America’s Deceptive 2012 Fiscal Cliff – Part 2

By Michael Hudson

[Part 1] […] [Part 3]

Today’s financial war against the economy at large

Today’s economic warfare is not the kind waged a century ago between labor and its industrial employers. Finance has moved to capture the economy at large, industry and mining, public infrastructure (via privatization) and now even the educational system. (At over $1 trillion, U.S. student loan debt came to exceed credit-card debt in 2012.) The weapon in this financial warfare is no longer military force. The tactic is to load economies (governments, companies and families) with debt, siphon off their income as debt service, and then foreclose when debtors lack the means to pay. Indebting government gives creditors a lever to pry away land, public infrastructure and other property in the public domain. Indebting companies enables creditors to seize employee pension savings. And indebting labor means that it no longer is necessary to hire strikebreakers to attack union organizers and strikers.

Workers have become so deeply indebted on their home mortgages, credit cards and other bank debt that they fear to strike or even to complain about working conditions. Losing work means missing payments on their monthly bills, enabling banks to jack up interest rates to levels that used to be deemed usurious. So debt peonage and unemployment loom on top of the wage slavery that was the main focus of class warfare a century ago. Credit-card bank lobbyists have rewritten the bankruptcy laws to curtail debtor rights, and to cap matters, the referees appointed to adjudicate disputes brought by victimized debtors and consumers are subject to veto from the banks and businesses that are mainly responsible for inflicting injury.

The aim of financial warfare is not merely to acquire land, natural resources and key infrastructure rents as in military warfare; it is to centralize creditor control over society. In contrast to the promise of democratic reform nurturing a middle class a century ago, we are witnessing a regression to a world of special privilege in which one must inherit wealth in order to avoid debt and job dependency.

The emerging financial oligarchy seeks to shift taxes off banks and their major customers (real estate, natural resources and monopolies) onto labor. Given the need to win voter acquiescence, this aim is best achieved by rolling back everyone’s taxes. The easiest way to do this is to shrink government spending, headed by Social Security, Medicare and Medicaid. The fact that these are the programs that enjoy the strongest voter support has inspired the Big Lie of our epoch: the pretense that governments can create money only to pay the financial sector, leaving the beneficiaries of social programs entirely responsible for paying for Social Security, Medicare and Medicaid, not the wealthy. This Big Lie is used to reverse the concept of progressive taxation, turning the tax system into a ploy of the financial sector to levy tribute on the economy at large.

Financial lobbyists discovered that the easiest ploy to shift the cost of social programs onto labor is to conceal new taxes as user fees, using the proceeds to cut taxes for the elite 1%. This fiscal sleight-of-hand was the achievement of the 1983 Greenspan Commission. It confused people into thinking that public budgets are like family budgets, concealing the fact that governments can finance their spending by creating their own money. They do not have to borrow, or even to tax (at least, not tax mainly the 99%).

The Greenspan tax shift played on the fact that most people see the need to save for their own personal retirement. The well-subsidized deception at work is that Social Security requires a similar pre-funding on the public level – by raising wage withholding. The trick is to convince wage earners that it is fair to tax them more to pay for government social spending, yet not also to ask the banking sector to pay similar a user fee to pre-save for the next time it itself will need bailouts to cover its losses. Also asymmetrical is the fact that nobody suggests that the government set up a fund to pay for future wars, so that future adventures such as Iraq or Afghanistan will not “run a deficit” to burden the budget. So the first deception is to treat only Social Security and medical care as user fees. The second is to aggravate matters by insisting that such fees be paid long in advance, by pre-saving.

There is no inherent need to single out any particular area of public spending as causing a budget deficit if it is not pre-funded. It is a travesty of progressive tax policy to only oblige workers whose wages are less than (at present) $105,000 to pay this FICA wage withholding, exempting higher earnings, capital gains, rental income and profits. The raison d’être for taxing the 99% for Social Security and Medicare is simply to avoid taxing wealth, by falling on low wage income at a much higher rate than that of the wealthy. This is not how the original U.S. income tax was created at its inception in 1913. During its early years only the wealthiest 1% of the population had to file a return. There were few loopholes, and capital gains were taxed at the same rate as earned income.

The government’s seashore insurance program, for instance, recently incurred a $1 trillion liability to rebuild the private beaches and homes that Hurricane Sandy washed out. Why should this insurance subsidy at below-commercial rates for the wealthy minority who live in this scenic high-risk property be treated as normal spending, but not Social Security? Why save in advance by a special wage tax to pay for these programs that benefit the general population, but not levy a similar “user fee” tax to pay for flood insurance for beachfront homes or war? And while we are at it, why not save another $13 trillion in advance to pay for the next bailout of Wall Street when debt deflation causes another crisis to drain the budget?

But on whom should we levy these taxes? To impose user fees for the beachfront reconstruction would require a tax falling mainly on the wealthy owners of such properties. Their dominant role in funding the election campaigns of the Congressmen and Senators who draw up the tax code suggests why they are able to avoid prepaying for the cost of rebuilding their seashore property. Such taxation is only for wage earners on their retirement income, not the 1% on their own vacation and retirement homes.

By not raising taxes on the wealthy or using the central bank to monetize spending on anything except bailing out the banks and subsidizing the financial sector, the government follows a pro-creditor policy. Tax favoritism for the wealthy deepens the budget deficit, forcing governments to borrow more. Paying interest on this debt diverts revenue from being spent on goods and services. This fiscal austerity shrinks markets, reducing tax revenue to the brink of default. This enables bondholders to treat the government in the same way that banks treat a bankrupt family, forcing the debtor to sell off assets – in this case the public domain as if it were the family silver, as Britain’s Prime Minister Harold MacMillan characterized Margaret Thatcher’s privatization sell-offs.

In an Orwellian doublethink twist this privatization is done in the name of free markets, despite being imposed by global financial institutions whose administrators are not democratically elected. The International Monetary Fund (IMF), European Central Bank (ECB) and EU bureaucracy treat governments like banks treat homeowners unable to pay their mortgage: by foreclosing. Greece, for example, has been told to start selling off prime tourist sites, ports, islands, offshore gas rights, water and sewer systems, roads and other property.

Sovereign governments are, in principle, free of such pressure. That is what makes them sovereign. They are not obliged to settle public debts and budget deficits by asset selloffs. They do not need to borrow more domestic currency; they can create it. This self-financing keeps the national patrimony in public hands rather than turning assets over to private buyers, or having to borrow from banks and bondholders.


Why today’s fiscal squeeze adds to the economy’s costs and imposes needless austerity

The financial sector promises that privatizing roads and ports, water and sewer systems, bus and railroad lines (on credit, of course) is more efficient and will lower the prices charged for their services. The reality is that the new buyers put up rent-extracting tollbooths on the infrastructure being sold. Their break-even costs include the high salaries and bonuses they pay themselves, as well as interest and dividends to their creditors and backers, spending on stock buy-backs and political lobbying.

Public borrowing creates dependency that shifts economic planning to Wall Street and other financial centers. When voters resist, it is time to replace democracy with oligarchy. “Technocratic” rule replaces that of elected officials. In Europe the IMF, ECB and EU troika insists that all debts must be paid, even at the cost of austerity, depression, unemployment, emigration and bankruptcy. This is to be done without violence where possible, but with police-state practices when grabbers find it necessary to quell popular opposition.

Financializing the economy is depicted as a natural way to gain wealth – by taking on more debt. Yet it is hard to think of a more highly politicized policy, shaped as it is by tax rules that favor bankers. It also is self-terminating, because when public debt grows to the point where investors (“the market”) no longer believe that it can be repaid, creditors mount a raid (the military analogy is appropriate) by “going on strike” and not rolling over existing bonds as they fall due. Bond prices fall, yielding higher interest rates, until governments agree to balance the budget by voluntary pre-bankruptcy privatizations.


Selling saved-up Treasury bonds to fund public programs is like new deficit borrowing

If the aim of America’s military spending around the world is to prepare for future warfare, why not aim at saving up a fund of $10 trillion or even $30 trillion in advance, as with Social Security, so that we will have the money to pay for it?

The answer is that selling saved-up Treasury bills to finance Social Security, military spending or any other program has the same monetary and price effect as issuing new Treasury bills. The impact on financial markets – and on the private sector’s holding of government debt – by paying Social Security out of past savings – that is, by selling the Treasury securities in which Social Security funds are invested – is much like borrowing by selling new securities. It makes little difference whether the Treasury sells newly printed IOUs, or sells bonds that it has been accumulating in a special fund. The effect is to increase public debt owed to the financial sector.

If the savings are to be invested in Treasury bonds (as is the case with Social Security), will this pay for tax cuts elsewhere in the budget? If so, will these cuts be for the wealthy 1% or the 99%? Or, will the savings be invested in infrastructure, or turned over to states and cities to help balance their budget shortfalls and underfunded pension plans?

Another problem concerns who should pay for this pre-saving. The taxes needed to pre-fund a savings build-up siphon off income from somewhere in the economy. How much will the economy shrink by diverting income from being spent on goods and services? And whose income will taxed? These questions illustrate how politically self-interested it is to single out taxing wages to save for Social Security in contrast to war-making and beach-house rebuilding.

Government budgets usually are designed to be in balance under normal peacetime conditions, so most public debt has been brought into being by war (prior to today’s financial war of slashing taxes on the wealthy). Adam Smith’s Wealth of Nations (Book V) traced how each new British bond issue to raise funds for a military action had a dedicated tax to pay its interest charges. The accumulation of such war debts thus raised the cost of living and hence the break-even price of labor. To prevent this from undercutting of British competitiveness, Smith urged that wars be waged on a pay-as-you-go basis – by full taxation rather than by borrowing and entailing interest payments and taxes (as the debt itself rarely was amortized). Smith thought that populations should feel the cost of war directly and immediately, presumably leading them to be vigilant in checking grandiose projects of empire.

The United States issued fiat greenback currency to pay for much of its Civil War, but also issued bonds. In analyzing this war finance the Canadian-American astronomer and monetary theorist Simon Newcomb pointed out that all wars must be paid for in the form of tangible material and lives by the generation that fights them. Paying for the war by borrowing from bondholders, he explained, involved levying taxes to pay the interest. The effect was to transfer income from the Western states (taxpayers) to bondholders in the East.

In the case of Social Security today the beneficiary of government debt is still the financial sector. The economy must provide the housing, food, health care, transportation and clothing to enable retirees to live normal lives. This economic surplus can be paid for either out of taxation, new money creation or borrowing. But instead of “the West,” the major payers of the Social Security tax are wage earners across the nation. Taxing labor shrinks markets and forces the economy into austerity.


Michael’s latest book, Finance Capitalism and its Discontents is now available.

10 responses to “America’s Deceptive 2012 Fiscal Cliff – Part 2

  1. It is odd that SS and medicare must be prepaid while wars and flood damage are not. What is even odder is progressives (or many of them) want to increase the cap on SS, so that the fund will be “prepaid” for more than 25 years. Hell, some want it prepaid for 75 years. It suggests, in fact, that we are not in this boat together. Oh wait, that’s what you said!

  2. Workers have become so deeply indebted on their home mortgages, credit cards and other bank debt that they fear to strike or even to complain about working conditions. Dr Michael Hudson

    Yep. And it’s government backing (government deposit insurance, a legal tender lender of last resort, Federal borrowing,etc.) for the banks that allow them to endlessly create debt to enslave the population with.

  3. Once again, America’s most brilliant economist succinctly explains it. (And yet, there are still the mentally-challenged who direct all their attention to Group of Thirty dude, Krugman, either forever clueless or forever purposely misinforming?).

    And speaking of the enemy:

    (The guy who got together with the guys at Goldman to create the trashiest of trashy cdos, the Abacus CDO, so then he, and GS, could buy oodles of credit default swaps [naked swaps] to “earn” billions of dollars on that financial scam; $1.4 million per swap, $100 million average return, from a group called AIG/Financial Products, and there exists Americans who still aren’t aware of why they had to be bailed out, and the largest insurance swindle in human history?)

  4. Sorry, this is off topic. Anyone know when Hudson’s book will be available again on Amazon. I would like to order a copy, but I see it is “temporarily out of stock.”

  5. Good rabble-rouser of a piece, Mr.H – one whose thesis resonates with me. So when you’re done ‘cursing the darkness’ and are ready to light a candle (and the wick of a Molotov or two) give us a shout.

  6. Joe DiMattio

    Yes, debt is enslaving and not good for you. Soooo, don’t take on debt- don’t borrow. Why, don’t you warn people about the big problem with borrowing is that you are expected to pay it back. And, paying back is tough, sometimes impossible. Avoid promises you can’t keep. The government shouldn’t borrow either; it could more easily pay it’s bills and fulfill obligations to all of us if it did not have to service it’s debt. These are obvious truths. Corporations who borrow too much go broke; so do individuals and businesses. Some would have you believe that governments are an exception to this simplistic view because they can print money and use this money to “prime the pump” and keep the engines of the economy well oiled and chugging. Nothing is free. The cost of this is that the value of money goes down for everyone who has this money and prices go up. My beloved NYC raised property values and consequently taxes 20% at the height of the Real Estate bubble making everyone poorer since we live in those houses. The George Washington Bridge raised it fee from $8 to $12 in one swoop. Oops! In short, there is a giant grab for money everywhere. Everywhere you turn prices are going up as much as the market can bear. Capitalism is working best on the basis of who can command the most for the least effort. Obviously, the GW Bridge is a good business. So are Institution that have you as a captive customer. Health care institutions have you by the health. Colinoscopies cost over $4000 for 45 min. of effort. Get the money any way can. Borrow if you have to. Similarly, private schools have you by the head club. No college then McDonalds. There are more applicants for every job than jobs in most every category. Examine before entering. There they have you again. Borrowing is just another way to be gotten in caught in the traps that seem to be everywhere. Come on Joe! Stop this bloody lament. Stick to the point. Borrowing is not good for anyone except for the moneylenders and even there it’s problematic, consider Shylock.
    During the Hippytime we were looking for another way. We should keep looking. Obama help us!

    • Derryl Hermanutz

      You write, “Don’t go into debt. You have to pay it back. Nothing is free.”

      You’re wrong. Something IS free, if you happen to be a “bank”. Banks are free to “create” money. Where do you think all the trillions of dollars of money “come from”, that banks lend? Governments don’t create their own money and spend it into the economy. If governments created their own spending money, they wouldn’t be “in debt”. Productive businesses produce houses and cars and food, all of which are “worth” money. But pounding nails and bolting together car parts and planting and harvesting seeds does not “produce money”. Economic activity produces real wealth that is “bought and sold” for money. But that kind of actitivy does not produce actual money.

      Banks do not “produce” money either. Banks “create” money, by making loans and by purchasing government securities. The government signs IOUs called “bonds”, and banks create money to buy those bonds, then the government spends the money. But the government owes repayment to the banks that created the money, so the government is in “debt”. Just like all the private sector debtors.

      Banks create ALL the money, by lending newly created bank deposits that they ‘produce’ with keystrokes that add a new “credit” to the borrower’s bank account. Then the borrowers, government and private sector, spend their new loans into the economy where other people earn that spending as their incomes and deposit the money in THEIR bank accounts. That’s where all the money comes from in the first place: from borrowers spending it into the economy. The borrowers “owe” that money as their “debts” to the banks that created the money as “loans”. So if everyone paid off their debts, there would be no money left.

      It’s a perverse system, but this is the money system that we have. Congress legislated this system into existence with the 1913 Federal Reserve Act. So the fact of the matter is that “everything is free”, for bankers. And “nothing is free” for everyone else. Hudson knows this, which is why he writes against it.

  7. Another example that Michael doesn’t mention is the USPS, which Congress requires to fully fund it’s retirement obligations for 75 years. Nobody else has to do that, especially not Congress.

    • The object of this exercise is to drive the US Postal service out of business, so that it can be privatized.

      This year I noticed that mailing cards from the UK to the US are twice the price of those mailed from the US to the UK.
      USPS provides an excellent service at a very reasonable price.

  8. Excellent piece Michael. As wages stagnate, as educational costs suffer the Baumol disease, and as state governments cut spending on higher education, tuition rises well beyond what households can afford. Hence, student debt explodes. That forces students to make career decisions they wouldn’t have voluntarily made, and as you say increases uncertainty so that they will do almost anything for a buck. And, finally, Congress then makes it well-nigh impossible to get out of student loan debt. That’s closing the circle!