This is an edited and expanded transcript from a live phone interview by Dimitris Yannopoulos for Athens News, September 2012.
Dimitris Yannopoulos: As an academic with a strong grounding in economic history as well as banking and a Clean Slate, professor Michael Hudson has built his own school of thought – distanced from both Keynesians and neoliberals – with regard to the stark options facing a contemporary Western world drowning in unsustainable debts of governments and households at the mercy of global banks and financiers.
Options for the indebted amount to a choice between feudal-like servitude and freedom, because “debts that can’t be paid, won’t be.” That has become Prof. Hudson’s well-known tag line. He explains his logic in this interview with the Athens News, on the occasion of publication of his latest book, The Bubble and Beyond: Fictitious Capital, Debt Deflation and Global Crisis, which can be purchased here.
Q: How has the financial system evolved into the form of economic servitude that you call “debt peonage,” negating democracy as well as free-market capitalism as classically understood?
A: The hope of banking in the 19th century was that banks would make productive loans to finance industry. This promised to be something new. In the past, banks had made loans to ship and market goods once they were produced, but not to finance new capital investment by producers. Investment always had been self-financed out of savings. The new idea of industrial banking was for loans to be invested to earn profits, out of which to pay the interest and the principal back to the lenders.
No such productive lending occurred in antiquity or the feudal period. And as matters have turned out, instead of allying itself with industry, banking has moved into a symbiotic relationship with real estate, mineral extraction, oil, gas and monopolies to lend against economic rent. This technical term is defined as unearned income, obtained by charging prices in excess of cost value. Economic rent has no counterpart in the cost of putting means of production in place. It is created by special legal privilege to install tollbooths on roads, education systems and other basic needs. Land is provided by nature. The only “cost” is the price of buying the right to charge rent on it. Owners aim to charge as much as they can, without regard for how this may affect overall economic growth and balance.
Banks have the privilege of creating credit and charging it. Most credit is extended to buy property or rent-seeking privileges already in place, not new capital investment. It is easier for investors to buy a privilege to extract charges without producing anything. So banks back the ability of their customers to make money without new capital investment. The easiest way to do this is to make loans for real estate at increasingly debt-leveraged, bank-inflated prices. The time frame of banks is too short-term to develop production facilities, mount a sales campaign and develop markets for new goods.
Classical economists from the Physiocrats down through the Progressive Era a century ago explained why land rent, natural resource rent and monopoly rent should be the source of tax revenue for cities, states and nations. But instead of extending credit to increase tangible capital investment, about 80 percent of bank credit in the United States and most English-speaking countries is to buy real estate. Instead of extending loans to build factories to employ people, bankers look simply at what can be pledged as collateral on which they can foreclose. Buyers pledge their rental income to pay interest to the banks. The more the tax collector shifts taxes off property onto wages, profits and sales, the more rental income is available to pay banks – for even larger loans. This is why banks back untaxing real estate and deregulating monopolies, to maximize the economic rent that can be paid as interest.
So instead of financing industry, U.S. banks don’t lend against what may be produced in the future. They make loans against collateral already in place – including entire companies. Target companies are obliged to pay the debt that the corporate raider takes on with high-interest “junk” bonds. The process is more extractive than productive. The raider is free to downsize and outsource the work force, squeezing the budget in hope of coming out with a capital gain after paying off the banks and bondholders.
Stock markets were supposed to supply equity investment capital, but since the 1980s they have been turned into a vehicle for leveraged buyouts (LBOs). Raiders borrow money much like landlords borrow to buy a property and bleed it. This turns corporate cash flow into interest. Governments permit this to be tax-deductible, encouraging debt financing over equity. This worsens their fiscal position, forcing governments in turn to borrow in a deteriorating spiral.
Q: When did this process get out of hand?
A: The turning point was in 1980. Right after Margaret Thatcher led Britain’s Conservatives into office and began privatizing at enormous commissions that made the financial sector richer than ever before, the Reagan Administration was elected in the United States. Drexel Burnham led the transformation of the stock market into a vehicle for corporate raiders to take over companies, load them down with debt and pay out profits as interest. Just as real estate speculators hoped to end up with a capital gain, so raiders sought to resell companies at a gain – by downsizing the labor force, shifting to non-union labor, and renegotiating employee pensions downward by threatening bankruptcy as an alternative (leaving the Public Benefit Guarantee Corp. stuck with the bill). As an added bonus, the raider might grab the corporate pension fund or Employee Stock Ownership Plan (ESOP) for a quick payout to creditors, as Sam Zell did with the Chicago Tribune. So corporate financialization became destructive instead of productive.
This distortion of how stock markets were expected to raise equity capital is a result of tax policy that treats debt as a tactic of ownership, not a necessary cost doing normal business as used to be the case when companies had to use export financing and extend 90-day sales credit.
Banks have lobbied to keep interest tax-deductible regardless of whether it is to conduct normal production and sales or to buy assets. This favors corporate borrowing via bonds and bank loans instead of issuing stocks, so corporate debt ratios rise. And unlike stock dividends that reflect profits, interest must be paid without missing a beat or the company goes bankrupt.
Predatory finance has concentrated wealth and used it to buy control of governments and their regulatory agencies. It even has taken over the Justice Department and the courts, so that financial fraud in America has been decriminalized. Bank lobbyists back the campaigns of politicians committed to deregulating banking and its major clients (real estate, natural resources and monopolies). So there is no regulation of outright criminal behavior even by the largest banks such as Citicorp and Bank of America where fraud was concentrated.
Q: How do they get off the hook?
A: Nearly every large Wall Street bank has paid large sums of money to settle fraud cases without admitting criminal liability for their huge gains. So no banker has gone to jail. The top executives know that if they are convicted of billions of dollars of fraud, their banks will pay a fraction of this amount, not themselves. So the bank still makes a bundle even after paying the nominal fine, letting the culprits keep their salaries, bonuses and stock options for writing junk mortgages and operating in a manner that would have sent them to jail back in the 1980s. My colleague William Black at the University of Missouri at Kansas City has described how S&L fraudsters were sent to jail for doing what commercial bankers, investment bankers and their brokerage agencies much higher on the social pyramid have done over the past decade.
By now, the bankers know that the jig is nearly up, so they are giving themselves enormous new bonuses while they can. The Treasury for its part argues that if it fines the banks to recover the full amount of the fraud, the banks will be driven under – and the government will just have to bail them out again. In effect it would be paying the fine to itself. So it does nothing, except receive more campaign contributions from Wall Street.
Q: Is the so-called “financialization” of the economy an outcome of deregulating banking?
A: Financialization means operating companies and the overall economy to “create wealth” by inflating market prices for paper claims on wealth (bonds, stocks and bank loans) rather than tangible capital formation. The surplus is managed for financial purposes rather than to reinvest in the “real” economy. The aim is to make money by financial engineering, not industrial engineering.
Finance has expanded to absorb the entire economic surplus in the form of debt service to the banks. This leaves it unavailable for capital investment to increase production or consumption. The process began by taking over the real estate and insurance sectors, prompting national income economists to lump together what they call the FIRE sector: Finance, Insurance and Real Estate. It also should include the legal sector, because most law these days is corporate law to defend, protect or even facilitate financial fraud and monopolies. So as reformers said a century ago, finance is the mother of trusts – and also of monopolies and ultimately, austerity.
Savings banks and S&Ls were regulated to finance new home building and purchases. Bank lending could be regulated to finance actual business needs. Buying companies, creating derivatives to bet on prices by parties that have no direct business interest, easily could be ruled out of bounds for banking, especially at institutions whose deposits are insured by government or are part of a conglomerate that takes insured deposits. In the case of Citibank, for instance, the FDIC could not disentangle the bank from all the tangle of other Citicorp entities and off-balance-sheet constructs, footnotes and fine print. This makes it almost impossible to draw the line between economically necessary banking, gambling and outright fraud.
That should have been the lesson of the post-Lehman Brothers smashup of 2008. But for the banks, the lesson was simply: “We won. If we make our accounts complex enough, the government can’t regulate or even tax us. Good work, Tim Geithner and Ben Bernanke.”
Q: Isn’t this trend also because profits for financial investment in asset bubbles are much higher than profits in manufacturing?
A: There’s a problem in terminology here between technical economic jargon and popular understanding. Classical economists were careful to define the term “profit” to mean a gain made by investing in plant and equipment (capital) and hiring labor to produce goods to sell at a markup. Profits were a return on tangible capital investment and current expenses on labor, raw materials and other inputs.
This is not how the financial sector makes its gains, especially in bubbles. Interest, fees, commissions and penalties are the result of standardized legal privileges. Economists call these returns “economic rents” because unlike profits, they are independent of the cost of production. Their “cost” consists of buying privileges, not making tangible capital investment. The same is true of the other major element financial returns: the inflation of asset-price (“capital”) gains. Buying and selling a company, real estate or privilege does not create means of production.
A privilege is literally a “private law” (from the Latin legis, law), a monopoly right to impose a tollbooth. The most lucrative privilege is being able to create bank credit and take deposits insured by governments, ultimately by public right to tax. These financial returns have a different dynamic from commercial and industrial profits. They are made off the economy, not part of the economy’s physical and technological growth and capital formation. They are an overhead charge paid out of profits and wages. They absorb the surplus (profit), not add to it.
Here’s how it works. When a company’s stockholders are bought out on credit, its profits end up being paid as interest rather than reinvested to expand production and employment. Financialized companies are treated much as absentee-owned real estate: Raiders or other buyers pledge the income to the creditor. Buyers may even pay depreciation (tax-deductible cash flow) to the banks and bondholders, hoping to squeeze out a capital gain by selling off the company’s parts for more than the whole is worth. This may be done by closing down or selling low-return divisions. What is important to recognize here is that the basic dynamic is shrinkage.
Suppose that a company earns $1 million dollars of profit in a year. About $400,000 must be paid in income tax. A corporate raider now buys out the its stockholders (equity owners), for $10 million, which he borrows in junk bonds. The entire $1 million dollars of profit will now be paid to the banker or the bondholder in the form of interest, because there is no income-tax payment on this diversion of revenue. Financial engineers – the class that has replaced industrial engineers – aim to get rich not by earning profits (which are taxable), but by capital gains, which are taxed at much lower rates. So today’s financialized tax code encourages speculation rather than profit-making direct investment.
The company won’t report a profit, but the financial manager hopes to increase its market price to re-sell it on the stock exchange. This is done not so much by new investment or innovation, but by cutting costs and selling off its pieces to make a capital gain. This is how Republican Presidential candidate Mitt Romney’s Bain Capital made money. It is “balance sheet” engineering, not aimed at raising production or living standards.
Interest is deemed a “cost of doing business.” But it is not a cost of production; it is financial overhead. Since the 1980s, growth in this overhead has absorbed and even outstripped the rise in productivity. Instead of living standards rising, the economic surplus has taken the form of a return to the FIRE sector, mainly the financial sector – commercial banks, investment banks, mortgage packagers and brokers, and so forth. Real estate owners gained during the bubble years as property prices rose faster than the bank debt that was inflating them. But more income was pledged to the banks than was being earned. Dividends can be cut back when profits fall, but when interest payments are missed on bonds or bank loans, the company faces bankruptcy.
The same is true in real estate. The reckless junk mortgage lending and outright fraud led to a collapse of new lending after September 2008, leaving a residue of defaults, negative equity, bankruptcy, foreclosures and abandonments in its wake. $11 trillion was wiped out of private sector balance sheets as “paper gains” turned into real-life losses. This negative equity must now be paid to creditors out of actual earnings. That leaves less to spend on goods and services. So for the economy at large, production and employment, wages and profits shrink.
Q: Can you elaborate on what makes capital gains so different from business profits?
A: This is best understood in real estate, where the motto is “Rent is for paying interest.” A buyer will look at a property to see how much rent it pays off, and bid against other prospective buyers for a loan. The winner usually is whoever will anticipate earning the most rent from tenants to pay the interest – and promise to pay this to the bank.
For a corporate raider the motto is “Company profits are for paying interest.” What the speculator or long-term investor wants is a capital gain. Yet this gain (or loss) does not appear in the National Income and Product Accounts (NIPA), despite the fact that this is how banks get customers to borrow larger debts to buy homes they hope will rise in price. Borrowers thought they could get rich by becoming bigger bank customers. The larger the home they bought – with the largest mortgage loan – the more gains they would make.
The NIPA were not designed to analyze bubble economies making gains by inflating asset prices. They were designed to track direct investment to create tangible assets, along with profits and wages, government spending and taxes – but not financial phenomena that affect balance-sheet assets and debts. Yet financial engineering of balance sheets is what bubble economies are all about. That is what makes today’s finance capitalism so different from the industrial capitalism analyzed by the classical economists.
In this new world, property investors on credit appear not to be making any profit. They “expense” their revenue as interest, while their “capital” gains are invisible in the National Income and Product Accounts (NIPA). These asset price gains are taxed at much lower rates than are wage income and profits – and typically are not taxed at all if the gain is plowed back into buying yet more property. The effect is to divert investment away from tangible capital formation into financial speculation.
Q: Were derivatives and structured bonds the final stage in pumping up the financial bubble that burst in 2008?
A: Well, at least it was the stage leading into austerity and debt deflation. I call it Casino Capitalism. But I hesitate to say that any decay into a “final” stage has occurred until debt levels become dissipate their radioactive isotope sequence and settle into a leaden state. For the economy this means no more surplus is being created. This is the Dark Age stage – the final stage of the creditor-run Roman Empire. It is the Great Depression stage, and today’s New Austerity.
In today’s “derivative” stage of finance capitalism, large Wall Street banks make money off their customers and counterparties by betting which way the economy will go, much like betting on a horse race – except that “fixing” the financial race is not illegal, or at least is not prosecuted. As in other forms of gambling, the casino always wins and crime is rife. So the cards are stacked in favor of banks, and bank customers are left holding the bag. Credit default swaps are the easiest to manipulate in ways that were deemed illegal in the past.
Investment banks that deal in these derivatives don’t count their capital gains as profits. They are not part of the production process, unlike profits made by employing labor to work with capital equipment to produce output. Financial derivatives don’t have much to do with production and employment – except to shrink markets. They have to do with buying and selling assets to make a capital gain. This is the increasingly dominant speculative part of the FIRE sector’s takeover of the production and consumption economy. It has turned Industrial Capitalism inside out and made computerized gambling, debt extraction and raiding the most important part of stock and bond markets.
Q: Is this why derivatives don’t appear on the balance sheets of banks? And does this make it difficult to discover whether or not they are solvent?
A: Derivatives are bets on the price of assets and on which way interest rates – and hence, bond prices – will go. Banks place arbitrage bets on stocks, currencies or anything they want to. The result is a casino economy betting on which way prices will go rather than actually producing goods and services. But the banks don’t use money for this, so the bet is a “contingent liability” with an elusive statistical appearance, like the Higgs-Boson in physics. If you bet on the future but haven’t won anything or had to pay, the mere fact that a bet is outstanding doesn’t appear in your income-tax statement or even on your current balance sheet.
The problem is that for every winner there is a loser. So the economy as a whole doesn’t gain. On balance it’s a zero-sum game. In fact, large losers who can’t afford to pay the winners receive public bailouts. The winners insisted in 2008 that the government keep the game solvent by TARP, the Troubled Asset Relief Program, which should have referred to troubled gambles – the “assets” of the winners. The “crisis” only would have closed down the casino, not the “real” economy. But the government capitulated and agreed to keep the financial casino’s big players solvent so that winners could collect on their bets. So the central bank and Treasury print enough more public debt to make bad debts good. The big players are made winners, but by leaving the government with more debt. This debt is not a result of more current spending into the economy. It is purely a balance sheet winner/loser phenomenon.
Q: Hasn’t this system collapsed since 2008?
A: Just the opposite. Wall Street used the 2008 aftermath as an opportunity to panic Congress into taking the losses of big banks onto the public balance sheet, incurring $13 trillion of added federal debt. The crisis became an opportunity to turn democracy into an oligarchy. In effect the Obama administration told the real economy to drop dead. The European Central Bank (ECB) that now rules the eurozone did same thing to Ireland. After banks made reckless insider loans, the government pledged to make the creditors and bondholders whole by demanding that the non-financial economy pay the bad bank debts out of higher taxes and lower social spending.
Q: Isn’t the ECB taking over the function of bailing out EU governments, having done so with eurozone banks?
A: The ECB is not bailing out governments to maintain democratic programs but to change their policy in an aggressive manner. The aim is to replace democratically elected governments in Greece and Italy (and ultimately, everywhere) with oligarchy. German Chancellor Angela Merkel and other neoliberal leaders claim that democracy puts the interest of people ahead of paying bankers and bondholders. But there simply is not enough to maintain their living standards and sustain a growth in wealth at the top at existing rates, so something has to give. As far as the ECB, the U.S. Federal Reserve, Republicans and Democrats, British Conservatives and Labour are concerned, what should “give” are living standards, not the debt overhead. This is the leading demand of the oligarchic counter-revolution against democracy that plagues Europe and the entire Western world today.
Putting the interest of commercial banks first is what central banks do these days. That’s why the Federal Reserve Bank was made independent from the U.S. Treasury in 1913, and why the ECB is restricted to lending only to banks, not directly to governments to monetize their budget deficits. Central banks promote bank interests increasingly at odds with the rest of the economy – by “saving” them (and specifically, their bondholders) from having to suffer bankruptcy as a result of their bad loans. Buying government bonds from banks is a far cry from monetizing government spending directly. It gives banks interest returns on public debt that could be financed without such a charge. The central bank bails out bankers, not the economy – which is left debt-ridden. This makes the central bank pretense of acting to promote full employment hypocritical – because bailing out the banks while keeping debts in place has the effect of shrinking market demand and employment.
The first ploy to serve bankers and bondholders is to place technocrats (a scientific sounding euphemism for bank lobbyists) in place of elected governments in Greece and Italy. Today’s anti-democratic financial coup in Europe resembles the murder of the Gracchi and their supporters by oligarchic senators in Rome in 133 BC, inaugurating a century of financial war, which historians call the Social War. It was waged by the oligarchy (which had enriched itself largely by privatizing public land after the Punic Wars with Carthage, much as today’s oligarchy has grown rich by privatization and public-private financial “cooperation”). At issue was whether the economy should be run to enforce creditor “rights” by depriving the population of its liberty from debt bondage, or should annul the debts.
Advocates of debt cancellation (such as supporters of Catiline’s “conspiracy”) were killed, not unlike Chile in 1973 as General Pinochet enforced Chicago-style “free market” reforms at gunpoint. The Social War ended with a quarter of the population reduced to slavery. Today’s creditors do not put individuals formally into bondage, but leave them free to work and live anywhere they want – as long as they buy goods from privatized infrastructure squeezing out economic rent, pay their debts and pay taxes to subsidize high finance. That is the essence of neoliberal ideology, and explains why the banking sector subsidizes its pet politicians so well.
Q: Wasn’t Greece unique in allowing creditors to shift the burden of the financial and fiscal crisis onto its government, by turning it into a sovereign debt crisis?
A: The same fate was threatened in Ireland. The problem is that neither Greece nor other eurozone countries have a central bank to monetize their budget deficits. So they need to borrow from bankers and bondholders, at interest rates that rise as the dysfunctional system grows more untenable. Risk increases as governments shift taxes off property, rent-yielding “tollbooth” assets and the wealthy their onto labor and industry, and finance the resulting budget deficits by cutting public employment and wages, axing social welfare and selling off the public domain. Neoliberals are using Greece’s debt crisis as an opportunity to pry away whatever its government owns: real estate and public buildings, oil and gas rights in the Aegean, port facilities, electric utilities and roads.
In times past it would have taken an army to carry out what the ECB is achieving in Greece. The new appropriators would have had to invade the country to take over its land and infrastructure. But the ECB is doing this without military force, simply by appointing technocrats as proconsuls. A lame attempt is made to frighten voters into believing that There Is No Alternative (TINA, as Margaret Thatcher liked to express her diktat). Propaganda sites blare out a message that all this is for the best. Writing down debts is said to cause a crisis and poverty, not liberate economies from their debt overhead and thus make them more competitive.
The appeal to foreign “cosmopolitan” power is reminiscent of what occurred in Sparta at the end of the 3rd century BC. A creditor oligarchy had taken over, and two kings – first Agis IV and then Cleomenes III – sought to cancel the citizenry’s debts. Neighboring oligarchies called in Rome, which subjugated populations from the Aegean to Asia Minor, establishing “peace” by imposing martial creditor rule.
Greece will be surrendering without even a fight if it goes along with this neo-imperial creditor policy. That is the political aim of the oligarchy: to win by ideological and political conquest rather than the more expensive military oppression of an outright police state.
Q: Why has there been so much emphasis on austerity and internal devaluation to drastically reduce wages and pensions?
A: Financialization escalates the class war. For the last hundred years people thought the war was simply between employers and employees over workplace conditions, wage levels and benefits. But the debt overhead adds a new dimension. Finance controls governments, and unions typically are strongest in the public sector. Financial lobbyists and the their pet academics they corrupt promote austerity to weaken the demand for labor and drive down wages to a degree that could not occur on the company-by-company scale of clashing industrial employers and their workers.
For a dress rehearsal, look at Latvia, where neoliberals have had a free hand. Two years ago, internal devaluation reduced its public sector wages by 30 percent. This helped drag down private-sector wages. Cutbacks in public spending shrank the domestic market and hence employment – and spurred emigration of young labor. Workplace rights are being rolled back in a way 19th-century industrialists never dreamed they could achieve under democratic governments.
In the United States, Federal Reserve Chairman Alan Greenspan explained triumphantly to Congress in 1997 that what was so remarkable since 1980 was that labor productivity rose by about 83 percent, but real wages didn’t rise. The Maestro found the explanation to be that workers had taken on enormous mortgage debts, education debts, auto loans, and live on credit-card debt in order to keep up with their neighbors. Testifying before the Senate Banking Committee in February 1997, he explained why wages were rising so slowly despite historically low unemployment levels. Under normal conditions unemployment at the rate then being registered – about 5.4 percent, the same as in the boom years 1967 and 1979 – would have led to rising wage levels as employers competed to hire more workers. However, Chairman Greenspan testified:
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.
Again in July 1997 in Congressional testimony, he said 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.” Reporter Bob Woodward described him as calling this the “traumatized worker” effect. Their precarious financial situation made them afraid to go on strike or even to complain about working conditions, because if they are fired and miss a payment in their electric utility or phone bill, the interest rate on their credit card jumps to 29 percent. And if they miss a few mortgage payments, they risk losing their home, leaving many workers in fear becoming “one paycheck away from being homeless.” That’s what the debt overhead has achieved for relations between labor and capital.
Nearly everyone expected that democratic governments would promote rising living standards and expand markets, not act to shrink them. It seemed logical that technology would increase the economic surplus and hence make it less necessary for families, companies or governments to run up debt to rentiers even more rapidly than the tangible surplus was growing.
Q: If neither Greek banks nor local industrialists are gaining from this looting, what do creditors expect to receive from borrowers that can’t pay their debts, mortgages or taxes? How does a jobless workforce help them?
A: The financial sector always has been so short-term as to be self-destructive. There’s been a race to the bottom. Creditors treat the economy like an oil well, to be depleted, ignoring the long-term consequences. The aim is to extract the surplus before anyone else does.
Under this prime directive, political economy turns into the anti-social economics of Ayn Rand and the Chicago School. Financial predators find their Alan Greenspans and Tim Geithners to act as their factotums to give government power to the most avaricious and shortsighted members of society. Turning governments (or at least their central banks) into boards of directors of the financial wreckers, they dismantle the power of government (kings in the Bronze Age, democratic governments today) to write down debts or regulate credit.
You are right to note that families and companies cannot pay their debts when governments imposes such extreme austerity. Bank loans go bad and the government’s tax revenue declines, widening the deficit. This is well illustrated decade after decade, case after case for the International Monetary Fund’s austerity programs imposed on Latin America in the 1970s and ‘80s. So it obviously is a deliberate policy, backed by the banks. That should be your first clue that there is a “Stage 2” to all this.
These nationally destructive programs required military dictatorships backed by U.S. armed force and covert attacks on domestic opposition – the systematic targeted murder of labor leaders, teachers, land reformers and intellectuals on a continent-wide scale. Greece is now being treated the way that Latin American countries were back then. It has not been necessary for U.S. State Department to support the usual assassination teams as it did to help the Chicago Boys in Chile and Operation Condor in the Americas. The absence of covert and overt force simply reflects the absence of serious remaining opposition to pro-creditor austerity plans and their “Stage 2” privatization today. Governments have been weakened and corrupted in preparation for the kill.
By contrast, the power of growth once the financial oligarchy is checked from imposing its destructive economic policies is demonstrated by how successfully Latin American and other countries are taking off economically now that U.S.-backed dictatorships are being thrown off in. On the other hand, there is still a bonanza to be squeezed out of Greece and the rest of Europe by worsening the crisis to the point where hapless governments there do what Latin American governments were forced to do: privatize the public domain, turning it over to buyers on terms laid down by the banks, and refrain from regulating the privatized monopolies.
Of course many banks will go under and many governments will be driven into insolvency. Big fish to eat little fish. That’s the objective. Banks that go under will sell off their debt claims on the cheap to vultures flying in from other countries to enjoy a field day, as they did in taking over Iceland’s banks. (That story has not been widely told.)
Financialization leads to the bankruptcy of local banking systems so that outsiders can swoop in for a huge property grab. Many countries have pension systems that can be looted after the manner perfected under Pinochet in Chile in the late 1970s. Many banks do indeed become casualties. The most highly criminalized U.S. banks – Countrywide Washington Mutual (WaMu) and their cohorts deepest into fraud in recent years – were absorbed by the five largest U.S. “too big to fail” giants.
Of course this will impoverish the economy. But the big banks and bondholders hope to be fast enough to take their money and run, to repeat the process somewhere else. Ultimately they face the problem that Alexander the Great faced: He cried when he found no more worlds to conquer. So finance capital will end in tears – first for the debtors, then for the creditors themselves. The parasite will die with the host. That is how the Roman Empire declined and fell.
Q: How has finance capitalism shaped economic theory to treat public spending and investment as deadweight overhead instead of focusing on rentier income and property claims as overhead as the classical economists did?
A: Rhetoric plays a key role here. The essence of a “free market” financial style is to take planning out of the hands of government – democratically elected political representatives – and centralize it in Wall Street and other financial centers. Their aim is to disable public regulation, which Frederick Hayek called the Road to Serfdom. The preferred alternative of Hayek’s neoliberal followers is today’s financial Road to Debt Peonage. Unchecked license to banks gives rentiers the unchecked freedom to exploit, instead of government protecting society by ensuring it freedom from exploitation.
This isn’t the kind of “free market” that economists discussed this in the 19th and 20th centuries. It is an exercise in Orwellian doublethink, a market of unchecked fraud and exploitation, with wealth and power being untaxed. This is the economics of General Pinochet elaborated along the lines that Ronald Reagan’s “crazies” in the United States pushed under the slogan of the “Washington Consensus.” As Grover Norquist put matters, the aim is to “shrink government to a size so small that it can be drowned in the bathtub.” The victim that is to end up being drowned in debt is the citizenry – labor and industry.
This neoliberal scenario would strip governments of the sovereign power to write down debt – and given the power to bail out the financial sector for the losses that its exponentially growing debt overhead entails as it tears the economy apart. The inevitable result is to plunge all society into debt, ending in a frenzy of asset stripping as creditors bail out and buy as much land, natural resources and other property for whoever will accept their “paper” financial claims.
A financialized “free market” is one of centralized planning. But it shifts this planning out of the hands of government and centralizes it in those of Wall Street and other banking centers. Financial dirigisme aims to endow a rentier oligarchy, not uplift the citizenry in the “real” production-and-consumption economy.
What is important to recognize in analyzing this shift in the locus of centralized planning is that the financial sector’s objectives are the opposite of those in the public sector. Democratic governments seek to increase employment, output and living standards. But relinquishing central planning to the banks will replace democracy with oligarchic financial planning to impose austerity to lower wages and living standards. What ends up being reduced is public spending on goods and services, Social Security and medical care, pensions, and taxes on wealth and debt-leveraged “capital” gains. In contrast to public purchases of goods and services employing labor, new government debt is created mainly to bail the banks out of the losses that result from their self-destructive over-lending and outright gambling.
The effect is to increase the government’s deadweight overhead. The ensuing public debt crisis is used as an opportunity to grab whatever property is in the public domain – infrastructure, real estate and mineral rights – and to persuade governments to create new monopolies to sell off and use the proceeds to pay the debts owed to the large financial institutions. Chicago, for instance, sold Wall Street investors the right to install parking meters on its sidewalks – increasing the cost of driving and doing business.
This is how the South Sea Bubble was orchestrated: Britain’s government had won from Spain the asiento monopoly for slave trade with the Americas. It sold stock in the company to the public, with payment to be made in government bonds. Insiders bought with only part-payment down, making early gains and later selling out. The public was left holding the bag when the overpriced hyped-up stock crashed. The Bush plan to privatize Social Security is basically Pinochet’s and Thatcher’s “pension fund capitalism” expanded to orchestrate bubbles by inflating asset prices on credit. Steering wage withholding into the stock market would bid up prices simply via supply and demand, not because of rising corporate earnings in a debt-deflated economy. Once the inflow of new employee contributions slows, the rise in stock prices will collapse, just as the mortgage bubble collapsed.
Financial planning under oligarchic government is all about the FIRE sector. Banks hope that the final stage in this process will see the government create new public debt to bail out the banks. Such bailout credit does not finance tangible production recover.
Relinquishing the allocation of credit while untaxing property and finance transforms the mode of planning into the diametric opposite of what it meant to the Enlightenment and to the classical economists who sought to steer the drives of industrial capitalism to serve society’s long-term growth. Unfortunately, the history of economic thought no longer is taught as part of the neoliberalized economics curriculum, at least here in the United States. So people are not aware either of how destructive financialized management and planning has been ever since the fall of Rome, or of the alternative developed by the Enlightenment, classical political economics and Progressive Era reforms.
Q: What would be a progressive solution to this crisis? Should the central bank simply monetize the deficits and the consequent increase in public debt?
A: It is a mathematical fact that debts that can’t be repaid, won’t be. But in the meantime, trying to collect them threatens to tear the economy apart. A lot of pain will be saved by cancelling the debts. Greece should tell its fellow Europeans that every government has a prime mandate to protect its people from catastrophe. To carry this policy out, Greece should annul its debts and begin again with a Clean Slate, like Germany enjoyed in 1948. This would make it a low-cost competitive economy – as long as it taxes the free lunch of the land’s site-value rent that has been freed from debt, as well as natural resource and monopoly rents as a basis for its post-Clean Slate fiscal policy. So fiscal and financial reform need to go together.
The technocratic solution is indeed for the central bank to create new government IOUs – money – to bail out bankers at home and abroad by giving them good government money in exchange for debt claims gone bad (junk mortgages and so forth). The government then would try to collect. This is how the United States has handled its junk mortgage burden. Banks have dumped their portfolios on the government with few questions asked – leaving debts in place by victims of predatory mortgages. If these debts are kept on the books – while the government lets banks foreclose – it will make the financial sector by far the most powerful actor. The economy would polarize between creditors and debtors as society falls into poverty.
My alternative is to anticipate that the end game must be a Clean Slate one way or another.
Q: Do we need a central bank to monetize and coordinate such a policy?
A: The central bank’s role should be to regulate commercial banks and their lending policies, not serve as their lobbyist as presently is the case. You also need a central bank to provide liquidity, seasonally and occasionally to the banking system – but only for temporary disruptions. This does not mean bailouts in the form of loans to insolvent banks whose losses have wiped out their reserves and hence their equity capital investment. The bondholders need to be wiped out along with stockholders in such bankruptcies, and the banks “de-privatized” by turning them into Public Option banks. Unfortunately, the important dividing line between liquidity loans and insolvency bailouts has disappeared under the pretense that we are going through merely a temporary downturn can recover if only the government agrees to give yet more, unlimited capital to the banks.
What has happened is that central banks are doing just the opposite of what they need to do. Before the EU bank grab, central banks were supposed to create money to finance government budget deficits, so that governments are not forced to borrow from bondholders, or from commercial banks charging interest for credit that they create electronically on their own computer keyboards.
The problem is that unlike the Bank of England or the U.S. Federal Reserve, Europe doesn’t have a real central bank to finance government deficits directly. The ECB won’t lend to governments – which is what central banks were founded to do. The ECB only buys bonds from commercial banks – at a higher price than the “free market” would set. Governments give special tax breaks to insolvent companies, and end up bailing them out when the bubble bursts and the financial scenario breaks down.
This neoliberal “free market” policy financial-style is antithetical to what most people think of as free markets. Protecting big banks from insolvency enables them to take all-or-nothing gambles whose size exceeds their net worth – gambles on arbitrage and other derivatives, often against their customers and usually against each other. If their bets win, they keep the money and pay it out to their managers as high bonuses and salaries. If they lose, the cry to the central bank and government that the economy will be plunged into depression if the losers are not bailed out to pay the winners.
In this zero-sum game, governments are called on to pay rising bailouts. Either the central bank monetizes bank losses with bailout “swaps” – paying with government IOUs (new bonds exchanged for financial junk) – or governments are told to sell off public property, or to bleed the economy by making “taxpayers” bear the burden of the government’s failure to tax wealth in recent years.
This capture of central bank policy to feed an unregulated and increasingly perverse banking sector is hardly what voters expected when they joined the eurozone. Greece joined Europe because it wanted to increase its prosperity, not let the financial sector end up with all the benefits. To promote fair growth whose benefits are widely distributed, it needs a real central bank – and taxation of unearned income, windfall gains and “unexplained enrichment.” These are all forms of economic rent. Either this needs to be created within the eurozone, or else Greece and the European periphery should start afresh with the kind of Clean Slate that fueled Germany’s Economic Miracle. Europe needs a debt cancellation to bring debts back within the ability to pay.
Greece may find allies in Southern Europe (Italy, Spain, Portugal), the BRICS or neighboring countries in the Baltics and Far East. And the non-banking classes of Germany and its creditor allies should be made to feel welcome to join in the South’s effort to restructure eurozone finances so as to avert an epoch of debt peonage resulting simply from lack of a proper central bank finance government deficits.
Q: Could a re-nationalized Greek central bank create enough money to pay off the debt in euros before the ECB has the chance to pull the plug on it?
A: The eurodebt is so much larger than the private sector’s ability to carry that it cannot be paid without selling off the public domain. New ECB credit to enable the Greek government to keep current on its payments to bondholders would give “real” value to debt that is fictitious inasmuch as it has no counterpart in the real ability to pay. So the question is not whether the ECB can create “free” credit in unlimited amounts. The issue is whether it should do so.
Bondholders financed a sharp rise in Greek public debt despite the government’s failure to tax wealth or prevent a reported 50 billion euro capital flight to Swiss banks alone. So what was being financed was an untenable situation, a “hothouse” environment for credit decoupled from the “real” economy.
It is true that debts can be paid off by printing the amount of money that’s needed. That happened in the United States when the Federal Reserve created $13 trillion to cover the bad debts held by the banks before they could stick Europeans, pension funds and other gullible buyers with junk mortgages and convoluted derivatives. The Fed rescued the banks, not the economy. It kept bad debts on the books instead of writing them down, while its $800 billion Quantitative Easing #2 in 2011 was sent abroad. The banks took the money and jumped ship.
Having created a reckless and unpayably high debt overhead, the banks are now subjecting the national economy to debt deflation. Debtors are trying to pay by reducing their consumption and tangible new investment.
The healthier and more realistic policy would have been to write down mortgage debt to the ability to pay. Bondholders should lose, and only FDIC-insured depositors should be rescued. Instead, the Federal Reserve and Treasury have financed bank losses and bad gambles, left the private sector’s debt overhead in place, and given firm government debt to the banks in exchange for their junk loans. It’s like Aladdin and his magic lamp, “New lamps for old,” except that the new bonds are firm government liabilities and the old debts are junk.
Greece should learn from America’s folly and refuse to borrow from the ECB to pay bondholders on debts that have been run up by not taxing wealth, especially that of the FIRE sector. The EU’s designers and bureaucracy have been complicit in letting the wealthy avoid taxes by accounting tricks such as taking their profits in tax-avoidance and capital flight centers such as Switzerland. Greek banks also have acted as enablers in this capital flight and tax evasion. So I suggest that Greece tell eurozone creditors to pursue this flight capital themselves, while Greece makes a fresh start to build a more functional financial and fiscal system.
Q: Haven’t Germany and the major Eurozone countries shifted the bulk of Greek public debt out of the hands of private bondholders (mainly EU banks and hedge funds) onto the official sector – EU states via the ECB and IMF – ultimately to insist that Greek and other EU taxpayers pay for the tax avoidance that you say has forced the government to borrow so much in recent years?
A: That’s right. The eurozone is waging economic warfare against Greece. As a sovereign nation, Greece has a right to respond by taking back control of its property. The simplest option is to tax economic rent, windfall gains and “unexplained enrichment.” If a taxpayer has reported only 5000 euros income, but has property worth millions of euros, the property should be taken, the payer and his family should be obliged to pay back taxes, and a few criminal convictions should serve as an object lesson to help enforce compliance with the tax code.
The tax code itself should shift toward taxing visible wealth: land, natural resources and monopolies. So fiscal reform needs to accompany financial reform. Central banks will shy from accepting this. They will claim that this would plunge the financial sector into crisis. But the crisis is inevitable and irrepressible, much as William Henry Seward called America’s Civil War looming as an “irrepressible conflict.” The financial sector cannot and should not continue as it is. The existing debt claims (“savings”) held by the 1% on the 99% should be wiped out along with the debt overhead. Pension funding, Social Security and other basic social spending should be organized on a pay-as-you-go basis rather than entailing “forced saving” in the form of paycheck withholding to be lent to governments to enable them to cut taxes on the rich and on rentiers.
The situation is much as if criminals had used their crime proceeds to take over the government, abolish the anti-crime laws, abolish the police force (or put their own gangsters in control), and give amnesties to the prisoners. Such a society would end up criminalized in short order. But that is basically how today’s world has been financialized. The financial sector has placed its own managers in charge of writing the EU’s tax and banking laws, enforcing (or not enforcing) them, using government funds to bail themselves out – and then taking their money and running.
Remember that Northern Europe responded to the papacy in Rome draining tribute. Nations finally elevated national interest to the highest religious plane as the only way to break the financial bond. Protestantism was largely a financial response against papal bankers, the Lombards, Florentines and their brethren described by Dante in his Inferno. To achieve financial independence, Northern Europe needed a new ideology capped by religious independence – and indeed, civil independence from religion. That came finally in the form of the Protestant Reformation. Henry VIII nationalized England’s monasteries and church lands.
Greece needs to do the political equivalent today – not via religion as such, but by promoting an ideological alternative to the almost theocratic neoliberal pro-creditor doctrine insisting that paying debts is part of “free markets,” and denying that any income or wealth is unearned or that there is any such thing as economic rent and unearned income.
Q: How can Greece counter the terror propaganda warning about the horrors and calamities that threaten to befall the nation if it defies its troika conquerors and tries to go it alone?
A: The real terror is what would happen if Greece surrenders to these financial aggressors.
Throughout most of history, populations and governments have fought back against creditors. Either they win and resume their economic growth, or the creditors will win and impose austerity, turning economies toxic and driving many citizens to emigrate. We are seeing today the equivalent of Rome’s Social War, 133-29 BC.
Creditors know that they are paper tigers in a fight with a government that uses its sovereign legal powers. So creditors try to weaken government, denouncing taxes and accusing it rather than creditors of being a deadweight responsible for austerity. They often use violence, but first seek to shape the popular value system and even its religious ideology to depict themselves as economic saviors, “job creators” doing God’s good work.
Creditors have mounted a vast public relations campaign to bluff debtors to refrain from fighting back. But the reality in this financial war is that Greece can do whatever it wants with regard to which debts get paid or while will be written down or written off altogether. Greece has a wide array of options. It can re-denominate debts in its own currency and then devalue. Or it can simply repudiate the debt as being unpayably high.
Greece wouldn’t need to act alone in defending its economy. Its diplomats can pursue agreements with other countries that are in the same sinking debt boat. They may reject that the eurozone model of austerity and debt deflation. In America, for instance, Donald Rumsfeld has referred contemptuously to “old Europe.” This reflects a feeling that the eurozone is a Dead Zone. Greece can say that it has no intention of being sucked financially and fiscally into this dead zone. It can approach the BRIC countries, and even ask for U.S. support to become a new potential growth area.
Q: What are the options available to the rest of the world to resolve the debt crisis and avoid global depression?
A: Shrinking economies fall further into arrears in a debt spiral. The question today is whether a new ideology and political reform program will emerge to complete the task of classical political economy: to free markets from unproductive debt overhead and unearned rentier income. The alternative is a Counter-Enlightenment that would roll back the democratic era that industrial capitalism promised to inaugurate.
Rentier interests have escalated their fight against Progressive Era reforms. The financial interests have gained control of the mass media and universities, the courts and now the government itself under the U.S. “Citizens United” ruling that relinquishes election campaign financing to whomever has the most money. TV commercials and a massive ideological propaganda machine aim to convince voters that There Is No Alternative to debt peonage. This ideological inversion of Enlightenment values celebrates asset-price inflation and endorses the polarization between creditors and debtors as “wealth creation” and the workings of the “free market,” as if this is a natural evolution, not a hijacking and derailing of economic development.
At issue is how society will resolve the buildup of debts that can’t be paid. If governments let the financial sector foreclose, they will end up being forced to privatize the public domain under duress conditions at distress prices. They also will have to dismantle public administration and welfare services. The financial conquest is capped by turning tax policy over to financial lobbyists who claim to serve as objective technocrats. But their agenda is to make the economic polarization between creditors and debtors irreversible, ushering in a Dark Age of austerity and deepening debt peonage in which wages, profits and property rents are earmarked to pay interest – on loans that can’t be paid in a shrinking economy.
The alternative is write down debts to what can be paid, within the framework of a mixed public/private economy whose tax policy and monetary system aim to distribute wealth and income more equitably. The history of how societies have dealt politically with their debt overhead throughout history needs to be highlighted in the public consciousness and placed at the heart of the academic curriculum and media discussion.
A new set of economic measures needs to be reported and kept in the forefront of political discussion. Asset-price inflation – the bubble economy’s debt-leveraged real estate, stock and bond market boom – needs to be distinguished from consumer price inflation to demonstrate how banks have simply inflated the cost of housing and buying a retirement income rather than made the economy richer. The falling share of homeowners equity shows how this process has become debt leveraged.
The National Income and Product Accounts need to recognize the magnitude of the FIRE sector and treat its revenue as eating into the economic surplus, not increasing it. And asset-price (“capital”) gains need to be tracked as part of “total returns” to explain the economic polarization between rentiers and wage earners.
But that is another story.
 Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 26, 1997 – Statements to the Congress – Transcript Federal Reserve Bulletin, April, 1997.
 Testimony of Chairman Alan Greenspan, “The Federal Reserve’s semiannual monetary policy,” report
before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
July 22, 1997.
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.