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THE NATIONAL DEFENSE UNIVERSITY THE NATIONAL DEFENSE UNIVERSITY HOLDS A PANEL DISCUSSION ON ADAPTING TO GLOBAL CHALLENGES, PART 1, AT THE NATIONAL DEFENSE

Washington Transcript Service April 7, 2009

Washington Transcript Service 04-07-2009 THE NATIONAL DEFENSE UNIVERSITY HOLDS A PANEL DISCUSSION ON ADAPTING TO GLOBAL CHALLENGES, PART I, AT THE NATIONAL DEFENSE UNIVERSITY 2009 SYMPOSIUM ON AMERICA'S SECURITY ROLE IN A CHANGING WORLD APRIL 7, 2009 SPEAKERS: UNATTRIBUTED SPEAKERS [*] (SPEAKERS ARE UNATTRIBUTED BECAUSE THEY ARE SPEAKING ON BACKGROUND) (UNATTRIBUTED SPEAKER): Ladies and gentlemen, I will start with my brief introductory remarks as you're taking your seats so that we have the maximum amount of time for this panel and for the rest of the ones throughout the day.

It is a distinct pleasure and honor to welcome back to NDU a friend, (inaudible). As you can see from his file, he's currently (inaudible).

And before that, he lived several full careers in other places, including a long tenure here at the National Defense University, where, as my recollection serves correctly, he's spent over 10 years and two segments of that time.

Prior to that, he's been (inaudible). He was (inaudible) for Central and Eastern Europe. He is a great friend of the National Defense University. He's a thoughtful analyst, an astute crafter of policy.

(Inaudible), please?

(UNATTRIBUTED SPEAKER): Well, thank you, (inaudible).

Good morning, everyone. Thank you. It's a pleasure to be back here in beautiful Lincoln Hall. And I apologize in advance for my scratchy voice. I'm not trying to channel (inaudible), but I am fighting a little cold. So I'll hope to not interfere too much with today's proceedings.

I know you want to hear from our speakers.

As the first panel really looking at widening the aperture quite a bit and looking particularly at the impact of the changing global economic picture with the broader security environment, and we have an array of speakers who have looked very profoundly and long range at the changing global system, and a number who have a strong background in some of the new and emerging threats, particularly in the area of how economics and security are becoming more and more linked.

The startling comments, of course, of the director of national intelligence in the last few weeks, that the leading national security threat that the national intelligence community is looking at is the broader social unrest and potential for further instability caused by the global financial crisis -- excuse me.

So let me go about -- we're going to proceed in an order from, sort of, the broadest to -- down to some other specific issues within this broad remit, and particularly also looking at the challenge of emerging threats in the domain of information technology and cyber.

So we're going to start our panel first with (inaudible), who is currently (inaudible). He has served in a number of senior positions in government over the last 20 years. Most recently, from June of 2007 to January of this year as (inaudible) the Department of State and also a leader in a number of senior positions, including (inaudible) the National Intelligence Council.

He served also and helped shepherd some of the global assessments that they've done at the National Intelligence Council during that time, particularly the -- I think probably the 2010 and the 2025 study. So he's seen a number of very long-range studies and participated in them.

Next, we'll turn to (inaudible) at the Center for International Studies at the Massachusetts Institute of Technology. (inaudible) He's been involved in a number of analyses and worked with The Economist's intelligence units on their Japan country reports. He's also been involved in the Stanford University Asia APRC, Asia-Pacifc Research Center, and a Asia strategist at Soros' private management fund, so he'll bring a broad understanding of global finance issues and other matters.

And lastly, (inaudible) Center for Advanced Studies in Science and Technology Policy (inaudible) which is a private research and advisory organization focused on information technology. (inaudible).

(Inaudible) is going to focus on some of the issues of information technology and cyber, and in particular the challenge of both cyber-protection and cyber-deterrence.

So let me turn now the floor over to (inaudible).

(Inaudible)?

(UNATTRIBUTED SPEAKER): Well, (inaudible), thank you very, very, much, and it's a great pleasure for me to be here today at INSS. I want to thank Patrick Cronin for inviting me and for organizing I think what's a really interesting discussion over the next two days.

So I'm going to focus my remarks at what is an increasingly significant interface between two worlds, the world of globalization and international economics and international financial on the one hand, and the world of geopolitics and national security on the other. There's been an increasing interest in this interface in recent years, but, frankly, it's been not an easy one to get a handle on.

I know when I was on the National Intelligence Council and we began doing our series of 15-year-out look-aheads, one of the biggest challenges we had was integrating that interface between the worlds of globalization, on the one hand, and the world of geopolitics on the other. And, frankly, in the last year, it's gotten much harder. So, equally important, if not more important, but much more complicated, much harder to do.

Last summer, (inaudible) policy planning in the State Department and was beginning to think about doing the transition papers for the incoming secretary of state, we actually began to write a paper on global financial multi-polarity on the rise of sovereign wealth funds, on commodity power.

We were writing on the theme of: Has globalization shifted from being essentially dis-inflationary to inflationary and what were the implications of that? And that's just not all that long ago.

And today, we're in such a powerfully and remarkably different world.

At that time, we saw the broad stability risks coming out of this being the stability risks coming out of inflation in both food prices and fuel prices in places like Egypt, places like Pakistan.

Today, just last week, the Egyptian government make an official announcement that they now see unemployment as a much more profound risk than inflation. Ambassador Lodhi's here. I know she's very well aware of the crisis that the Pakistani textile sector is going through now, and that has very, very profound stability implications for one of the most important countries for the United States.

So we've been in a world that's gyrating. We've been in a world in which we've seen oil prices go from near $150 down to the $40s and the $30s even a couple of months ago, up now around $50. That created enormous angst in Moscow, enormous angst in Caracas, enormous angst in particular in Tehran, where the Iranian leadership literally never considered that kind of a drop in prices to be within the realm of what was possible.

So this interface between global economics and geopolitics and national security is a very, very, very significant one for us.

So what can we say about the global redistribution of economic power as we head out of the financial crisis hopefully in the next six to 12 months?

First of all, I want to make an over-arching theme, is that we are seeing the rise of government and of political influence in finance, and in economics more generally, all over the world, so that the era of deregulation, the era of the dominance of private actors, the era of finance as a driving force of globalization and international politics, per se, private finance I believe is really coming to an end.

That doesn't mean that globalization is coming to an end. It doesn't mean that we're heading into a period of greater protectionism, necessarily. But what we're going to be looking at is going to look quite different from where we've been.

And one very important difference is the role of government. In some places, that's likely to be a blip in the more advanced countries, but it's quite remarkable in places like both China and India that the impact of the financial crisis, the impact of the global recession, has basically reinforced the views of those governments that they did the right thing by protecting their finance systems at least partially from the vagaries of the international market; for the Indians, that they did the right thing to have a cautious policy towards broader global trade integration.

So these governments have gained confidence that their models that are quite different from ours in the United States or in the Anglophonic world, or even in Europe, are correct.

Now, it seems to me, looking forward, that this broad shift in economic power and influence in the world, and economic dynamism towards the Pacific, towards the Asia-Pacific region, is still going to be with us, that China and India both look pretty resilient, China actually more problematic than India, but with tremendous financial reserves and also a tremendous ability to utilize economic levers, both to sustain political stability and for broader national economic purposes.

So I think the shift to Asia that we've all been talking about is still on, is still real, will still be taking place.

What's going to happen with countries like Russia, Iran, Dubai, much less clear.

Certainly Iran, even by standards of the region, by standards of resource-producing countries in the Middle East, has performed very poorly since the Islamic revolution in the 1970s. They will be more vulnerable now coming out of this.

Russia will be more vulnerable. What we haven't seen is that increased financial vulnerability turned into less aggressive and less ambitious foreign policy behavior, and that will be one of the interesting pathways to watch.

Saudi Arabia and the Gulf states are also looking relatively robust.

I think one of the themes that may be reversed as we look out over the next several years is the trend that we've seen towards ever- greater numbers of developing countries being primarily oriented towards private investment rather than public investment for their growth. I think that trend that we've been watching for 20 years may actually be reversed, at least over the next several years now.

And that has profound implications for our foreign aid programs and for how we think about countries in the world, particularly in places like sub-Saharan Africa, where some of the best performers who've been able to go to market, have been able to become relative to international financial markets may find themselves in a less advantageous position over time. In general, I think we're likely to see, as I mentioned, the relative demise of private finance as a driver of the globalization process.

So what's all of this going to mean? (inaudible) talk a little bit about the U.S. power and political flux as we head out into the next several years.

I think the main trend here is, increasingly, we are entering into a non-polar, rather than a uni-polar or a multi-polar world.

Now, at first blush, this might look a little silly.

On the one hand, U.S. military power is, in many ways, unparalleled in the world. The advantages -- the direct military advantages over other powers is, if anything, widening rather than narrowing. The main vulnerability on the national security side to the United States, which had been the war in Iraq, has turned dramatically in the last 12 to 16 months from being basically something on the liability side to, I would argue, something that's primarily now on the positive side of the equation.

We have a new president who is extraordinarily popular both at home, but equally significant all over the world. And if anything, in the short run, the financial crisis has shown the resilience of American power.

The dollar has strengthened; that while the rest of the world, in some senses, blames the United States for bringing on the financial crisis, they also very much look to the United States to lead the world out of the financial crisis.

So in many ways, U.S. power, the resilience of that power, has come into play.

But let me make four or five points here about why I think we, nonetheless, are heading towards a more non-polar world.

On the crisis, the first point is the loss of credibility in the U.S. financial and regulatory model and the loss of reputation that the financial crisis itself has generated.

Now, part of that creates a leadership moment for the United States and for the president. And to the degree that we can work together and carve a pathway rapidly out of this, U.S. power will definitely be enhanced.

But the rest of the world is still looking, and, frankly, waiting, for the United States to take the moves that will resuscitate our banking sector, free up credit, and allow us to move back into a positive economic growth environment. in our site national defense university

Second is that, while U.S. military power remains unparalleled, our ability to translate that military power into influence for outcomes is waning. And that's part of just a world in which a wider range of themes and factors have come to the fore.

The third point is that, as I look around the world, I'm, frankly, less concerned with the rise of competing powers to the United States and more concerned about free riding, more concerned about the unwillingness, the inability, the lack of orientation in other countries to step up to the plate.

We saw it, frankly, even last week, and last week was a pretty good week overseas for President Obama. I think the G-20 meeting particularly in the upgrading of the financial resources of the International Monetary Fund and the enhancing of what used to be the Financial Stability Forum, which will now be the Financial Stability Board, were important achievements.

On the other hand, what the U.S. was really looking for was a commitment to a much more coordinated global effort to restart the world economy that didn't happen.

At the NATO meeting, for all the talk of the NATO allies supporting our new strategy on Afghanistan and Pakistan, the fact is that they did not pony up a great deal of resources. Indeed, our strategy, I believe, is based on the assumption that they won't, and it's an appropriate assumption.

But both of these speak to both the limited ability of the United States to use that military power, and even its continued financial centrality, to leverage action on the part of others and, frankly, that no one else in the world wants to step up into a powerful leadership role.

China talks about it as something way in the future, and they have a very long-term vision on this. But they're, right now, unprepared to step up to the plate. So we're unlikely to see a move towards a real multi-polar world which would have competing or cooperating powers willing to contribute in a major way to global problem-solving.

At the same time as the power and influence of the United States, while still by far the strongest of any individual country, is somewhat on the wane, and I think that's the way to think about this.

Now, what could change this? What could change this prediction of increasing non-polarity?

I think the one player out there that could really change it is China. And should China shift its orientation -- right now, I think China is essentially cautious. They're very cautious on the financial side.

They basically believe that the world that the United States continues to lead is one that is conducive to their rise. They continue to see their economic future intimately linked to that of the United States.

On the other hand, they're in some ways, I think, living a world that may not come into being. Their preferred future for the aftermath of the financial crisis looks pretty similar to what we had going into the financial crisis, that is the U.S. as the consumer of first and last resort and China as the producer and the exporter of choice. Whether we're going back to that world, I think we probably aren't.

In that context, the U.S.-China economic relationship is really going to hit some tough bumps in the next year and a half or two years as we seek to move China much more rapidly than they're willing or capable to move to a more domestically-driven economy, and they continue to have this hope that the U.S. will go back to our bad old ways.

Now, I think we can manage that relationship. If we can't, and if there is a rising nationalist critique of the conservative financial policies in China, if China re-orients, then we're in a world that might be increasingly multi-polar, and would at the same time, I believe, be increasingly challenging for the United States.

So to my mind, the non-polar world has a lot of challenges, but the most likely multi-polar world would be one in which that multi- polarity would be driven by Chinese nationalism with very, very negative regional security implications for East Asia and very challenging security implications for the United States.

Thank you very much.

(UNATTRIBUTED SPEAKER): Thank you very much, (inaudible).

(Inaudible)?

(UNATTRIBUTED SPEAKER): Thank you, (inaudible).

I'm going to look at the crisis largely as (inaudible) did, but with a little bit more detail on the economics and perhaps on some of the political and security implications.

The basic question that I'm going to ask is, "How bad is the crisis, and what does it mean?" The answer that I'm going to come to is that parts of the world are effectively in depression, and that that will inevitably have profound implications for U.S. security interests.

Now, to make that argument, there are two main points I want to touch upon.

The first is the economics of the crisis, and the second is the political and security implications. Again, the conclusion is that the world has become a much more dangerous place over the last 18 months.

So the first point, the economics. There are three topics in this bunch that I want to address. The first is a leverage story, the second is story of supply and demand, and the third is the outlook for the global economy, moving forward. We'll start with the story of leverage.

Basically, what that is is corporations and banks increasing their borrowing in order to increase their returns on investment. And clearly, I think everyone understands that, right now, the degree of leverage or borrowing in the global economy got way, way out of hand.

There are several reasons for the increase in leverage over the last 15 or 20 years.

One is a big increase in savings in a lot of countries, including particularly China. Maybe it's wrong to say an increase in savings, but a continued, very high level of savings.

The second is insouciant monetary policy that, because of the addition of China and India to the global labor force 15, 20 years ago, there's been less pressure on prices. Inflation has been more restrained, and the effect of that has been to free up central banks to expand the money supply much more aggressively than they would have in, say, the 1970s.

The next element of it is deregulation and innovation.

Essentially, the last 20 years has seen massive changes in the financial system. The expansion of old kind of non-banks, meaning the credit arms of the big manufacturing companies, GE Capital, things like that, which have become huge and increased their lending very dramatically.

Another is the emergence of new sorts of lending institutions, hedge funds and things that effectively act in some ways like banks.

Another is new products, mortgage-backed securities, the credit default swaps, things which allow companies and investors to increase their borrowing and their leverage, again, largely in parts of the economy that aren't regulated.

Which leads to the next problem, which is regulatory failure, that as the financial system expanded, grew both in complexity and size, regulators did not expand the ambit of their authority so they could watch this.

So in the United States, you had the Federal Reserve looking at the commercial banks and then assuring us that all is well; the Securities and Exchange Commission looking at the investment banks, or not looking at the investment banks, and telling us that all is well; and nobody watching what's happening with hedge funds, the non-banks, and other very powerful parts of the financial system.

Even as there were these gaps in the regulatory structure of the United States and other countries, there were similar gaps between the regulatory systems of, say, the United States and the U.K. So what happened was a massive degree of borrowing occurred in parts of the global economy that nobody was watching.

So we combine these factors of very high savings rates in parts of the world, very loose monetary policy in all the major economies, innovation, new financial industries that weren't regulated, what we end up with is a massive increase in the volume of capital that was going into global markets.

Now, where did that capital go? It really went to the places where there was the least resistance, meaning the most liberal global markets, the United States, the U.K. And then it went into the property sectors, so you saw bubbles develop in property sectors, the United States, Spain, the U.K., Ireland, Australia.

So you had a global bubble, based on all this increased leverage, with much larger specific bubbles in real estate markets in some of the key countries.

Now, when the subprime crisis occurred, it basically drove down asset values so financial institutions and corporations suddenly think, "Hey, we have much less net worth than we thought." So they said, "We have to reduce our leverage ratios. We have to pay down our debt." About a year and a half ago, this process started, with all these institutions simultaneously paying down debt, selling assets. And that's created this inexorable force that's driving all sorts of asset values dramatically down.

The problem is that we're not through with this process. If you look at where banks, non-financial institutions are right now, I think we really have a year or a year and a half more of this very aggressive deleveraging, downward pressure on asset prices. That's what's driving this crisis: massive downward pressure on asset prices.

Now, the second part of my economic story is a story of supply and demand, and here I'm talking about the global imbalances. If we had met two years ago to talk about financial risks in the system, what we would have talked about was the massive U.S. deficits, which everybody thought was problematic.

The traditional story, the conventional view, is that this was driven by excess spending by American households, also households in the U.K. and a few other places. Essentially, people here were spending so much money that they had to borrow, and essentially were dragging capital out of Japan and China and the developing world, and that the imbalances were, therefore, the faults of these rich countries that insisted on spending beyond their income levels.

I don't really think that that perspective is particularly helpful in explaining what's going on in the world now. The more helpful way is to look at it from the point of view of the supply of capital; not the demand for capital, but the supply.

The fact is, as I suggested before, the world has had much too much savings over the last decade.

Now, the reason for that varies from place to place. Some of the major saving countries, Japan and China, parts of Europe, are countries where people are getting old. And as people in late middle age start to prepare for retirement, they save much more. So those countries have these large amounts of savings. There's not enough demand within the economy, so they pump money into the international economy.

Another group of big savers, and this is the one that's really problematic, is the developing world. Economic theory tells us that poor countries should be borrowing from the rich countries, investing that so they can grow more quickly. But, frankly, the developing world hasn't been doing that.

And why? Well, because the international financial system has treated them very poorly over the last 20 years. The 1990s, there was the Mexican debt crisis, in '94, '95, 1997 the Asian crisis, 1998 the Russian crisis, then came Argentina. We've had a huge number of these, and they have dramatically hurt large groups of people in the developing world.

So what do those countries do? They say, "I can't trust the exchange rate system, so I'm running a surplus." They intentionally started exporting capital so that they could raise their foreign reserves so that, if there's a crisis, they can then spend that money and protect their people.

It's totally rational behavior, but the effect is, to pump this extra money into the global economy.

Then, the other group of savers is, of course, the oil exporters and the commodity producers who, in this world of very rapid GDP growth, gained a ton of money by exporting.

So the effect is you've got all these countries that are pumping savings into the global economy. Unless somebody borrows that money and spends it, there's not enough demand to absorb the goods and services coming out of the world, and so you end up with a very long recession, or even a depression.

In this sense, it was fortunate that you had the United States, the U.K., Australia, some of these other countries, spending beyond their income levels, because that was the engine of demand that drove global growth. Now, what happened when the bubble collapsed is that you've wiped out the U.S. engine of global growth.

Essentially, household savings have increased by about 300 to 400 percent over the course of a year. That means that the current account deficit that the United States has been running, which got as high as 6, 6.5 percent of GDP, is going to be less than 2 percent this year, probably approaching 1. It means that demand for global goods and services has collapsed.

And that's where we are now. Not only do we have this negative pressure on asset prices, we've lost $15 trillion in wealth in the United States. People are saving now. And unless somebody replaces that savings, we're not going to have significant GDP growth, going forward, globally.

Which leads to my third point in the economic category, an attempt at some prognostication. How about are things, and how bad are they going to be for the foreseeable future? And here, I may be a little bit more pessimistic than (inaudible).

This year -- and to put some background behind this, global GDP has not shrunk since 1945. This year, it will shrink by 2.5 percent. Disastrous performance. The question is, how quickly will the world economy rebound?

And statistically, for a number of reasons, it looks like you'll get some slight GDP growth in the world economy next year, less than 1 percent.

But after that, the growth rate is not going to increase very much because there's not going to be very much demand. Basically, as the Americans have lost $15 trillion in wealth, the global economy has lost about $50 trillion so far -- $40 trillion to $50 trillion.

So people are scared, and globally, they're going to be inclined to save a lot. And as (inaudible) said, if you look at China and India, some of these countries that haven't completely liberalized, they're going to say, "Hey, we did the right thing." Those developing world countries that have been saving because they're afraid of crises are going to walk away from this saying, "We did the right thing." They're not going to start spending more, which means that there's not going to be enough demand to replace the U.S. demand.

So the outlook is, this year, we have 2.5 percent negative GDP growth for the world. Next year, maybe 0.7 percent or 1 percent, and then we get a little bit higher, say 3 percent annual GDP growth from 2011 to 2013. That's nice, but it's roughly half, or a little bit less than half, of what we were getting two or three years ago.

So what we're entering is we're going to have a very nasty downturn this year followed by a slight increase, but the rate of recovery is not going to be very high. So how does this kind of compare in terms of historical experiences? Are we specifically in a depression?

And the answer here is unclear, but the fact that it's unclear is actually pretty disturbing. So I looked at a couple of definitions for what actually is a depression. One definition is if you get 10 percent GDP shrinkage. Another is if the unemployment rate rises above 10 percent in a country and stays there for a while, several years.

Well, by that standard, some parts of the world are already in depression. 10 percent decrease in GDP? This year we will see that in Iceland, Ireland, Taiwan, South Korea, Singapore, perhaps in the Baltic countries, certainly in the Ukraine, and other parts of the world are also at risk of this.

Now, unemployment, it looks like the crisis will probably cost 50 million jobs around the world. In the United States, the unemployment rate is 8.5 percent. It will rise significant above 10 percent, could stay there for a while. Same is true of Europe.

So the bottom line is parts of the world are in depression, and other parts could be in depression. We'll have to wait and see. It's a pretty ugly situation.

Now, the second kind of category of things I wanted to look at was the political and security implications. And here there are some general challenges, and then something that I'm going to call the geography of the crisis, some examples of places that will be hurt badly.

The general challenges. First is global unemployment and hunger.

(Inaudible) mentioned that, a couple of years ago, we would have said that food prices are a problem. They're still a problem. Demand for food has not decreased. Everybody has lost a lot of wealth, but the need for food is still there.

So, essentially, a lot of poor countries are going to be hurt. A lot of people are going to slide into poverty.

Another general challenge is the expansion of the government role in the global economies. Basically, because tax revenues are shrinking really dramatically in all the major economies, deficits are going to increase.

And because governments are going to try to replace the lost demand, there's going to be a great deal of government spending.

If you look at the United States, this year the deficit will probably be 12, 13 percent of GDP. Next year, 13, 14 percent. Europe, the U.K., Japan, same kind of pattern. I would not be surprised to see the world -- the major economies increase their debt- to-GDP ratios by 30 to 40 percent before we're out of this mess. Massive increase in government spending relative to the size of the economy.

In the meantime, monetary policy. Because deleveraging means corporations are determined to pay down their debt, they don't care what the interest rates are that the Federal Reserve sets. They just don't care.

That means that, to increase economic activity, central banks have to start quantitative easing, buying assets from the private sector, stocks, bonds, real estate, things like that. In all the major economies, we're going to see governments buying a lot of that. A big stake will be kind of achieved in all the major economies financial markets.

And then, of course, there's the nationalization of banks around the world. In the United States, we hate the word "nationalization," so we're coming up with lots of other words. But largely, big chunks of the banking sector are already nationalized. So government becomes much bigger.

Second element of kind of global challenge is the retreat from liberalism. As (inaudible) said, the Anglo-American system of financial organization has been discredited. Part of that's justified. A lot of it's justified. But there will be something of an over-reaction.

Governments are going to re-regulate financial sectors, and that's probably a good thing, in part, but we'll also get a lot of really bad regulation. And then people everywhere are going to demand more protection, and that leads to another global challenge, which is increased protectionism.

The World Trade Organization says that, since November, December of last year, there have been 47 significant increases in protectionist barriers around the world. Last November, the G-20 got together, pledged that it would not increase protectionism. Of those 20 countries, 17 countries have subsequently done just that.

Financial recapitalization is occurring everywhere. It is, by definition, nationalistic.

For example, when the United States government recapitalize American banks, they demand that those banks continue to lend domestically.

Well, the banks have to do that, but they want to shrink the size of their balance sheets because they think they're over-leveraged. So the only thing they can do is cut back on international lending.

So the global financial system is tending to break down into national systems. All of these are forms of protectionism and nationalism.

Another problem is, of course, again, something (inaudible) alluded to, which is the loss of American prestige. Everybody blames us.

We deserve a good chunk of that blame. But when places like France and Germany, that didn't do any better than us, blame us, there is something of that which seems a bit tendentious (ph).

Now, the dollar is the exception. The dollar strength (inaudible). But otherwise, U.S. prestige has been hurt a lot.

Now, the final element of this political and securities part is looking at some of the areas of the world that are going to be hurt. Europe is going to be hurt pretty significantly within the euro zone, the countries that use the euro. The U.K. has been hit hard by deleveraging. Germany, on the other hand, has been hurt by the collapse in global trade.

The worst-hurt countries in Europe are Ireland, Turkey and Greece. Greece could default on its national debt. Another element of this is that the euro as a currency will come under great stress because people are going to say, "Hey, this hasn't worked for us." My guess is its currency union stays together, but there will be a lot of pressure.

Eastern Europe, these are countries that have been hurt by the loss of trade, also because they borrowed a lot from Western Europe. Countries that are going to be hurt here are the Baltics and the Balkans, Hungary, Romania. Ukraine will be hurt very badly. As I said, GDP there will shrink by 10 percent.

If we look at kind of the CIS and a chuck of Asia, Russia will be hurt because they lose the oil revenues. Afghanistan, Pakistan, Tajikistan, the Kyrgyz Republic, those are all countries that, largely because they were already weak, are going to suffer a lot from this. You have to wonder about their political stability.

In East Asia, Japan has been hurt very badly. China's done relatively well. The ASEAN countries are hurt significantly because of the loss of commodity markets. Of course, you've got to look at a place like North Korea and wonder if even a marginal destabilization from the financial and economic sectors could be a problem. I think it's something that's worth looking at.

And then, there's something that I call the commodity cell, the commodity exporters. Places like Iraq and Iran are going to suffer significantly because of the loss of oil revenues, Venezuela. Sub- Saharan Africa, because it exports so many commodities, will be hurt a lot. I would look particularly at Zimbabwe, which is going to lose the money with which it paid off the important political center. Latin America I think, because those are commodity exporters today, suffer a lot, Bolivia in particular because of its dependence on oil.

So the conclusion that I'd like to suggest is that the world economy is in much worse than a normal recession, something which in some respects is approaching the dimensions of a depression. Governments are under great pressure to deal with this, but they're going to have a very hard time because the deleveraging process is not over and because there is a significant lack of global demand.

U.S. prestige suffers because of the role that we have played in all of this. And again, as (inaudible) suggested, one thing that would be very helpful is if the U.S. government could step forward and provide more leadership in trying to get the world out of this. Doing so, however, will be very difficult, under these circumstances.

(UNATTRIBUTED SPEAKER): Well, thank you very much. It's a very sobering analysis indeed, and I hope we can come back to a number of those topics in the discussion, where we will have about 30 minutes for discussion after this.

But (inaudible)?

(UNATTRIBUTED SPEAKER): I'm almost too depressed to go on.

(UNATTRIBUTED SPEAKER): I know. I was going to say...

(UNATTRIBUTED SPEAKER): I'm too depressed to go on.

(UNATTRIBUTED SPEAKER): If anyone wants to go check with your broker, we'll have a five-minute break after he finishes.

(UNATTRIBUTED SPEAKER): Exactly.

Let me actually try to, sort of, transition from that into what I was asked to talk about, which is the impact of the information revolution.

I'm going to make a broad claim to start with before I get to talking about information technology and cyber specifically, and suggest that a lot of the things that we've just heard about are actually enabled by a revolution in information and communication technology.

And you couldn't have this development actually happen without it, including particularly you couldn't have the new players, like hedge funds and everything else. You couldn't have the new products. You couldn't securitize debt. You couldn't do all those things. You couldn't actually even get in those positions in the first place.

I also want to pick up on something that was said earlier about how different things are than a year ago. A year ago, if you were talking about the impact of information and communications technology -- sorry -- information and communications technology on the world, you might start the conversation by talking about the impending death of the nation-state.

And of course, we've just heard about how it's taking on a new role in this environment.

I'm going to suggest a little later that, either way that plays out, information technology will be a significant component of that. The way that nation-states are going to have to manage this problem is through the use of information technology, which makes cyber, cyber- attacks even more relevant, if it actually devolves the other way and takes away from their power, which creates other kinds of threats.

Anyway, so let me go back now and try to start from talking about the information revolution. And it is a revolution in the sense that it is actually a paradigm shift that requires actually rethinking your conceptual models about how you go about thinking about security.

Actually, to pick up again on something (inaudible) said, the very fact that regulatory failure came out, I would argue to a large extent was because these new products, these new players, were enabled by technology, and the old models of regulation, which were based on regulating an analog world -- an analog record-keeping world, couldn't keep pace.

And the same problem, I would suggest, is happening with our security models in the context of global and national security. And that's all a setup to get over my depression. Let me get to what I was going to talk about.

So I need to be careful, though, in talking about technology. I mean, I don't want to sound like a technology determinist (ph), but technology doesn't determine the outcomes, but it does enable and change the potentialities within which humans and society can organize itself. And it's really that organizational principle that I'm going to keep coming back to that is significantly different, that is a revolution, and that needs to be thought about in the context of thinking of new conceptual models to deal with security.

Basically, let me make three, sort of, over-arching claims, and then, sort of, flesh them out. The change in information technology and communication technology has basically led to new vulnerabilities, new threats, and provides the opportunity for new responses. And I want to talk about each of those in sort of that order.

The new vulnerabilities -- and again, I'm going to talk about them much more conceptually and abstract than we just heard with the specifics of how it sort of plays out in the global economy. But what's happened as we've developed over 100 years now from an industrial model -- again, I'm going to keep claiming driven a little bit by the information technology and communication technology revolution, but even some of the sort of social and economic factors that have nothing to do with the technology.

We've driven towards efficiency, and one of the claims I'm going to make is that efficiency is actually the antithesis of security. I mean, efficiency is security's worst enemy. And what I mean by that is what we've done is we're creating a strategically fragile society, economy, any sort of complex system that you want to talk about that we depend on.

And those new vulnerabilities, as we become more efficient, we take out sort of the flak and redundancy that, in the past, protected us from shocks to the system.

In particular, as you develop complex systems, and specifically networks, you end up with two kinds of failures that can happen, that make these systems strategic fragile. You can have single points of failure.

Again, lots of examples.

I mean, MIT specifically, I mean, just think about the Internet.

The domain name system is essentially a single point of failure. If you took out the domain name system, the Internet stops functioning. There's a single point of failure built into that system.

The other problem in complex systems is cascading failures, which we see across the board. I mean, a great example is how essentially -- and I know I'm overstating this case -- but the failure of subprime mortgages in six counties in the United States resulted in essentially the economic crisis, I mean, or at least triggered the beginning of it. And that's because of cascading failures across systems. And as you have these assets deployed across systems, they keep triggering, and you're in this downward spiral. OK.

Same thing is happening across the board with all these other things. So leave vulnerabilities aside for a second, OK, new threats.

So information technology actually is also an enabler of new -- so for all the things that it does positively, it also obviously enables the negative side of that.

And in the threat side, it has provided the opportunity for essentially non-state actors, although I'm going to come back and, sort of, argue against myself in a second, but we have a security model that's premised on managing international relations and global stability and problems through nation-states, a system of nation- states. And we've given them, essentially, the monopoly on violence, to use violence between themselves and with respect to their own citizens.

And information technology, communication technology, is actually breaking down that monopoly. It's allowing, for instance -- I mean, just talk about non-state, sort of, network groups -- it allows those groups, essentially, to project power in a way that historically you could only do if you were a nation-state. It's changed the economics of power projection in a way that allows those players to actually have a seat at the table to either start, incite, meddle in international crises that in the past would -- the only players at the table would be nation-states.

Finally, what do we do about all this? I mean, what are the responses? And I think that information technology and network organization actually allows you to come up with some new models to think about how to organize yourself.

And so now, let me do the second half, which is really what I think the premise was for me to talk about, actually cyber itself, and let's talk about cyber as the model. But I want to be clear that I'm talking about this as a model in cyber, but it really applies to the system more broadly as the whole system has become complex and has a lot of the same characteristics that cyber do when you look at it.

Cyber is fundamentally different, although it's the same as a lot of other things. People are people, and they're going to do the same thing they've done for 40,000 years. They're going to throw rocks at each other and fight over stuff and everything else.

But we have a system, and we've constantly managed human affairs based on the sort of physics of the real world. And physics, I mean the fundamental laws that govern the real world. And inefficiencies and friction and all of those things serve to control behavior.

In cyber, the physics -- and physics and economics, I should say, are different. There's a zero marginal cost of distribution and production in cyber. There's a complete de-localization of borders. There's a collapse of time, et cetera, et cetera, et cetera.

So when we talk about cyber specifically in the context of, sort of, cyber-security and, sort of -- and (inaudible), in the real world, in a crisis you have a sort of ladder of escalation. You have a, sort of, temporal development of things over time that you can observe and you can interact with and move.

In cyber, things can go from completely benign to completely malicious instantaneously. There's this total collapse of the sort of frictions that we use in the real world to slow down decision-making and to be able to regulate and to do all these other things that we were talking about.

OK. So now we've jumped all over the place. Let me see if I can pull this all together.

So one of the problems in cyber specifically but I'm going to argue now globally as a security problem is that we come out of a world that's defense-oriented, where you can defend assets. You can defend targets.

But now -- and again, I'm going to use cyber as a specific example, although I'd suggest that the entire world is like this -- the area of potential attack, the number of vectors of attack, the players that are involved are so great that you'll run out of resources before you can actually defend all the targets and before you can take out all of the players. web site national defense university

So you have to move to, sort of, a new model. And to me, the only model has, sort of, two parts to it.

One is a deterrence model, but we need to talk about what deterrence means in this new environment, and the other is a sort of resilience recovery more based on, sort of, public health, identify a new pathogen that comes up, swarm resources to it, deal with it quickly and move on.

But the second part -- and that's the most important, probably, thing of the whole thing -- you have to recognize failure. And again, cyber is a good example for this. You can't build systems that are going to be sure. They are going to fail. And if you don't build that into your model from the start on how you're going to deal with the failure, how you're going to recover from it, how you're going to get on with doing what you need to do, you're going to lose the battle.

How much time do you want to leave for questions before you (inaudible)?

(UNATTRIBUTED SPEAKER): We have plenty of time. You could take at least...

(UNATTRIBUTED SPEAKER): A couple -- five more minutes?

(UNATTRIBUTED SPEAKER): Three or four more minutes, yes.

(UNATTRIBUTED SPEAKER): OK.

So let's talk a little bit about cyber-deterrence, and again, using this as a model for other things.

Deterrence in the old day was basically you threaten someone with consequences that were sufficient enough to keep them from doing whatever it is you were threatening with, I mean, utility (ph) deterrence being, obviously, the great example of this.

In cyber, because of the number of players, because of the ambiguous attribution, I mean, there's a whole host of reasons it's very difficult to do that. And it's very difficult for your threats to be credible.

I mean, first of all, they're completely contestable. I mean, you can contest both at the attribution level, and you can certainly contest the response, particularly if the response is a cyber-response.

If on the other hand, as people have argued, and there's certainly lots of literature out there about people threatening to use kinetic response in response to a cyber-attack, I think the reality in today's world that particularly the United States, maybe some other players as well, would actually kill people who had killed bits (ph) without some other crisis overlying it is probably unrealistic.

So when you really get down to that, you're in a place where the traditional model of strategic deterrence is completely contestable and, therefore, probably has little deterrence effect. So how do you actually deter behavior in this world? And again, I'm talking cyber, but think about it in the broader term of global things, including a lot of the things that you've talked about as this sort of thing.

I think there's a model that's based partially on this deterrence through punishment, and I'll come back to that. But punishment traditionally is aimed purely at that first party, right? "You do this, and I'm going to do this back to you." I think there are lots of opportunities particularly in cyber, but maybe also in the complex world with inter-dependencies, to exert power and to use deterrence directly on third parties who can control first party's behavior. In particular, obviously in cyberspace, you could threaten nation-states, or even ISPs, to control the behavior within their system.

And the threats don't necessarily have to be kinetic or violent.

They could be, "Look, we'll just degrade the ability of your network to work with our network until you bring it up to whatever capacity that we want to put as a standard." And we're doing this, quite frankly, in the cargo trade area. I mean, this is exactly the model we used in cargo, right? I mean, if your ports are secure, then your stuff doesn't get into our ports until it goes through some process. You can do that in cyber, and you can do that in many other places.

The second area of just, sort of, new models of deterrence is futility. And futility is different than traditional defense by denial.

Futility is really -- defense by denial, the traditional defense model, is premised on goal-denying strategies, and goal- denying strategies make success potentially unsuccessful, and therefore the aggressor takes that into his equation.

Futility is slightly different. Futility takes away the gain even from success. And cyber is a great example of this, because in cyber you can actually have 100 percent perfect recovery. In other words, if the target is data and you have a backup, the backup is a perfect copy of the original.

And it's not like somebody blows up your tank and you need a second tank to replace it, which is twice as expensive and you're degraded because you have half the tanks you started with. In cyber, it's actually 100 percent recovery.

You also can think about -- and again, I know (inaudible) here -- but a lot of people use, I think, an example of sort of cyber kinds of tactics, including making an argument that this is a strategic attack.

I'm not sure that's actually accurate, but -- for instance, the kind of denial of service attacks that hit (inaudible) Georgia during their political crises.

Well there, you could use a different strategy futility. For instance, if distributors are started denial of service attacks are your problem, then you have -- for example, maintaining the strategic reserve of bandwidth that could be assigned to places, including allies that needed it. One of the interesting things in the Georgian thing was that the DDOS attacks on the Georgian government Web site, their solution to it was to move their Web sites to Google blog spots, right?

Why? Because Georgia was a land -- not landlocked -- cyber- locked country where DDOS attacks could actually seriously impact their ability to get information in and out. But by moving to Google blog spots, Google deals with DDOS attacks every day, as do most of commercial I.T.

suppliers in the United States. So you could have a commercial -- so, anyway, that's futility.

The second and third -- I'm sorry -- the third and fourth things tie up directly some things that you guys talked about. One is dependency, and one is counter-productivity (ph).

Dependency, in a sense, may be actually the most effective deterrent strategy that we can have, going down the road. And obviously, there's lots of examples where you can think about how this works. But the very fact that -- I mean, one of the things that people talk about in cyber, you go to cyber-warfare information, warfare contract (ph), and the first thing people say is, "Oh, my God, if we get into a conflict over Taiwan, China is going to bring down Wall Street." Well, you know, China's dependent on Wall Street, and they're dependent on Wall Street not just for their trade, but to maintain their elites. I mean, that's where all their elites have their money. So -- maybe not anymore, but (inaudible) -- and particularly now that they've heard your presentation.

But again, it's sort of facetious, but if you think about it, OK, so there's the thing that's actually fostering those kinds of dependencies actually gives you security. So actually inviting people into your network, and network I'm talking about broadly, your economic network, your financial network, other things, not just your I.T. network.

Inviting your enemies, or potential adversaries, into your network actually is a form of security in this future model where it's a very non-polar, multi-player, multi-dimensional strategic environment.

There's much more about the (inaudible) -- let's just leave that aside -- (inaudible).

The final one is counter-productivity, where you actually -- where you can foster an environment in which the use of particular tactics or weapons, including cyber, actually are counter-productive to your long-term interests. I mean, we've tried to do this with nuclear weapons. I mean, we've tried to make the fact that the use of nuclear weapons is so morally apprehensive that people won't do it. We've tried to do it, even -- I mean, it's classic counter- intelligence -- I mean counter-insurgency strategy where you try to separate terrorists from other political insurgents by trying to de- legitimize the use of violence, et cetera, et cetera.

One could go down that route, and it's interesting to see that the UN, just I think a month ago, the secretary general has asked that cyber weapons be included in conversations about weapons of mass destruction in all the U.N. forums, going forward.

Anyway, so there's lots more, but, you know, (inaudible). We'll leave that for...

(UNATTRIBUTED SPEAKER): Well, thank you very much, (inaudible).

Thank you. that's -- really for all of you for a very broad and very stimulating sets of analysis.

I mean, I think what we've heard is that it's obviously, as we look at the global security environment, the theme of this over- arching conference, a complex and more volatile global environment with a changing rule set where U.S. power and influence and its ability to persuade others to follow our lead is going to be definitely linked, as we heard from two of the panelists, about our ability to restart the global economy, but at the same time questioning, of course, some of the methods that the United States is advocating, and we can come back to some of that, particularly in the aftermath of the G-20.

And also, lastly, we heard, and a number of our -- and I hope he can talk a bit more about the responses -- we need very nimble responses in several domains, and including the question which I hope we can come back to, (inaudible), on the question of regulation.

One of the points, of course, that the Europeans were pushing for at the G-20 was this idea of a super-regulator, further global regulation of the global financial system, and also perhaps come back to some of our questions about a systems strategy and intervention strategies, particularly in the countries that are going to be hardest hit.

Now let me just quickly -- I think we're going to flash up the rules of the road here on this question and answer period. Just to remind you, first of all, that we have some microphones deployed around the auditorium, and we would ask you to please wait to be recognized, identify yourself by your name and organization. If you have a question for a specific panelist, please indicate that.

And just a reminder of the NDU rules of non-attribution. All of the speakers, while we don't have any current or serving officials here today, they all still are speaking on the terms of the non- attribution rule, which means you can draw on this for your own personal edification and conversation, but just don't attribute it to any of the speakers.

So, let me see. I think we have a first question from (inaudible) somewhere here. Yes, sir?

QUESTION: Yes, sir. (inaudible) a member of the Young Professionals in Foreign Policy.

(inaudible), on CNBC, New York University economics professor Nouriel Roubini is known as "Dr. Doom," so I'm hoping you have a nickname as well, or we maybe can come up with one because I know, of the folks here, we were enlightened by your discussion, but also very frightened.

My first question deals with China. Because of its economic surplus over the last several years, they've been exerting their influence on different parts of the world. But because of the financial crisis and consumer spending here in the United States affecting their economy, unemployment is beginning to rise in China.

What geopolitical effects will that have in terms of internal just domestic stability, and also their future exertion of influence? Any of the panel members can answer that question.

My second question deals a little bit with cyber but more as a technology. As we move towards mobile payments, stored value cards, the Internet and just flattening out the world, what effects will that have on our national security as far as we see in Asia and Europe that you can make a payment to anyone in around the world in seconds. We have not done a good job of regulating hedge funds. How will these new technologies affect both our national security and financial regulations?

(UNATTRIBUTED SPEAKER): OK. Thank you very much.

(inaudible), you want to start, and then...

(UNATTRIBUTED SPEAKER): (Inaudible.) (UNATTRIBUTED SPEAKER): Yes, (inaudible), maybe.

(UNATTRIBUTED SPEAKER): So, China is increasing its economic size very rapidly. It's roughly the size of Japan already, which is, I think, more quick than a lot of us had thought probable maybe 10 years ago. And of course, obviously running the big current account surplus is amassing huge amounts of wealth has allowed China to become important as a creditor nation funding American spending, for example, but also to start acquiring assets around the world.

How does this change that? Well, one thing that happens is China is going to have -- I would guess that the current account surplus will remain positive, but it will probably shrink in size a little bit over the next couple of years. I think China's appetite for risky investment abroad will also shrink quite dramatically. So we're less likely to see kind of spectacular attempts to buy things around the world.

China remains very important as a creditor to the United States.

But as (inaudible) said, we're in this situation of mutual dependency.

China wants the United States to continue to spend with deficits so we can buy more Chinese goods and services, but we're not going to be able to do that.

At the same time, China doesn't really have any choice as to where it puts its money. Really, three options for where it puts its money:

one is the U.S. dollar, one is the euro and one is the yen. Well, the euro's in real trouble because the economy there is in trouble. Germany won't expand fiscally enough to support growth.

The European central bank is reacting far too slowly. It's crippling some, basically, Southern Europe and Iceland because those countries are hurt disproportionately. Pressure on the euro is increasing, so who would want to buy the euro? I mean, it's obviously a very dangerous currency relative to the others.

So the only two possibilities are the yen and the dollar. Of course, the yen market is much smaller, so China can't put a huge chunk of money there without hurting itself by driving up the prices of what it's buying, so they have no choice but to continue buying U.S. assets.

So relations between the United States and China get a little bit worse because China's angry at us. They're going to continue buying dollars, which means the dollar will be strong.

Domestically, China already says that 20 million people have lost their jobs because of the crisis. That's likely to continue. But I think it's probably easy to over-estimate the danger that this represents to China.

Remember, in 1998, the Chinese government lied about this a lot.

They said the economy grew at 8 percent. It probably grew at significantly less than half that rate. If you look at railroad traffic, consumption of energy, things like that, the economy really, really decelerated. There was no spectacular crisis in the politics.

I think the situation is the same now, except that the downturn's not going to be as bad as it was in 1998, and you have to remember that the government is sitting on massive amounts of money. The debt- to-GDP ratio is very low, at 18, 19 percent of GDP. Government thinks it can triple its national debt if it has to.

So I would expect a massive expansion in government investment, infrastructure, particularly railroads, things like that. That will keep a lot of people off the streets, increase at least state forms of employment.

So my guess is China can ride through this pretty reasonably.

One area in which they will increase their influence internationally is swap agreements. You've got all these countries around the world that need money, and they're afraid of how they're going to defend their exchange rates. Right now, the United States, but also China, are lending a lot of money to these countries to help.

So I would expect that, particularly in East Asia but also parts of the developing world, you'll see China extending offers of credit to a lot of countries and gaining some influence at the expense of the United States through doing that. It is in the global interest that they do that, however.

(UNATTRIBUTED SPEAKER): Yes, just...

(UNATTRIBUTED SPEAKER): (Inaudible), do you want to take a...

(UNATTRIBUTED SPEAKER): ... a very brief comment.

I think that (inaudible)'s basically right, with the caveat that I think there's a lot of uncertainty about what's really happening in China now, that if you look at the discussion about China and compare the domestic discussion among Chinese economists with the discussion internationally, there's a disconnect here.

And I think part of the disconnect has to do with the Chinese political leadership really bases all of their legitimacy on delivering the economic goods. They will. I think (inaudible)'s basically right.

They will. But I'm not convinced that this is less of a downturn for China than 1998.

But, I do think, essentially, (inaudible)'s right, that they basically will continue to buy our treasuries, shifting a little bit into real assets. They're seeking to purchase some big mineral companies in places like Australia, other places around the world. But you aren't going to see a break in the main patterns.

(UNATTRIBUTED SPEAKER): Just -- you want to come back on that just briefly, and then I'll...

(UNATTRIBUTED SPEAKER): Very quickly.

(UNATTRIBUTED SPEAKER): (Inaudible)?

(UNATTRIBUTED SPEAKER): It's hard to say exactly what's happening in the Chinese economy because the statistics are largely made up. 1998, the growth rate might have dropped to 2, 3, 4 percent, I think.

This time -- this year, China's economy will grow by 6 percent, and it's -- even if you assume a worst-case scenario, going forward, China's growth rate's probably 4 to 5 percent.

So the magnitude of this crisis is not, I don't think, going to be worse than 1998. It will last longer, and that's a problem, but definitely (inaudible)'s right in saying that there is this problem of legitimization, because commercial expansion is so important to China.

I would expect demonstrations, things like that, to increase. I just think that they're manageable, probably.

(UNATTRIBUTED SPEAKER): Great, thanks.

(inaudible), did you want to come back on the second question?

I'm sorry...

(UNATTRIBUTED SPEAKER): Oh, well, the second part's just about they've increased use of online finance and stuff.

And I think there's two points I would make to that that are, sort of, more generic. I mean, one is you have to separate, sort of, cybercrime from, sort of, strategic threats. I mean, those are two different things.

Cybercrime might be bad when they have to figure out how to deal with it, but the fact that more people can get into your ATM or not is not nation-threatening, essentially.

The more serious challenge to security models, I think, is the fact that, if more people come online, it increases, obviously, the numbers of attackers and the vectors that can attack, and that the system itself is subject to, particularly as we put more and more control devices online, things that control critical infrastructure online, is this, sort of, strategic information warfare kind of concept.

And what that really does is it's not so much China and other large countries and developed countries that we need to worry about. It's really that it empowers the next level of player: nation-states that can't project deep-water navies, that don't have the standing army. This is a cheap way for them to challenge U.S. and other power.

And so you'll see an increased use of them both directly, covertly but directly through their intelligence services and militaries, but even more so the use of proxies. Use of proxies and/or useful idiots, depending on whether they're actually being paid or not, in this area is very significant.

And I think the resources out there, sort of the proxy for hire out there, is huge and can't be underestimated. I mean, it's huge. You can hire million-unit botnets right now to -- right now, most are being hired by porn spammers, but you could hire that same thing to bring down a small country.

(UNATTRIBUTED SPEAKER): This is the Estonia attack...

(UNATTRIBUTED SPEAKER): The Estonia attack and everything else, which obviously is...

(UNATTRIBUTED SPEAKER): Right. OK, thank you.

Maybe let's pool a few questions. I'd just ask you to be brief in your questions and try to make them one part.

Yes, over there? I'm sorry. (inaudible)?

QUESTION: Good morning, (inaudible).

With all three panelists, you talked about the situation whereby the private sector has an incredibly important role in all these security issues. Within a regulatory framework, we're looking at a very confrontational approach between private sector and government.

Do you see a model for a cooperative approach between the private sector and government in order to manage the system or to be ahead of the curve to prevent these types of system failures?

(UNATTRIBUTED SPEAKER): OK, thank you. Any other questions on global financial regulation or other issues in that area, or any -- the floor is open. I just wanted to pool a few. I can't see -- oh, way up in the back. I'm sorry.

QUESTION: (inaudible).

One thing that always comes up as a very, very dirty word is "nationalism," and for the most part it can be catastrophic. However, I was wondering, and it might seem like a very simple -- juvenile, even -- question, would some degree of nationalism in this country serve to bolster -- well, to bolster our economy would serve to bolster the global economy in terms of -- you guys mentioned that there weren't any other countries willing to step up and take the plate in terms of being financial leaders.

So if that responsibility is falling solely on the shoulders of the U.S., wouldn't it be important for us to get onto solid ground, once again, and then kind of have the trickle effect?

(UNATTRIBUTED SPEAKER): OK. And yes, there's one over in the far corner there, (inaudible).

QUESTION: (inaudible).

It's understandable that there's a sort of impulse to re- regulation, globally and domestically, in the face of a crisis that's seen as originating in the private sector. I don't have your comprehensive and systematic view of what's gone on.

But episodically, as I look at the evolving financial crisis in this country, almost everywhere I look, I see some aspect of either failure of regulatory agencies or opportunities given to regulators to step in and regulate before the crisis that were turned down or passed up.

You can think of examples ranging from the SEC's reports on Madoff and Allen Stanford that never reached the bottom of those cases before the collapse. You can think of the conjunction of Alan Greenspan and Bob Rubin ganging up, so to speak, on the CFHT chairman to prevent or obviate derivatives regulations.

You can look at John Taylor's recently little book, "Getting Off Track," criticizing the Fed for maintaining easy monetary policy far too long after 9/11 and contributing to the housing bubble. You can look at the application of the Community Reinvestment Act, as interpreted by Congress and sort of imposed on banks to obviate redlining in disadvantaged neighborhoods that helped contribute to a mortgage crisis.

So against that background, what assurance do we have that re- regulation and the regulators who have enforced new regulations, will be wiser than the ones we've had?

(UNATTRIBUTED SPEAKER): Great. OK, thank you.

And just not to pile on, but maybe if (inaudible), if you want to touch on that, what is it? What was -- what do you assess the outcome of the G-20 on this score, and what were the Europeans looking for, and some of the other governments looking for, more on this notion of this super-regulator? But let me start with (inaudible) this time, maybe, and we'll work back.

(UNATTRIBUTED SPEAKER): Maybe a couple of points on that.

I think there are regulatory frameworks out there that would be collaborative. I think in many countries, including the United States, we're in a political environment in which there's likely to be regulatory overshoot. And I think (inaudible) mentioned that. I think he's absolutely right. I think that we have had a failure of regulation. I think the points that you were raising are correct.

But when I look at where regulation is likely to go, I think particularly absent -- I mean, the timing of it has been unfortunate, because I think that you -- what you really need to get effective regulation is a very strong hand from the executive branch, which is going to be less politically motivated than the Congress.

If the Congress, at the end of the day, has regulation in its portfolio, they will have to do it. Unfortunately, what's happening now, given that the administration does not have -- literally have the personnel in place to do effective planning and thinking about these things, is that the leadership on this has moved into the Legislative branch that's, I think, much more powerfully affected by political passions of the moment.

And I think that will lead to a regulatory overshoot.

I do not think we're heading towards a global systemic regulator for a number of reasons. But importantly, that the two themes that you often hear in the G-20 of both increasing the effective participation of new powers in the institutions of global governance and increasing surveillance and regulation at the national -- by international bodies over national economies, actually rub against each other, because most of the new players are not going to want increasing regulation.

So when we increase the role of China, of the Gulf states, et cetera, in the voting procedures of the IMF, they will come down on the side of less IMF national surveyance (ph). So I actually don't believe we're heading towards any kind of a systemic global regulator, although that is what President Sarkozy certainly had in mind.

Let me raise just one point on we may be heading into a long and deep depression-recession. I think it's very uncertain. I think if anything is clear about the last year, year and a half, has been our inability to predict where this thing is going. And I do think the points about deleveraging and demand are very real, but that's why you have -- there's a huge global stimulus package. There is an effort under way, public-private partnership play by the administration to resuscitate credit and the banking system.

If you begin to have this gaining traction, particularly in the face of a lot of financial resources sitting on the side, both here in the United States, in the Gulf, in Asia, I don't believe that we are inevitably in a long, deep downturn. I do agree that the upside, because of the global demand problem, is not going to be anything like a V-shape. But we don't really know. we've got to be very careful to posit a range of scenarios when we think about what's going to happen in the next 12 to 18 months, because we really don't know.

(UNATTRIBUTED SPEAKER): (Inaudible.) (UNATTRIBUTED SPEAKER): I'm going to start by taking that on.

I've been looking at global economics for 20 years, and I have to say that never in my life have I seen the data so consistent from so many parts of the world. It is really hard to get away from some pretty negative conclusions, particularly about this year and going forward.

Definitely always questions about how long it's going to last, but I think that we're in for a five-year period of significantly depressed global GDP growth. And statistically, that's hard to escape.

There are scenarios. The major scenario is the one that I've basically outlined. The second scenario is depression. The chances of that are 30 percent globally, and then there's also a chance of hyperinflation.

I think the odds of that are about 10 percent.

But I've looked a lot at this, and the kind of base scenario is more of us as I've outlined it. And I think the risks of downside surprises are still more significant than upside.

Now, moving forward, how could the United States or other countries try to provide global leadership? And there are three elements to this. The first is we've got to get out of this mess, or at least stop the situation from getting worse.

And that's largely a question of fiscal spending and quantitative easing monetary boost in the United States. Yes, there's been a huge increase in fiscal spending. I don't think it's enough. Japan is looking at numbers that are inadequate. Germany is certainly not doing what Europe needs.

I think what the United States has done is a start, but frankly, the latest package of stimulus puts about a third of the spending this year. The rest of it is down the road. Frankly, the fiscal stimulus is not sufficient yet.

Monetary easing, the U.K. and the U.S. are the ones that have been the most aggressive here. Yet if you look at what's actually needed, the quantitative easing that's occurred so far is probably a third or a fourth of what we'll ultimately end up with. So yes, there's been a big increase in stimulus. Not enough.

Next element is a question of regulatory reform, which (inaudible) first brought up and some other people have gotten to, the notion of a global regulator. I don't think that's going to happen.

But I think if you take the word "global" and talk about within the United States, yes. I mean, there has to be a center of authority, somebody who's watching the leverage ratio throughout the economy. And I don't know if that's the Fed or somebody, but somebody has to be responsible for looking at all lenders.

Internationally, there are two ways around the problem. One is a global regulator, which I don't think is politically possible. The other is much greater coordination between regulatory authorities, much greater transparency, exchange of information and cooperation. We have to head in that direction.

(UNATTRIBUTED SPEAKER): And that's what the FSD is being set up to do.

(UNATTRIBUTED SPEAKER): The third element, and this is one that people don't think about so much, is this global imbalance in supply and demand.

Again, it doesn't make any sense at all for the rich countries to be borrowing from the poor countries. Poor countries should be borrowing from rich countries and investing. They're the ones capable of fast GDP growth, not the advanced Western countries.

So we have to fix that. And what that means is coming up with changes in the exchange rate system so that the poor countries can actually trust it. I mean, I don't blame anybody who went through the 1997 crisis for saying, "I don't trust the system." And I don't blame anybody who doesn't trust the IMF. The IMF has made things a lot worse. So everybody's basically trying to insure themselves.

Somehow we've got to change the system so that the developing world, at least the really responsible countries there, are confident enough to borrow money and invest it, encourage investment. So that happens one of two ways. Either we completely change the exchange rate system, and I don't really know how you do that, or else you dramatically increase the scale of somebody, the IMF or somebody, and change the conditions under which they lend so the poor countries feel safe in this global economy.

This is a critical part of the solution. So greater fiscal expansion, monetary loosening, changing -- making adjustments in the exchange rate system, and then, of course, trying to come up with a global system of regulation that's politically feasible and not too onerous in terms of slowing GDP growth. Those are areas where the United States could help a lot.

(UNATTRIBUTED SPEAKER): I want to weigh in on this, although just -- one thing on this regulation thing. It's something I said earlier.

One of the problems with saying, "OK, let's re-regulate," is that we're still using old conceptions and old models for our regulation. I mean, I would suggest that not only is it a failure of regulation, as one of the questions suggested. Regulation wasn't really the problem. It was a failure of management.

The CEOs didn't know what was going on. It's not that the regulators didn't know. I mean, you have this disconnect. And part of this is information technology, and part of it is the sort of power has moved down to the edge, decision-making as moved to the edge, and now decision making at the edge is so apparently situationally aware, not really situationally aware, that they can make decisions that threaten the entire system.

I'm not going to go into the whole thing, but, I mean, we are going through this huge change from a world that is premised on bureaucracy being the best way to manage information, goes up the hierarchy to someone who has the big picture and can make decisions, to a world that's networked, where decisions are being made at the edge.

When decisions are made at the edge, the only solution, I suggest, is not regulation as we think about it, but is forced disclosure and more transparency at the edge. I mean, I think that's the only solution to these things, but that's a different thing.

Now, a totally different thing, the question about nationalism and stuff. I just want to throw one thing out. I don't have anything to say about it. But if MySpace was a country, do you know what size country it would be? MySpace has 250 million members. It would be the fourth largest country in the world after China, India and us, and ahead of Brazil.

I'm not suggesting that nation-states are going away, but I'm suggesting that there are going to be huge organizational things going on, people connected through networks and things like that with loyalties that go to those networks that transcends national borders and other things, that are going to really mess up this whole thing and how we go about regulating it unless we really, really start from first principles about what it is that -- how those things interact and what these inter-dependencies are.

(UNATTRIBUTED SPEAKER): And those of us that are over 30 are really going to be in trouble. We don't even understand it. I can't get my son to let me be a friend on his page.

But anyway, are there any other broad questions if we -- I wanted to -- we have a few minutes left. Yes, there's one in the back row.

QUESTION: I'd like to get you to talk more about the security implications of what was raised. (Inaudible), in your comments, you alluded to the testimony of Dennis Blair, and his first sentence was that the economic crisis is the greatest threat to security today, and his second sentence was, "We all remember, in the Great Depression, what happened in Europe, the rise of all kinds of extremist movements." So I wonder if (inaudible) could speak. You spoke about unemployment and hunger, and then you went on. But maybe you could elaborate, or any of the other panelists, or (inaudible) even, on what kind of security implications you see arising from these economic dangers that you project.

(UNATTRIBUTED SPEAKER): OK. I think we have time to just add one small addition to that question, if you can be brief.

(UNATTRIBUTED SPEAKER): Part of the -- (inaudible).

Part of the flipside of that, can you comment as to whether the economic crisis will underscore somehow perhaps, the brittleness in some of these nations, China and Russia? We assume they're monolithic, being authoritarian, but there's factions within there that the elites are not completely united, and it might exacerbate some of the tensions in there.

We might see some opportunities or changes that we might not have expected.

(UNATTRIBUTED SPEAKER): OK. Why don't we start, (inaudible)?

(UNATTRIBUTED SPEAKER): The Great Depression differs from the present situation in a number of ways.

One is it's much worse. It's not a garden-variety depression.

GDP shrunk by a quarter.

What we're talking about in the worst hit countries is 10 percent. So we're talking about, kind of, 19th-century typical depressions in some parts of the world right now. The possibility, I think, of a, kind of, prolonged stagnation, say three to five years of significantly sub-par growth, I think we're in that, with the possibility of a more typical depression still something that you can't rule out.

That's where we are. The situation is not anywhere near as bad as the 1930s.

The other element which is different is the 1920s, 1930s was a time when there were kind of profound debates about ideology. There were two or three different models, kind of fascism, communism, capitalism.

People felt very strongly about that.

The Depression played into that, as well as kind of the residual problems from World War I. I don't think we're in a situation like that.

Other than Islam, it's hard to see alternative kind of ideologies that could really divide the world. So I think the situation is a lot more containable now than it was then.

The other problem, though -- and this is where I think (inaudible) is really right -- the Internet really does change a lot of things. Countries like China and Russia can't really control people's exchange of information. You've got a lot of unfocused anger and anxiety globally. Those feeling are being transmitted nationally and internationally very quickly.

So I think we see two things happening. One is much more kind of brittleness, to use that term, in countries around the world who were already fairly brittle, and then you've got this significant increase in public pressure on governments at a time when many governments have significantly fewer resources.

So again, my approach would be to look around the world. Find the places that are relatively brittle, rigid to start with, and then see how much economic stress they're going to undergo, and then also it's more difficult to quantify a question of how are these emotions being expressed and felt by people. It changes a lot from country to country.

(UNATTRIBUTED SPEAKER): Thanks. Maybe (inaudible), I want to give you one last word in, and then (inaudible) can have the final word...

(UNATTRIBUTED SPEAKER): Well, I just -- I really think that -- I'm repeating the same thing over. I really think, though, that people really have to think about how networks change things.

I mean, just to pick right up on your point, I mean, disgruntled populations who can't speak to each other are one thing, and they're manageable in a different way than disgruntled populations who can organize themselves, who can self-organize themselves and project power. And they can project power both cyber, but they can project power locally, politically in other ways. It's just a different mindset.

And the model that we have that is sort of hierarchical, state on state or institution on state, regulatory and/or security, I'm not suggesting we throw that out and start all over. But on top of that, we need to have a security model that is a much more integrated security model that uses hard and soft power, the things we heard this morning from the undersecretary, that really understands how the nature of challenges, of changes to states and to state interests, et cetera, are going to be projected in the future.

And it just is different. I mean, it's different when you can have 250 million people and can organize and say, "Hey, we're all part of MySpace." Now, if they all say we're part of whatever the next ideological movement is, we've got a different problem.

(UNATTRIBUTED SPEAKER): The two places that I would look at as being challenging are, one is Eastern Europe, the former Soviet Union, in which the impact of the crisis has been very, very sharp.

Nationalism is still a powerful phenomenon, and for those countries that aren't included in how the European Union defines their internal space, I think there's going to be a great deal of competition with Russia moving into political vacuums. And I think Ukraine, to my mind, is place number one where there'll be a challenge coming out of that.

The second is East Asia, where you've had -- there's been a lot of stability in East Asia, both internally and regionally, but it's built on very high rates of economic growth. There aren't regional mechanisms to deal with conflict. And again, nationalism runs very, very, very strong.

And I think of particular interest there will be to watch China, where there's definitely a nationalist reaction building up from below.

I actually think that the Chinese regime, in many ways, is less nationalist today than they were three or five years ago, but will they remain so, particularly if we're in a (inaudible) world. If we're in a (inaudible) world in which this goes on for a long time, I do think that it will be forms of aggressive nationalism.

Now, there may be some broad trends, national phenomena here. I mean, the timing of this I think coincides with, really, a crisis, in many ways, for Islamic extremism around the world except in a couple of places.

But Islamic extremism is not doing nearly as well in Southeast Asia, not doing nearly as well in the Gulf, not doing nearly as well in the Middle East. Central Asia or South Asia is an exception to that.

But whether there's a pickup there to articulate a theme here, we will have to watch. And that would be, I think, particularly dangerous were it to happen.

(UNATTRIBUTED SPEAKER): Right. Well, one quick thing.

I mean, one is the transnational threat, which I think actually -- I mean, which I've argued about. But one of the interesting things, just picking up what you said, the Chinese blogosphere is 100 times more nationalistic than the Chinese government.

(UNATTRIBUTED SPEAKER): Absolutely. Absolutely.

(UNATTRIBUTED SPEAKER): I mean, just across the board. So it's already -- I mean, even the internal threat kind of thing has changed already because of the information technology.

(UNATTRIBUTED SPEAKER): All right. Well, thank you all very much. This has really been a fascinating discussion. And I think it's just a really very compelling reminder of -- and I applaud Patrick Cronin and Jerry Favors and INSS for starting off with this.

It's another reminder, in an era of economic globalization, how important it is for the community that follows economics and technology be talking to the security community, because obviously the trends we've heard today are really changing the global and security environment, and INSS has been in the forefront of bringing some of this dialogue forward.

So I commend you for getting off to -- and I thank all our panelists for really giving us a very good context in which to pursue some of the more specific discussion on what this means for international security planners and energy security and some of the other challenges we face in the years ahead.

So thank you all very much.

END

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