[Watch a clip from Surviving Progress (2011)]
Below are the transcripts from the film Surviving Progress I was a part of. The film can be purchased from the website.
Canada FILM group on PROGRESS 2010: The Road to Debt Serfdom Cinémaginaire, ASHOP (USA): Interview with Michael Hudson – Tapes #112-113-114
Theme: In the name of “progress,” the world is regressing to neoserfdom.
Mainstream economics has become a body of assumptions selected to rationalize a “trickle-down” tax policy favoring the financial sector driving the rest of the economy into debt, turning the economic surplus into interest charges – to be recycled into yet more debt creation. Claiming that wealth at the top pulls up the rest (“the rich are job creators”), the policy inference is to shift taxes off financial wealth and property onto labor and industry.
What this view leaves out of account is that some ways of “getting rich” are corrosive, not productive. The wealthiest 10% have gotten rich mainly by getting the bottom 90% into debt. And labor (“consumers”) try to escape from their financial squeeze by going even deeper into debt, to buy homes and status before their access price rises even further out of reach. But what is pushing up real estate and other prices is easy bank credit – that is, debt. So the debt expansion calls for yet more debt to keep the financial system solvent.
This is not industrial capitalism as analyzed by the classical economists. It is something quite different. It is a regression to the ancient usury problem that destroyed Rome.
Yet this is not part of today’s economics curriculum. Finance and debt is neglected, and hence in society’s view of the future and where present trends are leading. The debt crisis shortens lifespans, worsens health and leads to emigration, suicide and general impoverishment. So the world economy has entered a regressive epoch whose policies are just the opposite of those of the Progressive Era a century ago.
This inverts the direction in which policy has been moving for the past eight centuries. Already in the 13th century the Churchmen sought to bring prices in line with costs of production, ultimately reducible to the cost of labor. By the 19th century, classical economics was moving toward what Keynes called “euthanasia of the rentier.” But since the 1980s, neoliberalism has promoted euthanasia of the production-and-consumption economy. This pro-financial neoliberal economics is aggressive, not peaceful, and its idea of globalization is neofeudal, not progressive.
Most theories of progress assume that economic relations tend toward a stable balance that is fair. So progress is onward and upward. As the economy gets bigger and bigger, people become more equal, wealthier, and also smarter when it comes to voting and acting in their self-interest. National economies are supposed to become more alike, not more polarized, and to evolve toward happier leisure societies, not descend into a lifetime of debt peonage and insecurity. Any disturbance in this happy picture is supposed to be automatically corrected.
Once an imbalance develops – a buildup of unpaid debts and other built-in payments to vested rentier interests – economic and political feedback mechanisms tend to make the imbalance worse. Societies polarize between creditors and debtors, between property owners and renters, between those with pensions and social security and those without, and between fortunate heirs and the disinherited.
The central flaw in the today’s economic education
Economies are not single homogeneous units. Finance and property ownership are independent from the production-and-consumption core. The debt overhead expands faster than the economy’s ability to pay. This forces a political choice as to whether to write down debts to the ability to pay, or let creditors foreclose on the property of debtors – and in the case of indebted governments, forcing selloffs of the public domain.
Most people think of the economy simply as a combination of labor and technology to produce goods to sell at a profit, which normally is reinvested in new capital formation to produce yet more. That is how progress is supposed to occur. Classical economists expected that the surplus produced would be invested in more capital, new technology, higher education, and better health and living standards. This would raise the productivity of labor and capital to provide a life of leisure for the population.
Most 19th- and early 20th-century observers expected the managerial class to consist mainly of government officials. Bankers would be part of the forward planning process, allocating resources to promote growth aimed at producing and consuming more goods. Instead, the financial sector is autonomous, wrapping itself like an outer layer of an onion around the “real” production and consumption economy to extract as much as it can by loading the economy down with debt, and calling this “wealth creation” when it bids up asset prices.
So the central flaw in today’s economic theory is its failure to recognize that the exponential expansion of debt is external to the “real” economy of production and consumption. Rentier overhead owed to a financial oligarchy is absorbing the surplus.
Sustaining the growth in debt by lending to inflate asset prices on credit
Running into debt is euphemized as “debt leveraging,” borrowing at interest to buy homes, other real estate or entire companies whose price is expected to keep on rising. The rise is supposed to occur as banks lend more and more credit on easier and easier terms. So investors believe that it is easier to ride the wave of asset-price inflation than to invest in creating new means of production or new output.
Bankers seek out real estate investors and offer the following deal: “We’ll lend you enough to buy the land and building. We’ll sit down and calculate how much net rental cash flow the building will yield, over and above expenses. You will agree to pay us all this rent, and we’ll lend you the money to buy the property.”
A symbiotic relationship is at work. A real estate investor will ask, “What do I get out of that?” The banker will reply: “You get the capital gain. Bid against your rivals and win the largest loan by agreeing to pay us your rental income as interest, and you’ll get a gain when you sell the property at a higher price – especially if you increase your rent roll.”
The government subsidizes speculation by taxing capital gains at only half the rate levied on earned income – wages and profits. And if the investor turns around and uses the gain to buy yet more property, no tax has to be paid at all. And the rental income is “freed” from the income tax because the tax code lets landlords pretend that buildings are losing value even while real estate is rising in price. The over-depreciation fiction makes appear that property is not making money, while it actually is more remunerative than anything else!
Classical economists valued property by capitalizing its earnings at the going rate of interest. But matters are more complex today. Property is worth whatever a bank will lend to a new buyer. Larger loans are made as lending terms get easier. Interest rates decline, so a given flow of income will support a larger loan. Down payments are reduced as a proportion of the purchase price, so that buyers can borrow a larger proportion of the asset’s sales price. And less amortization needs to be paid as the loans are stretched out in time and paid off more slowly. Most important during the 2001-07 bubble, lenders cared less and less about whether the borrower actually could pay at all. They found gullible pension funds and other institutions to buy as many debt claims as they could create. The concept of “ability to pay” all but disappeared.
Real estate prices are bid up on credit as families borrow to buy homes and rental properties. The winner normally is the borrower willing to pay the bank the property’s entire rental income in exchange for a mortgage loan. The hope is to make a gain by selling the house or office building – and above all its land, that is, its site value – to a new buyer. Of course, all of this has to stop at some point. It stopped around 2006 in the United States.
Corporate raiding is financed much like real estate speculation
Corporate raiders have applied these principles to fund leveraged buyouts. Looking for industrial companies to buy, they make the same deal with their banker that real estate investors offer: “You get the income, I’ll get the capital gain.” (Hedge fund operators also get a 2% commission on the deal’s total value.) The raider goes to Wall Street underwriters or banking group sand tell them how much they hope to squeeze out of the target company.
The raider will look not only at what the company is presently earning, but also at how much it is reinvesting in new equipment, research and development and other projects with long-term payouts, and how much it is paying in taxes and dividends. The raider may pay out all this cash flow to backers who provide the buyout credit.
Before the debt-leveraged buyout, stockholders got dividends and the government got taxes on corporate earnings. But thanks to the fact that interest is tax-deductible, creditors are able to get the sum of taxes plus dividends. The tax collector thus subsidizes the raid. And the new owner for his part plans to make a capital gain by breaking up the company, downsizing, outsourcing and squeezing labor, and stopping spending on R&D and long-term projects. (The equivalent behavior for landlords is to “bleed” their property by cutting back on maintenance and repairs, raising rents to the maximum, and paying their suppliers more slowly.)
But at a certain point this financial plan doesn’t work any more. Loans begin to go bad and asset prices fall, leaving negative equity in their wake. This is largely because it is easier to make money by downsizing, at least in the short run, and shift production abroad, while the financial sector seeks to absorb the entire surplus (earnings before interest, taxes, depreciation and amortization, abbreviated as ebitda) as debt service – interest, fees and amortization. This impoverishes the economy by not leaving companies with enough to buy more plant and equipment, or even to replace what is wearing out or becoming obsolete.
In a similar dynamic, homeowners cut back on other needs to pay their mortgages. And even as the economic surplus is turned over to the financial sector, it recycles its revenue to load down the economy with more and more debt – new loans to new borrowers and larger loans to old ones. So as fast as the financial sector builds up its own wealth, it relends it. The economy’s debt grows exponentially – faster than the economy can keep up as carrying charges on all this debt exceed the non-financial economy’s surplus.
Debts that can’t be paid, won’t be
This brings business upswings to an end. It therefore is necessary to clear up the belief that most debts can be paid. Most people want to pay the debts they take on. They imagine that banks wouldn’t lend unless they thought the borrower could pay. So borrowers end up blaming themselves when they can’t keep up, rather seeing the economy-wide debt deflation.
Banks foreclose on homes and other collateral, but this isn’t the business they’re in, and they usually don’t want property on their balance sheet. Their game is to lend money and let ambitious speculators take the risk – and to finance raiders who will downsize a company’s labor force, cut back long-term investment projects, and even break up the company so as to pay the banks out of capital gains – financial gains, not tangible capital formation. As long as banks can turn around and sell their IOUs and bad loans to third parties, they don’t care whether or not the debts can be paid. Their ability to “originate and resell” debts was a major step to creating a fictitious financialized economy.
The major problem that banks face is that debt in every country is growing more rapidly than the economy’s ability to keep current on debt service. People, companies and government itself must pay a rising share of their revenue to the banks. Mortgage borrowers pay more of the real estate rent, and companies more of their cash flow. This leaves less revenue available to buy new equipment, build factories and invest in research and development. So the economy becomes post-industrialized, leaving it with a shrinking surplus to pay the bankers.
Creditors try to solve the problem by lending borrowers enough to pay the interest falling due. This may work as long as more debt leveraging raises asset prices. Homeowners, for instance, keep refinancing their mortgages as if it were “equity extraction,” free money rather than debt. This asset-price inflation worked for the stock market until 2000 when the leveraged buyout craze ended. Alan Greenspan called it “wealth creation.”
From his banker’s-eye perspective, the way to make money is to downsize and pay workers less. This leaves more money to pay the bankers – in the short run. But it stifles the economy’s ability to create a surplus out of which to pay the banks. This is the major problem with the financial vantage point generally: Its time frame is short-term.
Running into debt ultimately is self-destructive. U.S. housing costs, for example, absorb some 40 percent of family income for many families, either for rent or to pay their mortgage and other carrying charges. Sheila Barr at the FDIC seemed almost radical when she urged the government only to guarantee mortgages in cases where the debt is scaled back to 32 percent of family income. A higher rate squeezes the family budget too far. On an economy-wide level, it raises the cost of living and doing business, pricing U.S. exports out of world markets and making the economy unsustainable internationally.
How debt gives a financial dimension to the class war against labor
Mr. Greenspan found an unanticipated virtue in loading down families with debt. He pointed out to Congress that American families now owe so much on their homes, credit cards and other obligations that they are afraid to go on strike. They are even afraid to complain about working conditions, because they’re one paycheck away from homelessness. Missing a paycheck means missing a debt payment – and that will sharply increase the credit card rates they have to pay (up to 30%) and entail heavy late fees. Foreclosure is threatened.
When asked in February 1997 why prices haven’t gone up to reflect the sharp rise in the money supply that was fueling the dot.com bubble, Mr. Greenspan explained that for starters, the credit creation was not being used to employ labor and thereby bid up wage levels. It was being lent out to labor – as home mortgage loans and equity loans, student loans, credit-card debt and other personal debt. American families are too deep in debt to afford to go on strike like they could in the 1940s and the ‘50s. Testifying before the Senate Banking Committee, Mr. Greenspan explained why wages were rising so slowly despite historically low unemployment rates. Under normal conditions the rate then-current 5.4 percent rate – the same as in the boom years 1967 and 1979 – would have led to rising wages as employers competed to hire more workers. However,
Mr. Greenspan said:
As I see it, heightened job insecurity explains a significant part of the restraint on compensation and the consequent muted price inflation.
Surveys of workers have highlighted this extraordinary state of affairs. In 1991, at the bottom of the recession, a survey of workers at large firms indicated that 25 percent feared being laid off. In 1996, despite the sharply lower unemployment rate and the demonstrably tighter labor market … 46 percent were fearful of a job layoff.1
Again in July 1997 he testified that a major factor contributing to the “extraordinary” and “exceptional” U.S. economic performance was “a heightened sense of job insecurity and, as a consequence, subdues wage gains.”2 By making workers afraid to strike, this “traumatized worker” effect has helped win the class war for industrial capital. Wages are kept down by debt pressures on workers, as well as by corporate debt leading to industrial shrinkage, outsourcing and a slower demand for labor. For Mr. Greenspan, poverty meant a victory for his Federal Reserve Board’s constituency, the financial sector.
As matters have turned out, this conflict is not just between employers and their workers. On the employer’s back rides the banker, who tells companies that that paying debt service should take priority over building more factories to expand their market. Nobody ever said that the class war was economically rational. Financial managers applaud lower wages as leaving more business profits available to be paid out as interest. But lower wages leave less income to be paid for rent or capitalized into mortgage loans, the banking sector’s largest market.
So the surplus that people expected to take the form of a leisure society is used instead to pay debt service. The rise in living standards that people were promised from technology hasn’t materialized. If you read what was written a half century ago, back in 1945 when World War II ended, people thought that with all the technology that was expected – the medical technology, new means of power transportation and consumer goods – everyone would be able to live a life of leisure. But the surplus hasn’t gone to raise living standards, and certainly not to shorten the workweek. It has gone to pay more interest and fees to the financial sector. The postindustrial society is being de-industrialized, indebted and on the road to debt serfdom.
The exponential growth of debt outruns the economy’s ability to pay
One long-term economic trend has progressed more than any other: that of debt. Debt grows more rapidly than output, population or anything else. And it grows by purely mathematical means, exponentially. Economies and populations have never kept pace.
Any rate of interest can be thought of as a doubling-time. The effect is like a bank depositor who leaves savings in an account to grow as interest mounts up each year, earning interest on the interest. At any given rate, the debt will double and redouble as the creditors who receive this interest (mainly the banks and the wealthiest 10 percent of the population) take their financial returns and look for new borrowers with new ventures.
This often involves lowering their loan standards. Becoming more risky is the only way to keep the volume of loans/debts doubling. So the debt becomes what 19th-century critics from Marx to Henry George called “fictitious.” There is no real prospect of the financial claims ultimately being paid. They can only be rolled over, pretending that the debtors are credit-worthy by lending them the money to pay the interest and amortization falling due.
Already in 2000 BC the Babylonian language had a word for this: mashmash, interest (mash) on the interest. Student training exercises calculated this doubling and redoubling to see how investors could multiply the money they put into commercial ventures. Yet in modern times this mathematics is associated mainly with the exponential growth of population, not of debts and savings. Malthus famously said in 1798 that population keeps growing exponentially at geometric rates while the food supply grows only at “arithmetic” rates, in a straight line, leaving no room for everyone to eat at “nature’s banquet.” But population is now shrinking in the most deeply financialized economies, as it shrank in Europe in the 1930s. In the post-Soviet economies life expectancy has shortened, fertility rates plunged and emigration accelerated.
As matters turned out, Malthus was wrong. When incomes rise, population grows more slowly, not faster. But even more important is that Malthus got the idea of exponential growth from that of compound interest – the rise in debt left to accumulate interest year after year. This is how Richard Price explained the contrast between geometric and linear growth a generation before Malthus, in the 1770s, addressing the problem of Britain’s national debt.
Debts grow exponentially, but economies don’t. Their growth typically takes the shape of an S-curve, tapering off. And a major reason causing business upswings to taper off is the growing debt burden. Paying debts diverts spending away from markets, and hence shrinks investment and employment. The economy can’t keep pace with the debt burden, so liquidation occurs, and downturns end in a crash. Every society in recorded history has found that debts grow more rapidly than the ability to pay. This inherent disparity between the growth in debt and that of the economy’s production and consumption should be the starting point of economic theory, and politics should be all about how to solve this problem.
Richard Price’s analogy of a penny saved at compound interest
By 1776 when the American colonists revolted, Britain and France had spent so much money on war that most of their budget was earmarked to pay the public debt that had been run up for five hundred years to go to war with each other. Since about the 13th century each new war loan on was collateralized by a new tax to pay the interest. Matters came to a head when Britain and France went to war in 1757 over their rivalry, especially in the American colonies.
Richard Price, an actuarial mathematician, had warned n 1772, that all the government’s income would soon be spent on interest on its war debt. To explain the problem to the public, he chose the example of a penny invested at the time of Jesus Christ at five percent interest. At simple interest – just paying the five percent each year – the interest would amount to a total 7 shillings and 12 pence by his day. However, reinvesting this interest as it fell due would accrue an amount equal to a solid sphere of gold as large as 120 earths. And if this penny had been left to accrue and reinvest interest at six percent, it would have amounted in value to a solid sphere of gold extending from the sun’s orbit all the way out to Saturn.
Many people at the time of Jesus saved pennies, of course. And the rate of interest was much higher. Roman senators, governors and well-to-do individuals such as Cicero and Seneca charged 20 or even 30 percent. But nobody has a sphere of gold even as large as one earth. The reason is that no economy could pay this much. All the gold that’s ever been mined in the world would measure a cube only 18 meters on each side. So the ability to pay interest is limited by the amount of gold – or the value of assets owed.
The moral is that an economy encouraging savers simply to leave their money to accumulate must lose it in a convulsion of bankruptcy that wipes out the increasingly nominal savings. The sums that are supposed to be paid can’t be, just as all those pennies saved at the time of Jesus couldn’t be paid in the end.
As matters turned out, England continued to fight with France, especially after the French Revolution in 1789 brought Napoleon to power. By the time the war ended in 1815, some 75% of England’s public budget was spent on debt service.
The Persian chessboard analogy for the exponential “magic of compound interest”
There is a famous story about the power of compound interest and how rapidly any sum grows – savings and the debts in which they are invested. The king of Persia wanted to reward the inventor of chess. “Whatever you want in my kingdom is yours, as a reward for having created this wonderful game. Just tell me what you want.”
“I only want something simple,” the inventor replied. “Take this chessboard. I’d like you just to fill it up with grain.” The king asked what he meant. The investor explained, “I just want one grain on the first square, but I want you to double the amount on each next square – two grains on the second, four on the third, and so forth.”
The king thought that this didn’t sound like very much, and agreed. He started the first row with one grain of wheat, and put two grains on the second square, four grains on the next, then eight, 16, and 32. The seventh had 64 grains, and the eighth square128 grains.
So far, the king was happy. Then he went on to the second row, from 252 grains on the ninth square, 504 and so on. The pile kept growing, but at the end of about two rows it still looked like not much grain. But by the time the 30th square was reached, the king saw that the doubling and redoubling, which at first had seemed to go so slowly, was threatening to absorb all the grain in the kingdom. He saw that by the time the 64th square was reached, his promise would amount to more grain than is produced in the world. He turned to the chess inventor and said: “By the time this finishes, you’re going to have all of the grain that was ever produced in the world.” The inventor said, “That’s the idea.” This is how any form of exponential growth keeps multiplying.
This is what pension funds are promising to achieve, at the typical rate of 8% annually – a doubling time of nine years. The question is, how can the underlying economy support this financial doubling? In a fairly short period of time the amount of money owed will exceed what is being earned. Industry will end up paying more interest than it can make in profit, and individuals will owe more on their mortgages, student loans, auto loans and credit card debt than they can earn over and above break-even costs of living. In such cases the only way to can keep current on bank loans is to reduce consumption (for individuals) and new capital investment (for corporate debtors).
This is the point at which the financial system becomes extractive instead of helping economies grow. It takes money out of the economy to pay debt service, which keeps on doubling and doubling. Arrears mount up and are simply added on to the debt. The world is approaching the point where all the surplus is owed as interest. This is the position in which the king of Persia found himself by about the 30th square of the chess game described above.
The lily pond analogy
Think of lilies floating on a pond. They reproduce rapidly, doubling every day. Suppose you start with one lily plant, and it doubles each day. Suppose that by the 30th day the pond will be completely full of lilies. They will cover the whole surface, which will prevent the fish from getting oxygen, and life in the pond will die. This is what is happening ecologically as well as financially in many parts of the world today.
The question is, on what day is the pond half full? The answer is the 29th day, because the doubling rate will fill it up completely in the next day’s lily cycle. One day the pond is half full of lilies stifling the pond of oxygen, the next day it’s dead.
The global economy is now living in the pre-crash last day of the lily pond analogy – the point at which it is half full. “Half full” sounds as if we still have time to fix things. But if you’re doubling the lilies’ growth every day, then tomorrow the pond will be full. This is the position we are in, ecologically as well as in terms of the debt overhead. The debt burden is stifling growth in Iceland, Latvia and other post-Soviet economies, Greece and Ireland, Spain and Portugal. And it keeps growing.
In the United States, California and other states are having to lay off employees. A major financial problem is the inability of their pension funds to make the 8% compound interest that was calculated as necessary to enable them to pay their retirees by letting early pay-ins multiply. This hasn’t materialized, and it cannot do so. President Obama and the Bush Administration created $13 trillion worth of debt simply by adding it onto the government balance sheet in 2009-10 just to make creditors whole rather than wiping out bad debts.
How long can the debt expansion go on? In economic terms it has about one day more – that is, one doubling time – to go.
Should we put our faith in financial miracles?
Benjamin Franklin, J. P. Morgan and Einstein are among many celebrities credited with saying that compound interest as the Eighth Wonder of the World. Financiers know the principle best. The important thing to realize is that the principle only applies to the financial sphere, not to “real” economic growth. But the economy is moving inexorably toward the point where the entire surplus over basic subsistence break-even needs is paid to the banks as interest. This is the essence of “capitalizing” revenue. The business plan of bank marketing departments is to get the entire economic surplus paid out as interest.
Unlike antiquity’s Seven Wonders, the Eighth Wonder’s power is destructive, not productive. It’s easier to foreclose than to produce. Most people think of how the economy – and their own fortunes – can grow. But the financial sector’s attempt to extract interest (“Plan A”) ends up in “Plan B,” appropriating the fruits of this growth for itself as financial dynamics overpower the industrial economy.
The problem is that any rate of interest is a doubling time. Trying to pay it ends up shrinking an economy’s ability to create a surplus. So the financial worldview is ultimately self-destructive. It ends up emptying out a country’s raw materials, cuts down its forests, appropriates its water, and finally empties it out of people.
Economists use what’s called the rule of 72 to calculate it. If you take any rate of interest like 5%, and you divide 72 by 5, that’s the doubling time – just over 14 years. If you divide 72 by 6, it’s shorter (12 years). And 72 divided by 10% works out to just over 7 years. This is called the “magic” of compound interest because the real economy doesn’t double anywhere near as fast. That’s what makes savings that are lent out ultimately uncollectible – and hence, fictitious.
How usury became socially acceptable
Ancient languages had no separate words for usury and interest. Usury meant taking any interest at all. The usury denounced in the Bible was not commercial interest (mainly on shipping loans), but credit to individuals, mainly cultivators on the land threatened with being reduced to debt bondage and loss of their land or crop rights – their basic means of support.
Written records go back about four thousand years, to 2,000 BC, with sketchy inscriptions and economic records going back to about 3200 BC. Down to the time of Jesus – that is, for more than half of what has become Western civilization – it was normal for Near Eastern rulers to periodically cancel the debts when they became too large to pay. A tradition of periodic debt settlement is found in Asia from Tibet to Japan, often linked to New Year ceremonies of social renewal. The idea always has been to keep finance from unbalancing the overall economy, by preventing the accumulation of debts from getting out of hand.
Most of the financial problems that occur today were dealt with already in Sumer in the third millennium BC and in Babylonia in the second millennium. New rulers taking the throne would cancel the personal debts and agrarian debts so that their rule would begin in economic balance. The word for debt cancellation in Sumerian was amargi, meaning a return to the original “mother situation,” assumed to have been equitable. Throughout the ancient Near East, from Sumer to Babylonia to Egypt, the idea of equilibrium was an economy free of bad debts and debt bondage. Clean slates were the means of maintaining balance.
Jewish religion took Clean Slates out of the hands of kings and put them at the core of Mosaic Law in Leviticus 25, the Jubilee Year. Its Hebrew term was deror, cognate to Babylonian andurarum. Every ruler of Hammurabi’s dynasty (2000-1600 BC) proclaimed andurarum cancelling personal “consumer” debts. These typically were denominated in grain, as most of the population lived on the land. In addition to canceling these debts, royal andurarum proclamations liberated bondservants pledged to creditors (they were returned to their families), and also restored the land rights that had been forfeited to foreclosing creditors.
However, neither the Babylonian andurarum laws, their Sumerian antecedents nor the Biblical Jubilee Year canceled commercial debts. The guiding principle evidently was that a merchant who borrowed for commercial purposes could afford to lose all his money but still retain his citizenship rights to his land. The concept seems at first glance to be akin to the classical contrast between productive and unproductive loans. But the key aim was more direct: not to disenfranchise citizens. Babylonian, Sumerian and Egyptian rulers had a good reason for this. To let citizens be reduced to debt bondage would prevent them from serving in the army. Rulers wanted to maintain a self-sufficient citizenry so that their armies would not be defeated by debt-free rivals.
By the fourth century BC a Greek general known as Tacticus wrote a military manual advising that the way to conquer a city was to win the people over to your side by promising to cancel their debts. And by the same token, the way to defend a city was promise to cancel the debts of their citizens, and also free the slaves to give them a motive for fighting to defend it. This is what Zedekiah did in the Bible, and what Coriolanus did in Rome. (They then went back on their word!) But by classical antiquity it was much harder to reverse debt bondage, because the debts were owed to private-sector creditors, no longer mainly to rulers. It was easy for rulers to cancel the debts when most were owed to their own palace and to the temples. But by classical antiquity, interest-bearing debt had become secularized and privatized.
Today, many Westerners, especially Europeans, are faced with lifetimes of paying off creditors. The property bubble has burst in Europe, but it doesn’t have the American protection that permits mortgage debtors simply to walk away, leaving the creditor with the house but not a further claim. Europeans who default on their home mortgages remain personally liable and have to spend the rest of their lives making up the bad debt – the “negative equity” – to the mortgage holder. So in effect they’re being reduced to debt peonage.
How much can debtor countries pay?
For many decades the large New York banks looked at Latin American governments as major customers. When I went to work for Chase-Manhattan in 1964, I was told to look at the ABC countries – Argentina, Brazil, and Chile – and estimate how much they could afford to borrow. I started by calculating how much they could export over and above what they had to import. For Chile, my starting point was to calculate its volume of copper output and multiplying it by the price it received (not world free market prices, but insider “producer price” sold at a steep giveaway discount to the U.S. parent copper companies).
The major import was food. Chile had the world’s largest supply of guano fertilizer, but the worst farm productivity because of its latifundia/microfundia land tenure system inherited from the Spanish conquest. My job wasn’t to say what would actually help them pay by changing the political system, or to help them change the exploitative U.S. minerals investment. Anaconda was a prime Chase customer, while Kennecott was a prime Citibank customer. Like any financial analyst, I took the status quo for granted and simply asked how much could be extracted from an economy that was malstructured from the start.
The aim was to create a model showing how much net foreign exchange a country could generate and pledge to banks as interest. Bank marketing departments hoped to lend up to the point where the entire surplus of a debtor economy would be earmarked to pay interest.
By the 1970s, countries had difficulty paying. Many simply added the interest onto the loan each year. So their foreign debt grew exponentially, accruing more interest due each year. This process reached its limit in the 1980s. Mexico announced in 1982 that it lacked the funds to pay its foreign debt. Most Latin American countries stopped paying. They already were paying virtually all their balance of payment surplus to the banks, leaving them without enough foreign exchange to import basic necessities, not to speak of building new factories. U.S. creditor banks didn’t declare default, because they would have had to write down their loans to a realistic value. The debts were rolled back with a “haircut” by “Brady bonds,” debt write-downs negotiated on the condition that debtor countries commit economic suicide.
The International Monetary Fund (IMF) and World Bank pointed out that there was an option to bankruptcy: privatization of the public domain. The World Bank had lent billions of dollars during the 1960s and ‘70s for governments to pay U.S. and European companies to build up their infrastructure. Now that it was in place, debtor governments were told to start selling it off and use the proceeds to pay their creditors, along with other assets in the public domain: mineral rights, water, forests, roads and other transportation, and especially the phone systems. And governments were not to regulate these monopolies by limiting their charges to their cost of production, as the United States itself had been doing for a century. The new buyers were allowed to make easy money jacking up the fees they charge, that is, by rent-seeking. This made these privatized enterprises highly remunerative for international banks extending buyout money and for money managers to invest in their stocks and bonds.
The alternative was for debtor governments to repudiate their debt on the ground that it was the result of bad advice. But politicians receptive to this approach were opposed by well-funded candidates willing to follow the Washington Consensus and sell off the public domain, the land, forests, water, public enterprises, government airlines and phone companies, electric power companies, mineral rights and so forth. So the banks found themselves with a wonderful new market – not only governments borrowing afresh, but also private investors borrowing to buy these privatized enterprises on credit.
The Soviet Union since its breakup in 1991 provides an object lesson in what debt does to an economy’s population – and finances. Post-Soviet states were advised that economic progress meant turning state property over to insiders. This was done initially almost for free, but increasingly involved credit. Kleptocrats flipped their properties to new buyers on credit. By the time privatization became available to homeowners – especially in the Baltics – buyers had to borrow the acquisition money from the banks. And most bankers were foreign affiliates who made loans in Euros or other foreign currencies rather than domestic currency.
In 2006, Russia’s President Vladimir Putin remarked that the neoliberal “free market” reformers sent from Washington and the World Bank under the Yeltsin dictatorship in the 1990s had destroyed more of Russia’s population than World War II had done, when some 20 million people died. Russian life expectancy shrank by an average of ten years, its economic growth rate was plunging, its population shrinking, its skilled labor emigrating, and neoliberal asset stripping had dismantled its manufacturing, de-industrializing the nation and indeed most of the former Soviet Union. Russia was turned into a raw materials exporter.
By 2008 most post-Soviet economies were strapped as a result of mortgage debt taken on in foreign currency. Real estate bubbles became the vehicles by which central banks obtained the foreign exchange to cover their trade deficits. Once these bubbles burst, foreign-currency mortgage lending dried up. This left these economies with no visible means of support – except to borrow from the IMF and European Union. (Currency depreciation would have led to further defaults, as debts denominated in foreign currency would have become even more expensive to carry.) Lacking minerals and fuels, they have run deepening trade deficits as they import most of their consumer goods and capital goods. Iceland and Latvia are the two most heavily debt-burdened countries being told to pay debts far beyond their ability to do so. Large numbers of people are losing their homes, labor is emigrating, hospitals and schools are being closed down as foreign creditors impose financial and fiscal austerity.
Austerity threatens not only to bankrupt the Baltics, Hungary and other East European economies, but also their bankers in Sweden and Austria. To save these banks, European Union officials and the IMF offered credit on the condition that these countries impose austerity. Latvia, for example, was told to close down its emergency medical service and many of its hospitals and schools. This spurred an emigration of doctors and teachers. Polls report that one-third of Latvia’s population of working age between 20 and 35 years old intends to emigrate, lacking jobs at home. The surplus is being stripped to pay banks.
Much the same is happening in Greece, Spain and Ireland as they knuckle under and commit fiscal and financial suicide on the installment plan. When debt-burdened economies go into recession, their cardiovascular disease rates rise, people get sick and lifespans shorten as public health systems are decimated under IMF-EU financial demands. Government spending on education and basic infrastructure is downsized and assets sold off to pay creditors.
What Iceland, Ireland, Greece and Spain expected to be Social Democracy when they sought to join the European Union has turned out to be a pro-financial regime turning economic planning over to bank managers. When neoliberals say that they want to get rid of government planning because that is the road to serfdom, what they really want is to shift government planning to Wall Street, the City of London and the Paris bourse. And the problem with letting bankers do the planning is their short-term time frame. They make money in ways that shrink economies, not help them grow. So from the financial point of view, the banking system’s business plan turns out to be a road to debt serfdom: a shrinking economy with no surplus over and above basic break-even living standards. This is what happened in feudalism in the wake of Rome’s collapse at the hands of its creditor oligarchy.
Economies have been turned into Ponzi schemes requiring exponential credit growth
A pyramid scheme is basically a Ponzi scheme, a chain letter that needs to keep attracting new players or collapse. Any system with exponentially growing debts – or promises to pay based on scheduled interest accruals – is this kind of scheme. Given that any rate of interest implies a doubling time, it is like playing “double or nothing” in Las Vegas. Ultimate collapse is inevitable. It comes at the point where no more new players are putting in enough money to enable the earlier subscribers to keep on “doubling up.” The most recent entrants are then left holding an empty bag.
In real estate bubbles, new buyers must borrow enough new credit to buy homes and office buildings at a high enough price to enable owners to keep on refinancing their debts so as to borrow the interest charges falling due – even if rental income is not keeping pace. For pension funds invested in the stock market, new buyers must keep bidding up stock prices at a rate enabling the funds to pay retirees out of “paper” gains. For real estate and stock market bubbles alike, new buyers must expect the rise in asset prices to continue with a momentum of their own, without much regard for how the economy at large can support these gains.
In the United States, pension funds are struggling to meet the typically 8% annual growth target they need to meet their scheduled out-payments. There is no way this can be earned in today’s debt-burdened economy without taking dangerous risks.
Half the pension funds in America could achieve solvency by going to Nevada and betting on black or white. Half would double their money and meet their target. But the other half would lose everything. Pension funds may be tempted to pursue this desperate gamble because they’re dead if they keep on the present course and fall further behind the projected annual gains necessary to maintain solvency. The economy simply is not providing an opportunity to do this any longer with any degree of safety. So gambling is the only financial game left in town. The financial tragedy of our time is that most players are certain to lose.
The basic principle is, “Big fish eat little fish.” Someone has to be devoured, because pyramid schemes build up debts so quickly that no economy can keep up the appearance of solvency for long. In times past, tangible capital investment was supposed to build up savings, paying investors out of loans invested productively. But as economies have been financialized, life support takes the form of more and more debt. Central banks monetize fresh credit and lend it to banks to keep the bubble expanding.
Easy credit prolongs Ponzi schemes by driving interest rates down and asset prices up
The private sectors of most economies emerged with relatively little debt in 1945, as there was little to borrow for during the wartime years. From the end of World War II in 1945 until 1980, debt ratios rose steadily – and so did interest rates, from about 2% to more than 20% in the United States for prime corporate borrowers.
To prevent a financial meltdown, banks flooded the U economy with credit. Interest rates came down – to just a quarter of one percent (0.25%) by 2010 for bank borrowing from the Federal Reserve. The lower the interest rate, the more credit a bank customer can borrow against a given revenue stream. This is called the capitalization rate (“cap rate” for short). Rising debt leverage fueled an enormous debt bubble – what lobbyists for the financial sector euphemized as “wealth creation.”
Students are taught to calculate debt leverage in the first week of business school. Any flow of income – what a company earns, what a real estate property will yield in rent, or what a person earns over and above break-even expenses – can be pledged to a bank as backing for a loan. The banker views this income as a potential flow of interest payments. $100 a year will pay interest on a $2,500 loan at 4%, or a $2,000 loan at 5%, a $1,677 loan at 6%, but only a $1,000 loan at 10%. The banker seeks to lend the real estate buyer or corporate raider as much as can be carried at the going rate of interest. Bank customers bid against each other to buy property, and the winner emerges as the one who gets the largest loan by agreeing to pay the banker the most. “Equilibrium” is supposed to be reached when the banker ends up with all the property’s net income as interest.
Real estate investors and corporate raiders are willing to make this deal in the hope of coming out with a capital gain. This may be achieved by squeezing out more income (downsizing companies and outsourcing their labor force), or waiting for the central bank to act as handmaiden to the commercial banks by inflating asset prices to fuel the debt bubble.
Buying assets on credit in this way – debt leveraging – was the way to get rich by riding the wave of asset price inflation. Interest rates were falling and credit terms were becoming easier, enabling bank customers to keep bidding up property. It was like a Ponzi scheme as new buyers of property on credit provided capital gains for early borrowers to “cash out.” As long as prices for real estate, stocks and bonds rose by more than the interest rate, borrowers came out ahead, at least on paper. Bankers increased their loans at a rate that absorbed the added income, while balance sheets showed a rising net worth for households, companies and real estate. The volume of land and buildings, plant and equipment and other investment did not increase much, but its market price – what banks would lend against it – soared. So from a bankers’-eye perspective the economy was getting wealthier.
Debt is the bankers’ product, after all. The economy at large has adopted their vantage point, shifting attention away from the fact that “real wages” (what take-home wages are able to buy after paying essential financial, insurance and real estate charges) are not rising. The aim is to focus the attention of debtors on the rising market price of their homes rather than at their rising debt. The trick is to make them willing to live at a lower standard in order to build up what they see as wealth in the form of their house price, and contribute to pension funds and buy mutual funds in the expectation that these will support them after they retire.
This is a picture painted by bank marketing departments and money managers eager to charge commissions. The bankers’-eye view is not based on tangible wealth or growth in living standards. It is that of business school students indoctrinated with exercises in debt leveraging up to the point where interest charges absorb all the available cash flow. Subsequent training shows them how to increase this cash flow by squeezing labor, increasing productivity by working employees harder, and how to raise their companies’ stock price (thereby increasing the value of the stock options that upper management gives itself) by using earnings to buy back stock or even borrowing to buy their stock or pay higher dividends. This is how industrial companies are financialized, “creating wealth” simply in the form of higher stock market and bond market prices, not by increasing productive capacity and living standards.
Debt leveraging is the “post-industrial” mode of getting rich. But what now backs the expansion of debt is not capital investment producing more output. It is the supply of “cheap” credit “chasing” real estate, stocks and bonds. Few buyers who joined the real estate bubble as it moved toward its 2008 peak asked what economic conditions were needed to support the rising property market. By historical standards, debt/income ratios were rising off the chart. But as long as the “paper” price of assets was rising faster than their debt, people thought they getting richer buying property on credit.
The happy illusion of feeling financially wealthy was based on the expectation that there always would be a greater fool to buy one’s property. This required that banks would keep on lending enough credit to enable these “greater fools” to keep the game of financial musical chairs going, bidding up property prices on credit ad infinitum. “As long as the music is playing, you’ve got to keep dancing,” quipped Citibank’s Charles Prince. And until 2008 the banks kept providing music for this dancing.
But interest rates couldn’t be reduced further once they fell under one percent for banks in the United States in 2009, while mortgage drifted down near five percent. There was no further range to maneuver. Speculators began to withdraw from the market – and they accounted for about a sixth of home purchases in 2007. Prices started falling – but the debts remained in place. So refinancing loans at higher debt levels stopped – and so did the capital gains. Once borrowers couldn’t make easy gains buying and selling assets, the pyramid scheme came to an end. People couldn’t resell their homes to the proverbial greater fool.
The economy began to shrink as debtors had to pay the banks rather than receiving fresh credit from them. Consumer spending was cut back, as was industrial spending on capital equipment and building new factories. Foreclosure time had arrived.
Destroying the Amazon to pay Wall Street
The hope of getting rich from a debt-financed financial bubble was a dream from the outset. Governments owe more and more, companies owe more and so do families as debt service absorbs the surplus over and above basic break-even expenditures. The only way to pay is to strip assets faster, at an exponentially growing rate. So they’re emptying out the economy in a vain attempt to pay the debts that keep on building up and accruing yet more interest and penalties as payments fall behind.
Collateral damage from this financial attack includes cutting down the forests. Since the 19890s many countries have turned their public infrastructure into privatized tollbooths charging access fees to phone service, roads and other transportation, power and other basic needs. The more revenue that the buyers are able to strip to pay the creditors that lent them the credit to buy the public domain being privatized, the more the economy shrinks. So while rising debt service prevents companies from buying new machinery and individuals from raising their living standards, the need to use tax revenue to pay creditors blocks governments from maintaining their infrastructure and protecting the environment.
This is how financial debt leads to ecological debt. Brazil’s rain forest is one of the more conspicuous victims. Creditor demands left the nation with little revenue to replant the forests, and there was little financial interest in taking the time to replant trees. When they were cut down, it stopped raining, because the trees are what made it rain. The land started to dry up, shrinking the growth of its forests all the more. But the debts keep growing.
The problem is that the banker’s time frame is short-term. As economies are stifled by their debt burden, Wall Street, the City of London and other creditors decide to take the money and run. This is a criticism that was being made already by World War I. British economists such as William Foxwell criticized the fact that while government planning aims at long-term economic growth, the financial sector tends merely to grab what it can. The financial business plan collapses at the point where the debt overhead strips the economy of its ability to replenish its capital and the earth itself. The IMF and World Bank are directing debtor countries to pay by stripping their forests, emptying out their oil wells, selling their water and other natural resources.
This voluntary pre-bankruptcy sale is the end game of the financial expansion. Bankers take their money and run, to start digging holes in other countries, and emptying them out. This is what globalization has become. It is not sustainable financially or, for that matter, ecologically.
Financial conquest today achieves what military conquest did in times past
While financial asset stripping has led ecology to become more unbalanced, economies are shrinking and lifespans are shortening. The final stage of this destruction occurred when banks lent money to speculators trying to make gains by buying assets to sell at a higher price. Banks encouraged this asset-price inflation by lending buyers more and more to bid up prices for assets. This process didn’t require more to be produced or more labor to be employed. It focused on leveraged buyouts fueling a global financial bubble.
Europe was changing its laws and its tax systems to subordinate financial growth to serve that of industry and agriculture early in the 20th century. But World War I ended this drive. When the allies won, Anglo-American banking practice predominated over German and Central European industrial finance. And the bankers’-eye view sees progress as leading toward the point where the entire economic surplus is earmarked to pay the financial sector.
Finance today is as destructive as military warfare in times past. Creditor claims for interest payments establish financial tribute. The resulting austerity is associated with rising disease rates, cardiovascular injury and alcoholism, rising suicide and mortality rates. Life spans shorten, birth rates decline and emigration accelerates, especially by young adults of prime working age and the most highly educated and skilled labor.
Russian President Vladimir Putin has said that the neoliberal financial reforms foisted on Pres. Yeltsin’s regime by the Harvard Boys after 1991 caused a shortfall in population of about 20 million – as much as Russia lost during World War II. So the power to create credit to indebt foreign countries has become as dangerous as fielding armies in times past.
Is the problem personal greed or institutional and financial structures?
Many people see Wall Street using bailout money to pay huge bonuses as a symptom of personal greed. The moralizing approach is to think that if we can change people’s personality to be more altruistic, we wouldn’t have this problem and the world would be fairer. But simply to call finance “greedy” is to project an anthropomorphic dynamic to what basically is an abstract and impersonal mathematical dynamic. The problem is not greedy people as such, but the mathematics of compound interest and the way it has been privatized. It’s not that Wall Street, the City of London or the Paris bourse deliberately are wrecking economies. It’s true that there are many selfish wealth-addicted people who behave in an asocial manner. But the financial dynamic is impersonal and basically mathematical.
When you follow the money, it turns out that many funders of corporate takeovers are institutions, with pension funds in the forefront. So the problem turns out to be the way in which finance has been institutionalized, and the warped tax framework that steers investment along economically corrosive lines. But class warfare also has played a role as industry has long backed financial operators because of their shared interest in suppressing labor.
Workers were anything but greedy back in the 1950s when they negotiated lower wage payments in the short run so that they would have more security in their retirement. They simply wanted to secure their pensions. But tragically, the most reasonable way to achieve this appeared to be to put their savings into pension funds that financialized these savings in ways that benefited the financial sector, not the “real” economy or the long-term interests of labor.
General Motors, which started the pension fund plan, didn’t want workers to have a voice in management. It insisted that labor’s pension savings and corporate contributions be turned over to money managers to buy stocks and bonds. This inflow quickly became the major factor pushing up stock market prices from the late 1950’s onward, prompting Peter Drucker to coin the term “pension-fund socialism.”
This saving for future security was the opposite of greed. The workers who contributed to the pension funds weren’t greedy. They were giving up wage increases in return for pensions and health insurance. But pension fund managers used labor’s savings in increasingly speculative ways as the financial sector became disconnected from direct investment in means of production. The system has become mal-structured independently of the personality or psychology of its managers.
The actuarial promise was that pension funds would keep on doubling and redoubling, paying for retirement and health care out of “paper” capital gains. At first, these gains were assumed to take the form of dividends on earnings from new capital investment in factories and equipment, research and development employing labor. There was supposed to be a self-feeding economic expansion. But it turned into asset-price inflation – rising prices for stocks and bonds fueled by pension-fund savings. Profits were made by cutting labor costs, not by new capital investment. The financial sector made money by loading the industrial economy down with debt, increasing the price of doing business and living, and thereby pricing labor out of world markets.
In recent years pension funds have bought stocks mainly from venture capitalists and managers cashing out on their stock options. They have been withdrawing money from the stock market while the workers who were putting their wage withholding into it. Industrial cash flow and labor’s savings have been financialized and used to speculate in assets-in-place (including junk mortgages, corporate takeover loans and derivatives gambles) rather than to promote direct investment that employs labor and expands the “real” economy. So the question is, what kind of progress is most important: debt-leveraged “capital” gains from higher real estate, stock and bond prices; or more means of production and consumption in a context of environmental stability?
You could say that it was financial planners who were greedy in designing a system that made speculators rich and benefited primarily the economy’s wealthiest 10 percent who own most of the stocks and bonds. The system has collapsed for labor and small savers, whose savings have been siphoned off by the top of the economic pyramid.
Meanwhile, the financial system has become corrosive, expanding at the expense of the industrial economy and living standards while diverting public spending to pay creditors. Financial planners may claim that there is no alternative, but this obviously is not the case. Giving priority to creditor claims is not universal in history, nor is it necessary today.
Take the case of China. Rather than emulating U.S. practice and investing for financial gains – making money from money – the starting point is industrial engineering with a materials-based input-output approach. Financially, the idea is to steer savings and credit into the capital formation needed to sustain rising production and living standards. This is what classical 19th-century economists expected the West to do.
How the West’s financial laws are a legacy of the way the Roman Empire collapsed
There were no financial bubbles in antiquity. Debt bondage and forfeiture of crop rights was merely temporary in duration, and was regulated on much more stable and also more humanitarian terms than those which characterized Western civilization from Roman times down through 18th-century Europe. The reason was largely pragmatic. Any city or state that let its creditors enslave the population for bondage and foreclose on the land would be emptied out by a flight of people, or defeated in war.
Rome was the first country not to cancel the debts and free its bondservants. It went to war to support the oligarchies in Sparta, whose kings Agis, Cleomenes and Nabis sought to annul the debts late in the 3rd century BC, much as the United States today has overthrown many elected leaders in Latin America – not only Salvador Allende in Chile but most recently the President of Honduras, and has tried to overthrow Hugo Chavez in Venezuela.
Rome conquered the Mediterranean region militarily, not economically. Its wars of the first century BC, especially against Mithridates in Asia Minor – the richest province – ended up stripping local economies, looting the temples and melting down their golden ornaments and statues, and using the booty to hire mercenaries to conquer yet more regions. The problem is that they took so much, so greedily, that they stripped the Empire’s ability to maintain its basic infrastructure, from public buildings to waterworks. As the historian Tacitus described the accusation of one critic of the Empire: “You make a desert, and call it victory.”
A major turning point occurred in 133 BC. Tiberius and Gaius Gracchus were tribunes from an aristocratic Roman family that sought to promote land reform and oppose financial corruption. The Senators took the long benches in their chamber, which is on a high cliff, and pushed Gracchus and his supporters over it. The next hundred years (until Augustus took power in 29 BC) saw Rome engulfed in a Social War, which the oligarchy won by force of arms. Its creditor-oriented laws and behavior stripped the imperial economy bare. When there was nothing left to conquer, the extractive system fell apart, pushing Western Europe into a Dark Age.
At home as well as throughout its Empire, Roman law gave creditors the right to foreclose on the property and personal liberty of debtors irreversibly. This creditor right was deemed more important than the freedom of citizens or the rights of property owners to their customary and traditional self-support land in what had been the family-based communal land tenure arrangements that qualified them for citizenship, and hence for service in the army.
Nearly all earlier societies had reasoned that they needed to cancel debts, because reducing debtors to servitude would leave fewer people to fight in the army. Rome got money to hire mercenaries by making war a paying proposition. Roman governors looted their colonies, especially Asia Minor and Egypt, and brought the money to Rome. But it was put mainly into landed estates, which were all that survived when urban economy disintegrated.
Modern terminology would call Rome neoliberalized – or conversely, America today is acting like the Roman oligarchy, stripping what it can to endow hereditary estates whose owners live in gated communities much like the Roman manors on the land. In this sense the business plan of most financial managers today is neofeudal.
Europe’s medieval recovery in the 12th century retained Roman legal principles putting creditor interests over those of the people and even over those of landowners, who could lose their land to foreclosing creditors. So creditor-oriented Roman law did not “protect property.”
Parallels between the Roman elite and today’s financial polarization
It seems ironic that neither Social Democrats nor Labour parties have taken the lead in advocating a change in financial and tax practices to subordinate the debt system to industry and democratic growth. Proposals for reform come mainly from critics within the financial class itself. After all, who would be better able to see how finance works in corrosive ways, and how that game is now almost over. (Some magnates, to be sure, simply want to pull up the ladder to prevent others from making money, now that they themselves have become the power elite.) The ancient antecedents are Kleomenes in Athens “taking the people into his camp,” and the Gracchi in Rome.
The financial sector thus is dividing into two groups. Most want to take the money and run, seeing that the game’s over. Their ranks include big bank CEOs like Sandy Weill or Richard Fuld of Lehman Bros, and Goldman Sachs since Hank Paulson organized the $13 trillion bailout. Their philosophy is to take what they can for themselves, emptying out what they can, spending bailout money on bonuses and bailing out their casino-capitalist counterparts, and sitting back to become the ruling class for the next century while the economy goes bankrupt. The other group, much smaller in number, recognizes that this would impoverish the economy and also would create an ecological disaster by stripping the environment to pay debt service.
But members of this group are the exception. The financial sector calls itself libertarian simply on the ground that it opposes government taxing and regulatory power. But its business plan –collateralizing the entire economic surplus for debt service – threatens to reduce the private sector to debt serfdom. Its fiscal policy of by shifting taxes off banks and their major customers (real estate and monopolies) onto labor and industry makes the economy high-cost, as does the campaign against government regulation, anti-usury laws and even truth-in-lending laws. Claiming to protect populations from going down the road to serfdom, ideological propagandists depict central bank independence and deregulation as the bulwark of democracy. But the effect is simply to siphon money up to the top of the pyramid, whose elite depict their own fortunes as constituting progress even as their policy shrinks and “post-industrializes” the economy.
Interviewer: How did you come to view the economy in this way?
I learned about compound interest working for Wall Street banks, first by tracing the recycling of savings into mortgage lending, and then by analyzing Third World debt – how the loans destroyed rather than helped the debtor countries pay. It is natural for people who have worked in the banking field to be most familiar with how the financial sector is not really part of the real economy of production and consumption, but is external to it, relating to it in a predatory and extractive manner. The financial sector is best thought of as a wrapping around the production and consumption economy, ultimately shrinking it. The national income and product accounts depict Wall Street as providing financial services. But this is playing with language. The main activity is to empty out the economy. This is not really “providing a service.”
The result is an economy of privilege centered on a financial oligarchy, not a real economy becoming more democratic. You can think of economies as being a symbiosis between two quite different sets of dynamics. Economy #1 is what most people think of, producing goods and services, working for a living, and then you buy what you’re producing. But Economy #2 grows more like a parasite. The finance, insurance and real estate (FIRE) sector extracts income without producing much real service. It has a monopoly privilege to create credit and charge interest without much labor being involved. It has the legal privilege to force people to buy health insurance from designated companies, and monopolies are able to charge more than the cost of production.
Interviewer: What do you see as an alternative?
There’s a basic principle that should be the guide for economic reform: A debt that can’t be paid, won’t be. The question is, just how won’t it be paid. Since the 1980’s the IMF and World Bank have told Third World and Asian countries that they will be treated as pariahs unless they pay their foreign debts by holding a pre-bankruptcy sale – privatize their public enterprises and natural resources. This only makes them poorer and even more indebted.
The alternative is to write off the debts that have steered economies into financial and trade dependency. Debts that can’t be paid should be scaled down to what can be paid, preferably in an equity-for-debt swap.
But right now the solution is to turn the debtor’s assets over to creditors. This strips debtor countries of their forests, subsoil mineral rights and water. The financial sector will foreclose and evict mortgage debtors from their homes, cut back on public healthcare and shrink the population through forced emigration, shortening life spans and falling birth rates. It’s better to scale back the debts to the people, and to replace interest-bearing debt with equity.
Europeans began to discuss financial alternatives in the 1810’s. In France, Saint-Simon advocated restructuring the banking system to replace lending at interest with a more equity-based investment. The Saint-Simonians sought to subordinate finance to industry by having banks lend in the form of profit-sharing arrangements – much like commercial ventures had been organized for thousands of years. The advantage of equity investment is that when profits decline, the debtor’s obligation reflects the capacity to pay. The debt doesn’t grow more rapidly than industry can pay. This was the principle that underlay the Credit Mobiliere in France. By the late 19th century, banks in Germany and Central Europe normally took an equity position as well as a debt position in their industrial customers.
The financial problem of bankruptcy resulting in a forfeiture of assets to foreclosing creditors is now global. A substantial proportion of government debts, corporate debts and personal debts exceed the foreseeable means to earn enough to pay. The question is, how will the world resolve this situation? I believe that what you should do is to roll back the debts to what can be paid. But governments are doing just the opposite. They are trying to save the debt overhead, to “make good” on the loans, including the excess over and above the means to pay. The question is, can the gap be closed – and if so, how, and what is the best way to do it?
So far, governments are creating public debt to bail out creditors for their bad debts. The burden of this subsidy will fall on future taxpayers (but not the financial sector or its real estate customers). This will raise the cost of doing business and living in debt-burdened economies. So the “sanctity of debt” is not really a free market solution. It is antithetical to what most people think of as a free market. If you are not debt-free, you are not economically free. If your taxes are spent on paying banks interest for the “service” of simply creating credit on a computer keyboard, then you are paying a financial class a rentier tribute that in times past could be obtained only by military force and occupation.
The way to resolve the problem of negative equity should be to calculate a normal rental income for properties pledged as collateral, and write down the debt to a reasonable capitalization of this income. But instead of scaling back the debt to what can be paid, governments have made the creditors whole for their bad loans. Fictitious claims have been made real. In America, $13 trillion was given to Wall Street for its bad gambles rather than letting casino finance go under. Most of the bailout was used to subsidize credit default swaps and other gambles in the financial casino. The economy would not have suffered if this web of cross-gambles had simply been let go, cancelling out what Wall Street firms owed each other. If the winners couldn’t collect, well, that’s what happens in casinos with bad risks. Instead of saying “That’s your problem,” the government bailed out the Wall Street casino rather than letting it die what should have been a natural death. It was as if Las Vegas casino owners complained that they couldn’t collect from their losers and asked the government to please pay them for the balance owed – “bailing out” the losers much like the government bailed out A.I.G. on its swap-default guarantees.
This situation could have been averted by the kind of tax reform that Adam Smith, John Stuart Mill and other classical economists advocated. Taxing “free lunch” rent would collect what the financial sector is after instead of taxing labor and industry. This would have saved the economy from rent extraction being paid out as debt service. But as matters stand, the finance, insurance, and real estate (FIRE) sector has become a single conglomerate. Letting its web of debts be wiped out would be a simple reform, and taxing or regulating such economic rent would prevent the problem from developing. That is how a “free market” really should work. If creditors lend more than a country can pay, they should lose. Otherwise their victims will be impoverished and the economy will shrink.
The problem has taken on a serious political dimension, because one party’s debt finds its counterpart in another’s savings. Some 90 percent of the population is in debt to 10 percent at the top of the economic pyramid. Freeing the economy from debt means annulling the claims of this top 10 percent. It is largely to prevent this that they seek control of the government, through a combination of their campaign contributions and control of the popular media. They have shown themselves willing to strip the planet and reduce populations to poverty in order to collect what they believe is owed to them. They are not willing give up their claims. This will be the political fight of the 21st century. It is whether we will have oligarchy or democracy.
Two kinds of progress
The world is confronted with two quite different visions of progress. The Progressive Era’s idea was for growth in production and living standards – a better world for children to grow up and enjoy more leisure than their parents had. This traditional idea of progress is now being rivaled by a bankers’-eye view. The marketing departments of banks aim to get the economic surplus – all growth in wages, corporate profits and real-estate prices – for themselves. The idea is for the economic surplus to be capitalized into interest payments and paid out as debt service by labor, real estate, monopolies and infrastructure, industry and agriculture, and whatever governments can give away or tax.
The neoliberal (that is, pro-financial) dream leaves little available for rising living standards, capital replenishment or environmental renewal. It benefits mainly the top 10 percent of the population at the expense of the bottom 90 percent. The other kind of progress is for the 10 percent that wants to monopolize the gains by financial means. They won at the end of Rome and again in medieval Europe when they subdued population to feudalism. Their modern counterparts on Wall Street, the City of London, the Paris Bourse and other financial centers envision getting the fruits of technology and the savings of the bottom 90 percent for themselves. Business schools now focus on teaching students how to debt-leverage, “financializing” the economic surplus, by extending bank loans against it and turning the surplus into interest and other financial charges.
Unfortunately, this is predatory progress.
The financial sector and FIRE vs. the “real” economy –“fictitious” vs. material progress
Neoliberal economics has stripped not only the natural environment but also the teaching of classical economic thought and history. Babylonian school exercises already in 2000 BC taught students how to calculate compound interest. We have their textbooks calculating the growth of herds in an S-curve while debt dynamics grew exponentially faster. This seems to have helped them be better economic managers than the IMF and advocates of the Washington Consensus, subordinating debt to economic growth for two thousand years. Today’s economic models fail to contrast this exponential growth of debt with the growth of the real economy tapering off in an S-curve.
Economies failing to base their policy on this contrast will become debt-ridden, deindustrialized and uncompetitive internationally. Yet a political corollary of pro-financial doctrine is a willingness to suppress ideas (and people) that do not agree with you. The first thing the Chicago Boys did in Chile was to close down all economics and social science departments outside of the Catholic University where they held doctrinaire sway. They realized that to impose a neoliberal style “free market” requires sufficiently totalitarian control of the universities and popular media to block any familiarity with alternative financial, and fiscal policies. If the history of how debt destroys economies were taught, societies would recognize the financial problem for what it is. Educational systems would focus on how to resolve the disparity between the growth of debt and that of the nonfinancial economy. A bank regulator who understands how Wall Street extracts its free lunch would be likely to do something to create a better system.
As the French poet Charles Baudelaire noted: “The devil wins at the point where the public comes to believe that he doesn’t exist.” Finance wins at the point at which economists stop talking about debt, and talk as if all loans were productive and the debts could be paid. So today’s economics curriculum is basically a disinformation system, subsidized by financial lobbyists to turn out “useful idiots” who don’t believe that a debt problem exists, any more than they believe that there is any such thing as a free lunch. To deter reform, the financial sector selects people like Alan Greenspan or Ben Bernanke who actually believe what they’re saying. The best con man or disinformation lobbyist is one who believes what he’s saying.
In reality, of course, the economy is all about how to get a free lunch, and the easiest way to get one is by financial means. This involves persuading the population that borrowing is the way to get rich, not the road to debt peonage.
So we are brought back to the question of just what kind of progress we are going to have. Any doubt about how deliberate the rentier sector is about its asset stripping without regard for its adverse economic consequences is dispelled by looking at the furious decade of lobbying by banks and credit-card companies leading up to the U.S. bankruptcy “reform” of 2005. Tens of millions of dollars were spent to back (politicians committing themselves to stripping away anti-usury regulations and other basic consumer protection. More recently, the intense lobbying around the modest financial reforms just passed in 2010 was highlighted by anguished cries from Wall Street claiming that prospective Consumer Protection Agency threatened to make borrowers pay more to handle the “bureaucratic paperwork.” The cost of credit was said to rise if truth-in-lending laws prevented banks from cheating their customers.
Deception is the name of the game. Alan Greenspan did give a mea culpa apology for his neoliberal model not working, but economics students are still being taught a travesty of free markets without being told how opposite the modern neoliberal view is from that of the classical economists. Students are taught about a mythological “tragedy of the commons” if it is not privatized – which means, if Wall Street doesn’t control it. But the author of that doctrine retracted it, and financial control of nature quite obviously is stripping the environment. The connection between financial debt and ecological debt is that financial debt can only be paid at the cost of stripping the environment along with other assets.
So the central flaw in our economy today is to view the finance sector as part of the real economy rather than as a parasite wrapped around it and extracting its surplus. Financial managers have taken the political system out of the hands of democracy. Wall Street and its counterparts in other countries have appropriated the power to create credit and charge interest for this privilege, much as medieval conquerors took the land and charged rent as an access price. There’s little that individuals can do but try to stay out of debt. But economies as a whole need debt, so the solution is not to ban it or ban interest; it is to return creditor power to the public sector, where enterprise first developed thousands of years ago.
Wall Street for its part sees that the game is over. That’s why its managers have decided that it’s time to take the money and run. The debt overgrowth has gone too far for Wall Street to save, so all they can do is back politicians who will give them as many bailouts as possible. They’re doing is not lending this out as promised, because there already is too much negative equity to support a new takeoff. So wealthy investors are using their money to buy as many tangible assets as they can – castles, yachts, and escape houses in every country they can. When you see insiders jumping ship like this, when most investment money takes the form of flight capital to less debt-burdened economies – those that still have room to take on more debt – you know the game is over. There’s little to be done at this point except to write down the debts – or maybe decide how to rebuild society after the financial and fiscal Dark Age that the financial predators have pushed us into. It’s not the first time in history they’ve done that.
Latvia or Iceland could be America’s future if we let neoliberal financial managers do to us what they did to Latvia, imposing flat taxes of 51% on labor while un-taxing property. The result was a debt-financed real estate bubble that collapsed in negative equity – with homeowners being personally liable for as far as the eye can see. Many are emigrating to escape a lifetime of debt payments to pay for the banking system’s irresponsible lending.
Neoliberals insist that there is no alternative to their junk economics. They try to exclude alternative ideas from the journals they control, so that only their side of the picture will be presented. This stifles debate, because “free market” economists know that the only way their doctrine can win out is by totalitarian control of the academic system, the popular media and politics. Serious discussion of economic issues therefore occurs mainly in countries where financial lobbyists are not so thoroughly in control.
Interviewer: What do you foresee if such changes are not made? What grounds are there for hope?
As we enter an era of debt peonage, much of the world may end up like Iceland and Latvia, subjected to financial and fiscal austerity without an economic surplus left to maintain living standards. Companies will not be able to invest in plant and equipment if they must pay their junk-bond holders and other creditors. Governments will not be able to maintain the environment, but will have to let it be stripped to pay foreign creditors. The earth may be gutted as economies are stifled by letting their debts grow exponentially. This should be taught as the basic financial model, rather than distracting students to think of the “real” economy operating on a barter basis without unproductive lending creating a bad debt overhead.
Most people think that if someone borrows money, they should be able to repay it. But the reality is that many can’t pay, except by borrowing even more. The debt keeps growing, forcing economies to cut back public spending, including ecological renewal. Brazil is cutting down its forests and other countries are permitting companies to strip the environment and even sell off water rights to get the money to pay the creditors. This is called progress. But financial progress ends up becoming antithetical to human progress, industrial and agricultural progress at the point where economies are stripped by the mathematics of compound interest.
Many people blame themselves as they fall into debt. The natural tendency is to take responsibility. But unfortunately, there’s little that most people can do as individuals. The problem is the financial system that has gained control of government policy and is behaving in a destructive way. The oligarchy’s first rule is to take away democracy’s most important financial right, that of creating money and regulating debt. The lie is repeated again and again that the hallmark of democracy is an independent Central Bank. But no real democracy would give Wall Street veto power over its bank regulators. That’s oligarchy, not democracy.
It often is said that people can’t live without hope, but hope also may be their undoing. Hope is what financial predators and other con men play on. They’ve played on the hope that despite declining real wages in the United States since 1979, families can maintain their living standards if they borrow and hope that real estate prices will rise and retirement can be paid out of paper stock-market gains. The public relations trick is to convince people that they can get rich by running into debt to speculate and gamble at the financial racetrack. This is a false hope. Throughout history the hope of most people has been to stay out of debt. An economics of deception has turned their hope and desire for life against them.
This is why the financial sector so often has been likened to a parasite. It is not simply a case of the parasite taking the surplus for itself. In nature, successful parasites are more than just organisms that sap the host of nourishment. To succeed for long, the biological parasite needs to take over the host’s brain and trick it into believing that the free rider is part of the host’s own body, even its baby to be protected and nurtured. That is how the financial sector operates. It tricks the host economy’s brain – the educational system and the government as planner and lawmaker – to make it think that the way to grow is to promote a financial oligarchy. What the financial sector really does is suck up everything for its own benefit, and depict this appropriation as irreversible “progress” and “wealth creation.” The classic warning remains that of the prophet Isaiah denouncing the rich (mainly creditors) for putting plot to plot and house to house until there is no room in the land for people.
Most people think of progress as being straight and irreversible – and that government regulation and planning “interferes” with growth by being deadweight overhead. Neoliberal economics claims that “automatic stabilizers” maintain equilibrium. But this view does not apply to the mathematics of compound interest. Balance needs to be restored from outside the system.
Bronze Age rulers succeeded better in handling imbalances that build up in financial and property relations. They realized that balance is not achieved automatically from within. The idea of circular time required periodic renewal to restore balance – the status quo ante – by proclaiming Clean Slates to clear away the payment arrears (mainly rents and fees owed to the palace and its collectors), annul consumer debts, liberate bondservants, and also, it seems, to release exiles from Cities of Refuge to re-incorporate them into society.
This policy was applied for more than half the length of our civilization (from 3000 BC down to the time of Jesus). And in his first reported sermon, Jesus said that he had come to proclaim the Jubilee Year. By contrast, today’s idea of progress involves building up the debt overhead into this accumulation.
Today’s financial crisis is making more people aware of the antithesis between financial capital and industrial capital, and with the idea that financial wealth can be parasitic rather than productive. The financial sector and its debt claims (bonds, mortgages, bank loans, etc.) are not on a par with physical capital, factories and other tangible means of production. Debt claims – financialized wealth – are more parasitic than productive. This is why bankers have now taken the place that the 19th century assigned to the landlords as society’s main recipients of exploitative unearned income.
The way to counter the idea of progress as a buildup of savings that represent other peoples’ debts is to study how economies throughout history have dealt with (or in the case of Rome, failed to resolve) their debt problems. As preparation, it would help to review classical political economy and its definition of economic rent and asset-price gains as unearned income.
The popular fallacy is that economies can get bigger without having to make the choice of saving economic balance and flexibility rather than carry debt imbalances forward. But progress does not occur symmetrically. Different parts of the economy grow at different rates. The financial sector’s buildup of debt imbalances grows faster than the real economy.
What is mainly growing today is pollution – debt pollution as well as ecological pollution. You don’t want the polluters to be the ones who define what progress is, because they will celebrate their own activities as “wealth creation.” Their business plan is to transfer society’s wealth to themselves, not build up that of the world. So the economy shrinks. That is why credit card companies now make more money from penalties and late fees than they make on interest charges. In the end, destruction of the “real” economy dries up the financial sector as well.
BEGIN: The domestic economic problem can best be seen by looking at the international strains pushing U.S. trade into chronic deficit. Why is the United States no longer competitive? Simply look at what is pushing up basic break-even costs for its labor. Some 40% of blue-collar wages go for rent, and 15% for debt service (credit cards, bank loans, auto loans, student loans, etc.). About 8% is paid on state and local and excise taxes. Before the employee even takes home his paycheck, 11% is deducted for Social Security and Medicare, and about 15% for income taxes. Thus, before spending anything on goods and services, over two-thirds of income is earmarked for the finance, insurance and real estate (FIRE) sector.
This is overhead. It is not part of the labor-costs of production. It is price, not value.
Technology was supposed to reduce the labor-cost of production and usher in a leisure economy. Yet most employees now work overtime trying to carry their debt burden.
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy. His new book summarizing his economic theories, The Bubble and Beyond, is now available. He can be reached via his website, email@example.com.