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[Senate Hearing 109-909]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 109-909

 
                           OVERSIGHT OF THE 
                      INTERNATIONAL MONETARY FUND

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    INTERNATIONAL TRADE AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                                   ON

PROGRESS ON REFORM OF THE INTERNATIONAL MONETARY FUND, FOCUSING ON THE 
 GROWING ROLE OF INTERNATIONAL DEBT SECURITIES, THE INCREASE IN VOLUME 
 OF PRIVATE CAPITAL FLOWS, AND THE INCREASING INTERCONNECTION BETWEEN 
                           FINANCIAL MARKETS

                               __________

                              JUNE 7, 2005

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

   Available at: http: //www.access.gpo.gov /senate /senate05sh.html
            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                                 ______

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                  RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       JON S. CORZINE, New Jersey
MEL MARTINEZ, Florida

             Kathleen L. Casey, Staff Director and Counsel
     Steven B. Harris, Democratic Staff Director and Chief Counsel
             Skip Fischer, Senior Professional Staff Member
                Steve Kroll, Democratic Special Counsel
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor

                                 ------                                

            SUBCOMMITTEE ON INTERNATIONAL TRADE AND FINANCE

                      MIKE CRAPO, Idaho, Chairman
                   EVAN BAYH, Indiana, Ranking Member
CHUCK HAGEL, Nebraska                TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming             ROBERT MENENDEZ, New Jersey
JOHN E. SUNUNU, New Hampshire
ELIZABETH DOLE, North Carolina

                  Gregg Richard, Legislative Assistant
       Catherine Cruz Wojtasik, Democratic Legislative Assistant

                            C O N T E N T S

                              ----------                              

                         TUESDAY, JUNE 7, 2005

                                                                   Page

Opening statement of Senator Crapo...............................     1

Opening statements, comments, or prepared statements of:
    Senator Bayh.................................................     6

                               WITNESSES

Randal Quarles, Acting Under Secretary for International Affairs, 
  U.S. Department of the Treasury................................     2
    Prepared Statement...........................................    34
Allan H. Meltzer, The Allan H. Meltzer University, Professor of 
  Political Economy, Carnegie Mellon University and Visiting 
  Scholar, American Enterprise Institute.........................    12
    Prepared Statement...........................................    38
C. Fred Bergsten, Director, Institute for International Economics    15
    Prepared Statement...........................................    40

              OVERSIGHT OF THE INTERNATIONAL MONETARY FUND

                              ----------                              

                         TUESDAY, JUNE 7, 2005

                               U.S. Senate,
   Subcommittee on International Trade and Finance,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Mike Crapo, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. This hearing will come to order.
    Good morning. This is the hearing of the Committee on 
Banking, Housing, and Urban Affairs, Subcommittee on 
International Trade and Finance, on International Monetary Fund 
oversight. Today, as the title of our hearing indicates, we are 
here to discuss the International Monetary Fund. As the largest 
contributor of the IMF, the United States has the 
responsibility to ensure that our resources are being used 
wisely. The United States, with the urging and support of the 
U.S. Congress, has been a key supporter in moving the IMF in 
the right direction in terms of getting more accountability and 
understanding of what is happening inside the IMF.
    I would like to recognize and thank our witnesses for the 
significant contributions they have all made in making this 
happen. None of any of this would have been possible without 
the creation and hard work of the International Financial 
Institutions Advisory Commission and the continued pushing and 
prodding from the Treasury Department.
    Although it is important that we recognize the real 
progress that has been made, we are not yet done. More needs to 
be done, and it is my hope that today's hearing will further 
demonstrate what progress we have made and what progress we 
need to make in the future. This will help us to determine what 
specific measures need to be addressed next.
    The other main issues before us today are Argentina's 
attempt to conclude a new debt repayment agreement with the 
IMF, China's 10-year-old fixed exchange rate between the dollar 
and the yuan, and a potential IMF gold sale as a means of 
financing additional IMF debt reduction. These are significant 
challenges, and I look forward to a thorough discussion of 
these issues as well.
    For our first panel today, we welcome Randal Quarles, the 
Acting Under Secretary of the Treasury for International 
Affairs. In this capacity, Mr. Quarles advises the Secretary of 
the Treasury on U.S. participation in the international 
financial system, including subjects such as financial 
regulation, macroeconomic policy, exchange rate policy, trade 
and investment, and our participation in the International 
Monetary Fund and the World Bank, among other institutions. 
Prior to his most recent appointment at the Treasury 
Department, Mr. Quarles served as the U.S. Executive Director 
at the IMF from August 2001 through March 2002.
    Our second panel will include two witnesses: Dr. Allan H. 
Meltzer, the Distinguished Professor of Political Economy at 
Carnegie Mellon University; and Dr. C. Fred Bergsten, Director 
of the Institute for International Economics, here in 
Washington, DC. Drs. Meltzer and Bergsten have extensive 
experience with the IMF. In November 1998, as a part of the 
legislation authorizing $18 billion of additional U.S. funding 
for the IMF, Congress established the International Financial 
Institutions Advisory Commission to recommend future U.S. 
policy toward the IMF and the World Bank, commonly referred to 
as the Meltzer Commission in reference to its Chairman, Dr. 
Meltzer. Dr. Bergsten also served on this Commission and co-
authored the dissenting opinion. And I might note that we have 
had them before us in different contexts many times on these 
issues, and we appreciate both of them coming yet once again to 
help us continue to address these issues.
    With that, we will begin with the testimony, and I would 
remind all of the witnesses that we have a clock. Because of 
the small number of witnesses, we have doubled the amount of 
time we traditionally allow for oral testimony, and so we are 
allowing each of you 10 minutes. We would encourage you to pay 
attention to the clock, though, because we do want to have a 
little time for questions and answers and some dialog.
    Mr. Quarles.

                  STATEMENT OF RANDAL QUARLES

       ACTING UNDER SECRETARY FOR INTERNATIONAL AFFAIRS,

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Quarles. Thank you, Chairman Crapo. I am very pleased 
to be here today to talk about our agenda as a shareholder of 
the International Monetary Fund. I will focus my oral remarks, 
with your permission, on efforts to modernize the IMF, and if 
my formal written testimony could be submitted for the record, 
I would appreciate that.
    Senator Crapo. Yes, the formal written testimony of each 
witness will be a part of the record.
    Mr. Quarles. And in that written statement, I have an 
update on Argentina's economy and their engagement with the 
IMF.
    Reform of the IMF has been a high priority for the Bush 
Administration. The growing role of international debt 
securities, the increase in the volume of private capital 
flows, the increasing interconnection between financial 
markets, as well as the experience with crises in the 1990's, 
all underscore the need for action.
    The Meltzer Commission helped provide impetus for this 
reform through the recommendations in their report of March 
2000. Congress has been an active participant in this effort 
for change.
    Over the last 5 years, the progress we have made on this 
front includes clearer limits and criteria for large-scale 
official sector lending; a tighter focus by the IMF on its core 
macroeconomic areas of expertise; greater concentration on 
short-term financing; increased transparency in the IMF's 
operations, as well as in the national data of the member 
countries of the IMF; and adoption of collective action clauses 
as standard market practice in sovereign bond documentation to 
help promote orderly restructurings and reduce disruption.
    I think those are all major steps forward, but as you noted 
at the outset, we are not prepared to relax our efforts. In 
response to calls from the United States and others, the IMF is 
now undertaking a review of its role and strategy for the 
medium term. We have several key priorities in this process:
    One, strong surveillance and crisis prevention. We need to 
further tighten the focus and the selectivity of analysis that 
the IMF does to integrate more fully capital market and 
financial sector analysis into the daily life of the Fund.
    A second priority for the United States has been the 
establishment of a new non-borrowing program. We strongly 
believe that the IMF needs a new tool to provide a structured 
engagement in support of strong economic policies where there 
is no need for borrowing. We have proposed such a mechanism. We 
have won the support of our partners in the G-7, and we expect 
that proposal to be taken up by the IMF's Board this summer. 
And demand for such an arrangement is already emerging from IMF 
member countries.
    We are also looking for more effective engagement of the 
Fund with low-income members. Working with low-income countries 
to help them achieve macroeconomic stability is a vital part of 
the IMF's mission. At the same time, the Fund is not a 
development institution, and its financial operations should 
reflect its mission to provide short-term balance-of-payments 
financing. We have urged the IMF to undertake a close 
examination of its approach in low-income countries with a view 
to helping these countries achieve better economic results.
    Helping low-income countries depends also on ending the 
lend-and-forgive cycle so that they can move into an era of 
sustainable debt. And the Bush Administration has put forward a 
bold proposal to provide up to 100 percent relief on 
International Development Association and African Development 
Fund loans to the heavily indebted poor countries. Action on 
this debt is critical to putting these poor countries on a 
sustainable path.
    If there were any debt relief in the IMF, it would need to 
be financed from the existing resources of the IMF. We do not 
believe that gold sales--whether they were to be executed in 
the market or off the market--are necessary or warranted.
    Before concluding, let me draw your attention to the issue 
of representation in the IMF, which is something else that we 
have been pressing in our strategic review.
    The IMF is accountable to its 184 member governments 
through a weighted voting structure that is aligned with the 
countries' global economic standing. But change in the world 
economy over the last number of decades has outpaced that in 
the IMF, particularly given fast-paced growth in emerging 
market economies and given integration in Europe.
    Secretary Snow has strongly signaled the need for the IMF 
structure to evolve. In our view, this is vital to maintaining 
the good will of its members and to preserving the centrality 
of the IMF in the global financial system.
    Change will not come quickly or easily, but we believe the 
effort is essential to the long-term effectiveness of the 
institution.
    And with that, I thank you for the opportunity to be here 
today, and I am looking forward to your questions.
    Senator Crapo. Thank you very much, Mr. Quarles, and we do 
appreciate the focus of the Treasury Department on the reform 
of the International Monetary Fund and your continued efforts 
to improve it.
    I would like to first talk with you a little bit about 
Argentina. Argentina's default was unprecedented in size and 
for having the lowest recovery rate in history and for the 
process that has stretched the guidelines of sovereign debt 
negotiations. Argentina's sovereign debt restructuring has 
widespread implications not only for creditors but also for 
Argentina's long-term financial stability, developing country 
debt markets, and guidelines for future sovereign debt 
restructuring, as well as for IMF policies.
    What lessons do you think we have learned by our engagement 
with the IMF and the Government of Argentina throughout this 
process?
    Mr. Quarles. Well, I guess the first thing I would say is 
that the learning process is not over. There will be continued 
engagement between the Fund and Argentina.
    I think that one of the central things that we probably 
learned with respect to the debt restructuring process, which 
was the focus of your question, is that it is not necessary for 
the Fund to take an interventionist stance in debt 
restructuring between a country and its private creditors for 
that process to proceed. In our view, the debt exchange has now 
been completed, and Argentina needs to have a strategy for 
dealing with the remainder of its creditors. But the stance 
that the IMF has taken with our support throughout this process 
has been that the details of how that exchange is accomplished 
and the details of that strategy going forward are for 
Argentina to develop and for the creditors to evaluate, and 
that as a systemic matter the system will operate better going 
forward if parties do not feel that they are able to draw the 
official sector, and particularly the IMF, into mediating or 
directing those sorts of negotiations.
    The IMF creates the macroeconomic framework in which the 
negotiations can take place, but it is not more interventionist 
than that.
    Senator Crapo. Let me interrupt there. In this case, 
Argentina has reached an agreement with 76 percent of its 
bondholders. The 24 percent that are outstanding still remain 
to be handled. Would your discussion there apply to that? In 
other words, what would you think should be the IMF's position 
with regard to the remaining 24 percent who did not participate 
in the decision that was made previously?
    Mr. Quarles. Well, I think that, as you noted, the official 
sector's interest is ensuring that Argentina has somehow 
resolved its situation with all of its creditors, though it 
needs some strategy for dealing with the remaining 24 percent. 
But I do not think that it is up to the IMF to dictate that 
strategy; rather, the Fund says we need to ensure that you have 
resolved the situation with your creditors; you have done a 
debt exchange that has resolved that situation for 76 percent; 
there is another 24 percent that remains out there; you need to 
address that situation. But it is not for the Fund to say how 
that situation should be addressed. These are issues that can 
be worked out between sovereigns and their private creditors. 
And I think the system will work better if they are left to 
that solution, and as the system adjusts to the fact that the 
IMF hanging out its shingle does not get all of the debt 
restructuring business, if you will, the system will operate 
better.
    I think the fact that the debt exchange has been able to 
proceed as it has and that Argentina has begun indicating it 
will develop a strategy for the remaining creditors from some 
public statements that have been made indicates that, contrary 
to the views of some it would not be feasible for restructuring 
to proceed with the IMF taking this stance--we create the 
framework, but you do the deal--contrary to that perception, it 
is, in fact, moving forward.
    Senator Crapo. Then in the case of future sovereign 
defaults, would I be correct in assuming that it would be 
Treasury's intention to encourage the IMF to allow countries to 
negotiate outcomes without IMF interference?
    Mr. Quarles. Again, it depends on how one defines IMF 
interference. I think that it is up to the IMF to say the debt 
restructuring needs to proceed. It is up to the IMF to create 
macroeconomic stability in the country, to engage with the 
country to create a macroeconomic framework in which the debt 
restructuring would proceed, but not to be interventionist in 
the details of that restructuring. Those are negotiations for 
countries and their private creditors.
    Senator Crapo. So it would be a stimulus for the 
restructuring, but not to dictate details.
    Mr. Quarles. Exactly.
    Senator Crapo. Now, Argentina has already given signals 
that it plans to return to the international bond market in 
just--I think it is 3 years after the default, the biggest 
default in the history. Will this send a signal to other 
countries to follow Argentina's example and basically default 
and then renegotiate their debt?
    Mr. Quarles. I do not think so. The costs that Argentina 
has paid for the default were substantial. There were social 
costs that included riots in which many people died as a result 
of the disruption that was associated with the default. They 
had to freeze the deposits in their banking system. I think 
anyone who looks at the consequences of Argentina's default 
would say that is not a model to emulate. I do not think is 
going to be an attractive model to emulate. And certainly in 
our discussions with countries in the region, we have not 
gotten indications that there is any sort of groundswell of 
view that Argentina's path is a model to emulate.
    Senator Crapo. Thank you. I think one of the lessons that 
we have learned from Argentina is that if the International 
Monetary Fund provides funding, governments tend to postpone 
tough decisions, and then ultimately the problem gets bigger.
    When the IMF does not intervene and provide the additional 
funding, do you think that that provides an incentive for these 
countries to negotiate and resolve issues?
    Mr. Quarles. I do. There are situations in which I think 
IMF intervention can be helpful, but it needs to be focused on 
achieving objectives that are clear and in the service of a 
strategy that is well thought out. But, you know, as a general 
matter, I do think that we need to be very careful about IMF 
assistance, and particularly large-scale IMF assistance, as a 
way of forestalling the tough decisions that countries need to 
make.
    Senator Crapo. Thank you. I just have one more area of 
questioning, and I would like to shift gears now to China and 
its exchange rate policies and, frankly, just to ask you to 
share your opinion with us on the Chinese exchange rate issue 
and what you think the United States action, if any, should be.
    Mr. Quarles. Well, as Secretary Snow was recently before 
the Senate testifying, we have delivered a foreign exchange 
report that describes the situation with China. We have engaged 
with them over the course of now nearly 2 years on dealing with 
the obstacles to their moving to a more flexible exchange rate 
regime as they have defined and described them.
    I think that engagement has been successful enough, 
fruitful enough that we have come to the conclusion that China 
is technically ready, as the Secretary has previously 
testified, to make that move. So as we consider this question 
going forward, we look at China in that light. So, I think we 
have been fairly comprehensive in the foreign exchange report 
that we delivered as to the details of the situation. The main 
point is that I think our engagement with China has been 
fruitful, it has resulted in progress in addressing these 
obstacles, obstacles on a path that they have said that they 
want to move on, and so I think that, as the Secretary said, 
they are now technically ready to move.
    Senator Crapo. Thank you. We have been joined now by 
Senator Bayh, the Ranking Member of the Subcommittee, who has 
also been very helpful not only in terms of this Committee in 
setting up this hearing, but also on a number of these issues. 
And I would like to turn next to Senator Bayh.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you very much, Senator, and thank you 
for calling these hearings. And, Mr. Quarles, thank you for 
your time and your service to our country.
    I would like to begin by asking a couple of questions about 
how Argentina got into trouble in the first place. As I 
understand it, wasn't one of the difficulties there that they 
had a large systemic budget deficit problem related to the 
financing of the states that was assumed by the federal 
government? And there was some political dysfunction as well, 
but wasn't that one of the underlying problems that they had?
    Mr. Quarles. In my view, it was the central underlying 
problem, this question of fiscal federalism, which is an issue 
we run into in a number of countries and how to appropriately 
balance the fiscal obligations of a central government and a 
state government and a federal system. Argentina under their 
constitution had a system that allowed state spending which the 
federal government was essentially required to fund without the 
ability to----
    Senator Bayh. In my previous capacity, as Governor, I might 
have thought that was okay.
    [Laughter.]
    But taking a more global view, it really got them into 
trouble, didn't it?
    Mr. Quarles. Absolutely.
    Senator Bayh. Which leads me to my second question. Given 
that that was part of their problem and has occasionally led 
other countries into difficulty as well, what ground do we 
stand on with our own sizable deficits, which run the risk of 
being systemic given the aging of our population? I mean, have 
we not undermined our own credibility in terms of advising 
other countries about fiscal probity?
    Mr. Quarles. I think the path that the Administration has 
outlined of shrinking the deficit in half over the course of 
the next 5 years is, in fact, exactly the right path to 
establish the credibility that we need. We need to perform on 
that path, without question, but given where we are currently, 
our debt to GDP----
    Senator Bayh. Could I ask you something, Mr. Quarles? 
Forgive me for interrupting.
    Mr. Quarles. Not at all.
    Senator Bayh. Do you encounter anyone from abroad who finds 
that projection to be credible?
    Mr. Quarles. I do. I guess I would say they want to see 
continued performance, but over the course of the last 2 years, 
the deficit has begun to shrink. It has begun to shrink as an 
absolute amount.
    Senator Bayh. Are we including the costs of the military 
situation in Iraq and all the other things that are off budget 
but really contribute to our actual deficit?
    Mr. Quarles. Even over the course of the last 2 years, that 
has begun to shrink even factoring those in. They factor into 
both years. The total amount is shrinking as a percentage of 
GDP, and a significant element of that certainly during the 
last year has been an increase in revenues. So everything that 
observers are looking at to see in the performance of the 
United States in shrinking its deficit is the deficit actually 
shrinking, not just as a percentage of GDP, although that is 
certainly quite important.
    Senator Bayh. Has the IMF not chastised us for our deficit 
and said that there is a relatively narrow and potentially 
closing window of opportunity to deal with it before the baby 
boomers start retiring?
    Mr. Quarles. I am not sure I would characterize it as 
``chastising,'' but the IMF has certainly looked at the budget 
deficit issue.
    I think all observers agree that the key question is: Can 
we keep the deficit under control? Can we shrink it? Not do we 
need to close it immediately, because the consequences for 
growth of the country of closing it immediately and, therefore, 
for world economic growth would be substantial.
    So what we need to do is establish a credible path to 
shrinking the deficit as opposed to closing it immediately, and 
so far we have been performing.
    Senator Bayh. I certainly agree with the aspiration. I have 
only been in this town for 6\1/2\ years, but it strikes me as 
perhaps the triumph of hope over experience, but we shall see.
    Our 6-percent GDP current account imbalance, are there 
other countries that are running a current account imbalance of 
that magnitude?
    Mr. Quarles. At the moment there is certainly no large 
economy that is running a current account deficit of that 
magnitude. Australia has for many years run a current account 
deficit of roughly that size, not quite 6 percent, but 4 or 5 
percent of GDP.
    Senator Bayh. If this occurred in another country, would we 
refer to it as a sign of strength?
    Mr. Quarles. It depends. I think we actually can view it as 
a sign of strength in Australia. There are large differences 
between the United States and Australia as economies. I think a 
significant portion of the explanation of the U.S. current 
account deficit is, if it results from a perception of capital 
around the world that an economy is a superior place for 
investment, then as a sign of strength of the economy, it 
probably is one. Is there an imbalance building up that can 
continue forever? It probably cannot continue forever. I think 
Chairman Greenspan, among others, has said that. But is it an 
immediate problem? Under those circumstances probably not.
    Senator Bayh. My concern, Mr. Quarles, is that the only 
thing I can predict with some assurance about the future is 
that the unexpected will happen. Might there be some contagion 
from abroad? Might there be an energy disruption? And we can go 
down the list of potential horribles? Who knows? God forbid, 
none of them will happen. But if you look back over the course 
of history, something unexpected and perhaps adverse is almost 
always occurring. And with an imbalance of this size, have we 
not taken much of the slack out of the system and really run a 
greater risk than would otherwise be the case of having a real 
retrenchment in our currency with perhaps dramatic consequences 
for our economy?
    Mr. Quarles. When we look at the size of the deficit the 
first place to begin is what base do we begin from; that is to 
say, the current account deficit measures the growth in foreign 
claims on the United States, so what base do we begin from? And 
foreign claims in the United States, net foreign claims, are 
about 25 percent of our GDP, which is not at all a concerning 
level of foreign claims.
    So they are growing, and while that cannot continue 
forever, when you begin from a base of that size, again, I 
think you say this is not a rubber band that is at the point of 
snapping. It is being stretched. If it comes back into 
adjustment, not in a disruptive fashion but in an orderly 
fashion, then that is something that is to be expected and 
something that is not likely to cause disruption to the 
economy.
    Senator Bayh. Economic theory would suggest that it would 
get back into alignment through what, a continuing depreciation 
in our currency?
    Mr. Quarles. There are a variety of ways it could come back 
into alignment, and one way would be an increase in the savings 
rate in the United States, if you view it as the savings-
investment imbalance. Another way would be an increase in 
growth outside of the United States in our peer economies, 
particularly Europe and Japan.
    Senator Bayh. Are you counting on an accelerating growth in 
Europe?
    Mr. Quarles. We are working with them to try to improve 
their prospects.
    Senator Bayh. I understand, but, I mean, it looks like a 
difficult challenge at the moment.
    Mr. Quarles. I would agree with that.
    Senator Bayh. And the reason I ask, it gets back to Senator 
Crapo's question, with our largest imbalance currently with 
China and another chunk of it with Japan, both of which really 
take steps to prevent the currencies from realigning, it 
further exacerbates the imbalance in other ways.
    Mr. Quarles. And that is one of the reasons why we have 
emphasized the concept of a three-legged stool as the way of 
dealing with the current account problem. We have the savings 
issues in the United States, which we can deal with by measures 
to increase private savings, by decreasing public dissavings by 
bringing the budget deficit down. You have growth in Europe as 
another leg of the stool, as a way of increasing the 
attractiveness of Europe as a locus for investment. And then 
you have Asian currency flexibility as a way of providing other 
mechanisms for adjustment.
    Senator Bayh. Well, that is why I started off with our own 
budget deficit. It seems to me that is the one thing that we 
have the greatest control over. We would like to promote 
savings in the long-run, but that is a longer-term challenge. 
Growth in Europe is a longer-term challenge. Currency 
flexibility on the part of the Asian countries is something 
that should be done right away, but I suspect will take a 
little time to accomplish. And that is why, if we are looking 
at trying to put a little more flexibility into our own system 
to empower us to deal with the unknown, that is one thing we 
can do in the shorter-term.
    Mr. Quarles. We do. We need to be mindful of what the 
effects on growth would be, of shrinking it immediately. I 
think we also need to be humble about our ability to know what 
the effect on the current account deficit would be of a 
shrinkage of the fiscal deficit by any particular size. The 
Federal Reserve has estimates that shrinking our current fiscal 
deficit completely would only shave off about 1 percentage 
point of the current account deficit, so at a 6-percent deficit 
that still leaves 5 percent that needs to come from elsewhere.
    Senator Bayh. It is better than nothing.
    Mr. Quarles. It is better than nothing. But given, again, 
when you take all the pieces of the puzzle and put them 
together, what would the effect on growth be? What is the 
likely effect on the current account deficit? How much of a 
current risk as opposed to longer-term risk is the current 
account deficit? I think the path that we are on is the 
responsible one of shrinking that deficit over time, developing 
credibility by performing on a predetermined plan, which we 
have identified and so far for 2 years have been, in fact, 
overperforming on. We are going to overperform this year. You 
know, I think that is the responsible path, and so far we have 
been able to stay to that path.
    Senator Bayh. May I have time for two last questions, 
Senator?
    Senator Crapo. Yes, as a matter of fact, I do not have any 
further questions, and so please go ahead.
    Senator Bayh. I just have two more, Mr. Quarles, and then 
we will set you free.
    For a country trying to come to grips with a budget 
deficit--Argentina before, some others--would the IMF 
ordinarily recommend tax cuts as a part of a program to try to 
come to grips with a deficit that a country is seeking to 
shrink?
    Mr. Quarles. Well, that depends on the situation. The IMF 
certainly will frequently recommend to countries as a way of 
improving their growth performance that they reduce marginal 
rates and broaden the base.
    Senator Bayh. I am not talking about that. I am talking 
about net receipts. You are talking about a revenue-neutral 
readjustment.
    Mr. Quarles. Right, simply as a way of closing a budget 
deficit, if you took other things totally equal, then, no, you 
are not going to close a budget deficit by reducing receipts.
    Senator Bayh. Thank you for your candor.
    And, finally, there was a book written sometime ago by a 
professor from Yale--I think his name was Paul Kennedy--called 
``The Rise and Fall of Great Powers.'' And the central theme 
running through the book was that when great countries have 
security commitments and military commitments that exceed their 
financial and economic ability to finance, if you look back 
across history they have come to some heartache in those 
circumstances.
    That is one of the reasons I am concerned that we are 
borrowing so much from abroad, even as our military and 
security commitments are expanding. Does this concern you?
    Mr. Quarles. Given the current situation where, as I said, 
the net foreign claims on the United States are at a reasonably 
moderate level for a country of our wealth and size, I do not 
think that we are at all at a point of crisis with respect to 
the growth on foreign claims or our borrowing from abroad. We 
do need to increase domestic savings in this country, and we 
need to be creative in finding ways to create the framework in 
which those savings will increase. But we are certainly not at 
all at a point of crisis as far as the growth of foreign claims 
on the United States.
    Senator Bayh. If the Chinese were to announce tomorrow they 
were going to start diversifying out of dollar-denominated 
assets, what would happen to the value of our currency?
    Mr. Quarles. Well, I think that is hard to say. Rebalancing 
the portfolio----
    Senator Bayh. Would it go up? Would the dollar strengthen?
    Mr. Quarles. I am actually not trying to be coy about this 
at all. I do not think that we can say what the----
    Senator Bayh. When the rumor was going through Seoul a 
couple of months ago that they were going to diversify out of 
dollar-denominated assets, the dollar went into a fall. And 
when the Prime Minister of Japan, apparently inadvertently, 
mentioned that perhaps they would start diversifying, the 
dollar went into a free fall. It is reasonable to assume that 
since we, in fact, borrow more from China, the effect would be 
the same, only more.
    Mr. Quarles. Those were very short term. I mean, what the 
effect would be on any particular day I think, again, is hard 
to say, although markets do not like new news, and so there 
would be some movements. Those statements were immediately 
retracted.
    Senator Bayh. They were comments or rumors that were then 
denied. I am asking what if another government--in this case 
China--announced as its policy in fact that they were going to 
be diversifying out of dollar-denominated assets.
    Mr. Quarles. I do not think that the long-term effect, even 
the medium-term effect on the U.S. economy would be dramatic at 
all. What the near-term financial effects would be I think are 
difficult to predict.
    Senator Bayh. I will let you go. The reason I ask the 
question is I think most people would assume that it would have 
a downward effect on the dollar, perhaps dramatically so, for 
at least a period of time. And I wonder whether that is a 
position of strength, of independence, and whether, in fact, in 
some ways our financial sovereignty is not impaired when we are 
as dependent as we currently are on other countries to pay our 
bills, including the bills of our military.
    Mr. Quarles. We have actually had a demonstration effect on 
that. People have been concerned about this. It is certainly an 
issue we have looked at in the Treasury for some time as the 
Asian official sector has been purchasing Treasury securities, 
and this concern has been articulated that we are therefore 
somehow beholden to the Asian official sector.
    This was particularly said about Japan 2 years ago, and 
then about a year ago--and that if at any time Japan were to 
stop purchasing Treasury securities, that the effect on U.S. 
interest rates would be significant.
    Our stance at the Treasury based on our knowledge of the 
Treasury market was that the likely effect on interest rates 
would be quite small, if anything, because of the depth and 
liquidity of the Treasury market, and that if even a large 
participant were to withdraw, others, probably from the private 
sector, would step in and take up those securities at a 
relatively small increase in cost. What we saw when Japan 
ceased intervening and, therefore, largely withdrew from the 
Treasury market in March 2004, was that over the course of the 
next several months, long-term interest rates, our 10-year 
interest rates, actually declined in line with what our 
hypothesis would have been before. Even the departure of what 
at that time was the most significant single purchaser of our 
securities, the complete departure from the market was largely 
taken up by additional private sector purchases.
    So, again, we are not Pollyanna-ish about this at all. It 
is an issue that we look at. The holders of our debt is an 
issue that we continue to look at. What the possible 
implications rebalancing our portfolios are is something that 
we give a lot of thought to. But I do think that we have had 
this recent demonstration effect, that even the withdrawal of 
the very large purchaser has effects on our cost of funding, on 
the Treasury's cost of funding that are small, if even 
measurable.
    Senator Bayh. Well, perhaps you are right. Let us hope you 
are right. It is a question of whether it is a risk we want to 
run. And you are a good man, Mr. Quarles. I look forward to 
working with you, and I am grateful for your willingness to 
expose yourself to our questions today. Thank you.
    Mr. Quarles. Thank you, sir.
    Senator Crapo. Thank you very much, Mr. Quarles. We 
appreciate your attendance.
    Senator Crapo. We will excuse this panel and call up our 
second panel which consists, as I indicated, of Dr. Allan H. 
Meltzer, who is Professor of Political Economy at Carnegie 
Mellon University, and Dr. Fred Bergsten, who is the Director 
of the Institute for International Economics.
    Gentlemen, we appreciate you being with us. We have 
allocated, as I indicated at the outset, 10 minutes to each of 
you if you choose to use all 10 minutes of it for your 
presentation, and then we will engage in some questions, and we 
will start with Dr. Meltzer.

                 STATEMENT OF ALLAN H. MELTZER

                THE ALLAN H. MELTZER UNIVERSITY

                PROFESSOR OF POLITICAL ECONOMY,

                CARNEGIE MELLON UNIVERSITY, AND

        VISITING SCHOLAR, AMERICAN ENTERPRISE INSTITUTE

    Mr. Meltzer. Thank you, Mr. Chairman. Mr. Chairman, Senator 
Bayh, it is a privilege to have this opportunity to review 
progress on reform of the International Monetary Fund. I 
commend the Chairman and the Members for their continued 
interest in this important topic.
    I am pleased to report that there has been progress on 
central issues. On other important issues, much is unfinished, 
and in some cases unstarted. From a comprehensive list of 
topics proposed by your staff, I have chosen to discuss 
progress toward the adoption of recommendations of the Meltzer 
Commission, but I touch on the other questions that the staff 
raised.
    In the view of the Meltzer Commission, the IMF has two main 
tasks. Its most important activity is to increase the stability 
of financial markets, or if crises cannot be prevented, to 
localize problems or crises and keep them from spreading to 
countries or markets that would otherwise be unaffected.
    A related but distinct activity is to reduce market risk by 
improving the quality and increasing the quantity of 
information available to lenders and creditors. The IMF has 
made a sustained effort to improve the quantity and quality of 
information on member countries. More is desirable. Especially 
needed are reductions in the time before information becomes 
generally available.
    A remarkable change came to fruition this year. Argentina 
settled its defaulted debt with about 75 percent of its 
bondholders. This was the largest default ever, and it involved 
hundreds of thousands of individual debt holders and more than 
100 separate debt issues. Coordination did not at first seem 
promising, but it was achieved and without outside 
intervention.
    Unlike earlier practice, the IMF was not a party to the 
negotiations. It did not make additional loans to Argentina to 
assist in the settlement and bail out the lenders. The 
settlement was based on decisions between the Argentine 
Government and representatives of the bondholders, particularly 
my colleague, Adam Lerrick, who did much of the negotiation for 
the bondholders. I am confident that in time Argentina can 
settle with the remaining bondholders without IMF intervention. 
I consider this a big step forward because risks and returns 
were related. Lenders who received high interest rates on risky 
loans had to bear the risk when it came. This improves the 
functioning of markets, warns the bondholders and spares 
taxpayers from paying for lenders' errors of judgment.
    Also Argentina's financial problems were mainly confined to 
Argentina. When they threatened to spread to its neighbor, 
Uruguay, the IMF arranged a large loan. This is in keeping with 
its principal function, preventing the spread of crises.
    In its response to Argentina and Uruguay, the IMF followed 
the spirit and often the letter of the Meltzer Commission 
recommendations. It is not always so. The Meltzer Commission 
made two unanimous recommendations. The first called for 
writing off debt--even Fred Bergsten agreed with us on these--
the first called for writing off ``all claims against heavily 
indebted poor countries (HIPC's) that implement an effective 
economic and social development strategy.'' The second called 
on the IMF to limit its lending to short-term loans leaving 
long-term loans for poverty reduction to others. Instead, the 
IMF created the Poverty Reduction and Growth Facility (PRGF). 
The IMF has no special expertise in economic development and 
poverty reduction. These problems should be left to the World 
Bank. While I agree with those who say that the development 
banks are ineffective, unfocused, and should be thoroughly 
reorganized--I am certainly one who believes that--duplication 
of their work at the IMF is not the right solution. The Poverty 
Reduction and Growth Facility should be closed.
    The IMF, the World Bank, and the G-7 countries have not 
agreed on programs for debt relief for several of the heavily 
indebted poor countries, the so-called ``HIPC countries.'' Some 
agreements have been made and countries have agreed to use the 
resources released thereby for education and health. Great 
Britain is pressing for new agreements at the 2005 summit in 
Scotland, and indeed here in Washington today.
    Part of the discussion of debt relief is misleading, highly 
misleading. The HIPC countries do not actually service most of 
their debts and have not for a long time. To prevent default 
the IMF and the development banks lend the country enough to 
make payments, increasing the countries' indebtedness. A HIPC 
country receives credit for payment, but little or no new 
money. Debt relief, as usually discussed, is actually a way of 
increasing HIPC country borrowing. It would increase the 
countries' available resources, since debtors would receive the 
same payment but would not have it offset by a debt service 
payment of similar size to the international financial 
institutions. The net transfer would increase.
    The main issue in current discussion are how the transfer 
should be financed and how the increased net transfer should be 
used to improve social and economic conditions in the debtor 
countries. Gold sales by the IMF are one option that has been 
proposed. As you know, the Congress wisely disallowed the sale 
of the U.S. gold deposit at the IMF without its consent. The 
gold should be returned to the members and revalued by them. 
Part of the profit could be used to reduce HIPC debt. Gold 
sales would have to come before this Commission. I hope it 
would be turned down.
    One of the Meltzer Commission's main recommendations called 
for replacement of conditional loans with loans based on a 
limited number of preconditions accepted in advance by the 
troubled country. The purpose of this proposal includes 
reducing risk, increasing incentives for reform, and giving the 
borrowing country a large part of a choice of its own policies. 
To its credit, the IMF has reduced substantially the number of 
conditions attached to its loans. It considered but did not 
adopt preconditions. As part of the comprehensive review of 
this strategy that is now under way, it proposes that future 
lending should be ``anchored in strong country ownership.''
    Now, I should say that the IMF is in the process of 
examining its procedures and it will issue a final report on 
what needs to be done at its September IMF/Bank Fund meeting 
here.
    This is a good step away from the command and control of 
the 1990's based on the so-called ``Washington consensus.'' 
``Ownership'' means that the country has a major role in the 
choice of policies. Much evidence suggests that reform is made 
more likely when political leaders in the country choose it, 
support it, and decide to implement it. The Fund's own research 
suggests that much of the time countries do not implement the 
conditions to which they agreed to get a loan.
    Preconditions reduce risk in other ways. Countries that 
avoid pegged but adjustable exchange rates, improvident fiscal 
and inflationary monetary policies, and weak financial systems 
are more prone to crisis. Reducing or removing these sources of 
instability reduces the chance of a crisis. Further, negotiated 
preconditions accepted in exchange for a commitment to assist 
in a crisis reduce the long delay that often occurs before 
assistance is given.
    A critical part of this proposal is that countries would 
have greatly increased incentives to reform. If they did not 
agree to preconditions, they would not be eligible for 
assistance. This alone increases the incentives for reform. But 
this incentive increases because private sector lenders would 
distinguish between countries that adopted reforms and those 
that did not. They do not under the present long-time 
prevailing arrangements have much incentive to do that.
    The international private capital market is the principal 
supplier of loans. It offers 5 to 10 times the volume offered 
by international financial institutions. The private market 
would offer more loans at lower interest rates to countries 
that adopt preconditions. They are safer. Reformers in the 
countries could replace arguments claiming that the IMF 
requires reform with citation of the benefits to the country, 
more capital at lower interest rates.
    The IMF faces many possible challenges. Will other 
countries follow Argentina by defaulting and renegotiating 
debt, as your question asked a few moments ago? Will 
recognition of increased risk reduce the amount of private 
sector lending? Does the large accumulation of reserves by 
Asian countries and other recent changes signal a decision by 
these countries to manage future crises without the IMF? Have 
the Asian crisis countries taken a further step toward 
development of a regional financial bloc? If the IMF no longer 
bails out private lenders, will private lenders object to the 
IMF's preferred creditor status which has no legal basis?
    The IMF's loans are heavily concentrated in the debts of a 
small number of countries. Will one or more of these countries 
default on the IMF?
    We should recall that the IMF's original purposes included 
monitoring and maintaining a fixed exchange rate system. The 
IMF should take more responsibility for the exchange rate 
system to adjust under or overvalued exchange rates. It is well 
know that if more countries allowed their exchange rates to 
adjust, there would be fewer crises. Many observers claim that 
undervalued Asian exchange rates and the large U.S. current 
account deficit will end with a major financial crisis. They 
use the word ``unsustainable'' when they discuss the U.S. 
current account deficit. I am far from certain, even skeptical, 
about these claims. But we should recognize that there is a 
risk that will not be removed and may be increased by the many 
adjustments that follow an appreciation of China's exchange 
rate. In keeping with its original purpose, the IMF should try 
to implement a cooperative solution that revalues the yuan and 
reduces the U.S. deficit, current account deficit.
    Finally, corruption is a major problem in some developing 
and developed countries. No one can rid the world of bribery 
and corruption, but the IMF could do more than it now does to 
limit it.
    Thank you.
    Senator Crapo. Thank you very much, Dr. Meltzer.
    Dr. Bergsten.

                 STATEMENT OF C. FRED BERGSTEN

        DIRECTOR, INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Bergsten. I am delighted to be before the Committee 
again, particularly because Dr. Meltzer and I completely agree 
on the one issue I want to emphasize. It is the last issue he 
mentioned, which has to do with the adjustment of the huge 
international imbalances we now face and which Senator Bayh has 
already emphasized.
    I want to make just one point to the Committee, and it 
echoes what Dr. Meltzer said at the end but puts it more 
strongly. The International Monetary Fund (IMF) is failing to 
implement its own rules on one of the most crucial issues 
facing the world economy--the imbalance in currency 
relationships. This imbalance in turn is a central problem in 
the current account difficulties that we face, and that surplus 
countries face, and that raise the crisis risks for both the 
world economy and our own domestic trade policy. You here in 
Congress see these risks every day when you confront pressures 
to restrict trade, in large part because of the big currency 
imbalances and their pass through to our big current account 
deficit, of which the main counterpart is the surplus 
countries.
    I want to focus on why the IMF should be doing more in this 
area and why the U.S. Government itself should be mobilizing 
the IMF much more effectively, enabling and indeed pushing the 
IMF to be much more effective at exercising its stewardship 
responsibility for the world economy.
    As Senator Bayh has mentioned, the global current account 
deficit of the United States is very large. Indeed, it is now 
getting close to an annual rate of $800 billion or 7 percent of 
our GDP, and it has been growing by over half a percent of GDP 
a year for 10 years. In short, it is on an unsustainable 
trajectory. Not only is the level bad, but also its trajectory 
and future growth.
    On the flip side, the global current account surplus of 
China is also very large. China's global surplus this year will 
exceed $100 billion, more than 6 percent of its own GDP, and it 
too is growing very rapidly. But it is not just China. A number 
of other Asian countries have very large and growing surpluses, 
most notably Japan, which still has by far the largest surplus 
of any country in the world, but also Korea, Taiwan, Hong Kong, 
Singapore, and Malaysia, all running substantial global 
surpluses, which are the counterpart of the U.S. global 
deficit. And it takes two to tango--you cannot get our deficit 
down unless you get the surpluses of the surplus countries 
down.
    As Senator Bayh said, the United States has to lead the 
correction of the imbalances by increasing its rate of national 
saving. Incidentally, we have to borrow $5 billion of foreign 
capital every working day to keep our own economy afloat. If it 
does not come in happily at current interest rates, exchange 
rates, equity prices, property prices, and the like, we will 
face financial instability, whether a crisis or not. It is a 
vulnerability we want to avoid. So we have to take the lead. 
But an essential part of the correction inevitably is a further 
large decline in the exchange rate of the dollar, which I would 
estimate at being something like an additional 20 percent or so 
on a trade-weighted average against the currencies of our major 
trading partners.
    Over the last couple of years, the dollar has already 
declined a lot against the truly floating currencies--the euro, 
the pound, the Swiss franc, the Canadian dollar, and the 
Australian dollar. But the next phase of the dollar decline 
needs to take place against the currencies of East Asia because 
those countries are running the world's largest surpluses, they 
have the world's fastest growth rates, and they have been 
intervening massively in the currency markets to block 
appreciation of their currencies--in the cases of China and 
Malaysia--or to limit the appreciation far below what market 
forces would have produced.
    It puzzles me that our own Administration and the rest of 
the G-7 governments, all of whom profess fealty to market 
economics and letting the market determine these things, have 
been very slow in responding to this blatant, sizable, and 
prolonged intervention, which clearly blocks market forces. 
China is the key. Some people do not even realize that China, 
by pegging to the dollar, has actually ridden the dollar down 
over the last 3 years, meaning that the Chinese exchange rate 
has not just stayed flat against the world but has actually 
weakened, meaning that the most competitive country in the 
world has become even more competitive by riding the dollar 
down against the euro, the Canadian dollar, and even to some 
extent the yen and other currencies in Asia.
    Moreover--and this is really crucial--the other Asian 
countries, from Japan all the way through India, are very 
reluctant to let their exchange rates rise against their tough 
competitor China and therefore are unwilling to let their rates 
go up against the dollar, if that also means going up against 
the renminbi, as it does, as long as China continues to peg to 
us. It is a big problem.
    What should be done about it? In my view, it is the 
responsibility of the IMF to promote correction of such huge 
costly and potentially destabilizing imbalances in the world 
economy. In fact, the Fund's own Articles of Agreement enjoin 
member countries to ``avoid manipulating exchange rates or the 
international monetary system in order to prevent effective 
balance-of-payments adjustment or to gain unfair competitive 
advantage over other member countries.''
    Back when floating rates became the norm of the system in 
the 1970's, the Fund fleshed out that rule and laid out 
principles to monitor exchange rate practices. Its principles 
identified three variables as determining whether a country was 
manipulating: Protracted large-scale intervention in one 
direction in the exchange markets. China clearly meets those 
criteria. Incidentally, up to a year ago, so would have Japan, 
but it has not intervened for the last year. Malaysia also 
meets the criteria.
    To its great credit, Secretary Quarles and our own Treasury 
indicated this in its latest semiannual report to the Congress, 
after it had whitewashed China's behavior for a couple of 
years, but still inexplicably fails to label China a 
manipulator per se. It nevertheless strongly attacks the 
Chinese exchange rate practices and calls for immediate action. 
Whatever the language of the Treasury reports, the United 
States and the rest of the G-7 should insist that the IMF 
insist that China and a few others comply with its own rules, 
which I just reiterated.
    Several people, myself included, have talked about the 
possible need for trade remedies to induce China to move its 
exchange rate in a constructive direction. That may at some 
point be necessary. But first we should certainly try the 
multilateral, institutional, legal approach readily available 
to us in the IMF. It amazes me why the United States and the 
rest of the G-7 have not gone that route. If you had to bring a 
trade case later in the World Trade Organization (WTO), you 
would then have the requisite IMF underpinning for it, which is 
required under WTO rules anyway. So it is a win-win 
proposition, and we have to do it.
    The Fund has limited its own activities in this area to 
quiet efforts to persuade China to become more flexible in its 
currency regime, which is certainly desirable over time, has 
not focused on the immediate need to raise the value of the 
exchange rate of the renminbi. Secretary Quarles and the 
Treasury talked rightly about the need to flexibilize the 
Chinese economy, its banking system, and its monetary policy, 
so that over time it can move to a more flexible exchange rate. 
And the Chinese themselves have said that.
    But you do not need any of that to get what I think is 
necessary, namely, a one-shot revaluation of the exchange rate 
of the renminbi. They should keep the fixed exchange rate for 
now, though widening the margins to make it more flexible. They 
should keep the capital controls for now, given the weakness of 
the banking system. But they should substantially change the 
price of their fixed rate.
    Our analysis shows that if China would revalue its currency 
by 25 percent, and the rest of the Asians would go halfway in 
that direction, it would reduce the U.S. current account 
deficit by at least $60 billion. If the rest of the Asians went 
all the way with China, which the markets might well push them 
to do--and they might then be prepared to do--the United States 
would achieve something like $100 billion of current account 
correction.
    As I said before, we are running an $800 billion deficit 
now. We need to cut it by $300 billion to $400 billion--not to 
zero but roughly in half--and this achievement from the 
correction of the Asian currency relationships would carry us a 
substantial way down the path. We still have to increase our 
own saving rate and the Europeans still have to grow faster but 
we would get at least a quarter to a third of the needed 
correction if we got the adjustment of the Asian currencies.
    So the bottom line--and I want to emphasize that one point 
today because I think it is so crucial and so urgent--is that 
our own government and the rest of the G-7 should insist that 
the IMF take the lead and implement its own rules. It does at 
the end of the day come back to the United States and the G-7.
    The G-7 finance ministers are meeting this weekend. I hope 
they agree to launch this initiative. The G-8 summit is meeting 
in a month. Tony Blair is here talking with President Bush 
about it today. It is well and good for the G-8 to take new 
steps to help Africa develop and to worry about climate change 
but we have a critical, large, and urgent problem facing the 
world economy. I hope and recommend that the G-7 countries, at 
the finance ministers' meeting this weekend and at the summit 
next month, mobilize the IMF to implement its own rules to get 
this crucial part of the global adjustment under way.
    Thank you.
    Senator Crapo. Thank you very much, Dr. Bergsten.
    I will start out with you, Dr. Meltzer. You indicated in 
your testimony--in fact, let me go back to a previous hearing 
about 3 or 4 years ago, when we were talking about the Meltzer 
Commission's report and the World Bank. And this is going to 
tie in to my first question. I am recalling at that time that 
one of the reforms that was proposed for the World Bank was 
that instead of just making loans to national that were 
basically over which we did not have any real oversight, that 
we instead--and I am not remembering the exact mechanism--but 
that instead that we focus on the exact services that were 
intended to be provided and pay for the services, rather than 
simply making an unmanageable loan. Could you clarify that a 
little bit for me?
    Mr. Meltzer. Yes. What we wanted and what we recommended 
was managed grants.
    Senator Crapo. That is right.
    Mr. Meltzer. To its credit, the Bush Administration has 
pushed that. It has met a lot of resistance from some of those 
people who are out there today saying, ``We need to give $50 
billion more.'' They resisted the idea of giving monitored 
grants, but they eventually made a small step in that 
direction. We need to take a much larger step.
    What we would do is we would say, ``Pick a problem. Let the 
country pick its problem.'' It says, ``We want water, potable 
water in the villages. We will hire somebody, take bids, get 
potable water in the villages, and pay them when it is there.''
    Senator Crapo. We pay the provider of the service?
    Mr. Meltzer. The World Bank, yes, pays provided the water 
is there. That way we get around some of the corruption that is 
involved, some of the non-feasance perhaps.
    Senator Crapo. Is the World Bank operating that way to any 
significant extent?
    Mr. Meltzer. To a very limited extent. The World Bank 
fought the idea, the French particularly did a lot of talking 
right after the report came out. The French said, maybe we will 
do this by 5 percent or something, of the amount that we give; 
a trivial amount and only as a sop to the United States.
    Senator Crapo. The reason I ask is that, as you know, the 
Meltzer Commission unanimously recommended that the IMF should 
get out of the business of poverty reduction loans.
    Mr. Meltzer. Right, and I still recommend that.
    Senator Crapo. I think you still recommend that, and if I 
understand your testimony correctly, you recommend that the 
Poverty Reduction Growth Facility simply be eliminated. Dr. 
Bergsten I think recommends it be transferred to the World 
Bank.
    Mr. Meltzer. That is essentially the same thing.
    Senator Crapo. And that is about the same thing. So the 
World Bank is doing that function, and the question I was 
getting at is do you both agree that it should not be a 
function that is performed by the IMF. First of all, do you 
both agree with that?
    Mr. Meltzer. Yes. I think the main reason is that it does 
not believe that the World Bank is an efficient mechanism for 
doing what it is supposed to be doing.
    Senator Crapo. Dr. Bergsten.
    Mr. Bergsten. I certainly continue to agree with that view. 
I would add that there have been a couple of management changes 
at the IMF since the issuance of the Meltzer report, and under 
one of those moving the Poverty Reduction and Growth Facility 
to the World Bank was seriously considered. The management, in 
fact, was convinced that it was the right thing to do.
    When the management toured Africa and talked to the 
beneficiary countries however, they all very strongly resisted 
the idea. It was not just the French on the donor side. It was 
the recipient African countries who argued that the only 
benefit they could get from IMF membership was the credit from 
this Poverty Reduction and Growth Facility.
    Moreover, when faced with the alternative of shifting it to 
the World Bank, the African countries said, ``Ah, but that is 
not really quite the same thing. The IMF is a much more serious 
institution; and if we pass muster with the IMF, we get a lot 
better rating in the credit markets.'' Both Dr. Meltzer and I 
would like to see them move toward that.
    It was very interesting how that issue evolved. 
Implementing the transfer, not elimination, but the transfer 
from the Fund to the Bank was seriously considered. In fact, in 
their usual bureaucratic way, they had even cooked up a swap, 
where the Fund would transfer the PRGF to the Bank and get 
something back in return so they would not have to fire too 
many of their bureaucrats.
    Senator Crapo. But you still support that transfer.
    Mr. Bergsten. I support the transfer. It needs to be done. 
It is way overdue.
    Senator Crapo. All right. Dr. Meltzer, in your testimony, 
again, you also talked about the preconditions to assistance 
that we need to assure are in place. Could you specify a little 
more detail about what those preconditions should be?
    Mr. Meltzer. Yes. They would be fiscal solvency, proper 
monetary policy, an adjustable exchange rate, opening the 
banking system, the local banking system to foreign banks, 
which, incidentally, is an agreement that we have, that 
countries have with the World Trade Organization, so it is 
something that just says they ought to do what they have agreed 
to do and slowly they have been doing it. Those would be some 
of the principal things we would do. We would avoid some risks 
with foreign banks in the country. When there is a banking 
problem they would run to the foreign banks instead of run from 
the currency, which is a much better solution, and with a more 
flexible exchange rate they would be less prone to crises. The 
biggest problems that we have had in recent years have been 
combinations of banking crises and exchange rate crises. The 
preconditions would try to get rid of those, but would 
recognize that there are other sources of crisis and, 
therefore, we would lend to them automatically when they came 
through. Automatically means that the IMF would continue to 
monitor them and would keep them on the preferred list, if you 
want, and that would be a market indicator to people in the 
private market which says, hey, this is a good country or this 
is not a good country.
    Senator Crapo. And would you agree that that is probably 
the most significant reform that we should focus on at the IMF 
at this point?
    Mr. Meltzer. Yes. That is hard to get. I mean, they have 
thought about it. They actually announced something which is 
very close to that called CCL. You know, they could not get 
very many countries to agree to it. One reason that countries 
would not agree to it was the IMF would not make the guarantee 
that the country would get the assistance.
    Senator Crapo. So why make the reform if I do not get the 
assistance.
    Mr. Meltzer. Exactly. Why make the commitment?
    Senator Crapo. Dr. Bergsten, I want to get to your points 
on China, but, first of all, your thoughts on the suggestions 
about the preconditions to assistance and that being the next 
strong focus.
    Mr. Bergsten. I am very pleased that Dr. Meltzer's views on 
the nature of the preconditions--it is fair to say--have 
evolved a bit over the years, because when the Commission 
report was prepared and issued--it is fair to say--he will have 
to correct me as the chief author.
    Mr. Meltzer. I will.
    [Laughter.]
    Mr. Bergsten. I am sure.
    Senator Crapo. It would not be a hearing between you two if 
we did not have a little bit.
    Mr. Bergsten. As I recall, the overwhelming emphasis in 
terms of preconditions from the majority was the soundness of 
the banking system in a developing country.
    Mr. Meltzer. Not true.
    Mr. Bergsten. Well, let us go back and parse the language. 
That is an eminently desirable requirement, but it is not 
enough. The point that the minority emphasized in our dissent 
was that limiting the preconditions in that way might have two 
very adverse effects. One, it might enable a country to get IMF 
credit even if its macroeconomic policy was way out of whack; 
and, two, it might preclude assistance to a country which 
needed the help and was systemically important but had had a 
weak banking system.
    Let me illustrate by referring to the country you discussed 
earlier--Argentina. My recollection--and I am basing this 
largely on a study done at my institute by Michael Mussa, the 
former Chief Economist of the IMF--is that the Meltzer 
Commission majority's criteria would clearly have qualified 
Argentina for IMF credits deep into its crisis period because, 
prior to the crisis, Argentina had a sound financial system 
with lots of foreign banks. Indeed, Charles Calomiris, one of 
the chief architects of the majority report, said so publicly.
    So if one of our goals--and I address that in my written 
statement--is to avoid big IMF mistakes like the big credits to 
Argentina, which prolonged the crisis and expanded the agony, 
the Meltzer majority's remedy would not have done that. So the 
broadening of Professor Meltzer's criteria to now focus first 
on fiscal policy, second on exchange rates, and third on the 
banking system sounds a lot better. But it is not complete. 
There is monetary policy, as he well knows. There are lots of 
other things. I think any set of preconditions is going to be 
limiting, but I like Meltzer 2005 a lot better than Meltzer 
2000.
    Senator Crapo. Well, I am going to let Dr. Meltzer have the 
last word on my testimony here, and then in the second round I 
will come back to you, Dr. Bergsten, on your issues regarding 
China.
    Dr. Meltzer, you can have the rest of my round.
    Mr. Meltzer. Rather than argue about the past, which is 
written down in print and I know what is there, let me just say 
that I am very happy that we agree now, at least we seem to 
agree now that preconditions would be a very good way for the 
Fund to go. That is the important point going forward, not 
arguing about the past.
    Mr. Bergsten. I did not say that I would go for 
preconditions. In fact, my last comment was that any set of 
preconditions is almost certain to be too constraining.
    Senator Crapo. Dr. Bergsten, you do not agree with 
preconditions?
    Mr. Bergsten. No, and I think the experiment that Professor 
Meltzer mentioned with the contingency credit line, the CCL, is 
evidence of the problem. There were no takers.
    Senator Crapo. Okay. Anything else, Dr. Meltzer?
    Mr. Meltzer. There were no takers because I sat in a 
meeting with the Managing Director of the Fund--and there were 
four or five of us there--it was pretty clear that the Fund 
bureaucracy would not agree to making a contingent credit line, 
CCL, would not agree to do that and say if you meet the 
conditions you get the assistance. What they said is, well, we 
want to take another look-see, we want to see whether 
everything is okay. That is what stretches out the problem. And 
Mexico was a good example where we stretched out the problem 
for months. Things got worse and worse and worse, and 
eventually we faced a big crisis. It would have been a crisis 
but a smaller crisis if we had handled it early along the lines 
that we suggested, that I suggested.
    How much earlier? Well, that crisis was clear and apparent 
as early as July of the year before they devalued. That is when 
the United States started to give 700--what the United States 
used to do was almost--was just terrible. They would lend them 
the money on Friday so that it would show up on the statement 
of the Mexicans on Monday, and then on Tuesday the Mexicans 
would pay it back.
    Senator Crapo. Let me interrupt because Senator Bayh is 
under a time pressure. I want to give him some time for 
questions here.
    Senator Bayh. Thank you. I apologize. It is a fact of life 
around here that sometimes you are required to be in two places 
simultaneously. I have yet to figure out how to accomplish that 
without feeling like I am shortchanging both sides of the 
equation.
    I want to thank both of you. Just real quickly, Dr. 
Meltzer, it sounds as if you feel that the outcome in Argentina 
has occurred in a way that will limit the risk of moral hazard 
going forward.
    Mr. Meltzer. Correct.
    Senator Bayh. One of the last meetings we had of this 
Subcommittee, we had a roomful of the creditors, and I do take 
some exception to the actions of the Argentine Government. But 
at the same time, we looked at the creditors and said, you 
know, they call it a risk premium because it is risky?
    Mr. Meltzer. Right. And they will learn that much better if 
they go through the Argentine--where they lost a very large 
amount.
    Senator Bayh. And I do not want to put myself in the middle 
of your conversation here, but in your view--the Argentines 
defaulted for 24 hours and then made their payment to the IMF. 
Was that correct? They technically defaulted?
    Mr. Meltzer. No. They defaulted on their debt in December--
--
    Senator Bayh. I am talking about to the IMF.
    Mr. Meltzer. The IMF, oh, yes, but that was just--that was 
nothing.
    Senator Bayh. In your remarks, in your testimony, you 
posited the risk of other defaults going forward and that kind 
of thing.
    Mr. Meltzer. Right. As Secretary Quarles said--and I asked 
this question of the Brazilians, especially the Brazilian 
Finance Minister, how would they feel about defaulting on their 
debt as a result of Argentina? They said the Argentina 
experience was rather bad, so that has quieted the people in 
Brazil who think we should default on the debt because it was 
so bad. And that is encouraging.
    Senator Bayh. Are we talking about private sector debt or 
IMF debt?
    Mr. Meltzer. As well as government sector debt. I think the 
pressure in Brazil was to default on both, but especially on 
the public sector debt. So, I think that is encouraging.
    On the other hand, it is a long time, and we have 
countries--we had Peru at one point, Alan Garcia defaulted on 
the IMF debt, and it stayed defaulted until he was thrown out. 
Now he is a candidate for President again and we do not know--
Peru is not doing too badly.
    Senator Bayh. You think the lesson that some of the other 
countries have taken away from this is that----
    Mr. Meltzer. They got rid of 70 percent of their debt.
    Senator Bayh. I was going to say that from what I can tell, 
just as a lay person observing from afar, they have not 
concluded that default led to their problems but was perhaps 
one step in getting out of them which is a dangerous conclusion 
to reach.
    Mr. Meltzer. Well, but I think it was your comment before--
that is right. It is a dangerous conclusion to reach. But your 
comment before was Argentina is going to return to the debt 
market. My prediction to Mr. de Rato a couple of months ago was 
that when they settled this, as I thought they would, the 
investment bankers would be on the next plane down to Argentina 
with a suitcase full of bonds. So why did they do that? Well, 
they say, you know, Argentina does not have much debt anymore; 
you know, 70 percent of it has been wiped out, or thereabouts.
    Senator Bayh. It is collective amnesia?
    Mr. Meltzer. Or the greater fool theory.
    Senator Bayh. They are all evaluated on short-term 
performance and do not think about the long-term risks perhaps. 
But my final question to you, and then, Dr. Bergsten, a couple 
of things for you. As I understand it, Argentina has in some 
respects not followed the conventional economic advice from the 
IMF and others in trying to get their country back on the right 
track, and yet things seem to have stabilized, and at least 
temporarily there is some growth taking place there.
    Now, is the lesson that they and others are going to derive 
from that just, you know, hey, we can flout conventional wisdom 
in these areas and things will turn out just fine? So my 
question to you would be the sort of stabilization of 
Argentina, return to some growth, is this a lasting phenomenon 
there? Or what lessons will be derived from that?
    Mr. Meltzer. I do not think it is a lasting phenomenon, but 
it certainly has been a successful couple of years for 
Argentina. It is growing fast and all that. It has not gotten 
its GDP back to where it was before it defaulted and before it 
devalued.
    Senator Bayh. Let me ask the question a little bit 
differently. If you are a country that is on the cusp of 
getting into some difficulty, are you going to follow the IMF's 
advice? Or based on Argentina's experience, are you going to 
follow their path? I mean, they might look at this and say, 
hey, things turned out okay for Argentina, maybe we should try 
that, too?
    Mr. Meltzer. Yes, the history, first, is that countries, I 
think according to the IMF's own evaluation, countries follow 
about 50 percent of the advice that they agree to when they 
make these agreements. So there has not been a strong record, 
and there has been study after study to show, is there an 
effect of the IMF? Well, it is hard to see. Even the IMF study, 
it is hard to see that there is much effect of the advice that 
they give.
    Senator Bayh. I am not sure Congress takes 50 percent of 
the advice we get. What do you think?
    Mr. Bergsten. Bringing down the average badly.
    Mr. Meltzer. In the case of Argentina, I would say 
Argentina, in my experience with a large number of countries, 
even Brazil, is one of the most nationalist countries I have 
ever seen. I mean, we are Argentines, we do not have to take 
advice from anybody. And they do not. So they did not follow 
too much of the advice.
    Senator Bayh. I am more concerned about what other 
countries will think going forward, observing this experience. 
Will they conclude, hey, the IMF prescriptions, you do not need 
to follow them in order to get back on your feet and heading in 
the right direction?
    Mr. Meltzer. One hopes not, but, I mean, I would not want 
to make a prediction as to what is going to happen in Latin 
America, especially, which is where the IMF has been most 
active. You have a lot of countries--Venezuela is certainly not 
going to take advice from anybody. Bolivia could take advice 
from almost anyone and do better than it is doing.
    Senator Bayh. Do you have a take on all this, Dr. Bergsten?
    Mr. Bergsten. Yes, I would be more optimistic. One of the 
remarkable elements of this whole episode has been the failure 
of the Argentine example to spread to other countries. We do 
not know whether it will over the long-run. But so far, so good 
on that count. There was a lot of fear that the Lula 
government, when they took office in Brazil, might have been 
tempted to follow the Argentine example. After all, they had 
problems. They had to go to the IMF. Many people thought Brazil 
would have faced a debt crisis. There was legitimate debate 
about that.
    Brazil rejected the Argentine model very explicitly and 
went the more conventional way. But here is what I think the 
explanation is. One has to be very careful about the timing of 
when the Argentines defaulted. On my reading, the Argentines 
defaulted when they were already well into their crisis. They 
had huge and unsustainable fiscal deficits. They had a hugely 
overvalued exchange rate which they had maintained way too 
long. And, incidentally, the IMF had failed to criticize them 
on both counts.
    A huge failure of the IMF was not using the good times--
when Argentina was doing well in the mid-1990's--to lean on 
them on the budget and on the exchange rate system. The IMF 
failed to do that. The IMF is culpable for the onset of the 
Argentine crisis and then for prolonging it by giving them a 
big loan after it was too late.
    But from the Argentine standpoint, the key element is that 
they were well into the crisis. Things were crumbling all about 
them. So it was not whether to default to avoid a crisis but to 
default to avoid an even deeper crisis, even deeper recession, 
which would have been required to keep paying the debt on 
schedule.
    So in that sense, the default has been a huge success for 
Argentina, as their president reminds us every day. But as I 
tried to document in my statement, none of the feared spillover 
effects have been observed, at least to date, and I do not 
think will be, because everybody realizes that what Argentina 
went through is devoutly to be avoided. When the Lula 
government in Brazil looked at the alternative of taking 
preventive action to head off getting into a crisis, including 
continuing to pay its debt, that looked a lot better than 
letting things deteriorate and then having an excuse to 
default.
    So the timing element is really crucial. In that sense, the 
Argentine episode is probably sui generis, at least relative to 
most countries see it coming and can head something off, with 
or without IMF help, at an earlier stage.
    Mr. Meltzer. Before you go, Senator, I would like to object 
or at least differ with Mr. Bergsten on one point that he made 
to you on a subject which is of considerable interest. He 
described the position of the United States and the need for 
reform as urgent. I do not think it is urgent. I think there is 
a risk. But I think it is wrong to make a crisis out of a 
problem. We have a problem. It has been going on.
    Senator Bayh. You are referring to our current account 
imbalances?
    Mr. Meltzer. Current account imbalance, the Chinese 
exchange rate, and Southeast Asian exchange rates. I think 
there is a problem. But the problem comes--has been there for a 
while and it is going to be there for a while. And it is not 
going to go away, and we do not need to treat it as a crisis. 
That is how we can make crises occur. We should recognize it as 
a risk.
    Senator Bayh. I am tempted to ask you whether you think 
Social Security is a problem or in crisis, but I will not.
    Mr. Meltzer. It is not a crisis. It is a problem.
    Senator Bayh. My point simply is crisis/problem, it is kind 
of in the eye of the beholder in some senses. We are trying to 
deal with both short-term and long-term problems. But I 
appreciate your comment.
    Mr. Bergsten. I would like to make one comment back to Dr. 
Meltzer, though, because he and I firmly agree on trade policy, 
the need to avoid trade restrictions, and maintain an open 
trade system.
    Mr. Meltzer. Until today.
    Mr. Bergsten. But we agree on the basics. Here is my point: 
The current account imbalance and the continued overvaluation 
of the dollar have two unsustainabilities. One is the 
international financial unsustainability, the risk that the 
foreign capital might stop flowing in, the dollar might drop 
sharply, up goes inflation, up go interest rates, down goes our 
economy. And Professor Meltzer rightly says we do not know 
whether, that could be sustained for a while longer, we do not 
know when, if ever, that risk will become a crisis.
    But I would submit there is a second unsustainability, 
which is already pretty close to becoming a crisis--the 
domestic political unsustainability, the pressures you all face 
every day to restrict trade as a tenth-best alternative to 
getting the macro imbalances under control.
    Senator Bayh. Let me follow-up on----
    Mr. Bergsten. If you look at the record of U.S. trade 
policy over the last 30 to 40 years, the best leading indicator 
of U.S. imposition of trade barriers is not the unemployment 
rate or any of our domestic economic variables, it is the 
external imbalance in the valuation of the dollar. When the 
dollar gets way overvalued, when we run big current account 
deficits, the domestic politics of trade policy shift. A lot 
more industries and workers look for import relief. Export 
interests decline in interest and clout. The domestic politics 
changes. That is when we risk breaking the trading system.
    When Jim Baker did the Plaza Agreement in 1985 and drove 
the dollar down 50 percent over the next 2 years, he did it not 
because there was any fear that foreign investment in the 
dollar was collapsing. It was because the Congress, as some of 
my friends in the Ways and Means Committee put it at the time, 
would have overwhelmingly passed the Smoot-Hawley tariff had it 
come to the floor. It was the trade system that was at risk, 
and that is where I think Dr. Meltzer and I probably would 
agree.
    Senator Bayh. If I could just conclude, I apologize I am 
going to have to run to this other meeting. I was intrigued by 
your suggestion that we go to the IMF. What suasion can the IMF 
bring other than just--what leverage do they have on countries?
    Mr. Meltzer. They can try to arrange a bilateral movement.
    Senator Bayh. To put a fine point on it, why should the 
Chinese listen to them if they are not listening to us?
    Mr. Meltzer. The Chinese--it is useful when you think about 
a problem of this kind to think about what is it that is 
motivating the Chinese. What is motivating the Chinese is 150 
million Chinese who would like better jobs. All right, so 
keeping their exchange rate, we should understand that. 
Employment is a big issue for us and always is a big issue for 
us.
    Senator Bayh. I appreciate their domestic motivations very 
well.
    Mr. Meltzer. All right.
    Senator Bayh. If the IMF goes and begins to engage in these 
discussions, why would the Chinese not just dismiss them?
    Mr. Meltzer. It would try to make a bilateral change or a 
multilateral change; that is, it would try to negotiate--
instead of our spitting at the Chinese and their spitting back, 
we would try to get together and find something which would say 
we will do something and you do something and, therefore, we 
need an intermediary.
    Senator Bayh. It gives them a multilateral cover for doing 
the right thing, it is a loss of face, that sort of thing?
    Mr. Meltzer. On both sides.
    Mr. Bergsten. It is a name and shame campaign to mobilize 
not the United States bilaterally, as Dr. Meltzer said, but the 
global community through an institution of which China is 
itself not only a member but also a very active member--it has 
its own seat on the Executive Board--to bring a collective 
judgment that what China is doing is hurting not the United 
States job situation but the world economy as a whole.
    Senator Bayh. So it is moral suasion.
    Mr. Bergsten. It is moral suasion. It is a name and shame 
campaign.
    Senator Bayh. Unlike the WTO, though, there is nothing 
concrete they can do to actually----
    Mr. Bergsten. I am afraid that is right. But as I said, if 
that did not work and we then had to go to the WTO, in a case 
like that the WTO rules require the imprimatur of the IMF in 
the first place. So you would have it, and then you could take 
it to the WTO and say there is nullification and impairment, 
there is a subsidy--you could use at least three WTO rules. But 
you would have to have IMF validation.
    Senator Bayh. My last question: Is there any doubt in your 
mind in terms of what the IMF would conclude with regard to 
currency practices of China?
    Mr. Bergsten. If the IMF read its own rules literally and 
in terms of common English, there would be no doubt.
    Senator Bayh. The reason I ask is that our own Treasury 
just issued a document that--well, it was curious.
    Mr. Bergsten. I agree with that, as I said in my statement. 
The IMF, like any international institution, is political. I am 
sure the Chinese would lobby against a movement of that sort, 
and it would be a test for the IMF. And that is one reason I 
would like to pose it.
    Senator Bayh. Gentlemen, thank you very much.
    Senator Crapo. Thank you very much, Senator, and we 
appreciate your support here.
    Actually, Senator Bayh got into exactly the area that I was 
going to get into at the conclusion of my questioning, my last 
questioning period, and that is, I am intrigued, Dr. Bergsten, 
by your suggestion that we turn to the IMF to try to get China 
to take the right steps. And there has already been a 
discussion here about just what authority and ability the IMF 
might have.
    I would like to pursue that a little further, and let me be 
sure I understand your testimony correctly. You indicate that 
you think that the current pressure to cause the Chinese to 
simply float their exchange rate is not the right suggestion--
--
    Mr. Bergsten. In the short-run.
    Senator Crapo. In the short-run.
    Mr. Bergsten. Right.
    Senator Crapo. In the long-run it would be, but that in the 
short-run we should just have one significant revaluation of 
the exchange rate of the renminbi. Did I say that right?
    Mr. Bergsten. You got it.
    Senator Crapo. To have a revaluation, and that revaluation 
would be, in your opinion, best if it were around 25 percent 
and followed by the other Asian nations.
    Is there anything that we could argue--in this discussion 
that the two of you have indicated could and should take place 
through the IMF to try to be a facilitator of this decision, is 
there anything other than simply saying, hey, it is best for 
the world that you do this?
    Mr. Bergsten. Yes. I think--and here Dr. Meltzer is, of 
course, right--the Chinese are going to be driven to a very 
large extent by their internal considerations. One can make an 
overwhelmingly persuasive case that this big revaluation is 
very much in China's internal interest.
    Senator Crapo. I had heard some discussion to that effect, 
and that is why I asked the question.
    Mr. Bergsten. There are three reasons. One, their top 
leadership has acknowledged the economy is growing too fast. 
They say they want to slow it down, at least a percentage point 
or two, for the next couple of years. A revaluation would do 
that by slowing growth of demand for their exports.
    Two, they have inflation pressure. It has calmed a little 
bit now, if you believe the official statistics, but it is 
still substantial. Less than a year ago, it was running 8 to 9 
percent on their inter-company producer price index. A 
revaluation of the currency will reduce import prices and fight 
inflation.
    Three, huge flows of speculative capital are coming into 
China, despite their capital controls, and ballooning their 
money supply. They are adding $20 billion to $25 billion per 
month to their foreign exchange reserves. They buy those 
dollars to keep the price of the dollar up and renminbi down. 
That is the way they keep their fixed rate and avoid the market 
pressure for appreciation of their currency.
    But the monetary effect is a huge increase in their 
international reserves which in turn tends to increase the 
domestic money supply and generate inflation pressure.
    The People's Bank of China, like any central bank, tries to 
sterilize that but they themselves admit they are not able to 
do that fully because the capital inflow is so great. And that 
is, therefore, expanding the money base; that it is adding to 
the inflation pressure. Moreover, since that money goes through 
the private banks, it is likely the private banks are making 
bad loans, nonperforming loans to their state-owned enterprises 
and others, thus reversing the progress they had been making in 
reducing the instability of their financial system. So the IMF 
should be arguing with them purely on domestic grounds.
    In addition, they are getting a spate of external trade 
barriers against their exports. We are seeing it every week 
here--for example, against their textile products. But it is 
not just textiles--it has been semiconductors, wood furniture, 
color TVs, and shrimp. It is widespread and growing rapidly. 
The Europeans are now joining in the game. So the Chinese face 
a real choice on the external side-- taking more trade barriers 
against their exports or revaluing the currency.
    When you add that to the internal reasons, it makes for a 
very powerful case, which our own Treasury and the IMF can, and 
should, be making. It would clearly provide an internationally 
defensible, persuasive case to mobilize the international 
community through the IMF to go to the Chinese and argue sweet 
reason. It might still not work, but it would be different if 
the world as a whole through the IMF were doing this rather 
than the United States bilaterally or even the rich-country 
grouping in the G-7.
    Senator Crapo. Dr. Meltzer, do you agree? And do you have 
anything to add to that?
    Mr. Meltzer. I do not think there is a crisis and people 
have been warning about this crisis for quite a long time. I do 
think that there is--of course, I understand and I am sure you 
understand--the pressures that come on Congressmen and Senators 
about trade. But it is important to remember that, gee, we are 
pretty close to full employment in this country. We may be 
losing jobs, but we are also gaining jobs. It is not true that 
we are going to have a huge effect. I think Fred is simply way 
off base if he thinks the Chinese are going to revalue by 
anything like 25 percent. You know, I think they are talking 
about something much smaller than that. It is not going to have 
a big effect on our current account deficit. So we ought not to 
run the risk of upsetting a system which has worked very well 
since 1950 in terms of producing more growth in more countries 
and more spread of freedom than any system that we have had at 
any time in man's history. We ought to remember that we sit at 
the end of a period of enormous progress all over the world, 
and we do not want to disrupt that system, and the open trading 
system is an important part of----
    Senator Crapo. And you believe the disruption would be any 
kind of trade retaliation.
    Mr. Meltzer. I think the trade--that going the trade remedy 
is a first step toward--we, after all, are the proponents. It 
was Franklin Roosevelt and Henry Morgenthau that pushed the 
idea of mutual reduction in tariff barriers. That got built 
into the IMF originally, through the GATT, and now through the 
WTO. We are the proponents of that. We pushed that. We open up, 
we try to help countries to become democratic. One of the 
things we do is we sign bilateral trade agreements with them, 
so we say we are going to let you come into our market, but in 
exchange we want to see some stability in that country.
    I think we want to be very careful about throwing away a 
system that has worked extremely well. But I do believe that 
prudent people look at risks and say I do not know whether this 
is unsustainable forever. But at least there is a chance that 
it could disrupt in a crisis. Therefore, we want to take an 
orderly approach where we make some concessions to the world by 
reducing our current account deficit. And let me say that the 
trade deficit, the second time--we saw this in the 1980's--the 
budget deficit has come down; the trade deficit, the current 
account deficit is not coming down. There is not a one-to-one 
correspondence between those two things. We do need to do 
things which increase our saving rate. Those are long-term 
things, but they are very important. And that is where the 
President is going to have a tax reform commission which is 
going to come with a proposal for tax improvements, presumably 
to help the saving rate. The Congress should really try to look 
at that, take it seriously as a long-run fundamental change.
    The Chinese need to do something about their exchange rate. 
There is no question about that. But we need to do that slowly, 
and they need to do it in a systematic way that affects all of 
Southeast Asia. That is why I think a neutral, rather less 
involved group like the IMF, which has responsibilities in this 
area, is a good place to try to negotiate these differences on 
a multilateral basis.
    Senator Crapo. You know, the two of you together I think 
have painted a pretty good picture of the positions and the 
arguments that are made around this issue, and, in fact, you 
have also raised the macro political issues that we deal with 
here in Congress.
    I tend to think that it would be a great thing, Dr. 
Bergsten, if we could succeed in the arguments that you make 
and the strategy that is proposed here that you both support of 
having the IMF try to play a role in facilitating this and get 
the Chinese to have a one-time revaluation up to 25 percent.
    On the other hand, I also tend to think that Dr. Meltzer 
might be right that it is not highly likely to success that 
they would do that.
    Now, I do not know and I would love to--I certainly think 
we should try it. But it certainly raises the political issues 
that we are dealing with here in Congress. The fact is that the 
Chinese have been manipulating the U.S. dollar for a decade or 
more.
    Mr. Meltzer. At great cost to them. The cost to them is 
something like 1 or 2 percent of their GDP every year.
    Senator Crapo. That is at great cost to us, too.
    Mr. Meltzer. Well, you know, we are----
    Senator Crapo. Given things are so great here in the--I 
mean, there is a lot of the positive you can point out. There 
is a great cost here that we are paying.
    Mr. Meltzer. That is right, but there is a great benefit. I 
mean, we get real goods and services from them, and we give 
them pieces of paper, which we can ultimately devalue if we 
wish. We are not suffering terribly as a result of this. There 
are local problems that come because of the wood industry, the 
textile industry. But to think that we are going to save the 
textile industry by a Chinese revaluation, that is going to 
have more beneficial effect on Mexico than it is on us.
    Senator Crapo. Can I assume that--and I would like you both 
to just comment on this again. You have both touched on it 
already, but I am hearing both of you say that the Congress 
should avoid the political pressure to impose trade barriers as 
a pressure to get a solution here. Am I correct there?
    Mr. Meltzer. Absolutely.
    Mr. Bergsten. I yield to no one, including even Dr. 
Meltzer, in my zealous support of the free trading system for 
50 years. I have been working very hard on it for all my 
career. So, I absolutely concur with everything he said on 
that.
    I do observe, however, as I mentioned before, that the 
politics underlying an open trading system are threatened when 
there are big macroeconomic imbalances. It could be prolonged 
recessions, like in the 1930's, but it could also be prolonged 
currency imbalances. I cited the example of the mid-1980's, 
when President Reagan, despite being clearly pro-market and 
pro-free trade, put up more trade barriers than any President 
in the 20th century because of the currency imbalances and the 
big growth in our trade deficit.
    During the Reagan Administration, voluntary export quotas 
were foisted on Japan on almost everything--autos, steel, 
machine tools, you name it; other countries did so as well. 
Why? Because of big macro imbalances.
    We were at risk of losing the open trading system, which 
Dr. Meltzer and I both espouse so strongly, because of 
macroimbalances--in that case, it was truly macro in the United 
States, the fiscal policy, the fiscal/monetary mix, but also 
the exchange rates, which threatened the system. Therefore in 
defending the open trading system, I will frequently emphasize 
taking tough measures, if necessary, to eliminate the currency 
imbalances.
    I acknowledge that it sounds paradoxical to say I want to 
threaten trade controls against China to avoid the risk of 
putting on trade controls. That is why I want to try everything 
else first, and that is why I think this IMF strategy would be 
the way to go right now. But if at the end of the day China and 
the other Asian countries continue to resist any adjustment 
from their standpoint, we may have to get tough. It was done in 
the United States in the early 1970's; it was done in the mid-
1980's. It succeeded both times, with some crockery broken 
along the way. You prefer not to do that.
    But think back to what Secretary Quarles said. He talked 
about the three-legged stool they have in mind for dealing with 
this problem, and in broad terms I agree with that. One leg is 
the Asian currencies. They have been trying sweet reason on 
their own for 2 years. It has had zero impact. The question is 
whether, with the step-up in U.S. action, per the Secretary's 
latest report, there will be some response from the Asian side. 
I dearly hope so. But I am also realistic enough to say there 
may not be. And if they move, it might be a token step, and you 
might not get any significant adjustment out of it.
    So it is not just that they move but the move be big enough 
to have a discernible impact. If they--China but also the rest 
of Asia in part, using China as a justification--continue to 
resist, then we face the choice of either letting the 
imbalances get bigger, building the financial risks, and 
clearly increasing the risks to the open trading system or 
trying to deal with the problem, even if it means taking the 
gloves off. I resist that. I prefer not to do it. But sometimes 
in the real world you have to go that way.
    Senator Crapo. Dr. Meltzer, what if we try this and it does 
not work? Can we still face the Chinese manipulation of the 
dollar?
    Mr. Meltzer. We have the ultimate weapon which we have, 
which is we can inflate and wipe out most of that debt. So that 
is a weapon that we have. That is certainly not a weapon that I 
recommend, but before I brought down the international trading 
system, I would certainly think about what other weapons there 
were in the arsenal.
    Let us go back and before we make a crisis out of this 
problem, let us go back and Think through. We receive valuable 
goods and services from the Chinese, including things which 
help us keep the cost of manufactures down, as well as the cost 
of consumer goods. In exchange for that, we give them pieces of 
paper. That is a great system for us because it does not cost 
us anything to print those pieces of paper, and we get real 
value for it.
    Now, what makes it a problem? It becomes a problem because 
there are many people who believe that it is unsustainable, 
that it cannot go on, and, therefore, we should do something 
about it. But before we use the sledgehammer, we ought to go 
slowly. So that is why I describe this as a risk. There is a 
risk that people who are--I am not convinced, but there is a 
risk that the people who say that this is a problem will be 
right. Therefore, a prudent man says, well, let us take some 
steps in the direction of correction. And what are some ways of 
doing this? Well, we have tried. I think the Chinese have 
certainly moved--I do not think that it is correct, as Fred 
says, to say that the Treasury's patience has been completely 
lost and nothing has happened. I think the Chinese have heard 
from us, from the Europeans, from others, and they are moving.
    They never give the date and the action in the same 
sentence, so we never know whether there is going to be a 
Chinese move. But I think that they have gotten the message.
    There is always a question in negotiations of this kind 
whether, if you are quiet and not aggressive, you get more 
action than you do if you are too aggressive. I mean, the 
Chinese are proud. They are not likely to revalue their 
currency because we ask them to or we demand it of them. So 
that is why calm negotiation which deals with the risk of this 
problem over a longer period of time, which says, you know, 
what do we want? A one-time revaluation of the Chinese 
renminbi? No. I would like to see Chinese put on a path which 
would move them toward a floating exchange rate. That is not so 
hard for them to do, and they know what they have to do. They 
have to improve their banking system. Well, they have $700 
billion worth of bonds. They could shore up their banking 
system to some extent. What they need to do is to make the 
internal changes, which are very important, and not keep 
building up the bad loans of the banking system and using that 
as an excuse for not being able to move their currency. So we 
want to move the negotiations so that they look at their 
problems and we look at our problem.
    Senator Bayh talked about, sort of alluded to the fact that 
Argentina had run a big deficit. The United States is in a 
peculiar position. Its debt is all in dollars. Argentina's debt 
was in dollars. But we can produce dollars, so that puts us in 
a unique position in the world, and it is probably that more 
than anything else which keeps us from having a crisis now 
instead of a problem. So I say we do want to go to some neutral 
agency; we do want to negotiate. Fred and I agree about that. 
But we want to make really major moves on both sides--here to 
increase the saving rate, there to shore up the financial 
system and float the exchange rate.
    Senator Crapo. Well, like Senator Bayh, I am starting to 
run into some time pressures now, too. I know that both of you 
also have a lot more to say. Dr. Bergsten, I know you were 
trying to get in there. Can you just say it in a couple of 
minutes?
    Mr. Bergsten. I must admit I was shocked to hear Dr. 
Meltzer, who has written a definitive study of the history of 
U.S. monetary policy, suggest we might respond to this by 
inflating our debt away.
    Mr. Meltzer. We have been known to do that.
    Mr. Bergsten. But I certainly do not advocate it, and I 
know you do not.
    Mr. Meltzer. I did not.
    Mr. Bergsten. The trade measures I would contemplate, even 
as a last resort, would be much less costly to the United 
States and the world economies than for the United States to go 
on an inflationary binge to, in that sense, devalue the 
currency and inflate away our debt. So, I would not go that 
way.
    Mr. Meltzer. I do not recommend that. I just said that is 
an alternative to the things that you were talking about, which 
would be to bring down the world trading system.
    Mr. Bergsten. A decidedly inferior approach, and mine would 
not bring down the trading system. Mine would seek to defend 
the trading system.
    A final point. Timing is crucial, as you were emphasizing, 
Mr. Chairman. Dr. Meltzer says go slowly. The Treasury has been 
going slowly for 2 years. I do not think it has much to show 
for it other than a bunch of very small technical changes in 
the way the Chinese run their financial system. By the Chinese' 
own testimony, it is going to be many years before they are 
ready to move to a flexible exchange rate. When I asked them 
about this over the last 2 or 3 years, they said, well, around 
the time of the Beijing Olympics in 2008. That is only 3 years 
away now but it is still pretty long, as these things go. And 
my guess is it will be 5 to 10 years before their banking 
system and the rest of their economy is in shape to really 
support a true floating exchange rate system, which means 
elimination of most or all of their capital controls.
    That is not at all feasible on the kind of time horizon 
that I worry about in terms of domestic political 
unsustainability as well as international financial 
unsustainability.
    We have tried for 2 years. It has not gotten anywhere. I do 
not want to wait 5 to 10 more for the Asians to move. I am 
afraid all hell will have broken loose on both the financial 
and trade sides long before that. Therefore, I want to think 
about what has admittedly been the unthinkable of taking 
tougher actions.
    But before I get there, I do not know why we do not 
mobilize the existing institution to defend its existing rules, 
which are clearly being violated. That is a no-brainer, and it 
seems to me the Committee ought to push hard for that.
    Senator Crapo. And it seems to me the two of you agree on 
that.
    Mr. Meltzer. We do.
    Senator Crapo. I want to thank you both for coming today, 
and you always provide us with not only a lively interchange, 
but with some very significant debate about very tough issues. 
I appreciate you coming before us again to do that, and I think 
you have given this Committee and this country some very good 
ideas about how to proceed.
    Thank you very much for coming.
    Mr. Meltzer. Thank you, Mr. Chairman.
    Mr. Bergsten. Thank you, Mr. Chairman.
    Senator Crapo. This hearing is adjourned.
    [Whereupon, at 11:47 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                  PREPARED STATEMENT OF RANDAL QUARLES
            Acting Under Secretary for International Affairs
                    U.S. Department of the Treasury
                              June 7, 2005
    Thank you Chairman Crapo, Ranking Member Bayh, and other Members of 
the Subcommittee. I am pleased to be here today to talk about our 
agenda as a shareholder of the International Monetary Fund (IMF).
    Reform of the IMF has been a high priority since the start of the 
first Bush Administration. Former Under Secretary John Taylor appeared 
before the full Committee last May and summarized our work to date in 
both the IMF and World Bank. He laid out the underlying rationale for 
our quest to update these institutions--noting the growing role of 
international debt securities, the increase in the volume of private 
capital flows, and the increasing interconnection between financial 
markets. As he said at the time, those factors, combined with the 
crises of the late 1990's, made abundantly clear that greater 
predictability, accountability, and more systematic behavior on the 
part of the official sector were vital to enhance the international 
financial policy framework.
The Path of Reform
    The International Financial Institutions Advisory Commission 
(IFIAC), chaired by Dr. Allan Meltzer, helped provide impetus for 
reform. The Commission's report in March 2000 provided important 
insights about how the IMF and other international financial 
institutions could better realize their goals. The Commission's 
recommendations contributed to a serious debate about IMF reform, in 
which this Committee was an active participant. With strong advocacy 
from Treasury, the IMF has acted on reform. Specific steps by the IMF 
have been detailed in a series of annual reports to Congress--most 
recently in October 2004. Let me summarize some of the highlights over 
the last 5 years:

 The international community has clarified the limits and 
    criteria for large-scale official sector lending. Consistent with 
    the Meltzer recommendations, there has been no quota increase in 
    the IMF. With IMF liquidity at historic highs, there is no need to 
    add to its resources. Further, we have encouraged the presumption 
    that the IMF, rather than governments, is responsible for providing 
    large scale loan financing in the face of crises. With IMF 
    resources limited, this presumption provides an overall budget 
    constraint and thereby an overall limit on loan assistance. 
    Further, requests for large loans that represent exceptional access 
    to IMF resources now face new procedures, including a higher burden 
    of proof in the form of a special report that documents how IMF 
    financing will support strong policies in the borrowing country.
 IMF programs are now more focused on its core macroeconomic 
    areas of expertise. In work on lending programs, the IMF is more 
    tightly focused on its core areas of monetary policy, fiscal 
    policy, the balance of payments, exchange rates, and the financial 
    sector. Further, the IMF relies more heavily on more robust 
    analytical tools, particularly for risk assessment, enhancing its 
    capacity to anticipate and deter financial crises.

   We achieved changes to reorient IMF lending to focus more on 
        short-term financing, discourage casual or excessive use, and 
        provide incentives to repay as quickly as possible. This 
        includes higher interest rates for higher levels of access to 
        discourage excessive reliance on Fund resources. It also 
        includes limited use of Extended Arrangements, to reinforce the 
        focus on making resources available only for the short-term. 
        These changing incentives are having an effect.
   The IMF is much more transparent than it was 5 years ago. 
        Seventy-eight percent of staff reports for lending arrangements 
        and Article IV's are made public. The IMF provides extensive 
        information publicly about its financial operations. And the 
        IMF has a permanent, independent evaluation office that has 
        been producing high-quality reviews of specific IMF policies 
        and activities.

 As part of the effort to correct incentives and prepare for 
    more effective resolution of crises that occur, there has also been 
    a major step forward on making the process of restructuring 
    sovereign bonds more orderly. In that regard, the Administration 
    worked closely with other countries to make routine the use of 
    collective action clauses (CAC's) in sovereign bond documentation 
    to promote orderly restructuring and reduce disruption. One year 
    after the launch of this initiative, Mexico responded by including 
    CAC's in its New York law governed bonds. Brazil, Korea, South 
    Africa, and Turkey soon followed, and inclusion of CAC's quickly 
    became standard market practice.

    These are major steps forward. Yet we are not prepared to relax our 
efforts. More needs to be done to ensure that the IMF is positioned for 
the challenges off the 21st century. In partnership with the G-7 and 
others, the United States has called for a strategic review to identify 
changes needed to make the IMF (and the World Bank) more responsive, 
relevant, and helpful to their members. The IMF has taken up this 
charge and is now undertaking a review of its role and strategy for the 
medium term.
Pushing the Next Wave of Reform--U.S. Priorities
    Like any other institution, the IMF must continually examine itself 
to make sure that it is doing the best it can to achieve its core 
objectives. Fostering international monetary cooperation and balance of 
payments adjustment to support international financial stability and 
economic growth clearly remains its key aim. The purpose of this review 
is to make sure the institution is doing all it can to advance this 
goal.
    As we engage in this review with other members of the IMF, the 
United States has several key priorities: Strengthening IMF 
surveillance and crisis prevention; creating a more effective way for 
the IMF to actively support strong policies without lending; and 
realigning the IMF's role in low-income countries to achieve better 
results. Let me explain what we have in mind in each of these areas.
Strengthening Surveillance and Crisis Prevention
    The IMF's core mission is to oversee the international monetary 
system to ensure its effective operation, and for that purpose to 
exercise surveillance of the macroeconomic and exchange rate policies 
of its members. In this way the IMF should help prevent crises and 
foster adjustment in global imbalances.
    This process offers the IMF a unique opportunity to assess risks, 
influence policy, and help prevent crises. Indeed, surveillance has 
proven a very useful tool. Yet the execution of surveillance needs 
further enhancement. Action is needed, for instance, to further tighten 
the focus and selectivity of analysis. We also believe that the IMF 
needs to integrate more fully capital market and financial sector 
analysis into the daily life of the Fund. In addition, the IMF has a 
critical role to play in exercising firm surveillance over its members' 
exchange rate policies to promote international adjustment. In recent 
months, the IMF has called for multilateral actions, including greater 
exchange rate flexibility in emerging Asia, and particularly in China.
Promoting Strong Policies without Lending
    The IMF has traditionally had two levels of engagement with member 
countries--either the IMF reviews economic performance and policies 
annually through surveillance or, at the member's request, the IMF 
provides financial support conditioned on implementation of economic 
reforms that the IMF helps design and monitor. There is no middle 
ground between routine review and conditional finance.
    The United States strongly believes that the IMF needs a new tool 
to provide for structured engagement in support of strong economic 
policies where there is no need for borrowing. We have proposed a new 
nonborrowing program to serve this role. Participation would be 
voluntary for member countries. The process of laying out an economic 
program would be led by each participating country, with the 
opportunity for country authorities to engage closely with IMF staff as 
they work to strengthen their country's macroeconomic policy framework 
and macroeconomic institutions.
    The proposal now has the support of our partners in the G-7, and we 
expect it to be taken up by the IMF's Executive Board this summer. 
Demand for such an arrangement is already emerging from IMF member 
countries. We expect that some countries may actively seek to convert 
their borrowing relationship with the IMF to this basis and that others 
will welcome such a nonlending arrangement once their existing program 
expires, as a way of maintaining a signal from the IMF about the 
strength of their economic policies. This signal could be particularly 
useful to countries with strong macroeconomic foundations that 
nonetheless continue to depend on other donors for development 
financing or that are transitioning to market-based financing away from 
development finance. And it should help protect IMF resources for those 
countries with specific balance of payments needs.
Supporting Low-Income Countries Effectively
    Low-income countries face enormous economic and development 
challenges. Engaging with these countries to help them achieve 
macroeconomic stability--through policy advice, technical assistance, 
and financing when appropriate--is a vital part of the IMF's mission. 
Yet the Fund is not a development institution, and its financial 
operations should reflect its mission to provide short-term balance of 
payments financing rather than longer-term development aid.
    While there is disagreement among economists about the impact of 
IMF assistance on economic growth in low-income countries, the growth 
performance of many of these countries has been disappointing over the 
past two decades. A central challenge for the IMF is to improve the 
effectiveness of its own engagement in low-income countries to help 
them achieve sustained improvement in economic outcomes.
    Prolonged use of IMF resources is a serious problem, particularly 
for low-income borrowers, and is exacerbated by the Fund's practice of 
rolling-over existing exposure. Nearly all (30 of 32) countries with 
PRGF programs at the start of 2005 had at least two prior PRGF 
arrangements, each of which lasts 3 years. Prolonged reliance on IMF 
support can impede domestic ownership of economic policies and the 
development of institutions and can blur the IMF's short-term balance 
of payments role versus the longer-term development finance role of the 
MDB's.
    We have encouraged the IMF to undertake a close examination of its 
approach in low-income countries--with a view to helping these 
countries achieve better economic results. Good economic policies are 
fundamental to the efforts of low-income countries to increase economic 
growth and improve the lives of their citizens. The IMF needs to find a 
way to support good policies more effectively, and in a way that is 
consistent with its role as providing temporary and short-term 
assistance in response to balance of payments shocks.
    As a top priority, the IMF needs to establish and maintain high 
standards for its support for countries' economic programs. Weak or 
half-hearted policy efforts should not merit IMF financial support, in 
emerging markets or low-income cases.
    When countries are pursuing strong policies, the PRGF should be 
flexible enough to respond to countries facing short-term adverse 
developments in their balance of payments. The PRGF also needs to be 
available to support needed macroeconomic reform over the medium-term. 
It should not, however, be geared to provide long-term development 
finance. Indeed, we believe that the proposed nonborrowing program that 
I have described for you above would offer a particularly important 
tool for low-income countries that have progressed through 
stabilization and no longer need to rely on IMF financing.
    And perhaps most important, helping low-income countries depends on 
ending the lend-and-forgive cycle, so that they can move into an era of 
sustainable debt. The IMF has recently implemented a new debt 
sustainability framework, which establishes new standards for 
determining whether countries can or should take on additional debt.
    It is critical that the IMF and other lenders integrate this 
framework into their operations. This, along with increased use of 
grants in IDA and the AfDF, as well as further bilateral and 
multilateral debt relief in those institutions for the HIPC countries, 
can provide a clear path to end the cycle of repeat lending and debt 
problems holding back the poorest countries.
    With respect to debt relief, the Bush Administration has put 
forward a bold proposal that would relieve the debt burdens of poor 
countries. The proposal calls for immediate action to provide up to 100 
percent relief on IDA and AfDF loans to the Heavily Indebted Poor 
countries (HIPC's). Action on this debt is critical to putting these 
poor countries on a sustainable path.
    Any debt relief in the IMF would need to be financed from existing 
resources in the IMF.
    We do not believe that gold sales--whether they were to be executed 
in the market or ``off-market''--are necessary or warranted. I know 
that the issue of gold is of particular interest. Treasury has 
repeatedly voiced our opposition to a sale of IMF gold. Gold provides 
important underlying strength to the IMF's financial position. Selling 
IMF gold requires an 85 percent majority vote; since the United States 
has a 17.1 percent voting share in the IMF, our agreement is required 
before such a sale can go forward. Congressional approval is required 
for the U.S. Executive Director to vote in favor of such an IMF gold 
sale.
Modernizing the IMF's Governance
    The IMF is accountable to its 184 member governments through a 
weighted voting structure aligned with countries' global economic 
standing. However, change in the world economy has outpaced that in the 
IMF's voting structure, particularly given fast-paced growth in 
emerging market economies and integration in Europe.
    We feel strongly that the IMF is a financial and shareholder 
institution the governance of which should evolve along with the world 
economy. If countries are growing strongly and making increasing 
contributions to the global economy, then there should be a parallel 
enhancement of their position in the IMF. This is vital to maintaining 
the goodwill of members, on which the IMF relies to make its lending 
possible, and to preserving the centrality of the IMF in the global 
financial system.
    Beginning in October 2004, Secretary Snow has emphasized that 
change is needed to address the growing disparity between the IMF's 
governance structure and the realities of the world economy. In April, 
he took a further step when he asserted that it is time to examine 
these issues now--and that progress should not, and indeed need not, be 
linked to an increase in the IMF's quota resources, which is not 
necessary given the current strength of the IMF's financial position. 
In particular, he has suggested that shifting quotas within the 
existing total could yield substantial progress. This could allow for 
quota shares to reflect the advent of monetary union in Europe and the 
increasing role of fast-growing emerging markets, especially in Asia.
    Change will not come quickly or easily. The issues are complex, and 
extensive dialogue and cooperation will be needed to find a way 
forward. Yet we believe the effort is worthwhile--and indeed essential 
to the long-term effectiveness of the institution. An IMF for the 
future must be an IMF in which all have a stake.
Argentina
    One of the important tasks that has faced the IMF over the last 4 
years has been dealing with the situation in Argentina, so let me say a 
few words about Argentina's economy and engagement with the IMF.
    The Argentine economy continues to recover from the sharp 
contraction that accompanied the 2001-2002 financial crisis. Real GDP 
grew 9 percent in 2004, following growth of 8.8 percent in 2003. 
Inflation ended 2004 at 6 percent after spiking to 41 percent at the 
end of 2002. The exchange rate has been roughly stable since mid-2003 
and reserves have grown $11.5 billion since the end of 2002.
    These positive results have been underpinned by better 
macroeconomic policy since the crisis. The Federal Government increased 
its primary surplus to nearly 4 percent of GDP in 2004 from a zero 
balance in 2001. Monetary policy succeeded in limiting the growth of 
the money supply to prevent an upward inflationary spiral.
    The United States has supported IMF engagement with Argentina 
through the transitional program launched in January 2003 and the 3-
year program launched in September 2003. The purpose of these programs 
was to lock in macroeconomic stability and attack impediments to 
growth. Essential reforms include addressing Argentina's chronic fiscal 
problems related to Federal-provincial fiscal relations and weak tax 
administration, restoring the health of the banking sector, and 
improving the investment climate. The IMF program helped establish a 
basis for facilitating the normalization of Argentina's relations with 
its external creditors.
    Argentina's performance under the 3-year program has been mixed. 
Argentina has continued to perform strongly on its macroeconomic 
targets. However, we still have concerns regarding the implementation 
of its structural policy commitments under its IMF program. The IMF has 
not made any disbursements to Argentina since March 2004.
    With respect to the debt restructuring, in January 2005 Argentina 
launched a debt exchange offer to restructure its $82 billion in 
principal claims of defaulted debt. Over 76 percent of creditors 
accepted Argentina's offer, while 24 percent (representing $20 billion 
in principal claims) did not.
    With the recent settlement of the debt exchange, Argentina is now 
returning its focus to negotiating a new arrangement with the IMF. A 
key issue will be the development of an Argentine strategy to resolve 
the rest of the defaulted debt. There are a number of possible ways 
Argentina could do this, but it is important for Argentina to be clear 
about how it will proceed.
    In addition to completing its debt restructuring, Argentina also 
needs an economic program that supports sustained growth so that it can 
continue to raise living standards and meet its financial obligations. 
Sustained growth requires improving the investment climate in order to 
attract private capital. Resolving the situation in the utilities 
sector will be an especially important signal to investors in this 
regard. Growth also requires locking-in fiscal improvements by fixing 
Federal-provincial fiscal relations to prevent the provincial 
overborrowing that contributed to the 2001 financial crisis. Finally, 
continued strengthening of the banking sector will be important for 
providing the credit Argentina needs to grow. Key reforms in the 
banking sector include completing bank compensation, which Argentina 
has made further progress on in the past month, defining the role of 
public banks in the banking sector, and continuing with the defined 
path of regulatory reforms.
Conclusion
    I appreciate the opportunity to reflect on the path of IMF reform 
and lay out for you the Administration's priorities as we continue to 
press change in this vital institution. I believe that important 
progress has been made. Yet there is more to be done to ensure that the 
IMF operates effectively in the 21st century. I hope my remarks today 
make clear our commitment to maintain the momentum of reform.
    I welcome your questions.

                               ----------

                 PREPARED STATEMENT OF ALLAN H. MELTZER

                    The Allan H. Meltzer University,
     Professor of Political Economy, Carnegie Mellon University and
            Visiting Scholar, American Enterprise Institute
                              June 7, 2005

    Mr. Chairman and Members of the Committee: It is a privilege to 
have this opportunity to review progress on reform of the International 
Monetary Fund (IMF). I commend the Chairman and the Members for their 
continued interest.
    I am pleased to report that there has been progress on central 
issues. On other important issues, much is unfinished, and in some 
cases, unstarted. From the comprehensive list of topics proposed by 
your staff, I have chosen to discuss progress toward the adoption of 
recommendations of the Meltzer Commission, but I touch on other 
questions that the staff raised.
    In the view of the Meltzer Commission, the IMF has two main tasks. 
Its most important activity is to increase the stability of financial 
markets or, if crises cannot be prevented, to localize problems or 
crises and keep them from spreading to countries or markets that would 
be unaffected. A related but distinct activity is to reduce market risk 
by improving the quality and increasing the quantity of information 
available to lenders and creditors.
    The IMF has made a sustained effort to improve the quantity and 
quality of information on member countries. More is desirable. 
Especially needed are reductions in the time before information becomes 
generally available.
    A remarkable change came to fruition this year. Argentina settled 
its defaulted debt with about 75 percent of its bondholders. This was 
the largest default ever, and it involved tens of thousands of 
individual debt holders and many separate debt issues. Coordination did 
not, at first, seem promising, but it was achieved without outside 
intervention.
    Unlike earlier practice, the IMF was not a party to the 
negotiations. It did not make additional loans to Argentina to assist 
in the settlement and bailout the lenders. The settlement was based on 
decisions between the Argentine Government and representatives of the 
bondholders. I am confident that in time, Argentina can settle with the 
remaining bondholders without IMF intervention. I consider this a big 
step forward because risks and returns were related. Lenders who 
received high interest rates on risky loans had to bear the risk when 
it came. This improves the functioning of markets and spares taxpayers 
from paying for lenders' errors of judgment.
    Also Argentina's financial problems were mainly confined to 
Argentina. When they threatened to spread to its neighbor, Uruguay, the 
IMF arranged a large loan. This is keeping with its principal 
function--preventing the spread of crises.
    In its response to Argentina and Uruguay, the IMF followed the 
spirit and often the letter of the Meltzer Commission recommendations. 
It was not always so. The Meltzer Commission made two unanimous 
recommendations. The first called for writing off ``all claims against 
heavily indebted poor countries (HIPC's) that implement an effective 
economic and social development strategy.'' The second called on the 
IMF to limit its lending to short-term loans leaving long-term loans 
for poverty reduction to others. Instead, the IMF created the Poverty 
Reduction and Growth Facility (PRGF). The IMF had no special expertise 
in economic development and poverty reduction. These problems should be 
left to the World Bank. While I agree with those who say that the 
development banks are ineffective, unfocussed, and should be thoroughly 
reorganized, duplication of their work at the IMF is not the right 
solution. The PRGF should be closed.
    The IMF, the World Bank, and the G-7 countries have not agreed on 
rules for debt relief for several of the heavily indebted poor 
countries (HIPC). Some agreements have been made, and countries have 
agreed to use the resources released thereby for education and health. 
Great Britain is pressing for new agreements at the 2005 summit in 
Scotland.
    Part of the discussion of debt relief is misleading. The HIPC 
countries do not actually service most of their debt. To prevent 
default, the IMF lends the country enough to make payments, increasing 
the countries' indebtedness. A HIPC country receives credit for payment 
but little or no new money. Debt relief, as usually discussed, is 
actually a way of increasing HIPC country borrowing. It would increase 
the countries' available resources, since debtors would receive the 
same payment but would not have it offset by a debt service payment of 
similar size to the IMF. The net transfer would increase.
    The main issues in current discussions are how the transfer should 
be financed and how the increased net transfer should be used to 
improve social and economic conditions. Gold sales by the IMF are one 
option that has been proposed. As you know, the Congress wisely 
disallowed the sale of the U.S. gold deposit at the IMF without its 
consent. The gold should be returned to the members and revalued by 
them. Part of the profit could be used to reduce HIPC debt.
    One of the Meltzer Commission's main recommendations called for 
replacement of conditional loans with loans based on a limited number 
of preconditions accepted in advance by the troubled country. The 
purpose of this proposal includes reducing risk, increased incentives 
for reform, and giving the borrowing country a large part in the choice 
of policies. To its credit, the IMF has reduced substantially the 
number of conditions attached to its loans. It considered, but did not 
adopt, preconditions. As part of the comprehensive review of its 
strategy that is now underway, it proposes that future lending should 
be ``anchored in strong country ownership.'' (IMF Survey, 34, number 7, 
April 25, 2005, 105)
    This is a good step away from the command and control of the 1990's 
based on the so-called Washington consensus. ``Ownership'' means that 
the country has a major role in the choice of policies. Much evidence 
suggest that reform is made more likely when political leaders in the 
country choose it, support it, and decide to implement it. The Fund's 
own research suggests that much of the time countries did not implement 
the conditions to which they agreed to get a loan.
    Preconditions reduce risk in other ways. Countries that avoid 
pegged but adjustable exchange rates, improvident fiscal and 
inflationary monetary policies, and weak financial systems are more 
prone to crisis. Reducing or removing these sources of instability 
reduces the chance of a crisis. Further, negotiated preconditions 
accepted in exchange for a commitment to assist in a crisis reduce the 
long delay that often occurs before assistance is given.
    A critical part of this proposal is that countries would have 
greatly increased incentives to reform. If they did not agree to 
preconditions, they would not be eligible for assistance. This, alone, 
increases the incentive for reform. But this incentive increases 
because lenders would distinguish between countries that adopted 
reforms and those that did not.
    The international private capital market is the principal supplier 
of loans. It offers 5 to 10 times the volume offered by international 
financial institutions. The private market would offer more loans at 
lower interest rates to countries that adopt preconditions. Reformers 
in the countries could replace arguments claiming the IMF requires 
reform with citation of the benefits to the country, more capital at 
lower interest rates.
    The IMF faces many possible challenges. Will other countries follow 
Argentina by defaulting and renegotiating debt? Will recognition of 
increased risk reduce the amount of lending? Does the large 
accumulation of reserves by Asian countries, and other recent changes, 
signal a decision by these countries to manage future crises without 
the IMF? Have the Asian countries taken a further step toward 
development of a regional financial bloc? If the IMF no longer bails 
out private lenders, will the private lenders object to the IMF's 
preferred creditor status?
    The IMF's loans are heavily concentrated in the debts of a small 
number of countries. Will one or more of these countries default on the 
IMF?
    We should recall that the IMF's original purpose included 
monitoring and maintaining a fixed exchange rate system. The IMF should 
take more responsibility for the exchange rate system to adjust under 
or overvalued exchange rates. It is well-known that if more countries 
allowed their exchange rates to adjust, there would be fewer crises. 
Many observers claim that undervalued Asian exchange rates and the 
large U.S. current account deficit will end with a major financial 
crisis. They use the word ``unsustainable'' when they discuss the U.S. 
current account deficit. I am far from certain, even skeptical, about 
these claims. But we should recognize that there is a risk that will 
not be removed and may be increased, by an appreciation of China's 
exchange rate. In keeping with its original purpose, the IMF should try 
to implement a cooperative solution that revalues the yuan and reduces 
the U.S. deficit.
    Finally, corruption is a major problem in some developing (and 
developed) countries. No one can rid the world of bribery and 
corruption, but the IMF could do more than it now does to limit 
corruption.

                 PREPARED STATEMENT OF C. FRED BERGSTEN
            Director, Institute for International Economics
                              June 7, 2005

    It is a pleasure to testify before the Committee again concerning 
your ongoing oversight of the International Monetary Fund. The topic 
remains of great importance and our Institute for International 
Economics will in fact be holding a major conference on IMF reform on 
September 23 to address a number of specific proposals for 
strengthening and enforcing the rules of the monetary system, improving 
the governance of the Fund itself, reforming its lending programs, and 
reassessing the ways in which it might be financed in the future. All 
Members of the Subcommittee and staff are cordially invited to 
participate in our event!

Exchange Rates in China and East Asia
    The most important and urgent issue facing the international 
monetary system and the IMF at the present time is the huge imbalance 
in major national economies and exchange rates. The global current 
account deficit of the United States is very large (nearing an annual 
rate of $800 billion, almost 7 percent of our GDP) and growing rapidly. 
The global current account surplus of China is very large (over $100 
billion this year, about 6 percent of its GDP) and also growing very 
rapidly. A number of other Asian countries--most notably Japan but also 
Korea, Taiwan, Hong Kong, Singapore, and Malaysia--are also running 
substantial global surpluses that are the counterparts of the U.S. 
global deficits.
    We in the United States must lead the correction of these 
imbalances by raising our rate of national saving so that we will not 
be so reliant on inflows of foreign capital--which we must now borrow 
at the rate of $5 billion every working day--and thus condemned to run 
the counterpart current account deficits, which generate enormous 
pressures for trade protection (which are now being rapidly realized, 
especially against China) as well as huge international financial 
risks. This requires a combination of restoring the budget surpluses 
that we were running just a few years ago, to reduce public dissaving, 
and increasing our pitifully low rate of private saving.
    One essential element of the global correction will be a further 
large decline in the exchange rate of the dollar, probably by at least 
20 percent on a trade-weighted average against the currencies of our 
major trading partners. The dollar has already declined substantially 
against the currencies that float freely in the exchange markets: 
Notably the euro, pound, Swiss franc, Canadian dollar and Australian 
dollar. The next phase of the dollar's decline needs to take place 
against the currencies of the East Asian countries that are running the 
world's largest surpluses and have the world's fastest growth rates--
but have intervened massively in the exchange markets to block any 
appreciation of their currencies at all (China, Malaysia) or to limit 
that appreciation far below what market forces would have produced.
    China is the key country. Its surplus is now the largest among the 
major Asian economies as a share of its economy. It has been increasing 
its competitiveness by riding the dollar down against most other 
currencies, thus achieving a trade-weighted depreciation of about 10 
percent over the past 3 years. Moreover, the other Asian countries 
(from Japan to India) are terrified of losing competitive position 
against China so will resist the rise of their currencies against the 
dollar as long as doing so also means rising against the renminbi. The 
need for appreciation of the Asian currencies is particularly acute 
from a U.S. standpoint now that the euro, which had risen 65 percent 
against the dollar from its lows of late 2000 to its peak earlier year, 
is under downward pressure as a result of the apparent rejection of the 
proposed constitution for the European Union.
    It is the responsibility of the International Monetary Fund to take 
the lead in promoting correction of such huge, costly, and potentially 
destabilizing imbalances in the world economy. The Fund's Articles of 
Agreement in fact enjoin member countries to ``avoid manipulating 
exchange rates or the international monetary system in order to prevent 
effective balance-of-payments adjustment or to gain unfair competitive 
advantage over other member countries'' (Article IV, Section 1, 
paragraph iii). In 1977, early in the era of floating exchange rates, 
the Fund laid out principles for its surveillance over members' 
currency policies that identified ``protracted, large-scale 
intervention in one direction in the exchange markets'' as indicating a 
need for Fund discussion with the offending country.\1\
---------------------------------------------------------------------------
    \1\ A complete analysis of this issue can be found in Morris 
Goldstein, ``The International Financial Architecture,'' in C. Fred 
Bergsten and the Institute for International Economics, The United 
States and the World Economy: Foreign Economic Policy for the Next 
Decade (Institute for International Economics, 2005.) Goldstein also 
suggests a number of other important IMF reforms that should be pursued 
in the near future.
---------------------------------------------------------------------------
    China clearly meets these criteria. (So does Malaysia and so would 
have Japan until it ceased its massive intervention a little over a 
year ago.) Our own Treasury indicated as much in its latest semiannual 
report to the Congress, after whitewashing China's behavior for several 
years and still inexplicably failing to label it explicitly as a 
``currency manipulator'' as called for under the relevant statute of 
U.S. law.
    The International Monetary Fund, however, appears to have limited 
its activity on this issue to quiet efforts to persuade China to reform 
its currency regime (as opposed to raising upward its exchange rate.) 
It apparently was unwilling to endorse the critique of China's policy 
in the latest Treasury report, incomplete as that was.
    The Fund is of course a creature of its major member countries, 
especially the United States and the rest of the G-7, so the 
responsibility lies with those governments at least as much as with the 
institution itself. Part of the problem is that the U.S. Treasury and 
the rest of the G-7 have, at least until very recently, been proposing 
the wrong thing: They have been asking the Chinese to float their 
exchange rate, which is neither desirable (because it might float down, 
worsening the current account imbalances) nor feasible (because the 
Chinese banking system is far too fragile to support anything 
resembling a true float, especially with a sharp reduction in China's 
capital controls), rather than for the sizable one-shot revaluation of 
perhaps 25 percent that is essential to make a substantial contribution 
to reduction of the global imbalances.\2\
---------------------------------------------------------------------------
    \2\ Our estimate at the Institute for International Economics is 
that a Chinese revaluation of 25 percent and upward appreciations of 
one half that much by the other East Asian countries would reduce the 
U.S. current account deficit by about $60 billion after the full 
effects phased in over two to 3 years. The U.S. gain would be at least 
$100 billion if the exchange rates of the other Asian countries rose by 
the full amount of the Chinese move.
---------------------------------------------------------------------------
    The Fund, with its systemic and global responsibilities, should 
nevertheless have been making a much more forceful and much more 
pragmatic effort to bring the global imbalances back under control. To 
its credit, it has been vocally pushing the United States to initiate 
(especially budget) actions that would reduce its external deficits. It 
has likewise been urging the Europeans to implement structural reforms 
to accelerate the growth of domestic demand in their economies, to 
offset the adverse impact they will experience from the declines in 
their trade surpluses that are an essential counterpart of reduction in 
the U.S. deficits. Without much stronger support from the G-7 
countries, however, notably including the United States itself, there 
is little that the Fund can do to achieve realization of such policy 
alterations--including with respect to the Chinese and other East Asian 
exchange rates.

Argentina
    Another key question facing the IMF at present is its relationship 
with Argentina as that country emerges from its traumatic depression 
and debt crisis. The Fund badly mishandled Argentina virtually 
throughout the run-up to that crisis. It endorsed the country's rigid 
currency peg, even as it was becoming increasingly overwhelmed, and 
failed to insist on fiscal tightening during the boom period of the 
middle 1990's, setting the stage for the escalation of budget deficits 
and debt that brought on the biggest default in modern history when 
things turned sour. It then prolonged and deepened the agony by lending 
large amounts that enabled the Argentine authorities to further 
postpone the policy changes whose necessity had become blindingly 
obvious.\3\
---------------------------------------------------------------------------
    \3\ The full story is in Michael Mussa, Argentina and the Fund: 
From Triumph to Tragedy (Institute for International Economics, 2002.)
---------------------------------------------------------------------------
    At the same time, the lessons of the Argentine crisis for the 
international monetary system and the IMF are not yet clear. Argentina 
itself is recovering briskly. It is now receiving so much foreign 
investment that its currency is rising and it has recently adopted 
restraints on capital inflows. The global financial system suffered 
little contagion from the Argentine episode, despite the country's 
being both the largest borrower among emerging market economies and 
engineering the largest sovereign default in modern history. Emerging 
market economies are receiving near-record capital inflows so no 
significant ``chilling effect'' can be discerned at least for now. The 
apparent ``success'' of the Argentine default strategy does not seem to 
have tempted other countries to pursue a similar strategy and Brazil 
next door has in fact been a model of rectitude even under the Lula 
Government.
    All these results will of course need to be stress tested during 
the next global economic downturn and sharp rise in world interest 
rates before firm systemic conclusions can be drawn. One close observer 
of the process concludes that ``Argentina's crisis has done little so 
far to validate or discredit the idea of statutory sovereign 
bankruptcy'' but adds that ``It achieved impressive debt relief in a 
reasonably short timeframe without either CAC's (collective action 
clauses) or bankruptcy.'' \4\
---------------------------------------------------------------------------
    \4\ Anna Gelpern, ``What Bond Markets Can Learn from Argentina,'' 
International Financial Law Review, April 2005.
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Debt Relief and IMF Gold Sales
    Another operational issue confronting the Fund is whether to 
relieve some of its poorest member countries of their debt to the Fund 
itself (now about $6 billion for the forty or so countries identified 
as Heavily Indebted Poor Countries, or HIPC's) and, if so, how to 
finance the resulting impact on the Fund's balance sheet. The most 
promising candidate is use of the Fund's own gold reserves, which are 
worth more than $40 billion. A limited version of this idea, which 
enabled the Fund to mobilize profits on its gold holdings without 
actually selling any of them into the market, was actually implemented 
in 1999 and yielded about $2 billion for debt relief.
    There is considerable debate over the desirability of debt relief 
as a mechanism for providing assistance to poor countries. Whatever the 
economics of the issue, however, it is clear that this particular 
channel attracts more political support than most other methods of 
providing foreign aid. In addition, our own careful study of the issue 
suggests that debt relief has a number of advantages over more 
traditional forms of aid: Increasing ownership of their development 
program by poor countries because of their greater autonomy in using 
the funds, reduced transaction costs, increased fungibility and hence 
utility of the resources, elimination of tying, and freeing donor 
countries of the need to extend new aid to the debtor countries simply 
to finance repayments of existing debt. We advocate several important 
changes in existing debt relief techniques but support the basic 
strategy, including through mobilization of another portion of the 
IMF's sterile gold stockpile.\5\
---------------------------------------------------------------------------
    \5\ The full analysis is in Nancy Birdsall and John Williamson, 
Delivering on Debt Relief: From IMF Gold to a New Aid Architecture 
(Center for Global Development and Institute for International 
Economics, 2002.)
---------------------------------------------------------------------------
    A related issue is whether the IMF should continue to lend to the 
world's poorest countries through its Poverty Reduction and Growth 
Facility (PRGF). This is one of the few issues, along with the 
desirability of comprehensive debt relief itself, on which there was 
unanimous agreement among the members of the Meltzer Commission: that 
the IMF should get out of the business of making poverty reduction 
loans. My own proposal, however, is not to eliminate the PRGF but 
rather to transfer it to the World Bank, whose primary mission is 
poverty reduction in poor countries. This would inter alia clear the 
decks for the IMF to extend debt relief to those poor countries without 
placing itself in the self-contradictory position of then extending new 
loans to the very same countries that had just been judged incapable of 
paying their existing debts.

Meltzer Commission Report
    These were among the very few issues, however, on which there was 
agreement on the Meltzer Commission. I have testified to this 
Subcommittee or the full Banking Committee on these differences on a 
number of occasions including in March 2000 upon the release of the 
Commission's report, in April 2000 and most recently in May 2004. As 
the author of the dissenting minority report, I am pleased that the 
U.S. Treasury and the G-7 Finance Ministers rejected the main proposals 
of the majority almost immediately and that those proposals mercifully 
enjoyed a very brief period of serious consideration.
    Suffice it to note today that the majority's proposals look even 
worse in retrospect, if that is possible, than they did when issued. 
They would clearly not have precluded the mistaken program for 
Argentina described above because Argentina, which was (mistakenly) the 
Fund's ``poster child'' for much of the 1990's, would almost certainly 
have been deemed to meet the majority's requirements for 
prequalification for Fund assistance. Former IMF Chief Economist 
Michael Mussa notes that ``On the criterion of having a sound banking 
system, with widespread participation of foreign banks, Argentina was 
clearly outstanding . . .and it was particularly praised in this regard 
by one of the members of the Meltzer Commission majority. Presumably, 
on those grounds (my note: Which were the majority's chief criteria), 
under the Commission's proposals, Argentina would have qualified for a 
very large package of precommitted support.'' \6\
---------------------------------------------------------------------------
    \6\ Mussa, Argentina and the Fund, p. 73.
---------------------------------------------------------------------------
    On the other hand, the Meltzer Commission majority's requirement 
would almost certainly have precluded the very successful Fund program 
for Brazil (and the program for Turkey, whose ultimate outcome is less 
clear but which has succeeded to date). Their proposals to shut down 
several major sources of funding for poor countries, including the 
regular lending program of the World Bank, fly in the face of the 
revealed preferences of virtually every rich country in the world 
(including our own, in both the Administration and the Congress) to 
sharply increase the flow of resources to counter poverty and 
underdevelopment. I hope we can focus today's discussion on issues of 
current and future relevance rather than rehashing stale debates that 
were closed out for all practical purposes half a decade ago.

```