will promote economic growth in the united states, we have the exact same dynamic and we have got to make sure nothing we do here in washington detracts from economic growth. so with that, i just have one final chart and it speaks to the u.s. government in relationship to european economies and to me, this is an incredibly key metric. i'm a business guy, manager, accountant so i look at key metrics. the size of our debt in relation to our gdp is important but i think this is even more important. when you look at federal government and it's size and relation to our economy, 24%, you add state and local governments and total government is the 39.2% which means 39 cents of every dollar that our economy generates filters through some form of government. government disawe number of wonderful things and it's not particularly effective or efficient at many things and i think it's a bad metric when you compare it to european socialist

nations. congratulations, america, we've arrived at the lower level of european-style socialism. norway spends 40% of its government gdp. greece, i think we'll hear about greece andity. greece is 47%. italy is 49%. and france is 53%. that's a metric we need to manage and reduce the size of the government. with that, mr. chairman, i pr appreciate the indulgence and turn it over to witnesses. >> there's lots of things you said i agree with and some that i don't. i think my sharpest area of disagreement would be the new health care law because cbo told us that will reduce deficits and dealt by a trillion dollars many the second ten years and i believe that's the case. i know you don't share that view. that's what makes our democracy

vibrant, having disagreements. but tlus much i agree with and what a most strongly agree with is that rear on an unsustainable course. and i think that's undeniable that we're on an unsustainable course. we've had the head of the congeeshl budget office testify before the committee that we're on an unsustainable course. we've had the head of office and management and budget so testify. the chairman of the federal reserve testify we're on an unsustainable course. we've had the secretary of treasury testify we're on a unsustainable course and i think it's undeniable and it's the central thrust of your argument as i hear it. and i think you're entirely right about that and we've got an obligation, we have an obligation on this committee and an obligation in the senate, the house has an obligation. the president does. to try to get us on aa more

sustainable course. and, you know, it doesn't take that much to get us to balance. i said without advocating it, a 6% increase in revenue from what's currently scheduled, a 6% reduction from spending from what's scheduled would save us $6 trillion and balance the budget. now, i don't think it should be an even split revenue and spending and every body in which i've served, fiscal commission group of six, we weighed heavily on the spending cut side of the equation but i personally believe we need additional revenue but as you describe, not with an increase in tax rates. i think that would be counterproductive to our competitive position in the world. you know, there are places where there is agreement on both sides

here. my fondest hope is that we find a way this year to actually make substantial progress. i'm leaving after this year i would love nothing better than to leave behind the legacy of getting america back on track. one of the things facing us, obviously, are external issues. we're discussing, i think, one of the biggest threats to our economy and deficits and debt, is the european economic challenges, another is what could happen with respect to military engagements around the world. we'll be dealing with that at a later hearing. let's go to our witnesses this morning. we'll start with simon johnson. dr. johnson, thank you, again, very much for being here. please proceed. we'll go right through the

witnesses. and then we'll open it up to questions and we'll dozen-minute rounds and -- we'll do seven-minute rounds. dr. johnson, please proceed. >> thank you, senator conrad and johnson and thank you also for placing the conversation today in the context which you just did of the u.s. budget and our unsustainable situation. i think that is absolutely correct and i'd like to frame my remarks very much to responds to that. i'll make three points. first of all, the eurozone has already failed. the eurozone was established as a abc onof the build a large and more powerful economy that this hadn't worked. as you said a moment ago, fiscal mismanagement lies at the heart of their problems and i

completely agree. they're trying to solve fiscal problems through, i think you might call it, monetary solutions. i might call it monetary innovations, a less positive word. i don't think this is going to end well. for them or for us. and with regard to your question about the new agreements, the latest rounds of agreements, senator conrad, i think this is very small steps in the right direction, but very small steps relative to the problems and relative to what they need to do. so i think we should encourage them to do more. not just a fiscal problem. it's a fiscal problem on top of a competitiveness problem untop of an unsustainable balanced trade and of course, on top of debt levels, as you well know, and in greece and now, in portugal and ireland and arguably, also in italy, these debt levels are not sustainable under their current arrangements. now, even minor optimistic

colleagues from whom you'll hear in a moment, i think will agree. outcome in europe will be deep recession. austerity. that's the good scenario. high unemployment, low growth and that's got not good news for our situation. the down side scenario that i would emphasize, my second point, is much worse. the spillovers from their sovereign debt problems to their financial system and from their megabanks that frankly, are very badly run, have far too little capital, those issues were clear already in 2007/2008 when i was the chief economist at the imf, they have not made the system safer and it is a dagger pointed directly at our financial system. and in terms of what you both care about, in terms of the direct negative impact on our economy and our budget, this is a huge risk. this is a risk we can take steps to mitigate.

we cannot solve the european's problems for them. that would be illusion and extreme arrogance on our part to presume but we can build better protections for ourselves. first and foremost around the stability of our financial system. the financial services roundtable has a report out claiming that all the well in our banking including our big banks and we have fortress balance sheets in those banks and that's not true. it's not an accurate depiction of the level of equity financing relative to debt, the buffs against losses we have in our bank. federal reserve is women aware of this and you showed us the remarks of former vice care blinder and i'm sure mr. bernanke and his colleagues share those sentiments in private with you but they must take the logical step of suspending bank dividends. it makes no sense to aloup the banks to pay out the capital. they should keep it on their balance sheet and build up their equity relative to the losses they could face, for example, if

the euro market collapsed which i would say is a real possibility, if that market were to collapse, we need as much of a buffer as possible in our banks. and the suspension of bank dividends ordered by the federal reserve applied on a blanket basis would stabilize and help strengthen our financial system. secondly, we should be scoring. your point, senator johnson, we should be scoring for you, the fiscal impact of financial calamity. and particularly, the dangers posed by financial system that's run irresponsibly. they spore for you important contingent liabilities including as you showed us, medicare. that's a contingent. we don't know what exact costs will be for medicare in 30 been 40 or 50 years and the cbo takes a hard look at that and gives you a sensible baseline read and they should do the same for our financial structures as exposed to europe.

what would happen if there was a serious solve when debt for italy? how would that affect our economy, even the principal holds with no direct cost from bailouts it could still cause a massive recession and lose a lot of tax revenue and it would push up the borrowing at the federal level and state and local levels to the extent that's possible. you should be looking at it. i did not propose you hold up this year's budget on that basis but when you talk to director i think you should impress on him i'm on the cbo panel of economic advisers. i think they'll be receptive if congress pushes them hard in that direction. there are serious unfunded liabilities for us in this area. third and finally, with regard to the international monetary fund. the imf should be working to build a firewall, not within the eurozone. not lend more money to the dangerous and counterproductive situations we now see in the

eurozone. the europeans run a reserve currency, the euro. they are perfectly capable of sorting out this problem for themselves. they haven't done it yet, i grant you, and they need a lot of encouragement and they're getting that from the executive branch, mr. geithner has been good on this and more encouragement from congress but most important, the imf should focus on protecting other countries. build a firewall outside the eurozone and protect the innocent bystanders. and let them sort it out and help other countries with whom we do a lot of trade that have financial systems intertwined with ours and have them buffs themselves against calamity that might arise in a situation. the imf have taken this up and issued a paper to their membership. it was a secret paper, the details are poorly related. i understand they can't do

hearings. but they can brief you in private and communicate their intent and i would urge you and your staff to impress on them at every available opportunity, build a firewall outside of the eurozone. not attempt to fix the eurozone. the europeans should do that for themselves. thank you very much. >> thank you, once again, excellent testimony. >> thank you, your very kind remarks at the outzest about our stewardship of 30 years but i'm not league. i'll stay on as a scene juror fellow and hope to continue to participate in activities like this. one of the great privileges i've had over that period is to work with you, this committee many times and i thank you for the opportunity to do so again. i share with you that simon expressioned, you've expressed, senator johnson expressioned, europe is in deep economic

difficulty and no doubt they're headed for recession that may be prolonged. europeans have failed to get ahead of the crisis and failed to restore market confidence. however, and here's what passes for optimism these days, i take the view that none of th apocalyptic forces will be in place. i don't think the euro will break up. it is a possibility that greece might drop out or be kicked out. but i don't think there will be any widespread defedex there is the eurozone. in fact, as i'll indicate, i think europe will come out of the crisis stronger and over time, will restore its position as a key player in the world economy. why do i say that? three reasons. i've watched the evolution of the whole european integration project for the last 50 years. they've faced a series of crisis. frequently existential crisis to

threaten the existence of you're ron and they come out every time stronger and moved on forward and better. if you look at current crisis and every time it has reached a tipping point, where there was much commentary, it's going to collapse if they don't shape up, every time that's happened they have done enough to avoid the apocalypse. they aif kept going forward and built new institutions. they built a firewall. avoided financial disaster and i think that will continue. for a very simple reason. the overwomening imperative in all european countries to hold the european union together and that now means holding the eurozone together. that has become, for all practical purposes, the definition of you'europe. they know europe is wrapped up in sustaining the euro and they will. one reason is the ghastly history of europe.

remember why they created the european union in the first place, to overcome the previous millennium of slaughter in europe, most dramatically, the first half of the last century. i visited the holocaust museum again. if you've done that recently it gives you plenty of memory of why the europeans have pulled together to avoid letting europe, again, explode into kind of holocaust and disaster that they experienced. so they're going to hold europe together. in addition to that, they have an overwhelming economic interest. germany, the pivotal country, has a nirvana economic situation. germany is the largest surplus trading country and it bases it's whole economy on an export-led economy. when they had their own deutsche

welle mark and they would choke off their competitors and fight off the germans. now, the germans have the world's largest trade surplus and a weak currency which, for them, is the perfect outcome and every german knows it and they'll continue it and virtually at any price would be worth paying for them to keep that situation together. if you went to a new deutschemark it would explode up in value and the whole german economic prok which has been impressive the last few years, would collapse. so the bottom line is both germany and europe as a whole has a huge, huge interest in holding the eurozone together. so my conclusion, and it's, i think, supported by the evolution of the current crisis is that germany will pay whatever is necessary to keep the eurozone together. the european central bank will put in whatever amount of resources are necessary and will play lender of last resort, own

though they can't say it. there's one problem with this their you. neither the germans nor the european central bank nor the europeans broadly can do what i'm confident they will do, why not? it would be the epitome of moral hazard if the germans pronounced that they were going to rescue everybody no matter what the cause. that would take the pressure off. mario moly is speaking on friday and he'll lay it out. he wants to keep the pressure on his country so that the domestic politics will support the reform program that they all know they need so the germans and ecb cannot say they'll provide all the resources even though i'm confident they will. second lip, the usual juggling among the creditors. germany and the other successful northern europeans. the european central bank. the vat bank who are now

negotiating and the international monetary fund and they're all tried to fob off shares of the packages to the others and preserve their own negotiating position stoed, therefore, none of them wants to say he or she will take care of the whole problem, even though, in fact, they will. so the result is a situation that's very unsatisfactory for the market. the market wants to hear assurances and firm words of rescue and those can't be given, even though i'm confident that those rescue also take place and therefore, the market situation is likely to remain unsettled and volatile, even though i'm confident that the outcome will be successful in the sense of successful financial engineering to avoid financial breakdown. but that's not getting to the recession and the underlying economic problem which is still there. i want to draw two or three major conclusions for the united states and answer more questions. as you said, mr., the united

states has a huge interest in this situation being resolved successfully. so we have to do whatever we can to support a successful solution. i agree with simon that the europeans should provide the bulk of the resources to do that and they got the wherewithal but i disagree with him that the international monetary fund shouldn't be available if necessary, we don't know yet, to lend more to help resolve the problem. the imf did pick up one-third of the original packages for greece, portugal and ireland, and i think that was very helpful, not so much in terms of resources but bringing the imf condition into play and helping to promote the necessary adjustmentment in the debtor companies. when i say necessary adjustment, i don't mean just fiscal austerity but structure reforms that are necessary to restore

growth. all the debt countries need to restore growth is structural reform of their labor markets, their uncompetitive private sectors. their own financial systems. all of those structural reforms are needed and the imf is very helpful in promoting that given its experience and the resources that it can bring to bear. so i believe the u.s. should support if it turns out to be necessary, additional imf financial contributions to the european problem on a minority basis, maybe the one-third in the previous cases, maybe less, but certainly it could be significant, and i therefore think the united states should support the current efforts of the imf to created a new fund, 500 to $600 billion which in conjunction with the funds the europeans are raising would take the fire wall to over a trillion. so there would be enough there

to avoid any significant financial disruption either from italy or spain. i think the u.s. should support that. but i do not think the united states should contribute. the funding the imf needs should be borrowed from the big sur plus and creditor companies. china, japan, singapore, hong kong, brazil, russia, mexico, many of those countries already said they will lend and they should be tacked. they have big sur pluses and big reserves. we should support the effort but not put in our own money. the u.s. needs to take this as a wake-up call itself and you suggested that, mr. chairman. if you take those cbo realistic projections and i would say, even add a little more dose of realism, you have u.s. budget deficits exceeding a trillion dollars a year, more than 5% of gdp for the decade to come and then it gets worse because of

aging. so if you project the numbers, our debt and deficit numbers within ten years look like greece' did as it entered into its crisis. the european crisis has shielded us from our own follies. because europe's weakness meant that foreign capital, global capital moved into the dollar and pushed our interest rates lower despite our inability so far to put our own house in order. remember that only three or four years ago, greek interest rates were at the same level as german interest rates. because the omnipotent markets that we like to extoll, got it totally wrong. the markets thought that greek debt was as good as german debt because greece was part of a eurozone led by germany. and all of a sudden they realized that was wrong and greek interest rates tripled the level of germany's. the united states is very happy

at the moment to have very low interest rates, in large part because europe and japan are so weak and so the other financial markets don't attract the capital but that worm could turn very fast, very viciously. and if the european crisis teaches us anything, it's that we have to learn from that example. and not simply delight in the fact we have more time but, either use that time. this committee has played a major leadership role with that and i urge and implore you to take the time that's now available to do that, if not, we, too, two or three years from now, certainly within the next five to ten, could go the way of some of the europeans whose tre vails would we now bewhale. thank you. >>lerrick, thank you for

coming. >> i want to recapitulate what happened. the europe crisis is not a currency. the euro maintained its value. it's at $1.3 which is in historic range. europe has a fiscal crisis compounded by a failure to take corrective action. that's just destroyed its credibility in the capital markets. it is a self-inflicted crisis. the european monetary union set out rules that limited deficits to 3% of gdp and debts to 60% of gdp and the markets said this is a fiscal performance guarantee. they thought that how moj niced the credit throughout the union. you saw the interest rates of greece's debt fall from 8% of germanys to less than a quarter of a percent above germany's. but the rules were never enforced. by 2007, you had ten of the --

seven of the original 12 members over the debt limit by 2010, it was ten of the members. what had happened was weak governments had used massive borrowing to offer their citizens a standard of living, their productivity could not deliver. and so now what you have when this crisis started in greece in 2009, greece just denounced our deficits two times is what we had told you a few months ago and the market recognize there was a problem. what should have hand two years ago is greece should have defaulted on the debt and the other countries should have just tightened up their budgets. the fundamental problem in europe, really, is european policymakers don't understand the markets and don't like markets and think they can dominate markets and that's why you've seen a mess over the last two to three years. the inability of europe to address its crisis stems from a fundamental disagreement over the responsibilities of members of the eurozone.

without a fundamental agreement, all you've seen is a series of political compromises that have only further eroded market credibility because they failed. germany leads the north and they believe the cause of the crisis is a lack of discipline in the south. profited members should cut their spending, lower their wages, increase their productivity, which is the exact path that germany took in the approximately ten years ago and that's the source of germany's current prosperity. under the german view, each member is responsible form its own fiscal well being and growth. if markets see credible action the crisis will end. southern believe it's caused by germany's success. if germany hand done so well they'd be in good shape. that's an interesting way of accountability but that's their view. they think union solidarity requires massive transfers from

the strong members to the weak and they need a euro bond to lower their financing costs and reduce adjustment paying. what's interesting is the role france played in there. france, instead of steining with the other aaa countries has decided to be the head of the south. they see this as a way of gaining political leadership of europe while leaving the cost of bailouts with germany. as one of the germans told me, the french are very bad at economics but very good at diplomacy. the great danger is that you know have a conflict within europe. germany wants immediate fiscal correction by the individual governments. the rest of europe and the obama administration, want the european central bank so simply print up $2 trillion euros and buy every weak government bond in sight and drive interest rates down to 4% and the real problem can be dealt with later and that's basically mimicking

the federal reserve's policy of driving down the interest rates and flooding the economy with cash. germany disagrees. if a long-term solution is not offered, there's no amount of money that will solve this problem. and i believe that if germany capitulates as my colleague believes they will, you'll wind up with a currency crisis on top of a fiscal crisis. the issue then becomes -- what is the next level of europe? germany has a clear view of what the future of europe is going to be and they've found two tools that will force union fiscal discipline after two years of reasoning, threatening and pleading had no effect on their fellow members. they see market sources fail where diplomacy failed. if you keep painfully high interest rates on the politicians that will compel them to make difficult choices that need to be made. the second step they've done is

removed the you thnathan u than anymority requirements. before they could stop the euro without a veto and therefore, they set up a system where there will be no access to emergency funding unless a member agrees to the fiscal conduct. and what will happen is the fear of being left behind is going to support -- left behind without support is going to force submission to this fiscal reform. and so what you'll see over the next two to three years is germany will draw the eurozone towards a fiscal union with central control over national budgets and strong, automatic sanctions against spending offenders. this is a difficult path. it's the greatest danger is that a crisis will loom in the interim. what you're seeing is a very difficult process and there's going to be missteps. there's going to be obstacles and what you'll see are the