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July
11, 2003
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Lobe
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Wake Up and Smell the Dynamite
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Queer as Grass
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3, 2003
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David
Lindorff
Outlawing Subversives: Hong Kong
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John
Chuckman
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Jackson
Thoreau
New Far-Right Scheme: Impeach Supreme Court Justices
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Goff
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Perry
Bush's Wars Web Log 7/3
July 2, 2003
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Christian
Good Killing and Bad Killing
Richard
Falk
After Iraq, Does UN War Prevention Have a Future?
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Podur
Uribe's Onslaught Across Colombia
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Bush's Wars Web Log 7/2
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1, 2003
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Glahn
RIAA Watch: No, No Bono
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Weapons in Search of a Name
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Leupp
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Bush's Wars Web Log 7/1
June
30, 2003
Karyn
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The Do-Nothings: an Exposé
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Neve Gordon
The Roadmap and the Wall
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The Revelation of St. George: "God Told Me to Strike Saddam"
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Hope in Dark Times
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Bush's Wars Web Log 6/30
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June
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You Call These Democrats an Alternative?
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Rehnquist Family Values
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Tom Delay: "I am the Government"
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Keep Your Hands Off Iran, Please!
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Vest
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Indonesia's War on Journalists
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|
July
11, 2003
An Interview with
Economist Michael Hudson
The
Coming Financial Reality
By STANDARD SCHAEFER
The war in Iraq is allegedly over, interest rates
are going lower and there are rumors of recovery although the
economy is still in the doldrums. A Bush is president, but an
election is around the corner. It sounds a bit like the recession
of 1990-1991. In fact, the recovery from that period, anemic
as it was marked by very little growth in employment--was
actually stronger than this one. The US economy grew at an annual
rate of 3.1% compared to the 2.6% annual rate currently. Except
for the 1992 recovery, the last seven economic recoveries were
much stronger than this one, and each of them, corresponded with
the usual amounts of job creation. So far, the current unemployment
rate has actually edged higher to 6.4%, and among African-Americans
is twice as high. Meanwhile the mainstream financial press has
been arguing that the virtue of "jobless recoveries"
is even higher rates of profitability for corporations.
Generally echoing the jingoism of the
general media, financial publications such as The Wall Street
Journal, The Economist and Business Week have chosen
to highlight the job growth in one sector-services. The refinancing
boom, as they argue, contributes to the service sector by promoting
the retail industries: lower mortgage payments mean more money
for consumer goods. But, in this case, it also means all-time
high rates of consumer debt. The Federal Reserve continues to
exacerbate this problem, most recently by dropping rates once
again, ostensibly to stave off deflation. The financial press
celebrated the move by hyping the stock market. Little attention
was paid to the fact the Fed itself admitted that the main reason
for the rate cut was that the economy "has yet to exhibit
sustainable growth."
Meanwhile, the 2003 federal budget--thanks
in part to Bush's war and his reckless tax cuts-is expected to
approach a $500 billion shortfall this year. In comparison, Clinton's
tax increases were almost progressive. His deficit reduction
and spending restraint kept interest rates low and spurred the
investment boom. Capital gains taxes from investment played a
major role in creating the $236 billion budget surplus in  2000. Today, however, those
taxes have been cut, along with dividend taxes and the massive
federal deficit has begun to wreak havoc on the states' budgets.
California's $38 billion shortfall is a nationwide all-time record.
Thirty-eight other states are in situations nearly as dire. This,
of course, means there will be huge layoffs in the public sector.
And unemployment means no pricing power for labor, no wages to
pay off debts accrued during the bubble, a potential wage of
foreclosures and a resulting set off layoffs in the service sector.
On July 1st, as the state legislatures
began their new fiscal year, I spoke with heterodox economist
and historian Michael Hudson, one of the few with both real experience
inside the financial services sector. He believes that it is
not enough to know that corporations will do everything imaginable
to extract profit at the expense of the workforce. It is not
enough to know that politicians represent their donors, not the
electorate. He believes you also need to have some background
in the financial system as a whole to understand where the economy
is headed and why "free market" propaganda dominates
the terms of debate, despite all the evidence of its failings.
Professor Hudson is presently writing
a book on the bubble, focusing on the increasing dominance of
the financial industry over industrial production. I asked him
to relate his ideas to the coming state of social security, employment,
Bush's war against the poor and the middle-class, and the international
ramifications of US economic policy.
The downside of low
interest rates
Standard Schaefer: Let's start with
the economy in general. Today's interest rates are the lowest
since the1958 recession, but the economy is essentially stagnant.
What is your take on the Federal Reserve's interest rate policy?
Michael Hudson: The first effect of these
low rates is to benefit the banks. That's the aim of central
bankers today. Whether it benefits the economy at large is another
matter.
The banking system's cost of obtaining
funds is now almost as low as it was after World War II. But
long-term rates for mortgages and credit cards have not fallen.
So the lending margins of banks have widened, increasing their
earnings. This is why we don't face a Japanese-style bank collapse.
U.S. banks have managed to avoid bearing the brunt of the stock-market
losses by passing their bad stock investments and bad debts on
to their customers, the pension funds and mutual funds. Labor
and its savings have borne the brunt of the post-2000 market
downturn. It's the people who put their trust in banks and other
financial managers that are on the short end of the stick.
The rates that have responded most significantly
to lower borrowing costs are short-term loans for financial speculation,
above all for derivatives and related buying or selling of stocks
and bonds on margin--enormous gambles on which way the dollar,
the stock market and interest rates may go. This kind of lending
does not help the economy invest more in fixed capital formation.
It merely helps create a thriving and profitable new bank business.
Like Japan, the U.S. economy has painted
itself into a debt corner that is locking in low interest rates.
These rates can't go up without causing widespread distress.
This "lock-in" is a second effect of the Fed's policy.
As interest rates have fallen, home owners and businesses have
found their income able to support a larger debt pyramid. A thousand
dollars per month can carry twice as high an interest-only loan
at 5% as it can at 10%.
Instead of using the decline in interest
rates as an opportunity to pay down their debt, they have borrowed
more. Mr. Greenspan has encouraged them to do this so that they
can go out and spend more money, creating more profits for producers
of the goods they buy. This is the first time in history an economic
planner has advised people that they can live better and the
economy can grow faster by running deeper into debt. This philosophy
blatantly serves the commercial banks and other lenders and savers
rather than keeping their self-interest in check as government
financial policy would be doing in a better-run economy.
Most of America's new debt creation represents
floating-rate mortgages. Their interest charges may rise if general
interest rates increase. This will enable banks to pay their
depositors rising rates, thereby holding onto these deposits
rather than seeing the scale of withdrawals that killed the savings
and loan associations (S&Ls) in the 1980s.
However, if and when interest rates rise,
carrying charges on most peoples' debts will jump sharply, especially
for real estate. Some people and companies that have borrowed
to the hilt will default, and be forced to sell their assets.
Prices for real estate and stocks will fall, and many debtors
may find themselves with negative equity in the property they
have bought. By negative equity, I mean that the price of their
home may fall to less than they owe on the mortgage.
The very thought of this scenario happening
will deter U.S. planners from increasing interest rates in the
foreseeable future because of the problems this would cause.
But just as high interest rates caused problems in the past,
low rates may cause a new kind of problem for the future.
A good example is the effect that low
interest rates are having on corporate pension funds and other
personal savings. Companies with "defined benefit plans"
are obliged contractually to set aside earnings in a special
fund that will generate enough interest, dividends or capital
gains to be paid out to a growing number of retirees. Rather
than paying these pensions out of current income as it is earned
or plowing their earnings back into investment in their own business,
companies take their income and "financialize" it by
buying stocks and bonds for their pension funds.
As interest rates fall toward zero, however,
an infinite amount of savings is required to produce interest
income. This is the basic folly of not simply paying pensions
on a pay-as-you-go policy in the way that Germany has done. As
interest rates fall, companies need to set aside more and more
of their net cash flow for their pension plans. And at today's
interest rates, almost all their earnings are absorbed by pension-fund
commitments. This problem is as serious in Britain and other
countries as it is in the United States.
This phenomenon has a number of effects.
First of all, reported company earnings will fall after netting
out pension-plan contributions. This is not good for the stock
market, and makes it even harder for companies to pay pensions
out of capital gains they hope to make.
To avoid this problem, companies are
abandoning their "defined benefit plans" for "defined
contribution" plans. The change in wording (from
"benefit" to "contribution") means that instead
of getting a promised stream of benefits upon their retirement,
employees will have a specific amount withheld from each paycheck.
In effect they are told that their employers don't have any real
idea as to how much these workers are going to get upon retirement.
Only the top executives have worked out golden parachute packages
with stipulated payouts.
Companies also are firing workers just
before they become fully vested in their pensions. This cheats
them out of what they had expected and indeed, deserved. But
a simpler way to wipe out corporate pension commitments is to
merge with another firm or allow oneself to be raided, under
terms that the new company changes the pension rules. The raiders
empty out the pension funds and uses them for their own purposes,
partly to pay off their financial backers and partly to pay bonuses
to their leading officers out of the savings they have expropriated
from the employees.
This is what Dick Cheney did at Halliburton
with one of the companies it absorbed, attesting to the support
this anti-labor stratagem has at the highest levels of our government.
Inflating a financial
bubble as a precondition for privatizing Social Security
SS: How does all this effect public
pensions and, most of all, Social Security?
MH: Lower interest rates mean slower
accruals of interest in the government's own Social Security
and medical care funds. Low interest rates show how futile it
is to try and pay for the future by buying bonds or stocks, or
otherwise saving money without somebody, somewhere, actually
investing to produce the goods and services that people they
are going to buy when they retire. Saving, stock and bond speculation
and real estate speculation do not by themselves lead to new
investment. In fact, the higher speculative and financial returns
are, the less incentive there is to actually tie down money in
building new factories and expanding business.
I should point out that non-profit foundations
also are being squeezed. The government has proposed that grant-giving
foundations must give away no less than 5% of their endowment
value in grants each year. Most foundations won't be able to
earn 5%. Rather than just sitting by as sinecures for cronies
watching their endowments grow, they will have to begin doing
something with the money they have accumulated, although their
funds may shrink.
These exorbitant shares for management
in the face of falling returns should warn people of what folly
it would be to privatize Social Security. The only hope for it
to be adopted lies in the privatizers' ability to convince people
that there's going to be a new bubble that can make back the
money they lost (or simply failed to make) in the last bubble.
SS: You have said that governments
always are complicit in bubbles. How so?
MH: Every stock market bubble in history,
starting with the South Sea and Mississippi bubbles in the 1710s
in Britain and France, has been sponsored by government. The
driving force has been the government's attempt to cope with
debt obligations beyond its foreseeable ability to pay. Creating
a bubble has been a way to solve their public debt problem--and
to pay off political insiders at the same time, thereby killing
two birds with one stone.
Modern governments are not politically
able to simply default on their debts--at least, not debts owed
to their own bondholders in their own currency. The problem has
to be solved through "the marketplace."
The simplest solution is to get people
voluntarily to swap their government bonds--or in today's case,
their Social Security entitlements--for stocks that then can
be permitted to fall in price, once the investment no longer
is the government's responsibility.
For this to occur, it is necessary to
prime people to expect that stock prices will rise sharply. They
have to see fortunes being created in a new speculative run-up,
and their imaginations as to a glorious new future need to be
piqued.
In England in France the "new economy"
industry of the day was the slave trade between Africa and the
New World, and it promised to provide unprecedented gains. England
bought the asiento slave-trading monopoly from Spain,
and France began to establish plantations in its Louisiana territory.
Stocks in the South Sea and Mississippi
Companies were issued in tranches, permitting people to buy on
margin with only a small proportion as down payment, so that
they could quickly double their small initial payment as the
stocks were engineered upward in price. It seemed that money
could be made off money itself. This is a basic illusion that
is necessary for bubbles to take off.
But where was the money to come from?
In the 1710s the major vehicles for saving were government bonds.
Stock markets had not yet really come into being. In fact, it
was the bubbles that created them in Britain and France, and
also helped develop international investment as the Dutch in
particular became major stock buyers.
Investors paid by exchanging government
bonds for stocks in the South Sea and Mississippi companies.
The stocks had fallen in price to a fraction of their par value,
but were accepted at par, so bondholders felt that they were
being given a chance to break even. And as stock prices rose,
more and more bonds had to be exchanged for a given number of
shares in the two companies.
This is the background that may help
explain today's privatization scheme for Social Security. There
actually is a dual problem.
On the one hand, as in the early 18th
century, the U.S. Government has future obligations that it claims
it will have difficulty in paying. This actually is not the case,
but there is another factor at work. That factor is the desire
by financial institutions to make money off a new stock run-up,
and to find a vast new source of money management fees for their
executives.
The problem facing money managers is
that the domestic U.S. savings rate has fallen to zero (actually,
it is negative, as indebtedness is building up more rapidly than
new saving is being accumulated). Despite this unprecedented
development, employees are obliged to accumulate forced savings,
in the form of the income withheld from their paychecks by F.I.C.A.
withholding for Social Security and Medicare, and put into government
bonds in the accounts of these two government agencies.
The financial sector is looking at these
funds like a shark that sees nice juicy prey swimming in the
water. They would love to get their hands on Social Security
and Medicare funds to manage, at a 2% fee. Even just 1% this
would amount to tens of billions of dollars annually, not including
the speculative gains that could be made on the turbulent market
run-up.
Chile in the mid-1970s was a dress rehearsal
for the immense management fees that the large financial conglomerates
could rake off from privatizing Social Security. The financial
conglomerates given control of these funds were well connected
to the Pinochet dictatorship, and they were told to buy domestic
Chilean stocks--the stocks of other companies in the Chilean
zaibatsu whose banking arms were managing these investments.
Stock prices then were allowed to collapse once the insiders
had taken their money out, South Sea style.
The financial insiders made off well,
but the workers lost their savings. The plan then was revamped
with management turned over to U.S. and other international companies,
with the stipulation that the pension savings had to be invested
in the stocks of large Chilean companies.
This was the scheme thought up by the
Chicago Boys brought in by the military junta. Their experiment
with the "free market" thus was introduced at gunpoint.
This also became the case elsewhere in Latin America, where labor
unions organized riots to protest their forced saving being turned
over to international stock-brokerage firms. But the privatization
is being done as an inside job by the Chicago Boys with strong
arm-twisting by the IMF and World Bank acting as the financial
sector's international lobby.
SS: How are the Fed's bubble-promoting
policies contributing to this move to privatize Social Security?
MH: First of all, it was Alan Greenspan
that lowered interest rates early in the 1990s when the stock
market boom began to flag. Despite the fact that he talked about
"irrational exuberance," he made speculation rational
by channeling the flow of funds to inflate the bubble.
He could have raised margin requirements
on stocks. That is the time-honored way of discouraging borrowing
that is used to bid up the price of stock. Or, Mr. Greenspan
could have increased bank reserve requirements against deposits
lent out to stock speculators. Or he could simply have told the
banks to slow down on stock market lending if they did not want
to see such requirements being imposed. But he did none of these
things. He felt that inflating the bubble was what was making
his reputation as a financial genius, John law-style. And his
policies certainly helped get him reappointed for yet a new term
as Chairman of the Federal Reserve System.
This explains why he is repeating his
policy of lowering interest rates today and flooding the financial
sector with cheap credit. Yet this money is not being invested
in creating new means of production or employing more labor.
This brings us to the scenario for privatizing
Social Security. If the system's gigantic holdings of government
bonds are sold off (with the Federal Reserve Bank supplying the
funds to monetize the requisite credit) and put into the stock
market, this rush of funds is going to push up stock prices.
It will inflate the new bubble that is being promised, which
will be called a "recovery." Stocks will be pushed
up for a few years as more paycheck withholding is channeled
into Social Security than out-payments are made to retiring Baby
Boomers, the Big Generation born right after World War II.
The big stock-market institutions will
speculate on a boom and make much more than simple capital gains
through their leveraged derivatives trading. Smaller investors
will use some of the gains to buy real estate, bidding up prices
for housing, commercial buildings and other property.
SS: This sounds like a winning political
program. If it makes Americans richer--or even if it just makes
them feel richer--shouldn't they support a financial boom along
these lines?
MH: The turning point will come just
before the point is reached where more people retire than are
entering the employment market. Stocks will begin to be sold
off as institutional money managers dump their holdings, mainly
onto their clients and small investors who do not realize that
the wind is changing.
The stock market will collapse, as it
did in 1710 in England and France. But the policy will have succeeded
in getting people to give up their claims on the government for
payment. When the dust settles, the government balance sheet
will be freed of its Social Security and Medicare obligations.
That's the basic objective.
Public officials and newspaper commentators
will wring their hands and exclaim, "Well, you see the madness
of crowds. People are greedy." But who really will be to
blame? The crowds will have been doing what the professionals
advised them to do. This bubble is a symptom of the madness of
crowds mainly to the extent that it is a psychologically orchestrated
disinformation program.
The same thing is happening in almost
every country. The Fed's policy of lowering interest rates is
a precondition for reviving popular hopes for a Bubble and suckering
voters to approve Social Security privatization. Starting a new
bubble will set the public up for the rip-off the financial sector
is hoping will make the 2000s as nice for it as the 1990s were.
How the financial
sector is concentrating economic planning in its own hands
SS: It sounds contradictory: the private
sector-most notably the financial service companies is sponsoring
a massive planned economy-even though they denounce planned economies
as inefficient and ineffective. And the government-who would
normally do such planning-seems to accept that they can't do
the job properly. And yet they quietly support letting the private
sector do it themselves. How can this be?
MH: The large financial conglomerates
are using their economic gains to break down public regulatory
power so as to transfer economic control and resource allocation
into their own hands. Yet their objective is simply to pursue
the short-term trading gains, not to see savings invested in
fixed capital formation.
To promote deregulation, financial lobbies
and their academic public relations spokesmen have rewritten
economic history. In so doing, they have turned it upside down.
The result is a caricature of government regulation, whitewashing
the universally bad experience of privatization's failures. A
rosy Walt-Disney picture of the future is painted to convince
the population to relinquish its existing government protections
and sign them over to the new planners.
If you want to see America's future under
these new conditions, you might want to look at Russia's experience
since 1991, where the Washington Consensus had a free hand. Look
at what it brought about. In abolishing what it called the Road
to Serfdom resulting from government planning and regulating
markets, Russia, Britain and Chile have become object lessons
for a New Road to Serfdom--financial rentier serfdom,
in which a class of people live off the fixed income from government
bonds or land rents paid by others who do the work to generate
this revenue.
If ever there was a Faustian proposal
by the proverbial devil, this is it. And it is good to remember
Baudelaire's quip about the devil: He achieves his victory over
humanity at the point where people become convinced that he doesn't
exist.
Today, the debt problem has all but ceased
to exist intellectually, along with property and rentier
economic relations in general. A body of theory has been popularized
that excludes the study of debt, history and the history of economic
thought. Peoples' attention has been distracted into speculation
about of how they might get rich in a parallel universe that
might exist in theory--if one accepts the narrow-minded assumptions
that are being taught--but whose most important real-world consequence
is to impose a debt spiral on America and other nations.
SS: What should the government do
to protect labor and most savers from the losses resulting from
the bubble bursting? Is re-regulation and planning the solution,
or is it part of the problem?
MH: Free enterprise under today's financial
conditions threatens to bring about an unprecedented centralization
of planning, not in the hands of government but by the financial
conglomerates and money managers. Whatever government planning
power is destroyed becomes available for them to appropriate,
with plenty of vigorish left for the politicians whose campaigns
they back and who will "descend from heaven" into high-paying
private-sector jobs, Japanese style, after having performed their
service for the new regime.
SS: The financial regime is nothing
but parasites?
MH: The problem with parasites is not
merely that they siphon off the food and nourishment of their
host, crippling its reproductive power, but that they take over
the host's brain as well. The parasite tricks the host into thinking
that it is feeding itself.
Something like this is happening today
as the financial sector is devouring the industrial sector. Finance
capital pretends that its growth is that of industrial capital
formation. That is why the financial bubble is called "wealth
creation," as if it were what progressive economic reformers
envisioned a century ago. They condemned rent and monopoly profit,
but never dreamed that the financiers would end up devouring
landlord and industrialist alike. Emperors of Finance have trumped
Barons of Property and Captains of Industry.
SS: Why have so many academic and
think-tank economists endorsed the Bubble Economy and the privatization
of Social Security?
MH: First of all, they have re-defined
as "wealth creation" what most investigative journalists
and other people with old-style values would call a rip-off and
many people a free lunch. Their next step has been to follow
Milton Friedman and deny that a Free Lunch exists. Yet the economy
has become all about getting a free lunch. That is the essence
of the classical theory of rent: one collects interest off bonds
or land rent, well beyond cost outlays. The aim is property income,
not the creation of new means of production.
SS: Why haven't people been able to
see through this switch of values more clearly?
MH: The financial beneficiaries of the
stock-market bubble call it "wealth creation." Two-thirds
of Americans are homeowners, and they feel that they are benefiting.
Rising prices for houses are called "wealth creation,"
and borrowing more money against this property is called "value
extraction." In fact, riding the wave of asset-price inflation--the
real estate and stock market bubble--has been the way in which
most people have been able to get to be what they consider to
be pretty rich.
Stock traders say "The trend is
your friend." Rising prices for assets seem to make most
people better off, unless they are renters, or ethnic minorities,
or immigrants, or come from large families and don't inherit
a home of their own, or get sick and need to pay for medical
care, or get fired, or get their pension fund ripped off or otherwise
fall outside what most people think of as the bell-shaped curve
of good fortune. But polls show that most Americans expect to
grow rich, and the bubble seems to be the way to do it.
How financial engineering
has replaced industrial engineering
SS: What is the role of technology
in all this? The "Progressive Century" was inaugurated
by breakthroughs in energy, electricity and then nuclear power,
radio, air travel, medical cures and so forth. How much has actual
technology been responsible for "real" wealth creation
as opposed to bubble financing?
MH: Higher prices for houses and stock
in large corporations look like a way to build up wealth without
having any tangible cost associated with it. This absence of
what the classical economists defined as value--ultimately the
cost of supplying labor effort--has changed the popular meaning
of "wealth" to mean financial market value, not industrial
capital measured in terms of its productive power. In this sense
today's anti-government economics runs against what economists,
politicians and most people considered to be industrial progress
a century ago.
SS: Given all the we know about the
corporate crime and deregulation behind bubble of the '90s, why
is no one talking about the old-fashioned solutions like those
types of regulation that have been shown to actually increase
competition and increase the efficiency of the markets.
MH: The bubble of the 1990s has been
called a dot.com bubble, an internet bubble and other forms of
technological bubble, but technology was only a vehicle for what
basically was a financial bubble. It was not powered by industrial
engineering as much as by "financial engineering,"
manipulating corporate balance sheets in a Japanese zaitech-style.
Investment bankers treated telecoms and
kindred companies as vehicles to float their stock, take huge
cuts for themselves, and then make yet more money on first-day
stock run-ups. These are the practices that Eliot Spitzer's office
took the lead in investigating when Pres. Bush's deregulatory
appointees blocked the SEC and other government agencies from
protecting the public interest.
The bubble was fed largely by the "forced
saving" that was withheld from the paychecks of employees.
These "savers" were not permitted to spend their savings
in a discretionary way--for instance, using it to buy their homes
or pay down their mortgages or even to pay off their higher-interest
credit-card debt. The money that was withheld out of wages and
salaries was set aside in pension or retirement plans managed
either by their employer or by large financial institutions.
These money managers, along with investors
using their own liquid savings, saw prices for high-tech companies
taking off. Even though most investors knew there was a bubble,
they thought that they could ride the wave and get out quickly
before other people did.
Of course, the turnaround time is so short that only the large
financial institutions are able to play this game. To be good
at it, you have to devote your entire life to following the market
hour by hour. Only professionals can afford the time and effort
to do this.
Most people held onto their stocks when prices turned down in
2000 because they imagined that they would go up--someday. They
thought the crash was simply one more zig-zag, not a phase change,
largely because they saw that Alan Greenspan was committed to
using monetary policy to prevent a stock-market downturn. When
Long-Term Credit Management (LTCM) got into trouble in 1997-98,
he bailed out the banks that had put up the money that was gambled
on derivatives. The government seemed committed to protecting
savers from risk, or at least protecting the large banks and
other financial institutions deemed "too big to fail."
Saving the economy from a market downturn was what made Mr. Greenspan's
reputation as a financial "maestro," after all. People
wanted to believe that he could succeed, because his success
would enable them to make money on their own savings.
The media jumped on the bandwagon, and this is where psychological
engineering came into play, without even having to be planned.
Days on which the stock-market averages turned down were euphemized
as "profit-taking," implying that the basic trend was
upward and that most people simply took out profits, presumably
to spend on SUVs and other signs of consumer affluence.
The reality is that when stocks decline, the only "profits"
being made are by short sellers--gamblers that stocks will fall
in price--who cover their bets at a low price. When markets rise,
these short sellers are "squeezed," as they have to
buy stocks at a high price that they bet would fall rather than
rise. So the media get matters backward in oversimplifying their
reports to always give a positive spin on every development,
up or down.
Financial analysis in most news broadcasts and in the press was
becoming part of the entertainment industry, turning news reports
into virtual advertisements for the bubble and Mr. Greenspan.
His origins as an Ayn Rand acolyte seemed to be reaching their
logical conclusion, and he credited the boom to the "magic"
of deregulation, getting the government out of the oversight
business so as to let money managers make everyone rich.
What we are dealing with here is Junk Science in the service
of political ideology. The closest parallel I can think of is
Lysenko's biological and genetic theories promoted under Stalin
on ideological grounds. The idea that environmentally acquired
characteristics could create lasting genetic change in species
was supposed to support the idea that a new Soviet Man could
be created. Mr. Greenspan and his financial supporters believed
that he had changed the economic and political environment of
modern capitalism. It seemed that the laws of economic nature
themselves were being transformed by developing a way for the
Federal Reserve to modify industrial economies and their value-creation
through labor and physical capital investment by financial engineering
that required neither growing employment nor new fixed capital
formation.
So the economy's DNA molecule had been changed in a way that
made business cycles--including downturns--a thing of the past.
Mr. Greenspan helped prevent a downturn by flooding the economy
with money, while the U.S. Treasury and State Department arm-twisted
Europe and Asia to keep on accepting a growing U.S. trade and
payments deficit by using their surplus dollars to spend on Treasury
bills to finance America's growing domestic federal budget deficit.
A new kind of circular flow seemed to have been created--not
Say's Law of Markets, which depicted producers as paying their
labor and suppliers and these parties turning around and buying
the products they produced. Labor had to borrow to keep up its
living standards, and companies were running into debt to stay
afloat. Repaying these debts withdrew revenue from this circular
flow between capital and labor, employers and consumers.
The new circular flow was to have Europe and Asia recycle the
U.S. payments deficit to finance the budget deficit, so that
Americans didn't have to save money any more. They could spend
what they had, and let foreign central do the saving.
This was not really getting the government out of economic affairs,
of course. It put European and Asian governments right in the
middle of the new kind of circular flow. In the process, of course,
the U.S. Government was running up an unprecedented and unsustainable
debt to foreign governments, or at least to their central banks.
When the dust settled after the stock-market downturn proceeded
after 2000, the gains that people had thought were exposed as
largely illusory. They turned out to have been produced by fraud.
What is remarkable is that despite the fact that Arthur Andersen
was put out of business and its practices turned out to have
been followed (although not quite so blatantly) by the other
big accounting companies, Mr. Greenspan's reputation remained
intact. Despite the SEC's regulatory failure to have prevented
the accounting and financial fraud, no public reaction against
deregulation as such has occurred.
The reason largely is because the monetarists have created an
intellectual vacuum in academia and the popular press when it
comes to thinking about any alternative to regulation. Margaret
Thatcher put it in a nutshell with her famous TINA--There Is
No Alternative.
Of course there are alternatives. But
the free-market boys have been able to foreclose serious discussion
by acting as censors of any such discussion. It seems therefore
that today's individualistic free-market philosophy is not compatible
with a free market in ideas. This is a byproduct of the financial
sector's rise to dominance. It is what I referred to above when
I spoke about the parasite taking over the host's brain as well
as diverting nourishment to feed itself and its progeny.
SS: How precarious has all this left
today's situation? Has deflation become a serious threat?
MH: Deflation in the form of falling
commodity prices does not look like much of a threat, at least
not as it was following the Civil War and World War I, when debtors
found their interest and principal payments fixed while their
money-wages declined.
The kind of deflation that is occurring
today is not the traditional phenomenon of falling prices (price
deflation) but a bleeding of incomes--debt deflation. As debts
grow, more income must be paid out as interest and amortization
rather than being available for spending on goods and services.
This breaks the circular flow that economists call Say's Law
of Markets, whereby supply is supposed to create its own demand.
The principle doesn't work when people use their income to pay
mortgages on increasingly expensive homes and pay credit card
debts and other loans they have had to take out just to break
even as the economic screws have been tightened. Families that
have not gone further into debt usually have had to take extra
jobs to stay afloat.
How Bush's tax cuts
favor finance at the expense of industry and labor
SS: It almost sounds like the government
is getting out of business, cutting taxes as well as regulatory
activity. What is the effect of Bush's tax policy, particularly
reducing the capital-gains tax to just 15% and ultimately eliminating
it altogether?
MH: Nobody seems to be talking about
this, but about 80 percent of capital gains are real estate gains.
The real estate sector tries to camouflage itself as new technology
entrepreneurs, representing its tax cuts as benefiting mom-and-pop
family businesses developing new products. But capital gains
other than real estate only account for 20 percent of the tax.
This makes the term "capital gains"
a euphemism for land-price gains. It is not the building that
grows in value, after all, but the geographic site on which it
happens to be situated. Buildings wear out, but are maintained
by "maintenance and repairs," normally about 10% of
the rent roll and of course tax deductible as a normal operating
cost.
Landlords also can depreciate their buildings--and
new buyers can depreciate them all over again, and they can be
re-depreciated ad infinitum, as if they were losing value.
Real estate investors (but not homeowners) are allowed to depreciate
and re-depreciate buildings at such a generous rate that all
the nominal rental income left after paying interest is offset
by such fictitious "non-cash costs." When the building
finally is sold, the fictitious write-offs are registered as
a capital gain. There is no obligation that landlords repay what
they would have had to pay at the higher income-tax rate had
such fictitious depreciation not been permitted.
The upshot has been to make it much more
profitable for investors to buy land and property already in
existence than to invest in creating new plant and equipment
that actually employs labor. Why invest in a risky enterprise
when all you need do is put down as little money as you can,
borrow the rest, and ride the real estate and stock market bubble?
This favoritism to real estate is part
of the anti-industrial character of modern tax codes. These tax
laws are the product of intensive political lobbying by the FIRE
sector. The financial lobby is happy to back the real estate
lobby, secure in the knowledge that whatever rental income the
government relinquishes from taxation is left free for prospective
borrowers to pledge to their mortgage lenders. These buyers bid
against each other, until one party or another has committed
the entire rent roll to pay interest, hoping that ultimately
he or she will be able to sell the property at a capital gain,
keeping the difference.
In this deal bankers get the operating income, the absentee owner--or
the homeowner, for that matter--get the capital gain. This policy
works in financial bubbles. But when the downturn comes, it results
in negative equity.
Speculation has become a faster and even less risky way to make
one's fortune than the tangible investment which the Bush administration
pretends is the objective of its tax cuts. Why build new structures
when you can buy one already in place? Why create more fixed
capital formation, when after-tax capital gains yield a higher
"total return," that is, current income plus asset-price
gain?
How Bush's federal
tax cuts are forcing up state and local taxes and prices
SS: Let's turn to the state budgets.
The mainstream press is attacking the state legislatures for
overestimating their surpluses from the boom and overspending
on social programs.
MH: It's appropriate that we're discussing
this today, July 1, because this is the beginning of the new
fiscal year for many state and city budgets. This year will inaugurate
a new kind of austerity plan that will resemble if not surpass
those imposed by the IMF on Latin American countries in past
decades. And like most austerity plans, the result threatens
to be higher prices, depopulation and emigration.
But first, with regard for your comment
about "overspending," many states set up "rainy
day" funds prior to the 2000 elections. They put their extraordinary
capital gains tax revenues in these funds, rightly anticipating
that these gains could not possibly be permanent over any protracted
period of time. But Mr. Bush's tax policies, in conjunction with
the bursting of the stock market bubble, have now led to the
depletion of such funds.
I'm not sure what "overspending" means. Government
commitments are financed mainly out of tax revenues, not borrowing.
Local governments relied mainly on property taxes, but have been
shifting these onto labor. What has occurred has not been more
spending so much as an un-taxing of real estate and the financial
sector to which it pays most of its net rental income. Because
local borrowing is limited by law, lower tax returns will cut
spending.
SS: The traditional federal grants-in-aid
to the states have dried up. Is this problem related to Bush's
tax cuts?
MH: Cutting the capital-gains tax has
hurt because this was the major extraordinary fiscal source in
the 1990s. States and cities used it as an excuse for holding
off raising real estate taxes in keeping with the boom in property
prices. In Pennsylvania the real estate tax is only 1 percent
of assessed property value, which has been growing around 10
percent a year. Land prices are soaring in California, but property
taxes are limited to just 2% annual increase, from a base that
is now utterly obsolete.
The basic principle is that what the tax collector refrains from
taking is left available to be pledged to bankers for mortgages
to buy property to ride the real-estate price boom.
As for the stock market boom, since it burst since 2000, states
have found themselves without this extraordinary source of credit,
which now appears to have been a one-time surge.
What has not been adequately emphasized is that Bush's tax cuts
imply sharp, devastating tax increases at the state and local
levels. New York City's decline in tax receipts has forced it
to raise its real estate taxes by 18% and public transit fairs
by 33%. It also has to cut back services, providing less public
service for the existing tax levy. The effect has been to increase
the unit price of civic services. The money is going to creditors
instead.
Also increased has been the cost of obtaining a public education.
CUNY--the City University of New York, which operates a number
of campuses--is raising tuition reportedly beyond the ability
of many of its traditional students to afford. The irony here
is that just last week the U.S. Supreme Court approved the legality
of the University of Michigan's affirmative action program for
black and Hispanic students. Just as this corrective policy was
legalized, states were forced to increase public college tuition
so sharply as to put higher education out of reach of its intended
constituency.
The cutbacks in hiring are expected to hit minority workers the
hardest, for the large cities traditionally have had a large
proportion of minority labor in their public administration.
For many years state and municipal hiring absorbed a large part
of the growing labor force. This employment now has been closed
off as departments are being downsized.
Another effect is that culture is being Thatcherized. There is
no longer a non-commercial classical music station in New York
City. When I moved here in 1960, it was common to hear WNYC,
WNCN or other classical music stations on the radio in offices
or homes. Now there either is silence or the opposite--loud,
blaring repetitive commercials interrupting semi-classical "easy
listening" music, pop music and political talk shows.
With regard to live music, symphony orchestras are facing bankruptcy
throughout the United States. The same phenomenon happened in
Britain after 1980 under Margaret Thatcher, but the situation
in New York is even more extreme. At least when I visit London,
I hear my friends listening to BBC music, and there is still
a lively musical scene. In New York the opera and symphony have
been turned into backdrops for local real estate promotion.
In 1930 real estate accounted for 80% of state and local revenues
nationwide. Today this ratio is down to about 17%. The fiscal
burden has been shifted off property owners onto labor. To put
this into perspective, the value of New York City real estate
alone exceeds that of all the machinery in the United States.
What used to be welcomed as a postindustrial society thus is
lapsing back into the pre-industrial rentier economy.
The focus of economic activity is property gains, not actual
production. New York's industrial neighborhoods have been gentrified
and their traditional small manufacturing companies, employees
and family businesses have been driven out.
There's an interesting political twist to the fiscal crisis of
the states. The three biggest problem states are California,
Massachusetts and New York, which all went Democratic in the
2000 presidential election. It is as if the Bush administration
is saying, "Drop Dead, Democratic States" when it comes
to federal revenue sharing.
Even when it comes to anti-terrorist spending, for instance,
New York has been short-changed. Next month, in August 2003,
Project Liberty is going to lay off some two thousand social
workers hired after 9/11 to work with the families of victims
and others affected by the attack on the World Trade Center.
FEMA (the Federal Emergency Management Agency) provided $150
million for psychotherapy. This was more money than the government
had given for mental health in its entire history, for all disasters
put together. It would seem to be enough to send every New Yorker
to a shrink and still have some money left over.
But now it seems that $50 million is missing. The Bush bureaucrats
decided that rather than find out where the missing money went
(and into whose election campaign?), they would just shut down
the program as a result of their own mismanagement.
International implications
of low interest rates, tax cuts and a new financial bubble
SS: We spoke before about the your
insightful view of the balance of payments between nations. (See
the super imperialism interview.)
How do low rates and the dollar's falling affect prices and the
balance of payments?
MH: One effect of low interest rates
is to keep the dollar's exchange rate down. Although interest
rates are an element of cost, lower interest rates in this particular
case may work to raise prices, to the extent that a declining
dollar leads to higher prices for imports priced in non-dollar
currencies and those not tied to the dollar. If the OPEC countries,
for instance, were to price oil in euros, this would make forward
hedging more expensive if the dollar declines further.
A second effect is to make clear to the world that the United
States is conducting economic policy with only its own objectives
in mind, with a "benign neglect" for how its balance-of-payments
affects other countries. A falling dollar means a rising euro,
and this will squeeze European industrial exporters. Germany
will feel the squeeze most of all.
U.S. diplomats are anticipating that the problems that Germany
faces with its overvalued currency may force it to roll back
its social legislation, especially its pro-labor rules and pension
system. The aim is to transfer the economic surplus from labor
to finance, as is occurring in the United States. This would
break up the world's social democracies politically and economically,
forcing them to follow the U.S. financial restructuring.
The economist David Hale recently estimated that Europe and Asia
will end up financing about 60 percent of America's domestic
federal budget deficit this year, by recycling the surplus dollars
being pushed onto the world via the U.S. international payments
deficit. So instead of the deficit "crowding out" domestic
U.S. saving, America is getting the kind of free ride that we
discussed in our last interview. Europe and Asia are lending
us the money at virtually no interest to buy as much as we want
from them, for our paper IOUs of increasingly dubious quality.
SS: How are their central banks responding
to this phenomenon?
MH: They are lowering their own interest
rates in what is becoming much like the beggar-my-neighbor devaluations
and tariff wars that occurred in the 1930s. Lowering interest
rates in today's case certainly is preferable to raising tariffs
and manipulating currencies as occurred 70 years ago. But by
lowering interest rates, British and continental European pension
plans also are experiencing the same insolvency that I described
above with regard to U.S. pension funding, except for countries
such as Germany that are in much better condition because they
have not "financialized" Social Security but pursued
a pay-as-you-go policy of paying pensions out of current output.
This enables them to use their current revenue to invest in expanding
the means of production--including construction--rather than
putting it into financial paper.
SS: You have described central banks
as following the Washington Consensus. But there are those like
Jack Kemp who argue that we need to return to the gold standard.
Likewise, in "Gold and Economic Freedom," Alan Greenspan
argued for central bank independence on the ground that the alternative
is fiat currencies, which lead to hyperinflation and eventually
to the collapse of financial systems. Does this logic hold water
as solution to the financial regime you've described today?
MH: There is no historical basis for
his ideology. It is basically an attempt to demonize public control
of the monetary system. This prejudice has been sponsored by
the financial sector hoping to elbow governments out of the picture.
Rather than being based on economic history, it reflects Mr.
Greenspan's mentor, Ayn Rand, and her passionate antipathy to
government. The empirical evidence is just the opposite, which
helps explain why the free-enterprise monetarists have excluded
economic history from the academic curriculum.
A colleague of mine, Stephen Zarlenga, has just published a historical
study, The Lost Science of Money (2002), showing that
public-sector fiat money has a much better record than privately
created fiat money. The best example is America's own greenbacks
issued to finance the Civil War in the 1860s. Several of the
colonial currencies also worked well, even the Continental Currency
(the "continentals"), of which 200 million were authorized
and printed. Their value collapsed when the British counterfeited
billions of them in order to stifle the colonies becoming financially
independent. But this wasn't a problem of the currency itself.
Zarlenga also demonstrates that Germany's
hyperinflation of the 1920s was aggravated by the Reichsbank
lending credit to private speculators betting against the German
mark. He thus turns the tables on the privatizers by showing
that their anti-government views rest on a false mythology.
What is most important to recognize about
successful government financial policy is that control of the
money supply historically has been accompanied by control over
the economy's debt overhead, including the ability to write off
debts that could not be paid. This is an area of study that is
excluded by the Chicago Boys' economic curriculum. They talk
about money as if it were something disembodied rather than part
and parcel of the debt overhead--an overhead that is compounding
exponentially.
SS: What long-term lessons can we
draw from the history of national treasuries taking control of
monetary policy rather than central bankers and commercial bankers?
MH: The main distinction that needs to
be drawn concerns whether the monetary system is privately or
publicly controlled. Public systems are stable mainly because
they aim at supporting long-term investment. The private-sector's
credit creation has different aims. The usual priority is to
finance short-term asset-price gains--that is, to inflate bubbles.
If you want to see a public fiat currency that works, look at
the U.S. greenbacks. This has become a forgotten epoch in financial
history, yet it led to the first clear mathematical formulation
of the quantity theory of money, expressed by Simon Newcomb already
in the 19th century.
Every hyperinflation in history, especially
in the Germany of the 1920s, stemmed from the government's being
painted into a debt corner and trying to inflate its way out
of debt. This is what Adam Smith himself noted when he observed
that no government in history ever had repaid its debts, although
some had pretended to do so, i.e., by inflating prices.
The same observation could be made of
private-sector debt as well. The question that needs to be asked
today concerns just how America is going to avoid paying
its debts, and how other countries are not going to pay their
own public and private debts?
It looks like the debts to labor will
be wiped out in order to preserve the "sanctity" of
debts owed to the wealthiest layer of the population. Obligations
to pension funds and social Security and medical insurance and
life insurance will be wiped off the books, in order to pay a
small number of rentiers--the class that Mr. Bush has
made exempt from inheritance taxes, lowered capital gains taxes
for, and reduced income taxes on. His policy is essentially one
of "Big fish eat little fish."
Professor Michael Hudson is an
independent Wall Street financial economist. After working as
a balance-of-payments economist for the Chase Manhattan Bank
and Arthur Anderson in the 1960s, he taught international finance
at the New School in New York. Presently, he is Distinguished
Professor of Economics at the University of Missouri (Kansas
City). He has published widely on the topic of US financial dominance.
He has also been an economic adviser to the Canadian, Mexican,
Russian and US governments. His books include Trade, Development,
and Foreign Debt (Pluto, 1992, 2 vols.). He is the author of
Super
Imperialism.
Standard Schaefer is an independent economic journalist, a cultural
historian, literary critic, national award-winning poet and short
fiction writer. He is the fiction and the non-fiction editor
of the New Review of Literature. He can be reached at
ssschaefer@earthlink.net.
© 2003 Michael Hudson and Standard
Schaefer. This interview is part of a work-in-progress. Any reproductions
or excerpts are subject to request.
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