Tuesday, September 29, 2009

An Interview with World Bank President Robert Zoellick

Last night I had the pleasure of interviewing distinguished World Bank President Robert Zoellick. Mr. Zoellick told me not to take dollar supremacy for granted. He blasted the Federal Reserve for bungling the asset price bubbles. He believes that Treasury - not the Fed - ought to be our uber-systemic risk regulator. And he says the United States has huge policy choices in front of it.

Here's the transcript from our interview.

KUDLOW: World Bank President Bob Zoellick, thanks for coming back on Kudlow Report, sir.

Mr. ZOELLICK: Glad to be with you, Larry.

KUDLOW: Let me just begin with some news. We've had a terrific rally up here on Wall Street. Dow's up about 150 points as of this conversation. And as you know, in the last six months world stock markets, emerging stock markets, have had a tremendous rally. Is this a signal that the global recession is over and world recovery is upon us?

Mr. ZOELLICK: I think it's a signal that the governments have broken the fall in financial markets and that there's a lot of liquidity out there. But there's still a big question about whether the real economy will kick in.

KUDLOW: What are the economics, people at the World Bank--you've got a splendid staff, you've got a large staff. What are they saying about forecasts for, let's say, 2010, next year?

Mr. ZOELLICK: In general they see a cautious and gradual recovery; concern that there's not enough demand because the US consumer won't play the role that it has in the past, so a possibility that developing countries could step in with the right financing. But also some big risks. So for example, if you look at China's recovery, which has been strong, it's been fueled by a huge increase in credit that's now starting to get turned back. So later in 2010 we face additional risks.

KUDLOW: Let me go to your speech today. You gave a very strong speech before the Johns Hopkins International School. And at the beginning, right up top, "US would be mistaken to take for granted the dollar's place as the world's predominant currency." We would be mistaken to take for granted. Let me ask you to clarify, what do you mean by that?

Mr. ZOELLICK: Well, it's something I feel really strongly about, Larry, and I think you do as well. You know, on the one hand, I don't believe all the stuff about that the dollar isn't the key reserve currency. It is. You could see people turn to it today because--in the crisis because of a flight to security. But my point is Americans do not recognize that, you know, countries over--all over the world would die for the ability to be able to print money, to issue bonds as freely as the United States has. And as you look at out years, that's not something we can take for granted. So what that means is coming out of this crisis, the Fed's policies in terms of making sure we have a recovery without inflation, making sure that you got a good, strong value for the dollar, having a sense that the financial markets, yes, they need to improve the safety and soundness, but they have the depth and liquidity they've historically had, those are not going to be easy issues, but they're going to be absolutely critically for the United States for decades to come.

KUDLOW: If the US dollar continues to decline--I mean, by and large for about eight years, under Republican and now Democratic administrations, the dollar has been weak. If the dollar continues its chronic decline, would that stop world economic recovery?

Mr. ZOELLICK: Well, you know, it depends on what else is going on and it depends, you know, how far of a decline and it depends on some of the effects that it has on interest rates. But my point really goes more to the direct interests of the United States. And I took a historical reference with Prime Minister Pitt of Britain saying that while people talk about the great campaigns that won the Napoleonic wars, it was the fact that he restored Britain's credit that allowed them to fight a 20-year war and pay for a coalition. Now, the larger point there is the United States has been in a unique position in terms of being able to have the dollar accepted as the predominant reserve currency. The euro did a good performance in this crisis, it will be an alternative. I don't think China's renminbi is going to move to an open capital account soon. But in the speech I outline why over the next 10 years, 10, 20 years, it will also move to be more of an international role. So my message is whether it's budget deficits or whether it's the monetary policies, don't take the dollar for granted.

KUDLOW: Well, are you inferring a criticism here? I mean, are these self-inflicted wounds by the USA in terms of overspending or overborrowing or over money printing?

Mr. ZOELLICK: Well, I think across different administrations, across different times, you know, we haven't been able to get the discipline over the budget deficit across parties, different Congresses, different parties. And given the fact that we're going to have a budget deficit as a percentage of GDP of over 10 percent, that is now fundamental to get on top of. You've seen the projections in terms of US debt as a--as a percentage of GDP. You know, for years it hovered in a range that was manageable. But the types of numbers that people are talking about move it into a whole different league. And that's the type of thing, combined with monetary policy, that should be a priority for people across the political spectrum.

KUDLOW: China has talked about this, numerous Chinese officials; Maria Bartiromo interviewed President Lula of Brazil and he talked about it. I didn't hear anything specific from the G-20 on the dollar's status, Bob. Did you? I mean, was there something, you know, in the back scenes, in the back rooms, in between the lines, because this is a question people on Wall Street and investors are asking.

Mr. ZOELLICK: I think it showed up more in the discussion about the nature of having a sustainable recovery. And obviously part of that is monetary policy. You'll see a lot of references to imbalances. That partly, of course, relates to the different trade imbalances, but it also relates to the need for countries to be able to pay their bills and get control and discipline over their spending. So it wasn't so much focused on currency and exchange rates, but that hovers in the background.

KUDLOW: All right. Moving on here, you have another topic in the speech that I think is controversial. You take some shots at central banks and, by implication, the Fed. Let me just read one of the money paragraphs and get you to respond. "Central banks fail to address risks in the new economy. They seemingly mastered product inflation in the '80s, but most decided that asset bubbles were difficult to identify and restrain with monetary policy. They argue that the damage to the economy from jobs, production and savings and consumption could be contained once bubbles burst through aggressive easing of interest rates." And then you say, flatly and declaratively, "They turned out to be wrong." Now, I'm just quoting from your speech. What are you saying here? What'd you have in mind?

Mr. ZOELLICK: Well, it's not all central banks. If you will also see in the speech, I actually compliment the European Central Bank. I think Jean-Claude Trichet did a pretty good job coming into the crisis and managing it. And while I didn't get into this level of detail, Canada's central bank, for example, has tried to look at some of the asset price inflation. And I think--to be fair, I think the Federal Reserve and all the other central banks did a good job once the crisis hit. But I--the key point of that paragraph was what I said about asset price inflation. Central banks felt that that was something they couldn't manage, shouldn't manage, they could deal with it through other means, and they learned a lesson, as we all have to learn out of this crisis, that that didn't work.

Now, the other point, though, I make about the central banks is less trying to cast blame, it's more a question of political economy in the United States. As you know, Larry, we didn't have a Federal Reserve until 1913. I mean, you go back to Alexander Hamilton, Congress and banks and bankers are--that's always been a rather acidic mix. And so--and it's going to be a big challenge to say that the Federal Reserve, which with its independence, which I think is appropriate for monetary policy, should be given additional role in the bank regulatory area. And I think you can see that in the debates in Congress. And frankly, my reading of the different reports and seeing at the time was one of the real challenges was whether the Treasury Department had enough authority to pull the regulators together. So it's going to depend on each economy. So with central banks, part of this deals with political history and kind of attitudes towards the role of independent central banks. My view is the Fed's going to have a big enough challenge concentrating on the monetary policy getting out of this crisis. That's what I think should be the prime focus. I personally think the Treasury needs a little bit more authority on the regulatory side.

KUDLOW: Well, that was my inference from reading this, that you think the Treasury should be the uber regulator of the uber banks. Let me just read. You're saying--this is your speech--"My reading of recent crisis management is that the Treasury needs greater authority to pull together a bevy of different regulators. Moreover, the Treasury is an executive department and therefore Congress and the public can more directly oversee how it uses any authority." You seem to be saying let the Treasury have the principal role and you are, sir, injecting yourself in a very controversial discussion going on in Washington. May I ask why?

Mr. ZOELLICK: Well, I'm just sharing the perspective of somebody who's been involved in this for about 25 or 30 years. And from my perspective, you know, whether it be Secretary Paulson or Secretary Geithner, you read the newspapers, you can see them trying to struggle to deal with the regulators. You've got a financial banking regulatory system that has a legacy of history of a vulcanized financial system. So if people are going to overhaul that, there's a need to try to make sure that you've got somebody responsible and accountable.

The second observation in that paragraph is I believe very much in a--in a democratic sense of responsibility. The Congress is going to be sensitive to make sure that it can exercise oversight over financial regulation, as it should. And it's much more natural to have that in an executive branch which has to get elected every four years and plays--has a--has a balance of power relationship, shared powers with the Congress, than it is in an independent central bank.

Now, different countries are going to do this differently. You see this debate in Britain, you see it in Europe. But I think for the US system, the key message is now that we're coming out of the crisis, the real danger is going to be complacency. We got to fix the regulatory supervision. In my view, I would make sure that the Treasury had the authority to play the role it should.

KUDLOW: All right. So you're saying we got to fix the regulatory system, give the Treasury a large piece. You're also saying we got to fix the dollar. Let me just ask you, are you also inferring it's time for an exit strategy from TARP, from all the spending and borrowing and from all the money printing? Are you suggesting it is time right now for the USA to protect its system and its integrity and the value of its currency for a exit--an exit strategy?

Mr. ZOELLICK: Well, I think the US--and again, the--both the Federal Reserve and the executive branch are preparing for the exit. At the same time, I think one has to be careful about trying to pull the plug of support too quickly because, as I said, I think you face a lot of uncertainties in 2010. So you've seen some of the articles that have been written in terms of Kevin Warsh and others from the Federal Reserve trying to identify some of these issues. So I think that they're doing the right thing. And I also mean to emphasize this is not going to be an easy call. But it's going to be a critical call and it's one that needs the informed debate.

KUDLOW: Last one, Bob Zoellick. Big German elections, the center-right won. Chancellor Merkel was re-elected with strong support from the Free Democratic Party. They're all pledging supply-side tax cuts, and I can't help but ask you, is supply-side tax cutting going to be coming back into vogue instead of all this Keynesian spending? Would Germany lead the way and change world economic policies?

Mr. ZOELLICK: Well, that's been the view of some of the parties in the coalition. The CSU, the Bavarian party has got a great young leader, zu Guttenberg, but also the Free Democrats. I think they're going to have to balance it with their own budget issues. And, you know, while--Larry, while I support lower taxes, I also support paying for what you spend. So that's going to be their decision on how they manage the spending and the--and their overall revenues. It is an interesting commentary, though, about I think something you feel more generally out there, which is that while there are different ideas about stimulus and the role that it played, I think people want to make sure that they pay their country's bills, and that's a good thing.

KUDLOW: All right, World Bank President Robert Zoellick, we appreciate your time, we appreciate your controversial speech. Thanks for coming back on Kudlow.

Mr. ZOELLICK: You bet, Larry.

KUDLOW: All right.