Daily Archives: January 27, 2012

Banks Weren’t Meant to Be Like This. What Will their Future Be – and What is the Government’s Proper Financial Role?

By Michael Hudson
This article first appeared at FAZ

The inherently symbioticrelationship between banks and governments recently has been reversed. Inmedieval times, wealthy bankers lent to kings and princes as their majorcustomers. But now it is the banks that are needy, relying on governments forfunding – capped by the post-2008 bailouts to save them from going bankruptfrom their bad private-sector loans and gambles.

Yetthe banks now browbeat governments – not by having ready cash but bythreatening to go bust and drag the economy down with them if they are notgiven control of public tax policy, spending and planning. The process has gonefurthest in the United States. Joseph Stiglitz characterizes the Obamaadministration’s vast transfer of money and pubic debt to the banks as a “privatizingof gains and the socializing of losses. It is a ‘partnership’ in which onepartner robs the other.”[1]Prof. Bill Black describes banks as becoming criminogenic and innovating“control fraud.”[2]High finance has corrupted regulatory agencies, falsified account-keeping by“mark to model” trickery, and financed the campaigns of its supporters todisable public oversight. The effect is to leave banks in control of how theeconomy’s allocates its credit and resources.

If there is any silver lining totoday’s debt crisis, it is that the present situation and trends cannotcontinue. So this is not only an opportunity to restructure banking; we havelittle choice. The urgent issue is who will control the economy: governments,or the financial sector and monopolies with which it has made an alliance.
Fortunately, it is not necessary tore-invent the wheel. Already a century ago the outlines of a productiveindustrial banking system were well understood. But recent bank lobbying hasbeen remarkably successful in distracting attention away from classicalanalyses of how to shape the financial and tax system to best promote economicgrowth – by public checks on bank privileges.

How banks broke the social compact,promoting their own special interests
            
People used to know what banks did.Bankers took deposits and lent them out, paying short-term depositors less thanthey charged for risky or less liquid loans. The risk was borne by bankers, notdepositors or the government. But today, bank loans are made increasingly tospeculators in recklessly large amounts for quick in-and-out trading. Financialcrashes have become deeper and affect a wider swath of the population as debtpyramiding has soared and credit quality plunged into the toxic category of“liars’ loans.”
            
Thefirst step toward today’s mutual interdependence between high finance andgovernment was for central banks to act as lenders of last resort to mitigatethe liquidity crises that periodically resulted from the banks’ privilege ofcredit creation. In due course governments also provided public depositinsurance, recognizing the need to mobilize and recycle savings into capitalinvestment as the Industrial Revolution gained momentum. In exchange for thissupport, they regulated banks as public utilities.
            
Over time, banks have sought todisable this regulatory oversight, even to the point of decriminalizing fraud.Sponsoring an ideological attack on government, they accuse publicbureaucracies of “distorting” free markets (by which they mean markets free forpredatory behavior). The financial sector is now making its move to concentrateplanning in its own hands.
            
The problem is that the financialtime frame is notoriously short-term and often self-destructive. And inasmuchas the banking system’s product is debt, its business plan tends to beextractive and predatory, leaving economies high-cost. This is why checks andbalances are needed, along with regulatory oversight to ensure fair dealing.Dismantling public attempts to steer banking to promote economic growth (ratherthan merely to make bankers rich) has permitted banks to turn into somethingnobody anticipated. Their major customers are other financial institutions,insurance and real estate – the FIRE sector, not industrial firms. Debtleveraging by real estate and monopolies, arbitrage speculators, hedge funds andcorporate raiders inflates asset prices on credit. The effect of creating“balance sheet wealth” in this way is to load down the “real”production-and-consumption economy with debt and related rentier charges, adding more to the cost of living and doingbusiness than rising productivity reduces production costs.
            
Since 2008, public bailouts havetaken bad loans off the banks’ balance sheet at enormous taxpayer expense –some $13 trillion in the United States, and proportionally higher in Irelandand other economies now being subjected to austerity to pay for “free market” deregulation.Bankers are holding economies hostage, threatening a monetary crash if they donot get more bailouts and nearly free central bank credit, and more mortgageand other loan guarantees for their casino-like game. The resulting “too big tofail” policy means making governments too weak to fight back.
            
The process that began with centralbank support thus has turned into broad government guarantees against bankinsolvency. The largest banks have made so many reckless loans that they havebecome wards of the state. Yet they have become powerful enough to capturelawmakers to act as their facilitators. The popular media and even academiceconomic theorists have been mobilized to pose as experts in an attempt toconvince the public that financial policy is best left to technocrats – of thebanks’ own choosing, as if there is no alternative policy but for governmentsto subsidize a financial free lunch and crown bankers as society’s rulers.
            
The Bubble Economy and its austerityaftermath could not have occurred without the banking sector’s success inweakening public regulation, capturing national treasuries and even disablinglaw enforcement. Must governments surrender to this power grab? If not, whoshould bear the losses run up by a financial system that has becomedysfunctional? If taxpayers have to pay, their economy will become high-costand uncompetitive – and a financial oligarchy will rule.

The present debt quandary
            
The endgame in times past was towrite down bad debts. That meant losses for banks and investors. But today’sdebt overhead is being kept in place – shifting bad loans off bank balancesheets to become public debts owed by taxpayers to save banks and theircreditors from loss. Governments have given banks newly minted bonds or centralbank credit in exchange for junk mortgages and bad gambles – withoutre-structuring the financial system to create a more stable, less debt-riddeneconomy. The pretense is that these bailouts will enable banks to lend enoughto revive the economy by enough to pay its debts.
            
Seeing the handwriting on the wall,bankers are taking as much bailout money as they can get, and running, usingthe money to buy as much tangible property and ownership rights as they canwhile their lobbyists keep the public subsidy faucet running.
            
The pretense is that debt-strappedeconomies can resume business-as-usual growth by borrowing their way out ofdebt. But a quarter of U.S. real estate already is in negative equity – worthless than the mortgages attached to it – and the property market is stillshrinking, so banks are not lending except with public Federal HousingAdministration guarantees to cover whatever losses they may suffer. In anyevent, it already is mathematically impossible to carry today’s debt overheadwithout imposing austerity, debt deflation and depression.
            
This is not how banking was supposedto evolve. If governments are to underwrite bank loans, they may as well bedoing the lending in the first place – and receiving the gains. Indeed, since2008 the over-indebted economy’s crash led governments to become the majorshareholders of the largest and most troubled banks – Citibank in the UnitedStates, Anglo-Irish Bank in Ireland, and Britain’s Royal Bank of Scotland. Yetrather than taking this opportunity to run these banks as public utilities andlower their charges for credit-card services – or most important of all, tostop their lending to speculators and gamblers – governments left these banksoperating as part of the “casino capitalism” that has become their businessplan.
            
There is no natural reason formatters to be like this. Relations between banks and government used to be thereverse. In 1307, France’s Philip IV (“The Fair”) set the tone by seizing theKnights Templars’ wealth, arresting them and putting many to death – not onfinancial charges, but on the accusation of devil-worshipping and satanicsexual practices. In 1344 the Peruzzi bank went broke, followed by the Bardi bymaking unsecured loans to Edward III of England and other monarchs who died ordefaulted. Many subsequent banks had to suffer losses on loans gone bad to realestate or financial speculators.
            
By contrast, now the U.S., British,Irish and Latvian governments have taken bad bank loans onto their nationalbalance sheets, imposing a heavy burden on taxpayers – while letting bankerscash out with immense wealth. These “cash for trash” swaps have turned themortgage crisis and general debt collapse into a fiscal problem. Shifting thenew public bailout debts onto the non-financial economy threaten to increasethe cost of living and doing business. This is the result of the economy’sfailure to distinguish productive from unproductive loans and debts. It helpsexplain why nations now are facing financial austerity and debt peonage insteadof the leisure economy promised so eagerly by technological optimists a centuryago.
            
So we are brought back to thequestion of what the proper role of banks should be. This issue was discussedexhaustively prior to World War I. It is even more urgent today.

How classical economists hoped to modernizebanks as agents of industrial capitalism
            
Britain was the home of theIndustrial Revolution, but there was little long-term lending to financeinvestment in factories or other means of production. British and Dutchmerchant banking was to extend short-term credit on the basis of collateralsuch as real property or sales contracts for merchandise shipped(“receivables”). Buoyed by this trade financing, merchant bankers weresuccessful enough to maintain long-established short-term funding practices.This meant that James Watt and other innovators were obliged to raiseinvestment money from their families and friends rather than from banks.
            
It was the French and Germans whomoved banking into the industrial stage to help their nations catch up. InFrance, the Saint-Simonians described the need to create an industrial creditsystem aimed at funding means of production. In effect, the Saint-Simoniansproposed to restructure banks along lines akin to a mutual fund. A start wasmade with the Crédit Mobilier, founded by the Péreire Brothers in 1852. Theiraim was to shift the banking and financial system away from debt financing atinterest toward equity lending, taking returns in the form of dividends thatwould rise or decline in keeping with the debtor’s business fortunes. By givingbusinesses leeway to cut back dividends when sales and profits decline,profit-sharing agreements avoid the problem that interest must be paidwilly-nilly. If an interest payment is missed, the debtor may be forced intobankruptcy and creditors can foreclose. It was to avoid this favoritism forcreditors regardless of the debtor’s ability to pay that prompted Mohammed toban interest under Islamic law.
            
Attracting reformers ranging fromsocialists to investment bankers, the Saint-Simonians won government backingfor their policies under France’s Third Empire. Their approach inspired Marx aswell as industrialists in Germany and protectionists in the United States andEngland. The common denominator of this broad spectrum was recognition that anefficient banking system was needed to finance the industry on which a strongnational state and military power depended.

Germany develops an industrial bankingsystem
            
Itwas above all in Germany that long-term financing found its expression in theReichsbank and other large industrial banks as part of the “holy trinity” ofbanking, industry and government planning under Bismarck’s “state socialism.”German banks made a virtue of necessity. British banks “derived the greaterpart of their funds from the depositors,” and steered these savings andbusiness deposits into mercantile trade financing. This forced domestic firmsto finance most new investment out of their own earnings. By contrast, Germany’s“lack of capital … forced industry to turn to the banks for assistance,” notedthe financial historian George Edwards. “A considerable proportion of the fundsof the German banks came not from the deposits of customers but from thecapital subscribed by the proprietors themselves.[3]As a result, German banks “stressed investment operations and were formed notso much for receiving deposits and granting loans but rather for supplying theinvestment requirements of industry.”
            
Whenthe Great War broke out in 1914, Germany’s rapid victories were widely viewedas reflecting the superior efficiency of its financial system. To someobservers the war appeared as a struggle between rival forms of financialorganization. At issue was not only who would rule Europe, but whether thecontinent would have laissez faire or a more state-socialist economy.
            
In1915, shortly after fighting broke out, the Christian Socialistpriest-politician Friedrich Naumann published Mitteleuropa, describing how Germany recognized more than any othernation that industrial technology needed long‑term financing and governmentsupport. His book inspired Prof. H. S. Foxwell in England to draw on hisarguments in two remarkable essays published in the Economic Journal in September and December 1917: “The Nature of theIndustrial Struggle,” and “The Financing of Industry and Trade.” He endorsedNaumann’s contention that “the old individualistic capitalism, of what he callsthe English type, is giving way to the new, more impersonal, group form; to thedisciplined scientific capitalism he claims as German.”
            
Thiswas necessarily a group undertaking, with the emerging tripartite integrationof industry, banking and government, with finance being “undoubtedly the maincause of the success of modern German enterprise,” Foxwell concluded (p. 514).German bank staffs included industrial experts who were forging industrialpolicy into a science. And in America, Thorstein Veblen’s The Engineers and the Price System (1921) voiced the new industrialphilosophy calling for bankers and government planners to become engineers inshaping credit markets.
            
Foxwellwarned that British steel, automotive, capital equipment and other heavyindustry was becoming obsolete largely because its bankers failed to perceivethe need to promote equity investment and extend long‑term credit. They basedtheir loan decisions not on the new production and revenue their lending mightcreate, but simply on what collateral they could liquidate in the event ofdefault: inventories of unsold goods, real estate, and money due on bills forgoods sold and awaiting payment from customers. And rather than investing inthe shares of the companies that their loans supposedly were building up, theypaid out most of their earnings as dividends – and urged companies to do thesame. This short time horizon forced business to remain liquid rather thanhaving leeway to pursue long‑term strategy.
            
Germanbanks, by contrast, paid out dividends (and expected such dividends from theirclients) at only half the rate of British banks, choosing to retain earnings ascapital reserves and invest them largely in the stocks of their industrialclients. Viewing these companies as allies rather than merely as customers fromwhom to make as large a profit as quickly as possible, German bank officialssat on their boards, and helped expand their business by extending loans toforeign governments on condition that their clients be named the chiefsuppliers in major public investments. Germany viewed the laws of history asfavoring national planning to organize the financing of heavy industry, andgave its bankers a voice in formulating international diplomacy, making them“the principal instrument in the extension of her foreign trade and politicalpower.”
            
A similarcontrast existed in the stock market. British brokers were no more up to thetask of financing manufacturing in its early stages than were its banks. Thenation had taken an early lead by forming Crown corporations such as the EastIndia Company, the Bank of England and even the South Sea Company. Despite thecollapse of the South Sea Bubble in 1720, the run-up of share prices from 1715to 1720 in these joint-stock monopolies established London’s stock market as apopular investment vehicle, for Dutch and other foreigners as well as forBritish investors. But the market was dominated by railroads, canals and largepublic utilities. Industrial firms were not major issuers of stock.
            
In anycase, after earning their commissions on one issue, British stockbrokers werenotorious for moving on to the next without much concern for what happened tothe investors who had bought the earlier securities. “As soon as he hascontrived to get his issue quoted at a premium and his underwriters haveunloaded at a profit,” complained Foxwell, “his enterprise ceases. ‘To him,’ asthe Times says, ‘a successful flotation is of more importance than a soundventure.’”
            
Much thesame was true in the United States. Its merchant heroes were individualistictraders and political insiders often operating on the edge of the law to gaintheir fortunes by stock-market manipulation, railroad politicking for landgiveaways, and insurance companies, mining and natural resource extraction.America’s wealth-seeking spirit found its epitome in Thomas Edison’shit-or-miss method of invention, coupled with a high degree of litigiousness toobtain patent and monopoly rights.
            
In sum, neither British nor Americanbanking or stock markets planned for the future. Their time frame was short, andthey preferred rent-extracting projects to industrial innovation. Most banksfavored large real estate borrowers, railroads and public utilities whoseincome streams easily could be forecast. Only after manufacturing companiesgrew fairly large did they obtain significant bank and stock market credit.
            
What isremarkable is that this is the tradition of banking and high finance that hasemerged victorious throughout the world. The explanation is primarily themilitary victory of the United States, Britain and their Allies in the GreatWar and a generation later, in World War II.

The regression toward burdensomeunproductive debts after World War I
            
The development of industrial creditled economists to distinguish between productive and unproductive lending. Aproductive loan provides borrowers with resources to trade or invest at aprofit sufficient to pay back the loan and its interest charge. An unproductiveloan must be paid out of income earned elsewhere. Governments must pay warloans out of tax revenues. Consumers must pay loans out of income they earn ata job – or by selling assets. These debt payments divert revenue away frombeing spent on consumption and investment, so the economy shrinks. Thistraditionally has led to crises that wipe out debts, above all those that areunproductive.
            
In the aftermath of World War I theeconomies of Europe’s victorious and defeated nations alike were dominated bypostwar arms and reparations debts. These inter-governmental debts were to payfor weapons (by the Allies when the United States unexpectedly demanded thatthey pay for the arms they had bought before America’s entry into the war), andfor the destruction of property (by the Central Powers), not new means of production. Yetto the extent that they were inter-governmental, these debts were moreintractable than debts to private bankers and bondholders. Despite the factthat governments in principle are sovereign and hence can annul debts owed toprivate creditors, the defeated Central Power governments were in no position to dothis.
            
And among the Allies, Britain ledthe capitulation to U.S. arms billing, captive to the creditor ideology that “adebt is a debt” and must be paid regardless of what this entails in practice oreven whether the debt in fact can be paid. Confronted with America’s demand forpayment, the Allies turned to Germany to make them whole. After taking itsliquid assets and major natural resources, they insisted that it squeeze outpayments by taxing its economy. No attempt was made to calculate just howGermany was to do this – or most important, how it was to convert this domesticrevenue (the “budgetary problem”) into hard currency or gold. Despite the factthat banking had focused on international credit and currency transfers sincethe 12th century, there was a broad denial of what John MaynardKeynes identified as a foreign exchange transferproblem.
            
Never before had there been anobligation of such enormous magnitude. Nevertheless, all of Germany’s politicalparties and government agencies sought to devise ways to tax the economy toraise the sums being demanded. Taxes, however, are levied in a nation’s owncurrency. The only way to pay the Allies was for the Reichsbank to take thisfiscal revenue and throw it onto the foreign exchange markets to obtain thesterling and other hard currency to pay. Britain, France and the otherrecipients then paid this money on their Inter-Ally debts to the United States.
            
AdamSmith pointed out that no government ever had paid down its public debt. Butcreditors always have been reluctant to acknowledge that debtors are unable topay. Ever since David Ricardo’s lobbying for their perspective in Britain’sBullion debates, creditors have found it their self-interest to promote adoctrinaire blind spot, insisting that debts of any magnitude could be paid.They resist acknowledging a distinction between raising funds domestically (byrunning a budget surplus) and obtaining the foreign exchange to payforeign-currency debt. Furthermore, despite the evident fact that austeritycutbacks on consumption and investment can only be extractive,creditor-oriented economists refused to recognize that debts cannot be paid byshrinking the economy.[4]Or that foreign debts and other international payments cannot be paid indomestic currency without lowering the exchange rate.
            
The more domestic currency Germanysought to convert, the further its exchange rate was driven down against thedollar and other gold-based currencies. This obliged Germans to pay much morefor imports. The collapse of the exchange rate was the source ofhyperinflation, not an increase in domestic money creation as today’screditor-sponsored monetarist economists insist. In vain Keynes pointed to thespecific structure of Germany’s balance of payments and asked creditors tospecify just how many German exports they were willing to take, and to explainhow domestic currency could be converted into foreign exchange withoutcollapsing the exchange rate and causing price inflation.
            
Tragically, Ricardian tunnel visionwon Allied government backing. Bertil Ohlin and Jacques Rueff claimed thateconomies receiving German payments would recycle their inflows to Germany andother debt-paying countries by buying their imports. If income adjustments didnot keep exchange rates and prices stable, then Germany’s falling exchange ratewould make its exports sufficiently more attractive to enable it to earn therevenue to pay.
            
Thisis the logic that the International Monetary Fund followed half a century laterin insisting that Third World countries remit foreign earnings and even permitflight capital as well as pay their foreign debts. It is the neoliberal stancenow demanding austerity for Greece, Ireland, Italy and other Eurozoneeconomies.
            
Banklobbyists claim that the European Central Bank will risk spurring domestic wageand price inflation of it does what central banks were founded to do: financebudget deficits. Europe’s financial institutions are given a monopoly right toperform this electronic task – and to receive interest for what a real centralbank could create on its own computer keyboard.
            
But why it is less inflationary forcommercial banks to finance budget deficits than for central banks to do this?The bank lending that has inflated a global financial bubble since the 1980shas left as its legacy a debt overhead that can no more be supported today thanGermany was able to carry its reparations debt in the 1920s. Would governmentcredit have so recklessly inflated asset prices?

How debt creation has fueled asset-priceinflation since the 1980s
            
Banking in recent decades has notfollowed the productive lines that early economic futurists expected. As notedabove, instead of financing tangible investment to expand production andinnovation, most loans are made against collateral, with interest to be paidout of what borrowers can make elsewhere. Despite being unproductive in theclassical sense, it was remunerative for debtors from 1980 until 2008 – not byinvesting the loan proceeds to expand economic activity, but by riding the waveof asset-price inflation. Mortgage credit enabled borrowers to bid up propertyprices, drawing speculators and new customers into the market in theexpectation that prices would continue to rise. But hothouse credit infusionsmeant additional debt service, which ended up shrinking the market for goodsand services.
            
Under normal conditions the effectwould have been for rents to decline, with property prices following suit,leading to mortgage defaults. But banks postponed the collapse into negativeequity by lowering their lending standards, providing enough new credit to keepon inflating prices. This averted a collapse of their speculative mortgage andstock market lending. It was inflationary – but it was inflating asset prices,not commodity prices or wages. Two decades of asset price inflation enabledspeculators, homeowners and commercial investors to borrow the interest fallingdue and still make a capital gain.
            
This hope for a price gain madewinning bidders willing to pay lenders all the current income – making banksthe ultimate and major rentier incomerecipients. The process of inflating asset prices by easing credit terms andlowering the interest rate was self-feeding. But it also was self-terminating,because raising the multiple by which a given real estate rent or businessincome can be “capitalized” into bank loans increased the economy’s debtoverhead.
            
Securities markets became part ofthis problem. Rising stock and bond prices made pension funds pay more topurchase a retirement income – so “pension fund capitalism” was coming undone.So was the industrial economy itself. Instead of raising new equity financingfor companies, the stock market became a vehicle for corporate buyouts. Raidersborrowed to buy out stockholders, loading down companies with debt. The mostsuccessful looters left them bankrupt shells. And when creditors turned theireconomic gains from this process into political power to shift the tax burdenonto wage earners and industry, this raised the cost of living and doingbusiness – by more than technology was able to lower prices.

The EU rejects central bank money creation,leaving deficit financing to the banks
            
So the plan has backfired. When“hard money” policy makers limited central bank power, they assumed that publicdebts would be risk-free. Obliging budget deficits to be financed by privatecreditors seemed to offer a bonanza: being able to collect interest forcreating electronic credit that governments can create themselves. But now,European governments need credit to balance their budget or face default. Sobanks now want a central bank to create the money to bail them out for the badloans they have made.
            
For starters, the ECB’s €489 billionin three-year loans at 1% interest gives banks a free lunch arbitrageopportunity (the “carry trade”) to buy Greek and Spanish bonds yielding ahigher rate. The policy of buying government bonds in the open market – afterbanks first have bought them at a lower issue price – gives the banks a quickand easy trading gain.
            
How are these giveaways lessinflationary than for central banks to directly finance budget deficits androll over government debts? Is the aim of giving banks easy gains simply toprovide them with resources to resume the Bubble Economy lending that led totoday’s debt overhead in the first place?

Conclusion
            
Governmentscan create new credit electronically on their own computer keyboards as easilyas commercial banks can. And unlike banks, their spending is expected to servea broad social purpose, to be determined democratically. When commercial banksgain policy control over governments and central banks, they tend to supporttheir own remunerative policy of creating asset-inflationary credit – leavingthe clean-up costs to be solved by a post-bubble austerity. This makes the debtoverhead even harder to pay – indeed, impossible.
            
So we are brought back to the policyissue of how public money creation to finance budget deficits differs from issuinggovernment bonds for banks to buy. Is not the latter option a convoluted way tofinance such deficits – at a needless interest charge? When governmentsmonetize their budget deficits, they do not have to pay bondholders.
            
I have heard bankers argue thatgovernments need an honest broker to decide whether a loan or public spendingpolicy is responsible. To date their advice has not promoted productive credit.Yet they now are attempting to compensate for the financial crisis by tellingdebtor governments to sell off property in their public domain. This “solution”relies on the myth that privatization is more efficient and will lower the costof basic infrastructure services. Yet it involves paying interest to the buyersof rent-extraction rights, higher executive salaries, stock options and otherfinancial fees.
            
Most cost savings are achieved byshifting to non-unionized labor, and typically end up being paid to theprivatizers, their bankers and bondholders, not passed on to the public. Andbankers back price deregulation, enabling privatizers to raise access charges.This makes the economy higher cost and hence less competitive – just theopposite of what is promised.
            
Banking has moved so far away fromfunding industrial growth and economic development that it now benefitsprimarily at the economy’s expense in a predator and extractive way, not bymaking productive loans. This is now the great problem confronting our time.Banks now lend mainly to other financial institutions, hedge funds, corporateraiders, insurance companies and real estate, and engage in their ownspeculation in foreign currency, interest-rate arbitrage, and computer-driventrading programs. Industrial firms bypass the banking system by financing newcapital investment out of their own retained earnings, and meet their liquidityneeds by issuing their own commercial paper directly. Yet to keep the bankcasino winning, global bankers now want governments not only to bail them outbut to enable them to renew their failed business plan – and to keep thepresent debts in place so that creditors will not have to take a loss.
            
This wish means that society shouldlose, and even suffer depression. We are dealing here not only with greed, butwith outright antisocial behavior and hostility.
            
Europe thus has reached a criticalpoint in having to decide whose interest to put first: that of banks, or the“real” economy. History provides a wealth of examples illustrating the dangersof capitulating to bankers, and also for how to restructure banking along moreproductive lines. The underlying questions are clear enough:
  • Have banks outlived their historical role, or can they be restructured tofinance productive capital investment rather than simply inflate asset prices?
  • Would a public option provide less costly and better directed credit?
  • Why not promote economic recovery by writing down debts to reflect the abilityto pay, rather than relinquishing more wealth to an increasingly aggressivecreditor class?


Solving the Eurozone’s financialproblem can be made much easier by the tax reforms that classical economistsadvocated to complement their financial reforms. To free consumers andemployers from taxation, they proposed to levy the burden on the “unearnedincrement” of land and natural resource rent, monopoly rent and financialprivilege. The guiding principle was that property rights in the earth,monopolies and other ownership privileges have no direct cost of production,and hence can be taxed without reducing their supply or raising their price,which is set in the market. Removing the tax deductibility for interest is theother key reform that is needed.
            
A rent tax holds down housing pricesand those of basic infrastructure services, whose untaxed revenue tends to becapitalized into bank loans and paid out in the form of interest charges.Additionally, land and natural resource rents – along with interest – are theeasiest to tax, because they are highly visible and their value is easy toassess.
            
Pressure to narrow existing budgetdeficits offers a timely opportunity to rationalize the tax systems of Greeceand other PIIGS countries in which the wealthy avoid paying their fair share oftaxes. The political problem blocking this classical fiscal policy is that it“interferes” with the rent-extracting free lunches that banks seek to lendagainst. So they act as lobbyists for untaxing real estate and monopolies (andthemselves as well). Despite the financial sector’s desire to see governmentsremain sufficiently solvent to pay bondholders, it has subsidized an enormouspublic relations apparatus and academic junk economics to oppose the taxpolicies that can close the fiscal gap in the fairest way.

            

Itis too early to forecast whether banks or governments will emerge victoriousfrom today’s crisis. As economies polarize between debtors and creditors,planning is shifting out of public hands into those of bankers. The easiest wayfor them to keep this power is to block a true central bank or strong publicsector from interfering with their monopoly of credit creation. The counter isfor central banks and governments to act as they were intended to, by providinga public option for credit creation.



[1] Joseph E. Stiglitz,“Obama’s Ersatz Capitalism,” The New YorkTimes, April 1, 2009
http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html.
[2] http://neweconomicperspectives.org, and The Best Way to Rob a Bank is to OwnOne (2005).
[3] George W. Edwards, The Evolution of Finance Capitalism (NewYork: 1938):68.
[4] I review the literaturefrom the 1920s, its Ricardian pedigree and subsequent revival by the IMF andother creditor institutions in Trade,Development and Foreign Debt: A History of Theories of Polarization v.Convergence in the World Economy (1992; new ed. ISLET 2010). I provide thepolitical background in SuperImperialism: The Economic Strategy of American Empire (New York: Holt,Rinehart and Winston, 1972; 2nd ed., London: Pluto Press, 2002),