This is a rush transcript from "Special Report," November 23, 2010. This copy may not be in its final form and may be updated.


MARK TONER, STATE DEPARTMENT SPOKESMAN: North Korea's behavior has been very, very bad, provocative, belligerent, and, again, we're not going to get into buying in to this cycle of rewarding that behavior.

STEPHEN HADLEY, FORMER NATIONAL SECURITY ADVISER: China’s been worried that pressure on the North Korea that the nuclear issue might destabilize the regime. I think the bigger risk for China is that this transition will not go well and it will become unstable. And how does China feel about having a failed state or an unstable state on its border?


BRET BAIER, HOST OF “SPECIAL REPORT”: South Korean officials say some 200 artillery shells from North Korea hit one of South Korea's islands killing two South Korean marines, injuring 20 others, the first engagement of fire since the armistice in 1953, a serious bombardment, that is, since 1953.  Just moments ago, President Obama arrived from his trip to Indiana back to the White House. He went to the situation room to meet with his national security team. There you see a White House photo just released, and along with that came a brief read-out.  The president, quote, "reiterated the unshakable support of the United States for our ally, the Republic of Korea, and discussed ways to advance peace and security on the Korean peninsula going forward."  We were expecting the president on camera, but we're told perhaps around 9:00 tonight we might get a paper statement. Let's bring in our panel about all of this, Steve Hayes, senior writer for the Weekly Standard, Fox News contributor Juan Williams, and syndicated columnist Charles Krauthammer. Charles?

CHARLES KRAUTHAMMER, SYNDICATED COLUMNIST: That was a statement that was heard around the world. I'm sure the North Koreans are shaking as a result.

Last night I predicted the administration would do exactly the wrong thing and call as a result of this for a return to six party talks.  Sure enough our envoy to North Korea, who is now in Beijing last night called for, yes, a return to the talks.

This is after he had a meeting with the Chinese and he announced that it was extremely successful we and the Chinese had agreed that we would on the need for -- stronger measures, retaliation? No. On a need for multilateralism. Now that was going to have an effect on North Korea.

To return to the talks is exactly the wrong thing because it's exactly why if there’s any logic at all to what has happened that's why Pyongyang has been doing this, a) with the attack of artillery, and b) the revelation earlier this last week of this vast facility for uranium enrichment.

The point is this is a regime in transition, a regime in a succession crisis that is in economic disaster. The people are starving.  It needs to a because we in the South Koreans and the Japanese have correctly cut it off years ago, and this is the way it beckons us in to negotiations where, again, it will offer a phony agreement on some kind of halted, perhaps the uranium or plutonium program, and we will once again subsidize them.

It's the wrong reaction and I'm really shocked it came so early in the administration's deliberations.

BAIER: Juan, moments ago, we had a read-out from ABC, Barbara Walters has an interview with the president in which he says it's one more provocative incident in series from North Korea. He says he will talk to the president of South Korea, consulting closely in terms of the appropriate response. "We strongly condemn the attack, rallying the international community to put pressure on North Korea." Much of what we've heard before.

JUAN WILLIAMS, FOX NEWS CONTRIBUTOR: Right. The by word at the White House this afternoon was restraint. That they want to send a clear message they don't want to act rashly and do not want to add to what is already destabilized situation.

And the key is here that it would appear if you look at the motivation of what is going on in North Korea is the leadership transition to this 27-year-old son. And it appears the transition is going very badly. In addition the economy, economic stability of the country at this moment is further in jeopardy, although it's not clear why, what has shifted in recent days or recent weeks.

So now you have a situation where for some reason they feel it's imperative to, you know, thump their chest, make bellicose noises in order to somehow scare South Korea and China and the United States.

BAIER: Juan, if a child acts out, parents eventually have to do something and not give them a lollipop. But we are perhaps going back to talks to give them another lollipop?

WILLIAMS: No. I think what we have a situation where there has to be pressure put on China. This is China's issue. If you think about the uranium issue, obviously it was voluntary that the North Koreans reveal they had this uranium development plant. This was a signal again to the world, more chest thumping.

But I think China more than anybody else because I think it was last night Charles spoke about what if we give the Chinese and the South Koreans the green light --

BAIER: South Koreans.

WILLIAMS: Sorry, the South Koreans the green light to develop their own nukes? What a message that would be to China.

Well, China has been hands off slow to get involved in this. But the United States doesn't want to accelerate nuclear proliferation. Let me just throw in here, I think that's why I think ratification of the START treaty is more important than a lot of people want to admit.

BAIER: Let's stay on this topic.

STEVE HAYES, SENIOR WRITER, THE WEEKLY STANDARD: China has been more than accommodating of North Korea. They've been enabler of North Korea. It's true historically. It's the reason that the six party talks that failed thus far, and not only have they not been helpful, they have been counterproductive because they have been providing false comfort that North Korea’s actually do something because we asked the Chinese very politely to ask the North Koreans very politely to do something that the world has already agreed that North Korea should be doing.

So putting pressure on China -- I hope the White House is listening to Juan. Put pressure on China but make it real pressure. The United States need to do things rather than have restraint coming from the White House. Bosworth called for mutual restraint, as if he is telling the South Koreans please don't do anything that might provoke the North Koreans to hit you again. It's unbelievable thing to say in this context.

BAIER: Charles, here is what candidate Obama said about North Korea in 2008.


PRESIDENT OBAMA: In North Korea, we cut off talks. They are a member of the axis of evil. We can't deal with them. And you know what happened? They went…they quadrupled the nuclear capacity. They tested a nuke. They tested missiles. They pulled out of the non-proliferation agreement. And they sent nuclear secrets potentially to countries like Syria.


BAIER: So now the list can continue.

KRAUTHAMMER: I think everybody understands the only outcome of this eventually that will be considered success is if the regime eventually implodes and collapses of its own inefficiency and irrationality and lunacy in turmoil the way it governs itself.

And one way to do that is not to continue what we have been doing for 16 years, is negotiating and periodically caving in to threats like this or attacks like this with carrots, meaning keeping the economy of that state, which is really teetering on the edge of collapse, keeping it going.

We should stay away. We should if anything at a minimum is do nothing or keep it isolated, if we can, increase the sanctions. That has to be the beginning of a policy.

WILLIAMS: Let me ask a question. Do you realize they're threatening South Korea? So isolation is not going to answer that. They're threatening the ally.

KRAUTHAMMER: If they actually invade there will be a response by the United States --

WILLIAMS: So you're saying we would go to war.

KRAUTHAMMER: But that doesn't appear to be what the North --

BAIER: But, Charles isn't the real concern the proliferation here and the expansion of what North Korea could do?

KRAUTHAMMER: Unless we're ready to attack the facilities in North Korea, which we are not, which might provoke a nuclear response perhaps on Japan or even on Seoul, there is no way in which we can do anything about the existing facilities. All we can do is hasten demise of the regime.

HAYES: Which we can do. You can reinstate the sanctions from 2005 who had some effects. You can shut down the Khe San zone which is this area of economic activity between the north and south that provides money and sustenance to the regime. Without that money, regime could collapse on its own weight. People have humanitarian concerns that are certainly worth noting.

But at the same time, if you want to cripple the regime, there are things that can be done now to continue to cripple the regime, and I think we need to do everything short of military attack.

BAIER: Down the road -- military action, possibility or not?

KRAUTHAMMER: No. What we should do is pressure the Chinese, who hold the key here.

WILLIAMS: These people are irrational, unstable. If we contribute to the instability, I fear the worst outcome. So that's why people are looking for some other way to impact them.

HAYES: This may be yet another war of choice. It just may be the case that it's not our choice.

BAIER: We talked about candidate Obama. Candidate Hillary Clinton said the White House will receive a 3:00 a.m. call. The president was woken -- awoken at 3:55 a.m.

KRAUTHAMMER: And he put them on hold.

BAIER: Tell us what you think the U.S. should do about all of this. Logon to our homepage, FOXnews.com/specialreport. Vote in our online poll.

Next up, the Fed downgrades its economic forecast and wants more stimulus.


BAIER: President Obama traveled to Indiana today, saying that the economy is moving in the right direction. However, the Federal Reserve has come out with new projections about the economy moving forward. Officials have downgraded their economic forecast for this year and next.  The new numbers, the maximum is at 2.5 percent at 3.6 percent growth respectively. Both projections there are down sharply from previous forecasts.

What does it all mean in the big picture? We're back with the panel. Steve?

HAYES: On the central question of quantitative easing, should the Fed inject this $600 billion into the economy, essentially printing money, I think there are essentially two key questions. One is will it work? And the second is, is this something the Fed should be doing?

On the first, we don't know the answer but there are reasons to be skeptical. Certainly the first round of quantitative easing helped us come out of what was clearly an economic emergency. The economy was on the verge of collapse. You can make justification for doing what they did at that point, because the problem was the potential collapse of the economy, the global economy.  In this case, though, I think it's a far more difficult case for them to make, on the fact that this is what they should be doing because the crisis we face is one of debt. They're not solving the problem, they're exacerbating the problem.  And the political reality is that you have a Fed that is unaccountable, unelected, that answers in effect to no one doing the kinds of things for monetary policy to make up for the failure of fiscal policy, and that's a bad path to go down.

BAIER: Juan, there’s a disconnect here for folks listening to the president in Indiana and listening to the Fed and their projections for the economy a year-and-a-half from now.

WILLIAMS: First of all, this argument’s been ongoing for some time at the Fed. We got a peak in to it today but this is an ongoing argument and what the Fed should do and how far they should go to stimulate this economy.

And previously the worry about inflation outweighed the idea we need to do something at this moment. But because of continued high unemployment and the fact the elections have just past and it can't be interpreted as a purely political act, I think that's what triggered that internal decision. Go ahead and invest this money and put quantitative easing and invest money in the American economy.  The good news today by the way is that U.S. corporations are at a record in terms of their profits. But consumer confidence remains very low. So the Fed is betting that their action will not trigger inflation but in fact will trigger consumer confidence, more spending, and that will result in lower unemployment.

BAIER: And that's a big bet and people are not really confident it will pay off.

KRAUTHAMMER: That's right. It's also a risky bet because it could create a bubble. Our problem was that we had a bubble, and this is injecting money into an economy artificially without having the requisite increase of the productivity of industrial production and getting a new bubble and setting up a premise for inflation.

But I worry about something else, which is the political reaction by the conservatives and Republicans. The Ron Paul, the Rand Paul who always have been skeptical of the Fed and talked about even abolishing it or at least removing its independence are getting wind at their backs now.

And that worries me, because if there is one thing an advanced society has to have it's an independent central bank. And to corrupt it over this, the Fed is always human and always fallible. But regardless, it's better to have it act than having it act as an instrument of the politicians in power. I worry about a reaction. I think we ought to hold back and hold off on that.

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