Running on Empty: How the Democratic and Republican Parties Are…

Running on Empty: How the Democratic and Republican Parties Are Bankrupting
Our Future and What Americans Can Do About It

by Peter G. Peterson

2004 * 242 pp. * New York: Farrar, Straus and Giroux * $24.00

Presentation of the book and discussion at the Institute for International Economics,
August 9, 2004


Introduction
C. Fred Bergsten, director, Institute for International Economics

Let me welcome you today to the Institute for International Economics, to a very special
luncheon meeting on a critical topic with some of the top experts and leaders in the
world. I want to first thank our cohosts for this meeting, of which there are three: the
Concord Coalition and Bob Bixby, the Committee for a Responsible Federal Budget and
Maya MacGuineas, and the Center for Strategic and International Studies with President
John Hamre and Richard Jackson, the director of the Center's Global Aging Initiative,
which is directly related, as you will hear, to the topic that we are talking about today.
         We'll start with the honorable Peter G. Peterson's presentation of his new book on
the federal budget and the outlook for the nation's finances. It is fair to say that he has
been one of the most persistent, persuasive, and courageous voices on US fiscal issues for
the last couple of decades. This is his fifth book on numerous aspects of the topic, and I
guess he is now getting things right, because this seems to be the most successful. It's
been on the bestseller list for the last couple of weeks. There are indications that it may
be going even higher, and so it seems to have caught a theme of interest throughout the
country in addressing the fiscal problems that the United States now faces.
         It is of course a special pleasure for me, here at the Institute, to introduce Pete
Peterson. He was the founding chairman of the Institute for International Economics back
in 1981. He remains chairman today and, I should add, for the indefinite future, as he sees
no signs of slowing down in any of his activities. This, as you noted while coming in, is
the Peter G. Peterson building, which he played a central role in both inspiring and
constructing. And so it is a pleasure for me that this is in fact the biggest crowd we've
ever had, rivaled only by that for President Vicente Fox of Mexico, at our opening day
about three years ago.
         In any event, it is only one of Pete Peterson's nongovernmental activities. He is of
course chairman of the Council on Foreign Relations, founding president of the Concord
Coalition, and is involved in a very wide range of activities of this type. In "real life," he
is chairman of the Blackstone Group, one of the world's top private equity firms, which
he cofounded in 1985, after having been CEO of both Bell & Howell Corporation and
Lehman Brothers. On the government side, he was assistant to the president for
international economic policy and then secretary of commerce in the early 1970s. In
short, Peter Peterson is a very unique American: a corporate and financial leader, a
distinguished public servant, and now a bestselling author.


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It's a great pleasure to introduce my close friend and chairman Pete Peterson to talk about
a topic of crucial importance to the country.
         After Pete speaks, we will turn to Robert Rubin, secretary of the treasury from
1995 to 1998. We thought, as Pete said himself, that Bob was perhaps the best person to
give us his perspective on the issues that Pete Peterson has raised, what the outlook might
be going forward into the election campaign and beyond, and we'll turn to Bob to lead
off the discussion. Then, Pete, Bob, and I will take the podium and start a panel
discussion, bringing the audience in quickly, to be hosted by Alan Murray, DC bureau
chief of CNBC and former DC bureau chief of the Wall Street Journal.

Presentation of the Book
Peter G. Peterson, The Blackstone Group

I am often asked, "Why did you write this book now?" There are several answers to that.
One is, I'm a terminal masochist, and I love being assaulted by my best friends. On my
last book, Ted Sorensen issued the infamous and now famous comment about Gray
Dawn. He said, "Gray Dawn is a book that once you put it down, you won't be able to
pick it up." He called me the other day on getting my new book, called Running on
Empty, and said, "When I saw the title of your new book, Running on Empty, I assumed it
was an autobiography."
        I thought John Whitehead was a great friend. He preceded me as chairman of the
New York Fed, and I thought I was being gracious in cohosting a big 80th birthday
celebration for him. He got up and said, "I just finished reading Gray Dawn. It's the only
book I've ever read where you learn more from reading the blurbs than from reading the
book." So that's one reason: my masochism is being more fully fed.
        I have a second reason that sounds sanctimonious and self-righteous. But it has
the virtue of being true. I am the happy father of five kids and nine grandkids. And, I am
lucky enough to have carved out a life where I can spend some real quality time with
them. And as I think about them, a comment by Dietrich Bonhoeffer, the German
theologian, rings in my ears, "The ultimate test of a moral society is the kind of world it
leaves to its children." And as we quietly pass on huge, and I think unthinkable, taxes and
debts, as we quietly slip our kids and grandkids the check for our free lunch, I say we are
failing that moral test.
        I go further and suggest that in this political season it might not be a bad idea to
reformulate the famous Ronald Reagan question, "Are we better off than we were four
years ago?" by asking instead, " "Is the future going to be better off? Are our kids and
grandkids going to be better off than we are today?"
        When I say that, some parents ask, "Are you suggesting that we don't care about
our children?" And I say, "Absolutely not." But I am saying that parents and
grandparents are being grossly misinformed and disinformed by an unhealthy
combination of political and bureaucratic amnesia and anesthesia.
        I once asked Margaret Thatcher, the only developed-country leader who has
successfully attacked the long-term entitlement and fiscal problems, "Lady Thatcher,
what do you people talk about at your G-7 meetings? Are the other leaders aware of this
long-term problem?" She said, "Oh my yes, Mr. Peterson. They are very much aware of



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it, but their theory is it's going to hit on somebody else's watch, and why should I take
the pain for somebody else's gain?"
         Now permit me to give you a few examples of what I consider to be the political
high jinks, hypocrisies, and chutzpah, if you will. Let us start off with the unfunded, off
the books, long-term liabilities--or if you prefer, hidden liabilities.
         Official sources, and many unofficial, put the dollar level of unfunded liabilities at
between $45 trillion and $74 trillion, depending on the timeframe. That is more than our
collective net worth!
         Now some hypocrisy and chutzpah. We passed unanimously in the Senate the
Sarbanes-Oxley bill, in which we put public CEOs in jail if they don't accurately report
their liabilities. Under ERISA [Employee Retirement Income Security Act of 1974],
corporations are required to fund their long-term pensions over no more than 30 years.
Were ERISA and the Sarbanes-Oxley bill to apply to the US government, it would add
over one and a half trillion dollars to the annual budget.
         While I suggest a number of reforms in the budget process--including first,
reinstallment of the budget reinforcement act, including pay as you go; second, issuing a
comprehensive long-term budget; and finally, developing accrual and generational
accounting--I call my most fanciful the suggestion that Congress should now legislate
that our government and public budgets be subjected to the same Sarbanes-Oxley/ERISA
requirements as the rest of the public corporations.
         And why is that fanciful? Because we can safely assume that the enthusiasm of
Congress for that idea would be highly restrained. Why? For one thing, they would be
jailed if they were to continue their current reporting, or I should say, nonreporting of
these vast liabilities.
         A second example of political high jinks is the trust fund. When I was secretary of
commerce, for reasons that are not clear to me, Time magazine referred to me as the most
powerful secretary of commerce since Herbert Hoover. I burst out laughing, because
anybody who has ever had that job knows there has never been a powerful secretary of
commerce. In any event, I started collecting oxymorons.
         I believe the Social Security Trust Fund belongs in the first tier of classic
oxymorons. In the first place, the Social Security Trust Fund should not be trusted, and it
is not funded. We anesthetize the public with highly reassuring long-term statements that
the trust funds are solvent for decades. Yet, we do not tell the public that the payroll taxes
of our children and grandchildren would have to double to cover the costs of Social
Security and Medicare. That is an unthinkable burden. We do not tell the public that
whether you have a trust fund or not, you still face the same three hard choices: increased
taxes, cut benefits, or try to borrow unprecedented amounts.
         Now how much would we have to borrow? I think it's time we started thinking in
cash flow terms, because these programs are obviously pay-as-you-go programs. The
projected cash flow deficits for Social Security and Medicare go from a modest $25
billion in 2003, to a projected $783 billion in 2020, and trillions of dollars thereafter.
         Then, of course, our political dialogue includes a lot of euphemisms and
disphemisms. "We shall not pass our problems on to the next generation." Well who the
hell do we think we're passing them onto? Or, "It's your money. You deserve to get it
back." Who does the debt belong to? The ages, or what?




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         Milton Friedman tried to educate me, presumably, when I was at the University of
Chicago. He used to teach us that a long-term tax cut is not a tax cut at all, if it is not
accompanied by long-term spending cuts. It is just a deferred tax increase on your
children.
         Now another reassuring absurdity that we inflict on the American people is
referring to these entitlements programs as a social contract. I had one course in
commercial law in business school. And, I was taught a contract is not valid unless there
is a meeting of the minds of the parties involved. Recently, some good friends gave a
book party, and I thought I'd try to dramatize this point by inviting my wonderful seven-
year-old granddaughter, Chloe up to the stage. And I said, "Chloe darling, have you
signed on to trillions of dollars of unfunded liabilities? And this doubling of payroll
taxes?" And this adorable girl says "Papa"--as she calls me--"I am going to have to sell
a lot more lemonade, and you're going to have to increase my allowance." Indeed.
         Now in my apparent need to offend everyone, I attack what I call the theologies of
both parties. I use the word theologies deliberately, because a lot of these policies seem
faith directed and relatively untouched by analysis, history, or evidence. And they are
nearly always delivered with a kind of moral certitude.
         My party, the Republican Party, seems to have adopted a tax cut theology, which
has morphed into "any tax cut, any time." Now, to continue the theological metaphor: the
tax cutters have formed an unholy alliance with the big-spending, big-government
Republicans. Alas, a new oxymoron: the big-government Republicans.
         Not just Pete Peterson, the curmudgeon, but highly conservative institutions and
individuals agree. The CATO Institute refers to the "spending explosion." Dick Armey,
the former very conservative majority leader, says, "We can't pin this one on the
Democrats, we're in control of everything." Senator Chuck Hagel says, "Our party has
lost its moorings."
         In this vain, I was chagrined that my party, the so-called fiscally responsible
party, voided the very budget enforcement mechanisms--pay-as-you-go, spending caps,
and the like--that had made such a difference in the fiscally responsible 1990s.
         Finally, these Republicans are joined by their fellow "starve-the-beasters."
Paradoxically, their argument is in sharp contrast to that of the supply-side Republicans,
who might argue that increased revenues would grow us out of any problem. The "starve-
the-beasters" take the opposite view: cut taxes, they tell us, and revenues will fall. Then,
we can get rid of or drastically cut these benefit programs.
         I say to the "starve-the-beasters," you had better be careful what you wish for.
Have you considered certain melancholy facts? One-third of the people at retirement age
have no net financial savings. According to the Fed, half of all people aged 45 to 54 have
total gross financial assets--not net, but gross--of less than $46,000. According to the
Social Security Administration, Social Security and other benefits account for 91 percent
of the total cash income in the year 2000 for elderly households in the bottom fifth of the
income distribution.
         Now picture the scene, 77 million baby boomers, some significant portion of
whom are in serious need of support. Am I to believe that if we suddenly say, "Sorry
folks, there is a big cut in your benefits", there will be no political or social effects. And,
the elderly will say, "Thanks...I needed that and I deserved that." By the way, when in a
major crisis did governments get smaller?



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         So, to sum up what my party has done, they've done Lyndon B. Johnson one
better. We have guns, butter, and tax cuts.
         Now to my Democratic friends. In the interest of self-defense, I exclude Bob
Rubin, at least for today. If my party cannot see a tax cut it does not like, it might be
charged that many Democrats have hardly ever seen a universal entitlement program that
they didn't like. Viewed historically, I think it is fair to say that they have been the prime
movers, along with a few coconspirators, I have to admit, from my party, of the following
rather startling trend. Over the last 40 years, federal benefits to individuals have gone up
six times in inflation-adjusted terms.
         Let's review the current Medicare prescription drug benefit. In spite of the fact
that most serious analysts say that the projected costs of the current Medicare program
are unsustainable, we heard not a single word from the Democrats about controlling the
cost of the current program. Instead, Democrats complained that the new Medicare drug
benefit plan does not go nearly far enough. In other words, let's make this unsustainable
program even more unsustainable.
         Now one might ask, Peterson, you have been boring us relentlessly since the early
80s about the entitlements. What is new; that is, beyond the obvious reality that the first
baby boomers retire in only five years, and the next president is going to confront this
reality directly on his watch?
         I suggest there are three important new realities we must deal with. All three
center around the basic theme of some profound disconnects between ends and means.
All three are about our unwillingness to confront the long-term tradeoffs between
national security, economic security, and retirement security.
         First, we confront an unprecedented national security agenda to fight two wars:
the war on terror abroad and the war on terror at home. While we say we'll pay any price,
and we say that we know these wars will go on for years to come, we have in fact
seriously underestimated the cost. And, we are fighting both wars without a war budget.
         Some have forgotten that while our super power military is stunningly effective, it
is also stunningly expensive. It is very different from the good old days--World War II,
for example, which was a bit like organizing a federal jobs program, with quick training
of inexpensive troops with inexpensive equipment. In today's hi-tech high-cost military,
the brute fact is that these costs have ballooned--for example, a billion dollars a week for
just two divisions in Iraq conducting "stability operations".
         Some quick factoids. The CBO, which is after all under Republican control, has
looked at our budget estimates for the next 10 years for defense and said they should be
at least 18 percent higher or a trillion dollars more than the official estimates. And they
remind us that the official budgets have no provisions for any wars. They also have no
provision for additional troops, which 54 out of 61 members of the House Armed
Services Committee have proposed. Were we to meet the criticism of having a ten-
division army to meet our 12 decision priorities, the personnel-related expenses alone
would come to about $40 billion annually.
         Then, of course, there is the war on terror at home. I am very proud of the work
that the Council on Foreign Relations has done on homeland defense. Now in spite of all
the rhetoric, there are obvious critical holes in our homeland defense. Cargo containers,
first responders, health care systems, immigration control, protecting critical
infrastructures such as energy sources, pipelines, refineries, and so on. Just to cover only



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three of these vulnerabilities: Equipping our emergency responders, expanding our
medical facilities, and protecting our ports would cost over $120 billion over the next five
years.
        The second new reality that I think is receiving far too little attention are not
simply the budget deficits, but the huge foreign or current account deficits--the so-called
twin deficit. The previous record was in the 1980s, 3.7 percent of GDP. The dollar then
fell by a third, and we experienced a stock market crash. Today, it is at 5.4 percent of the
GDP, heading north by most accounts, into utterly uncharted territory.
        Catherine Mann, a fellow at the Institute, is here, and she has some future
estimates of current account deficits that might daunt even the most passionate optimist.
Perhaps during the discussion, Fred can talk about that.
        Currently, we import $4 billion of foreign capital every day--half to finance war
deficits, half for current foreign investments abroad. And even the IMF is giving us hell.
They remind us that a current account deficit of 5 percent of GDP is typically a danger
point. They remind us that external debt at 40 percent of the GDP--where we'll be in a
few years--is "an unprecedented level for a large industrial country."
        So as part of this book, I interviewed a dozen leading experts about the twin
deficits, experts who are much smarter than I am about such things. None of these people
believe that our current account deficits are sustainable. In the administration I served,
Herb Stein was our Nixon humorist, which I guess is another oxymoron. But you'll recall
his famous words, "If something is unsustainable, it tends to stop." And he said, if you
don't like that, "If your horse dies, I suggest you dismount." So the question we confront
here is: do we get off gently, or do we get thrown off?
        Now, roughly half of these experts say there is a substantial risk of some kind of
hard landing. Paul Volcker, for example, says that there is a 75 percent chance of a crisis
in five years. Rubin, who speaks with his usual understated and constructive ambiguity--
by which I mean no one knows what he is saying--refers to "a day of serious reckoning."
        Remember that a hard landing envisions a sudden big drop in the dollar, a big
spike in interest rates, nasty effects on financial markets in the economy, and so forth.
The other experts predict a softer landing. But make no mistake; we're talking about a
landing and not a takeoff. Now in truth, I don't think anyone knows how and when these
deficits will be made lower and sustainable. But we know they must be.
        The United States now directly or indirectly absorbs two-thirds of the total current
surpluses run by every nation of the world. This cannot continue. But redressing this
unsustainable global imbalance will require some profound and perhaps even traumatic
structural and indeed cultural changes of our own and other countries' political
economies. America must consume more, import relatively less, save relatively more,
and export more, and the rest of the world will need to do the opposite.
        Given the difficulties of these adjustments, our esteemed chairman of the Federal
Reserve, Alan Greenspan, has said that nothing worries him more than the "clouds of
emerging protectionism" as a possible "solution." And speaking of our chairman, I am
delighted he is here today. But I wonder, as tough as the agenda, Alan, has been on your
watch, whether you might turn out to prefer it over that of your successor.
        Whatever the outcome, I think these unprecedented twin deficits are great risks
that a great country should not be taking. And I am not simply talking about the
economic risk, I am talking about the national security risk and the foreign policy risk, of



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betting how long the biggest debtor and the biggest borrower can also be a great leader
and a great superpower.
         The third new reality is a rapidly aging world and the gargantuan fiscal demands
that come with it. We in the United States say that our 77 million baby boomer problem
is huge. However the problem in other developed countries is far more severe and will hit
sooner and harder. Why?
         Their birth rates are far lower than ours. Thus, they confront a big drop in young
tax-paying workers. The birth rate in Italy and Spain is 1.2, in Japan and France it's 1.4
or less; their benefits are much higher; they retire much earlier--in France only 34
percent of the people stay employed between the ages of 55 and 64; only 7 percent in
continental Europe have a pension plan; the unions are much more powerful; the taxes
are already much higher, averaging about 35 percent of payroll tax in Europe, 45 percent
of the GDP overall tax burden.
         Our friends at the Center for Strategic and International Studies have projected
that the public benefits spending demand for the elderly in Japan, France, Germany, and
Italy, will grow from 15 to 28 percent of the GDP in the next 40 years. That's
unthinkable, it seems to me.
         Speaking of Japan, let me tell you a little anecdote. I found myself at the Council
on Foreign Relations, sitting next to Mr. Kuroda, who until recently had been the vice
minister of finance and international affairs of Japan. The conversation goes roughly as
follows: "Mr. Kuroda, is the aging society in Japan and the related demands going to
present a significant problem to your country" ... "Oh yes, very serious problem" ...
"Mr. Kuroda, how are you going to finance these burdens?" ... "Well Mr. Peterson, we
have a high saving rate and a big current account surplus. And for a while we'll be able to
sustain it that way" ... "Mr. Kuroda, aren't you financing 25 percent of our current
account deficit? And have you figured out a way of spending the same money twice?" ...
"A serious problem Mr. Peterson."
         Finally, I lay out reforms in this book. They are built around the notion that we
must substantially increase our rate of net national saving, which is now hovering near
zero. And there are two ways to do this, obviously: One is to reduce the dissavings, or
negative savings of the budget deficit, and without fundamental reform of the
entitlements--this is a fool's mission, in my opinion. And the second is we have to
increase personal savings directly per se.
         As to reforming entitlements, may I say that both Social Security and Medicare
require reform? However, I believe that not only is Medicare the biggest fiscal problem,
accounting for three-fourths of the unfunded liabilities, but also a far more daunting
problem in political and even moral or ethical terms.
         Some say just drop Bush's tax cuts, at least on the wealthy. But the CBO
[Congressional Budget Office] tells us that even if we repeal all of the Bush tax cuts, they
are only about 10 percent of the problem. So we must confront the brute reality that
reduction in benefits are absolutely essential in Social Security and Medicare.
         Let's start with Social Security. After proposing in times past a variety of what we
might call micro changes, gradually increasing the retirement age or an affluence test, or
a Diet COLA, I've decided that this mille-step approach tends to aggregate a consensus
of negatives. I've decided that a simpler macro approach has much to say for itself--not




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just simpler to execute but simpler to explain to parents and their children, which I
consider crucial to a long-term political solution.
         It is quite widely known that Social Security benefits are indexed to inflation with
cost-of-living adjustments (COLAs). It is not widely known that these benefits are also
indexed to wages, and that makes it very difficult to grow out of the cost problem.
         If we were to eliminate the wage indexing, we would essentially eliminate the
unfunded liabilities of Social Security. If we have time to discuss it, I can explain why I
believe that parents and their children being told that they are getting the same benefits in
real terms can be presented as a fair and simple proposal.
         My second proposal is for mandatory savings in personal retirement accounts of
workers, of roughly 2 to 3 percent of the pay, with some subsidy for the poor. These
funds would be managed by a public/private board.
         Why mandatory you might ask? Fred Bergsten will recall that some years ago,
when he chaired the Competitiveness Policy Council created by the Congress and the
President, I was chairman of a subcommittee on capital formation--a subject about
which I knew virtually nothing. So I invited the best savings economist from the left,
right, and center. I asked that they educate me on the net effects on national savings--that
is net, after considering all the costs of the tax incentives. The general conclusion was
that the effect is both limited and ambiguous. But, I said, you keep saying that we have to
increase our savings in this consumption-obsessed culture of ours. So, how do you
propose that we do it? And virtually unanimously they said, in our consumption culture,
it would have to be mandatory.
         How to invest it? I propose these monies be put in global index funds, equity and
fixed income. Why indexed funds? Because, in the first place, they reduce administrative
costs substantially and thereby increase net returns. I want to remind you that many of
these individual accounts we keep talking about will be very small for a while. And
second, index funds avoid the political issues of which industries to invest in or not invest
in. That becomes a political football.
         Why a public/private board? I think it is essential that we get this money out of
the hands of government, who have demonstrated that they will spend it. And, we must
get the funds invested in the private sector.
         Now what about Medicare? It is a much bigger and much more formidable
problem. Why? Because it presents highly ethical life and death issues, and who decides,
and how one decides who gets what treatments. Because it confronts what Dan
Yankelovich calls a "maximum right" mentality--that Americans are "entitled"--not one
of my favorite words--to all the latest high-tech, high-cost treatments. This is a mentality
that has led our spending to be about two times that of the developed world, without any
measurable difference in health outcomes. In this book, I present half a dozen proposals
for controlling the cost of health care in ways that I hope are rational and humane.
         Finally, what does one need to do politically? What are the possible scenarios? I
give you two options or scenarios.
         Option A, one I vastly prefer: A massive dose of truth telling. And, given the
momentum and impact of the 9/11 Commission, I recommend that the next president
immediately appoint such a bipartisan twin deficit commission of trusted Americans, of
the quality of Tom Kean and Lee Hamilton. I'm talking about Paul Volcker, Bob Rubin,




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Sam Nunn, Warren Rudman, and Bob Kerrey--Americans of that quality, and not the
usual special interest devotees.
        It will also require, in my opinion, bold leadership by a president, who not only
educates but also leads Americans to take constructive action and ideally, creates a global
consensus for other developed countries to also take action. This is indeed, in my view, a
global problem if I ever saw one.
        Next, entitlement reform has to be in a bipartisan setting. A partisan approach to
reform energizes the "turkey shoot" phenomenon, which I used to experience in my home
state of Nebraska. In other words, the "turkey" who lifts his or her head with a proposal
gets shot.
        Scenario B, much to be deplored, is a crisis scenario. And there are a lot of hard
heads that I have talked to who believe this is what it will take to solve our long-term
fiscal problem. Let us pray this is not the case, because it will engender all kinds of
profound costs.
        In closing, let me remind you that if you pick this book up, don't put it down. You
won't be able to pick it up. Thank you very much.


Commentary
Robert Rubin, former secretary of the treasury

Fred asked me if I would make some comments on the issues that Pete's book raises. Pete
had given me an inscribed copy of the book, which I was very appreciative of. He told
me a moment ago, the reason he inscribed it was so I couldn't resell it. I would have
thought, given Pete's humility, he might have thought that his signature added to the
value, but who knows.
         Let me start by saying that I thought Pete's book was just terrific. It was a clear,
objective, apolitical statement about realities that seem to me are stark and that in my
judgment at least threaten to undermine our economic wellbeing, our national security,
and our society, unless they are effectively addressed.
         Pete mentioned his Margaret Thatcher anecdote, in which she said, in any given
moment, it's very easy for politicians to opt for current gratification, while letting
somebody else pay the price for the future. But that doesn't change the reality that there
is a price, and at least in my view, in our country today, that price has the potential of
being truly terrible.
         I break the economic analysis into three periods. One of them is the eight years of
our administration, the four years of the administration, and I think there are very
important debates about which economic policies would have best promoted economic
growth during those periods. And I think one can learn a fair bit from that with respect to
the future, but that's not the subject of today's discussion.
         As to looking forward, I break it down into two time periods. I tend to think of the
next 10 years, which you know is the congressional budget window, as one period. And I
at least think of that as the long term--maybe that's because I live on Wall Street, where
the short term is the next minute and the long term is a day. Anyway, that is a matter of
nomenclature.



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         And then if you take the decades beyond that 10-year period, which is the period
that Pete focuses the most on, I think of that as the long long term.
         Most independent analysts are now projecting, as you know, a fiscal deficit of
about $5 trillion to $5.5 trillion over the next 10 years. Goldman Sachs, for example, has
put out a series of reports with estimates in that range. That is a $9 trillion deterioration
from the CBO's report in January 2001, once you make some methodological
adjustments.
         Moreover, that deficit will worsen every year, because as Pete said, in the middle
of the next decade, baby boomer retirements start to accelerate at a rather rapid rate.
Moreover, while 10-year numbers are obviously highly unreliable, it is equally true that
there is no reason to think they'd be better rather than worse. In fact, Goldman Sachs
thinks that the risk is more on the up side. And that, it seems to me, was a fundamental
argument against the 2001 tax cuts, which were based on the notion of a very large
projected surplus.
         As Pete says in his book, and I think it's absolutely right, the 2001 and 2003 tax
cuts, which are estimated to cost roughly $4 trillion over the next 10 years, are at the
heart of the 10-year budget deficit that Goldman Sachs and other independent forecasters
now project. And I would add that the morass that we now have was totally unnecessary,
because with respect to the tax piece of the stimulus--and of course the Fed was the most
important part of the stimulus that we've had--the shorter-term stimulus could have been
fully accomplished with temporary measures that would have been more efficient, more
effective, and would have had no, or virtually no adverse, long-term effect.
         I think these 10-year numbers are politically difficult to deal with, because, as
Pete mentioned, we have serious geopolitical issues, national security issues, and difficult
demographic issues. I would add one more, which is that we're going to compete with
China and India, with large numbers of well-educated, low-wage workers, in a world
where distance has been irradiated as a factor for many activities, because of real-time
technology. I believe we are also going to have to invest very heavily in public education,
basic research, certain kinds of infrastructure, and other matters.
         Pete describes the very serious crowding-out effects that virtually all economists,
or at least the mainstream economists, today agree on with respect to sustained long-term
deficits. Pete also referred to an even more serious threat: a threat to interest rates, to
business and consumer confidence, and more generally, to our markets and our economy.
If the domestic and the international markets begin to believe that we are going into a
period of fiscal disarray, then as a consequence they will lose confidence in our bond
market and as a consequence of that plus our huge current account deficits, lose
confidence in our currency--and as you all know, our current account deficit is in some
fair measure spawned by our fiscal deficit.
         These effects haven't been felt yet, although I do think that the prospects of these
kinds of twin deficits have had some effect on confidence, on easiness, and on consumer
and business behavior. But fundamentally, these effects have not yet been felt on interest
rates. And the reason is that private demand for investment capital has been very weak.
But I've been involved with markets my entire adult life, and I don't think there is any
question that at some time, market psychology will change to reflect reality, as it always
does. And when that happens the effects that Pete describes are highly likely to occur.




                                                                                          10
Pete referred to Paul Volcker saying that Paul thought there was a 75 percent chance of a
crisis in the next five years.
         To a limited extent, entitlement reform can be part of a solution to the next 10 or
15 years. Although I think that the practical reality is that entitlement reform will at best
be a relatively small part of the solution to the 10-year problem--especially if you have
the view of the current retirees, and soon retirees are, for practical purposes, off the table.
         Thus, the solution will have to be primarily in revenues and spending from other
parts of the budget. Having said that, as Pete so dramatically and effectively
demonstrates, if you look out over the next several decades, entitlement growth presents a
truly impossible problem that will almost surely lead to exceedingly unhappy results.
         Again, it seems to me that the 2001 and 2003 tax cuts played a central role.
Number one, if you adjust the AMT [alternative minimum tax]--given that the middle
class is going to be swamped by the AMT, it seems to me that it is inevitably going to be
adjusted--then those tax cuts over these many decades are, roughly speaking, equal to
the increase in the cost of social security. In fact, if you present value it, the tax cuts are
more expensive than Social Security.
         The biggest problem, as Pete said, is Medicare.
         Also, I think these tax cuts make reform far more difficult, because when the day
we finally face reform comes, if we are in a situation where we have to say that we can
afford tax cuts that are heavily weighted toward the most affluent but can't afford current
Social Security and Medicare benefits, that situation, it seems to me, makes for
exceedingly more difficult politics.
         And that leaves me to politics and process. And on that matter I would make just
a few very brief bullet-point type comments, and we can leave the rest for discussion.
         First, most politicians like to talk about fiscal discipline. I lived through this in
1993 with President Clinton. Bill Hoagland can tell you the same thing from his
experience. It's easy to talk about but excruciatingly difficult to do. And the best
evidence is that our program in 1993 passed by two votes in the House and by a tie vote
[in the Senate]--the vice president [Al Gore] supported us. And if you look at the
political environment today, as Pete does so well in his book, one can get a sense of just
how difficult this is going to be.
         Second, in 1998--I don't think too many people remember this now--President
Clinton considered the possibility, at least, of a few reforms of Social Security. We put
out some feelers to see what the reactions might be. They were immediate and violent.
And therefore were immediately taken off the table. I think that the "turkey shooting"
example is right. In the environment we have today, if we try to put out a proposal to deal
with these very difficult problems, in a campaign, they will be violently attacked and
therefore, for practical purposes, either destroyed or severely damaged with respect to
future use, which may say a lot about our political process.
         Third, I think the only way to succeed--and I am not sure what the odds are that
we can succeed, short of a serious disruption--is to have a president with a deeply
internalized sense of the grave dangers we face, which Pete so aptly describes and a
congruent sense of commitment to lead, working with the leadership of both houses and
both parties, so there is joint ownership of these decisions.




                                                                                            11
        Fourth, based on my own experience--and I guess I alluded to this a moment
ago--I think even under those circumstances, even a committed president is very unclear
what the odds are that we can succeed before disruption.
        Finally, we need massively improved public understanding, which Pete also refers
to, with respect to these issues--if we're going to have the kind of political environment
in which fiscal discipline and entitlement reform can be accomplished short of a crisis.
Obviously the media could make a powerful contribution here. But it seems to me that
such a broad-based and serious focus perhaps does not exist at the present time.
        I think a great contribution could be made by somebody who cared enormously
about these grave threats--individuals or foundations willing to fund a massive,
multiyear public education campaign on these issues to try to create the framework
within which politicians could then act.
        With that, let me conclude by saying that I think all of us have to do whatever we
can to try to increase public awareness. Thank you all very much.

Panel Discussion
Moderator: Alan Murray, CNBC/Wall Street Journal

I'll ask a few questions to get us started and then open the discussion to the audience
because I am sure a lot of people out there have their own perspectives on this. But I will
start with the news of the morning, which is that the Bush-Cheney campaign has put out a
new advertisement this morning. It's called the Era of Ownership, has lots of warm fuzzy
photos of Bush on the ranch, and it talks about creating a society in which people own
their own homes, own their own healthcare plans--I believe a reference to medical
savings accounts--and own a piece of their own retirement, a reference to Social Security
reform. Pete Peterson, does that amount to a first step in the direction of reforms that can
seriously deal with this problem?

Peterson: Well, the difficulty with most such proposals, at least as I read them, is there is
talk about taking some percentage of the payroll tax, for example, and putting it in
individual accounts. Remember that these are pay-as-you-go systems, but there is very
little talk about where you get the money to cover the so-called transition costs. Clearly,
if you take this amount out, which will have to be funded by the government, and you
don't reduce the benefits for some period of time, what you are basically doing is adding
to the problem. So I can't be too impressed with these proposals until I understand where
the money is going to come from.

Murray: Is it a movement in the right direction, the wrong direction, or no movement at
all?

Peterson: I like the idea of people owning, or having personal accounts. I was CEO of a
company in Chicago that had profit-sharing plans. I noted that the minute people had a
sense of ownership in these plans it created a macro interest in how well the company
was doing. So the proposal I had for mandatory saving would envision accounts owned
by the individuals. They would understand what was in their accounts, and I think that is
enormously important. But if you notice, I can be self-serving, and why not, under these



                                                                                          12
circumstances--Rubin had the insensitivity to suggest that I should have negotiated an
honorarium from Bergsten for today and I just burst out laughing. Fred also believes in
comparative advantage, and his entire life has been on reaching into other people's
pockets. But there is a difference, if I can be self-serving about it, I at least have the
honesty to say, here's where the money's going to come from to create this sense of
ownership. And it comes from two sources. It comes from reducing the benefits and from
having increased mandatory personal savings. So I want to know where the money is
going to come from for these so-called ownership proposals.

Murray: So I think it is fair to say he's not overly impressed with what the Bush-Cheney
campaign put out today, but I have spent a lot of time searching the Kerry campaign
website, and I cannot find anything on entitlement reform--Medicare or Social Security.
Why should we believe that a Kerry administration would deal with these problems?

Rubin: I am actually not bothered by the Kerry campaign. I am not sure what he said
about entitlement reform. I don't think that he said much of anything. I know he's looked
at it, I spent about 8 hours with him after the primaries and before the general campaign
started and that transition period--I think there were five, yeah, four people who were
formerly part of the campaign and I as sort of an outsider--talking about these next 10
years and if he is elected what he is going to face, because I think he's got an even worse
problem than President Clinton faced coming in, in terms of these enormous deficits and
the effect they can have on what will be his term if he is elected. And I don't think there
is any question, at least in my mind, Alan, there is the turkey-shoot problem that Pete
mentioned, but I don't think there is any question that he is focused on that as
internalized and need to deal with, just as President Clinton had. I honestly don't think on
entitlements that he has addressed them.

Bergsten: Could I just follow up on that? Because I think this immediate period, the next
four years, and the next 8 to 10 years are really critical for the reasons that Pete has said,
and how much is entitlement reform, how much is other things, we don't know, but I
really want to ask a question to both Pete and Bob about that. Pete, you have posed a
huge dilemma of political economy, you suggested that it is verging on the impossible to
deal with the budget problem for all the reasons you said, but it is true that in the 1990s,
there was a huge budget correction. Bob Rubin, as secretary of the treasury, his
administration moved from a deficit of 6 percent when they came in to a surplus of 2
percent when they left. How do you explain that? How do you explain, given all those
difficulties that you emphasized, that they were able to make that big an improvement,
and does that suggest that it would not be so difficult to do it again? To Bob, my question
is, since you as the architect of the improvement lived through it, you have written about
it ­

Rubin: President Clinton, I might add, would have a somewhat different view than what
you just described.

Bergsten: Well, as you describe very persuasively in your book, President Clinton was
absolutely crucial. But my question is, what would be needed from a President Kerry or a



                                                                                           13
second-term President Bush next year? What would be necessary by way of a new
program to head off the kind of risk you, Volcker, and Pete have talked about? Would it
be a precise program of five years of reduction like you did in 1993? Would it be more
than that now? Would it have to bring the entitlements in? I think those are the immediate
operational questions, and they are central to this election campaign, so I would like to
hear both Pete and Bob on really a fundamental national issue.

Peterson: Well, let me take a shot at it. Other than Rubin's infinite charisma, which has
to be a very important part of the explanation, it seems to me that there is a rather
decisive difference between the Bush and Clinton administrations. We have gone through
a decade or so of a very substantial reduction in the defense budget, and that reduction in
the defense budget--from Bill Hoagland's here--from 5 to 6 percent of the GDP down to
3 percent, was an enormous aid in turning this deficit thing around. The reason I put
emphasis on our national security needs, abroad and at home, is that it is my prediction--
and I don't know whether Bill agrees--that if you want to talk about the national security
interests, those expenditures are going to go up, not down, and that is a very decisive
reason why, other than Rubin's charisma, I think it is considerably tougher in this
situation than it was then.

Rubin: Fred, I would add that I totally agree with Peter. As Pete said, you've also got the
entitlement problem--baby boomers start to retire in about four to five years. We are
now a debtor nation instead of a creditor nation. I think we have a much more difficult
environment, and the politics have gotten even worse than they were in 1993.

Murray: That's what I wanted to ask about, because it wasn't just 1993, of course it was
1983 as well, when significant changes were made. Has it become politically--you talk
about this a little bit at the end of your book--more difficult to deal with these things
than in 1983 or 1993?

Peterson: Of course in 1983, we had the power of that other supremely charismatic
person, Alan Greenspan--that was supposed to be a joke, but I guess it wasn't--whom
you may recall chaired a commission on this particular subject. Seriously, I think the
problem is more difficult because I don't think that it is just a new cliché that we have
become highly polarized. We have a Congress that is unbelievably, where 90-some
percent get reelected. They are appealing both to the far right and the far left of their
particular parties, and it seems to me that makes the kind of essential compromise that we
are now going to have to deal with much more difficult.

Rubin: I would agree with Pete. Secondly I would add one more thing, the 1993
campaign was conducted, the economy started to decline, or growth slowed down
enormously the second half of 1989, then you got into the early 1990s, you have a
recession, and rightly or wrongly, people associated a lot of that with deficits--I
remember the debate. And that created an environment in which Ross Perot and Paul
Tsongas ran on deficit reduction, and that really had traction, and then that became part
of President Clinton's campaign, but it was in the context of a situation where the
American people felt--rightly or wrongly, I think rightly--that they had suffered



                                                                                            14
economically because of a sustained period of deficits. And you don't have that
environment right now, Alan, so I think it is much more difficult.

Murray: But you were suggesting we may well have that at some point in the next four
years.

Rubin: I'll tell you, I know an awful lot of people--because of what I do for a living and
also because I am an investor--who are involved in thinking about money. I don't know
if people would agree with this or not, but I don't, it is an interesting dichotomy, it is
almost a schizophrenia, I think that almost all those who are thoughtful think that
someplace out there, there could be just immense trouble. And yet, when you look at their
forecast, and their investment, they very often don't take that into account. I asked one of
them the other day, a person whose name everybody here would recognize, why that was,
and he said, "Look, I think some places are in horrible trouble and I just hope to get off
the merry-go-round before it stops. But the problem is there is no way of predicting when
it is going to happen and we don't feel it yet and therefore it is very hard to stay out of
markets." And I think that politics is sort of in an analogous situation.

Murray: Because I don't think that anybody thought when Bill Clinton was coming into
office that his great moving passion in life was to put on the green eyeshades and balance
budgets. What I remember happening in the early 1990s was that this was when James
Carville, who might have had a very different agenda, started complaining about--he
said, if I come back in another life, I want to be the bond market, because the bond
market has the power. Well, that was his way of saying, I am sure, that in meetings, you
would say, if we do that, the bond market will go crazy. There was an external force that
forced you ­

Rubin: Well, we still have an external force. At the present time, bond rates are relatively
low because we have had this period of very low private demand for capital, but I think
that at some point if private demand for capital picks up, or you just have a change in
market psychology, for any one of many reasons, you could have a very different looking
bond market.

Murray: And Fred, will it be the bond market or could it be a dollar crisis?

Bergsten: Well, Pete and Bob both mentioned the external side. Since this is the Institute
for International Economics, maybe it is worth a word. It is important to remember that
these deficits, though related, are not twin in any precise sense. For example, all the time
that the budget deficit was coming down during the late 1990s, the current account deficit
was going up. They were in fact moving in opposite directions, and there were similar
periods historically, so they are not twin in any immediate or precise sense. Having said
that, they are clearly related, as both of you said, and I would hypothesize that if the
situation leads to a crisis, and action is forced by a crisis as opposed to rational
preemptive action, it may very well be from the external side. We have put out on the
table, and you can pick up when you leave, some new projections on the current account
deficit by Catherine Mann, and she may elaborate if we get into this in the discussion, but



                                                                                         15
they are truly frightening. Pete referred to that. If you look at a reasonable projection for
the current account deficit going forward, making reasonable assumptions about US
growth, foreign growth, interest rates, and the like, you find the current account deficit
starting to rise again by a full percentage point of GDP per year, and hitting something
like 10 to 12 percent over the next five years. That is assuming no further change in the
dollar exchange rate and making reasonable, rather conservative, growth assumptions--
in other words, you really get to astronomical levels. If people came to believe that
projection, I've got to believe there would be a sharp correction in the dollar exchange
rate at some point along the way.
         A question then--and it goes back to Pete and Bob--would that lead to a
constructive policy response, namely something on the budget and the more underlying
factors or, as Pete hinted and quoting the Chairman [Greenspan], trade protection or some
irrational, ineffective, but politically understandable, response? That is one big question.
The second thing is that this is really a global problem, not only for the aging reason Pete
mentioned but also because when--I don't say if--the United States does have to bring
its external deficit down, which means we have to consume less at home than we produce
at home, you have to get the reverse outcome in the rest of the world. They have to be
consuming more than they are producing. In other words, they have to increase domestic
demand or else the world economy could go into the tank. The outlook on that is not
promising. The euro has been the currency that has appreciated most against the dollar
over the last couple of years with very little response by the Europeans to boost domestic
demand. Yes, there was a little fiscal correction that actually broke the Maastricht
requirements but nothing on monetary policy and very little on structural reform to pick
up the slack from the inevitable decline in their external surpluses. That is a global
adjustment problem, in addition to the enormous risks we face at home if the dollar went
into a sharp fall after we are close to full employment in another year or so. That I think
is one big conundrum. But the question to both of you: Is that likely to trigger
constructive policy reaction, or might it make the thing worse?

Peterson: Dr. Rubin, I think you've served in the government more recently than I have,
perhaps you want to make the hazardous bet on whether the response will be constructive
or­

Rubin: We could ask Chairman Greenspan. He could give us clear and unambiguous
guidance.

Peterson: He may be the only person in the world who makes you sound explicit. I'd like
to make--I don't know why I want to do this, it is probably reckless--a kind of a softer
point on our political situation. I am not a sociologist, I am not a political scientist, and
I'm not even an economist. But I think one of the things that makes this a long-term
problem, which is what I am focusing on, is the whole series of things that have happened
to our culture over the last 40 to 50 years, which get partly expressed in the fact that we
have gone from being the biggest saver in the world to the biggest consumer. They are
reflected in the baby boomer generation, which kind of says, "I want it all, I want it
now," and there is a lack of focus on the longer term for reasons that I am not smart
enough or well educated enough to fully understand. But I am now old enough to have



                                                                                          16
remembered my parents' generation. And they spent a lot of time thinking about the
long-term future and the idea that if we want to make an investment in whatever it is for
the long-term future, we ought to pay for it. And I think something the next president has
to focus on seriously as part of this politically very difficult educational job is to
somehow get the country reoriented once again to our long-term future. How he does it I
understand is just part of the problem, but it is an important part of the problem. I think
the 1960s had a very divisive effect on this country. Vietnam, the assassination of
African-American leaders, of presidents, of presidents' brothers created this feeling of
"damn it, the world's unfair, and I need to be taken care of and to hell with other people,
and let's take care of my particular needs." But I think there is something cultural going
on in the United States that makes the handling of the long-term problems considerably
more difficult than it might have been 10 to 20 years ago.

William Coleman (former secretary of transportation): I know there are people in
Iraq now whom I admire very much, I just think you kind of over-jazz the situation when
you say there aren't Americans who have the concern. Secondly, when you made your
remarks, I thought about something that President Roosevelt once said that he had never
seen a president who could be in office if he didn't get elected, and I think that if I took
what you said in recommendation and gave it to President Bush to pitch for the next three
months, or to Senator Kerry, I am pretty sure there would be an opening of the gap but
the wrong way. Thirdly, I was very intrigued with something that Secretary Rubin said
but didn't really express more. And that is that we have an asset in this country of about
25 percent of the people who are really not educated, and if you really could get them
educated so they would be as smart as the three of you, that is a new asset, which may
give us the next revival we need in terms of our economic activity. You are so successful
because you have an opportunity, and if you could take the 25 percent that doesn't and
really get them involved in the economic situation, that may be the answer to some of our
problems.

Murray: Your political point, your second point, raises another interesting question.
Somebody said to me the other day, this will never be dealt with in any president's first
term.

Peterson: I believe I may be stupid, but I am not stupid enough to suggest my agenda in
a presidential election campaign by either candidate. I said the next president should
immediately convene a twin deficit commission, but not discuss the specific dimensions
of the problem and specific reforms before the election.

Murray: But is it possible that if he wants a second term, he might decide that it is an
agenda best left for four years?

Peterson: For another four years?

Murray: It could. I mean, 1983 and 1993 were both first terms.




                                                                                            17
Rubin: You know much more about politics than I do, but I think that if I were the next
president or whoever it might be and, given--just like Clinton said in January 1993 in
Little Rock, and we were talking about what to do, he said, I want to take on this deficit
thing because we have to get the economy back on track and this is a threshold issue ­ he
didn't say this, but I think he also sort of thought to himself that if the economy did not
get back on track, he wasn't going to be a second-term president. I kind of think the next
president could, well should, have that view; I'm not saying he will.

Bergsten: But just to elaborate that, if you take seriously the crisis risks that we were
discussing and you felt that there was, to quote Volcker, a 75 percent chance in five
years, which must mean a 60 percent chance or more than half in four years, then just
from self preservation to get a second term you want to take preemptive action. That is of
course a tricky calculation, depending on your sense of crisis risk, but also the fear of
crowding out via higher interest rates, the things that motivated the Clinton
administration to address the budget, but I would have thought that a replication of 1993
was a pretty sage choice for whoever is in the White House in January.

Peterson: I think the best time to do it, Alan, again none of us are politicians, is almost
immediately upon taking office, because one of his political motivations is to try to take
steps that make some kind of crisis less likely during the balance of his three or four
years.

Bergsten: Therefore I am puzzled at your proposal for a commission, Mr. Chairman,
would not that delay it a year?

Peterson: If we could get something done a year after October, I would say Hallelujah,
but I think the extraordinary success of the 9/11 commission demonstrates that this
country can be educated if the people on it are of true bipartisan, nonpartisan quality who
are immensely respected.

Murray: Well the model in 1983 was to appoint the commission before the election but
to tell them to keep their mouths shut until after the election, which I think they
successfully did.

Peterson: Alan Greenspan is very good at keeping his mouth shut, certainly.

Rob Dugger, Tudor Investment Corporation: Alan, just a reminder, in 1987, there was
no discussion of the S&L [savings and loan] crisis, and immediately upon completion of
the election, the solution was implemented and very quickly enacted right afterwards. I
would like to return to Fred's question, which had to do with what happened in the 1990s.
Secretary Bob Rubin's successor in the position of secretary of the treasury, in a debate
between Alan Krueger and Jim Heckman in a recent conference on human capital,
offered a hypothesis that much of the strength of the economy in the 1990s was a result
of human capital maturation, human capital that had been formed 40, 50, 60 years ago.
And if I think about this, and the issue of how to make the transition to solve the political
problem, I'm reminded of how often in polling education turns out to be the number one



                                                                                          18
voter concern. I'll just remark that Alan Greenspan has given five speeches in recent
years on education, and those of us who read everything he says find those to be among
his very best insights on the economy. Bob Rubin has talked about it and being bipartisan
and moving quickly. I'm wondering if there's a way--when you talk over and over again
Mr. Petersen in your book about kids and passing the buck to kids--if there's a political
compromise to move this agenda forward that is inter-generational in nature. And can we
work out something with respect to upper-income households and beneficiaries of the tax
cut or seniors who are such large beneficiaries of Medicare and Social Security in a quid
pro quo to take those benefits and allocate them to investing them in kids?

Peterson: Let me add a specific element to Chairman Greenspan and Bob's emphasis on
education. It seems to me that some realities about our new competitors in China and
India should be made clear to the American people. For those of you who have not
looked at the numbers, these two countries produce several hundred thousand engineers
and scientists a year. Last year, we produced, I believe, 65,000, and a substantial number
didn't stay in this country. I think the next president could make a case that most people
would understand that quite apart from the generic case for education, we are moving
into a highly technological world, and if this idea that the higher-paying jobs are going to
be in this country, it seems to me that they're going to be there because we got the people
scientifically trained in order to do it. So among the national priorities that I'd put a lot of
emphasis on is how do we regenerate once again a major thrust on science and
technology and innovation, which I think is at the heart of our success in the long term.

Bergsten: Incidentally, that's the basis of many of the studies we've done here at the
Institute. It is absolutely essential to have any hope of maintaining a political foundation
for open trade policy, support for globalization a