Michael Hudson: how finance capitalism leads to debt servitude
October 19th, 2012
This edited transcript is expanded from a live phone interview with Michael Hudson by Dimitris Yannopoulos for Athens News. It summarizes some of the major themes from Hudson’s new book, The Bubble and Beyond: Fictitious Capital, Debt Deflation and Global Crisis, published in the UK in July 2012 and available from Amazon.co.uk. The article is cross-posted from Naked Capitalism
Q: How has the financial system evolved into the form of economic servitude that you call “debt peonage” in your book, implying a negation of democracy as well as free-market capitalism as classically understood?
A: The original hope of banking and finance capitalism in the 19th century was that banks would make productive loans to finance industry. The aim was for banks to do something new, that no economy had done in the past: make loans not merely to ship and market goods once they were produced, but to finance new capital investment by manufacturers and producers, as well as by the public sector to build infrastructure. The idea was for these investments to create profits out of which to pay the interest and the principal back to the lenders.
This was defined as productive lending. Nothing like it occurred in antiquity or in the post-feudal period. Investment always had been self-financed out of savings. Banks only entered the picture when it came to shipping and trading what had been produced.
As matters have turned out, banking has allied itself with real estate, mineral extraction, oil, gas and monopolies instead of with industry. So instead of getting a share of the profits, it has focused on lending against economic rent. This technical term is defined as unearned income. It is obtained by charging prices in excess of cost value. Economic rent has no counterpart in the cost of putting means of production in place. And land has no cost; it is provided by nature. The only “cost” is the price of buying the right to charge rent on it. This economic rent is created by special legal privilege or ownership rights to install tollbooths on roads, education systems and other basic needs. Owners aim to charge as they can, without regard for how this affects overall growth and balance.
Banks have the privilege of creating credit and charging for access to it. Most bank credit is extended to buy property or rent-seeking privileges already in place. Banks rarely are set up to evaluate new capital investment. Their time frame is notoriously short-term. It takes time to develop production facilities, mount a sales campaign and develop markets for new goods. It is easier simply to buy a privilege to extract charges without producing anything at all. This is what property rights are, along with special privileges such as charging interest without making a tangible investment. So banks back the kind of economy that makes money without new capital investment. The easiest way to do this is to make loans for real estate at increasingly debt-leveraged, bank-inflated prices. They call this a post-industrial “service” economy. It is simply a rentier tollbooth economy.
Classical economists from the Physiocrats down through the Progressive Era a century ago explained why land rent, subsoil natural resource rent and monopoly rent should have been the source of tax for cities, states and nations. That is the essence of classical economics. But instead of supporting productive industry by extending credit to increase tangible capital investment, the banking system has extended credit mainly (about 80 percent in the United States and most English-speaking countries) to buy real estate and load it down with debt. The result is that rental income is used to pay interest to the banks rather than to pay taxes. This forces governments to tax wages, profits and sales. That increases the cost of living and doing business, on top of the interest charge.
In search of this loan market, banks have come to back untaxing real estate and deregulating monopolies, so that their economic rent can be paid to the banks as interest by customers eager buy these rights – and charge even higher rents or raise prices even further without making a new capital investment of their own. Instead of financing industry, U.S. banks don’t make loans for what can be produced in the future. They make loans against collateral already in place – including entire companies with high-interest “junk” bonds. The target company is obliged to pay the debt that the corporate raider takes on. The raider then is “free” to downsize and outsource the work force, squeeze the budget and hope to come out with a capital gain after paying off the banks and bondholders. The process is more extractive than productive.
This is the basic problem with the Anglo-American-Dutch banking system. Instead of extending loans to create new factories to employ people, new means of production, bankers look at what can be pledged as collateral on which they can foreclose.
Stock markets were supposed to supply “equity investment” capital. But they have been turned into a vehicle for debt-financed leverage buyouts (LBOs). Raiders borrow money much like landlords borrow to buy a rental property and bleed it. This turns corporate cash flow into interest. Governments permit this to be tax-deductible, so this encouragement of debt financing over equity worsens their fiscal position. It forces them into debt to bondholders. So the process becomes a deteriorating financial spiral.
A: The turning point was in 1980, when the Reagan Administration was elected in the United States, right after Margaret Thatcher led Britain’s Conservatives into office and began the big privatization sell-offs at enormous, unprecedented commissions that made the financial sector richer than ever before. Drexel Burnham led the practice of turning the stock market into a vehicle for banks to emulate their real estate loan departments by creating credit for corporate raiders to take over companies, load them down with debt and extract profits to pay out as interest. This was done by downsizing the labor force, shifting over to non-union labor, and where possible, renegotiating employee pensions downward or simply grabbing the pension funds or Employee Stock Ownership Plans (ESOPs) to pay creditors. So corporate finance became destructive instead of productive.
This sort of banking has concentrated wealth, and used it to privatize and buy control of governments and their regulatory agencies. Banks have lobbied to keep interest tax-deductible so as to favor corporate financing by issuing bonds and taking out loans instead of issuing stocks. Bank lobbyists back the political campaigns of lawmakers committed to deregulating the banking industry and its major clients (real estate, natural resources and monopolies). It even has taken over the Justice Department and the courts, so that financial fraud in America has been decriminalized, as there is no regulation of outright criminal behavior. This is especially true of the largest banks such as Citibank and Bank of America where the fraud tends to be concentrated, as my colleague William Black at the University of Missouri at Kansas City has shown.
Q: How do they get off the hook?
A: Nearly every large Wall Street bank has paid large sums of money to settle criminal fraud cases with the U.S. legal authorities, without admitting criminal liability for their huge gains. So no banker has gone to jail. The banks have paid the fines, not the managers who have paid themselves enormous salaries, bonuses and stock options for writing junk mortgages and operating in a manner that would have sent them to jail back in the 1980s. That’s when S&L fraudsters were sent to jail for doing what commercial bankers much higher up on the social pyramid have done over the past decade.
The top executives know that if they are convicted of billions of dollars of fraud, their banks will pay a fraction of this amount, not themselves. They know that the jig is nearly up, so they are giving themselves enormous bonuses and running. The Treasury argues that if it fines the banks to recover the full amount of the fraud, they’ll be driven under – and the government will have to bail them out. In effect it would be paying the fine to itself. So it does nothing, except receive more campaign contributions from Wall Street for being so passive.
Q: Is the so-called “financialization” of the economy an outcome of deregulating banking and finance?
A: Financialization is an appropriate term because it means the surplus is used for financial purposes and not spent on the real economy. It began by taking over the real estate and insurance sectors, prompting national income economists to lump together what they call the FIRE sectors (Finance, Insurance, Real Estate). It also should include the legal sector, because most law these days is corporate law that condones, protects or even facilitates financial fraud and monopolies. Finance has expanded to absorb the entire economic surplus in the form of debt service to the banks. This leaves it unavailable for capital investment to increase output or consumption.
Q: Isn’t this also because the profits for financial investment in asset bubbles are much higher than profits in manufacturing?
A: There’s a problem in terminology here, between technical economic jargon and popular understanding. Classical economists were careful to define the term “profit” to mean an economic gain made by investing in plant and equipment (capital) and employing labor to produce goods and services to sell at a markup. Profits were a return on tangible capital investment and current expenses on labor, raw materials and other inputs.
This is not how the financial sector makes its gains. Its interest, fees, commissions and penalties are the result of built-in, standardized legal privileges. Economists call these returns “economic rents.” Unlike profits, they are independent of the cost of production. Their “cost” consists of buying privileges, not of making tangible capital investment. The same is true of the other major element financial returns: asset-price (“capital”) gains.
A privilege is literally a “private law” (from the Latin legis, law), a monopoly right. The main privilege is to create bank credit and take deposits that are insured by governments, ultimately by public debt and the right to tax. These financial returns have an entirely different dynamic from commercial and industrial profits. They are made off the economy, not part of the economy’s physical and technological growth and capital formation. They are an overhead charge paid out of profits and wages.
In these respects, financial returns and profits are quite different dynamics. When a company is bought out on credit, the profits end up being paid out as interest rather than reinvested to expand production and employment. Financialized companies are treated much as absentee-owned commercial real estate: Buyers pledge the rent (in this case, the corporate profits) to the creditor who lends the credit for the purchase. Buyers may even pay depreciation (tax-deductible cash flow) to the banks and bondholders – hoping to squeeze out a capital gain or sell of the company’s parts for more than the whole is worth. Low-return divisions are closed down or sold off. The basic dynamic is shrinkage.
Paying out profit as interest leaves no reportable earnings. Interest is deemed a “cost of doing business.” But it is not a cost of production. It is financial overhead. And since the 1980s, growth in this overhead has absorbed and even outstripped the rise in productivity. Instead of living standards rising, the economic surplus has taken the form of a return to the FIRE sector, mainly the financial sector – commercial banks, investment banks, mortgage packagers and brokers, and so forth. Real estate owners gained during the bubble years as property prices rose faster than the bank debt that was inflating them. But the reckless junk mortgage lending and outright fraud led to a collapse of new lending after September 2008, leaving a residue of negative equity, bankruptcy, foreclosures and abandonments in its wake.
Companies that pay out all their cash flow as interest do not pay income taxes on this diversion of revenue, because interest is a tax-deductible expense. As for the financial engineers at the top – the class that has replaced industrial engineers – they aim to get rich not by earning profits, but by capital gains. These are taxed at much lower rates. So the financialized tax system encourages speculation rather than profit-making direct investment.
Suppose that a company earns $1 million dollars of profit in a year. About $400,000 must be paid in income tax. A corporate raider will buy the company’s stockholders (equity owners), for $10 million in junk bonds. The entire $1 million dollars of profit will now be paid to the banker or the bondholder in the form of interest. The company won’t report a profit, so there is no tax payment. The financial manager will hope to increase the company’s price (to re-sell it on the stock exchange) by cutting costs or selling off its pieces to make a capital gain. This is how Republican presidential candidate Mitt Romney’s Bain Capital made money. It is “balance sheet” engineering, not aimed at raising production or living standards.
Q: What makes capital gains so different from business profits?
A: This is best understood in real estate. The motto of new buyers is that “Rent is for paying interest.” The parallel for a corporate raider is that “Company profits are for paying interest.” A real estate buyer will look at a building to see how much rent it pays off, and bid against other prospective buyers for a loan. The winner usually is whoever will anticipate earning the most rent from tenants to pay the interest – and promise to pay this to the bank. What the speculator or long-term investor wants is the capital gain.
Yet this does not appear on the National Income and Product Accounts (NIPA), despite the fact that bubble economies are all about orchestrating such gains. That is how the banks got people to borrow larger and larger debts – hoping to buy homes that would rise in price. The larger the home they bought – with the largest mortgage loan – the more money they would make in the bubble economy. They thought they could get rich by becoming bigger bank customers.
The NIPA were not designed to analyze this kind of an economy making gains by inflating asset prices rather than investing directly to create tangible assets. They were designed to track direct investment, profits and wages (along with government spending and taxes), not monetary and financial phenomena that affect balance-sheet assets and debts. But financial engineering of balance sheets is what all about, and that is what makes today’s finance capitalism so different from the industrial capitalism that classical economists analyzed.
The result is that property investors on credit appear not to be making any income. They “expense” their revenue as an interest charge, while their capital gains are invisible in the National Income and Product Accounts (NIPA). These “capital” gains in asset prices are taxed at much lower rates than taxes on wage income and profits. In fact, they typically are not taxed at all, if the gain is spent on buying yet more property. By making capital gains tax exempt, the tax code diverts investment away from tangible capital formation into financial speculation.
Q: Were derivatives and structured bonds the final stage in pumping up the financial bubble that burst in 2008?
A: Well, at least it was the stage before austerity and debt deflation. I call it Casino Capitalism. Large Wall Street banks made money by betting which way the economy would go, much like betting on a horse race. As in other forms of gambling, the casino always wins – and crime is rife. Credit default swaps are the easiest to manipulate in ways that were illegal in the past. So the cards are stacked in favor of banks against their customers and counterparties.
Investment banks that deal in these derivatives don’t count their capital gains as profits. They are not part of the production process, unlike profits made by employing labor to work with capital equipment to produce output. Derivatives and the financial system don’t have much to do with production and employment – except to shrink markets. They have to do with buying and selling assets to make a capital gain. This is the increasingly dominant speculative part of the FIRE sector, not part of the production and consumption economy. We’ve turned Industrial Capitalism inside out and made gambling the most important market, not production and consumption.
Q: Is this why derivatives don’t appear on the balance sheets of banks? And does this make it difficult to know whether or not they are solvent?
A: Derivatives are bets on the price of assets and on which way interest rates – and hence, bond prices – will go. Banks bet on stocks, currencies or anything they want to. But they don’t use money for this, so the bet is a “contingent liability” with an elusive statistical appearance, sort of like the Higgs boson in physics. The result is a casino economy betting which way prices will go rather than actually producing goods and services.
The problem is that for every winner there is a loser. So on balance it’s a zero-sum game. The economy as a whole doesn’t gain. In fact, large losers who can’t afford to pay the winners receive public bailouts. The government says that the economy needs to keep the casino’s big players solvent or the game will end and there will be a crisis. So the central bank and Treasury print more public debt to make bad debts good. All the big players are made winners leaving the government with more debt. This debt is not a result of spending more current income into the economy. It is purely a balance sheet phenomenon.
Q: Hasn’t this system collapsed since 2008?
A: Just the opposite. The 2008 aftermath was used by Wall Street as an opportunity to panic Congress into taking the losses of big banks onto the public balance sheet, incurring $13 trillion of added debt. In effect the Obama administration told the real economy to drop dead. The crisis became an opportunity to turn democracy into an oligarchy. The same thing happened in Ireland. After its banks made enormous insider loans, reckless loans and fraudulent loans, the government pledged to make the gamblers whole. The non-financial economy must now pay the bad bank debts, because the European Central Bank (ECB) now rules the eurozone economies.
Q: Isn’t the ECB taking over the function of bailing out EU governments, having done so with eurozone banks?
A: The ECB is not bailing out the existing status quo as much as acting to change it. The aim is aggressive, not passive. It is to replace democratically elected governments in Greece and Italy (and ultimately, everywhere) with oligarchy. German Chancellor Merkel and other neoliberals claim that democracy would put the interest of people first. And there’s not enough to maintain their living standards and sustain a growth in wealth at the top at existing rates. So something has to give – and it is living standards, not the debt overhead. This is the social revolution in which Europe and the entire Western world is in today.
The ECB puts commercial banks first. That’s what central banks do. That’s why the Federal Reserve Bank was made independent from the U.S. Treasury in 1913. They are there to promote bank interests, increasingly at odds with the rest of the economy. The first ploy is to place technocrats (a scientific sounding euphemism for bank lobbyists) in place of elected governments in Greece and Italy.
The anti-democratic transformation occurring in Europe today resembles what occurred in Rome in 133 BC to inaugurate a century of financial war, which historians called a Social War. It was waged by the creditor oligarchy (which had enriched itself largely by privatizing public land after the Punic Wars with Carthage, much as today’s financial oligarchy has grown rich by privatization and corrupt public-private financial “cooperation”). At issue was whether the economy should be run to enforce creditor “rights” by depriving the population of its liberty from debt servitude, or should help the citizenry prosper.
The patrician creditor class used violence and murder of political leaders, as in Chile in 1973. Advocates of debt cancellation (such as supporters of Catiline’s “conspiracy”) were killed. The Social War ended with much of the population falling into bondage. Today’s creditors are winning not to put individuals into bondage, but to let them be free to work and live anywhere they want – as long as they pay taxes to government to subsidize high finance, and buy goods and prices from privatized infrastructure squeezing out extortionate economic rent. This is the ECB’s idea of a free market financial-style. That is the essence of neoliberal ideology, and explains why its politicians are so well subsidized by the banking sector.
A: Neither Greece nor other eurozone countries have a central bank monetize their budget deficits. So they need to borrow from bankers and bondholders, at interest rates that rise as the dysfunctional system grows more untenable. Governments have been directed to shift taxes off property and the wealthy onto labor and industry, and to finance the resulting budget deficits by raising taxes, cutting wages, axing social welfare and selling off the public domain. Financial neoliberals are using Greece’s debt crisis as an opportunity to pry away whatever its government owns: real estate and public buildings, mineral wealth, oil and gas rights in the Aegean, port facilities, electric utilities and roads. The eurozone banking sector is to benefit, not the Greek people.
In times past, what the ECB is achieving in Greece would have taken an army to carry out by invading the country and taking over its land and infrastructure. The ECB is doing this without military force, just by appointing technocratic proconsuls of high finance. A lame attempt is made to frighten voters into believing that There Is No Alternative (TINA, as Margaret Thatcher liked to express her diktat). Propaganda sites blare out that all this is for the best. It is as if writing down debts will bring about poverty, not liberate economies from debt.
The situation is reminiscent of what occurred in Sparta at the end of the 3rd century BC. Sparta’s kings Agis IV and Cleomenes III sought to cancel the citizenry’s debts, as a creditor oligarchy had taken over. Neighboring oligarchies called in Rome, which waged a war (ultimately against Nabis, the last old Spartan leader), ending the democracy with Rome’s Empire. It established “peace” by imposing martial creditor rules that ended up driving the population to emigrate and shrink.
If Greece goes along with this, it will be surrendering without even a fight. That is the political aim of the oligarchy: to win by conquest of the brain and ideology rather than the more expensive physical oppression of an outright police state.
Q: Why has there been so much emphasis on austerity and internal devaluation to drastically reduce wages and pensions?
A: Financialization escalates the class war in a new way. For the last hundred years people thought the war was between employers and employees over workplace conditions, wage levels and benefits. But the debt overhead adds a new dimension in class war. Finance controls governments, especially in the public sector where unions typically are strongest. Most of all, financial lobbyists and the academic advisors they corrupt promote austerity and unemployment so as to drive down wages to a degree that could not occur in the company-by-company clash between industrial employers and their workers.
In the United States, Federal Reserve Chairman Alan Greenspan explained triumphantly to Congress that what was so remarkable since 1980 was that labor productivity rose by about 83 percent, but real wages didn’t rise. The Maestro found the explanation to be that workers had been obliged to take on enormous mortgage debts, education debts, auto loans, and live on credit-card debt in order to keep up with their neighbors. Their precarious financial situation made them afraid to go on strike or even to complain about working conditions, because if they are fired and miss a payment in their electric utility bill, the interest rate on their credit card jumps to 29 percent. And in America if you miss a few mortgage payments, you can lose your home. So many workers fear that they are “one paycheck away from being homeless.” That’s what the debt overhead has achieved for relations between labor and capital. The two-thirds of Americans who own their homes are afraid to complain and lose their job, because this would threaten their economic solvency and hence their social status.
What’s happening in Greece is similar. And for a dress rehearsal, look at Latvia, where neoliberals had a free hand. Two years ago, internal devaluation reduced its public sector wages by 30 percent. This helped drag down wages in the private sector. Cutbacks in public spending shrank the domestic market and hence employment – and spurred emigration of young labor. Workplace rights are being rolled back in a way 19th-century industrialists never dreamed they could achieve under democratic government.
Nearly everyone expected that democratic government would act to promote rising living standards and expanding markets, not to act on behalf of the wealthy to shortsightedly shrink them. It seemed logical that technology would increase the economic surplus and hence make it less necessary for families, companies or governments to run up debt, not sink into it even more rapidly than the tangible surplus was growing.
Q: But if neither Greek banks nor local industrialists are gaining from this, what do international creditors expect to receive from borrowers that can’t pay their debts, mortgages or taxes? How does a jobless workforce help them?
A: The financial sector always has been so short-term as to be self-destructive. There’s been a race to the bottom – who can extract the surplus for themselves before anyone else does? Creditors treat the economy like an oil well, to be depleted, ignoring the long-term environmental consequences.
In this case the economic environment consists of tangible capital and technology, including the education and culture of the citizenry, capped by the debt overhead and rising concentration of property ownership, along with the political corruption that accompanies the polarization of wealth by giving government power to the most avaricious, shortsighted and vicious members of society. So political economy turns into the asocial and anti-social economics of Ayn Rand and the Chicago School, and financial predators find their Alan Greenspans and Tim Geithners to act as their factotums. They dismantle the power of government (kings in the Bronze Age, democratic governments today) to write down debts or regulate credit. Government becomes a board of directors of the financial wreckers.
You are quite right to notice that if such a government imposes such extreme austerity that families and companies cannot pay their debts, the banks will lose and the government can’t collect the taxes it needs to reduce the deficit. This is what the International Monetary Fund’s austerity programs imposed on Latin America of the 1970s and ‘80s. That required military dictatorships backed by U.S. armed force and covert destruction of the left – mass murder of intellectuals, labor leaders and school teachers on a continent-wide scale. Greece is now being treated economically the way that Latin American countries were treated by the IMF back then. It has not been necessary for U.S. state Department to send in the usual assassination teams to impose financial “equilibrium” creditor style, as under the Chicago Boys in Chile and Operation Condor in the Americas. The absence of covert and overt military force simply reflects the absence of serious opposition to the creditor plan.
Now that U.S.-backed dictatorships are being thrown off in Latin America and elsewhere, these countries are taking off economically. It shows the power of growth, once the financial oligarchy is checked from imposing its self-destructive economic policies. On the other hand, there is still a bonanza to be squeezed out of Greece and the rest of Europe by worsening the crisis – to the point where hapless governments there do what Latin American governments did: privatize the public domain, turning it over to buyers on credit, that is, on terms laid down by the banks, while deregulating the privatized monopolies.
Of course many banks will go under and many governments will be driven into insolvency. That’s the objective. The idea is for big fish to eat little fish. Banks that go under will sell off their debt claims on the cheap to major financiers in other countries. The vultures will have a field day, as they did in taking over Iceland’s banks. (That story has not been widely told.)
Financialization leads to the bankruptcy of local banking systems so that outsiders can come in and make a huge property grab. So the banks become casualties, just as the most highly criminalized U.S. banks that were deepest into fraud — Countrywide, Washington Mutual (WaMu) and their cohorts — were in recent years absorbed by the five large U.S. “too big to fail” giants. Many countries have pension systems that can be looted after the manner perfected under dictator Augusto Pinochet in Chile in the late 1970s. This in fact remains the U.S. plan today.
Of course it will impoverish the economy. But the big banks and bondholders hope to be able get out fast enough to take their money and run, and repeat the process somewhere else. The problem ultimately is that which Alexander the Great faced: He cried when he felt there were no more worlds to conquer. So finance capital will end in tears – first for the debtors, then for the creditors themselves. The parasite will die with the host. That is what caused the decline and fall of the Roman Empire.
Q: How has finance capitalism shaped economic theory to change the idea of a “free market” and treat social spending and investment as deadweight overhead instead of treating rentier income and property claims as overhead as in the classical economics of industrial capitalism?
A: Rhetoric plays a key role here. The essence of a “free market” financial style is to take planning out of the hands of government – democratically elected political representatives – and centralize it in Wall Street and other financial centers. Relinquishing the allocation of credit and untaxing property and finance transforms the mode of planning into the diametric opposite of what it meant to the Enlightenment and to the classical economists who sought to steer the drives of industrial capitalism to serve society’s long-term growth and raise living standards.
A free market financial-style means disabling government regulation (which Hayek called the Road to Serfdom), to give rentiers the unchecked freedom to exploit, not protect society by ensuring it freedom from exploitation. So this isn’t really a “free market” as people discussed this in the 19th and 20th centuries. It is a market of unchecked fraud and exploitation, with wealth and power being untaxed as well as deregulated. This is the economics of General Pinochet elaborated along the lines that Margaret Thatcher in England and Ronald Reagan’s “crazies” in the United States pushed under the slogan of the “Washington Consensus.” As Grover Norquist expressed matters, the aim is to “shrink government to a size so small that it can be drowned in the bathtub.” Of course, it is the citizenry that ends up being drowned in debt.
In practice a financialized “free market” simply shifts planning out of the hands of government and centralizes it in those of Wall Street and other banking centers. Financial dirigisme aims to endow a rentier oligarchy, not uplift the citizenry and the “real” production-and-consumption economy. So what ends up being reduced is not government debt, but public spending on goods and services, especially on social security and medical care – along with taxes on wealth and debt-leveraged “capital” gains. In contrast to public purchases of goods and services employing labor, new government debt is created mainly to bail the banks out of the losses that result from their self-destructive over-lending and outright gambling. The effect is to increase the government’s deadweight overhead under oligarchy, in contrast to democracy.
What is important to recognize in analyzing this shift in the locus of centralized planning is that the financial sector’s objectives are the opposite of those in the public sector. Democratic governments seek to increase employment, output and living standards. But relinquishing central planning to the banks, as the ECB and Washington Consensus wants to do, replaces democracy with oligarchy. Under these conditions financial planning takes the form of austerity, lowering wages and living standards. The ensuing economic crisis is used as an opportunity to grab whatever property is in the public domain – infrastructure, real estate and mineral rights, and even the creation of new monopolies to sell off and use the proceeds to pay the debts. (Chicago, for instance, sold the right of Wall Street investors to install parking meters on its sidewalks – increasing the cost of driving and doing business.)
This is how the South Sea Bubble was orchestrated: Sale of the asiento monopoly on the slave trade with the Americas that Britain’s government had won from Spain. Stock in the company was sold to the public – with insiders making early gains and then selling out before sticking the public with the crash. This is basically the plan to privatize Social Security. It is Pinochet’s and Thatcher’s “pension fund capitalism” expanded to orchestrate bubbles by inflating asset prices on credit, and then letting the economy collapse as it becomes high-cost and insolvent. The process is capped by the government creating debt to bail out the banks, but to help the tangible production-and-consumption economy recover. So financial planning under oligarchic government is all about the FIRE sector.
Unfortunately, economic history no longer is taught as part of the neoliberalized economics curriculum, at least here in the United States. So people are not aware of how destructive financialized management and planning has been ever since the fall of Rome.
A: The technocratic solution is indeed for the central bank to create new government IOUs – money – to bail out bankers at home and abroad. If they the existing debts are paid in this way (or by letting banks foreclose), it would make the financial sector by far the most powerful economic and political actor. The economy would polarize between creditors and debtors, government insider rentiers while the rest of society falls into poverty.
My alternative is to anticipate that the end game must be a Clean Slate in any event. It’s simply a mathematical fact that debts that can’t be repaid, won’t be. So trying to collect them threatens to tear the economy apart. A lot of pain will be saved by cancelling the debts. Greece should tell its fellow Europeans that every government has a prime mandate to protect its people from catastrophe. To carry this policy out, Greece should annul all its debts and begin again with a Clean Slate, like Germany did in 1948. This would make it a low-cost competitive economy – as long as it taxes the free lunch of the land’s site-value rent that has been freed from debt, as well as natural resource and monopoly rents as a basis for its post-Clean Slate fiscal policy. So fiscal and financial reform need to go together.
Q: Do we need a central bank to monetize and coordinate such a policy?
A: You need a central bank or Treasury to create money to finance budget deficits without recourse to commercial banks and bondholders charging interest for credit that they create electronically on their own computer keyboards. The central bank’s role should be to regulate commercial banks and their lending policies, not serve as their lobbyist as presently is the case. The problem is that Europe doesn’t have a real central bank to finance government deficits, unlike the Bank of England or the Federal Reserve. This is crazy! The ECB won’t lend to governments – which is what central banks were founded to do. The ECB only buys from commercial banks, buying government bonds at a much higher price than the “free market” would set. So here again, neoliberal “free market” policy financial-style is antithetical to what most people think of as free markets.
It also runs against what voters expected when they joined the eurozone. Greece joined Europe because it wanted to increase its prosperity. To do this, it needs a real central bank. Either this needs to be created within the eurozone, or else Greece and the European periphery should start afresh with the kind of Clean Slate that fueled Germany’s Economic Miracle. All Europe needs a debt cancellation to bring debts back within the ability to pay.
Germany and its creditor allies would be welcome to join in the South’s effort to restructure eurozone finances, escaping from the craziness of a currency area of governments without central banks. The important thing is to avert an epoch of debt peonage resulting simply from being denied the right to have a proper central bank to do what every central bank in every civilized country of the world will do, namely finance the public deficit.
Q: Could a re-nationalized Greek central bank create enough money to pay off the debt in euros before the ECB has the chance to pull the plug on it?
A: The eurodebt shouldn’t be paid at all. In any case, it can’t be paid without selling off the country’s public domain. It is true that debts can be paid off by printing the amount of money that’s needed. That happened in the United States when the Federal Reserve created $13 trillion to cover the bad debts held by the banking system before it could stick Europeans, pension funds and other gullible buyers with junk mortgages and impossibly convoluted derivatives.
The problem is that the Fed’s act rescued the banks, not the economy. It kept the bad debts on the books instead of writing them down. The banks created a recklessly and unpayably high debt overhead that is subjecting the national economy to debt deflation as debtors try to pay by drastically reducing their consumption and tangible new investment. The opposite policy should be pursued: Mortgage debt should be written down to the ability to pay instead of the Federal Reserve and Treasury financing bank losses and bad gambles. Bondholders should lose, and only FDIC-insured depositors be rescued.
Greece should learn from America’s folly and refuse to borrow from the ECB to pay bondholders on debts that have been run up by lacking a central bank and by not taxing the wealthy – and by letting them avoid taxes by accounting tricks such as taking their profits in tax-avoidance centers such as Switzerland. Greek banks have acted as enablers in capital flight and corruption. So let eurozone creditors pursue this flight capital while Greece builds a more rational financial and fiscal system with a Clean Slate. It may find allies in Southern Europe (Italy, Spain, Portugal), the BRICS or neighboring countries in the Baltics and Far East.
Q: Haven’t Germany and the major Eurozone countries shifted the bulk of Greek public debt out of the hands of private bondholders (mainly EU banks and hedge funds) onto the official sector (EU states via the ECB and IMF), ultimately to be paid by Greek and other EU taxpayers?
A: That’s right. As matters stand, the eurozone has been waging warfare against Greece. Greece has a right to respond by taking back control of its property by taxing its economic rent or windfall gains. This is why the financial sector a century ago sought to deny that there was any such thing as economic rent, that is, unearned income.
Remember that Henry VIII nationalized the monasteries and church lands in England. Northern Europe responded to the papacy in Rome draining tribute by elevating national interest to the highest religious plane as the only way to break the financial bond. Protestantism was largely a financial response against papal bankers, the Lombards, Florentines and their brethren described by Dante in his Inferno. To achieve financial independence, Northern Europe needed a new ideology capped by religious independence – and indeed, civil independence from religion. That came finally in the form of the Protestant Reformation. Greece needs to do the same thing politically today. This requires an ideological alternative to neoliberal pro-creditor doctrine insisting that paying debts is part of “free markets” and denying that any income or wealth is unearned.
Q: How can Greece counter the terror propaganda warning about the horrors and calamities that threaten to befall the nation if it defies its troika conquerors and tries to go it alone?
A: The real terror is what would happen if Greece surrenders to the financial aggressors behind the ECB. Throughout most of history, populations and governments have fought back. Creditors know this, which is why it really is the banks that are afraid, because they’re paper tigers in a fight with a government that uses its sovereign legal powers. Greece can do whatever it wants with regard to which debts get paid or are written down or written off altogether. It can re-denominate debts in its own currency and then devalue. Or it can simply repudiate the debt as being unpayably high.
In the first place, Greece wouldn’t have to act alone. It has options. Its diplomats can pursue agreements with other countries that are in the same sinking debt boat. They may reject that the eurozone model of austerity and debt deflation. In America, for instance, Donald Rumsfeld has referred contemptuously to “old Europe.” This reflects a feeling that the eurozone is a Dead Zone. Greece can say that it has no intention of being sucked financially and fiscally into this dead zone. It can approach the BRIC countries, and even ask for U.S. support to become a new potential growth area.
Q: What are the options available to the rest of the world to resolve the debt crisis and avoid global depression?
A: A shrinking economy tends to fall further into arrears in a debt spiral. The question today is whether a new ideology and political program of reform will emerge to complete the task of classical political economy by freeing markets from unproductive debt overhead and unearned rentier income. The alternative is a Counter-Enlightenment that would roll back the democratic era that industrial capitalism promised to inaugurate.
Rentier interests have escalated their fight against Progressive Era reforms to defend financial interests. They have gained control of the mass media and universities, the courts and now the government itself under the U.S. “Citizens United” ruling that relinquishes election campaign financing to whomever has the most money – which is turned into TV commercials and a massive ideological propaganda machine to convince voters that There Is No Alternative to debt peonage. This bold ideological inversion of Enlightenment values even celebrates asset-price inflation and debt peonage as the workings of the “free market” as if it were a natural evolution, not a hijacking and derailing of economic development.
At issue is how society will liberate itself from the buildup of debts that can’t be paid. If governments let the financial sector foreclose, they will end up being forced to privatize the public domain under duress conditions at distress prices. They will have to dismantle public administration and welfare services. The problem is capped by having to turn tax policy over to financial lobbyists who claim to be objective technocrats. The result must be economic polarization between creditors and debtors ushering in a new Dark Age of poverty and deepening debt peonage. Wages, profits and property rents will be earmarked to pay interest – on loans that can’t be paid in a shrinking economy.
This is the point at which the financial sector uses its political clout to demand bailouts from the government, adding to public debt. The new credit given to the banks is sent abroad as banks jump ship. This is what happened to the U.S. Federal Reserve’s $800 billion Quantitative Easing #2 in 2011.
The alternative to this nightmare scenario is write down debts to what can be paid, within the framework of a mixed public/private economy geared to distribute wealth and income more equitably. This involves not only monetary and financial reform but tax reform as well. It needs to be highlighted in the public consciousness by placing at the heart of the academic curriculum and media discussion the history of how societies have dealt politically with their debt overhead throughout history.
A new set of key measures needs to be reported and kept in the forefront of political discussion. Monetary theory needs to distinguish between asset-price inflation (the bubble economy’s debt-leveraged real estate, stock and bond market boom) and consumer price inflation. The National Income and Product Accounts need to recognize the magnitude of the FIRE sector and treat its revenue as eating into the economic surplus, not increasing it. And asset-price (“capital”) gains need to be tracked as part of “total returns” to explain the economic polarization between rentiers and wage earners.
But I realize that all this is another story.
Michael Hudson is president of the Institute for the Study of Long-Term Economic Trends (ISLET), distinguished research professor of economics at the University of Missouri, Kansas City and author of The Bubble and Beyond (2012), Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003), Trade, Development and Foreign Debt (1992 & 2009) and of The Myth of Aid (1971). Watch Max Keiser interviewing Michael Hudson On The Edge
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