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If reading the papers has given you the general impression that Washington, D.C. is sorely lacking in leadership, try looking at it through Kim Wallace's prism. If you can bear it.

Wallace is chief political strategist for

Lehman Brothers

, and his job is to evaluate inside-the-Beltway goings-on from an investment perspective for the bank and its clients.

He doesn't particularly like what he sees.

One of the most grievous situations in Wallace's view is fairly abstract. The U.S. hasn't done enough to explain itself and its recent economic success story to the rest of the world, and as a result risks breeding petty jealousies that stand in the way of efficient markets. "Given the prosperity," he said in an interview this week with


, "given the fact that we are, as much as anybody, catalysts for this opening of the world, we ought to try harder. There are obligations that come with being a superpower, economic and strategic. I would argue that Washington, as a policymaking apparatus, has not given due attention to being understood fully throughout the world."

The good news from the Hill, in Wallace's view, is that investors don't have a lot to fear from the upcoming elections. "Both parties have been sufficiently imbued with this notion that prosperity is good for politics that both of them are risk-averse to upsetting what's been going on the last nine years," he said. "So I'm not sure investors should anticipate a great change in policy on the individual sectors or macropolicy in this election."

Lately Wallace has also been thinking about the risks of investing in Latin America, the ways in which the tax code is likely to change as a result of Internet transactions, the fate of Taiwan, and the outcome of the presidential election.

Wallace joined Lehman in 1994 as a senior political analyst. From 1990 to 1994 he served as a legislative assistant to Senate Majority Leader

George Mitchell

, (D-Maine) specializing in fiscal policy. For three years before that he was an analyst for the

Senate Budget Committee


-- Elizabeth Roy

Wallace met with members of's

editorial staff, including Executive Editor Jonathan Krim, Associate Managing Editor John J. Edwards III, Markets Reporter David A. Gaffen, Associate Editor Jennifer Howze, Associate Editor Justin Lahart, Staff Reporter Scott Moritz, Senior Writer Ian McDonald and Senior Writer Elizabeth Roy. The transcript of that interview follows.

Greatest Current Risks

Beth Roy

: "Can you tell us what you see as the greatest risks to the current state of affairs in the market? Is the road open broadly that way?"

Kim Wallace

: "The greatest risks are probably the stresses to the international financial structure that you only know about once the calamity has occurred.

"Other threats: As we continue to grow markets, and grow the world through so-called globalization -- the ability of electrons and people to move around real fast -- a premium is placed on very cogent, consistent and clearly communicated international policy, just so that moves are understood for what they're meant. Sure, there's diplomacy, there's always some guesswork around it, but, going forward, it's going to be very important that the top 20 countries of the international system understand each other and have trust in those communications links. Because mistakes are going to happen, and some of those mistakes, particularly in the financial world, are hard to unwind very quickly. The response takes some time, though that will be helped by better international relations.

"We don't have those now, in my estimation. I think there's going to be some work done."

Beth Roy

: "I'm having a little trouble understanding the second point that you're making. Is there an example of something that's occurred recently?"

Kim Wallace

: "In my view, most of the strongest parties in the Middle East have doubts about the serious intent of the


administration in international affairs. I think the same can be said of our trading partners in Asia, and to some extent, Western Europe, particularly during the Kosovo war conflict.

"There were questions in NATO that had a lot less to do with military affairs than with political affairs, in terms of who was leading the effort and what was the original aim when you declared victory.

"Part of that had to come from the different experiences and economics in the last 10 years on either side of the Atlantic: red-hot economy over here, very strong bull market into its second leg, coming off of a bull market that started in the '70s -- very different experience in Europe.

"The capabilities of the joint war fighters, if you will, NATO, was very different in the field. It became apparent quickly that we could not, as NATO, fly joint missions because our materials don't speak to each other. The systems of our aircraft are so far advanced compared with the systems of most of the NATO countries that the only time we could use our whole capabilities was when we took on sorties ourselves. That builds up envy that leads to the possibility for misunderstandings.

Dumb Luck and Personal Relationships

"I think an example of that is

The Economist

-- in my view a very good media outlet -- that in one way or another questions the prosperity of America, how long it's going to last and the sensibilities of the policy. It's almost as though we continue to dumb-luck our way into this, decade after decade after decade.

"You're dealing with human emotions, you're dealing with relationships, and that involves human beings and sometimes they get jealous. I think that leads to misunderstandings. I think it leads, to some degree, to pettiness, that can lead to wider gulfs in relations that in fact hurt."

Beth Roy

: "And what are the market and investment implications?"

Kim Wallace

: "The investment implications are that if London takes on this London vs. New York City -- who's going to be the real financial center of the world? -- and begin to pay attention more to that than they do to fast, efficient, trusting clearing -- that potentially leads in problems.

"If the decisions made by the

World Trade Organization

, or the


, the


for that matter are more aimed at 'leveling the playing field,' rather than achieving mutually beneficial objectives, that has potentially destructive consequences."

Justin Lahart

: "So it sounds like you're saying the Clinton administration has not adequately explained our prosperity to the rest of the world."

Kim Wallace

: "Or the strategies and policies that led to it and that can possibly keep it going. It's not just the Clinton administration but we've got a Congress that in the last five years has not sent very clear or very constructive messages about international relations. I would say Washington has some distance to go to explain itself to the world, while reflecting the value of Americans. Also building an international policy that is more sensitive to what's going on in the world. The world is a bigger place than it was 10 or 15 years ago. A John Wayne-type State Department does not work for us any longer."

Justin Lahart

: "It sounds like what you're saying is we're not managing the jealousy."

Kim Wallace

: "Yes. And we're not managing the relations that, if left on their own, build to jealousies. We didn't build this prosperity in the last 10, 15 years at the expense of the European different developmental paths. An example would be, three years ago people wondered when and if it would happen in Europe, and now a lot of the capital that was once here is chasing over their system, in my opinion. And we're at different places along that continuum. It's important that we understand and recognize that, and that there are sensitivities that flow from that."


"Do you think we're seeing some of this in the current



Kim Wallace

: "We're seeing it in OPEC negotiations, the fact that the ministers of the cartel are not drastically motivated to make sure that they take care of our political issues with gas prices going up, and the longer-term economic issues of supply, is an outgrowth of what I'm talking about. The failed ministerial meeting in Seattle is an outgrowth of what I'm talking about.

"The developing nations came there absolutely sure that they were not going to give a millimeter to the U.S. -- one, to a president that was going out, seeking to build a legacy; two, to a U.S. trade regime that thought it could put together an agenda and implement it almost ad hoc.

"And then from the EU side, there was absolutely no willingness to help out in that effort. Seattle failed before they landed on the ground because of lack of communication, the manifestation of the problem I'm talking about."

New President, New Politics?

Jennifer Howze

: "Do you think that a new president coming in can do things to change that much?"

Kim Wallace

: "The pressure will be for that to change, absolutely. When Clinton came in 1992, and you could even go back to 1996, the importance of understanding growing global markets, and the necessity that our moves, both strategic and political, be completely understood by our trading partners and strategic allies, in my view at least, was subjugated to domestic political issues. Now, I don't hit Clinton for that as tough as some people do, because every leader of every country considers domestic politics while they're doing international relations, that's a fact. But given the prosperity, given the fact that we are catalysts for this opening of the world, we ought to try harder. There are obligations that come with being a superpower, economic and strategic. I would argue that Washington has not given due attention to being understood fully throughout the world."

Ian McDonald

: "What kind of policy do you think would be more inclusive and constructive rather than apologist for the jealousy?"

Kim Wallace

: "We've got to demonstrate that even as we attempt to protect the environment as it is in the year 2000, that in 1700, 1800 and 1900, we were great users of the environment to get where we are economically, and that those choices are more difficult now for developing countries than they were for us because of the abundance when we were developing.

"For example, I think that the issue of labor rights has got to be looked at through a prism that takes into account places along the developmental continuum of various regions and countries and those regions. It's not as easy as saying that Company A should close down sweatshops, when, in fact, some of that activity provides livelihoods to people who would otherwise not have it.

"Those decisions need to be addressed from a salvage standpoint as well as an international relations standpoint. That takes a long time for a politician to first assimilate and communicate in a way that constituents can care about, and then are willing to follow. The risks of spending time on that exercise are great in this political environment. At some point, they have to lead."

China's Position

Scott Moritz

: "Do you think that whoever takes over after will be able to accomplish those objectives, once they deal with China and its entry to the WTO? One of Clinton's objectives is to try to change their internal policies through increased trade."

Kim Wallace

: "I'll talk about the general one, and answer your question, which was related, then I'll get onto China specifically. The answer is yes, but I think largely because the pressures are going to come to participate more in this global economy, and there will be new responsibilities in doing so. We will have pressures placed on our multinationals if they continue to invest deeper into the markets that bleed back into the political system.

"So, yes, you can't avoid it. The question is, how do you manage it and how do people benefit from it, winners and losers?

"China, specifically. It is much more likely that people in the free trading world are going to be able, over time, to affect social policies in China once we have engaged China, fully, economically. The change will be slow, on all counts, simply because that's the pace of that culture and that political system. To anticipate anything else, you're almost kicking yourself. In my view, some policymakers don't present the question to themselves: Either I reward China for bad behavior by giving permanent normal trade relations status, or I use the stick to force them to change by denying it, is probably not accurate any more."

Scott Moritz

: "Well, isn't that what Clinton's done? Sort of tried to walk that fine line?"

Kim Wallace

: "He is trying to walk that fine line and so are the opponents, and other proponents. By that I mean, let's break the proponents up into factions: people concerned about national security, people concerned about human rights, including religious rights, labor rights, and the rest.

"Clearly, they are basing their positions on past and current circumstances, not engaging what might be in the future, and almost ignoring trends that are occurring in China after its membership in the WTO. You cannot credibly argue that China, the regime, is the same as it was in 1959 as it was in 1999.

"You can make the argument that they haven't gone far enough, there's repression across the board. But to say that there hasn't been progress is to ignore the progress. Proponents who look at the economic argument, obviously they had to make people comfortable with this notion that change will come slowly but change will come, and therefore the economic engagement is in our interests now, and over the long haul."

Investors and the Incoming President


: "What sort of issues, domestically, do investors in telcos and drugs in the financial sector need to be aware of in this election year?"

Kim Wallace

: "Well, I'm of the view that both parties, right now, have been sufficiently imbued with this notion that prosperity is good for politics, that both of them are risk-averse to upsetting what's been going on the last nine years. So I'm not sure investors should anticipate a great change in policy on the individual sectors or macropolicy in this election.

"What's going to happen in the next two years after the election, you have to look at what's going to happen in the next five years, because unless we get unified government in Washington, the policy outcomes are likely to be pretty much similar to what we've got going now, from an economic standpoint, from a market standpoint. You don't have liberal Democrats who are looking forward to taking chairs in the House so that they can wreck the economic engine. That's folly. There's no one out there who's thinking that.

"When people who fear the Democrats coming into control of the House use

Charlie Rangel

as the poster child for going back to backward policies, it's mainly make-believe. Charlie Rangel is a seasoned legislator who's very much a liberal, but who also understands that prosperity pays off for liberals as well as his constituents and conservatives.

"It is unlikely that as Chair of the

Ways and Means Committee

he's going to come forward with a plan that worsens our fiscal situation. I think the play in this election is down at the state level, because the legislatures will use the 2000 Census, however accurate it may be, to draw legislative districts for the next 10 years. It's very important, whether you're anticipating a completion of the Reagan realignment that started in California in the early and mid-'70s, or if you think there will be something of a snap back to more moderate policies in the national legislature.

"What's happening down at the states is a lot more important over the long term than what's going to go on in Washington with the electoral standoff, in my view.

"And out of all of that, I don't think economic policy changes greatly."

Latin America as Test Case

Beth Roy

: "If I could jump back to the very first point you made about stresses to the international financial structure that don't present themselves immediately, we don't know about them until the crisis occurs -- are there parts of the world, or countries or aspects of the financial system that you're concerned about?"

Kim Wallace

: "I'll start with the public concerns of policymakers who do this for a living. Treasury Secretary

Larry Summers

made a great case in the media yesterday, both from an economic standpoint to North Americans but also as a test of whether or not in this growing world prosperity are the haves and the have-nots going to figure out a way to bring the have-nots along and make their lives a little bit better than they were, say, in the '60s or the '70s?

"Latin America presents itself as a very good test case. It is attempting to open to more market forces in its economies, and that is placing tremendous stress on the domestic political systems as well as the domestic financial systems -- much less the trading systems of South America -- to the extent that you have leaders in those countries willing to take the risks to move forward in a way that most policymakers think sets you up for the next decade or two, as opposed to going backwards to deficit spending and abject poverty in those areas. That's a great risk, I'm not going to call it a crapshoot, but definitely, there are pressures on the go-backwards side in Latin America, that are domestic.

"Again, politicians don't always like to be visionaries and take people forward in great leaps and bounds. Many times, they just like to be re-elected. You know, people are taking personal risks. But risks that are worthwhile."

Jonathan Krim

: "A lot of people are, there's sort of this investment craze for the TMTs type of media, telecom ..."

Kim Wallace

: "Thank goodness."

Jonathan Krim

: "It seems like a lot of what you see is sort of a global movement, and we see a lot of investment by U.S. companies in emerging markets. What kinds of risks are there? It seems like -- since you are dealing with information, is that the risk of people worrying about U.S. hegemony in those areas?"

Kim Wallace

: "A couple of issues there. First, is the cultural issue, I think addressed most often, and most loudly, by the French and the Canadians. The other aspect of your point is the difference between portfolio investment and direct investment. The direct investment stock in telecom and technology is, generally, on the whole, all positive because you are bringing a factor that multiplies capabilities of people, that allows for distance learning, that allows for telemixing, that allows for the sharing of information, both in terms of portfolio investment and just information about anything, that heretofore was not possible.

"Generally, that's good. The smarter people are, the better their countries are and the more open their markets tend to become. All in all, that's good. But the danger is in the portfolio investment side that you alluded to.

"Not all of these companies that jump 120% every month are worth that and, more importantly, will be worth that in two to five years.

"You all know, because you write about it frequently, that the makeup of the investor segments in the U.S. right now, by and large, has not been through a shock to the system like we witnessed in 1987, and in the early '70s. We don't know how they will react. The


reports to this in February's bulletin, that now 52% of U.S. households are invested in the markets, one way or another, up from 27%, 15 years ago.

"To the extent that markets have volatility and that exhibits itself in gyrations that last longer than a week, or two or three, we don't know how investors will behave. We don't know the impact to all companies, we don't know the effect to the economic system should that kind of a shot come."

Internet Taxes and the Black Helicopter Crowd


: "How do you see the issue of Internet taxes playing out in the next some years?"

Kim Wallace

: "I think it's irrational, and by that, I mean, in my view, there is no economic justification, there is no policy justification providing the perverse incentive for people to move transactions online, away from person-to-person transactions.

"Very few serious policymakers advocate a meter tax on the Internet, but for the Federal government particularly to decide that state and localities ought not to be able to decide their sources of revenue, and live with the consequences, is against our history, in terms of taxation.

"What I see are pressures to move towards some sort of tax regime that can survive, irrespective of the venue of transaction. Whether you do the deal over a counter in Malaysia or between Finland and Denver online, if taxes are levied on what's being transacted, taxes ought to be levied.

"I think those pressures are going to grow because international accounting agencies and taxation agencies have already come forward with plans for this kind of standardization. There's going to be strong resistance to it for a lot of reasons.

"One of the reasons is the so-called Black Helicopter Crowd will use this as yet another example that we all are becoming the same, and that there's some force that we can't touch that is now governing us. To the extent that that force exists, it is ones and zeros. It's certainly not black helicopters. Policymakers will adapt, but one of the things that they're going to have to do is make sense of policies like taxation, to take into account technology is not going backwards. The policies are going to have to catch up. It doesn't make sense. Internet tax moratorium doesn't make sense."

Beth Roy

: "The Internet obviously has huge implications for the level at which taxes are collected. If things continue to move hugely in the direction of states and local governments not being able to collect nearly as much in taxes as they do now because of transactions moving onto the Internet, do you see implications for politics in this country?"

Kim Wallace

: "Let's wait until we have the first economic dip and it lasts longer than two quarters, and the federal government not only doesn't have the willingness but doesn't have the means to make up the revenue that is lost, and then you have the automatic state ledgers kicking in the cost of what the federal government is spending to get through that recession. States and localities are going to remember that from 1998 when they tried to get Washington to make sense of this, and Washington didn't. That will cause some backlash.

"The notion of the evolution of power back to the states that was really hot through 1992 to 1993 will come back, and will come back in full force.

"Some politicians are likely to have to explain why the situation turned out the way it did, and that's going to cost some people their jobs. And you're going to see people who were supported by widespread prosperity, who by changes in social insurance and welfare reform are going to be in more dire straits than they are now.

"The ability to get a job in this country, just about for anybody who's able and willing, are pretty good. When that changes, those people will become a burden first, to cities and to states, and those people won't scream to Washington for assistance. It will come at a bad time."

For part two of the transcript, click here.