Global Policy Forum

By Joseph Stiglitz

JOANNE MYERS: We welcome members and guests to our Books for Breakfast program. This morning Dr. Joseph Stiglitz will be discussing his recently published book The Roaring Nineties: A New History of the World's Most Prosperous Decade.

Not too long ago many of us were privileged to listen to a discussion of Dr. Stiglitz's internationally best-selling book Globalization and Its Discontents. At that time our guest examined the strengths and weaknesses of the main institutions governing globalization.

This morning's talk could be described as a natural sequel to this earlier work, as Dr. Stiglitz sees parallels between what went wrong with globalization abroad and what went wrong with America in the nineties.

If you think that economic policies administered by America during the Roaring Nineties contributed to this decade of extraordinary growth, you may be right. Yet, before we become too nostalgic for the so-called "golden age of prosperity," the age of mega-deals and mega-growth, we should listen very carefully as our guest reexamines how one of the greatest economic expansions in history sowed the seeds of its own collapse, leaving us to ask a sobering question "why did it all go so wrong?" for, in Dr. Stiglitz's view, economic mistakes made in the nineties have led to many of the economic problems we are facing today.

One cannot be too economical when singing the praises of our guest this morning as Dr. Stiglitz is one of the most prominent and original economic theorists in the world today. As Chairman of former President Clinton's Council of Economic Advisors, and later Vice President and Chief Economist at the World Bank, Dr. Stiglitz was deeply involved in many of the policy decisions of the decade and was uniquely positioned to watch the nineties unfold.

He has helped to create a new branch of economics called the economics of information and has made major contributions to macroeconomics and monetary theory, to development economics and trade theory, to public and corporate finance, to the theories of industrial and rural organization, and to the theories of welfare economics and of income and wealth distribution.

In addition, he is recognized around the world as a leading economics educator. His academic career has taken him to Princeton, Stanford, MIT, Oxford, and Columbia, where he currently holds a chair and joint professorships in the Graduate School of Economics, School of International and Public Affairs, and its Graduate School of Business.

Dr. Stiglitz, just as we have benefited from your earlier analysis of flaws within the IMF, the World Bank, and the WTO, we are looking forward to hearing your views about finding the right balance between government and the market so that our economy can achieve the same growth and long-term efficiency in the years to come.

Please join me in welcoming Dr. Joseph Stiglitz.

JOSEPH STIGLITZ: Thank you very much for the introduction, which has actually said everything I had to say in the book, so I guess I can just answer questions. Let me just try to elaborate on a few of the things that you said.

What motivated me in writing this book was that the nineties were viewed as a fabulous decade. The economy was roaring. We even talked about the new economy which was to mean the end of the business cycle. We don't want to remember that, because we have lost almost 3 million jobs in the last three years. At least at the beginning of the decade, we also had a "globalization bubble." Everybody thought globalization American style would take over the world and bring prosperity to all.

By the end of the decade and the beginning of this current century, both of those bubbles have been broken. We realized that we were not on a never-ending, upward path, but that our economy was in a downturn. And even before that, December of 1999, with the protest movement in Seattle against the new round of trade negotiations, what was supposed to be the feather in the cap of Clinton's international economic policy turned into riots instead.

It was clear that if globalization was bringing unprecedented prosperity to the world, an awful lot of people didn't seem to know or appreciate it. One of the points in my earlier book was that that unhappiness was in fact justified. As early as 1997-1998, a global financial crisis showed that globalization wasn't working out quite as well as we had hoped.

If we had claimed, as we did so strongly in the Clinton Administration, that we should be given credit for the successes of the nineties, we ought to have to take some blame, because as I jokingly say, the downturn started even before Bush had a chance to do all the damage that he has done since. But it wasn't an issue of trying to assess credit or blame that motivated me. It was trying to learn the lessons of the nineties, to try to understand what we had done right and wrong, that prompted me to write this book.

In thinking about the economy, it is essential to try to get the balance between the market and the government or the state right to get good economic performance, and avoid very negative side effects on poverty. In some ways we failed to get that balance right. The central lesson of economics over the last more than 200 years has been Adam Smith's view about the "invisible hand" -- that markets lead, as if by an invisible hand, to efficiency; or that the individual pursuit of self-interest leads, as if by an invisible hand, to economic efficiency.

One of the main results of my work on asymmetric information -- which is just a fancy name for saying that different people know different things -- was to show that the reason the invisible hand often seems invisible is that it is not there. That means that there is an important role for government. Or to put it another way, every game needs rules and referees to avoid chaos, and that is true of the market game as well.

I will touch on four themes and then open it up to questions.

1. In the nineties we sowed some of the seeds of destruction of the bubble; the boom that we had, and some of the economic problems we have today originate in that.
2. The same can be said about the way in which we managed globalization. In our successes in the beginning, we again sowed the seeds of the problems that we had by the end of the decade and into the current one.
3. How in the first place did we get out of the recession of 1990-1991? The standard interpretation of what we did, I argue, is not only wrong but dangerous.
4. As I look at the Clinton record in economic performance and compare it to what happened before and after, I have to give it an A+.

Let me elaborate on these themes quickly.

1) What were some of these seeds of destruction? One has to do with macroeconomic policy, CEO stock options, broader accounting problems, excessive deregulation, the banking system, and taxation. One of the central problems was stock options and the way we accounted for them. The CEOs' compensation increased enormously during the 1990s, partly because many people didn't know about what was going on. That was only part of it. It is an example of ways in which markets are not functioning quite right.

Part of the reason that CEO compensation went up so much was that the portion of it that went into stock options increased enormously. Stock options are fantastic because the CEO knows it's of value, and that's why he likes it, but they seem to come out of thin air. It's like manna from heaven or the repeal of the law of conservation of matter -- somebody receives something, but nobody has to give it.

Those of us who studied physics know about the laws of conservation of matter, and if somebody is receiving something, somebody has to be giving it. The problem is that the people who were giving it didn't know that they were doing so. When you give a stock option you are giving something of enormous market value, which means the difference between what the market thinks is the market price and the price at which you will be able to purchase it. That capital gain is something of value. You are diluting other shareholders' interests in a company.

It is a way of paying CEOs that may make sense in terms of incentives. It went too far. Did people know what they were giving their CEOs? Why is that important? The most important factor goes back to the economics of information. The way the market system works is that we have prices; prices guide the allocation of resources; when prices go up, that says "produce more of that, invest more in that industry."

But if that market signal is to lead to efficiency, the prices have to reflect reality. The information embedded in the prices has to be accurate information. If the market has distorted information, those prices do not reflect reality -- they could be too high, or in some cases too low. But in these cases, because you were not reflecting what was going on, the prices in a large number of sectors, particularly the high tech and telecom, were too high. What happened? We had more investment. They were doing what the prices said they were supposed to do: they were following the market signals. So they invested more.

But they invested too much, and we wound up with overcapacity, which eventually becomes so transparent that it cannot be sustained, the bubble breaks. And that is exactly what happened here. This is not the first time, but we could see it happening right before our eyes. In 1993-1994, when I was on the Council of Economic Advisors, we saw this coming, way before even the bubble started. We argued for reform of our accounting for these stock options. At the time nobody paid much attention.

The Financial Accounting Standards Board which is supposed to set these standards, had pointed out that there was a problem and had proposed a reform. The Council of Economic Advisors very strongly supported that reform. But the people who were making money out of this deception did not want reform. They went to Treasury, Commerce and Congress and said, "You have to stop the Financial Accounting Standards Board from making this reform."

We had an active debate. The argument that Treasury used was quite astounding: if we had this reform, prices and the stock market would fall. If people only knew what was being given away to their executives, if they only had the right information, they would realize the prices were overvalued and they would come down. We thought that was an argument for reform. They thought it was an argument against. But there was a reason: who wants to be a party pooper? And many people were making a lot of money, and expected to make even more money, out of this form of deception.

Pressure was put on Congress and the Administration. The Administration and the Congress put pressure on the FASB, and reform was killed. Arthur Leavitt, who was Chairman at the time of the Securities and Exchange Commission, views that as the most significant mistake of his career.

There were other problems. We pursued excessive deregulation. Many of the regulations in the U.S. dated back to the thirties and forties. The economy had changed and we needed to redesign our regulatory framework. The problem was that we followed the deregulation mantra. Rather than asking what was the right regulatory framework -- which meant we needed to strip down regulations in some areas; increase it in other areas, like accounting; change it in still others -- we followed the mantra "just get rid of the regulations."

The result was that we exacerbated some of the problem. It is not an accident that three of the problem sectors in the economy in the last few years are the sectors of deregulation -- telecom; electricity, where there was the manipulation; and banking.

Let me give a brief story that illustrates the point. We had a heated debate about banking reform. One aspect of banking reform was repeal of the Glass-Steagall Act, a bill that separates commercial from investment banking, which was passed after the problems in the twenties and thirties. The investment and commercial banks both saw new opportunities by getting together. The reason it had been passed earlier was that there were important conflicts of interest when you join them together. We argued: "If you bring them together, these conflicts of interest that we had seen before would re-emerge." Treasury's reply was: "Don't worry, trust us." And the other one was: "We'll create Chinese walls" -- walls to ensure that you don't talk to each other and thus avoid conflicts of interest. We responded: if you're not talking to each other, how will you have the synergies? The argument for putting things together was to create synergies of interaction. You can't have it both ways. If you are not going to talk to each other, keep it separate and then there is no risk of conflict of interest.

They repealed the Glass-Steagall Act. In what happened in Enron, you see the working out of the conflicts of interest and its contribution to the company's problems and its demise.

There are other more important conflicts of interest in the banking sector that have been well talked about -- the IPOs, with the conflict of interest between the investment banks and the CEO and the companies they represent, and between the analysts who give accurate information to ordinary shareholders but are making their money from the investment banks doing the deals. The system was rife with these conflicts of interest, and repealing the Glass-Steagall Act only made it worse.

Again, the SEC recognized some of these conflicts of interest and tried to do something about it. One of them was the Fair Disclosure initiative, which stated that if a company disclosed information to the analyst, it had to disclose it to everybody. By providing inside information to the analyst it created another element of a cabal between the analyst and the company that was a source of problems. I was on the commission organized by the SEC – Valuation in the New Economy – which included Ken Lay, the head of Enron. The representatives from many of these firms, including Enron, said: Fair Disclosure would be terrible; it will undermine; if you have to disclose it fairly, we won't disclose anything. This is a commitment to having a well-functioning market with information. They then went on to say: "You don't have to worry about this. You should trust us. Market forces will take care of it all." It did eventually, but not until many people got hurt in the process.

Another example was what we did with tax policy. As the bubble was going up and getting worse, what did we do? We cut capital gains taxes, saying to the market: if you make more money out of this speculative bubble, you can keep more of it. If you look at what happened to tax policy during the nineties, it is quite astounding. What we did in 1993 was raise taxes on upper-middle-income Americans who worked for a living, and then in 1997 we lowered taxes for upper-income Americans who speculated for a living. You ask the question: what sorts of values did that change represent? It had much to do with politics, but it still raises fundamental problems. The focus in my book is not so much the equity issues, which have been raised in the press, but the broader issues of efficiency, the workings of the market economy.

The final element to examine is macro policy as part of the seeds of destruction. Alan Greenspan recognized that there was a problem fairly early on. In 1996 he gave this famous speech about "irrational exuberance." He wanted to let the air out of the bubble gradually because there is a long history that if you let bubbles get too high, they cause problems when they crash. But markets usually can't be talked down. He did have an effect for about three days, and then the new data came out from the Labor Department and it started going up. The data don't reflect any effect of the speech.

But then, in 1997, 1998, 1999, when the market soared way over what it had been in 1996 -- if you believe there was a bubble in 1996, you had to believe that there was a real bubble by 1997, 1998, 1999 -- the Fed started talking up the bubble: "We're in a new era, new economy, profits will soar, low interest rates." But it was worse that that. We have a more information now because of finally forcing the Fed to disclose meeting proceedings with a long lag. Not only did the Fed recognize that there was a bubble, but they also recognized that they had some means to take care of it.

Raising interest rates would have been a problem because it would have weakened the economy at the same time it took the air out of the bubble. There are other instruments which he chose not to use -- for instance, raising margin requirements, analogous to requiring a larger down payment on a house; if you require a larger down payment on a house, it can dampen a speculative real estate bubble.

2) The second theme to examine is how we mismanaged globalization. At the end of the Cold War, the U.S. as the sole superpower had an opportunity and a responsibility to help reshape the global economic order. For forty years the conflict between the two economic systems had dominated every aspect of international economic life. Now the Cold War was over, market economies have triumphed, one had an opportunity to stand back from the way we had run the international system, to try to create an international economic order based on principles like social justice, fairness between developed and less-developed countries. But we lacked a vision. The financial and commercial sector in the U.S. did have a vision. They might not believe in government having an active role, except when it advanced their interest. The active role that they pushed for was to gain market access, to push an agenda that advanced our own interests.

As a result, we got some very unbalanced trade agreements. Mickey Kantor was carrying out the mandate that he was given. He wasn't trying to create a fair international economic order; he was trying to conclude the best deal for the U.S. One can trace the problems in the global financial system, the problems in Cancun more recently, the breakdown of the trade negotiations, to the unbalanced approach to globalization that we began in the nineties and made worse in the last few years.

3) The third topic is how to climb out of the downturn? Here the story of the Clinton Administration is very simple, and it has been repeated so often and so forcefully that it is believed by most people. We reduced the deficit, that allowed interest rates to come down, that stimulated investment, and that got us out of the recession. The only thing that's wrong with that story is that it is exactly the opposite of what has been taught in virtually every course in economics for the past seventy years, that is, if you face an economic downturn, the solution is to lower taxes or increase expenditure, which in turn increases the deficit, and stimulates the economy, and that gets you out of the recession. This is a dangerous doctrine in that it is the set of policies that were pursued in Argentina, in Thailand, in Indonesia, in Korea, and elsewhere, and in every case, reducing the deficit in an economic downturn had exactly the predictable effect that economic textbooks said: it made the downs into recessions and recessions into depressions.

It should have been clear that something was fishy about that story. Why? Because if what would grow the economy was lowering interest rates, stimulating investment, there is nothing in economic theory or history that says the Fed only has the ability to lower interest rates when the deficit is low. It is easier for the Fed to lower interest rates to achieve full employment when deficits are high. You may not lower the interest rates to the same level, but the level required to stimulate the economy to full employment is such that you can do it no matter what the level of deficit.

What was happening? This raises some very troubling questions for our institutions. The argument has long been put that we want to have an independent, nonpartisan central bank, that looks at these issues in a technocratic way. In fact that is not the case, because the Fed has had a political agenda. The reason I feel so strongly about it is not only this particular experience, but a few years later, in the spring of 2001, the Fed and its Chairman came out in support of a tax cut that was not designed to stimulate the economy but to give benefits to upper-income Americans who would likely not spend much of the money. The tax cut did not turn out to stimulate the economy.

But what is of more concern was the argument that he put forward, that the U.S. and the Fed faced an imminent threat, that we were about to pay off our national debt. We would have no debt, no T bills, and the Fed would have difficulty in undertaking open market operations. This imminent threat was not to come for about ten or twelve years, assuming that the numbers about the projection of the surpluses were real. Greenspan had been Chairman of the Council of Economic Advisors and he knew that the numbers in those projections ten years out are nothing but mythical. You don't spend your surpluses before they are realized. He never said, "Why do we have to spend our surpluses today, ten years before we see the debt running out? Congress is perfectly capable of spending money very quickly." So if it turned out that in the year 2008 we had almost gotten rid of our debt and we faced a threat of running out of T bills, it would have been very easy for Congress to have solved that problem overnight. But he wanted to look ten-twelve years ahead of time. His real mission was the conservative mission of downsizing the government, cutting back taxes. It was a political agenda, not an economic agenda, which raises fundamental questions about our institutional design.

4) The final question has to do with current economic policy. Every administration inherits advantages and weaknesses. When Clinton arrived during a recession -- we had a huge fiscal deficit of 5% of GDP -- we're back there again; we had a huge trade deficit; we had growing inequality -- for twenty years the bottom part of Americans' income distribution had been getting poorer; they had not partaken of any of the growth that we have had in the preceding twenty years.

During the Clinton Administration, the fiscal deficit was not only eliminated, but turned into close to a 2% surplus and a reversal of the growing inequality by the beginning of this century. When Bush came to power he inherited a weak economy, but he had one very big advantage: he had a 2% surplus. That provided him with money and resources, with which he could have fought that recession by designing a stimulus package for the economy. The ingredients were clear: increasing unemployment benefits, tax cuts for the lower-income individuals, aid to states and localities.

It was perfectly predictable what would happen over the next two years in terms of a stranglehold on the states and localities who faced balanced budgets. When their incomes decrease with a recession, they have to ease or cut back expenditures or raise taxes, which dampens the economy. The result is three years of economic malaise -- not all recession, but an enormous gap between our actual performance and our potential. We have lost approximately $1 trillion, which is a lot of money even for a rich country. When we think about what we could have done for our social problems with that $1 trillion, it makes you weep.

Meanwhile, the other problems have worsened. Almost inevitably whenever you have increasingly large fiscal deficit, your trade deficits increase. We, the richest country in the world, are borrowing more than $1.5 billion a day. We are not living within our means while we are lecturing countries all around the world that they should be doing so. The trade deficit means that we are losing jobs in manufacturing, which is resulting in our bashing. In the Reagan deficit in the eighties, we bashed Japan. Japan is sufficiently weak that we decided not to bash them this time, so we're bashing China which is having adverse effects for global political relations.

But the real fault lies with our macroeconomic policy, our fiscal policy, that is reflected in our trade deficit, and our failure to stimulate the economy, which we could have done given the huge surplus that Bush inherited. The bottom line is very simple. There were some very important strengths in the nineties. The new economy may have been hype. It was not the end of the business cycle. But there was new technology. Since then we have been living off the strength of the past. The Internet was an invention of technology that was discovered not in the nineties but in earlier decades. Innovation in one period depends on basic research that is done in an earlier period, mostly in the public sector.

That we are having deficits now, and will have deficits for years to come, means that the stranglehold on these basic expenditures necessary for making the market economy work will continue. We must learn these lessons of the nineties. We must restore the balance between the public and private sector if we are to resume the robust growth that is part of our potential, and make globalization work not only for us but for all the world.

JOANNE MYERS: We will open the floor to questions now.

QUESTION: You have created global confusion. In so many capitals around the world during the Cold War and immediately after, they knew what path to follow -- listen to the IMF, listen to the Treasury representative. He comes to your capital and says, "Deregulate, give stock options." He came with a package of advice to follow. In the 1990s, especially after the Asian financial crisis, especially after listening to you in your first book, and now certainly after listening to you in your second book, you have created a practical dilemma for policymakers. When they face real problems in the management of their economies, do they listen to the Treasury, the IMF or to you?

JOSEPH STIGLITZ: If they listen to Treasury and IMF, they know that they will go down the route of Latin American countries, which have seen their growth reduced to just over half of what it was during the fifties, sixties, and seventies, and where unemployment and poverty have increased. My book has resonated because of a disillusionment with old advice and the search for an alternative. One of the important points in my book is that the advice that Treasury and IMF have given does not describe what the U.S. or East Asia has done, and therefore does not describe what has led to success elsewhere.

For example, the IMF has often prescribed privatization of social security. This is a contentious issue in the U.S., but the evidence is that it certainly is not associated with improved security of old age retirement. If you look at the case of Argentina, which followed that advice, their entire deficit at the time of the crisis was a result of their privatization of social security. Had they not privatized social security, at the time of the crisis they would have had a zero deficit.

There are many other examples of a difference between what we say to other countries and what we do ourselves. In earlier stages of our development government played a very important role in our financial market -- Fannie Mae for housing, Small Business Administration for small businesses, student loans. In some years it was over 25% of all financing in the U.S. either through government agencies or guarantees. In 1863 we created our Land Grant colleges, which did research and extension services in agriculture. Not only did the U.S. government promote Internet, invent the Internet; it also laid the first telegraph line in 1840. There is a long history of balanced government involvement in the economy. It wasn't like socialism where it was overly obtrusive, but in the U.S. we have always tried to get that balance. We have not always done it perfectly. During the eighties we had the S&L crisis because of the way we deregulated the financial system.

The problem with the IMF and the Treasury is that they don't represent the broad view of the U.S.; they represent a view of one particular set of views that has not worked. What should governments do? Simplistic answers lead to problems. We need to debate these issues and look for conflicts of interest. The good news is that in Singapore and in other countries around the world, many people are now well educated and capable of addressing those issues.

QUESTION: Interest rates are the lowest, consumers are spending the maximum, the low dollar rate is good for exports, and the government is running at a deficit which is at a historical high. All of the elements of your recipe are there today, so you must be extremely happy with this successful macroeconomic configuration.

I note the complete absence of the role of savings in your presentation. If you compare the situation in the Netherlands, for example, with that in the U.S., there is a tremendous scheme of compulsory pension savings, which if you translate it to the American situation would mean a portfolio of about $10 trillion ready to make investments and provide a strong underpinning for your financial system. Since your recommendations go along the lines of increased spending, aren't you doing exactly the same as the stock-options style psychology, failing to inform consumers about the cost of the budget deficit?

JOSEPH STIGLITZ: Very few firms are able to finance all of their investment. Why do you borrow? You borrow to invest, to buy machines that allow you to grow, expand. If you are borrowing for investment goods -- for roads, infrastructure, technology, research -- those are investments in the future, and there are sound reasons why some of those investments should be funded by borrowing, because the benefits will be reaped in the future and the people who will reap the benefits are paying some of the costs by your borrowing. If you are a family and you are borrowing to have a nice vacation in the Bahamas, then you will have problems.

That is the fundamental distinction. If we are borrowing for investment -- which I recommend -- that makes sense, that makes your country stronger. My worry was that in the single-minded focus on deficit reduction we cut out some of the investments that were the basis of the roaring nineties, our technology, and that is jeopardizing our future.

Our savings have been very low. The current recovery was based on low interest rates that did not lead to more investment. If it had led to more investment, you would say, "That's great. We're stimulating the economy." At this juncture our economy is weaker than it was two years ago. We have been dis-investing, and our households have been getting more and more in debt. And that represents a certain fragility to our recovery because as the economy recovers, normally interest rates rise. The Fed only controls the short end of the T bill rate normally. Already, the spread between the short rate and the long rate is much larger than it was four years ago.

If the market reflects that the government is borrowing enormous amounts of money, it will see that interest rates are likely to increase in the future. There is a turnaround in our borrowing requirements from the 2% of GDP surplus to a 5% deficit, which represents about $700 billion over the next ten years. So we're demanding money to fund government consumption -- I don't now whether you call dropping bombs in Iraq consumption or investment, but it is certainly not leading to greater productivity in the American economy. We have deficit spending, which will be driving interest rates, but we will not have the underlying capital, either in education or infrastructure or technology or research, that will allow us to have the strength to go forward.

QUESTION: I was straining to hear from you the three words "service economy" and "consumerism." The conventional wisdom is that we no longer make anything, we don't make animate things; we sell our brains, we sell our services. Is that conventional wisdom true; and, if so, what is the long-term impact? What are the consequences down the road for this kind of an economy on our nation?

JOSEPH STIGLITZ: It is largely true. Right now in the U.S. only about 14% of our population is engaged in manufacturing. There has been a transformation analogous to what happened a little more than 100 years ago. We went from agriculture to manufacturing, and now we are going from manufacturing to a service sector economy.

At the global level this has some very important implications. We talk about the principle of comparative advantage: each country should be exporting and producing the things that it is relatively strong in, importing the things that it is relatively weak in. Our comparative advantage is in skill-intensive, research-intensive areas. If we specialize in those, our incomes will rise. China and other developing countries have a comparative advantage in manufacturing.

There are enormous difficulties in making a transition, particularly for those in manufacturing who will be losing their jobs, and there is a need for assistance in that transition. The U.S. risks following the path that we have in agriculture, a sector that has declined. And what are we doing now? We passed a bill two years ago that provides $190 billion for this declining sector of our economy. There are certain strengths in it, but the subsidies are going to the parts of our agriculture sector that can't compete; that's why we're giving it $190 billion. The real risk I see is doing the same thing in manufacturing, either through direct subsidies or attempts at protection in a variety of forms. It makes much more sense for us to think about what our strengths are and to recognize that there has to be assistance in making that transition.

QUESTION: Today, 46% of the American bonds and indebtedness is in the hands of foreigners. We have a very interesting nexus: we have our need to finance our deficit, so we are printing money; we are selling bonds, and we are selling bonds to China and other Far Eastern countries, and supporting their growth; they, in turn, finish the cycle by coming back and buying our bonds again. How do we get out of this? And do we ever inflate out of this, or are there political implications of a deeper nature?

JOSEPH STIGLITZ: On the issue of long-run stability of a global financial system, you have identified what is probably the most serious problem. We are living beyond our means. We are borrowing about 5% of our GDP from abroad every year, which means that every year they are buying up an equivalent of 5% of our GDP in assets, including U.S. Treasury bills and other assets.

The fundamental risk is that at some point foreigners' holdings of U.S. bonds get so large that they ask: "Is this prudent? Do I want to have as much of my wealth in U.S. Treasury bills?" What happens if there is a president who doesn't seem to know how to manage economic policy, or a Fed that doesn't know how to manage economic policy? What happens if somebody decides to want to inflate or waive the value of the bonds, or does it by mistake, or pretends that we are fighting a war and, as in the case of Johnson, doesn't disclose how much we are spending on that war?

There are many issues that people can raise, many reasons why prudent management would say, "Let's diversify and hold less in the form of U.S. Treasury bills." And, even a slight diversification of holding fewer of those would mean that they would be selling those bonds, which could cause significant global instability. It also means that there is a potential constraint on the pursuit of U.S. diplomatic policy. If the U.S. decides to beat up on a country, they can say, "Why are we holding so many U.S. Treasury bills, lending to the United States at 1% interest? Does this make sense for us?"

The fundamental problem is both the U.S. fiscal deficit, which leads to the trade deficit. As long as we are saving so little, we have to borrow from abroad. The saving could be either little in the public sector or in the private sector. Now it is on both sides, with negative savings in the public sector. The lack of savings in the U.S. and borrowing and the global reserve system contributes to an inherent instability. With the dollar reserve system, we have to ship our T bills for people to bury in the ground. We used to bury gold in the ground; now we are burying T bills in the ground, metaphorically. That means that they are holding more and more dollars, we are more and more in debt to others, and at some point the system has to fray. If it does so gradually, we can have reform. But if it happens suddenly, we could have enormous instability. The IMF and the finance ministers around the world ought to be talking about this, but in my six years' involvement in this issue I have not heard this issue raised in policy circles in any quarter.

QUESTION: In view of the pickup in the rate of economic growth in the last quarter, would you care to make a judgment about what will happen in the coming months, especially in increasing employment?

JOSEPH STIGLITZ: When I was Chairman of the Council of Economic Advisors and was asked questions like that, I said, "I have a very cloudy crystal ball." You don't want to go on record making a clear forecast. The first thing to remember is that the 7.2% growth number is a preliminary GDP number, and there are reasons to be suspect of it. There was a slight decrease in hours worked, and that means that we had a productivity increase of approximately 8%. That is not sustainable. The question is, did it actually occur? Do we really think the economy can have an 8% productivity increase?

The second point is that if you look at the numbers more closely, you see that in the last tax cut, the Democrats and liberal Republicans insisted that there be a smidgeon for middle- and lower-class Americans and aid to states and localities, so it was $30-40 billion that went in, which did stimulate the economy, as we had predicted. The irony here is that they got their paychecks -- not part of the Bush tax cut, but as part of the democratic initiative to get this through. It did stimulate some consumption expenditure, particularly in durables. Already by September there was some slowdown from what had happened in July and August. It is unlikely that we will be growing more rapidly than we did in the last two years, but we will still have a significant shortfall below our potential. We have probably lost a trillion dollars.

We have lost 2.8 million jobs over the last three years. To find jobs for new entrants into the labor force -- we have about a million entrants every year -- we should have been creating over a million jobs. So we have a job deficit of around 6 million jobs. I don't see us closing that job deficit in the next year or two. There are a number of uncertainties that are casting a pallor over the economy -- the high level of debt on the household sector, the weaknesses in the states and localities, the huge trade deficit, the concern about the government needing so much borrowing to finance its huge fiscal deficit.

JOANNE MYERS: Thank you very much.

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