even if you did in put in lots of public capital, clearly the aim, of course, is to re-privatize as soon as possible.  Once you cleaned up the balance sheets which is obviously the aim to take out toxic assets and don’t worry about the horrible process of trying to. To try to market great amount of toxic assets is I think is unworkable.  Just take them out, put them in a separate bank.  You then got a clean bank you can sell it back to the market because everybody then knows what the balance sheet is worth.  So I think nationalization is a complete real headache 1:39:49 and I don’t understand how it got into this debate at all.

Garrick Utley

Then we are going to take an iPod of this what you just commented and send it to Paul Krugman.  [Laughter]  So he can have--he is “The New York Time” columnist and economist who has been beating the drum for “nationalization” in that work.

Martin Wolf

Pre-privatization is what we call it.


Garrick Utley

Okay.  Right here.  Please identify yourself.

Fletcher Hughes

My name is Fletcher Hughes.  I’m an investment manager.  And I help to set up some of the Equity and Securities market in Eastern Europe.  My question is not strictly macroeconomic but it does turn on.  The question is who is responsible for the mess?  And I read your column regularly and some other things the “Financial Times”, and I’m surprised more interest hasn’t been fastened on the question of how these boards; the bank boards have been involved in this whole proposition?  And as I look at these boards, the bank boards, what I see are a lot of prominent names.  People who have accomplished a great deal on their own fields, but very few of them know anything about banking.  And I’m wondering whether you feel that as part of the reform in this whole mess we ought not to professionalize the bank board.  We require Merrill Lynch brokers to take certain test as a basic guarantee that they know what they are doing.  How about bank boards?  What can be done to turn these into more professional institutions?

Martin Wolf

Well, I agree.  First, I agree.  Second, I think its part of a generalized problem of corporate governance.  It’s not unique to banks.  This is a generalized problem of corporate governance particularly Anglo-Saxon shareholder.  I just spoke to somebody--shareholder-driven companies but I think it tends to be, in my view, this is a British perspective and I don’t want to put this too far because our banks have been pretty sensationally incompetent, too.  I won’t go into the reasons for that.  But it is very common in the United States as I see it for the Chairman and CEO role to be combined in one which is contrary to our standards.  Completely we would always insist on the separation of these two roles, and for the Board essentially to be appointed by these people.  So the board is an echo for they’ve been selected precisely because they aren’t a problem.  If you have a very complicated business which is very nontransparent and in addition have the benefit of very large implicit public guarantees, implicit or even explicit, and you have essentially a dictatorship is what I’m describing.  You’re going to depend entirely on the probity, good sense, self-discipline of one person.  Well, I have a view on relying on that.  It’s not a very good governance structure.  That’s why, politically, we have democracy.  So, I think that the corporate governance we’ve allowed to revolve not just in banking but more broadly is extremely defective.  This is being reinforced in the U.S. by excessive reduction actually in effectiveness of shareholders in a number of ways.  So I support what you say but I would go much further.  I think there’s a profound dysfunction in boards across particularly in Britain and America but I think it’s actually in the respects I’ve discussed worse here.

Garrick Utley

Question.  Please identify yourself.

Nick Schwartz

I’m Nick Schwartz with BGIA.  And I was wondering obviously one of the big problems right now is China’s excess savings clout and what do you think that they could do to spur basically to get rid of those excess savings whether by domestic consumption or spurring demand among its populace or investment in any way?  What are your thoughts?

Martin Wolf

Yeah, okay, that’s quite a big question.  First of all, for those of you who are not familiar with the numbers for China, and the numbers of China aren’t certain because natural income data of China are not so--But broadly speaking, this is the picture for China.  The gross national savings rate for China is 60% of GDP.  I repeat 60% of GDP and consumption is 40%.  The domestic investment is about 50% of GDP.  There are some problems with this data you may have to knock off 5 percentage points or so, if 50% of GDP in the current account surplus is roughly 10.  So that’s how the savings are disposed; 5/6 is at home and 1/6 is abroad.  Consumption is therefore obviously 40% of GDP.  Of that roughly speaking, 10 percentage point is public and the rest is household, so household consumption is 30% of GDP, roughly speaking.  But household disposable income is not much more than 40% of GDP.  These are all quite extraordinary numbers.  I mean this is so outsight the normal structure of an economy that it’s very difficult to answer this question easily.

So what this means is, I don’t go into the question of how it got to be like this because it’s fascinating and very complicated and I think a lot of it we don’t understand.  But this means that raising consumptions it’s a really big chunk of GDP out of household consumption, it means they have to stop saving altogether.  And households in China are not going to stop saving altogether.  It’s just not relevant, okay.

So all the stuff, these pugs, all these discussions right on safety nets, we constantly get it.  It’s absolutely irrelevant to this problem.  It’s very relevant to the future of Chinese welfare and something that should be done but it won’t solve this problem.  They’re saving about a third of disposable income and that probably what the Chinese are going to go on doing just as the Indians doing a little less than a third of their disposable income.  Two-thirds of the savings in China come from the corporate sector and government, not from the household sector and that’s the problem.  And the problem is a complete breakdown of corporate governance again because the savings from the corporate sector don’t belong to anybody, mostly governments.

So the answer in the short run is you extract resources from the corporate sector through dividends and taxation that goes to the government.  The government spends.  The government spends on public consumption and transferring income directly to the household sector.  That’s the core of it, very easy because China has a proper government.  It can run things unlike most comparable emerging countries.  If they decide to send money to every Chinese citizen, it would get there, if they really wanted to.  And that’s how in my view it starts and they can start spending it.  They can also spend on the house system which has collapsed in the rural areas, the education system, and so.  A lot of that is part of what they’re doing. 

Unfortunately, a lot of what they are now doing is not that.  It’s just even more cement and concrete and steel.  They got a capacity to produce 600 million tons of steel a year I understand, while you have to build an awful lot of roads and other things to use all that stocks.  So the problem is what again to do to increase spending in the short run will not add to jobs, it will not add to welfare, but it will all certainly add to the flow of concrete across China.  The longer term changes of what I’ve described--the medium term changes of what I described are change in getting the income to the household.  Forty percent of GDP disposable income is ridiculous.  It’s just ridiculous.  That means a vast part of the Chinese people aren’t receiving the income flow of the country.  And of course that explains why consumption is so low.  It’s completely different in China.

And in the longer run, they got to attach ownership to households and they go to get away from what has become, only in this decade, it wasn’t true previously, a very capital intensive line of development which isn’t generating employment.  In contrary to what many people think, everyone says they got to keep exports going to generate employment.  The manufacturing sector said it is not generating jobs in China.  And the reason they are not generating employment is the service sector doesn’t grow which is where jobs normally come from, it’s being need of share and that one grow without consumption, and that one grows once disposable income is 40% of GDP.  So basically, very simply, China has to be restructured.  From a 1.3 billion population country, so it’s not going to happen except in the crisis.  And the good thing about what’s happening and the only good thing about what’s happening is the crisis is now here.  And the Chinese government knows because that they really do understand.  I’ve spoke into them.  I’ve seen the Prime Minister recently in the World Economic Forum they know they have to change the structure.  And that is promising because unlike the Germans and the Japanese knowing that, I think they would do it.

Garrick Utley

I think we have to call a halt to it there but just to follow up on the point and on your question, somebody explained once about the complexities of China and all the figures, the details which Martin I’m sure masters much better than the rest of us.  Just look at it this way, any number you choose multiplied by 1.3 billion is a big number.  And I think coming back at this point quite aside from the financial crisis, the economic recessions which is now global and just how we are all interconnected.  It’s going to be this relationship in so many levels – political, social, cultural, economic and financial – between United States and China or the Western world and China, that’s going to be really determinant.  It has been said and I said and some of you have heard this many times that up till quite recently, the most important alliance in the world arguably was between the People’s Republic of China and the consumers Republic of Wal-Mart; export and consumption.  Well that world may be breaking down, that alliance may be weakening severely and we don’t know what’s going to take its place.  We hope and trust that’s not going to be the end of the world.  But it is the end of our session this evening.

I want to thank Martin again for being here.  [Applause]  And we’ll take you up on your invitation to come back annually and Carter, too, you want to say a word?  Because thank you very much for everything you have done to make this possible.  Thank you and above all thanks to all of you.  Goodnight.

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