Q: Given all that's happened in Gaza -- if you want to go back 60 years to the founding of Israel -- you have been among the most optimistic in saying that you believe a Palestinian state can be created and exist side by side in peace with Israel.

THE PRESIDENT: Right.

Q: Would you tell me what evidence there is, especially now, to maintain such optimism?

THE PRESIDENT: Well, first of all, a president must be able to look over the horizon; ... the only way for Israel to have the long-term security she needs is for there to be a democracy on her border. I recognize facts on the ground today make it hard for people to envision a state existing.

But, you know, eventually a democracy can take hold. And, as a matter of fact, the definition of a state was being negotiated by Prime Minister Olmert and President Abbas. And I just said on TV that what we're witnessing is the use of violence to stop the advance of democracies.

Now, eventually people in the Palestinian Territories will hopefully be able to make a clear decision about do you want a peaceful state, or do you want this kind of violence? And so this is yet another moment of clarity for people around the world and in the Middle East to see reality. And the reality is that a few use violence to stop the dreams of many.

The same thing happened in Iraq. As this young democracy was taking hold, terrorists, suiciders, killers did what they thought was necessary to shake the will of the people and shake the coalition so as to stop the advance of a free society. And yet, over time the Iraqi situation has gotten better and democracy is beginning to take hold.

I think the same thing can happen (in Gaza). I absolutely believe most people, most Palestinians, want to live in peace.

Q: And yet, when they had the chance to express their will, they voted Hamas in.

THE PRESIDENT: Well, they did -- in a relatively close election. But just remember, that vote wasn't on whether or not it was going to be war or peace. That vote was on who best can provide health and education. And I viewed the vote as a repudiation of the previous Fatah leadership, as well as a vote that said, we are sick and tired of corruption, non-transparency, and we expect to be treated better.

And so, yes, it was a vote that was also a moment of clarity. And one of the things I reminded the Fatah leadership is that, you know, you got a wakeup call -- and that is, the people were tired of you. And so, therefore, you ought to reform your party and get listening to the demands of the people, which is what's beginning to happen in the West Bank.

Q: How do you process that with the continued teaching at Palestinian schools of "hate the Jews," "hate the Gentiles," "hate the West"?

THE PRESIDENT: Whether it is hate the West, hate the United States, it's the whole propaganda war that's taking place. But it's not just isolated to the West Bank or Gaza, it is part of the propaganda campaign being waged by extremists throughout the Middle East -- you know, the United States is at war with Islam, or, the United States doesn't like you, or, the United States this, that or the other. And the way you defeat that is the development of free societies and better efforts on our own part to clarify what our position is.

But, yes, if your question is, do we face a big obstacle in convincing people that democracy and freedom is the way to move, then the answer is, absolutely, through the propaganda efforts of extremists.

On the other hand, we've got even a greater tool at our disposal, and that is the truth that freedom is universal. I have said it consistently through my administration. There is a God, and a gift of that Almighty, to every man, woman and child, is freedom. And I believe it. And I believe people, when given a taste of freedom; will make the sacrifices necessary to achieve freedom. And that's what you're seeing in Iraq, in Afghanistan, and some day will see in the Palestinian Territories. But, obviously, there are still a lot of obstacles toward that day.

You know, I've pushed hard with the Israeli and Palestinian leadership to define a state, because there needs to be a competing vision. And so people say, well, you shouldn't have argued for elections in the Territories. And my answer was, of course, we should argue for elections in the Territories, because it shows how the people feel, it's the most accurate poll there is. And it should say to people that, okay, you lost; what do I need to do to win? And the answer is not more violence; the answer is more peace, or more education, or more health care, or more business opportunities.

And that is beginning to happen in the West Bank. The prime minister is doing a really good job, along with the president.

Q: I went back and looked at the first interview you gave me shortly after you became president, and among the things you said was that you were not that worried about the deficit -- this was in 2001 -- because the deficit would seem to control congressional spending. Would you like to revise and extend those remarks?

THE PRESIDENT: Actually, this was before the attacks.

Q: Right.

THE PRESIDENT: The tax cuts had just been implemented to deal with a recession, and we were actually closing the current account deficit through the growth of revenues, as a result of increased economic activities, and at the same time were funding our troops and defending the homeland. And the other thing I kept saying was that the deficit that we truly ought to be focused on is not the current deficit, but the deficit inherent in the unfunded liabilities of Social Security and Medicare. Those were the big deficits.

Now, obviously, there's going to be a short-term increase in the deficit, as I took actions necessary to prevent this economy from collapsing, from a complete financial meltdown. People have asked me, was there a defining moment? Well, there was an important meeting in the Roosevelt Room when Secretary Paulson and Chairman Bernanke, in essence, said the financial situation is such that if you don't do something, Mr. President, we could have a depression greater than the Great Depression.

And if you're the president of the United States, you can sit there and say to yourself, 'well, I'm going to stick to principle and hope for the best, or I'm going to take the actions necessary to prevent the worst.' And I took the actions necessary to prevent the worst. And I fully concede that I flew against the principles of free market. In normal circumstances, my response would have been if they had made terrible decisions, let them fail. The problem in this case is the letting them fail scenario would have caused the average working guy immense grief.

Q: So what good are the principles?

THE PRESIDENT: The principles are to make the decision necessary to defend the principle itself. In other words, the whole purpose is to take the actions necessary to be able to have a free market in the future.

People say, well, they were just exaggerating the issue. I don't have the luxury of listening to my two top economic advisers and saying, 'well, you may be just exaggerating; we'll see what happens.'

Now, I readily concede people are concerned about the decisions I made, no question about it. I think that there is a lot of concern that this is the end of free markets as we know it; the free enterprise system, which has been so wonderful for America, will be discarded. I disagree with that, obviously. I think it's going to be very important for rational voices to continue speaking out as this economy recovers, and it will, and as the assets that will collateralize our positions get redeemed, that we remind people about the wonders of free markets and free enterprise.

One of the reasons why I hosted the international meeting in Washington -- and if you look at that statement, it is very clear -- it says, yes, we need to take actions to prevent a financial meltdown without destroying the foundations of free markets and free enterprise.

Q: You may be aware of a resolution before the Republican National Committee that says, we can't be a party of small government, free markets and low taxes, while supporting bailouts and nationalizing industries, which lead to big government, socialism, high taxes at the expense of individual freedoms. They're calling you -- some of them, including James Bopp, the vice chair -- calling you a socialist. What do you think of that?

THE PRESIDENT: I'm not aware of the resolution. I fully understand people's concerns about whether or not this country will be a country of free enterprise and capitalism and markets. I believe it will be. But I do know that the actions I've taken were necessary to prevent a major financial meltdown.

Q: I hate to quote somebody like former Alabama Governor George Wallace, who said, cynically in the '60s, "There's not a dime's worth of difference between the two parties." Is there? And what does it mean to be a Republican in 2009?

THE PRESIDENT: Well, that's very important for our party to make sure that we establish the principles that enabled me to win in the first place, and become the underpinnings of the policies that were enacted when I was president -- not only me, but also other presidents -- such as the universality of freedom. We ought to be the party that says freedom is universal, and freedom yields peace; the party that says, absolutely, we took the steps necessary to protect ourselves at home and, in the meantime, liberated 50 million people, and then helped them develop democracies in parts of the world where it was deemed impossible to have a democracy at some points in time.

That we're the party of free trade, low taxes. We cut taxes when I was president of the United States, not once, but several times. That we're the party of empowering individuals, that we believe in accountability and results. But if you're the president of the United States and you've got kids in harm's way, you're going to make sure those kids get all the equipment necessary to do their job. You bet the budgets expanded when I was president, in terms of military and defense, and homeland security, because we're at war.

Q: But we also have the prescription drug benefit, No Child Left Behind.

THE PRESIDENT: No Child Left Behind is a measure that says, in return for money, you measure. And it's one of the most advanced pieces of civil rights legislation we've had recently, because it said we're sick and tired of monies being spent on schools that aren't teaching children how to read and write and add and subtract. And, therefore, there will be accountability for money spent.

Secondly, on prescription drug benefit -- so the threshold is, should there be health care for elderly, from the governmental perspective. That decision was made in 1965 by Lyndon Johnson. And maybe some argue that we should never have done this in the first place, and, therefore, we ought to scrap the system. That's not my position. My position was let's make the system work; let's make it modern.

So when I campaigned for office -- and by the way, if you look at these issues we're discussing, I made it clear what my position was. If you look at the 2000 convention speech, I said one of the things we will do is reform Medicare: They have not led, we will. Same with education. People knew my position very clearly. And so on Medicare, we would pay $28,000 for the surgery, but not a dime for the prescription drugs to prevent the surgery from happening in the first place.

So in other words, we modernized the system, which -- as opposed to causing the exorbitant sums of money that was projected, it cost something substantially less than that. Because inherent in the Medicare was also competition for people's business, because I argue that we ought to trust seniors to make health-care decisions of their own, as opposed to just, here it is, take it or leave it -- we said, here is a variety of options from which to choose. So competition helps drive down price and enhance quality.

And finally, as part of the Medicare reform, there were health savings accounts, an innovative way of getting the consumer, the patient, the person purchasing health care to be directly involved in the relationship between needs and what's available. And that's important for pricing and quality over time.

Q: In your recitation of what Republicans still believe, you didn't mention the social issues. Colin Powell has blamed conservatives for the party's bad performance, urges the party to abandon some of these social issues. Would they be wise to do so?

THE PRESIDENT: I have, as you know, been a strong defender of the culture of life. And I believe that's an important part of our party's future.

I will be the first to concede that laws change only after hearts change, but our party has been on the leading edge of saying to people there's a better way than what took place in the past in the country on a very sensitive issue like abortion. We were the ones who fought for the ban on partial-birth abortion, and then went to the courthouse to defend it. We're the ones who promote adoption. And I hope I was able to do so in an understanding way. I said that I understand good people can disagree on this issue. But as we disagree, let's keep things in mind: that all life is precious; that a society is strong when it worries about the most vulnerable among us, whether it be those who are elderly, those who are sick, and those who are yet unborn.

And I do believe we have made progress on the issue of culture of life. I do believe people are beginning to understand why a person like me takes the position I take. And I do believe we can take those positions without being so judgmental that our voice is not heard. In other words, I have always tried to say I understand your position, but here's mine, and here's why I think this makes sense for a compassionate America.

Another issue that we get no credit for, of course, is drugs, where drug use is down with teenagers by 25 percent. One of the big initiatives that I think the Republican Party ought to stand strongly for is the faith-based initiative, where we recognize that government is going to play a role in helping people who are not as fortunate, can't help themselves. That ought to be a focus of government in my judgment. Maybe some would argue there should be no government help there. I disagree.

But I also say that what matters is whether or not the money that we're spending actually works. And in some cases, a faith-based program can do a better job than a government program. Take, for example, drug addiction. There are all kinds of government programs that try to help the addict and that's fine. But I have said that why don't we give the addict a voucher and let him or her choose where to find the help he or she needs; many of whom recognize it's the redemptive power of the Almighty that helps change their hearts and, therefore, helps change their behavior. And if that's the case, should we not welcome a faith-based institution to be a part of this fabric of providers to help us solve some of the very intractable problems that we face?

Q: You have said almost from the beginning, since 9/11, you've spoken of your belief in the doctrine of pre-emption. Your successor has said that he does not believe in that. Are there risks in his policy?

THE PRESIDENT: I think that the new administration will take a sober look at the world in which we live and come to the conclusions necessary to protect the homeland. You know, one of the things that is going to be very apparent for future presidents is that there is an enemy that still lurks and that the main job of the president is to protect the security of our homeland.

Q: Democrats and liberals have attacked you relentlessly and personally. Harry Reid, on one of the Sunday morning chat shows, called you "the worst president in history." Now, what has amazed me, and a lot of others, is that you've never responded in kind. Politically, it might have been beneficial to do so. Why didn't you?

THE PRESIDENT: I believe there's a way to conduct ourselves in public life without resorting to name-calling. And so I won't. I tend to ignore that.

Q: Doesn't it ever bother you?

THE PRESIDENT: Not really. Continued...