James K. Galbraith, who holds the Lloyd M.Bentsen, Jr. Chair of Government/Business Relations at the Lyndon B. JohnsonSchool of Public Affairs at the Universityof Texas in Austin, is the son of the legendary economist John Kenneth Galbraith. Heis a frequent speakeron matters related to the financial and economic crisis and has been a witness beforeCongress on several recent occasions. Mr. Galbraith is the author of sevenbooks. His two most recent books are: “UnbearableCost: Bush, Greenspan and the Economics of Empire” (published byPalgrave-MacMillan in late 2006), and “ThePredator State: How Conservatives Abandoned theFree Market and Why Liberals Should Too” (published by Free Press in August2008 – for more information visit: http://predatorstate.com).Robert B. Reich,Professor of Public Policy, Universityof California at Berkeley, wrote about “The Predator State”:

"James Galbraith elegantly and effectivelycounters the economic fundamentalism that has captured public discourse inrecent years, and offers a cogent guide to the real political economy.Myth-busting, far-ranging, and eye-opening."

Moreover, Mr. Galbraith has written severalhundred scholarly and policy articles, including columns in Mother Jones andarticles / op-ed’s in The American Prospect, the Nation, and the WashingtonPost. He studied economics as a Marshall Scholar at King's College, Cambridge in 1974-1975 and holds degrees from Harvard and Yale(Ph.D. in Economics, 1981). Later he served on the staff of the U.S. Congressas Executive Director of the Joint Economic Committee before joining thefaculty of the Universityof Texas in 1985. Inpublic life, he organized congressional oversight of the Federal Reserve (theHumphrey-Hawkins hearings) and worked on financial crises including the Third World debt crisis of the 1980s. In the 1990s heserved for four years as Chief Technical Adviser for macroeconomic reform tothe State Planning Commission of China. He was called to advise the House ofRepresentatives on the TARP legislation in September 2008 and on recoverystrategy in December of the same year. He was also invited to Congress to givehis point of view about the “Audit the Fed” initiative of Congressman Ron Paul(House Resolution 1207Federal Reserve Transparency Act of 2009 – to see Mr. Galbraith’s testimony onCapitol Hill follow this link: http://www.youtube.com/watch?v=oxAt-Un1k7I).

As an outspoken critic of the free market consensus, especially themonetarist version of Milton Friedman,[i]Mr. Galbraith argues that Keynesian economics offers a solution to the currentfinancial crisis, whereas monetarist policies would deepen it.

Mr. Galbraith’s scholarly research has focusedon the measurement and understanding of inequality in the world economy, underthe rubric of the Universityof Texas Inequality Project,UTIP (for more information on that topic visit the web-site of UTIP at http://utip.gov.utexas.edu). His policywriting ranges from monetary policy to the economics of warfare, with foraysinto politics and history, especially the history of the Vietnam War. He is aSenior Scholar with the Levy Economics Institute of Bard College, and Chair ofthe Board of Economists for Peace and Security, an international association ofprofessional economists (www.epsusa.org).His papers on macroeconomic topics can be found on the Levy web-site at www.levy.org. An archive of his writings can bealso found at http://www.utexas.edu/lbj/faculty/galbraith.html.

The following exclusive interview with James K. Galbraith is a JointVenture between New Deal 2.0 in the USA (www.newdeal20.org)and MMNews in Germany (www.mmnews.de).

Professor Galbraith, in Julyof 2009 you have signed an initiative of the Franklin and EleanorRoosevelt Institute that wants an answer to the question: What Caused the Crisis?[ii] May I ask for your personal answer?

Yes, you may. (laughs.) – The principal cause of the crisis was the dismantlingof the system of regulation and supervision in the financial sector which hadfor much of the post-war period kept the most dangerous elements of that sectorin check. In the absence of an appropriate system of effective supervision andregulation, what happens is that the actors in the system, who are intent upontaking the greatest degree of risk -- including actors who are intent uponusing fraudulent methods to increase their returns -- come to dominate parts ofthe system. As they do that, the general methods of assessing performance inthe market, specifically stock-market valuations, become counter-productive.That is to say, they  invariably rewardthe worst actors, while they force more traditional actors, who are stillrespecting the old norms of conduct, into a competitively disadvantagedposition. Thus the bad actors, the fraudulent actors, and the speculativeextremists quickly take over.

That is what happened specifically in theorigination of mortgages in the UnitedStates in the middle part of the lastdecade. You had a transition from a traditional method of issuing mortgages topeople who could be reasonably expected to service them, to a method oforiginating mortgages that were sold off immediately, that were rated in a waythat permitted them to be bundled and sold to fiduciaries, and where the issuerhad no interest in whether the borrowers could pay or not. In fact, in someways the lenders actively preferred people who did not intend to pay, becausethey could then inflate the value of the loan and earn a larger fee upfront fordoing it. And in this way, not only was there a large segment of the marketthat was explicitly corrupt, but the equity value of homes all across thecountry was compromised. When these practices collapsed, so too did the homevalues not only of people who had bad mortgages, but also those for many peoplewho had good mortgages, good incomes and perfectly good credit.

The result of that was a general slump inactivity. The wealth and financial security of much of the American middleclass disappeared. So far about a quarter of the measured wealth of theAmerican middle class has disappeared – about $15 trillion of $60trillion.  That’s bound to have afantastically traumatic effect on people’s consumption behaviour and on theirability to get new good credit. Even if they wish to continue to extend thepast pattern of borrowing in order to finance activity, they can’t do it.  So, this is a very big problem. It startswith a failure to supervise and regulate the financial system, and flows on tothe reaction of the broader population, which is to protect their remainingassets, to become extremely adverse to taking ordinary business and consumerrisks.

How much of thiscrisis is related to what you call “theEconomics of Empire” during the presidency of George W. Bush?

I think at the end of the day that’s not the primaryfactor. There was reason, good reason, to be concerned at the start of the IraqWar, that the war would be vastly more costly than was predicted, that it wouldbe a much more difficult war than was predicted, and that it would damage thestrength of America’s position in the world. All of that has certainlyhappened. But the war itself was not a strong enough fiscal stimulus to bringthe economy out of the recession of 2000/2001, at least not in a decisive way,and it’s partly for that reason that the Bush Administration 2004/2005 setabout actively encouraging the use of these credit mechanisms in the housingmarket. Out of that, they got a higher level of economic activity than theyotherwise would have had, they avoided a period of stagnation that otherwisewould have been worse --  was until thewhole business collapsed completely in 2007/2008.

Marshall Auerback statedin an interview that I had with him this:

“In all importantrespects we managed to recreate the exact same conditions of 1929 and historyrepeated itself with the exact same results. Take John Kenneth Galbraith’s TheGreat Crash,[iii]change the dates and some of the names and you’ve got the post mortem ofour current calamity.”[iv]

Do you agree with Mr.Auerback?

Of course, and so does the book-buying publicwhich took an enormous interest in “TheGreat Crash” over the last couple of years.

So you believe thatyour father’s “The Great Crash 1929,”which was first published in 1954, is still of relevance today?

It describes behaviour and psychology in thefinancial markets very effectively. There are a couple of important things thathave changed. One is the existence and continued vitality of some of theinstitutions that were created in the New Deal and the Great Society, giving usa much larger public sector as well as a very large non-profit sector, neitherof which existed in the 1920’s. The capacity of the public sector to move torun very large deficits very quickly and practically automatically, is a savinggrace; it’s the reason that we have a 10% unemployment rate and not a 25%unemployment rate in the wake of this crash. That’s an extremely important andvaluable difference between now and the 1930’s.

My father he does not give the same weight tothe element of outright fraud, back in 1929, that I would regard as a trulydominant factor in this crisis. There certainly was fraud in the 1920’s, therewas a great epidemic of what we would call bucket-shops in the stock-market,there was a lot of fraud in Floridareal-estate in the mid-1920’s. But this was overshadowed by a general euphoriaabout economic prospects. People who went into the stock-market, at least in myfather’s depiction of this period, were doing so out of a great deal ofauthentic enthusiasm. From that point of view the period resembles the late1990’s more than it does the middle 2000’s. During the middle 2000’s theeconomy was being propelled by predatory activity directed at a very vulnerablesegment of the American population, people who had been renters all theirlives, who really couldn’t afford to be moved into houses, who wereaggressively moved into them by unscrupulous lenders. The lenders basicallypushed loans on to borrowers that the lenders knew, or who ought to have known,could never have been serviced in full.

In a recent interviewfor MMNews, Hans-Olaf Henkel, who was once the head of the Federation of GermanIndustries as well as IBM Europe, said two things that I would like to confrontyou with because Mr. Henkel is an influential opinion-maker here in Germany.[v] The first thing hesaid was that basically no one saw this crisis coming and that he laughshimself to death whenever someone says that this crisis was foreseen. Can yougive Mr. Henkel some names in this respect? How about Dean Baker for example?

I’ve written a long article on not just theindividual economists, but groups of economists who saw the crisis coming veryclearly.[vi] Dean is one certainly with a strong claim.Dean follows a very simple method.  Helooks at critical ratios, such as the ratio of house prices to rental rates.When these deviated very far from their historical norms, that generates anexpectation that they would revert. People should have been looking at thatevidence and taking Dean’s predictions far more seriously than they did. But onthe other hand,  what Dean is pursuing isa very simple method and couldn’t be described as a school of economicanalysis.

There are at least three traditions ineconomics that were warning about what was coming in ways which were verycoherently related to a formal analytical program.

There is a group associated with the Levy EconomicsInstitute and led by Wynne Godley, former senior advisor to the British Treasury. This group was workingwith national balance sheets -- with the national income accounts -- andwarning very emphatically that the debt-burden of the household sector wasunsustainable..

There are people working in the tradition ofHyman Minsky, who of course were  trainedto expect financial instability. They were making similar points from asubstantially different conceptual basis.

And then there are people working broadly inthe tradition of my father, who look at the structures of economic power, andwho were warning that the supervision of the banking system was going to causean epidemic of fraud. There was a group of what we call “white-collarcriminologists”, who were examining these issues, and they are developing a newpolitical economy of crime.

This group had the experience of what happenedin the Savings and Loan crisis of the 1980’s, when certain patterns ofbehaviour, which are relatively standard in criminal financial activity, werevery clearly present. These patterns re-emerged in the early 2000’s in theEnron, Worldcom, and Tyco scandals, and they were re-emerging again in thehousing sector. To these people it was entirely obvious that a massive problemwas developing.

So, Mr. Henkel needs to read a little bit more,He needs to broaden his definition of what constitutes economic analysis, andneeds to recognize that the problem is precisely a group of people who insistthat nobody outside of their very narrow circle has any insight worth payingattention to. That’s a preposterous position. It’s a completely indefensibleposition. It reflects fundamental narrowed-mindedness and, as I may say,incompetence which is really on display for anybody to see. So I do not need tohammer the point too hard.

The otherthing that I want to know with regard to Mr. Henkel’s statements is this: Hesaid that this crisis was caused by a certain type of “do-goodism” amongAmerican politicians who wanted to make sure that every American citizen wouldhave a home of her/his own. What do you think when you hear such a thing?

It is an amusing interpretation of the motivesof someone like George W. Bush, who represented one of the most aggressivelypredatory tendencies in American politics ever to reach the White House. Thiswas a president who turned over regulation -- not just in finance but ineverything he got his hands on -- to the most reactionary elements of thebusiness community, to the most anti-regulation elements, so that regulatorystructures were run down everywhere. They were run down in consumer protection,they were run down in worker protection, they were run down in trade, they wererun down in ways which have significantly degraded the quality of life in the United States.

So, to suggest that this was some naïvealtruism on the part of that extraordinarily reactionary Republicanadministration is, I must say, a view that no one who has actually livedthrough this period in the UnitedStates would recognize.

Now, Mr. Henkel is probably thinking aboutinstitutions like Fannie Mae and Freddie Mac which were, in fact, privatefirms. Fannie Mae had been privatized for forty years, and it had, indeed,become a bastion of Washingtoncronyism. I think that’s fair to say. Those institutions were drasticallymismanaged by the overpaid appointees who were running them, no doubt aboutthat. Ginnie Mae, the Government National Mortgage Association, which was notprivatized, did not have the same problems.

But the truth is: this crisis emerged largelyfirst of all in the private-label mortgage sector, that is to say in purelyprivate entities like Countrywide, Washington Mutual, or IndyMac. The loanswere securitized through private banks, vetted by private ratings agencies. Thepoint here was not to put people in homes. It was clear to the lenders that thepeople that they were putting in homes would not be able to stay there.

The point was obviously to do two things. Onewas to create an enormous stream of revenue for these financial firms -- whowere in many cases friends and political supporters of the administration.Second, it was to create a temporary burst of economic activity  that would be to the political benefit of theBush administration. So, to the extent that you had political forces that wereexplicitly driving the process, those were the motivations. It was certainlynot some broad altruism toward a part of the population in which the politicalleadership of the country at the time never had any interest whatever.

Is there such a thing like “do-goodism” in Washington?

There is“do-wellism.”

What is this?

Large parts of the process are driven by a verystrong desire to increase one’s income and wealth. I’m not saying thateverybody in Washingtonis a crook. I’m not saying that there aren’t principled public servants evennow. But to say that they were dominating housing policy in the last decade isa very silly view.

But does at leastGoldman Sachs do “God’s Work” here on earth?[vii]

Well, I think you have to ask Mr. Blankfeinthat question. (laughs) The realityis: these firms have enormously increased their share of American economicactivity in the last twenty to thirty years. At the peak they were making, orperhaps even still, 40 % or more of total corporate profits. They were paying10 % of total wages. This is vastly out of proportion of the need for financialservices in any economy and in a substantially predatory relationship with therest of economic activity.

So, the task facing us is to figure out how tobring this sector under control, how to shrink it  and how to restructure it, so that it isformed of firms which actually compete with each other rather of operatingessentially as a large informal cartel with an implicit government guaranteefor the most wealthy and powerful operations in the business.

Let me give you a parallel. In many countries,in modern times, one had a large state-owned airline which provided rather poorservice and did not exploit the potential of that industry. An extreme exampleof that was in China,where you had one large, socialist airline. The Chinese did not privatize thatfirm. Rather they broke it up into many smaller airlines and allowed newcompanies to enter the market. Some were owned by the state, some by provincesand some by municipalities. It created an environment of enormouscompetitiveness between companies, and it enormously improved the service andforced a great modernization of the industry. (As an aside, I’ve heard on goodauthority that the Chinese got the idea for this from one of the 20^thcenturies greatest physicists, the American John Archibald Wheeler.)

That is the kind of thing that we need to dowith the banking industry. Banks are private-public partnerships. It can bestructured in a number of different ways. And the idea that you need to have asector which is dominated, with 60 % of the industry in a handful ofmultinational firms --  whose businessmodels are highly speculative, who are involved in the avoidance of taxes andregulation on a multi-national basis -- this is absurd. It’s a very poor way torun a modern economy, and to the extent that we don’t deal with this structuralproblem, we are going to continually run into problems of instability into thefuture.

With regard to thetrickle-up bailouts from autumn of 2008 – that you opposed[viii] – and onward: thosetrillions of dollars spent were not spent by “do-gooders” in the interestof protecting bank depositors or the general public; they went to protect bankbondholders, is this right?

Yes, that is essentially correct. But it wasnot just bondholders who were protected. Shareholders and holders ofsubordinated debt, which is risk capital, were also protected; in a resolutionthey would have been left out. That’s a serious problem. There was no realreason to do that. In a normal work-regulatory intervention in a bank which isinsolvent or at risk of insolvency, the historical effective practice of theregulatory agencies was to ensure that shareholders and subordinateddebt-holders, who were after all putting their money at risk in order to earn ahigher return in good times, were wiped out. They should have been. That is firstof all necessary to preserve the basic hierarchy of returns and risks in thefinancial markets, and necessary to establish in a credible and decisive waythe need for changing practices in the financial sector.

Isn’t it the case thatalmost by definition, money given, like via these bailouts, to corporations orbanks will show up most quickly as improvements in corporate earnings, and thenslightly later, as executive compensation?

The phrase “money given” is alittle bit vague. What was done in this case primarily was a purchase ofpreferred equity in the banks and that does not show up as earnings. The bestway to think of a capital injection, technically, is as a form of regulatoryforbearance. It was a way of saying to the banks, “we are not going to imposeupon you the restructuring of your balance sheets that would have been requiredby recognition that your capital had been diminished to the extent that it hadactually been diminished.” From a regulatory standpoint, buying preferredshares is essentially the same thing as reducing a capital requirement.

Two other things thenhappened.  The Federal Reserve reducedthe cost of funds to the bank existent to zero, and the Treasury made it clearthat the large institutions were not going to be permitted to fail. This wasthe message of the stress tests, which were clearly, I’d say, one of the mostsuccessful public relations exercises of recent times. They didn’t persuadepeople that the banks were sound. They simply persuaded people that thegovernment would not let them fail. The government was not going to allow thebanks’ unsoundness to trigger the normal actions that would have brought theminto conservatorship and ultimately to resolution.

As a result, the banks were able tobegin borrowing extensively. Some of these funds apparently found their way, bywhat channels is not entirely clear, right back into speculative asset markets.This meant that the stock market recovered and that commodity markets recoveredand people who were investing in those markets at the bottom with speculativehopes have been very, very greatly rewarded. I think that’s where the bankprofits partly come from. That, plus an enormous amount of interest arbitragewhich is to say, borrowing from the central bank at zero and then lending backto the treasury or similar, very secure, non risk-taking entities at 3 or 4 %,is also a way of making a lot of money if you do it on a sufficiently largescale. Those things have given the banks very good earnings and enabled them toresume paying bonuses.

And whatdo you think about the plan of the Securities andExchange Commission (SEC) to abolish the legal right to redeem moneymarket accounts?[ix]

DoI have a comment on it? I’m not on top of that one.

At the endof “The Predator State”you are explaining the consequences of the breakdown of the Bretton Woodsagreement by Richard Nixon in 1971. May I summarize my reading of it?

Sure.

Well, inthe chapter “Paying For It” youexplain that according to the system established in 1944, the U.S.current account deficit – and by extension its public budget deficit – waslimited by an obligation to exchange foreign-held dollars for gold. RichardNixon abolished that arrangement. You are arguing now that since the early1980s, the world has held the T-bonds that the U.S. chose to issue. Youacknowledge that the system is neither robust nor just, but you insist that solong as it lasts, it doesn't discipline the U.S.budget and therefore doesn't constrain U.S. government spending in anyway. Is this right so far?

Correct, sure.

I mentionthis because this is basically, at least as far as I understand it, the financialbackbone of the stimulus package you want to see taken place? And if this isthe case how would then a stimulus package look like if you could have it yourway?

First of all, it’s very clear thatthe United States government is not constrained externally, and it’s clear thatquite apart from the stimulus package, the automatic stabilizers and thefinancial rescue, which greatly ballooned the public debt of the United States,have had no effect on the ability of the United States government to funditself and no effect on the interest rates that the government pays. So, it, Ithink, follows from that logically and straight-forwardly that we have nothingto fear from additional efforts as long as they are necessary. And they’reobviously very clearly necessary. So the question is: what should be thestructure of those efforts?

I’ve always taken exception to theconstant reference to “stimulus” as the policy objective, because implied inthat word is the idea that all one needs to do is to undertake one or morerelatively short term spending sprees, on whatever happens to be available atthe moment, and that this will somehow return the economy to its pre-crisisstate, putting it on a path of what economists like to call “self-sustaininggrowth.” I maintain that in the present environment there is no such thing as areturn to self-sustaining growth. There will be no return to the supposedlynormal conditions, which were in fact, from a historical point of view, highlyabnormal, of the 1990s and 2000s.

What one needs is to set astrategic direction for renewal of economic activity. We need to create theinstitutions that will support that direction. Those institutions are public institutions, which create a framework forprivate activity. This is the way it is done. It is the way countries havealways developed in the past and, to the extent that they are successful, theywill always do so in the future or they won’t succeed. Seventy years ago whenwe were in the Great Depression, they built a national infrastructure: roads,airfields, schools, power-grids – this kind of thing was the priority. In thepost-war period, the creation and maintenance of a large middle class withsocial security, with medical care, with housing programs, universities – thesewere the priorities of the post-war period.

Now we clearly face an enormouschallenge with energy and climate. It’s a challenge that requires us to thinkin very creative ways, in very ambitious ways about how to change how we live,so as to make life on the planet tolerable a century or two centuries hence.This is a huge challenge. It requires design, planning, implementation,something with enormous potential for providing employment because things haveto be done, enormous potential for guiding new public and private investmentbecause one has to provide people with the means of making it realistic forindividual activity to support this larger objective. And that is the way tomove toward a renewed economic expansion. This strikes me very far from being a stimulus proposal. Itis a proposal for setting a new strategic direction for the economy and doingso over a relatively long time horizon with a view that you’re sustainingeffort for 15, 20, 30 years. That’s the way I think you need to think aboutthis.

Just to wrap up a long answer to ashort question: Why can’t we go back to the pre-crisis period? The answer isthat restructuring of the private household debts is an enormous task whichnecessarily takes a very long period of time. During that time, the pre-crisispattern of increasing debt will not resume. The asset against which theAmerican household sector collateralized its debt for 15 to 20 years, itshousing, has radically fallen in financial value. The houses are still therebut you can’t sell them for nearly as much as you could have three years ago.And that is a structural impediment to returning to the previous pattern ofeconomic expansion. And that impediment isn’t going to be removed in any shortperiod of time for the simple reason that the houses remain there as an excesssupply on the market and they remain therefore as a drag on housing prices.

Do you seea bit of a problem in the fact that the Federal Reserve bought approximately 80percent of the U.S.Treasury securities issued in 2009?[x]

No.

Why not?

Well, say what problem are youhinting at here, then I’ll explain.

Somepeople might say that this does fulfil the requirements for a Ponzi Scheme.

It certainly isn’t remotely relatedto a Ponzi Scheme. To be very clear, a Ponzi Scheme is a scheme in which aprivate party is issuing debts which can only be serviced by issuing more debtsto cover the interest. This is not a constraint on a sovereign government whichcontrols its own currency. Never is, never will be. There is a lot of looserhetoric about things like Ponzi Schemes and national bankruptcy which istypically the work of people who neither know nor care much about what they’retalking about.

Youalready said that energy should be part of a stimulus package or a larger plan.What do you think like for example about the immediate implementation in theU.S. of a national Feed-in Tariff mandating that electric utilities pay 3 % abovemarket rates for all surplus electricity generated from renewable sources, asMike Ruppert suggests in his new book “ConfrontingCollapse”?[xi] In Germany, the Feed-in Tariff wasquite a success story that created a huge amount of new jobs. Would you supportthis implementation?

I would need to study it, so I’m notsufficiently familiar to say. But it does sound, as you just described, like apromising line of attack.

With regard to theenergy problem, I would like to know if you take the phenomenon of Peak Oilseriously, and if so: why do you think that the financial, economic andpolitical establishment around the globe wants to keep quiet about it ordismiss it as “nonsense”[xii] even though thereseems to be a good amount of evidence that the world soon won't be able to meetenergy demands anymore?

I have read a fair amount on Peak Oil and I dothink that the argument in its favor is qualitatively different from, and moreserious than, earlier alarmist warnings about the supply of oil. The peak oilproposition relates to supplies of conventional oil, and it relates to the ideathat there is a normal (bell) curve associated with discovery and productionover time. That strikes me as a plausible hypothesis, and as one that back in 1956,successfully predicted he peak in conventional oil production in the United Statesin 1970. So it’s been around for a long time. So, I do think that it’s aproposition which needs to be taken seriously. As to your characterization ofthe actions and motives of large and powerful interests, I don’t have a theoryon that.

As Chair of the Board of Economists for Peace and Security: isn’t the whole ongoing “War on Terror” a fraud that is really driven bythe geopolitical competition for oil?

That’s a compound question. First part, is the“War on Terror” a fraud? I have always found that the concept of war on amethod to be a very dangerous way of arguing because it basically coversanything the speaker wants to cover. It is something which can have no end, nolimit, no success. It’s a construct which justifies the permanent commitment ofresources to an exercise in futility at best, and at worst a cover for allkinds of other purposes. And your suggestion is that one of those purposes isthe struggle for the control of oil.

My answer to that is: the interest of major oilproducers can be served without, and has been historically served withoutphysical access to production fields. The oil majors’ interests haven’tdepended on owning oil fields for many decades. So, when you ask what were theinterests of energy producers in the Iraq War -- and without saying that theyplayed the dominant role, which I think is very, very uncertain, in thedecision to undertake that war -- there’s no evidence whatever that theirinterest was to go over and produce the Iraqi fields. Quite the contrary, sincethe war they’ve not made a very serious effort to do that.

There’s been very little new internationalinvestment in Iraqin the post-war period. Very little certainly in the traditional oil-producingregions of Iraq.So, I think that their interests are served perhaps by preventing excess supplythat might otherwise have come on-line from Iraq from doing so, because thatwould have undermined the markets for oil produced in places where costs aremuch higher. One could make an argument along those lines. It strikes me asbeing economically more coherent, but I’m not going to get into the position oftrying to interpret the entire exercise in Iraq along those lines because Ithink, in point of fact, that other factors, including power politics in theMiddle East, and including domestic politics in the United States, also playedextremely important roles.

And there are people, who have studied GeorgeW. Bush, who write that he believed that you can’t be a successful president ofthe United Stateswithout a war. Perhaps the whole matter was as simple as that. I don’t know ifthat’s true or not, but one has to be, as a historical matter, very open-mindedabout the reasons why a particular government of the United States takes a particularaction of this kind.

The biggest“treasure”, I believe, that the Bush Administration left, are the records ofthe National Energy Policy Development Group, NEPDG, run by Vice-PresidentRichard Cheney in Spring of 2001. Those records are kept secret even though theAmerican public did pay for it – and not Mr. Cheney himself. Given the fact,that we can strongly assume that those records must be very precise when itcomes to oil reserve numbers, and given the fact, that we have for years nowall this debate about reserve estimates, wouldn’t it be time to open this “safedeposit box” in order to let the world see how much oil there is really left?

Again, a question with a number of predicatesthat I can’t speak to with authority. I don’t know what is in those files.

Well, they’re secret.

Yes. I do agree that files of this type shouldbe made public. If there is an argument, which undoubtedly some people willmake, for a national security reason not to make them public, then anappropriate procedure, which we have followed in this country in the past, isto appoint a panel of independent outsiders, not previously connected to thegovernment, to review the documents and to make them public unless there is acompelling reason not to, with arguments about what is compelling andnot-compelling ultimately resolved by the president himself. That’s a modelthat has been applied successfully in the past in the United States on a matter of thiskind. I think it would be very useful to do it in this and other instances onthe conduct of the Bush administration.

Two questions on RonPaul’s bill to audit the Fed, or more precisely the House Resolution 1207Federal Reserve Transparency Act of 2009, a bill requiring that an audit ofboth the Fed's Board of Governors and the Federal Reserve Banks be completedand reported to Congress before the end of 2010. You support this bill.

Yes.

Why?

The transparency of the Federal Reserve is anold battle between the Federal Reserve and Congress which I have been a partyto since my days on the staff of what was then the Banking Committee of theHouse of Representatives in the mid-1970s. The bill to audit the Fed at thattime was a project of the great Texas Congressman Wright Patman who, up until1975, had been Chair of the Banking Committee and had served in Congress from1929 until his death in the late 1970’s. I also worked on the development of aregular reporting procedure for the Federal Reserve, the Humphrey-Hawkins hearings on monetarypolicy, which has been in place ever since. After my days on that Committee,Chairman Henry B. Gonzales worked to expand the transparency of the FederalReserve, particularly with respect to making its archives open after a certain periodof time.

In every case, systematically, the pattern isthe same. The Federal Reserve always resists having its operationsinvestigated. But when it cannot resist any longer, it adjusts. And peoplequickly realize that the agency actually functions better under transparencythan under the previous regime of secrecy. This is perfectly normal. Secrecy,in almost all aspects of federal government, is a cover for inadequacy andinability to explain yourself in public. The Congress itself went through majorreforms of this kind in the 1970’s and everybody agrees, I think, that they ledto very significant improvements in the way Congress did business at least fora time. That’s point number one.

Point number two is that in the crisis that weare just going through, the Federal Reserve went to extraordinary steps tosupport the financial sector. Extraordinary steps, steps which it has persistently refused to presenta full accounting of to the Congress. The Chairman of the Federal Reserve hasarrogated to himself a power that he does not have in law, to withholdinformation from the Congress. The Federal Reserve is not the European centralbank. It’s not a constitutionally separate part of the governing structure. TheFederal Reserve is an agency of the United States government, createdby an act of Congress. The Congress has unquestionable oversight authority ofthe Federal Reserve and a presumptive right to any information it wants. TheCongress is a constitutional branch of government, the Federal Reserve is not.So this is a fundamental issue in the American system.

My view is that information requested byCongress or by the Government Accountability Office, which is the auditing armof the Congress, should be provided. The issue of whether that informationshould be kept confidential or not is a matter for Congress to decide, not forthe Federal Reserve. There is ample practice in other parts of the governmentwhere this works very well. There has never, so far as I know, been asignificant leak of national security information from Congress. Congress isbriefed, and leadership of the intelligence committees is briefed on sensitivecovert operations carried out by the national intelligence agencies. Securityon that has been remarkably good. Nothing that the Federal Reserve does hasremotely that degree of national security sensitivity.

The justification for secrecy is only aboutmoney and to some degree about – so they argue --the reputation of particularfirms, whether they are going to the discount window and whether this signalsthat they may be in some kind of difficulty. These are concerns of someimportance in normal times. They are concerns that are totally overridden in amoment of crisis, when every financial firm was in severe difficulties, andeverybody knows this fact.

 Theissue before us, is to ensure that actions of the Federal Reserve wereconducted in a way consistent with the public interest and with the detachmentthat one would normally expect of a public official from purely private financialconsiderations, especially favouritism to one firm as opposed to another. Thoseare issues which are legitimate to investigate, in fact it’s imperative to doso. Absent a full investigation, most people are going, rightly, to be verysuspicious.

The point of an audit is to get to the bottomof that matter. It’s a bipartisan bill. Ron Paul picked up the idea from hisfellow Texan on the other side of the spectrum, Wright Patman, and he’s beenjoined by progressive member from Florida, Alan Grayson, who is a verycompetent fellow, knows what he’s doing. It’s something which needs to betreated with great seriousness. It’s also something that has a lot of popularsupport, but it is not a demagogical “populist” measure. It’s a measure thatgets to the heart of the correct relationship between the Congress and thecentral bank in the constitutional structure of the government of the United States.        

Is it any surprise toyou that most of those economists who oppose the audit the Fed bill areactually on the payroll of the Fed?[xiii]

This is a fact which has been well documentedby a close colleague of mine here at the LBJ School,Robert Auerbach. The Federal Reserve engages in a very wide-spread practice ofconsulting contracts to economists who repay the Federal Reserve with loyalty.Since this is now well-known, it’s not surprising that no one takes theposition of an economist on a matter like this very seriously.

Do you agree with RonPaul that the “Fed will self destruct when it destroys the dollar”?[xiv] Is the Fed indeeddestroying the dollar? And do you see signs that a run on the dollar mightstart soon?[xv]

No, no, and no. I’ve spoken favourably of RonPaul about this question of the audit. He is in other respects a very strangeperson to have captured the mantle of populism because, while the populists werein favour of an elastic currency and their great cause was free silver (the useof silver as a monetary metal), Ron Paul is a hard money man. To the extentthat he has a clear vision of a monetary system, it’s a vision that would havebeen comfortable in the board room of a New York bank in the late 19^thcentury -- that the dollar has to be good as gold, etc., etc. He has held thisview for many years. As a very young man, I remember debating him on  radio in Washington D. C. about this and thiswas in the mid 1970’s.

The dollar is the national currency of a verylarge economy, and it is also the transactions and reserves currency of a verylarge share of world trade. The reasons for this are that the US is a very big place, and the USgovernment does not have any problem, never will have any problem servicing itsown debts in dollars. So, the UShas a great advantage in the world of being the target of flights to quality,and we provide a service to the world economy, which does not cost us very muchto provide. It’s fundamentally a matter of existing institutions and reputationand scale of American economic activity. This is not going to go away in myview, and it’s not threatened by reserve holdings of Japanor Chinaeither. It is much more likely that Greece,Portugal, or Spain will be forced from the euro than it isthat Texas or even California would be forced from the dollar.Much more likely.

For this reason, everything in world currencyterms has to be assessed in relative terms. The institutions that support thedollar, the public institutions, the Federal Reserve and the US Treasury, aremuch more flexible and better-adapted to economic management, generally, andthe crisis in particular, than is the euro system. The Europan system is asystem managed by a rigidly constrained central bank and by a loose network offinance ministers who are ridden by ideological differences and unable to turn tobring the power of the European economy to the assistance of the economies onthe periphery of the euro zone that had been most severely effected in fiscalterms by the crisis.

The world investment communities are well awarethat what happened in  November 2008 wasthat the dollar rescued the euro, not the other way around. This was done by amassive extension of swap of currencies from the Federal Reserve to the euro zoneto alleviate a massive shortage of dollars caused by banks and others hoardingdollar assets and dumping dollar liabilities. It’s true that the euro has goneup and the dollar has gone down since then, but the basic asymmetry in theseinstitutional arrangements and capacities remains.

So, I think Mr. Paul is really, first of all,wrong, alarmist and to some extent politically motivated. In spite ofeverything that’s gone wrong in the American economy it’s quite unwarranted to starttalking as though there’s an imminent collapse of the dollar. All reservesystems are fragile. All monetary regimes can collapse. It’s not excluded thatsomething very bad could happen. The costs of something like this are howeververy large, and the most likely thing is that the existing system, the existingrole of the dollar, will continue and as I say for the reasons that I’ve justgiven, the euro is in no position to replace the dollar.

Thank you very much for taking your time,Professor Galbraith!

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