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Fareed Zakaria GPS

Interview With Matthew Hoh; Afghanistan-Pakistan Examined

Aired November 01, 2009 - 13:00   ET

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

FAREED ZAKARIA, HOST: This is GPS, the GLOBAL PUBLIC SQUARE. Welcome to our viewers in the United States and around the world. I'm Fareed Zakaria.

We spend a lot of time on this show on AfPak. But this week it's more important than ever. The region remains in trouble. There were big bombings in Afghanistan and Pakistan this week.

And it is crunch time for the United States. Over the next few weeks, or a month or so, President Obama is going to have to decide whether to send in more troops, if so, how many, and what they will do there.

So, we think it's worth spending some time exploring what the alternatives are for the United States, its allies and, of course, the countries in the region.

And to look into all of this, we have a rare and important opportunity to hear from a man who has just returned from rural Afghanistan, where he had daily contact with the very people the United States is fighting.

I speak of Matthew Hoh, the young Foreign Service officer who resigned this week from his post in Afghanistan. He says flatly, there is no winning there. The enemy, he says, is not who we think they are. You will want to hear what he has to say.

Now, my own view on this subject remains that we should be cautious about the idea of large troop increases. General McChrystal is understandably very concerned about his success there and the success of his mission. But he is responsible only for Afghanistan. Naturally, he wants more resources for his mission.

President Obama, on the other hand, is responsible for America's interests across the world. And he must decide whether the dangers in Afghanistan, America's interests there and the strategy, justify putting what would be virtually the entire American Army into Afghanistan for the next decade and spending hundreds of billions of dollars to avert the potential threats out of there.

There are, of course, other threats that come out of Pakistan or other parts of the world, other opportunities. And he has to worry about all of that and balance it.

Now, there is one thing we could try, which is the McChrystal strategy in pieces. Let's put the McChrystal strategy to a test. Let's pick an area, put in troops there, enough troops -- we have 68,000 troops in Afghanistan right now -- clear out the bad guys, crucially, begin transferring power to the Afghan army and the Afghan authorities, and see if it works, and see what the resistance is. This, after all, is the clear, hold and build sequence that counterinsurgency is meant to be about.

If it seems like it's working politically, maybe we can expand it to areas where we think it needs to go. This is the test of whether or not the strategy that worked in Iraq will work in Afghanistan.

Now, beyond AfPak, we have a superb discussion on the economy with two great minds -- Martin Wolf, the columnist for the "Financial Times," and Robert Shiller. Shiller is the economist who accurately predicted the financial crisis, but also, the stock market collapse of 2000. You will want to hear what he has to say.

Let's get started.

(BREAK)

ZAKARIA: Matthew Hoh is the young Foreign Service officer who resigned this week from his post in Afghanistan. He joins me now.

Matthew, I'm going to just start by reading a bit from your resignation letter. You say, "I fail to see the worth or value in continued U.S. casualties or expenditures of resources in support of the Afghan government in what is truly a 35-year-old civil war."

And then you go on to say, "Thousands of our men and women have returned home with physical and mental wounds. The dead return only in bodily form to be received by families who must be reassured that their dead have been sacrificed for a purpose worthy of such futures lost, love vanished and promised dreams unkept. I have lost confidence such assurances can any more be made. As such, I submit my resignation."

These are very strong words.

Give us some sense of what this insurgency that we are fighting looks like. What did you think people were fighting U.S. troops for?

MATTHEW HOH, FORMER MARINE CAPTAIN AND U.S. STATE DEPARTMENT OFFICIAL: The first place where I really had -- where this was codified for me and where I started to understand what we were doing and how we were involved -- the Korengal Valley, which I'm sure a lot of your viewers are familiar with. It's been on the cover of TIME Magazine. The "New York Times" refers to it as the valley of death. Off the top of my head, unfortunately, I can't remember how many American soldiers we have lost there, but it's probably 30 or 40.

This is a valley, I don't know, 15, 20 kilometers long. There's only 10,000 people in it. They speak their own language. They speak Korengali. In the year 2009 we have a valley with people who speak their own language. Their only trade is the timber trade. And when they move their timber, they don't even leave their valley. Most of the time, I believe, they just take it to the Mazar Valley, and a middleman picks it up and brings it to Pakistan for them.

We show up. We enter their valley. We occupy the richest man's timber mill. And then we bring in Afghan army and Afghan police, who aren't from there.

And then what do we do? Then we have the Afghan police and Afghan army. They say to the Korengalis, they say, "These mountains here that your families have been cutting trees down, sustaining yourselves for hundreds of years, you don't own them. The central government does. And you have to pay tax on that."

I'm not sure how many people anywhere else in the world wouldn't take up arms against something like that.

And so, and for every Korengal we're in, like I said before, there's a hundred we're not. And there's like -- and that would happen in those other valleys, the same thing, too, in the south. You'll go to, like, these remote FOBs, and you'll ask the commander of the FOB, who's a...

ZAKARIA: FOB means?

HOH: I'm sorry, a forward-operating base. And these are bases of maybe a total of 40 Americans led by, just by a 23-year-old lieutenant. And really, I can't say enough good things about those young men. And I really wish there was more media coverage about how hard their lives were and how difficult the fight is for them. They really are some of the best warriors the American Army has ever had.

But you ask them, "How many local Taliban groups are there around here? How many local enemy groups are there around here?"

And they'll say, "Five or six within a five-kilometer radius."

"Well, do they work together with each other?"

"No, they don't. They stay in their own areas."

This is a very localized population, a population that's really keen on its surrounding community.

The province I was in, Zabul province -- 300,000 people in about 1,500 villages. Each village is roughly about 100 to 500 people. And then you have some urban areas along the highway.

And so, it's a very localized problem.

ZAKARIA: I know that, after you made your objections clear, there was a scurry of activity to try and get you to stay. You had conversations with people like Richard Holbrooke.

Why was Holbrooke not able to convince you to stay? HOH: I accepted his offer for about a week. And then I realized that, if I believed in this mission, if I believed that...

ZAKARIA: What was the offer?

HOH: The offer was to join his staff and be put in a position where I could continue to write and try and influence policymakers from within the administration.

Two things. One, if I believed in the mission, if I believed it was worth our guys dying for, if I believed that 60,000 troops in Afghanistan would defeat al Qaeda somehow -- which it won't -- I would have stayed in Zabul Province, which I've told everybody was the second-best job I ever had in my life.

However, the other part of it, too, was I realized that the administration was going to make a decision shortly, and then I would be stuck. And if I don't believe in it, if I don't think this cause is right, if I don't believe it's justified, then there's no reason to take that position.

ZAKARIA: Were you surprised by the strong reaction to your resignation?

HOH: It's been a bit overwhelming. It's been a bit overwhelming.

My thoughts were this. I would publish the letter. And I figured I would get one or two days of attention, and then it would fade away. And I was fine with that.

However, I've received such an outpouring and a flood of e-mails, and particularly from two communities that have convinced me to stay in this and be a part of the debate as long as possible until it doesn't make sense any more. And those two communities -- one was Afghan-Americans.

I've had a lot of Afghan-Americans contact me and say, "Matt, you get it. You understand. Yes, there is a civil war going on. You understand this conflict (ph). You understand how Afghan society works. You understand this split within the Pashtuns. You understand valleyism, or whatever you want to call it." And that has encouraged me quite a bit.

And the second one is active duty military. I have received many, many e-mails from active duty military and some guys who have just separated from service. Some are here in the States.

I've gotten many e-mails from guys in Afghanistan -- some are people I know, but a lot are people I do not know -- men and women who are saying, "Matt, thanks for doing this. Keep it up. We don't know why we're here. We're not sure why we're taking these casualties. We don't know what it's accomplishing."

ZAKARIA: Do you think -- the top military brass have all endorsed General McChrystal's report and request. Do you think that down on the ground there is a very different feeling?

HOH: Oh, yes. Yes, there is. I think on the ground -- and the perspective is that, what is the strategic value of what we're doing here. Why are we doing this? What are we getting out of it?

It's not going to defeat al Qaeda. It's not going to -- if you take our two goals as being the defeat of al Qaeda, and then, because of its nuclear weapons and because of the relationship with India, the stabilization of the government in Islamabad, 60,000 troops taking 50, 60 dead a month in this country, and how many wounded and killing how many Afghans, as well, it doesn't accomplish either of those goals.

ZAKARIA: Why doesn't it defeat al Qaeda?

HOH: My belief is that, after 2001, al Qaeda evolved. They became, as I like to say, an ideological cloud. It exists on the Internet. They don't need a safe haven in Afghanistan. They've got safe havens in five, six, seven other countries.

ZAKARIA: Most importantly, Pakistan.

HOH: Most importantly, Pakistan.

And they recruit worldwide. The attacks over the last bunch of years, to include our own attacks on 9/11, were conducted by non- Afghans, non-Pakistanis. They were trained and prepared and planned for outside of the region, for the most part. Everyone knows that the flight training took place here in the United States.

This is an organization that is very ephemeral. It doesn't really exist. Occupying a country is not going to defeat them. It's the proverbial fly versus the sledge hammer.

And furthermore, if we keep 60,000 troops -- well, let's look at it this way. If there is 20 or 30 million people in the Pashtun belt of Afghanistan and Pakistan, how many recruits does al Qaeda get from there a year? We don't know, but it's probably in the hundreds, at the most, by far. It's probably not even that many.

Well, in a population of 20 or 30 million, how are you going to keep 100 people from being disaffected and joining some fringe group? That's impossible.

Furthermore, occupying a location only provides justification and only lends credence to the goals of that organization. It only inspires young Muslim men to want to defend their culture against an occupying army, which is what we are.

ZAKARIA: And we will be back with Matthew Hoh in a minute.

(BEGIN VIDEO CLIP)

HOH: In Iraq, everyone lives along the river valley, in fairly decent-sized urban areas that we were able to control. In Afghanistan, it's a peanut butter spread of villages across the entire terrain. (END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: And we are back with Matthew Hoh.

Now, you talk about -- so all these people we're fighting are Pashtuns. And you say something here, which is, "The Pashtun insurgency" -- I'm reading again from your resignation letter -- "which is composed of multiple, seemingly infinite local groups, is fed by what is perceived by the Pashtun people as a continued and sustained assault, going back centuries, on Pashtun land, culture, traditions and religion by internal and external enemies.

"The U.S. and NATO presence and operations in Pashtun valleys and villages, as well as Afghan army and police units that are led and composed of non-Pashtun soldiers, provide an occupation force against which the insurgency is justified.

"In both RC East and South, I have observed that the bulk of the insurgency fights not for the white banner of the Taliban, but rather against the presence of foreign soldiers and taxes imposed by an unrepresentative government in Kabul."

Now, why are the Pashtuns alienated from the Karzai government?

HOH: The way I see it is this, is that there's a split within Pashtun society. And it's a split that goes back at least for 35 years since the fall of the king's reign.

The fact is that there is an urban, secular, educated, progressive class. And then there is a rural, poor, traditional class.

ZAKARIA: Within the Pashtun...

HOH: Within the Pashtuns -- and within the country as a whole, as well.

I firmly believe that we are taking part in a civil war. We are on the same side of the civil war that the Soviets intervened on. I think a lot of people forget that the Soviet Union didn't start the revolution in Afghanistan, but they actually entered to try and stabilize the country, because it was such a mess after two or three years of full-blown civil war there.

It's interesting. The Afghan...

ZAKARIA: And to play out what you're saying, just so I understand it.

HOH: Sure.

ZAKARIA: So, you have a divide among the Pashtuns. There's the urban middle class. And Karzai, presumably, who is a Pashtun, comes from this urban middle class. HOH: Correct.

ZAKARIA: Many of them left the country after the -- during the years of the civil war. And the ones who have stayed to fight, who fought the Soviet Union and who are now fighting us, are the rural, mountain tribe Pashtuns who resent the central government and its intrusions.

HOH: Who want to be left alone.

ZAKARIA: Who want to be left alone.

HOH: As one Afghan National Army general said it, he was very proud at Afghan independence, the celebrations, that the province he came from was one of the first to rebel against the central government. "And the reason why," he said, "is because the central government came to our villages and asked us what our wives' names were."

ZAKARIA: That's it?

HOH: That's it. And it's that intrusion into their lives that they resent, that they don't want.

ZAKARIA: Why has Karzai not been able to fix this? He is a Pashtun.

HOH: Again, I don't think it's -- there's no desire for him to fix it.

My belief is that this is a civil war, that we're taking one side of it.

Civil wars can end because one side just decimates the other. Or they can end, because both sides just tire of it or segregate themselves. Or they could end because of political reconciliation.

As of yet, there's been no desire by the Karzai regime to reconcile politically with any of the -- with anyone against them. And I...

ZAKARIA: So they see themselves -- I mean, he is part of a kind of urban Pashtun group...

HOH: Correct.

ZAKARIA: ... that has allied with the Northern Alliance, with these Tajiks and Uzbeks, against these rural Pashtuns. And he doesn't want to really make peace yet, because he's got the spoils of victory.

HOH: There's no benefit for him to do so. There's no benefit for him to do so.

ZAKARIA: People talk about talking to the Taliban. I mean, you're there on the ground. Is any of that going -- and let's say just talking to the insurgents, so that we don't get confused on this, the Taliban.

HOH: Sure, yes.

ZAKARIA: Is any of that going on?

HOH: Not that I saw. Nothing that, certainly, was effective that I saw.

Our policy -- and this was a bad policy -- our policy from the State Department's side and from the military side was, reconciliation is an Afghan issue, and we don't get involved in it.

Unfortunately, the Afghan government has no interest, like we just discussed, in actually reconciling with the people they're fighting, because there's no benefit for them to do so.

I just saw that the president this week authorized spending to try and reintegrate or reconcile with Taliban groups. Basically -- I don't know if flip is probably the right term to use -- but that is a step in the right direction. However, I'm not sure if we have the ability to do that. I don't know if we have the right people or the right skills within our forces to do something at that level.

ZAKARIA: You were in Iraq as a soldier. One of the arguments made about General McChrystal's report is, look, the surge worked in Iraq. You provided troops. You gave the population security. As a result, they felt comfortable allying against al Qaeda, allying with the government. The same would be true in Afghanistan.

What do you say?

HOH: I was on a -- first of all, Iraq and Afghanistan are different.

I was on a U.S. embassy team in Tikrit, Iraq, the birthplace or the home of Saddam Hussein, in 2004, 2005 doing governance and development operations closely with the military.

ZAKARIA: And it was also one of the hotbeds of a lot of the insurgency in Iraq.

HOH: Correct. And that was a Sunni nationals insurgency there until al Qaeda came in, al Qaeda in Iraq, really formally came in there.

I saw that place go, completely descend into chaos. We lost complete control of Iraq during that time. And it started to lead into that awful, awful blood bath where -- of that civil war they had.

I then was in Anbar Province as a commander of a Marine Reserve -- commander of a company in the fall of 2006 and the spring of 2007, where we turned that around.

It's a completely different scenario. I've done population control that they advocate. I've done it. I've bermed in cities. I've used biometrics. We've cleared cities. I've participated in that.

It's a different situation than Afghanistan.

When I came home, I got asked by a member of the administration, they said, "Oh, so you're not a COIN guy, a counterinsurgency guy. You're a C.T. guy, a counter-terrorist guy."

ZAKARIA: COIN being counterinsurgency, C.T. being counter- terrorist.

HOH: And my point is, you can't do this. It's not two camps. It's not like you're a Keynesian or a Friedman. You have to look at each place and analyze it thoroughly, and then apply a unique solution for each location.

And in the case of Afghanistan, you have 34 provinces. There's at least 34 different solutions.

And I have sympathy, a lot of sympathy for the folks at the embassy and at the military headquarters there, as well as the senior leadership here in D.C., because it's a very complex and very difficult situation. You can't cookie-cutter.

ZAKARIA: But the fundamental point you seem to be making -- correct me if I'm wrong -- is that, in Iraq the population was feeling insecure because of the insurgents, and so, securing them made perfect sense.

HOH: Correct.

ZAKARIA: In Afghanistan, actually, the population feels secure, if you leave them alone.

HOH: Correct.

ZAKARIA: And that they're really resenting your intrusion much more than they were in Iraq.

HOH: Correct.

In Anbar Province along the Euphrates River Valley, west of Ramadi, where I was, we were primarily fighting al Qaeda in Iraq. And there were a lot of Iraqis who were part of that, but it was led primarily by foreigners. And they offered nothing but murder and intimidation to the population. They were terrible.

And we used to say, if al Qaeda in Iraq had its act together and they offered something to the population other than murder and intimidation, we would be in a lot of trouble. And it's true. The population was definitely scared.

It was horrible. Al Qaeda in Iraq was a terrible, terrible organization. And so, we had that, and we were able to do that, and we were able to defeat them that way.

They were also small in number. There weren't a lot of them. And then we had, and also, too, the way the population and the terrain was in Iraq -- completely different. In Iraq, everyone lived along the river valley in fairly decent-sized urban areas that we were able to control, that were connected by one or two roads that we were able to control.

In Afghanistan, it's a peanut butter spread of villages across the entire terrain. And that terrain is just completely rugged. It's impassable in some places.

It's funny. We would talk to the Afghan National Police in some parts of the province. And they would ask for not more pickup trucks, but they'd ask for motorcycles, because the only thing you can -- the only thing probably better than a motorcycle to travel around on is a donkey there, because the terrain is so difficult to navigate.

ZAKARIA: What will happen if we do not go with the McChrystal plan, or we go to a very small troop increase? What will the troops who are there now do? And should we actually draw down some of these troops?

HOH: Oh, I do believe we should draw down. I do believe we should recognize we're in a civil war. I do believe we should recognize our priorities are the defeat of al Qaeda and the stabilization of Pakistan.

I'm by no means a Pakistan expert. But increasing troops is only going to fuel insurgency. We need to stop our combat operations in areas where we are fighting people only because they're fighting us.

Otherwise, it's going to be 2013, we're going to look back four years, and we're going to say, what have we accomplished? What did we get? What was this worth? What did we get out of this?

We might be able to stabilize the Afghan government in five to 10 years with a lot of resources. I believe we can militarily defeat the Quetta Shura in two to three years with a lot of resources and a lot of dead.

However, is it worth it? What do we get out of it? What's the benefit of us doing it? It doesn't politically defeat the insurgency in the south. And it doesn't, more importantly, it doesn't defeat al Qaeda.

ZAKARIA: Matthew Hoh, a pleasure to have you on.

HOH: Thank you.

ZAKARIA: And we will be back.

(COMMERCIAL BREAK)

ZAKARIA: Now for our "What in the World?" segment.

What got my attention this week was evidence that people are spending -- not in America -- in China. This could be a great boon for the world economy, because someone has to take the place of the American consumer.

So far, the Chinese have been great savers, both individually and as a nation. But there are signs that this might be changing. They are now being encouraged to spend -- straight from the top.

To stimulate big-ticket purchases, the Chinese government has been offering subsidies on many cars and home appliances. And it seems to be working. In September alone, Chinese consumers bought more than a million cars. And many analysts believe China is on track to overtake the U.S. and become the world's largest car market this year, 2009.

And it's not just cars. The beginning of October was a big holiday in China. Most Chinese had a whole week off to celebrate the People's Republic's 60th anniversary.

And what did they do with their time? Many of them shopped. Cameras, phones, TVs and jewelry were apparently all hot tickets.

According to the government, Chinese consumers spent $83 billion -- a 20 percent increase over the same holiday period last year -- while in the U.S., retail sales fell almost 6 percent in September compared with the prior year.

Now, in coming years, the Chinese will have even more to spend. Studies suggest that China's population is going to double its income in a 10-year span. McKenzie and Company says that by 2015, 50 percent of China's urban households will be upper middle class.

Now, with consumption comes the usual problems -- credit cards and debt. But it will take a long time and a lot of spending for China to catch up with America's troubles on those fronts.

China is starting to become a credit card society, especially among urban upper classes. A recent traveler to China told me he stood in line at a bank in Beijing, and he was behind a woman who seemed to have 30 credit cards in her wallet.

Now, many Chinese aren't paying off their credit cards. In the first six months of this year, the number of credit card accounts with payments two months overdue rose 133 percent. So, hopefully, the Chinese aren't learning too many bad lessons from the United States about charging themselves into bankruptcy.

And it still remains true that the U.S. could learn some very important lessons from China. At last check, the Chinese were still saving about 40 cents per dollar of disposable income. In the United States, it's more like three cents.

(BEGIN VIDEO CLIP)

ROBERT SHILLER: Because we're talking about people, and people who are just as smart as we are, and they're changing their way of thinking. And the institutions move faster than we can figure them out.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: We learned this week that the American economy grew for the first time in a year, and there was another seemingly positive sign. The closely watched Case-Shiller Home Price Index rose 1 percent.

If that sounds like good news for you, not so fast. Economist Robert Shiller of Yale University -- yes, he is the Shiller of the Case-Shiller Home Price Index -- is not so sure. He's my guest today -- welcome -- along with Martin Wolf, the chief economic commentator at the "Financial Times."

Welcome, gentlemen.

To me, you are an interesting figure, because you have called both of the last two bubbles that burst, the stock market bubble and the housing bubble. And you actually predicted that there would be a housing bubble that was going to be connected to finance. So, you saw tell-tale signs twice in the last 10 years accurately.

What are you seeing right now?

ROBERT SHILLER, ECONOMIST, THE CASE-SHILLER HOME PRICE INDEX: I wish I could see more clearly. I only write books when I feel like I know what's happening. I wish we understood exactly. The stimulus packages don't really seem big enough to have accounted for this.

I think that maybe the big thing was that we prevented collapse. In 1933 there was massive bank failures, and this time we didn't. We didn't have bank runs. Back then, there was the specter of people lining up outside of banks and failing to get their life savings.

So we've protected -- and so maybe that's it. Maybe there is just some spontaneous recovery of confidence, when you think of your government as basically good and responding to the crisis, even if the response might not have been big enough by itself.

ZAKARIA: But as a result of that, from very deep lows, you have seen asset prices go up quite a bit. Let's just take the developed world. You've seen the Dow Jones go up 30-odd percent. You've seen European stock markets go up. You've seen housing go up.

Are we now in the midst of a second bubble?

I say this, because I know there's a piece in Newsweek that quotes you saying that, effectively what happens often in financial crises is, to resolve the crisis the authorities, the monetary authorities loosen up credit and ease up on the money supply, and then the government spends money. And all this money produces a secondary bubble.

Are we in the midst of a second bubble? SHILLER: Well, it looks like we might be.

You know, I think you understated it. The S&P 500 rose almost two-thirds from its very bottom on March 9th until recently. It's the biggest turnaround in the stock market since the Great Depression.

ZAKARIA: Who are the stars in this turnaround? Bernanke, clearly is the -- is he the most important central banker, not just in terms of controlling the Fed, but in having been the most energetic in this process?

MARTIN WOLF, CHIEF ECONOMICS COMMENTATOR, "FINANCIAL TIMES": Yes, I think that history will treat Mr. Bernanke very kindly. He clearly -- there's no question, and I've commented on this before -- was wrong at the beginning. He famously downplayed the significance of the subprime crisis, right up to the summer of 2007.

But there's no question, among the major central banks, he realized the severity of the problem before anybody else. And he and his institution have been astonishingly imaginative in putting fingers in every dike you can imagine in trying to get sustained securitization. I mean, to the extent that there is a securitization market in the U.S., it's because of the Fed and the government- sponsored enterprises, Fannie Mae.

So, but particularly the Fed, I think the Fed has been quite remarkable. They knew what happened in the '30s. They were -- it's very clear. Mr. Bernanke repeats this to one, that they think now they were on the verge of the '30s. And they, I think, have taken measures which have prevented that sort of meltdown.

ZAKARIA: So, weigh in on this issue that takes up a lot of popular energy and attention.

On the one hand, there are people who say, "These banks were bailed out with taxpayer money. They would not exist, many of them, if not for the taxpayer money. And, certainly, they would not be able to make the profits they make without the cheap money from the Fed.

"And look at what they're doing. They're using it to trade. They're making enormous profits, and they're paying huge bonuses."

On the other side are the banks that say, "Look. You wanted a healthy banking system. You want us to have high capital ratios. How do we have high capital ratios? By keeping the capital and not lending it out. And by the way, in order to retain our talented people, of course we've got to pay big bonuses."

Where do you come out on that?

WOLF: Well, I wrote in one column recently that success really feels like failure. And it is important to stress that there was a basic success.

Bob made the point, I mean, that a year ago there was a real question about how much of the financial system would just exist. And governments around the world made the decision that, whatever it cost, they would write the insurance. Essentially they insured the whole system. It's why confidence has returned. It's why the financial system still exists.

And we wanted that to happen. And we want them to be profitable, because we want them to retain earnings and accumulate capital. So, it's very problematic, of course.

I must say that, I am myself pretty irritated, to put it mildly, about the bonus story, because this is -- as George Soros pointed out very recently -- this is a gift, essentially. They didn't earn it. It was transferred to them from the state, from the state, broadly speaking.

SHILLER: Well, I agree with Martin that it's an annoying issue. And it's breaking our sense of social compact. People are angry, and justifiably so.

But what to do about? To me, I would hope that this would spur public discussion about the structural problem that inequality, economic inequality, has been worsening in the United States and in other countries for 30 years. And it's gotten really -- especially at the high end -- it's gotten really off.

And it's not like we want to level income. I'm not saying spread the wealth around, which got Obama in trouble. But I think, I would hope that this would be a time for a national consideration about policies that would focus on restraining any possible further increases in inequality.

This, I think, is potentially the big problem which is bigger than this whole financial crisis. If these trends...

ZAKARIA: Why?

SHILLER: If these trends that we've seen for 30 years now in inequality continue for another 30 years, we're going to look like -- it's going to create resentment and hostility. It's not a country that -- we could turn into a country that even the rich would rather not be in.

We need -- what's beautiful about America is our sense of cooperation, our sense of we're all in this together, we're all citizens of this country. And we don't want an economic system that has a winner-take-all aspect to it.

And I think we ought to think about -- I have a proposal. I've talked about this in my other, some of my books. I have proposed that the government should index the tax system to inequality. I have a paper with Len Berman on that.

ZAKARIA: So, in other words, as inequality rises...

SHILLER: Automatically.

ZAKARIA: ... taxes rise, so that you... SHILLER: That's right.

ZAKARIA: ... can dampen some of this effect.

SHILLER: And we do that now in advance, even on a partial basis. So, we do have a progressive...

ZAKARIA: You know, lots of people probably think this is kind of quasi-communist.

SHILLER: I've heard that, but I don't think -- I think this is free market. This is to forestall the kind of resentment that leads to revolutions like that.

This is keeping our capitalist system and allowing people to get rich.

But just as rich as they are today -- let's not let this go astronomical, which is what it might do.

ZAKARIA: We will take a break, and we will be right back.

(COMMERCIAL BREAK)

ZAKARIA: And we are back with Robert Shiller and Martin Wolf, two of the great minds of economics.

Just on housing, because you really know this subject, do you think that it is unsustainable to have this return, these 10 percent rises in housing prices that are happening in urban markets in America?

SHILLER: Well, home prices have come down a lot, and so they're no longer so pricey. And in some cities, you know, in Vegas they're down 55 percent from the peak just a few years ago.

So, there's real -- and we could have some further increases. But I just -- still my instincts are that we're not going to have a bubble like we just had, which was historic. It was the biggest ever.

How could we have such a big bubble now, with all the problems that we have?

ZAKARIA: But does it mean these increases are real? Or does it mean that -- what?

SHILLER: Well, I think that it's plausible that they will increase for a while, in the short run. It's such a -- one thing I've learned about housing is momentum. Housing prices, they can go for years in the same direction. It's not like the stock market.

And they've been going up so smartly, that it is very plausible to me that we're going to see months more of increases. But whether it's years more, that's another thing.

ZAKARIA: In other words, whether it's sustainable. SHILLER: And the worry is...

ZAKARIA: Isn't housing meant to be a product of employment numbers? That is, as more people...

SHILLER: Right.

ZAKARIA: Right. But in the long run, if you don't have rising employment, how can you have rising home prices?

SHILLER: Well, that's what we've learned. I used to forecast home prices. And we learned: number one thing, momentum; number two thing, employment.

ZAKARIA: Interesting, interesting.

WOLF: Well, I think, in terms of deciding whether we're now seeing bubbles in these various markets is incredibly difficult to determine at this sort of level. I think it's important to distinguish rates of change from levels.

We have very deep troughs in pretty well all these asset markets. And there have been very big recoveries, and they look very impressive when we think about the percentages.

Bob knows more about this than I do, but if you look at the S&P, which has really gone up very considerably, in real terms it's way, way below where it was in the really big bubble, which is now 10 years ago, 1999 (ph) and (ph) 2000. And basically, at most, it's restored most of what it's lost.

So, I think it's very difficult to say -- and the same applies to housing -- that the levels of these prices for most of these assets look unreasonable.

So, what is, I think, a question is, how long can these rates of change continue? And of course, there is a question of what will happen when -- it's not an "if," it's a "when" -- monetary policy is tightened. That could well give something of a jolt.

ZAKARIA: Are you comfortable with the new financial reforms? Do you think we're doing enough?

WOLF: I think that we have got some of the story, clearly, right. We're going to raise capital standards. That's generally agreed.

Then begins to come the really difficult things -- having a new resolution authority, which allows you to wind up failing institutions, and then a way of handling the trading relationships between institutions, particularly in derivatives markets, in such a way that, if an institution is wound up, it doesn't cause the sort of chaos we saw when Lehman failed a year ago -- this sort of what I think of as taking down nodes in the network without destroying the whole network. Now, those are really difficult things. And over and above that, we have the problem of the time horizon. We don't want to impose all these higher standards right now. We want them to have more capital, but actually, we want them to lend.

So, there is a danger that they're going to be too cautious now. They're getting more capital in the system, but they're not lending. They're just playing games on the financial markets, making lots of profits.

So, we're making some progress. But can we be absolutely sure we'll have a definitively safer financial system globally after this? At the moment, it's not clear to me.

ZAKARIA: You know, you write a lot about behavioral economics, the way in which economics is not just a purely rational science, that human beings' psychology comes into play.

What I'm struck by listening to both of you is an enormous sense of uncertainty about what the future will be. I mean, you seem -- we seem to be in times where it's very difficult to boldly make a prediction. Why is that?

SHILLER: I would say it's because we don't -- the reason we don't have a science of economics as much as we'd like, is because we're hit by rare, black swan events from time to time. And those matter enormously.

We had the Great Depression in the 1930s, and we had a near miss just now. And it hasn't happened. You know, we have 70 years. We don't have many observations.

You might be asking us to be like weather forecasters, but weather forecasters have computed -- how many hurricanes have we had? We've had, like, hundreds of them. And in the same span, we've only had two depressions -- two near -- a real depression and a near depression.

We don't have a science, A, because of these rare events, and B, because we're talking about people, and people who are just as smart as we are, and they're changing their way of thinking. And the institutions move faster than we can figure them out.

ZAKARIA: Herbert Simon, who won the Nobel Prize in economics, had a great line. He said, the reason this is not a science is that the subjects of our study think -- unlike particles.

Martin Wolf, Robert Shiller, thank you so much.

And we will be right back.

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ZAKARIA: Now, for our Question of the Week.

Last week I asked you: Do you think the upcoming elections in Afghanistan can be free and fair?

Most of you said -- well, I'll let viewer George Cooper say it -- "Good luck, Afghanistan."

Mr. Cooper made this trenchant observation.

"It is hard to see how there will not be widespread fraud in a country where democracy is a charade at our behest. Afghanistan is not really set up for a meaningful central government."

Now, for this week's question, let's stick with this idea, because it really gets to the heart of the matter.

Do you think democracy is even possible in Afghanistan?

Remember, this is a country in which it has never really existed. But that doesn't mean it can't happen. Let me know what you think, and why.

As always, I want to recommend a book. This one is by the economist, Robert Shiller of Yale, who was one of my guests today.

He wrote it with Nobel Prize-winning economist, George Akerlof. It's called "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism."

Long title, great book. The animal spirits of the title are the hunger and enthusiasm for creating and spending and investing that make the economy hum. Shiller and Akerlof argue that these spirits can only be revived by massive government intervention programs.

It is behavioral economics. If people believe that credit and money are readily available, they will climb out of recessionary gloom and bring the economy back to health. It's fascinating stuff. It's a kind of Sigmund Freud meets John Maynard Keynes.

Now, please remember to check out our Web site at cnn.com/gps. We're adding new content and new viewers every week.

Thank you for being part of my program this week, and I will see all of you next week.